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 facilitates the Bank's ability to serve its customers' requirements for financial services. The holding company structure permits diversification by the Company into a broader range of financial services and other business activities than currently are permitted to the Bank under applicable law. The holding company structure also provides greater financial and operating flexibility than is presently permitted to the Bank.
The Bank has operated continuously since 1907 and conducts its business in East Alabama, including Lee County and surrounding areas. In April 1995, in order to gain flexibility and reduce certain regulatory burdens, the Bank converted from a national bank to an Alabama state bank that is a member of the Federal Reserve System (the "Charter Conversion"). Upon consummation of the Charter Conversion, the Bank's primary regulator changed from the Office of the Comptroller of the Currency (the "OCC") to 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. The Bank's business consists of (i) accepting demand, savings, and time deposits; (ii) making loans to consumers, businesses, and other institutions; (iii) investments in money market instruments, U.S. government and agency obligations, and state, county, and municipal bonds; and (iv) other financial services. Although it has no immediate plans to conduct any other business, the Company may engage directly or indirectly in a number of activities which the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
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 ("PSA"). The Bank also offers commercial, financial, agricultural, real estate construction and consumer loan products. The Bank is one of the largest providers of automated teller services in East Alabama with 15 locations. The Bank's Tiger Teller ATM cards can be used internationally through the Cirrus(R) network. In 1998, the Bank began offering VISA Checkcards, which are debit cards with the VISA logo that work like checks but can be used anywhere VISA is accepted, including ATMs. In 1999, the Bank launched its web page on the World Wide Web. In conjunction with the web page, the Bank began offering on-line banking and bill payment services.
Competition
The banking business in Alabama, including Lee County, is highly competitive with respect to loans, deposits, and other services, and the area is dominated by a number of major banks and bank holding companies which have 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 services offered through the mail, by telephone and over the Internet. Among the advantages that certain of these institutions have vis-a-vis the Bank are their ability to finance extensive advertising campaigns and to allocate and diversify their assets among loans and securities of the highest yield and in locations with the greatest demand.
Many of the major commercial banks operating in the Bank's service area, or their affiliates, offer services, such as international banking and investment services, which are not presently offered directly by the Bank. Such competitors, because of their greater capitalization, also have substantially higher lending limits than the Bank.
The Bank faces further competition for loans and deposits from a wide variety of local and nonlocal financial institutions. As more and different kinds of businesses enter the market for financial services, competition from nonbank financial intermediaries such as thrifts, credit unions, mortgage companies, insurance companies, and other financial institution intermediaries may be expected to intensify further. Community banks also have experienced significant competition for deposits from mutual funds, insurance companies, and other investment companies, and money center banks' offerings of high-yield investments and deposits. Certain of these competitors are not subject to the same regulatory restrictions as the Bank. Since September 29, 1995, any bank holding company located outside Alabama may presently acquire any bank based in Alabama or generally, any other state, subject to certain deposit-percentage, aging requirements, and other restrictions. Alabama has also opted to the provisions of the Interstate Banking Act which permits national and state- chartered banks to branch interstate through acquisitions of banks in other states. See "Supervision and Regulation."
Selected Economic Data
The Bank's PSA includes the cities of Auburn and Opelika, Alabama and nearby surrounding areas in East Alabama, primarily in Lee County. Lee County's population is approximately 102,000. Approximately 71% of the land in Lee County is devoted to agriculture, with 91% comprised of forests. An estimated 10% is urban or
developed. Timber and timber products, greenhouses and horticulture, beef cattle, and cotton are the major agricultural products. Principal manufactured products in the Company's PSA include magnetic recording tapes, tires, textiles, small gasoline engines, and hardware. The largest employers in the area are Auburn University, East Alabama Medical Center, Uniroyal-Goodrich, West Point Stevens, and Briggs & Stratton.
Loans and Loan Concentrations
The Bank makes loans for commercial, financial, and agricultural purposes, as well as for real estate mortgage, real estate construction, 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 construction, agricultural, and consumer lending than with 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. These standards are used to determine the creditworthiness of the borrower at the time a loan is made and are monitored periodically throughout the life of the loan.
The Bank has loans outstanding to borrowers in all industries within its PSA. 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. However, management believes that due to the diversified mix of industries located within the Bank's PSA, adverse changes in one industry may not necessarily affect other area industries to the same degree or within the same time frame. Management realizes that the Bank's PSA is also subject to both local and national economic fluctuations.
Employees
At December 31, 2000, the Company had 2 full-time equivalent employees, both of which are officers, and the Bank had 119 full-time equivalent employees, including 20 officers.
Statistical Information
Certain statistical information (as required by Guide 3) is included in response to Item 7 of this Annual Report on Form 10-K. Certain statistical information is included in response to Item 6 and Item 8 of the Annual Report on Form 10-K.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under federal and state law. This discussion is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the status or regulations applicable to the Company's and the Bank's business. Supervision, regulation, and examination of the Company and the Bank and their respective subsidiaries by the bank regulatory agencies are intended primarily for the protection of depositors rather than holders of Company capital stock. Any change in applicable law or regulation may have a material effect on the Company's business.
Bank Holding Company Regulation
The Company, as a bank holding company, is subject to supervision and regulation by the Federal Reserve under the BHC Act. Bank holding companies are generally limited to the business of banking, managing, or controlling banks, and other activities that the FRB determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. The Company is required to file with the Federal Reserve
periodic reports and such other information as the Federal Reserve may request. The Federal Reserve examines the Company, and may examine the Company's bank subsidiary. The State of Alabama does not regulate bank holding companies.
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. With certain exceptions, the BHC Act prohibits a bank holding company from acquiring direct or indirect ownership or control of voting shares of any company which 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 subsidiary. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities which 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.
In November 1999, Congress enacted the Gramm-Leach-Bliley Act ("GLB Act"), which made substantial revisions to the statutory restrictions separating banking activities from certain other financial activities. Under the GLB Act, bank holding companies that are "well-capitalized" and "well-managed" and whose subsidiary banks have satisfactory or better ratings under the Community Reinvestment Act of 1977, as amended (the "CRA") and meet certain other conditions can elect to become "financial holding companies." As such, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting and distribution, 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 merchant banking authority added by the GLB 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 with the intention of limiting the investment in duration, does not manage the company on a day-to-day basis, and the investee company does not cross-market with any of the financial holding company's controlled depository institutions. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLB Act applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. While the Company has not elected to become a financial holding company, in order to exercise the broader activity powers provided by the GLB Act, it may elect to do so in the future.
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 Section 23A of the Federal Reserve Act. 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 subsidiary 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 an affiliate be appropriately secured by acceptable collateral, generally United States government or agency securities. The Company and the Bank also are subject to Section 23B of the Federal Reserve Act, which generally limits covered and other transactions among affiliates to terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the bank or its subsidiary as prevailing at the time for transactions with unaffiliated companies.
Federal Reserve policy requires a bank holding company to act as a source of financial strength and to take measures to preserve and protect its bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. 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 are responsible for any losses to the Federal Deposit Insurance Corporation ("FDIC") as a result of an affiliated depository institution's failure. As a result, a bank holding company may be required to loan money to its subsidiary in the form of capital notes or other
instruments which qualify as capital under 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 perhaps to other creditors of the bank.
Bank and Bank Subsidiary Regulation
The Bank is subject to supervision, regulation, and examination by the Federal Reserve and the Alabama Superintendent of Banks, which monitor all areas of the operations of the Bank, including reserves, loans, mortgages, issuances of 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. See "FDIC Insurance Assessments".
The powers of Alabama-chartered banks include certain provisions designed to provide such banks with competitive equality to the powers of national banks regulated by the Office of the Comptroller of the Currency ("OCC").
The Federal Reserve has adopted the Federal Financial Institutions Examination Council's ("FFIEC") updated statement of policy entitled "Uniform Financial Institutions Rating System" ("UFIRS"), effective January 1, 1997. UFIRS is an internal rating system used by the federal and state regulators for assessing the soundness of financial institutions on a uniform basis and for identifying those institutions requiring special supervisory attention. Under UFIRS, each financial institution is assigned a confidential composite "CAMELS" rating based on an evaluation and rating of six essential components of an institution's financial condition and operations including Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk. 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 nontrading positions.
The GLB Act requires banks and their affiliated companies to adopt and disclose privacy policies, including policies regarding the sharing of personal information they obtain from customers with third parties. The GLB Act also permits banks to engage in "financial activities" through subsidiaries similar to that permitted financial holding companies.
Community Reinvestment Act
The Company and the Bank are subject to the provisions of the Community Reinvestment Act of 1977, as amended (the "CRA"), and the federal banking agencies' regulations thereunder. Under the CRA, all banks and thrifts 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 neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires a depository institution's primary federal regulator, in connection with its examination of the institution, to assess the institution's record of assessing and meeting the credit needs of the community served by that institution, including low- and moderate-income neighborhoods. The regulatory agency's assessment of the institution's record is made available to the public. Further, such assessment is required of any institution which 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, a federally regulated financial institution. In the
case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the records of each subsidiary depository institution of the applicant bank holding company, and such records may be the basis for denying the application. A less than satisfactory CRA rating will slow, if not preclude expansion of banking activities. The Bank had a CRA rating of satisfactory as of May 15, 2000.
Current CRA regulations rate institutions based on their actual performance in meeting community credit needs. CRA performance is evaluated by the Federal Reserve, the Bank's primary federal regulator using a lending test, an investment test, and a service test. The Federal Reserve also will consider: (i) demographic data about the community; (ii) the institution's capacity and constraints; (iii) the institution's product offerings and business strategy; and (iv) data on the prior performance of the institution and similarly-situated lenders.
The Bank is also subject to, among other things, the provisions of the Equal Credit Opportunity Act (the "ECOA") and the Fair Housing Act (the "FHA"), both of 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. In April 1994, the Department of Housing and Urban Development, the Department of Justice (the "DJ"), and the federal banking agencies issued an Interagency Policy Statement on Discrimination in Lending in order 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 DJ has also increased its efforts to prosecute what it regards as violations of the ECOA and FHA.
GLB and federal bank regulators make various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made to a bank's primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under GLB may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a "satisfactory" CRA rating in its latest CRA examination.
Payment of Dividends
The Company is a legal entity separate and distinct from the Bank. The prior approval of the Federal Reserve and/or the Alabama Superintendent is required 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. Federal law also prohibits any state member from paying dividends that would be greater than such bank's undivided profits after deducting statutory bad debt reserves in excess of such bank's allowance for loan losses. During 2000, the Bank paid cash dividends of $1,660,000 to the Company.
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 adequate capital above regulatory minimums. The appropriate federal regulatory and state authorities are authorized to determine, under certain circumstances relating to the financial condition of a state member bank or a bank holding company, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The Federal Reserve and the Alabama Superintendent have indicated that paying dividends that deplete a state member bank's capital base to an inadequate level would be an unsound and unsafe banking practice. The Federal Reserve and the Alabama Superintendent also have indicated that financial depository institutions should generally pay dividends only out of current operating earnings.
Capital
The Federal Reserve has risk-based capital guidelines for bank holding companies and state member banks, respectively. These guidelines require a minimum ratio of capital to risk-weighted assets (including certain off-balance- sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must consist of common equity, retained earnings and a limited amount of qualifying preferred stock, less goodwill and certain core
deposit intangibles ("Tier 1 capital"). The remainder may consist 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 2 capital" and, together with Tier 1 capital, "Total Capital").
In addition, the federal regulatory agencies have established minimum leverage ratio guidelines for bank holding companies and state member banks, which provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets ("leverage ratio") equal to 3%, plus an additional cushion of 1.0% - 2.0%, if the institution has less than the highest regulatory rating. 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 activity. 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.
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.
All of the federal banking agencies have adopted regulations establishing relevant capital measures and relevant capital levels. The relevant capital measures are the Total Capital ratio, Tier 1 capital ratio, and the leverage ratio. Under the regulations, a state member bank will be (i) well capitalized if it has a Total Capital ratio of 10% or greater, a Tier 1 capital ratio of 6% or greater, a Tier 1 leverage 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 meet and maintain a specific capital level for any capital measure, (ii) adequately capitalized if it has a Total Capital ratio of 8% or greater, a Tier 1 capital ratio of 4% or greater, and a leverage ratio of 4% or greater (3% in certain circumstances), (iii) undercapitalized if it has a Total Capital ratio of less than 8%, a Tier 1 capital ratio of less than 4% (3% in certain circumstances), or (iv) critically undercapitalized if its tangible equity is equal to or less than 2% of average quarterly tangible assets.
As of December 31, 2000, the consolidated capital ratios of the Company and the Bank were as follows:
Regulatory Minimum Company Bank ---------- -------- ----- Tier 1 risk-based capital ratio 4.0% 11.40% 10.75% Total risk-based capital ratio 8.0% 12.65% 12.01% Tier 1 leverage ratio 3.0-5.0% 7.85% 7.39%
FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit a capital restoration plan for approval. For a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution 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 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, the respective managements of the Company and the Bank do not believe that the provisions of FDICIA have had any material impact on the Company and the Bank or their respective operations.
FDICIA
FDICIA directs that each federal banking 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, and such other standards as the federal regulatory agencies deem appropriate.
FDICIA also contains a variety of other provisions that may affect the operations of the Company and the Bank, including new reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions, the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch, and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not well capitalized or are adequately capitalized and have not received a waiver from the FDIC.
Enforcement Policies and Actions
The Federal Reserve and the Superintendent monitor compliance with laws and regulations. Violations of laws and regulations, or other unsafe and unsound practices, may result in these agencies imposing fines or penalties, cease and desist orders, or taking other 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.
Depositor Preference
The Omnibus Budget Reconciliation Act of 1993 provides that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution in the "liquidation or other resolution" of such an institution by any receiver.
Fiscal and Monetary Policy
Banking is a business which 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 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 discount rate at which banks may borrow from the Federal Reserve, and the reserve
requirements on deposits. The nature and timing of any changes in such policies and their effect on the Company and the Bank cannot be predicted.
FDIC Insurance Assessments
The Bank is subject to FDIC deposit insurance assessments. The Bank's deposits are insured by the FDIC's Bank Insurance Fund ("BIF"), and it has no deposit insured by the Savings Association Insurance Fund ("SAIF"). Beginning in 1996, the FDIC has applied a new risk-based premium schedule which decreased the assessment rates for BIF depository institutions. Under this schedule, the annual premiums range from zero to $.27 for every $100 of deposits. The Deposit Insurance Funds Act of 1996 (the "Funds Act") authorized The Financing Corporation ("FICO") to levy assessments on BIF-assessable deposits at a rate equal to one-fifth of the FICO assessment rate that is applied to deposits assessable by SAIF, through the earlier of the merger of BIF and SAIF or December 31, 1999. The FICO assessments are set quarterly, and for BIF in 2000 ranged from 2.02 to 2.12 basis points. The FICO assessment rates for both BIF and SAIF for the first quarter of 2001 are 1.96 basis points of assessable deposits.
Each financial institution is assigned to one of three capital groups - well capitalized, adequately capitalized or undercapitalized - and further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state regulators and other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The actual assessment rate applicable to a particular institution will, therefore, depend in part upon the risk assessment classification so assigned to the institution by the FDIC. During the three years ended December 31, 2000, the Bank paid $0, respectively, in BIF deposit insurance premiums, and paid approximately $122,000, $28,000 and $27,000 in FICO assessments during 2000, 1999 and 1998, respectively.
Legislative and Regulatory Changes
Various legislative and regulatory proposals regarding changes in banking, and the regulation of banks, thrifts and other financial institutions and bank and bank holding company powers are being considered by the executive branch of the Federal government, Congress and various state governments. The FDIC changed, effective April 1, 2000, its deposit insurance assessments to more timely reflect changes in risk, and is engaged in a comprehensive review of its insurance premiums and how to better measure and price deposit insurance in light of an insured bank's size and risk. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. It cannot be predicted whether any of these proposals will be adopted, and, if adopted, how these proposals will affect the Company and the Bank. Various federal oversight authorities are also reviewing the capital adequacy and riskiness of government sponsored enterprises such as Fannie Mae and Freddie Mac. Changes from such review could affect the cost and availability of Fannie Mae and Freddie Mac Services.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its business from its main office and six branches. The main office is located in the center of Auburn, Alabama, in a 16,150 square foot building that is owned by the Bank. The original building was constructed in 1964, and an addition was completed in 1981. Portions of the building have been renovated within the last five years in order to accommodate growth and changes in the Bank's operational structure and to adapt to technological changes. The main office building is surrounded on two sides by paved areas that provide parking for 84 vehicles, including four handicapped spaces. The main office branch offers the full line of the Bank's services and has 2 ATMs, one walk-up ATM and one drive-through ATM. The Bank owns a drive-in facility located directly across the street from its main office. This drive-in facility was constructed in 1979 and has five drive-through lanes and a walk-up window.
The Bank's Kroger branch is located in the Kroger supermarket in the Corner Village Shopping Center in Auburn, Alabama. On September 15, 1987, the Bank entered into a 15-year lease agreement for approximately 300 square feet of space in the supermarket. This branch offers the full line of the Bank's services including an ATM, with the exception of loans and safe deposit boxes.
The Opelika branch is located in Opelika, Alabama, in a 4,000 square foot building. This branch is owned by the Bank and was built in 1991. This branch offers the full line of the Bank's services and has drive-through windows and an ATM. This branch offers parking for approximately 36 vehicles, including two handicapped spaces.
The Bank's Winn-Dixie branch opened April 3, 1997, at the Winn Dixie supermarket in the Tiger Crossing Shopping Center on the south side of Auburn, Alabama. The Bank has a five-year lease agreement for approximately 350 square feet of space in the supermarket. This branch offers the full line of the Bank's deposit and other services including an ATM, except loans and safe deposit boxes.
The Bank's Phenix City branch was opened August 19, 1998 in the Wal-Mart shopping center in Phenix City, Alabama, about 20 miles south of Auburn, Alabama. The Bank has a five-year lease agreement for approximately 600 square feet of space in the Wal-Mart. This branch offers the full line of the Bank's deposit and other services including an ATM, except loans and safe deposit boxes.
The Bank's Hurtsboro branch was opened June 28, 1999. This branch is located in Hurtsboro, Alabama, about 40 miles south of Auburn, Alabama, in a 1,000 square foot building. This branch was built in 1999 and is owned by the Bank. This branch offers the full line of the Bank's services and has drive-through windows and an ATM. This branch offers parking for approximately 8 vehicles, including a handicapped ramp.
The Bank's Auburn Wal-Mart Supercenter branch was opened September 20, 2000 inside the Wal-Mart shopping center on the south side of Auburn, Alabama. The Bank has a five-year lease agreement for approximately 695 square feet of space in the Wal-Mart. This branch offers the full line of the Bank's deposit and other services including an ATM, except loans and safe deposit boxes.
In addition, the Bank leases from the Company approximately 8,300 square feet of space in the AuburnBank Center (the "Center"), which is located next to the main office. This building, which has approximately 18,000 square feet of space, is also leased to outside third parties. Leases between the Bank and the Company are based on the same terms and conditions as leases to outside third parties leasing space in the same building. The Bank's data processing activities, as well as other operations, are located in this leased space. The parking lot provides parking for approximately 120 vehicles, including handicapped parking.
Directly behind the Center is an older home that is also owned by the Company. This building is rented as housing to university students. The rear portion of this property is used as a parking area for approximately 20 vehicles of Bank employees.
The Bank also owns a two-story building located directly behind the main office. The first floor of this building is leased to unaffiliated third parties.
The Company owns a commercial office building (the "Hudson Building") located across the street from the main office in downtown Auburn. The Hudson Building has two floors and a basement which contain approximately 14,395 square feet of leasable space. Approximately 63.2% of this building is available for rent by third-party tenants. The Bank occupies approximately 5,300 square feet, which includes a portion of the basement level used for storage and office space used to house certain bank functions. The Bank pays rent to the Company based on current market rates for such space.
In 1994, the Bank acquired a piece of commercial real estate located in Auburn on U.S. Highway 29. This property, which was acquired in satisfaction of debt previously contracted, was formerly used by a floor covering business and contained approximately 6,045 square feet of office, showroom, and warehouse space. The Bank subsequently removed an underground storage tank ("UST") containing petroleum products from the site. In March 1995, the Alabama Department of Environmental Management ("ADEM") requested that the Bank submit a Secondary Investigation Plan ("Secondary Investigation") as a result of underground soil and water contamination of petroleum-based hydrocarbon products. The Secondary Investigation was completed and submitted to ADEM by Roy F. Weston, Inc. ("Weston"), an independent consultant hired by the Bank. The Secondary Investigation indicated low concentrations of soil contamination on site and elevated concentrations of gasoline constituents both on-site and off-site. The Secondary Investigation indicated a low risk to human receptors, and Weston recommended to ADEM initiation of a quarterly ground water monitoring program for one year, at which time the program would be reassessed. In response to ADEM's Letter of Requirement dated January 18, 1996, Weston prepared and submitted, on behalf of the Bank, a Monitoring Only Corrective Action Plan on February 20, 1996. In 1999, Weston installed a passive waste removal system to remove petroleum-based hydrocarbon products from the groundwater test well. Quarterly groundwater monitoring will continue in 2001 as required by ADEM. Samples from the eight (8) existing monitoring wells will be collected and analyzed by Weston. The monitoring data will be submitted by Weston to ADEM as required. It is estimated that the cost for monitoring and providing reporting data to ADEM for 2001 will be approximately $9,000 (unless the site is released by ADEM during the year). The extent and cost of any further testing and remediation, if any, cannot be predicted at this time.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of its business, the Company and the Bank from time to time are involved in legal proceedings. The Company and Bank management believe there are no pending or threatened legal proceedings which upon resolution are expected to have a material adverse effect upon the Company's or the Bank's financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2000.
PART II -------
ITEM 5.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on the Nasdaq SmallCap Market, under the symbol "AUBN". As of February 28, 2001, there were approximately 3,924,573 shares of the Company's Common Stock issued and outstanding, which were held by approximately 450 shareholders of record. The following table sets forth, for the indicated periods, the high and low closing sale prices for the Company's Common Stock as reported on the Nasdaq SmallCap Market.
Closing Cash Price Dividends Per Share (1) Declared ------------------------- ----------------- High Low ------- -------- First Quarter $16.25 $10.78 $0.10 Second Quarter 12.00 11.00 0.10 Third Quarter 13.00 9.50 0.10 Fourth Quarter 12.00 8.75 0.10
First Quarter 18.00 $14.00 $0.06 Second Quarter 18.50 15.94 0.06 Third Quarter 17.50 12.38 0.10 Fourth Quarter 15.75 12.75 0.10 --------------- (1) The price information represents actual transactions.
The Company has paid cash dividends on its capital stock since 1985. Prior to this time, the Bank paid cash dividends since its organization in 1907, except during the Depression years of 1932 and 1933. Holders of Common Stock are entitled to receive such dividends as may be declared by the Company's Board of Directors. The amount and frequency of cash dividends will be determined through the judgment of the Company's Board of Directors based upon a number of factors, including the Company's earnings, financial condition, capital requirements, and other relevant factors. Company management presently intends to continue its present dividend policies.
The amount of dividends payable by the Bank is limited by law and regulation. The need to maintain adequate capital in the Bank also limits dividends that may be paid to the Company. Although Federal Reserve policy could restrict future dividends on Common Stock, such policy places no current restrictions on such dividends. See "Supervision and Regulation -- Dividends" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources."
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(1) Restated to reflect the three for one stock split in the form of a dividend on June 25, 1998.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is designed to provide a better understanding of various factors related to the Company's results of operations and financial condition. Such discussion and analysis should be read in conjunction with "Business" and "Financial Statements and Supplementary Data."
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the three years ended December 31, 2000, 1999 and 1998. This discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere herein.
Summary
Net earnings increased $92,000 (3.1%) to $3,014,000 during 2000 from $2,922,000 for the year ended December 31, 1999. Basic income per share was $0.77 and $0.74 for 2000 and 1999, respectively, an increase of 4.1%. Comparatively, net earnings during 1999 decreased $517,000 (15.0%) from the 1998 total of $3,439,000, while basic income per share showed a similar decrease of $0.14 per share for 1999 from a 1998 per share total of $0.88. The increase in net earnings for 2000 is attributable to an increase in net interest income and noninterest income offset by an increase in noninterest expense. The decrease in net earnings for 1999 is mainly attributable to an increase in provision for loan losses. See "Financial Condition -- Capital Resources" and the "Consolidated Average Balances, Interest Income/Expense and Yields/Rates" tables.
Total assets at December 31, 2000 and 1999 were $404,689,000 and $377,518,000, reflecting growth of $27,171,000 (7.2%). The Company's growth during 2000 resulted primarily from the growth in investment securities held to maturity and investment securities available for sale offset by a decrease in cash and cash equivalents. In addition, deposits grew $20,919,000 (7.1%) from $294,722,000 at year-end 1999 to $315,641,000 at year-end 2000. See "Financial Condition-Deposits", "Financial Condition-Loans" and "Liquidity."
Financial Condition
Investment Securities
Investment securities held to maturity were $26,900,000 and $10,068,000 at December 31, 2000 and 1999, respectively. This increase of $16,832,000 (167.2%) in 2000 resulted from a large increase in U.S. government agency securities and collateralized mortgage obligations ("CMOs"). The investment securities available for sale portfolio was $84,831,000 and $67,799,000 at December 31, 2000 and 1999, respectively. This increase of $17,032,000 (25.1%) reflects purchases of U.S. government agency securities and CMOs offset by the maturity of commercial paper. During the fourth quarter of 2000, the Company sold a held-to-maturity security with an amortized cost of $229,000 for a realized gain of $6,000. The Company sold the security in anticipation of a call that occurred in early 2001. There were no sales of investment securities held to maturity during the years ended December 31, 1999 and 1998.
The composition of the Company's total investment securities portfolio reflects the Company's investment strategy to provide acceptable levels of interest income from portfolio yields while maintaining an appropriate level of liquidity to assist with controlling the Company's interest rate position. In recent years, the Company has invested primarily in taxable securities due to its inability to fully realize the benefits of the preferential treatment afforded tax-exempt securities under the tax laws. Because of their liquidity, credit quality and yield characteristics, the majority of the purchases of taxable securities have been in investment grade mortgage-backed securities ("MBS") and CMOs. The yields, values, and durations of such MBS and CMOs generally vary with interest rates, prepayment
levels, and general economic conditions, and as a result, the values of such instruments may be more volatile than other instruments with similar maturities. Such MBS and CMOs also may have longer stated maturities than other securities, which may result in further price volatility.
The following table indicates the amortized cost of the portfolio of investment securities held to maturity at the end of the last three years:
The following table indicates the fair value of the portfolio of investment securities available for sale at the end of the last three years:
At December 31, 2000, the Bank owned CMOs with a total amortized cost of $43,977,000. All of the CMOs are rated AAA. The CMOs are all backed by federal agency guaranteed mortgages, except for one issue in the amount of $12,000 which is a privately issued mortgage pass-through certificate. Fair values for the private placement CMOs were estimated based on fair values for similar instruments.
The MBS portfolio's total amortized cost of $25,815,000 at December 31, 2000, is a mixture of fixed rate mortgages, adjustable rate mortgages ("ARMs"), and securities with balloon payments. At the time of purchase, the Bank considers various prepayment speeds and makes the purchase based on the ability to accept the yield and average life based on both increasing and decreasing prepayment speeds.
The following tables present the maturities and weighted average yields of investment securities at December 31, 2000:
Loans
Total loans were $262,529,000 at December 31, 2000, an increase of $1,923,000 (0.7%), over total loans of $260,606,000 at December 31, 1999. The primary growth during 2000 occurred in the commercial real estate mortgage loan area. The commercial real estate mortgage portfolio increased $14,180,000 (18.8%) to $89,465,000 at December 31, 2000 compared to $75,285,000 at December 31, 1999. The increase was due primarily to increased demand for commercial credits. Commercial real estate mortgage loans represented 34.1% and 28.9% of the total loans at December 31, 2000 and 1999, respectively. The residential real estate mortgage loan component of the loan portfolio increased $1,777,000 (3.0%) to $60,127,000 at December 31, 2000, over the 1999 balance of $58,350,000 and represented 22.9% of the total loan portfolio at December 31, 2000, as compared to 22.4% at December 31, 1999.
The above increases were offset by a decrease in the commercial, financial and agricultural loans. The commercial, financial and agricultural portfolio decreased $5,600,000 (7.25%) to $71,636,000 at December 31, 2000 compared to $77,236,000 at December 31, 1999. Commercial, financial and agricultural loans represented 27.3% and 29.6% of the total loans at December 31, 2000 and 1999, respectively.
In addition to originating mortgage loans for its own portfolio, the Company also originates residential mortgage loans which are sold in the secondary market. In addition to selling real estate mortgage loans to the Federal National Mortgage Association ("FNMA") with the Bank retaining the servicing, the Bank has arranged with one mortgage servicing company to originate and sell, without recourse, residential first mortgage real estate loans, with servicing released. During 2000, the Bank sold mortgage loans totaling approximately $10,912,000, to FNMA, with the Bank retaining the servicing, and sold mortgage loans, totaling approximately $5,623,000, to the mortgage servicing company, with servicing released. At December 31, 2000, the Bank was servicing loans totaling approximately $72,771,000. The Bank collects monthly servicing fees of 0.25% to 0.375% annually of the outstanding balances of loans serviced for FNMA. See "- Effects of Inflation and Changing Prices."
The following table presents the composition of the loan portfolio by major categories at the end of the last five years:
The following table presents maturities by major loan classifications and the sensitivity of loans to changes in interest rates within each maturity category at December 31, 2000:
Allowance for Loan Losses and Risk Elements
Interest on loans is normally accrued from the date an advance is made. The performance of loans is evaluated primarily on the basis of a review of each customer relationship over a period of time and the judgment of lending officers as to the ability of borrowers to meet the repayment terms of loans. If there is reasonable doubt as to the repayment of a loan in accordance with the agreed terms, the loan may be placed on a nonaccrual basis pending the sale of any collateral or a determination as to whether sources of repayment exist. This action may be taken even though the financial condition of the borrower or the collateral may be sufficient ultimately to reduce or satisfy the obligation. Generally, when a loan is placed on a nonaccrual basis, all payments are applied to reduce principal to
the extent necessary to eliminate doubt as to the repayment of the loan. Thereafter, any interest income on a nonaccrual loan is recognized only on a cash basis.
The Company's policy generally is to place a loan on nonaccrual status when it is contractually past due 90 days or more as to payment of principal or interest. A loan may be placed on nonaccrual status at an earlier date when concerns exist as to the ultimate collections of principal or interest. At the time a loan is placed on nonaccrual status, interest previously accrued but not collected is reversed and charged against current earnings. Loans that are contractually past due 90 days or more which are well secured and are in the process of collection generally are not placed on nonaccrual status.
Lending officers are responsible for the ongoing review and administration of each particular loan. As such, they make the initial identification of loans which present some difficulty in collection or where circumstances indicate that the possibility of loss exists. The responsibilities of the lending officers include the collection effort on a delinquent loan. To strengthen internal controls in the collection of delinquencies, senior management and the Directors' Loan Committee are informed of the status of delinquent and "watch" or problem loans on a monthly basis. Senior management reviews the allowance for loan losses and makes recommendations to the Directors' Loan Committee as to loan charge-offs on a monthly basis.
The allowance for loan losses represents management's assessment of the risk associated with extending credit and its evaluation of the quality of the loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain a level considered adequate to absorb anticipated loan losses. In assessing the adequacy of the allowance, management reviews the size, quality and risk of loans in the portfolio. Management also considers such factors as the Bank's loan loss experience, the amount of past due and nonperforming loans, specific known risk, the status and amount of nonperforming assets, underlying collateral values securing loans, current and anticipated economic conditions and other factors which affect the allowance for loan losses. An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by the Bank's Credit Administration area and presented to the Directors' Loan Committee on a monthly basis. In addition, the Bank has engaged an outside loan review consultant, on a semi-annual basis, to perform an independent review of the quality of the loan portfolio and adequacy of the allowance.
The Bank's allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses in comparison to a group of peer banks identified by the regulators. During their routine examinations of banks, the Federal Reserve and the Alabama Superintendent of Banks may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, credit evaluations and allowance for loan loss methodology differ materially from those of management. See "Supervision and Regulation."
While it is the Bank's policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management's judgment as to the adequacy of the allowance is necessarily approximate and imprecise.
The following table summarizes the levels of the allowance for loan losses at the end of the last five years and activity in the allowance during such years:
The allowance for loan losses was $3,634,000 (1.38% of total outstanding loans) at December 31, 2000, compared to $3,775,000 (1.45% of total outstanding loans) at December 31, 1999. In 2000, the Company was engaged in a detailed, ongoing loan review program using an outside loan reviewer. In November and early December 2000, management and the board of directors completed an extensive review of the loan reviewer's findings and the credits identified as having problems or potential problems. As a result, an additional provision of $600,000 was made to the allowance for loan losses as of September 30, 2000 and the financial statements as of and for the period then ended were restated to reflect such additional provision. This provision reflects, in part, an increase in the percentage of the Company's loan portfolio reviewed by the independent consultant in 2000, as well as management's more detailed evaluations, estimates and judgements regarding various identified credits. In addition, in December 2000, the Board contracted with another independent loan review services provider to undertake and complete a review of the Bank's portfolio and to assist the Bank's management in assessing the adequacy of the Bank's allowance for loan losses. Management considered the results of such third party review in determining the provision for loan losses for the fourth quarter of 2000. In addition to semi-annual loan reviews, starting in 2001, this loan review services provider will assist in implementing new policies and procedures for the loan process. The Bank's more rigorous internal reviews and changes in its credit practices, may result in additions to the allowance for loan losses, and the identification of additional potential problem loans.
During the first six months of 1999, the Bank recorded $332,000 in provision for loan losses based on internal reviews, growth in the loan portfolio and other components of its normal allowance methodology. During Summer 1999, the Bank was examined by the Federal Reserve, which criticized a number of loans and credits held by the
Bank. As a result of such examination and deterioration of certain credits, the Bank increased its allowance for loan losses by an additional $932,000. The Bank's regulators required the Bank to review its loan portfolio and improve its loan and credit policies and credit practices. As a result, the Bank has been engaged in enhanced reviews of its loan approval and credit grading processes. Since Summer 1999, the Bank has sought to better price its loans consistent with its costs of funds and its assessment of potential credit risk. Along with general increases in interest rate, this has had the effect of slowing the Bank's loan growth.
During 2000, the Company had loan charge-offs totaling $3,115,000 and recoveries of $352,000, as compared to $1,631,000 in charge-offs and recoveries of $92,000 in the prior year. Such deterioration primarily related to several large commercial loans in various industries which were identified as problem credits in the reviews and examinations as discussed above.
Management believes that the $3,634,000 allowance for loan losses at December 31, 2000 (1.38% of total outstanding loans), is adequate to absorb known risks in the portfolio at such date. However, no assurance can be given that adverse economic circumstances, generally, including a slowing economy, or other events, including additional loan review or examination findings or changes in borrowers' financial conditions, will not result in increased losses in the Bank's loan portfolio or in additional provisions to the allowance for loan losses. The Bank does not currently allocate its allowance for loan losses among its various classifications of loans. The decrease in the ratio of the allowance for loan losses to nonperforming assets between year-end 1999 and year-end 2000 was primarily due to an increase in charge-offs not fully offset by an increase in provision for loan losses.
While management recognizes that there is more risk traditionally associated with commercial and consumer lending as compared to real estate mortgage lending, the Bank currently has in place a tiered approach to determine the adequacy of its allowance for loan losses. This methodology focuses on the determination of the specific and general loss allowances for certain loans classified as problem credits and uses a five-year historical loss factor to determine the loss allocation for the remainder of the loan portfolio as opposed to allocations based on major loan categories. Level I includes specific allowances that have been reserved for impaired loans where management has identified specific losses. Level II allowances are set aside to cover general losses associated with problem loans which possess more than a normal degree of credit risk but where no specific losses have been identified. These loans have been criticized or classified by the Bank's regulators, external loan review personnel engaged by the Bank, or internally by management. The five-year historical loss factors, subject to certain minimum percentage considering regulatory guidelines, are applied to the Level II problem loans in determining the allocation. Level III is the allowance for the balance of the loan portfolio. The loans in this tier consist of all loans that are not classified as Level I or Level II problem credits, and less risk-free loans. Risk-free loans are defined as loans fully secured by cash or cash equivalents, readily marketable collateral, and portions of the portfolio that are partially covered by a U.S. Government or government agency guaranty. Adjustments are then made for local economic conditions. The allocation for Level III is determined by applying the historical loss factor, derived from prior years actual experience, to the adjusted outstanding balance for this classification. The Company is currently expanding its methodology to determine the adequacy of the allowance for loan losses by major loan types. This change is not expected to have a material adverse effect on the Company's consolidated financial condition or the results of operations.
On January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan" ("SFAS No. 114") and Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures" ("SFAS No. 118"), which amends SFAS No. 114, with no material effect on its financial condition or results of operations. At December 31, 2000, the Company had approximately $8,356,000 of impaired loans, which included 35 loans to 10 borrowers with a total valuation allowance of approximately $529,000. In comparison, at December 31, 1999, the Company had approximately $5,177,000 of impaired loans, which included two loans to the same borrower with a total valuation allowance of approximately $345,000.
Nonperforming Assets
Nonperforming assets consist of loans on nonaccrual status, loans that have been renegotiated at terms more favorable to the borrower than those for similar credits, real estate and other assets acquired in partial or full satisfaction of loan obligations and accruing loans that are past due 90 days or more.
Nonperforming assets were $8,695,000, $6,853,000, and $4,897,000 at December 31, 2000, 1999, and 1998, respectively. These levels represent an increase of $1,842,000 (26.9%) for the year ended December 31, 2000, and an increase of $1,956,000 (39.9%) for the year ended December 31, 1999. The increases in 2000 and 1999 were mainly due to an increase in nonaccrual loans due to a deterioration in certain loans determined by recent analyses and loan reviews.
An analysis of the components of nonperforming assets at the end of the last five years is presented in the following table:
If nonaccrual loans had performed in accordance with their original contractual terms, interest income would have increased approximately $826,000, $428,000, and $183,000 for the years ended December 31, 2000, 1999 and 1998 respectively.
Other Potential Problem Loans
Potential problem loans consist of those loans where management has serious doubts as to the borrower's ability to comply with the present loan repayment terms. At December 31, 2000, the Company had identified 120 loans totaling approximately $8,826,000 or 3.4% of total loans which were considered potential problem loans. At December 31, 1999, the Company had identified 92 loans totaling approximately $10,798,000 or 4.1% of total loans which were considered potential problem loans. Such loans have been considered in the determination of the Level II allowance previously discussed.
Deposits
Total deposits increased $20,919,000 (7.1%) to $315,641,000 at December 31, 2000, as compared to $294,722,000 at December 31, 1999. Noninterest-bearing deposits were $43,292,000 and $38,868,000 while total
interest-bearing deposits were $272,349,000 and $255,854,000 at December 31, 2000 and 1999, respectively. This trend is the result of management's decision to maintain a competitive position in its deposit rate structure coupled with the Bank's marketing efforts to attract local deposits and fund its loan growth. At December 31, 2000, as a percentage of total deposits, noninterest-bearing accounts comprised approximately 13.7%, while MMDAs, NOWs and regular savings made up approximately 35.2%, certificates of deposit under $100,000 comprised approximately 25.7%, and certificates of deposit and other time deposits of $100,000 or more comprised 25.4%. At December 31, 1999, as a percentage of total deposits, noninterest-bearing accounts comprised approximately 13.2%, while MMDAs, NOWs and regular savings made up approximately 35.5%, certificates of deposit under $100,000 comprised approximately 24.6%, and certificates of deposit and other time deposits of $100,000 or more comprised 26.7%.
The composition of total deposits for the last three years is presented in the following table:
The average balances outstanding and the average rates paid for certain categories of deposits at the end of the last three years are disclosed in the "Consolidated Average Balances, Interest Income/Expense and Yields/Rates" table immediately following:
(1) Loans on nonaccrual status have been included in the computation of average balances . (2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using an income tax rate of 34%.
The following table presents the maturities of certificates of deposit and other time deposits of $100,000 or more at December 31, 2000.
Weighted Average rate on time deposits of $100,000 or more at period-end............. 6.56%
Schedule of Short-term Borrowings (1)
The following table shows the maximum amount of short-term borrowings and the average and year-end amount of borrowings, as well as interest rates.
(1) Consists of securities sold under agreements to repurchase.
Capital Resources
The Company's consolidated stockholders' equity was $31,805,000 and $28,442,000 at December 31, 2000 and 1999, respectively, an increase of $3,363,000 (1.18%) since year-end 1999. The increase in stockholders' equity for 2000 is due to an increase in the accumulated other comprehensive income due to unrealized gain on investment securities available for sale and net earnings offset by cash dividends for 2000. The Company has funded its capital growth primarily through retained earnings since its early 1995 sale of common stock that raised approximately $1,234,000 of net proceeds to the Company.
During 2000, cash dividends of $1,570,000 or $0.40 per share, were declared on the Common Stock as compared to $1,256,000 or $0.32 per share, in 1999, representing an increase of $314,000 (25.0%). The Company plans to continue a dividend payout policy that provides cash returns to its investors and allows the Company to maintain adequate capital to support future growth and capital adequacy; however, the Company is dependent on dividends from the Bank as discussed subsequently. Management believes that a strong capital position is vital to the continued profitability of the Company and provides a foundation for future growth as well as promoting depositor and investor confidence in the institution. See "Supervision and Regulation."
Certain financial ratios for the Company for the last three years are presented in the following table:
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory actions, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Bank are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Management believes, as of December 31, 2000, that the Bank meets all capital adequacy requirements to which it is subject. See "Supervision and Regulation."
The following table sets forth the Bank's actual capital levels and the related required capital levels at December 31, 2000:
Liquidity
Liquidity is the Company's ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand, and maturing liabilities. Without proper management, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.
At the Bank, asset liquidity is provided primarily through cash, the repayment and maturity of investment securities, and the sale and repayment of loans.
Sources of liability liquidity include customer deposits, federal funds purchased and investment securities sold under agreements to repurchase. Although deposit growth historically has been a primary source of liquidity, such balances may be influenced by changes in the banking industry, interest rates available on other investments, general economic conditions, competition and other factors. The Bank has participated in the FHLB-Atlanta's advance program to obtain funding for its growth. Advances include both fixed and variable terms and are taken out with varying maturities. The Bank has a current line of credit of $63,810,000. This line is collateralized by a blanket lien against its one to four family residential mortgage loans. At December 31, 2000, the Bank had credit available from FHLB-Atlanta of $15,288,000, and had $48,522,000 in advances drawn down.
Overall, net cash provided from financing activities decreased $49,013,000 (71.3%) to $19,731,000 during 2000 from the previous year's total of $68,744,000. Net cash provided by operating activities increased $4,069,000 (292.3%) to $5,461,000 from $1,392,000 for the year ended December 31, 2000. Cash used in investing activities during 2000 approximated $34,646,000.
The Company depends mainly on dividends, management fees and lease payments from the Bank, for its liquidity. The Company only receives cash dividends from the Bank if the cash flow from other sources is not sufficient to maintain a positive cash flow, also giving consideration to regulatory restrictions. Accordingly, the Bank paid the Company $1,660,000, $855,000, and $385,000 in cash dividends for 2000, 1999, and 1998 respectively. The Company provides services to the Bank for which it is paid a management fee comparable to a third-party vendor. The Bank paid the Company $170,000 and $354,000 in management fees and $204,000 and $188,000 in lease payments for the years ended December 31, 2000 and 1999, respectively. These funds were used to pay operating expenses and fund dividends to the Company's shareholders. In addition, the Bank makes transfers to the Company, under its Tax Sharing Agreement, for payment of consolidated tax obligations. The Tax Sharing Agreement calls for the allocation of the consolidated tax liability or benefit between the Company and each subsidiary based on their individual tax positions as if each entity filed a separate tax return.
The Bank's liquidity, especially its loan to deposit ratio was criticized by the Bank's regulators in Summer 1999. The Bank has reduced its loan to deposit ratio from 91.58% at June 30, 1999 to 88.42% at December 31, 1999 and then to 83.17% at December 31, 2000. Since Summer 1999, the Bank has been carefully monitoring its liquidity, and has sought to better price its loans consistent with its costs of funds and the Bank's assessment of potential credit risk. This process has slowed and is expected to continue to slow the Bank's loan growth and related loan revenues.
Interest Rate Sensitivity Management
An integral part of the funds management of the Company and the Bank is to maintain a reasonably balanced position between interest rate sensitive assets and liabilities. The Bank's Asset/Liability Management Committee ("ALCO") is charged with the responsibility of managing, to the degree prudently possible, its exposure to "interest rate risk," while attempting to provide earnings enhancement opportunities. The dollar difference between rate sensitive assets and liabilities for a given period of time is referred to as the rate sensitive gap ("GAP"). A GAP ratio is calculated by dividing rate sensitive assets by rate sensitive liabilities. Due to the nature of the Bank's balance sheet structure and the market approach to pricing of liabilities, management and the Board of Directors recognize that achieving a perfectly matched GAP position in any given time frame would be extremely rare. ALCO has determined that an acceptable level of interest rate risk would be for net interest income to fluctuate no more than 5.0% given a change in selected interest rates of up or down 200 basis points over any 12-month period. Using an increase of 200 basis points and a decrease of 200 basis points. At December 31, 2000, the Bank's net interest income would decrease approximately 3.68% in a rising rate environment and increase approximately 2.62% in a falling rate environment. Interest rate scenario models are prepared using software created by Darling Consulting Group and licensed to National Bank of Commerce, Birmingham, Alabama.
For purposes of measuring interest rate sensitivity, Company management assumes that the asset and liability balances remain constant over the 12-month period. Deposit withdrawals are only considered in measuring liquidity. Although demand and savings accounts are subject to immediate withdrawal, all passbook savings and regular NOW accounts are reflected in the model as repricing after 5 years due to their historically stable volume pricing. High balance MMDAs and NOW accounts are considered volatile and, as such, are assumed to reprice in 1-3 months. Certificates of deposits are spread according to their contractual maturity. Investment securities and loans reflect either the contractual maturity, call date, repricing date, or in the case of mortgage related products, a market prepayment assumption.
Interest Sensitivity Analysis
The interest sensitive assets at December 31, 2000, that reprice or mature within 12 months were $146,294,000 while the interest sensitive liabilities that reprice or mature within the same time frame were $215,023,000. At December 31, 2000, the 12 month cumulative GAP position, was a negative $68,729,000 resulting in a GAP ratio of 68.0%. This negative GAP indicates that the Company has more interest-bearing liabilities than interest-earning assets that reprice within the GAP period.
The Bank enters into interest rate protection contracts to help manage its interest rate exposure. These contracts include interest rate swaps, caps and floors. Interest rate swap transactions involve the exchange of fixed and floating rate interest payment obligations based on the underlying notional principal amounts. Interest rate caps and floors are purchased by the Bank for a non-refundable fixed amount. The Bank receives interest based on the underlying notional principal amount if the specified index rises above the cap rate or falls below the floor strike rate. Notional principal amounts are used to express the volume of these transactions, but because they are never exchanged, the amounts subject to credit risk are much smaller. Risks associated with interest rate contracts include interest rate risk and creditworthiness of the counterparty. These risks are considered in the Bank's overall asset liability management program. The Bank utilizes periodic financial statements issued by the counterparty to analyze the creditworthiness of the counterparty prior to entering into a contract and to monitor changes in the financial condition of the counterparty throughout the term of the contract. Current contracts are issued by a securities broker-dealer and were entered into with the purpose of managing the Bank's interest rate exposure. Although none of the interest rate protection agreements are traded on any organized exchange, an active secondary market is available to the Company for such contracts.
The Bank's Asset Liability Management Policy states that establishing limits on interest rate swaps, caps, and floors can be somewhat confusing or misleading since the notional amount by which these instruments are expressed is never exchanged between counterparties and therefore is not "at risk." Furthermore, since they represent off-balance sheet tools used by ALCO to manage imbalances in the Bank's balance sheet in a prudent and cost effective manner, the appropriate volume of swaps for the Bank is not static; it changes with elements such as the economic
environment, the capital position, and the ability to efficiently replicate hedging actions in the cash markets. The Bank endeavors to limit outstanding notional value of off-balance sheet contracts executed for purposes of managing net interest income to 25% of total assets as reported in the most recent quarterly call report. Notional value of off-balance sheet contracts executed with one counterparty are limited to 10% of total assets as reported in the Bank's most recent quarterly call report.
The following table presents the Company's interest rate swaps and floors position as of December 31, 2000:
________________ (1) The weighted average rates received/paid are shown only for swaps for which net interest amounts were receivable or payable at the end of each period. Interest rates on variable rate derivative products held by the Bank are derived from the 3 month LIBOR rate.
The fair values of these off-balance sheet derivative financial instruments are based on dealer quotes and third party financial models. See "Results of Operations - Net Interest Income."
Interest rate swaps, floors and caps are accounted for on an accrual basis, and the net interest differential, including premiums paid, if any, is recognized as an adjustment to interest income or expense of the related designated asset or liability. Changes in the fair values of the swaps, floors and caps are not recorded in the consolidated statements of income because these agreements are being treated as a synthetic alteration of the designated assets or liabilities. The Company considers its interest rate swaps to be a synthetic alteration of an asset or liability as long as (i) the swap is designated with a specific asset or liability or finite pool of assets or liabilities; (ii) there is a high correlation, at inception and throughout the period of the synthetic alteration, between changes in the interest income or expense generated by the swap and changes in the interest income or expense generated by the designated asset or liability; (iii) the notional amount of the swap is less than or equal to the principal amount of the designated asset or liability; and (iv) the swap term is less than or equal to the remaining term of the designated asset or liability. The criteria for consideration for a floor or cap as a synthetic alteration of an asset or liability are generally the same as those for a swap arrangement.
If the swap, floor or cap arrangements are terminated before their maturity, the net proceeds received or paid are deferred and amortized over the shorter of the remaining contract life or the maturity of the designated asset or liability as an adjustment to interest income or expense. If the designated asset or liability is sold or matures, the swap agreement is marked to market and the gain or loss is included with the gain or loss on the sale/maturity of the designated asset or liability. Changes in the fair value of any undesignated swaps, floors and caps are included in other income in the consolidated statement of income.
Effects of Inflation and Changing Prices
Inflation generally increases the costs of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on the performance of a financial institution than the effects of general levels of inflation. In addition, inflation affects financial institutions' cost of goods and services purchased, the cost of salaries and benefits,
occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders' equity. Mortgage originations and refinancings tend to slow as interest rates increase, and such increases likely will reduce the Company's volume of such activities and the income from the sale of residential mortgage loans in the secondary market.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement, as amended, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has determined that the impact of SFAS No. 133 on the Company's financial statements upon adoption will not be material.
In September 2000, SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities was issued. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishments of liabilities after March 31, 2001. The statement is effective for recognition and reclassification of collateral and disclosures relating to securitizations transactions and collateral for fiscal years ending after December 15, 2000. The Company does not expect a material change to its results of operations as a result of adopting SFAS No. 140.
Results of Operations
Net Earnings
Net earnings increased $92,000 (3.1%) to $3,014,000 during 2000 from $2,922,000 for the year ended December 31, 1999. Basic income per share was $0.77 and $0.74 for 2000 and 1999, respectively, an increase of 4.1%. Comparatively, net earnings during 1999 decreased $517,000 (15.0%) from the 1998 total of $3,439,000, while basic income per share showed a similar decrease of $0.14 per share for 1999 from a 1998 per share total of $0.88.
The increase in net earnings for 2000 is attributable to higher net interest income and noninterest income offset by higher noninterest expense. The decrease in net earnings for 1999 is attributable to higher provision for loan losses and noninterest expense offset by a higher net interest income and noninterest income.
Net Interest Income
Net interest income is the difference between the interest the Company earns on its loans, investment securities and other earning assets and the interest cost of its deposits, borrowed funds and other interest-bearing liabilities. This is the primary component of the Company's earnings. Net interest income was $12,584,000 for the year ended December 31, 2000. This increase of $456,000 (3.8%) over 1999 is due to the increase in average interest earning assets during 2000 offset by a decrease in the net yield on total interest earning assets of 33 basis points to 3.41%.
Net interest income for 1999 was $12,128,000, $1,597,000 (15.2%) higher than 1998 net interest income of $10,531,000. This increase over 1998 was due to the increase in average interest earning assets during 1999 offset by a decrease in the net yield on total interest earning assets of 22 basis points to 3.74%.
The Company uses interest rate protection contracts, primarily interest rate swaps, caps and floors, to protect the yields on earning assets and the rates paid on interest-bearing liabilities. Such contracts act as hedges against unfavorable rate changes. The income and expense associated with interest rate swaps, caps and floors are ultimately reflected as adjustments to the net interest income or expense of the underlying assets or liabilities. The effect of such interest rate protection contracts resulted in a net decrease in net interest income of $18,000 for 2000 and an increase of $131,000 and $93,000 for 1999 and 1998, respectively. It is the intention of the Company to continue to utilize interest rate protection contracts to manage exposure to certain future changes in interest rate environments. However, there can be no assurance that such transactions will positively affect earnings. See "-- Interest Rate
Sensitivity Management", the "Consolidated Average Balances, Interest Income/Expense and Yields/Rates" table appearing elsewhere herein and the "Rate/Volume Variance Analysis" tables immediately following.
Rate/Volume Variance Analysis
_____________ (1) For analytical purposes, income for tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 34% effective federal income tax rate). (2) The change in interest due to rate is calculated by multiplying the previous volume by the rate change and the change in interest due to volume is calculated by multiplying the change in volume by the previous rate. Changes attributable to both changes in rate and volume are calculated by multiplying the change in volume by the change in rate.
Rate/Volume Variance Analysis
_____________ (1) For analytical purposes, income for tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment which equates tax-exempt income to interest from taxable assets (assuming a 34% effective federal income tax rate). (2) The change in interest due to rate is calculated by multiplying the previous volume by the rate change and the change in interest due to volume is calculated by multiplying the change in volume by the previous rate. Changes attributable to both changes in rate and volume are calculated by multiplying the change in volume by the change in rate.
Interest Income
Interest income is a function of the volume of interest-earning assets and their related yields. Interest income was $30,226,000, $25,477,000, and $21,720,000 for the years ended December 31, 2000, 1999, and 1998, respectively. Average interest-earning assets increased $44,475,000 (13.7%) during 2000, $57,687,000 (21.6%) during 1999, and $24,518,000 (10.0%) during 1998, while the fully taxable equivalent yields on average earning assets increased 34 basis points in 2000 after decreasing 29 basis points in 1999 and 6 basis points in 1998. The combination of these factors resulted in increases in interest income of $4,749,000 (18.6%), $3,757,000 (17.3%) and $1,871,000 (9.4%) during 2000, 1999, and 1998, respectively. See "--Consolidated Average Balances, Interest Income/Expense and Yields/Rates" and the "Rate/Volume Variance Analysis" tables.
Loans are the main component of the Bank's earning assets. Interest and fees on loans were $22,707,000, $20,392,000, and $17,468,000 for the years ended December 31, 2000, 1999, and 1998, respectively. These levels reflected increases of $2,315,000 (11.4%) during 2000, $2,924,000 (16.7%) during 1999, and $2,145,000 (14.0%) during 1998 due to increases in the average volume outstanding on loans over the past three years. While the level of average balances has grown to $261,499,000 in 2000 from $243,938,000 and $200,230,000 for 1999 and 1998,
respectively, the fully taxable equivalent yield on loans increased 32 basis points to 8.68% in 2000, and decreased 36 basis points to 8.36% in 1999 from the 1998 average yield of 8.72%.
Interest income on investment securities increased $2,258,000 (48.8%) to $6,883,000 in 2000, following an increase of $729,000 (18.7%) to $4,625,000 in 1999 and a decrease of $161,000 (4.0%) to $3,896,000 in 1998. The 2000 increase was due to a $25,810,000 increase in average volume outstanding and an increase in yield of 60 basis points compared to 1999 levels. The 1999 increase was due to a $11,032,000 increase in average volume outstanding and a comparable fully taxable equivalent yield compared to 1998 levels. The fully taxable equivalent yields on investment securities were 7.04% in 2000, 6.44% in 1999, and 6.44% in 1998. See "Financial Condition--Investment Securities."
Interest Expense
Total interest expense was $17,642,000, $13,349,000 and $11,189,000 for the years ended December 31, 2000, 1999, and 1998 respectively, representing increases of $4,293,000 (32.2%), $2,160,000 (19.3%) and $846,000 (8.2%) during 2000, 1999, and 1998, respectively. Total average balances outstanding of interest-bearing liabilities have continued an upward trend over the last three years to $321,432,000 in 2000 from $276,284,000 in 1999 and $222,954,000 in 1998. The rates paid on these liabilities increased 66 basis points in 2000 to 5.49% after decreasing 19 basis points to 4.83% during 1999, and decreasing 7 basis points to 5.02% during 1998.
Interest on deposits, the primary component of total interest expense, increased $3,968,000 to $14,849,000 (36.5%) during 2000 from $10,881,000 in 1999, which in turn represents a $1,324,000 (13.9%) increase from the 1998 level of $9,557,000. The average balance outstanding of interest-bearing deposits has increased steadily to the 2000 level of $271,641,000 as compared to $230,216,000 in 1999 and $193,408,000 in 1998. The average rates paid on interest-bearing deposits were 5.47%, 4.73%, and 4.94% for 2000, 1999, and 1998, respectively.
Interest expense on borrowed funds was $2,480,000 in 2000, $2,132,000 in 1999, and $1,406,000 in 1998. These levels represent an increase of $348,000 (16.3%) during 2000, an increase of $726,000 (51.6%) during 1999, and an increase of $744,000 (112.4%) during 1998. The increases are primarily due to increases in FHLB advances of $1,882,000 and $15,882,000 for 2000 and 1999, respectively.
Provision for Loan Losses
During 2000, the Company made a total provision for loan losses of $2,622,000 based on management's reviews and assessments of the risk in the loan portfolio, the growth of the loan portfolio and historical loan loss trends, and an evaluation of certain significant problem loans. This provision was taken primarily as a result of a deterioration in certain loans determined by recent analyses and loan reviews. In addition, the level of monthly provision has increased during 2000 and 1999 due to loan growth. During 1999 and 1998, the Company made total provisions for loan losses of $2,506,000 and $891,000, respectively. See "Financial Condition -- Allowance for Loan Losses and Risk Elements."
Noninterest Income
Noninterest income increased $351,000 (11.7%) to $3,349,000 for the year ended December 31, 2000, from the 1999 total of $2,998,000, which in turn represented an increase of $519,000 (20.9%) from the total of $2,479,000 for 1998.
Service charges on deposit accounts increased $233,000 (20.0%) during 2000 and $186,000 (19.0%) in 1999 both primarily due to increases in nonsufficient funds and overdraft charges mainly due to an increase in the number of items.
Other noninterest income increased $59,000 (3.2%) to $1,893,000 in 2000 from $1,834,000 in 1999. Comparatively, the 1999 total represented an increase of $347,000 (23.3%) from $1,487,000 in 1998. The increase in 2000 was primarily due to an increase in Mastercard/VISA discounts and fees due to Auburn University's acceptance of Mastercard/VISA for tuition, an increase in stock dividends from stock owned in other companies, and the loss on premises and equipment in the prior year due primarily to computer equipment that was not Year 2000
compliant. The increase in 1999 was primarily due to an increase in Mastercard/VISA discounts and fees due to the Auburn University's acceptance of Mastercard/VISA for tuition, an increase in ATM service charges, an increase in checkcard income and an increase in stock dividends from stock owned in other companies. This increase was offset by a loss on premises and equipment primarily for computer equipment that was not Year 2000 compliant. See "ITEM 1 - BUSINESS - SERVICES."
Noninterest Expense
Total noninterest expense was $8,865,000 for 2000, $8,138,000 for 1999, and $6,838,000 for 1998 reflecting an increase of $727,000 (8.9%) for 2000, an increase of $1,300,000 (19.0%) for 1999 and an increase of $453,000 (7.1%) for 1998.
Salaries and benefits decreased $444,000 (11.5%) to $3,408,000 for the year ended December 31, 2000, and increased $615,000 (19.0%) to $3,852,000 for the year ended December 31, 1999, from the 1998 total of $3,237,000. At December 31, 2000, the Company had 119 full-time equivalent employees, an increase of 4 over the level at December 31, 1999. At December 31, 1999, the Company had 115 full-time equivalent employees, an increase of 7 over the level at December 31, 1998. The salary and benefit decreases for 2000 was due to the decrease in the employee incentive plan payouts for 2000. The increase for 1999 was primarily due to new hires and merit raises and the cost of benefits associated with such increases.
Net occupancy expense was $1,110,000, $1,116,000, and $1,022,000 for 2000, 1999 and 1998, respectively, representing a decrease of $6,000 (0.5%) in 2000 and an increase of $94,000 (9.2%) in 1999 over the previous year's levels. The 2000 decrease is due to a decrease in depreciation on furniture and equipment offset by an increase in lease payments for computer equipment. The 1999 increase is primarily due to increases in lease payments for computer equipment, lease payments on building due to the addition of the Phenix City Wal-Mart branch and depreciation on furniture and equipment.
Other noninterest expense was $4,347,000 for 2000, $3,169,000 for 1999, and $2,578,000 for 1998. These levels represent an increase of $1,178,000 (37.2%) in 2000 and an increase of $591,000 (22.9%) in 1999 over the respective previous years. The 2000 increase is mainly due to the expenses associated with Auburn University's acceptance of Mastercard/VISA for tuition mentioned above, expenses due to the increased monitoring of nonaccrual loans, expenses associated with repossessed real estate and property, the Company's share of the net operating loss for a low income housing investment, and an increase in assessments due to an increase in FDIC Insurance Assessment rates and state bank assessment which had three assessments in 2000 compared to one in 1999. The 1999 increase resulted from expenses associated with Auburn University's acceptance of Mastercard/VISA for tuition mentioned above, professional fees for strategic tax services and legal fees related to certain nonaccrual loans. See "Supervision and Regulation-FDIC Insurance Assessments."
Income Taxes
The Company's income tax expense was $1,432,000, $1,559,000, and $1,842,000 in 2000, 1999, and 1998, respectively. These levels represent an effective tax rate on pre-tax earnings of 32.2% for 2000, 34.8% for 1999, and 34.9% for 1998. Details of the tax provision for income taxes are included in Note 10, "Income Tax Expense" in the Notes to the Consolidated Financial Statements included elsewhere herein.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk, with respect to the Company, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. Although the Company manages other risk, such as credit and liquidity, management considers interest rate risk to be the more significant market risk and could potentially have the largest material effect on the Company's financial condition. Further, the Company believes the potential reduction of net interest income may to be more significant than the effect of reduced fair market values. The Company does not maintain a trading portfolio, therefore it is not exposed to risk from trading activities. Nor does it deal in international instruments, therefore the Company is not exposed to foreign currency risk.
The Company's interest rate risk management is the responsibility of the Asset/Liability Management Committee (ALCO). ALCO has established policies and limits to monitor, measure and coordinate the Company's sources, uses and pricing of funds.
The Company manages the relationship of interest sensitive assets to interest sensitive liabilities and the resulting effect on net interest income. The Company utilizes a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on both a rise and fall in interest rates of 200 basis points over a twelve and twenty-four month period. The model is based on actual repricing dates of interest sensitive assets and interest sensitive liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rates of certain assets. The assumptions are based on nationally published prepayment speeds on given assets when interest rates rise or decrease by 200 basis points or more.
Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change the interest income and expense associated with the Company's interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of the Company's earnings. ALCO utilizes the results of the simulation model and the static GAP report to quantify the estimated exposure of net interest income to a sustained change in interest rates.
The Company makes use of off-balance sheet interest rate contracts to protect its net interest income against changes in interest rates. At year-end, the Company had off-balance sheet interest rate swap agreements with a notional value of $35 million. These contracts were negotiated to protect the Company's balance sheet against a fall or rise in interest rates. All are matched to specific assets and liabilities and none were booked for the purpose of trading. The effect of these instruments is considered in the simulation models.
Currently the Company's income exposure to changes in interest rates is relatively low. The Company measures this exposure based on an immediate change in interest rates of up or down 200 basis points. Given this scenario, the Company had, at year-end, a very slight exposure to rising rates and a benefit from falling rates. In performing these shock tests, the Company also runs a scenario based on a steeping of the current yield curve. In a steeping yield curve environment, the Company again experienced a very slight exposure to rising rates and a benefit from falling rates.
The following chart reflects the Company's sensitivity to changes in interest rates as of December 31, 2000. Numbers are based on a flat balance sheet and assumes paydowns and maturities of both assets and liabilities are reinvested in like instruments at either current interest rates, rates up 100 basis points, up 200 basis points, down 100 basis points and down 200 basis points. In the first table, net interest income at the Base model is a projection for the coming year, given a flat balance sheet and no change in interest rates. The dollar change and percentage change of the up and down 200 basis points and up and down 100 basis points is measured against the Base model. In the second chart, the dollar change and percentage change is measured against the first year's base model. Table three is a summary of the two years.
INTEREST RATE RISK Income Sensitivity Summary: Interest Rate Scenario (000) ---------------------------- (Dollars in thousands)
Policy Limit 5% for +/- 200 Basis Points (BP) over 12 months.
The preceding sensitivity analysis is a modeling analysis, which changes quarterly and consists of hypothetical estimates based upon numerous assumptions including the interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, and others. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, management cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. See "INTEREST SENSITIVITY ANALYSIS" table.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Financial Statements and Supplementary Data contained within this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III --------
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Information required by this item is set forth under the heading "Information about Nominees for Directors" on Pages 2 through 4 and under the heading "Executive Officers" on Pages 5 and 6 of the definitive proxy statement for the Company's Annual Meeting to be held on May 8, 2001, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this item is set forth under the heading "Meetings and Committees of the Board of Directors" on Page 4 and 5 and under the heading "Summary Compensation of Executive Officers" on Pages 5 and 6 of the definitive proxy statement for the Company's Annual Meeting to be held on May 8, 2001, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is set forth under the heading "Information about Nominees for Directors" on Pages 2 through 4 of the definitive proxy statement for the Company's Annual Meeting to be held on May 8, 2001, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is set forth under the heading "Certain Transactions and Business Relationships on Page 8 of the definitive proxy statement for the Company's Annual Meeting to be held on May 8, 2001, and is incorporated herein by reference.
ITEM 14.
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(a)(1) List of all Financial Statements -------------------------------- The following consolidated financial statements and report of independent certified public accountants of the Company are included in this Annual Report on Form 10-K:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statement of Earnings for the years ended December 31, 2000, 1999, and 1998
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 2000, 1999, and 1998
Consolidated Statements of Cash Flows for the years ended December 31, 2000, 1999, and 1998
Notes to the Consolidated Financial Statements
(b) Exhibits --------
3.1. Certificate of Incorporation of Auburn National Bancorporation, Inc. (incorporated by reference from Registrant's Registration Statement on Form SB-2 (File No. 33-86180)).
3.2. Bylaws of Auburn National Bancorporation, Inc. (incorporated by reference from Registrant's Registration Statement on Form SB-2 (File No. 33-86180)).
10. Material Contracts
10.1. Auburn National Bancorporation, Inc. 1994 Long-Term Incentive Plan (incorporated by reference from Registrant's Registration Statement on Form SB-2 (File No. 33-86180)).
10.2. Lease and Equipment Purchase Agreement, dated September 15, 1987 (incorporated by reference from Registrant's Registration Statement on Form SB-2 (File No. 33-86180)).
21.1 Subsidiaries of Registrant
23.1 Consent of Accountants
27.1 Financial Data Schedule
(c) Reports on Form 8-K -------------------
Reports filed on Form 8-K during the last quarter of the fiscal year ended December 31, 2000:
Form 8-K dated November 22, 2000 Filed under Item 5 - Other Events. Auburn National Bancoporation, Inc's September 30, 2000 Form 10-Q was erroneously filed by the Company's EDGAR service provider before it was complete.
Form 8-K dated December 6, 2000 Filed under Item 5 - Other Events. Auburn National Bancoporation, Inc's filed Form 10-QA to amend the erroneously filed September 30, 2000 Form 10-Q by the Company's EDGAR service provider before it was complete.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(With Independent Auditors' Report Thereon)
Independent Auditors' Report
The Board of Directors Auburn National Bancorporation, Inc.:
We have audited the accompanying consolidated balance sheets of Auburn National Bancorporation, Inc. and subsidiary (the "Company") as of December 31, 2000 and 1999, and the related consolidated statements of earnings, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Auburn National Bancorporation, Inc. and subsidiary as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Atlanta, Georgia February 2, 2001
See accompanying notes to consolidated financial statements.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Consolidated Statements of Earnings
Years Ended December 31, 2000, 1999, and 1998
See accompanying notes to consolidated financial statements.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended December 31, 2000, 1999, and 1998
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years ended December 31, 2000, 1999, and 1998
See accompanying notes to consolidated financial statements.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(1) Summary of Significant Accounting Policies
Auburn National Bancorporation, Inc. (the "Company") provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its subsidiary, AuburnBank (the "Bank"). The Company and Bank are subject to competition from other financial institutions. The Company and Bank are also subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory authorities. The Company does not have any segments other than banking that are considered material.
The accounting policies followed by the Company and its subsidiary and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practice within the banking industry. Certain principles which significantly affect the determination of financial position, results of operations and cash flows are summarized below.
(a) Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties that serve as collateral.
Management believes that the allowance for losses on loans is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
The Bank's real estate loans are secured by real estate located principally in Lee County, Alabama and surrounding areas. In addition, the foreclosed real estate owned by the Bank is located in this same area. Accordingly, the ultimate collectibility of a substantial portion of the Bank's loan portfolio and the recovery of real estate owned are susceptible to changes in market conditions in this area.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiary, AuburnBank. During the year ended December 31, 1998, the Company merged its existing subsidiary, ANB Systems, Inc. into the Company. All significant intercompany accounts and transactions have been eliminated.
(c) Cash Equivalents
Cash equivalents include amounts due from banks and federal funds sold. Federal funds are generally sold for one-day periods.
(d) Investment Securities
The Company and Bank account for investment securities under the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities whereby investment securities are classified in one of three portfolios: (i) trading account securities, (ii) held to maturity securities, and (iii) securities available for sale. Trading account securities are to be stated at fair value. The Company and Bank do not have trading account securities. Investment securities held to maturity are those for which the Company and Bank have both the intent and ability to hold until maturity and are stated at cost adjusted for amortization of premiums and accretion of discounts. Investment securities available for sale are stated at fair value with any unrealized gains and losses reported as a separate component of stockholders' equity, net of tax effects, until realized.
Accretion of discounts and amortization of premiums are calculated on the effective interest method over the anticipated life of the security, taking into consideration prepayment assumptions. Gains and losses from the sale of investment securities are computed under the specific identification method.
A decline in the fair value below cost of any available for sale or held to maturity security that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security.
The Bank uses interest rate swaps, caps, and floors as part of its overall interest rate risk management. Any premiums or discounts arising from the use of interest rate contracts are deferred and amortized over the lives of the interest rate contracts as an adjustment to interest income or expense. Interest income or expense related to interest rate swaps, caps, and floors is recorded over the life of the agreement as an adjustment to interest income or expense.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(e) Loans
Loans are stated at principal amounts outstanding. Interest on loans is credited to income on the simple interest method.
It is the general policy of the Bank to discontinue the accrual of interest when principal or interest payments become more than ninety days delinquent. When a loan is placed on a nonaccrual basis, any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are recorded on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
The Company accounts for impaired loans in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Under the provisions of SFAS No. 114 and No. 118, management considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is considered impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the note's effective interest rate, unless the loan is collateral-dependent, for which the fair value of the collateral is used to determine the amount of impairment. Impairment losses are included in the allowance for loan losses through the provision for loan losses. Impaired loans are charged to the allowance when such loans are deemed to be uncollectible. Subsequent recoveries are added to the allowance.
When a loan is considered impaired, cash receipts are applied under the contractual terms of the loan agreement, first to principal and then to interest income. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has not been recognized. Any further cash receipts are recorded as recoveries of any amount previously charged off.
A loan is also considered impaired if its terms are modified in a troubled debt restructuring. For those accruing impaired loans, cash receipts are typically applied to principal and interest receivable in accordance with the terms of the restructured loan agreement. Interest income is recognized on these loans using the accrual method of accounting.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
The Bank originates mortgage loans to be held for sale only for loans that have been pre-approved by the investor. The Bank bears minimal interest rate risk on these loans. Such loans are stated at the lower of cost or aggregate fair value.
(f) Allowance for Loan Losses
The amount of provision for loan losses charged to earnings is based on actual loss experience, periodic specific reviews of significant and nonperforming loan relationships, and management's evaluation of the loan portfolio under current economic conditions. Loans are examined for credit quality, documentation, and financial information annually by a qualified non-employee loan review examiner. Such provisions, adjusted for loan charge-offs and recoveries, comprise the allowance for loan losses. Provision amounts are largely determined based on loan classifications determined through credit quality reviews using estimated loss factors based on historical loss experience. Such loss factors are adjusted periodically based on changes in loss experience.
Loans are charged against the allowance when management determines such loans to be uncollectible. Subsequent recoveries are credited to the allowance.
(g) Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed on both the double-declining balance and straight-line methods for buildings and principally on a straight-line method for furniture, fixtures, and equipment over the estimated useful lives of the assets, which range from three to 39 years.
(h) Rental Property
Rental property consists of land; buildings; and furniture, fixtures, and equipment which are rented to the Bank and the general public. Rental property is stated at cost less accumulated depreciation. Depreciation is computed on both the double-declining balance and straight-line methods for buildings and principally on a straight-line method for furniture, fixtures, and equipment over the estimated useful lives of the assets.
(i) Other Real Estate
Real estate acquired through foreclosure or in lieu of foreclosure is carried at the lower of cost or fair value, as determined by independent appraisals, adjusted for estimated selling costs. Any write-down at the time of foreclosure is charged to the allowance for loan losses. Subsequent declines in fair value below acquisition cost and gains or losses on the sale of these properties are credited or charged to earnings.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(j) Derivative Financial Instruments
The Bank uses derivative financial instruments to swap floating rate assets or liabilities to fixed rate and to hedge the interest rate spread between assets and liabilities. These transactions serve to better match the repricing characteristics of various assets and liabilities, reduce spread risk, adjust overall rate sensitivity and enhance net interest income.
Interest rate swaps, purchased floors, and purchased caps are accounted for on an accrual basis, and the net interest differential, including premiums paid, if any, is recognized as an adjustment to interest income or expense of the related designated asset or liability. Changes in fair values of the swaps, purchased floors, or purchased caps are not recorded in the consolidated statements of earnings because these agreements are being treated as a synthetic alteration of the designated assets or liabilities. The Bank considers its interest rate swaps to be a synthetic alteration of an asset or liability as long as (i) the swap is designated with a specific asset or liability or finite pool of assets or liabilities; (ii) there is a high correlation at inception and throughout the period of the synthetic alteration, between changes in the interest income or expense generated by the swap and changes in the interest income or expense generated by the designated asset or liability; (iii) the notional amount of the swap is less than or equal to the principal amount of the designated asset or liability; and (iv) the swap term is less than or equal to the remaining term of the designated asset or liability. The criteria for consideration of a floor or cap as a synthetic alteration of an asset or liability are generally the same as those for a swap arrangement.
If the swap, floor, or cap arrangements are terminated before their maturity, the net proceeds received or paid are deferred and amortized over the shorter of the remaining contract life or the maturity of the designated asset or liability as an adjustment to interest income or expense. If the designated asset or liability is sold or matures, the swap agreement is marked to market, and the gain or loss is included in the gain or loss on the sale/maturity of the designated asset or liability.
(k) Income Taxes
Income taxes are accounted for under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company files its federal income tax returns on a consolidated basis.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(l) Earnings per Share
Basic earnings per share are computed on the weighted-average number of shares outstanding in accordance with SFAS No. 128, Earnings Per Share. The Company reserved 75,000 shares of common stock in May 1994 for issuance under stock option plans; however, no options have been granted as of December 31, 2000; thus, there are no potential common shares that would result in diluted earnings per share.
(m) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. This statement, as amended, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has determined that the impact of SFAS No. 133 on the Company's financial statements upon adoption will not be material.
In September 2000, SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities was issued. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishments of liabilities after March 31, 2001. The statement is effective for recognition and reclassification of collateral and disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company does not expect a material impact on its financial statements as a result of adopting SFAS No. 140.
(n) Reclassifications
Certain of the 1999 and 1998 amounts have been reclassified to conform to the 2000 presentation.
(2) Cash and Due from Banks
The Bank is required to maintain certain average cash reserve balances in accordance with Federal Reserve Board requirements. The amounts of those required balances as of December 31, 2000 and 1999 were approximately $3,632,000 and $3,573,000, respectively.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(3) Investment Securities
The amortized cost and approximate fair value of investment securities at December 31, 2000, were as follows:
The amortized cost and approximate fair value of investment securities at December 31, 2000, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
The amortized cost and approximate fair value of investment securities at December 31, 1999, were as follows:
During the fourth quarter of 2000, the Company sold a held to maturity security with an amortized cost of $229,335 for a realized gain of $5,979. The Company sold the security in anticipation of a call that occurred in early 2001. The Company also recognized a gain of $8,449 during 2000 as a result of a call of a held to maturity security. There were no sales of investment securities held to maturity during the years ended December 31, 1999 and 1998. Proceeds from the sale of investment securities available for sale during the year ended December 31, 2000 were $2,979,308. There were no sales of investment securities available for sale during the year ended December 31, 1999. Proceeds from sales of investment securities available for sale were $4,970,085 for the year ended December 31, 1998. Gross gains of $44,883 and $14,277 were realized on the sales for the years ended December 31, 2000 and 1998, respectively.
Investment securities with an aggregate carrying value of $90,132,664 and $72,483,891 at December 31, 2000 and 1999, respectively, were pledged to secure public and trust deposits as required by law and for other purposes.
The Company maintains a diversified investment portfolio, including held to maturity and available-for-sale securities, with limited concentration in any given region, industry, or economic characteristic. Investments in municipal governments are made throughout the U.S. with no concentration in any individual state.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
Included in other assets is stock in the Federal Home Loan Bank (FHLB) of Atlanta. FHLB stock is carried at cost, has no contractual maturity, has no quoted fair value, and no ready market exists. The investment in the stock is required of every member of the FHLB system. The investment in the stock was $2,426,600 and $2,333,000 at December 31, 2000 and 1999, respectively.
(4) Loans
At December 31, 2000 and 1999, the composition of the loan portfolio was as follows:
During 2000 and 1999, certain executive officers and directors of the Company and the Bank, including companies with which they are associated, were loan customers of the Bank. Total loans outstanding to these persons at December 31, 2000 and 1999 amounted to $5,576,841 and $10,305,953, respectively. The change from 1999 to 2000 reflects payments of $10,169,055 and advances of $5,439,943. In management's opinion, these loans were made in the ordinary course of business at normal credit terms, including interest rate and collateral requirements, and do not represent more than normal credit risk.
A summary of the transactions in the allowance for loan losses for the years ended December 31, 2000, 1999, and 1998 is as follows:
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
At December 31, 2000 and 1999, the Company had $8,355,841 and $5,177,329, respectively, of impaired loans. Impaired loans at December 31, 2000 and 1999 in the amount of $7,149,512 and $5,177,329, respectively, have a related valuation allowance of $528,967 and $345,496 at December 31, 2000 and 1999, respectively. Impaired loans at December 31, 2000 in the amount of $1,206,329 have no related valuation allowance.
For the years ended December 31, 2000, 1999, and 1998, the average recorded investment in impaired loans was $7,482,538, $4,368,233, and $2,370,393, respectively. The amount of interest income on impaired loans recognized during 2000 and 1998 amounted to $94,519 and $21,154, respectively. No interest income was recognized on impaired loans in 1999.
Nonperforming loans, consisting of loans on nonaccrual status and accruing loans past due greater than 90 days, amounted to $7,819,055 and $6,343,282 at December 31, 2000 and 1999, respectively. Nonaccrual loans were $7,792,049, $6,074,985, and $4,593,108 at December 31, 2000, 1999, and 1998, respectively. Interest that would have been recorded on nonaccrual loans had they been in accruing status was approximately $826,000, $428,000, and $183,000 in 2000, 1999, and 1998, respectively.
The Company had $874,000 and $510,000 in real estate acquired by foreclosure at December 31, 2000 and 1999, respectively.
The Company's loan servicing portfolio consisted of 930 loans with an outstanding balance of $72,770,862, 908 loans with an outstanding balance of $70,284,016, and 869 loans with an outstanding balance of $65,661,064, as of December 31, 2000, 1999, and 1998, respectively.
(5) Premises and Equipment
Premises and equipment at December 31, 2000 and 1999 are summarized as follows:
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(6) Interest-Bearing Deposits
At December 31, 2000 and 1999, the composition of interest-bearing deposits was as follows:
Interest expense on certificates of deposit and other time deposits of $100,000 and over amounted to approximately $4,543,000, $3,147,000, and $2,187,000 in 2000, 1999, and 1998, respectively.
The following table presents the maturities of certificates of deposit and other time deposits of $100,000 or more at December 31, 2000.
During 2000 and 1999, certain executive officers and directors of the Bank, including companies with which they are associated, were deposit customers of the Bank. Total deposits to these persons at December 31, 2000 and 1999 amounted to $4,312,433 and $4,076,791, respectively.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(7) Securities Sold Under Agreements to Repurchase
The securities sold under agreements to repurchase at December 31, 2000 and 1999 are collateralized by obligations of the U.S. Government or its corporations and agencies, state and municipal securities, or mortgage- backed securities, which are held by independent trustees. The following summarizes pertinent data related to the securities sold under agreements to repurchase as of and for the years ended December 31, 2000, 1999, and 1998.
(8) Other Borrowed Funds
Other borrowed funds at December 31, 2000 and 1999 consisted of the following:
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
Required annual principal payments on long-term debt for the five years subsequent to December 31, 2000 are as follows:
The Bank has a $63,810,000 available line of credit from the FHLB which is reviewed annually by the FHLB. The above advances are against this line of credit. Interest expense on FHLB advances was $2,467,523, $2,118,189, and $1,386,924 in 2000, 1999, and 1998, respectively. All interest rates on outstanding advances are fixed interest rates. The advances and line of credit are collateralized by the Bank's investment in the stock of the FHLB and all first mortgage residential loans, which are sufficient to draw the full line of credit.
(9) Comprehensive Income
The following table sets forth the amounts of other comprehensive income included in stockholders' equity along with the related tax effect for the years ended December 31, 2000, 1999, and 1998.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(10) Income Tax Expense
Total income tax expense (benefit) for the years ended December 31, 2000, 1999, and 1998 was allocated as follows :
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
For the years ended December 31, 2000, 1999, and 1998 the components of income tax expense were as follows:
Total income tax expense differed from the amount computed by applying the statutory federal income tax rate of 34 percent to pretax earnings as follows:
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 1999 are presented below:
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projection for future taxable income over the periods which the temporary differences resulting in the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(11) Retirement Plans
The Bank has a defined contribution retirement plan that covers substantially all employees. Participants become 20 percent vested in their accounts after two years of service and 100 percent vested after six years of service. Contributions to the plan are determined by the board of directors. Company contributions to the plan amounted to $91,611, $75,648, and $125,865 in 2000, 1999, and 1998, respectively.
(12) Off-Balance-Sheet Risk and Contingent Liabilities
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit and financial guarantees. Such instruments involve elements of credit risk in excess of the amounts recognized in the consolidated financial statements. The Company also uses derivative instruments in managing the Bank's interest rate exposure.
The Company's exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
The financial instruments whose contract amounts represent credit risk as of December 31, 2000 are as follows:
Commitments to extend credit $32,193,000 Standby letters of credit $ 6,849,000
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. All guarantees expire within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various assets as collateral supporting those commitments for which collateral is deemed necessary.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
The Bank enters into interest rate protection contracts to help manage the Bank's interest rate exposure. These contracts include interest rate swaps, caps, and floors. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. Entering into interest rate swap agreements involves not only the risk of dealing with counterparties and their ability to meet the terms of the contracts but also the risk associated with the movements in interest rates. Notional principal amounts often are used to express the volume of these transactions; however, the amounts potentially subject to credit risk are much smaller. The notional principal amount related to these contracts was $35,000,000 at December 31, 2000. Risks associated with interest rate contracts include interest rate risk and creditworthiness of the counterparty. These risks are considered in the Bank's overall asset liability management program. The Bank utilizes periodic financial statements issued by the counterparty to analyze the creditworthiness of the counterparty prior to entering into a contract and to monitor changes in the financial condition of the counterparty throughout the term of the contract. Although none of the interest rate protection agreements are traded on any organized exchange, the Company believes that an active secondary market exists for such contracts.
In February 1995, the Bank entered into two interest rate floors with respect to $20,000,000 in variable rate loans. These agreements allow the Bank to receive interest payments based on three-month LIBOR should the floor rate fall below 5.00% and 6.00%, respectively. The agreements required the Bank to pay a fixed amount of $26,000 and $76,500, respectively, upon consummation of the agreements. The purpose of these contracts was to reduce interest rate exposure to variable assets in a low interest rate environment. These contracts were terminated during February 2000.
In 1999, the Bank entered into four interest rate swaps with respect to various fixed rate certificates of deposit. These agreements allow the Bank to receive fixed interest payments at rates ranging from 5.44% to 7.75% per annum and to pay a variable rate equal to three-month LIBOR in the case of two swaps, and three-month LIBOR plus three basis points in the case of two swaps. The purpose of these contracts is to reduce the Bank's effective cost of funds to better match the costs of funding variable rate loans.
In February 2000, the Bank entered into an interest rate swap with respect to $20,000,000 in variable rate loans. This agreement allows the Bank to receive fixed-interest payments at 9.80% per annum and to pay a variable rate equal to prime. The purpose of these contracts was to reduce interest rate exposure to variable assets in a low-interest rate environment.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
The following table summarizes information on interest rate swaps at December 31, 2000:
All interest rate protection contracts above reprice quarterly. Interest rates on variable rate derivative products held by the Bank are derived from the three-month LIBOR rate and prime.
The Company and the Bank are involved in various legal proceedings, arising in connection with their business. In the opinion of management, based upon consultation with legal counsel, the ultimate resolution of these proceedings will not have a material adverse effect upon the financial position or results of operations of the Company and Bank.
(13) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107 (SFAS 107), Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company's financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company's financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
(a) Cash, Cash Equivalents, and Interest-Earning Deposits with Other Banks
Fair value equals the carrying value of such assets.
(b) Investment Securities
The fair value of investment securities is based on quoted market prices.
(c) Loans
The fair value of loans is calculated using discounted cash flows and excludes lease financing arrangements. The discount rates used to determine the present value of the loan portfolio are estimated market discount rates that reflect the credit and interest rate risk inherent in the loan portfolio. The estimated maturities are based on the Company's historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of accrued interest approximates its fair value.
(d) Off-Balance-Sheet Instruments
Fair value of interest rate swaps and interest rate caps and floors is based on quoted market prices. These values represent the estimated amount the Company would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the creditworthiness of the counterparties.
(e) Deposits
As required by SFAS 107, the fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, NOW accounts, savings, and money market deposit accounts, is equal to the carrying value. Certificates of deposit have been valued using discounted cash flows. The discount rates used are based on estimated market rates for deposits of similar remaining maturities.
(f) Short-term Borrowings
The fair value of federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings approximates their carrying value.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(g) Long-term Borrowings
The fair value of the Company's fixed rate long-term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company's variable rate long-term debt approximates its fair value.
The carrying value and estimated fair value of the Company's financial instruments at December 31, 2000 and 1999 are as follows (in thousands):
(14) Common Stock and Capital Requirements
The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory -- and possibly additional discretionary -- actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000, that the Company and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2000, based on its most recent notification, the Bank is categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's capital category.
The actual capital amounts and ratios and the aforementioned minimums as of December 31, 2000 and 1999 are as follows (dollars in thousands):
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(15) Dividends from Subsidiary
Dividends paid by the Bank are a principal source of funds available to the Company for payment of dividends to its stockholders and for other needs. Applicable federal and state statutes and regulations impose restrictions on the amounts of dividends that may be declared by the subsidiary bank. State statutes restrict the Bank from declaring dividends in excess of the sum of the current year's earnings plus the retained net earnings from the preceding two years without prior approval. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank's total capital in relation to its assets, deposits, and other such items. Capital adequacy considerations could further limit the availability of dividends from the Bank. At December 31, 2000, the Bank could have declared dividends of approximately $8,137,000 without prior approval of regulatory authorities. As a result of this limitation, approximately $21,673,000 of the Company's investment in the Bank was restricted from transfer in the form of dividends.
(16) Supplemental Information
Components of other noninterest income exceeding one percent of revenues for any of the years in the three-year period ended December 31, 2000, included merchant discounts and fees on MasterCard and Visa sales of $1,003,988, $656,187, and $391,315 in 2000, 1999, and 1998, respectively; and, NSF and overdraft charges of $1,030,928, $854,578, and $717,052 in 2000, 1999, and 1998, respectively. Also included were servicing fees of $193,375, $191,310, and $176,522 in 2000, 1999, and 1998, respectively; and, rental income of $144,232, $145,232, and $150,623 in 2000, 1999, and 1998 respectively.
Components of other noninterest expense exceeding one percent of revenues for any of the years in the three-year period ended December 31, 2000, included professional fees of $355,922, $405,197, and $254,981 in 2000, 1999, and 1998, respectively. Also included were marketing expenses of $203,201, $165,565, and $184,512 in 2000, 1999, and 1998, respectively; rental property expenses of $243,673, $246,273, and $238,570 in 2000, 1999, and 1998, respectively; and, MasterCard and Visa processing fees of $1,044,257, $650,061, and $371,361 in 2000, 1999, and 1998, respectively.
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
(17) Parent Company Financial Information
The condensed financial information for Auburn National Bancorporation, Inc. (Parent Company Only) is presented as follows:
Parent Company Only Condensed Balance Sheets December 31, 2000 and 1999
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
Parent Company Only Condensed Statements of Earnings Years Ended December 31, 2000, 1999, and 1998
AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2000, 1999, and 1998
Parent Company Only Condensed Statements of Cash Flows Years Ended December 31, 2000, 1999, and 1998
(18) Quarterly Financial Data (Unaudited)
The supplemental quarterly financial data for the years ended December 31, 2000 and 1999 is summarized as follows:
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Auburn, State of Alabama, on the 30th day of March, 2001.
AUBURN NATIONAL BANCORPORATION, INC. (Registrant)
By: /S/ E. L. SPENCER, JR. ------------------------- E. L. Spencer, Jr. President
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
AUBURN NATIONAL BANCORPORATION, INC.
EXHIBIT INDEX
______________________ * Incorporated by reference from Registrant's Registration Statement on Form SB-2 (File No. 33-86180).