AUBURN NATIONAL BANCORPORATION, INC 10-Q

ITEM 2. 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 results of operations and financial condition of the Company and the Bank. This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters ended March 31, 2021 and 2020, as well as the information contained in our Annual Report on Form 10-K for the year ended December 31, 2020. Special Notice Regarding Forward-Looking Statements Various of the statements made herein under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Quantitative and Qualitative Disclosures about Market Risk”, “Risk Factors” and elsewhere, are “forward-looking statements” within the meaning and protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance, achievements or financial condition of the Company to be materially different from future results, performance, achievements or financial condition expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements. All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation: ● the effects of future economic, business and market conditions and changes, foreign, domestic and locally, including seasonality, natural disasters or climate change, such as rising sea and water levels, hurricanes and tornados, coronavirus or other epidemics or pandemics; ● the effects of war or other conflicts, acts of terrorism, or other events that may affect general economic conditions; ● governmental monetary and fiscal policies; ● legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost of FDIC insurance; ● the failure of assumptions and estimates, as well as differences in, and changes to, economic, market and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio reviews; ● the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest-sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable; ● changes in borrower credit risks and payment behaviors; ● changes in the availability and cost of credit and capital in the financial markets, and the types of instruments that may be included as capital for regulatory purposes; ● changes in the prices, values and sales volumes of residential and commercial real estate; Table of Contents 28 ● the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, including the disruption effects of financial technology and other competitors who are not subject to the same regulations as the Company and the Bank; ● the failure of assumptions and estimates underlying the establishment of allowances for possible loan losses and other asset impairments, losses valuations of assets and liabilities and other estimates; ● the costs of redeveloping our headquarters and the timing and amount of rental income upon completion of the project; ● the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions; ● changes in technology or products that may be more difficult, costly, or less effective than anticipated; ● cyber-attacks and data breaches that may compromise our systems, our vendor systems or customers’ information; ● the risks that our deferred tax assets (“DTAs”), if any, could be reduced if estimates of future taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of net operating loss carry-forwards that we may be able to utilize for income tax purposes; and ● other factors and information in this report and other filings that we make with the SEC under the Exchange Act, including our Annual Report on Form 10-K for the year ended December 31, 2020 and subsequent quarterly and current reports. See Part II, Item 1A. “RISK FACT ORS”. All written or oral forward-looking statements that are made by us or are attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made. ITEM 1. BUSINESS Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company was incorporated in Delaware in 1990, and in 1994 it succeeded its Alabama predecessor as the bank holding company controlling AuburnBank, an Alabama state member bank with its principal office in Auburn, Alabama (the “Bank”). The Company and its predecessor have controlled the Bank since 1984. As a bank holding company, the Company may diversify into a broader range of financial services and other business activities than currently are permitted to the Bank under applicable laws and regulations. The holding company structure also provides greater financial and operating flexibility than is presently permitted to the Bank. The Bank has operated continuously since 1907 and currently conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank has been a member of the Federal Reserve System since April 1995. The Bank’s primary regulators are the Federal Reserve and the Alabama Superintendent of Banks (the “Alabama Superintendent”). The Bank has been a member of the Federal Home Loan Bank of Atlanta (the “FHLB”) since 1991. Certain of the statements made in this discussion and analysis and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Table of Contents 29 Summary of Results of Operations Quarter ended March 31, (Dollars in thousands, except per share data) 2021 2020 Net interest income (a) $ 6,057 $ 6,332 Less: tax-equivalent adjustment 120 120 Net interest income (GAAP) 5,937 6,212 Noninterest income 1,182 1,235 Total revenue 7,119 7,447 Provision for loan losses — 400 Noninterest expense 4,690 4,856 Income tax expense 423 390 Net earnings $ 2,006 $ 1,801 Basic and diluted earnings per share $ 0.56 $ 0.50 (a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." Financial Summary The Company’s net earnings were $2.0 million for the first quarter of 2021, compared to $1.8 million for the first quarter of 2020. Basic and diluted earnings per share were $0.56 per share for the first quarter of 2021, compared to $0.50 per share for the first quarter of 2020. Net interest income (tax-equivalent) was $6.1 million for the first quarter of 2021, a 4% decrease compared to $6.3 million for the first quarter of 2020. This decrease was primarily due to net interest margin compression resulting from the Federal Reserve’s interest rate reductions in response to COVID-19. Net interest margin (tax-equivalent) decreased to 2.66% in the first quarter of 2021, compared to 3.23% for the first quarter of 2020, primarily due to the lower interest rate environment and changes in our asset mix from the significant increase in customer deposits. At March 31, 2021, the Company’s allowance for loan losses was $5.7 million, or 1.23% of total loans, compared to $5.6 million, or 1.22% of total loans, at December 31, 2020, and $4.9 million, or 1.10% of total loans, at March 31, 2020. Excluding PPP loans, which are guaranteed by the SBA, the Company’s allowance for loan losses was 1.31% of total loans at March 31, 2021. The Company had no provision for loan losses during the first quarter of 2021, compared to a provision for loan losses of $0.4 million during the first quarter of 2020. The provision for loan losses during the first quarter of 2020 was related to changes in economic conditions and portfolio trends driven by COVID-19 and resulting adverse economic conditions, including higher unemployment in our primary market area. The provision for loan losses is based upon various estimates and judgements, including the absolute level of loans, loan growth, credit quality and the amount of net charge-offs. Noninterest income was $1.2 million for the first quarter of 2021 and 2020, respectively. For the first quarter of 2021, noninterest income included an increase in mortgage lending income of $0.3 million. The increase was primarily due to an increase in mortgage lending income as lower interest rates for mortgage loans positively affected refinance activity and pricing margins improved. For the first quarter of 2020, noninterest income included $0.3 million in non-taxable death benefits from bank-owned life insurance. Noninterest expense was $4.7 million for the first quarter of 2021 compared to $4.9 million for the first quarter of 2020. The decrease was primarily due to a reduction of $0. 2 million in various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn. Income tax expense was $0.4 million for the first quarter of 2021 and 2020, respectively, reflecting an effective tax rate of 17.41% and 17.80%, respectively. The Company paid cash dividends of $0.26 per share in the first quarter of 2021, an increase of 2% from the same period of 2020. At March 31, 2021, the Bank’s regulatory capital ratios were well above the minimum amounts required to be “well capitalized” under current regulatory standards with a total risk-based capital ratio of 18.25%, a tier 1 leverage ratio of 9.99% and a common equity tier 1 (“CET1”) ratio of 17.21% at March 31, 2021. Table of Contents 30 COVID-19 Impact Assessment In December 2019, COVID-19 was first reported in China and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in our markets. In response to the COVID-19 pandemic, the State of Alabama, and most other states, have taken preventative or protective actions to prevent the spread of the virus, including imposing restrictions on travel and business operations and a statewide mask mandate, advising or requiring individuals to limit or forego their time outside of their homes, limitations on gathering of people and social distancing, and causing temporary closures of businesses that have been deemed to be non-essential. Though certain of these measures have been relaxed or eliminated, increases in reported cases could cause these measures to be reestablished. Auburn University, a major source of economic activity in Lee County, went to remote instruction on March 16, 2020. Auburn University announced its guidelines for the remainder of the 2020/2021 school year, which involves both remote and in person instruction as well as other social distancing measures. The economic effects of these measures are not presently known. COVID-19 has significantly affected local state, national and global health and economic activity and its future effects are uncertain and will depend on various factors, including, among others, the duration and scope of the pandemic, the development and distribution of COVID-19 testing and contact tracing, effective drug treatments and vaccines, together with governmental, regulatory and private sector responses. COVID-19 has had continuing significant effects on the economy, financial markets and our employees, customers and vendors. Our business, financial condition and results of operations generally rely upon the ability of our borrowers to make deposits and repay their loans, the value of collateral underlying our secured loans, market value, stability and liquidity and demand for loans and other products and services we offer, all of which are affected by the pandemic. See “Balance Sheet Analysis – Loans” for supplemental COVID -19 disclosures. We have implemented a number of procedures in response to the pandemic to support the safety and well-being of our employees, customers and shareholders. • We believe our business continuity plan has worked to provide essential banking services to our communities and customers, while protecting our employees’ health. As part of our efforts to exercise social distancing in accordance with the guidelines of the Centers for Disease Control and the Governor of the State of Alabama, starting March 23, 2020, we limited branch lobby service to appointment only while continuing to operate our branch drive-thru facilities and ATMs. On June 1, 2020, we re-opened some of our branch lobbies as permitted by state public health guidelines. We continue to provide services through our online and other electronic channels. In addition, we established remote work access to help employees stay at home where job duties permit. • Our 2021 Annual Shareholders’ Meeting will, again, be a virtual meeting. Shareholders that wish to participate may access web portals and live streams of the Annual Shareholders’ Meeting. • We are focused on servicing the financial needs of our commercial and consumer clients with extensions and deferrals to loan customers effected by COVID-19, provided such customers were not more than 30 days past due at the time of the request; and • We are a participating lender in the PPP. PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the Small Business Administration (“SBA”) remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10-month period. We believe these loans and our participation in the program is good for our customers and the communities we serve. Table of Contents 31 A summary of PPP loans extended during 2020 follows: (Dollars in thousands) # of SBA Approved Mix $ of SBA Approved Mix SBA Tier: $2 million to $10 million — — % $ — — % $350,000 to less than $2 million 23 5 14,691 40 Up to $350,000 400 95 21,784 60 Total 423 100 % $ 36,475 100 % We collected approximately $1.5 million in fees related to our PPP loans during 2020, which will be recognized net of related costs, as a yield adjustment over the life of the underlying PPP loans. On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) was signed into law. The Economic Aid Act provides a second $900 billion stimulus package, including $325 billion in additional PPP loans. A summary of PPP loans extended under the Economic Aid Act follows: (Dollars in thousands) # of SBA Approved Mix $ of SBA Approved Mix SBA Tier: $2 million to $10 million — — % $ — — % $350,000 to less than $2 million 12 6 6,494 35 Up to $350,000 192 94 12,217 65 Total 204 100 % $ 18,711 100 % As of March 31, 2021, we collected approximately $0.9 million in fees related to PPP loans under the Economic Aid Act, which will be recognized net of related costs, as a yield adjustment over the life of the underlying PPP loans. The PPP, as amended and extended, is scheduled to stop accepting applications by May 31, 2021. We continue to closely monitor this pandemic, and are working to continue our services during the pandemic and to address developments as those occur. Our results of operations for the quarter ended March 31, 2021 , and our financial condition at that date reflect only the initial effects of the pandemic, and may not be indicative of future results or financial conditions, including possible additional monetary or fiscal stimulus, and the possible effects of the expiration or extension of temporary accounting and bank regulatory relief measures in response to the COVID-19 pandemic. As of March 31, 2021, all of our capital ratios were in excess of all regulatory requirements to be well capitalized. The effects of the COVID-19 pandemic on our borrowers could result in adverse changes to credit quality and our regulatory capital ratios. We continue to closely monitor this pandemic, and are working to continue our services during the pandemic and to address developments as those occur. CRITICAL ACCOUNTING POLICIES The accounting and financial reporting policies of the Company conform with U.S. GAAP and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements and the valuation of OREO and deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations. Table of Contents 32 Allowance for Loan Losses The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because the level of the allowance is based upon management’s evaluati on of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred, which serves to validate that full repayment pursuant to the terms of the loan is unlikely. The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement. An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, the impairment measurement is based on the fair value of the collateral, less estimated disposal costs. The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge- offs, net of recoveries of amounts previously charged -off. In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan. As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment. The Company analyzes each segment and estimates an allowance allocation for each loan segment. The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for each loan segment. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At March 31, 2021 and December 31, 2020, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups. The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures, and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors. Table of Contents 33 The Company regularly re-evaluates its practices in determining the allowance for loan losses. Since the fourth quarter of 2016, the Company has increased its look-back period each quarter to incorporate the effects of at least one economic downturn in its loss history. The Company believes the extension of its look-back period is appropriate due to the risks inherent in the loan portfolio. Absent this extension, the early cycle periods in which the Company experienced significant losses would be excluded from the determination of the allowance for loan losses and its balance would decrease. For the quarter ended March 31, 2021, the Company increased its look -back period to 48 quarters to continue to include losses incurred by the Company beginning with the first quarter of 2009. The Company will likely continue to increase its look- back period to incorporate the effects of at least one economic downturn in its loss history. During 2020, the Company adjusted certain qualitative and economic factors related to changes in economic conditions and portfolio trends driven by the impact of the COVID-19 pandemic and resulting adverse economic conditions, including higher unemployment in our primary market area. Further adjustments may be made in the future as a result of the continuing COVID-19 pandemic. Assessment for Other-Than-Temporary Impairment of Securities On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For debt securities with an unrealized loss, an other-than -temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that it will be required to sell the debt security before recovery, the other-than -temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other -than-temporary impairment write- down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes. The Company is required to own certain stock as a condition of membership, such as Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”). These non-marketable equity securities are accounted for at cost which equals par or redemption value. These securities do not have a readily determinable fair value as their ownership is restricted and there is no market for these securities. The Company records these non-marketable equity securities as a component of other assets, which are periodically evaluated for impairment. Management considers these non-marketable equity securities to be long-term investments. Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Fair Value Determination U.S. GAAP requires management to value and disclose certain of the Company’s assets and liabilities at fair value, including investments classified as available-for-sale and derivatives. ASC 820, Fair Value Measurements and Disclosures , which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 6, Fair Value, of the consolidated financial statements that accompany this report. Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have readily available active market pricing. However, some of the Company’s assets or liabilities lack an available or comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility, and other factors, taking into account current observable market data and experience. These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results. Table of Contents 34 Other Real Estate Owned OREO consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value of collateral, less estimated costs to sell at the date acquired, with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO. At March 31, 2021 and December 31, 2020 the Company had no OREO properties. Deferred Tax Asset Valuation A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely- than-not that some portion or the entire deferred tax asset 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 taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences at March 31, 2021. The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced. RESULTS OF OPERATIONS Average Balance Sheet and Interest Rates Quarter ended March 31, 2021 2020 Average Yield/ Average Yield/ (Dollars in thousands) Balance Rate Balance Rate Loans and loans held for sale $ 466,368 4.50% $ 452,155 4.81% Securities - taxable 289,981 1.33% 196,422 2.27% Securities - tax-exempt 63,050 3.68% 60,895 3.78% Total securities 353,031 1.75% 257,317 2.63% Federal funds sold 32,809 0.15% 29,758 1.26% Interest bearing bank deposits 70,350 0.09% 49,378 1.52% Total interest-earning assets 922,558 2.96% 788,608 3.76% Deposits: NOW 172,055 0.16% 149,344 0.51% Savings and money market 281,844 0.25% 220,909 0.46% Time Deposits 159,466 1.09% 167,447 1.44% Total interest-bearing deposits 613,365 0.44% 537,700 0.78% Short-term borrowings 3,161 0.50% 1,361 0.50% Total interest-bearing liabilities 616,526 0.44% 539,061 0.78% Net interest income and margin (tax-equivalent) $ 6,057 2.66% $ 6,332 3.23% Net Interest Income and Margin Net interest income (tax-equivalent) was $6.1 million for the first quarter of 2021 compared to $6.3 million for the first quarter of 2020. This decrease was due to a decline in the Company’s net interest margin (tax-equivalent). The tax-equivalent yield on total interest-earning assets decreased by 80 basis points to 2.96% in the first quarter of 2021 compared to 3.76% in the first quarter of 2020. This decrease was primarily due to the lower rate environment, including a 150 basis point reduction in the federal funds rate that occurred in March 2020 and changes in our asset mix due to the significant increase in customer deposits. Table of Contents 35 The cost of total interest-bearing liabilities decreased 34 basis points in the first quarter of 2021 from the first quarter of 2020 to 0.44%. The net decrease in our funding costs was primarily due to lower prevailing market interest rates. Such costs declined less than the declines in rates earned on our interest earning assets. The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations. The Company’s net interest margin could continue to experience pressure due to reduced earning asset yields and increased competition for quality loan opportunities. Provision for Loan Losses The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that management believes, based on its processes and estimates, should be adequate to provide for the probable losses on outstanding loans. There was no provision for loan losses for the first quarter of 2021, compared to $0.4 million in provision for loan losses for the first quarter of 2020. The provision for loan losses during the first quarter of 2020 was related to changes in economic conditions and portfolio trends driven by the impact of COVID-19 and resulting adverse economic conditions, including higher unemployment in our primary market area. The provision for loan losses is based upon various factors, including the absolute level of loans, loan growth, the credit quality, and the amount of net charge- offs or recoveries. Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover its estimate of probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 1.23% at March 31, 2021, compared to 1.22% at December 31, 2020. At March 31, 2021, the Company’s allowance for loan losses was 1.31% of total loans, excluding PPP loans, which are guaranteed by the SBA. While the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are based on estimates and judgments and are therefore approximate and imprecise. Factors beyond our control (such as conditions in the local and national economy, local real estate markets, or industries) may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses resulting in significant increases in the provision for loan losses. Noninterest Income Quarter ended March 31, (Dollars in thousands) 2021 2020 Service charges on deposit accounts $ 132 $ 172 Mortgage lending income 549 230 Bank-owned life insurance 103 398 Securities gains, net — 6 Other 398 429 Total noninterest income $ 1,182 $ 1,235 The decrease in service charges on deposit accounts was driven by a decline in consumer spending activity as a result of the COVID-19 pandemic. The Company’s income from mortgage lending was primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains or losses from the sale of the mortgage loans originated, origination fees, underwriting fees, and other fees associated with the origination of loans, which are netted against the commission expense associated with these originations. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either sell or retain the associated MSRs when the loan is sold. MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense. Table of Contents 36 The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by grouping MSRs by common predominant characteristics, such as interest rate and loan type. If the aggregate carrying amount of a particular group of MSRs exceeds the group’s aggregate fair value, a valuation allowance for that group is established. The valuation allowance is adjusted as the fair value changes. An increase in mortgage interest rates typically results in an increase in the fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease in the fair value of MSRs. The following table presents a breakdown of the Company’s mortgage lending income. Quarter ended March 31, (Dollars in thousands) 2021 2020 Origination income, net $ 537 $ 163 Servicing fees, net 12 67 Total mortgage lending income $ 549 $ 230 The increase in mortgage lending income was primarily due to an increase in mortgage refinance activity. The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to the origination and sale of new mortgage loans. The increase in mortgage lending income was partially offset by a decrease in servicing fees, net of related amortization expense as prepayment speeds increased in the first quarter of 2021, resulting in increased amortization expense. Income from bank-owned life insurance decreased primarily due to $0.3 million in non-taxable death benefits received in the first quarter of 2020. The assets that support these policies are administered by the life insurance carriers and the income we receive (i.e., increases or decreases in the cash surrender value of the policies and death benefits received) on these policies is dependent upon the returns the insurance carriers are able to earn on the underlying investments that support these policies. Earnings on these policies are generally not taxable. Noninterest Expense Quarter ended March 31, (Dollars in thousands) 2021 2020 Salaries and benefits $ 2,851 $ 2,831 Net occupancy and equipment 438 597 Professional fees 256 258 Other 1,145 1,170 Total noninterest expense $ 4,690 $ 4,856 The decrease in net occupancy and equipment expense was primarily due to a reduction of $0.2 million in various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn. Income Tax Expense Income tax expense was $0.4 million for the first quarter of 2021 and 2020, respectively, reflecting an effective tax rate of 17.41% and 17.80%, respectively. BALANCE SHEET ANALYSIS Securities Securities available-for-sale were $3 59.6 million at March 31, 2021 compared to $335.2 million at December 31, 2020. This increase reflects an increase in the amortized cost basis of securities available-for-sale of $31.3 million, and a decrease of $6.9 million in the fair value of securities available-for-sale. The increase in the amortized cost basis of securities available-for-sale was primarily attributable to management allocating more funding to the investment portfolio following the significant increase in customer deposits. The decrease in the fair value of securities was primarily due to an increase in long-term interest rates. The average annualized tax-equivalent yields earned on total securities were 1.75% in 2021 and 2.63% in 2020. Table of Contents 37 Loans 2021 2020 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Commercial and industrial $ 88,687 82,585 98,244 87,754 56,447 Construction and land development 30,332 33,514 31,651 32,967 32,302 Commercial real estate 254,731 255,136 250,992 250,588 256,099 Residential real estate 82,848 84,154 85,054 85,825 91,010 Consumer installment 6,524 7,099 7,731 8,631 8,424 Total loans 463,122 462,488 473,672 465,765 444,282 Less: unearned income (1,243) (788) (1,219) (1,491) (414) Loans, net of unearned income $ 461,879 461,700 472,453 464,274 443,868 Total loans, net of unearned income, were $461.9 million at March 31, 2021, an increase of $0.2 million from $461.7 million at December 31, 2020. Excluding PPP loans, total loans net of unearned income, were $433.2 million, a decrease of $9.5 million, or 2% from $442.7 million at December 31, 2020 . This decrease was primarily due to a decrease in commercial and industrial loans, excluding PPP loans, commercial and land development loans and residential real estate loans of $3.6 million, $3.2 million and $1.3 million, respectively, as lower rates increased refinance activity and payoffs . Four loan categories represented the majority of the loan portfolio at March 31, 2021: commercial real estate (55%), residential real estate (18%), commercial and industrial (19%) and construction and land development (7%). Approximately 20% of the Company’s commercial real estate loans were classified as owner -occupied at March 31, 2021. Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $8.2 million, or 2% of total loans, at March 31, 2021, compared to $8.7 million, or 2% of total loans, at December 31, 2020. For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required interest-only payments at March 31, 2021 and December 31, 2020. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any mater ial amount of other high-risk consumer mortgage products. The average yield earned on loans and loans held for sale was 4.50 % in the first quarter of 2021 and 4.81% in the first quarter of 2020. The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions, including the COVID-19 pandemic’s effects, on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, competitive pressures from a wide range of other lenders, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations. The Company attempts to reduce these economic and credit risks through its loan-to-value guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we have established and periodically review, lending policies and procedures. Banking regulations limit a bank’s credit exposure by prohibiting unsecured loan relationships that exceed 10% of its capital; or 20% of capital, if loans in excess of 10% of capital are fully secured. Under these regulations, we are prohibited from having secured loan relationships in excess of approximately $20.6 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $18.5 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At March 31, 2021, the Bank had no relationships exceeding these limits. Table of Contents 38 We periodically analyze our commercial and industrial and commercial real estate loan portfolios to determine if a concentration of credit risk exists in any one or more industries. We use classification systems broadly accepted by the financial services industry in order to categorize our commercial borrowers. Loan concentrations to borrowers in the following classes exceeded 25% of the Bank’s total risk-based capital at March 31, 2021 (and related balances at December 31, 2020). March 31, December 31, (Dollars in thousands) 2021 2020 Hotel/motel $ 48,268 $ 42,900 Lessors of 1-4 family residential properties 49,196 49,127 Multi-family residential properties 37,936 40,203 Shopping centers 29,562 30,000 Supplemental COVID-19 Industry Exposure We have identified certain commercial sectors with enhanced risk resulting from the impact of COVID-19. Loans within these sectors represent 86% of the Company’s total COVID-19 related modifications at March 31, 2021 and December 31, 2020. The table below summarizes the loans outstanding for these sectors at March 31, 2021 and December 31, 2020. Portfolio Segment Commercial and Construction and Commercial (Dollars in thousands) industrial land development real estate Total % of Total Loans March 31, 2021: Hotel/motel $ 741 5,604 48,268 $ 54,613 12 % Shopping centers — — 29,562 29,562 6 Retail, excluding shopping centers 401 — 17,544 17,945 4 Restaurants 1,317 — 12,158 13,475 3 Total $ 2,459 5,604 107,532 $ 115,595 25 % Portfolio Segment Commercial and Construction and Commercial (Dollars in thousands) industrial land development real estate Total % of Total Loans December 31, 2020: Hotel/motel $ 866 10,549 42,900 $ 54,315 12 % Shopping centers 8 — 30,000 30,008 6 Retail, excluding shopping centers 327 — 18,053 18,380 4 Restaurants 1,407 — 12,865 14,272 3 Total $ 2,608 10,549 103,818 $ 116,975 25 % In light of disruptions in economic conditions caused by COVID -19, the financial regulators have issued guidance encouraging banks to work constructively with borrowers affected by the virus in our community. This guidance, including the Interagency Statement on COVID-19 Loan Modifications and the Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID -19 Pandemic on Institutions, provides that the agencies will not criticize financial institutions that mitigate credit risk through prudent actions consistent with safe and sound practices. Specifically, examiners will not criticize institutions for working with borrowers as part of a risk mitigation strategy intended to improve existing loans, even if the restructured loans have or develop weaknesses that ultimately result in adverse credit classification. Upon demonstrating the need for payment relief, the bank will work with qualified borrowers that were otherwise current before the pandemic to determine the most appropriate deferral option. For residential mortgage and consumer loans the borrower may elect to defer payments for up to three months. Interest continues to accrue and the amount due at maturity increases. Commercial real estate, commercial, and small business borrowers may elect to defer payments for up to three months or pay scheduled interest payments for a six-month period. The bank recognizes that a combination of the payment relief options may be prudent dependent on a borrower’s business type. As of March 31, 2021 we have granted loan payment deferrals or payments of interest-only primarily on commercial and industrial and commercial real estate loans totaling $32.4 million, or 7% of total loans, compared to $32.3 million, or 7% of total loans at December 31, 2020. Table of Contents 39 The tables below provide information concerning the composition of these COVID-19 modifications as of March 31, 2021 and December 31, 2020. COVID-19 Modifications Modification Types (Dollars in thousands) # of Loans Modified Balance % of Portfolio Modified Interest Only Payment P&I Payments Deferred March 31, 2021: Commercial and industrial 2 $ 741 — % 100 % — % Commercial real estate 12 31,391 7 100 — Residential real estate 3 314 — — 100 Total 17 $ 32,446 7 % 99 % 1 % December 31, 2020: Commercial and industrial 2 $ 741 — % 100 % — % Commercial real estate 12 31,399 7 100 — Residential real estate 2 133 — — 100 Total 16 $ 32,273 7 % 99 % 1 % COVID-19 Modifications within High Exposure Commercial Real Estate Segments (Dollars in thousands) # of Loans Modified Balance of Loans Modified % of Total Segment Loans March 31, 2021: Hotel/motel 10 $ 26,419 48 % Restaurants 1 1,442 11 December 31, 2020: Hotel/motel 10 $ 26,427 49 % Restaurants 1 1,442 10 Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP. In addition, the Interagency Statement on COVID-19 Loan Modifications provides circumstances in which a loan modification is not subject to classification as a TDR if such loan is not eligible for modification under Section 4013. Allowance for Loan Losses The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover the Company’s estimate of probable losses inherent in the loan portfolio. The allowance for loan losses was $5. 7 million at March 31, 2021 compared to $5.6 million at December 31, 2020, which management believed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are described under “Critical Accounting Policies.” Table of Contents 40 A summary of the changes in the allowance for loan losses and certain asset quality ratios for the first quarter of 2021 and the previous four quarters is presented below. 2021 2020 First Fourth Third Second First (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Balance at beginning of period $ 5,618 5,575 5,308 4,867 4,386 Charge-offs: Commercial and industrial — (4) — (3) — Consumer installment (5) (1) (4) (28) (5) Total charge -offs (5) (5) (4) (31) (5) Recoveries 69 48 21 22 86 Net recoveries (charge-offs) 64 43 17 (9) 81 Provision for loan losses — — 250 450 400 Ending balance $ 5,682 5,618 5,575 5,308 4,867 as a % of loans 1.23 % 1.22 1.18 1.14 1.10 as a % of nonperforming loans 726 % 1,052 1,015 783 4,196 Net (recoveries) charge-offs as % of average loans (a) (0.06) % (0.04) (0.01) 0.01 (0.07) (a) Net (recoveries) charge-offs are annualized. As described under “Critical Accounting Policies,” management assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors. This evaluation is inherently subjective as it requires various material estimates and judgments, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The ratio of our allowance for loan losses to total loans outstanding was 1.23 % at March 31, 2021, compared to 1.22% at December 31, 2020. At March 31, 2021, the Company’s allowance for loan losses was 1.31% of total loans, excluding PPP loans. In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment, including the duration and magnitude of COVID-19 effects, in their entirety either improve or weaken. In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for loan losses based on their judgment about information available to them at the time of their examinations. Nonperforming Assets The Company had $0.8 million and $0.5 million in nonperforming assets at March 31, 2021 and December 31, 2020, respectively. The table below provides information concerning total nonperforming assets and certain asset quality ratios for the first quarter of 2021 and the previous four quarters. 2021 2020 First Fourth Third Second First (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Nonperforming assets: Nonaccrual loans $ 783 534 549 678 116 Other real estate owned — — — — 99 Total nonperforming assets $ 783 534 549 678 215 as a % of loans and other real estate owned 0.17 % 0.12 0.12 0.15 0.05 as a % of total assets 0.08 % 0.06 0.06 0.07 0.03 Nonperforming loans as a % of total loans 0.17 % 0.12 0.12 0.15 0.03 Table of Contents 41 The table below provides information concerning the composition of nonaccrual loans for the first quarter of 2021 and the previous four quarters. 2021 2020 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Nonaccrual loans: Commercial real estate $ 206 212 216 218 — Residential real estate 577 322 332 459 112 Consumer installment — — 1 1 4 Total nonaccrual loans $ 783 534 549 678 116 The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is 90 days or more past due, unless the loan is both well-secured and in the process of collection. At March 31, 2021, the Company had $0.8 million in loans on nonaccrual status compared to $0.5 million at December 31, 2020. The Company had no loans 90 days or more past due and still accruing at March 31, 2021 compared to $0.1 million at December 31, 2020. The table below provides information concerning the composition of OREO for the first quarter of 2021 and the previous four quarters. 2021 2020 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Other real estate owned: Residential $ — — — — 99 Total other real estate owned $ — — — — 99 Potential Problem Loans Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of a borrower has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Federal Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans. Potential problem loans, which are not included in nonperforming assets, amounted to $2.8 million, or 0.6% of total loans at March 31, 2021, and $2.9 million, or 0.6% of total loans at December 31, 2020. The table below provides information concerning the composition of potential problem loans for the first quarter of 2021 and the previous four quarters. 2021 2020 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Potential problem loans: Commercial and industrial $ 299 218 230 211 246 Construction and land development 247 254 563 568 910 Commercial real estate 173 188 188 165 170 Residential real estate 2,092 2,229 2,486 2,645 2,913 Consumer installment 9 23 42 55 63 Total potential problem loans $ 2,820 2,912 3,509 3,644 4,302 At March 31, 2021 the Company had $0.2 million in potential problem loans that were past due at least 30 days, but less than 90 days. Table of Contents 42 The following table is a summary of the Company’s performing loans that were past due at least 30 days, but less than 90 days, for the first quarter of 2021 and the previous four quarters . 2021 2020 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Performing loans past due 30 to 89 days: Commercial and industrial $ 42 230 48 83 4 Construction and land development 10 61 — — 8 Commercial real estate 180 29 — 168 — Residential real estate 399 1,509 106 620 922 Consumer installment 36 29 6 8 19 Total $ 667 1,858 160 879 953 Deposits Total deposits increased $40.8 million, or 5% to $880.6 million at March 31, 2021, compared to $839.8 million at December 31, 2020. Noninterest-bearing deposits were $265.9 million, or 30 % of total deposits, at March 31, 2021, compared to $245.4 million, or 29% of total deposits at December 31, 2020. These increases reflect deposits from customers who received PPP loans, the impact of government stimulus checks, delayed tax payments and less customer spending during the COVID-19 pandemic. The average rate paid on total interest-bearing deposits was 0.44 % in the first quarter of 2021 compared to 0.78% in the first quarter of 2020. Other Borrowings Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings generally consist of federal funds purchased and agreements with certain customers to sell certain securities under agreements to repurchase with an original maturity less than one year. The Bank had available federal funds lines totaling $41.0 million with none outstanding at March 31, 2021, and at December 31, 2020, respectively. Securities sold under agreements to repurchase totaled $3.3 million at March 31, 2021, compared to $2.4 million at December 31, 2020. The average rate paid on short-term borrowings was 0.50% in the first quarter of 2021 and 2020. The Company had no long-term debt at March 31, 2021 and December 31, 2020. CAPITAL ADEQUACY The Company’s consolidated stockholders’ equity was $103.6 million and $107.7 million as of March 31, 2021 and December 31, 2020, respectively. The decrease from December 31, 2020 was primarily driven by an other comprehensive loss due to the change in unrealized gains (losses) on securities available-for-sale, net of tax of $5.1 million and cash dividends paid of $0.9 million, partially offset by net earnings of $2.0 million. On January 1, 2015, the Company and Bank became subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes. The rules included the implementation of a capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. The capital conservation buffer was subject to a three year phase -in period that began on January 1, 2016 and was fully phased -in on January 1, 2019 at 2.5%. A banking organization with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At March 31, 2021, the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer. Table of Contents 43 Effective March 20, 2020, the Federal Reserve and the other federal banking regulators adopted an interim final rule that amended the capital conservation buffer. The interim final rule was adopted as a final rule on August 26, 2020. The new rule revises the definition of “eligible retained income” for purposes of the maximum payout ratio to allow banking organizations to more freely use their capital buffers to promote lending and other financial intermediation activities, by making the limitations on capital distributions more gradual. The eligible retained income is now the greater of (i) net income for the four preceding quarters, net of distributions and associated tax effects not reflected in net income; and (ii) the average of all net income over the preceding four quarters. The interim final rule only affects the capital buffers, and banking organizations were encouraged to make prudent capital distribution decisions. The Federal Reserve has treated us as a “small bank holding company’ under the Federal Reserve’s policy. Accordingly, our capital adequacy is evaluated at the Bank level, and not for the Company and its consolidated subsidiaries. The Bank’s tier 1 leverage ratio was 9.99%, CET1 risk-based capital ratio was 17.21%, tier 1 risk-based capital ratio was 17.21%, and total risk-based capital ratio was 18.25% at March 31, 2021. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio, 8.0% for tier 1 risk-based capital ratio, and 10.0% for total risk-based capital ratio to be considered “well capitalized.” The Bank’s capital conservation buffer was 10.25% at March 31, 2021. MARKET AND LIQUIDITY RISK MANAGEMENT Management’s objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. The Bank’s Asset Liability Management Committee (“ALCO”) is charged with the responsibility of monitoring these policies, which are designed to ensure an acceptable asset/liability composition. Two critical areas of focus for ALCO are interest rate risk and liquidity risk management. Interest Rate Risk Management In the normal course of business, the Company is exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic value of equity (“EVE”) model. Earnings simulation . Management believes that interest rate risk is best estimated by our earnings simulation modeling. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of market interest rates for the next 12 months and other factors in order to produce various earnings simulations and estimates. To help limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income from gradual changes in interest rates. For changes up or down in rates from management’s flat interest rate forecast over the next 12 months, policy limits for net interest income variances are as follows: ● +/- 20% for a gradual change of 400 basis points ● +/- 15% for a gradual change of 300 basis points ● +/- 10% for a gradual change of 200 basis points ● +/- 5% for a gradual change of 100 basis points At March 31, 2021, our earnings simulation model indicated that we were in compliance with the policy guidelines noted above. Table of Contents 44 Economic Value of Equity . EVE measures the extent that the estimated economic values of our assets, liabilities, and off- balance sheet items will change as a result of interest rate changes. Economic values are estimated by discounting expected cash flows from assets, liabilities, and off-balance sheet items, which establishes a base case EVE. In contrast with our earnings simulation model, which evaluates interest rate risk over a 12 month timeframe, EVE uses a terminal horizon which allows for the re-pricing of all assets, liabilities, and off -balance sheet items. Further, EVE is measured using values as of a point in time and does not reflect any actions that ALCO might take in responding to or anticipating changes in interest rates, or market and competitive conditions. To help limit interest rate risk, we have stated policy guidelines for an instantaneous basis point change in interest rates, such that our EVE should not decrease from our base case by more than the following: ● 45% for an instantaneous change of +/- 400 basis points ● 35% for an instantaneous change of +/- 300 basis points ● 25% for an instantaneous change of +/- 200 basis points ● 15% for an instantaneous change of +/- 100 basis points At March 31, 2021, our EVE model indicated that we were in compliance with the policy guidelines noted above. Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other economic and market factors, including market perceptions. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory , consistent levels of profitability within the framework of the Company’s established liquidity, loan, investment, borrowing, and capital policies. The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities, and as a tool to manage interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. From time to time, the Company may enter into interest rate swaps to facilitate customer transactions and meet their financing needs. These interest rate swaps qualify as derivatives, but are not designated as hedging instruments. At March 31, 2021 and December 31, 2020, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity. Liquidity Risk Management 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 obligations. Without proper management of its liquidity, 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. Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Company and the Bank are separate and distinct legal entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements. The Company depends upon dividends from the Bank for liquidity to pay its operating expenses, debt obligations and dividends. The Bank’s payment of dividends depends on its earnings, liquidity, capital and the absence of any regulatory restrictions. The primary source of funding and liquidity for the Company has been dividends received from the Bank. If needed, the Company could also issue common stock or other securities. Primary uses of funds by the Company include dividends paid to stockholders, Company stock repurchases, and Company expenses. Table of Contents 45 Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and the sale and repayment of loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank may participate in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and may be taken out with varying maturities. At March 31, 2021, the Bank had a remaining available line of credit with the FHLB of $286.9 million. At March 31, 2021, the Bank also had $41.0 million of available federal funds lines with no borrowings outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio. Management believes that the Company and the Bank have adequate sources of liquidity to meet all their respective known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months. Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual Obligations At March 31, 2021, the Bank had outstanding standby letters of credit of $1.4 million and unfunded loan commitments outstanding of $72.1 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank could liquidate federal funds sold or a portion of securities available-for- sale, or draw on its available credit facilities. Mortgage lending activities We primarily sell residential mortgage loans in the secondary market to Fannie Mae while retaining the servicing of these loans. The sale agreements for these residential mortgage loans with Fannie Mae and other investors include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the representations and warranties vary among investors, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, among other matters. As of March 31, 2021, the unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights was $263.7 million. Although these loans are generally sold on a non-recourse basis, we may be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred (make whole requests) if a loan review reveals a potential breach of seller representations and warranties. Upon receipt of a repurchase or make whole request, we work with investors to arrive at a mutually agreeable resolution. Repurchase and make whole requests are typically reviewed on an individual loan by loan basis to validate the claims made by the investor and to determine if a contractually required repurchase or make whole event has occurred. We seek to reduce and manage the risks of potential repurchases, make whole requests, or other claims by mortgage loan investors through our underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards. The Company was not required to repurchase any loans during the first quarter of 2021 as a result of representation and warranty provisions contained in the Company’s sale agreements with Fannie Mae, and had no pending repurchase or make-whole requests at March 31, 2021. We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements governing our rights and duties as servicer. The agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by us in such capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards are determined by servicing guides issued by Fannie Mae as well as the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase of an affected loan. Table of Contents 46 Although repurchase and make whole requests related to representation and warranty provisions and servicing activities have been limited to date, it is possible that requests to repurchase mortgage loans or reimburse investors for losses incurred (make whole requests) may increase in frequency if investors more aggressively pursue all means of recovering losses on their purchased loans. As of March 31, 2021, we do not believe that this exposure is material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99% of our residential mortgage loans serviced for Fannie Mae were current as of such date. We maintain ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor portfolios. Section 4021 of the CARES Act allows borrowers under 1-4 family residential mortgage loans sold to Fannie Mae to request forbearance to the servicer after affirming that such borrower is experiencing financial hardships during the COVID-19 emergency. Such forbearance will be up to 180 days, subject to up to a 180 day extension. During forbearance, no fees, penalties or interest shall be charged beyond those applicable if all contractual payments were fully and timely paid. Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on similar procedures or related evictions or sales until December 31, 2020. The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual basis. As a result, the Bank is not obligated to make any advances to Fannie Mae on principal and interest on such mortgage loans where the borrower is entitled to forbeara nce. Effects of Inflation and Changing Prices The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with U.S. GAAP and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation. CURRENT ACCOUNTING DEVELOPMENTS The following ASUs have been issued by the FASB but are not yet effective. ● ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments; Information about these pronouncements is described in more detail below. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): - Measurement of Credit Losses on Financial Instruments , amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, the new standard eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses using a broader range of information regarding past events, current conditions and forecasts assessing the collectability of cash flows. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however the new standard will require that credit losses be presented as an allowance rather than as a write-down. The new guidance affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. For public business entities, the new guidance was originally effective for annual and interim periods in fiscal years beginning after December 15, 2019. The Company has developed an implementation team that is following a gener al timeline. The team has been working with an advisory consultant, with whom a third-party software license has been purchased. The Company’s preliminary evaluation indicates the provisions of ASU No. 2016-13 are expected to impact the Company’s consolidated financial statements, in particular the level of the reserve for credit losses. The Company is continuing to evaluate the extent of the potential impact and expects that portfolio composition and economic conditions at the time of adoption will be a factor. On October 16, 2019, the FASB approved a previously issued proposal granting smaller reporting companies a postponement of the required implementation date for ASU 2016-13. The Company will now be required to implement the new standard in January 2023, with early adoption permitted in any period prior to that date. Table of Contents 47 Table 1 – Explanation of Non-GAAP Financial Measures In addition to results presented in accordance with U.S. generally accepted accounting principles (GAAP), this quarterly report on Form 10-Q includes certain designated net interest income amounts presented on a tax-equivalent basis, a non- GAAP financial measure, including the presentation and calculation of the efficiency ratio. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non- GAAP financial measures to their most directly comparable GAAP financial measures are presented below. 2021 2020 First Fourth Third Second First (in thousands) Quarter Quarter Quarter Quarter Quarter Net interest income (GAAP) $ 5,937 6,188 5,868 6,070 6,212 Tax-equivalent adjustment 120 123 122 127 120 Net interest income (Tax -equivalent) $ 6,057 6,311 5,990 6,197 6,332 Table of Contents 48 Table 2 - Selected Quarterly Financial Data 2021 2020 First Fourth Third Second First (Dollars in thousands, except per share amounts) Quarter Quarter Quarter Quarter Quarter Results of Operations Net interest income (a) $ 6,057 6,311 5,990 6,197 6,332 Less: tax-equivalent adjustment 120 123 122 127 120 Net interest income (GAAP) 5,937 6,188 5,868 6,070 6,212 Noninterest income 1,182 1,403 1,374 1,363 1,235 Total revenue 7,119 7,591 7,242 7,433 7,447 Provision for loan losses — — 250 450 400 Noninterest expense 4,690 5,086 4,653 4,959 4,856 Income tax expense 423 449 403 363 390 Net earnings $ 2,006 2,056 1,936 1,661 1,801 Per share data: Basic and diluted net earnings $ 0.56 0.58 0.54 0.47 0.50 Cash dividends declared 0.26 0.255 0.255 0.255 0.255 Weighted average shares outstanding: Basic and diluted 3,566,299 3,566,276 3,566,239 3,566,166 3,566,146 Shares outstanding, at period end 3,566,326 3,566,276 3,566,276 3,566,176 3,566,146 Book value $ 29.06 30.20 29.81 29.53 29.04 Common stock price High $ 48.00 43.00 56.80 63.40 59.99 Low 37.55 36.75 26.26 36.81 24.11 Period end: 38.37 42.29 36.26 57.09 41.98 To earnings ratio 17.85 20.23 15.97 24.29 16.66 To book value 132 % 140 122 193 145 Performance ratios: Return on average equity 7.37 % 7.63 7.26 6.34 7.24 Return on average assets 0.82 % 0.87 0.84 0.74 0.86 Dividend payout ratio 46.43 % 43.97 47.22 54.26 51.00 Asset Quality: Allowance for loan losses as a % of: Loans 1.23 % 1.22 1.18 1.14 1.10 Nonperforming loans 726 % 1,052 1,015 783 4,196 Nonperforming assets as a % of: Loans and other real estate owned 0.17 % 0.12 0.12 0.15 0.05 Total assets 0.08 % 0.06 0.06 0.07 0.03 Nonperforming loans as a % of total loans 0.17 % 0.12 0.12 0.15 0.03 Annualized net (recoveries) charge-offs as % of average loans (0.06) % (0.04) (0.01) 0.01 (0.07) Capital Adequacy: (c) CET 1 risk-based capital ratio 17.21 % 17.27 17.70 18.00 17.77 Tier 1 risk-based capital ratio 17.21 % 17.27 17.70 18.00 17.77 Total risk-based capital ratio 18.25 % 18.31 18.77 19.04 18.72 Tier 1 leverage ratio 9.99 % 10.32 10.38 10.62 11.17 Other financial data: Net interest margin (a) 2.66 % 2.81 2.72 2.95 3.23 Effective income tax rate 17.41 % 17.92 17.23 17.93 17.80 Efficiency ratio (b) 64.79 % 65.93 63.19 65.60 64.17 Selected average balances: Securities $ 353,031 325,102 315,542 291,333 257,317 Loans, net of unearned income 463,424 466,704 465,285 466,971 451,210 Total assets 980,884 944,439 924,949 893,720 838,725 Total deposits 863,194 828,801 810,747 782,381 734,047 Total stockholders’ equity 108,890 107,791 106,709 104,820 99,560 Selected period end balances: Securities $ 359,630 335,177 320,922 302,193 280,435 Loans, net of unearned income 461,879 461,700 472,453 464,274 443,868 Allowance for loan losses 5,682 5,618 5,575 5,308 4,867 Total assets 993,263 956,597 937,890 942,887 856,475 Total deposits 880,590 839,792 823,980 829,810 746,785 Total stockholders’ equity 103,639 107,689 106,314 105,299 103,563 (a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." (b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income. (c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank. Table of Contents 49 Table 3 - Average Balances and Net Interest Income Analysis Quarter ended March 31, 2021 2020 Interest Interest Average Income/ Yield/ Average Income/ Yield/ (Dollars in thousands) Balance Expense Rate Balance Expense Rate Interest-earning assets: Loans and loans held for sale (1) $ 466,368 $ 5,178 4.50% $ 452,155 $ 5,412 4.81% Securities - taxable 289,981 949 1.33% 196,422 1,111 2.27% Securities - tax-exempt (2) 63,050 572 3.68% 60,895 573 3.78% Total securities 353,031 1,521 1.75% 257,317 1,684 2.63% Federal funds sold 32,809 12 0.15% 29,758 93 1.26% Interest bearing bank deposits 70,350 16 0.09% 49,378 186 1.52% Total interest-earning assets 922,558 $ 6,727 2.96% 788,608 $ 7,375 3.76% Cash and due from banks 13,880 14,184 Other assets 44,446 35,933 Total assets $ 980,884 $ 838,725 Interest-bearing liabilities: Deposits: NOW $ 172,055 $ 66 0.16% $ 149,344 $ 188 0.51% Savings and money market 281,844 172 0.25% 220,909 253 0.46% Time deposits 159,466 428 1.09% 167,447 600 1.44% Total interest-bearing deposits 613,365 666 0.44% 537,700 1,041 0.78% Short-term borrowings 3,161 4 0.50% 1,361 2 0.50% Total interest-bearing liabilities 616,526 $ 670 0.44% 539,061 $ 1,043 0.78% Noninterest-bearing deposits 249,829 196,347 Other liabilities 5,639 3,757 Stockholders' equity 108,890 99,560 Total liabilities and stockholders' equity $ 980,884 $ 838,725 Net interest income and margin (tax-equivalent) $ 6,057 2.66% $ 6,332 3.23% (1) Average loan balances are shown net of unearned income and 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 a federal income tax rate of 21%. Table of Contents 50 Table 4 - Loan Portfolio Composition 2021 2020 First Fourth Third Second First (In thousands) Quarter Quarter Quarter Quarter Quarter Commercial and industrial $ 88,687 82,585 98,244 87,754 56,447 Construction and land development 30,332 33,514 31,651 32,967 32,302 Commercial real estate 254,731 255,136 250,992 250,588 256,099 Residential real estate 82,848 84,154 85,054 85,825 91,010 Consumer installment 6,524 7,099 7,731 8,631 8,424 Total loans 463,122 462,488 473,672 465,765 444,282 Less: unearned income (1,243) (788) (1,219) (1,491) (414) Loans, net of unearned income 461,879 461,700 472,453 464,274 443,868 Less: allowance for loan losses (5,682) (5,618) (5,575) (5,308) (4,867) Loans, net $ 456,197 456,082 466,878 458,966 439,001 Table of Contents 51 Table 5 - Allowance for Loan Losses and Nonperforming Assets 2021 2020 First Fourth Third Second First (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Allowance for loan losses: Balance at beginning of period $ 5,618 5,575 5,308 4,867 4,386 Charge-offs: Commercial and industrial — (4) — (3) — Consumer installment (5) (1) (4) (28) (5) Total charge -offs (5) (5) (4) (31) (5) Recoveries 69 48 21 22 86 Net recoveries (charge-offs) 64 43 17 (9) 81 Provision for loan losses — — 250 450 400 Ending balance $ 5,682 5,618 5,575 5,308 4,867 as a % of loans 1.23 % 1.22 1.18 1.14 1.10 as a % of nonperforming loans 726 % 1,052 1,015 783 4,196 Net (recoveries) charge-offs as % of avg. loans (a) (0.06) % (0.04) (0.01) 0.01 (0.07) Nonperforming assets: Nonaccrual loans $ 783 534 549 678 116 Other real estate owned — — — — 99 Total nonperforming assets $ 783 534 549 678 215 as a % of loans and other real estate owned 0.17 % 0.12 0.12 0.15 0.05 as a % of total assets 0.08 % 0.06 0.06 0.07 0.03 Nonperforming loans as a % of total loans 0.17 % 0.12 0.12 0.15 0.03 Accruing loans 90 days or more past due $ — 21 71 49 — (a) Net (recoveries) charge-offs are annualized. Table of Contents 52 Table 6 - Allocation of Allowance for Loan Losses 2021 2020 First Quarter Fourth Quarter Third Quarter Second Quarter First Quarter (Dollars in thousands) Amount %* Amount %* Amount %* Amount %* Amount %* Commercial and industrial $ 828 19.1 $ 807 17.9 $ 798 20.7 $ 679 18.8 $ 675 12.7 Construction and land development 551 6.5 594 7.2 582 6.7 613 7.1 582 7.3 Commercial real estate 3,259 55.2 3,169 55.2 3,120 53.0 2,915 53.8 2,596 57.6 Residential real estate 951 17.9 944 18.2 954 18.0 954 18.4 877 20.5 Consumer installment 93 1.4 104 1.5 121 1.6 147 1.9 137 1.9 Total allowance for loan losses $ 5,682 $ 5,618 $ 5,575 $ 5,308 $ 4,867 * Loan balance in each category expressed as a percentage of total loans. Table of Contents 53 Table 7 - CDs and Other Time Deposits of $100,000 or More (Dollars in thousands) March 31, 2021 Maturity of: 3 months or less $ 8,221 Over 3 months through 6 months 21,323 Over 6 months through 12 months 29,453 Over 12 months 45,678 Total CDs and other time deposits of $100,000 or more $ 104,675 Table of Contents 54 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information called for by ITEM 3 is set forth in ITEM 2 under the caption “MARKET AND LIQUIDITY RISK MANAGEMENT” and is incorporated herein by reference.