AUBURN NATIONAL BANCORPORATION, INC 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General 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 FHLB of Atlanta 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” as more fully described under “Special Cautionary Notice Regarding Forward-Looking Statements” below. The following discussion and analysis is intended 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 and nine months ended September 30, 2023 and 2022, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2022 and our interim reports on Form 10-Q for the quarters ended March 31, 2023 and June 30, 2023. Special Cautionary 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” “Description of Property” 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,” “designed”, “plan,” “point to,” “project,” “could,” “intend,” “seeks,” “model,” “simulations,” “target”, “view”, 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 local, including inflation, seasonality, natural disasters or climate change, such as rising sea and water levels, hurricanes and tornados, COVID-19 or other epidemics or pandemics including supply chain disruptions, inventory volatility, and changes in consumer behaviors; ● the effects of war or other conflicts, acts of terrorism, trade restrictions, sanctions or other events that may affect general economic conditions; Table of Contents 29 ● governmental monetary and fiscal policies, including the continuing effects of fiscal and monetary stimuli in response to the COVID-19 crisis, followed by changes in monetary policies beginning in March 2022 in response to inflation, including increases in the Federal Reserve’s target federal funds rate and reductions in the Federal Reserve’s holdings of securities; ● 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, including changes in various capital, liquidity and other rule proposals, as well as changes in supervisory and examination focus, in light of three regional bank failures in California and New York in March and May 2023; ● 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 inflation, changes in market interest rates and the shape of the yield curve on the levels, composition and costs of deposits and borrowings, the values of our securities and loans, loan demand and mortgage loan originations, and the values and liquidity of loan collateral, securities, and interest-sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable on collateral; ● the risks of further increases in market interest rates creating additional unrealized losses on our securities available for sale, which adversely affect our stockholders’ equity (including tangible stockholders’ equity) for financial reporting purposes; ● changes in borrower liquidity and credit risks, and savings, deposit 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; ● the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services, including the disruptive effects of financial technology and other competitors who are not subject to the same regulations as the Company and the Bank and credit unions, which are not subject to federal income taxation; ● the failure of assumptions and estimates underlying the establishment of allowances for credit losses, including asset impairments, losses valuations of assets and liabilities and other estimates; ● the timing and amount of rental income from third parties following the June 2022 opening of our new headquarters; ● 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 vendors’ systems or customers’ information; ● the risks that our deferred tax assets (“DTAs”) included in “other assets” on our consolidated balance sheets, 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 Table of Contents 30 ● other factors and risks described herein and under “Risk Factors” in our annual report on Commission Form 10-K as of and for the year ended December 31, 2022 or in any of our subsequent reports that we make with the Securities and Exchange Commission (the “Commission” or “SEC”) under the Exchange Act. All written or oral forward-looking statements that are we make 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. Summary of Results of Operations Quarter ended September 30, Nine months ended September 30, (Dollars in thousands, except per share amounts) 2023 2022 2023 2022 Net interest income (a) $ 6,380 $ 7,360 $ 20,591 $ 20,034 Less: tax-equivalent adjustment 108 117 322 339 Net interest income (GAAP) 6,272 7,243 20,269 19,695 Noninterest income 865 852 2,448 2,608 Total revenue 7,137 8,095 22,717 22,303 Provision for credit losses 105 250 (191) — Noninterest expense 5,362 5,415 16,791 15,374 Income tax expense 182 432 737 1,049 Net earnings $ 1,488 $ 1,998 $ 5,380 $ 5,880 Basic and diluted earnings per share $ 0.43 $ 0.57 $ 1.54 $ 1.67 (a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." Financial Summary The Company’s net earnings were $5.4 million for the first nine months of 2023, compared to $5.9 million for the first nine months of 2022. Basic and diluted earnings per share were $1.54 per share for the first nine months of 2023, compared to $1.67 per share for the first nine months of 2022. Net interest income (tax-equivalent) was $20.6 million for the first nine months of 2023, a 3% increase compared to $20.0 million for the first nine months of 2022. This increase was primarily due to improvements in the Company’s net interest margin. The Company’s net interest margin (tax-equivalent) was 2.97% for the first nine months of 2023 compared to 2.67% for the first nine months of 2022. This increase was primarily due to a more favorable asset mix and higher yields on interest earning assets. These higher yields on interest earning assets were partially offset by increased cost of funds. Average loans for the first nine months of 2023 were $514.7 million, a 16% increase from the first nine months of 2022. See “Results of Operations – Average Balance Sheet and Interest Rates” and “Net Interest Income and Margin” below. At September 30, 2023, the Company’s allowance for credit losses was $6.8 million, or 1.24% of total loans, compared to $5.8 million, or 1.14% of total loans, at December 31, 2022, and $5.0 million, or 1.05% of total loans, at September 30, 2022. The implementation of CECL required pursuant to Accounting Standards Codification (“ASC”) 326, which was effective January 1, 2023, increased our allowance for credit losses by $1.0 million, or 0.20% of total loans, as a day one transition adjustment. The Company recorded a negative provision for credit losses during the first nine months of 2023 of $0.2 million, compared to none during the first nine months of 2022. The provision for credit losses under CECL is reflective of the Company’s credit risk profile and the future economic outlook and forecasts. Our CECL model is largely influenced by economic factors including, most notably, the anticipated unemployment rate. The negative provision for credit losses during the first nine months of 2023 was primarily related to the resolution of a collateral dependent nonperforming loan, with a recorded investment of $1.3 million and a corresponding allowance of $0.5 million, that was collected in full during the second quarter of 2023. This was partially offset by an increase in the calculation of current expected credit losses due to loan growth during the first nine months of 2023. Table of Contents 31 Noninterest income was $2.4 million in the first nine months of 2023, compared to $2.6 million in the first nine months of 2022. The decrease in noninterest income was primarily due to a decrease in mortgage lending income of $0.2 million as a result of higher market interest rates for mortgage loans. Noninterest expense was $16.8 million in the first nine months of 2023, compared to $15.4 million for the first nine months of 2022. The increase in noninterest expense was primarily due to an increase in net occupancy and equipment expense of $0.4 million related to the Company’s new headquarters, which opened in June 2022, professional fees expense of $0.2 million, and other noninterest expense of $0.9 million. Income tax expense was $0.7 million for the first nine months of 2023 compared to $1.0 million for the first nine months of 2022. This decrease was due to a decline in the level of earnings before taxes and the Company’s effective tax rate. The Company's effective tax rate for the first nine months of 2023 was 12.05%, compared to 15.14% in the first nine months of 2022. The Company’s effective income tax rate is principally affected by tax-exempt earnings from the Company’s investment in municipal securities, bank-owned life insurance (“BOLI”), and New Markets Tax Credits (“NMTCs”). The Company paid cash dividends of $0.81 per share in the first nine months of 2023, an increase of 2% from the same period of 2022. The Company repurchased 10,108 shares for $0.2 million during the first nine months of 2023. At September 30, 2023, 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 15.98%, a tier 1 leverage ratio of 10.26% and a common equity tier 1 (“CET1”) ratio of 15.01% at September 30, 2023. At September 30, 2023, the Company’s equity to total assets ratio was 5.96%, compared to 6.65% at December 31, 2022, and 5.74% at September 30, 2022. For the third quarter of 2023, net earnings were $1.5 million, or $0.43 per share, compared to $2.0 million, or $0.57 per share, for the third quarter of 2022. Net interest income (tax-equivalent) was $6.4 million for the third quarter of 2023 compared to $7.4 million for the third quarter of 2022. This decrease was primarily due to decline in the Company’s net interest margin. The Company’s net interest margin (tax-equivalent) was 2.73% in the third quarter of 2023 compared to 3.00% in the third quarter of 2022. The decrease was primarily due to increased cost of funds and changes in our deposit mix, which was partially offset by a more favorable asset mix and higher yields on interest earning assets. The Company recorded a provision for credit losses during the third quarter of 2023 of $0.1 million, compared to $0.3 million for the third quarter 2022. Noninterest income was $0.9 million for both the third quarter of 2023 and 2022. Noninterest expense was $5.4 million in the third quarter of 2023 and 2022. Income tax expense was $0.2 million for the third quarter of 2023, compared to $0.4 million for the third quarter of 2022. This decrease was due to a decline in the level of earnings before taxes and the Company’s effective tax rate. The Company's effective tax rate for the third quarter of 2023 was 10.90%, compared to 17.78% in the third quarter of 2022. The Company’s effective income tax rate is principally impacted by tax- exempt earnings from the Company’s investment in municipal securities, bank-owned life insurance, and New Markets Tax Credits. CRITICAL ACCOUNTING POLICIES The accounting principles we follow and our methods of applying these principles conform with U.S. GAAP and with general practices within the banking industry. The accounting policies which we believe to be most critical in preparing our Consolidated Financial Statements are presented in the section titled “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. On January 1, 2023, we adopted FASB ASU 2016-13 Financial Instruments - Credit Losses (Topic 326) which significantly changes our methodology for determining our allowance for credit losses, and ASU 2022-02 , Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures which eliminated the accounting guidance for TDRs, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. See Note 1. Summary of Significant Accounting Policies in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q for further information related to these changes. There have been no other significant changes to our Critical Accounting Estimates as described in our Form 10-K. Table of Contents 32 RESULTS OF OPERATIONS Average Balance Sheet and Interest Rates Nine months ended September 30, 2023 2022 Average Yield/ Average Yield/ (Dollars in thousands) Balance Rate Balance Rate Loans and loans held for sale $ 514,706 4.71% $ 442,613 4.42% Securities - taxable 344,136 2.13% 371,595 1.69% Securities - tax-exempt 54,615 3.75% 60,034 3.59% Total securities 398,751 2.35% 431,629 1.95% Federal funds sold 4,372 4.86% 54,924 0.76% Interest bearing bank deposits 8,118 4.66% 73,630 0.82% Total interest-earning assets 925,947 3.70% 1,002,796 2.89% Deposits: NOW 189,586 0.75% 201,792 0.13% Savings and money market 291,988 0.63% 335,005 0.20% Time deposits 168,000 1.99% 155,824 0.84% Total interest-bearing deposits 649,574 1.02% 692,621 0.32% Short-term borrowings 3,748 2.43% 3,969 0.50% Total interest-bearing liabilities 653,322 1.02% 696,590 0.32% Net interest income and margin (tax-equivalent) $ 20,591 2.97% $ 20,034 2.67% Net Interest Income and Margin Net interest income (tax-equivalent) was $20.6 million for the first nine months of 2023, a 3% increase compared to $20.0 million for the first nine months of 2022. This increase was primarily due to improvements in the Company’s net interest margin (tax-equivalent). The Company’s net interest margin (tax-equivalent) was 2.97% in the first nine months of 2023 compared to 2.67% in the first nine months of 2022. This increase was primarily due to a more favorable asset mix and higher yields on interest earning assets. These higher yields on interest earning assets were partially offset by increased cost of funds. The cost of funds increased to 102 basis points, compared to 32 basis points in the first nine months of 2022. Since March of 2022, the Federal Reserve increased the target federal funds range from 0 – 0.25% to 5.25 – 5.50%. The tax-equivalent yield on total interest-earning assets increased by 81 basis points to 3.70% in the first nine months of 2023 compared to 2.89% in the first nine months of 2022. This increase was primarily due to changes in our asset mix and higher market interest rates on interest earning assets. The cost of total interest-bearing liabilities increased by 70 basis points to 1.02% in the first nine months of 2023 compared to 0.32% in the first nine months of 2022. Our deposit costs may continue to increase as the Federal Reserve maintains or increases its target federal funds rate, market interest rates increase, and as customer behaviors change as a result of inflation and higher market interest rates, and we compete for deposits against other banks, money market mutual funds, Treasury securities and other interest bearing alternative investments. The Company continues to deploy various asset liability management strategies to manage its risks from interest rate fluctuations. Deposit and loan pricing remain competitive in our markets. We believe this challenging rate environment will continue throughout 2023. Our ability to compete and manage our deposit costs until our interest-earning assets reprice and we generate new fixed rate loans with current market interest rates will be important to our net interest margin during the monetary tightening cycle that we believe will continue throughout 2023 and into 2024. Table of Contents 33 Provision for Credit Losses On January 1, 2023, we adopted ASC 326, which introduces the current expected credit losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our loans. Accordingly, the provision for credit losses represents a charge to earnings necessary to establish an allowance for credit losses that, in management's evaluation, is adequate to provide coverage for all expected credit losses. The Company recorded a negative provision for credit losses during the first nine months of 2023 of $0.2 million, compared to none during the first nine months of 2022. Provision expense is affected by organic loan growth in our loan portfolio, our internal assessment of the credit quality of the loan portfolio, our expectations about future economic conditions and net charge-offs. Our CECL model is largely influenced by economic factors including, most notably, the anticipated unemployment rate, which may be affected by monetary policy. The negative provision for credit losses during the first nine months of 2023 was primarily related to the resolution of a collateral dependent nonperforming loan, with a recorded investment of $1.3 million and a corresponding allowance of $0.5 million, that was collected in full during the second quarter of 2023. This was partially offset by an increase in the calculation of current expected credit losses due to loan growth during the first nine months of 2023. Our allowance for credit losses reflects an amount we believe appropriate, based on our allowance assessment methodology, to adequately cover all expected credit losses as of the date the allowance is determined. At September 30, 2023, the Company’s allowance for credit losses was $6.8 million, or 1.24% of total loans, compared to $5.8 million, or 1.14% of total loans, at December 31, 2022, and $5.0 million, or 1.05% of total loans, at September 30, 2022. The implementation of CECL, as of January 1, 2023, increased our allowance for credit losses by $1.0 million, or 0.20% of total loans, as a day one transition adjustment to ASC 326. Noninterest Income Quarter ended September 30, Nine months ended September 30, (Dollars in thousands) 2023 2022 2023 2022 Service charges on deposit accounts $ 148 $ 158 $ 456 $ 446 Mortgage lending income 110 126 345 566 Bank-owned life insurance 87 97 311 293 Securities gains, net — 44 — 44 Other 520 427 1,336 1,259 Total noninterest income $ 865 $ 852 $ 2,448 $ 2,608 The Company’s income from mortgage lending is primarily attributable to the (1) origination and sale of 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. 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 September 30, Nine months ended September 30, (Dollars in thousands) 2023 2022 2023 2022 Origination income $ 20 $ 39 $ 81 $ 315 Servicing fees, net 90 87 264 251 Total mortgage lending income $ 110 $ 126 $ 345 $ 566 Table of Contents 34 The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to the origination and sale of mortgage loans. Origination income decreased as market interest rates on mortgage loans increased and mortgage loan volumes also decreased. The decrease in origination income was partially offset by an increase in mortgage servicing fees, net of related amortization expense as mortgage prepayment speeds slowed, resulting in decreased amortization expense. Income from bank-owned life insurance was $311 thousand and $293 thousand for the nine months ended September 30, 2023 and 2022, respectively. Excluding a $52 thousand non-taxable death benefit received during 2023, income from bank-owned life insurance would have been $259 thousand and $293 thousand for the nine months ended September 30, 2023 and 2022, respectively. Noninterest Expense Quarter ended September 30, Nine months ended September 30, (Dollars in thousands) 2023 2022 2023 2022 Salaries and benefits $ 2,844 $ 2,975 $ 8,809 $ 8,901 Net occupancy and equipment 755 794 2,341 1,955 Professional fees 261 235 898 704 Other 1,502 1,411 4,743 3,814 Total noninterest expense $ 5,362 $ 5,415 $ 16,791 $ 15,374 Salaries and benefits decreased for both the quarter and nine months ended September 30, 2023. A decrease in the number of full-time equivalents was partially offset by routine annual increases in salaries and wages. The increase in net occupancy and equipment expenses was primarily due to increased expenses related to the Company’s new headquarters in downtown Auburn. This amount includes depreciation expense and other costs associated with operating the new headquarters. The Company relocated its main office branch and bank operations into its newly constructed headquarters during June 2022. The increase in other noninterest expense was due to various items including FDIC assessments, software costs, ATM and checkcard expenses, impairment related to a new market tax credit investment, due to the remaining tax credit being less than the Company’s investment, and a gain on sale of other real estate owned that was realized in the 2022. Income Tax Expense Income tax expense was $0.7 million for the first nine months of 2023 compared to $1.0 million for the the first nine months of 2022. This decrease was due to a decline in the level of earnings before taxes and the Company’s effective tax rate. The Company’s effective income tax rate for the first nine months of 2023 was 12.05%, compared to 15.14% in the first nine months of 2022. The Company’s effective income tax rate is principally impacted by tax-exempt earnings from the Company’s investments in municipal securities, bank-owned life insurance, and New Markets Tax Credits. BALANCE SHEET ANALYSIS Securities Securities available-for-sale were $373.3 million at September 30, 2023, compared to $405.3 million at December 31, 2022. This decrease reflects a $21.2 million decrease in the amortized cost basis of securities available-for-sale and a decrease in the fair value of securities available-for-sale of $10.8 million. The average annualized tax-equivalent yields earned on total securities were 2.35% in the first nine months of 2023 and 1.95% in the first nine months of 2022. Table of Contents 35 Loans 2023 2022 Third Second First Fourth Third (In thousands) Quarter Quarter Quarter Quarter Quarter Commercial and industrial $ 66,014 61,880 59,602 66,212 70,715 Construction and land development 70,129 63,874 66,500 66,479 54,773 Commercial real estate 281,964 275,801 267,962 264,573 249,527 Residential real estate 117,150 109,834 101,975 97,648 91,469 Consumer installment 10,353 9,022 9,002 9,546 7,551 Total loans $ 545,610 520,411 505,041 504,458 474,035 Total loans were $545.6 million at September 30, 2023, an 8% increase compared to $504.5 million at December 31, 2022. Four loan categories represented the majority of the loan portfolio at September 30, 2023: commercial real estate (52%), residential real estate (21%), commercial and industrial (12%) and construction and land development (13%). Approximately 23% of the Company’s commercial real estate loans were classified as owner-occupied at September 30, 2023. Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $8.7 million, or 2% of total loans, and $7.4 million, or 1%, of total loans at September 30, 2023 and December 31, 2022, respectively. For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required interest only payments at September 30, 2023 and December 31, 2022. The Company’s residential real estate mortgage portfolio does not include any option or hybrid ARM loans, subprime loans, or any material amount of other consumer mortgage products which are generally viewed as high risk. The average yield earned on loans and loans held for sale was 4.71% in the first nine months of 2023 and 4.42% in the first nine months of 2022. The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions, including inflation and the continuing increases in market interest rates, remaining COVID-19 pandemic effects including supply chain disruptions, reduced commercial office occupancy levels, housing supply shortages and inflation on our borrowers’ cash flows, real estate market sales volumes and liquidity, valuations used in making loans and evaluating collateral, reduced credit availability , (especially for commercial real estate) generally and higher costs of financing properties, which reduce the transaction and dollar volumes of commercial real estate property sales. Other risks we face include, among other things, 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. Various projects financed earlier that were based on lower interest rate assumptions than currently in effect may not be as profitable or successful at the higher interest rate currently in effect and currently expected in the future. 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 $23.2 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $20.8 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At September 30, 2023, the Bank had one loan relationship exceeding our internal limit. Table of Contents 36 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 September 30, 2023 and December 31, 2022. September 30, December 31, (Dollars in thousands) 2023 2022 Lessors of 1-4 family residential properties $ 57,126 $ 52,278 Multi-family residential properties 47,634 41,084 Hotel/motel 36,992 33,378 Allowance for Credit Losses The Company maintains the allowance for credit losses at a level that management believes appropriate to adequately cover the Company’s estimate of expected losses in the loan portfolio. The allowance for credit losses was $6.8 million at September 30, 2023 compared to $5.8 million at December 31, 2022, which management believed to be adequate at each of the respective dates. The assumptions, judgments and estimates, as well as the methodologies and models associated with the determination of the allowance for credit losses are described under “Critical Accounting Policies.” On January 1, 2023, we adopted ASC 326, which introduces the current expected credit losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our loan portfolio. Accordingly, beginning in 2023, the allowance for credit losses represents an amount that, in management's evaluation, is adequate to provide coverage for all expected future credit losses on outstanding loans. As of September 30, 2023 and December 31, 2022, our allowance for credit losses was approximately $6.8 million and $5.8 million, respectively, which our management believes to be adequate at each of the respective dates. Our allowance for credit losses as a percentage of total loans was 1.24% at September 30, 2023, compared to 1.14% at December 31, 2022. The increase in the allowance for credit losses is largely the result of the implementation of ASC 326 on January 1, 2023, which resulted in an adjustment to the opening balance of the allowance for credit losses of $1.0 million. Our CECL models rely largely on projections of macroeconomic conditions to estimate future credit losses. Macroeconomic factors used in the model include the Alabama unemployment rate, the Alabama home price index, the national commercial real estate price index and the Alabama gross state product. Projections of these macroeconomic factors, obtained from an independent third party, are utilized to predict quarterly rates of default. See Note 1 to our Financial Statements, above. Under the CECL methodology the allowance for credit losses is measured on a collective basis for pools of loans with similar risk characteristics, and for loans that do not share similar risk characteristics with the collectively evaluated pools, evaluations are performed on an individual basis. Losses are predicted over a period of time determined to be reasonable and supportable, and at the end of the reasonable and supportable period losses are reverted to long term historical averages. At September 30, 2023, reasonable and supportable periods of 4 quarters were utilized followed by an 8 quarter straight line reversion period to long term averages. Table of Contents 37 A summary of the changes in the allowance for credit losses and certain asset quality ratios for the third quarter of 2023 and the previous four quarters is presented below. 2023 2022 Third Second First Fourth Third (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Balance at beginning of period $ 6,634 6,821 5,765 4,966 4,716 Impact of adopting ASC 326 — — 1,019 — — Charge-offs: Commercial and industrial — — — (205) (13) Consumer installment (18) (56) (11) (3) (3) Total charge -offs (18) (56) (11) (208) (16) Recoveries 4 200 8 7 16 Net recoveries (charge-offs) (14) 144 (3) (201) — Provision for credit losses 158 (331) 40 1,000 250 Ending balance $ 6,778 6,634 6,821 5,765 4,966 as a % of loans 1.24 % 1.27 1.35 1.14 1.05 as a % of nonperforming loans 559 % 577 255 211 1,431 Net charge-offs (recoveries) as % of average loans (a) 0.01 % (0.06) — 0.04 — (a) Net charge-offs (recoveries) are annualized. Nonperforming Assets At September 30, 2023 the Company had $1.2 million in nonperforming assets compared to $2.7 million at December 31, 2022. The decrease in nonperforming assets was primarily related to the resolution of a collateral dependent nonperforming loan, with a recorded investment of $1.3 million, that was collected in full during the second quarter of 2023. The table below provides information concerning total nonperforming assets and certain asset quality ratios for the third quarter of 2023 and the previous four quarters. 2023 2022 Third Second First Fourth Third (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Nonperforming assets: Nonaccrual loans $ 1,213 1,149 2,680 2,731 347 Total nonperforming assets $ 1,213 1,149 2,680 2,731 347 as a % of loans and other real estate owned 0.22 % 0.22 0.53 0.54 0.07 as a % of total assets 0.12 % 0.11 0.26 0.27 0.03 Nonperforming loans as a % of total loans 0.22 % 0.22 0.53 0.54 0.07 Table of Contents 38 The table below provides information concerning the composition of nonaccrual loans for the third quarter of 2023 and the previous four quarters. 2023 2022 Third Second First Fourth Third (In thousands) Quarter Quarter Quarter Quarter Quarter Nonaccrual loans: Commercial and industrial $ 162 178 432 443 — Commercial real estate 801 819 2,103 2,116 170 Residential real estate 250 152 135 172 177 Consumer installment — — 10 — — Total nonaccrual loans $ 1,213 1,149 2,680 2,731 347 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 . The Company had no loans 90 days or more past due and still accruing at September 30, 2023 and December 31, 2022, respectively. The Company had no OREO at September 30, 2023 or December 31, 2022. Deposits September 30, December 31, (In thousands) 2023 2022 Noninterest bearing demand $ 279,458 311,371 NOW 212,412 178,641 Money market 190,426 214,298 Savings 88,730 95,652 Certificates of deposit under $250,000 51,092 93,017 Certificates of deposit and other time deposits of $250,000 or more 142,483 57,358 Total deposits $ 964,601 950,337 Total deposits were $964.6 million at September 30, 2023, compared to $950.3 million at December 31, 2022. The Company utilizes brokered deposits as an additional funding source. At September 30, 2023, the Company had $46.6 million in brokered deposits, compared to none at December 31, 2022. Excluding brokered deposits, customer deposits decreased $32.3 million, or 3%, during the first nine months of 2023. This decrease reflects net outflows to higher yield investment alternatives in a rising interest rate environment and increased customer spending. Noninterest-bearing deposits were $279.5 million, or 29% of total deposits, at September 30, 2023, compared to $311.4 million, or 33% of total deposits at December 31, 2022. The average rate paid on total interest-bearing deposits was 1.02% in the first nine months of 2023 compared to 0.32% in the first nine months of 2022. At September 30, 2023, estimated uninsured deposits totaled $337.4 million, or 35% of total deposits, compared to $381.7 million, or 40% of total deposits at December 31, 2022. The decrease in the percentage of the Bank’s deposits that are uninsured was in part due to customers’ increased use of the products facilitated by IntraFi that enable customers to maximize FDIC deposit insurance coverage for their deposits. During 2023, the Bank began participating in the Certificates of Deposit Account Registry Service (the “CDARS”) and the Insured Cash Sweep product (“ICS”), which provide for reciprocal (“two-way”) transactions among banks facilitated by IntraFi for the purpose of maximizing FDIC insurance. The total of reciprocal deposits at September 30, 2023 was $31.6 million, or 3% of total deposits. Uninsured amounts are estimated based on the portion of account balances in excess of FDIC insurance limits. The Bank’s uninsured deposits at September 30, 2023 and December 31, 2022 include approximately $185.7 million and $155.0 million, respectively, of deposits of state, county and local governments that are collateralized by securities having an equal fair value to such deposits. Table of Contents 39 The FDIC has proposed a special assessment on uninsured deposits of banks with over $5 billion in uninsured deposits to the FDIC Deposit Insurance Fund’s costs of the systemic risk determination made in connection with two recent bank failures. This proposal will not apply to AuburnBank. Other Borrowings and Available Credit The Company had no long-term debt at September 30, 2023 and December 31, 2022. The Bank utilizes short and long- term non-deposit borrowings from time to time. Short-term borrowings generally consist of federal funds purchased and securities sold under agreements to repurchase with an original maturity of one year or less. The Bank had available federal funds lines totaling $61.0 million with no federal funds borrowings outstanding at September 30, 2023, and December 31, 2022, respectively. Securities sold under agreements to repurchase, which were entered into on behalf of certain customers totaled $1.7 million and $2.6 million at September 30, 2023 and December 31, 2022, respectively. At September 30, 2023 and December 31, 2022, the Bank had no borrowings from the Federal Reserve discount window and no borrowings under the Federal Reserve’s new Bank Term Facility Program (“BTFP”), which opened March 12, 2023. The Bank is a member of the FHLB of Atlanta and has borrowed, and may in the future borrow from time to time under the FHLB of Atlanta’s advance program to obtain funding for its growth. FHLB advances include both fixed and variable terms and are taken out with varying maturities, and are generally secured by eligible assets. The Bank had no borrowings under FHLB of Atlanta’s advance program at September 30, 2023 and December 31, 2022, respectively. At those dates, the Bank had $307.7 million and $312.6 million, respectively, of available lines of credit at the FHLB of Atlanta. Advances include both fixed and variable terms and may be taken out with varying maturities. The average rate paid on the Bank’s short-term borrowings was 2.43% in the first nine months of 2023 compared to 0.50% in the first nine months of 2022. CAPITAL ADEQUACY The Company’s consolidated stockholders’ equity was $61.5 million and $68.0 million as of September 30, 2023 and December 31, 2022, respectively. The decrease from December 31, 2022 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 $8.1 million, cash dividends of $2.8 million, the cumulative effect of adopting CECL accounting standard of $0.8 million, and repurchases of the Company’s stock of $0.2 million, partially offset by net earnings of $5.4 million. Total unrealized losses on available-for- sale securities increased 20% from $54.7 million on December 31, 2022 to $65.5 million September 30, 2023. These unrealized losses do not affect the Bank’s capital for regulatory capital purposes. The Company paid cash dividends of $0.81 per share in the first nine months of 2023, an increase of 2% from the same period in 2022. The Company’s share repurchases of $0.2 million since December 31, 2022 resulted in 10,108 fewer outstanding common shares at September 30, 2023. These shares were repurchased at an average cost per share of $22.63. 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 September 30, 2023, the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer. On August 26, 2020, the Federal Reserve and the other federal banking regulators adopted a final rule that amended the capital conservation buffer. 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. This rule only affects the capital buffers, and banking organizations were encouraged to make prudent capital distribution decisions. Table of Contents 40 The Federal Reserve has treated us as a “small bank holding company’ under the Federal Reserve’s Small Bank Holding Company 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 10.26%, CET1 risk-based capital ratio was 15.01%, tier 1 risk-based capital ratio was 15.01%, and total risk-based capital ratio was 15.98% at September 30, 2023. 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 7.98% at September 30, 2023. On July 27, 2023, the Federal Reserve, the Comptroller of the Currency and the FDIC issued a joint notice of proposed rulemaking to implement the Basel III endgame components. The proposal which is subject to public comment and change only applies to banks and holding companies with $100 billion or more of assets. The proposal includes provisions dealing with: ● Credit risk, which arises from the risk that an obligor fails to perform on an obligation; ● Credit risk, which arises from the risk than an obligor fails to perform on an obligation; ● Market risk, which results from changes in the value of trading positions; ● Operational risk, which is the risk of losses resulting from inadequate or failed internal process, people, and systems, or from external events; and ● Credit valuation adjustment risk, which results from the risk of losses on certain derivative contracts. The Basel III endgame regulatory proposals are not applicable to the Company or the Bank . 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 While a gradual change in interest rates was used in the above analysis to provide an estimate of exposure under these scenarios, our modeling under both a gradual and instantaneous change in interest rates indicates our balance sheet is liability sensitive over the forecast period of 12 months. At September 30, 2023, our earnings simulation model indicated that we were in compliance with the policy guidelines noted above. Table of Contents 41 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 September 30, 2023, our EVE model indicated that we were in compliance with our policy guidelines. 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. Prepayments 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 also may enter into back-to-back 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 September 30, 2023 and December 31, 2022, 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. The Company seeks to manage its liquidity to manage or reduce its costs of funds by maintaining liquidity believed adequate to meet its anticipated funding needs, while balancing against excessive liquidity that likely would reduce earnings due to the cost of foregoing alternative higher- yielding assets. 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 regulatory restrictions on such dividends. The primary source of funding and liquidity for the Company has been dividends received from the Bank. If needed, the Company could also borrow money, or issue common stock or other securities. Primary uses of funds by the Company include dividends paid to stockholders, Company stock repurchases, and payment of Company expenses. Table of Contents 42 Primary sources of funding for the Bank include customer deposits, other borrowings, interest payments on earning assets, repayment and maturity of securities and loans, sales of securities, and the sale of loans, particularly residential mortgage loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window and the Federal Reserve’s recent BTFP borrowing facility. In addition to these sources, the Bank is eligible to participate in the FHLB of Atlanta’s advance program to obtain funding for growth and liquidity. Advances include both fixed and variable terms and may be taken out with varying maturities. At September 30, 2023, the Bank had no FHLB of Atlanta advances outstanding and available credit from the FHLB of $307.7 million. At September 30, 2023, the Bank also had $61.0 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 reasonably expected borrower, depositor, and creditor requirements over the next twelve months. Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual Obligations At September 30, 2023, the Bank had outstanding standby letters of credit of $0.8 million and unfunded loan commitments outstanding of $60.1 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 our securities available- for-sale, or draw on its available credit facilities or raise deposits. Mortgage lending activities We generally 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 September 30, 2023, the aggregate unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights, was $219.3 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 nine months of 2023 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 September 30, 2023. 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 agreements under which we act as servicer generally specifies standard s 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 our agreements with Fannie Mae and Fannie Mae’s mortgage servicing guides. Remedies could include repurchase of an affected loan. Table of Contents 43 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 September 30, 2023, 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. The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual basis. As a result, the Bank is not obligated to make any advances to Fannie Mae on principal and interest on such mortgage loans where the borrower is entitled to forbearance. Effects of Inflation and Changing Prices The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with 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. Inflation can affect our noninterest expenses. It also can affect our customers’ behaviors, and can affect the interest rates we have to pay on our deposits and other borrowings, and the interest rates we earn on our earning assets. The difference between our interest expense and interest income is also affected by the shape of the yield curve and the speeds at which our assets and liabilities, respectively, reprice in response to interest rate changes. The yield curve was inverted on September 30, 2023, which means shorter term interest rates are higher than longer interest rates. This results in a lower spread between our costs of funds and our interest income. In addition, net interest income could be affected by asymmetrical changes in the different interest rate indexes, given that not all of our assets or liabilities are priced with the same index. Higher market interest rates and sales of securities held by the Federal Reserve to reduce inflation generally reduce economic activity and may reduce loan demand and growth. Inflation and related changes in market interest rates, as the Federal Reserve acts to meet its long term inflation goal of 2%, also can adversely affect the values and liquidity of our loans and securities, the value of collateral for our loans, and the success of our borrowers and such borrowers’ available cash to pay interest on and principal of our loans to them. Inflation is running at levels unseen in decades and, while it has declined during 2023, it remains above the Federal Reserve’s long term inflation goal of 2.0% annually. Beginning in March 2022, the Federal Reserve has been raising target federal funds interest rates and reducing its securities holdings in an effort to reduce inflation. During 2022, the Federal Reserve increased the target federal funds range from 0 – 0.25% to 4.25 – 4.50%. The target federal funds rate was increased another 25 basis points on each of January 31, March 7, May 3 and July 26, 2023 to 5.25-5.50%, and further increases in the target federal funds rate may be made if inflation remains elevated. The Federal Reserve has indicated it will maintain higher target rates and restrictive monetary policy to meet its 2% inflation rate over the longer term and maximum employment goals. Our deposit costs may increase as the Federal Reserve increases its target federal funds rate, market interest rates increase, and as customer savings behaviors change as a result of inflation and customers seek higher market interest rates on deposits and other alternative investments. Monetary efforts to control inflation may also affect unemployment which is an important component in our CECL model used to estimate our allowance for credit losses. Table of Contents 44 CURRENT ACCOUNTING DEVELOPMENTS The following ASU has been issued by the FASB but is not yet effective. ● ASU 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method Information about this pronouncement is described in more detail below. ASU 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method , The amendments in this Update permit reporting entities to elect to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2023. The Company is currently evaluating the impact of the new standard on the Company’s consolidated financial statements. Table of Contents 45 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. 2023 2022 Third Second First Fourth Third (in thousands) Quarter Quarter Quarter Quarter Quarter Net interest income (GAAP) $ 6,272 6,888 7,109 7,471 7,243 Tax-equivalent adjustment 108 106 108 117 117 Net interest income (Tax -equivalent) $ 6,380 6,994 7,217 7,588 7,360 Nine months ended September 30, (In thousands) 2023 2022 Net interest income (GAAP) $ 20,269 19,695 Tax-equivalent adjustment 322 339 Net interest income (Tax -equivalent) $ 20,591 20,034 Table of Contents 46 Table 2 - Selected Quarterly Financial Data 2023 2022 Third Second First Fourth Third (Dollars in thousands, except per share amounts) Quarter Quarter Quarter Quarter Quarter Results of Operations Net interest income (a) $ 6,380 6,994 7,217 7,588 7,360 Less: tax-equivalent adjustment 108 106 108 117 117 Net interest income (GAAP) 6,272 6,888 7,109 7,471 7,243 Noninterest income 865 791 792 3,898 852 Total revenue 7,137 7,679 7,901 11,369 8,095 Provision for credit losses 105 (362) 66 1,000 250 Noninterest expense 5,362 5,825 5,604 4,449 5,415 Income tax expense 182 288 267 1,454 432 Net earnings $ 1,488 1,928 1,964 4,466 1,998 Per share data: Basic and diluted net earnings $ 0.43 0.55 0.56 1.27 0.57 Cash dividends declared 0.27 0.27 0.27 0.265 0.265 Weighted average shares outstanding: Basic and diluted 3,496,411 3,500,064 3,502,143 3,504,344 3,507,318 Shares outstanding, at period end 3,493,614 3,499,412 3,500,879 3,503,452 3,505,355 Book value $ 17.59 20.28 21.03 19.42 17.06 Common stock price: High $ 22.80 24.32 24.50 24.71 29.02 Low 20.85 18.80 22.55 22.07 23.02 Period end: 21.50 21.26 22.66 23.00 23.02 To earnings ratio 7.65 x 7.21 7.79 7.82 10.46 To book value 122 % 105 108 118 135 Performance ratios: Annualized return on average equity 8.59 % 10.37 11.44 28.23 10.35 Annualized return on average assets 0.58 % 0.75 0.77 1.75 0.75 Dividend payout ratio 62.79 % 49.09 48.21 20.87 46.49 Asset Quality: Allowance for credit losses as a % of: Loans 1.24 % 1.27 1.35 1.14 1.05 Nonperforming loans 559 % 577 255 211 1,431 Nonperforming assets as a % of: Loans and foreclosed properties 0.22 % 0.22 0.53 0.54 0.07 Total assets 0.12 % 0.11 0.26 0.27 0.03 Nonperforming loans as a % of total loans 0.22 % 0.22 0.53 0.54 0.07 Annualized net charge-offs (recoveries) as % of average loans 0.01 % (0.11) — 0.16 — Capital Adequacy: (c) CET 1 risk-based capital ratio 15.01 % 15.33 15.45 15.39 15.39 Tier 1 risk-based capital ratio 15.01 % 15.33 15.45 15.39 15.39 Total risk-based capital ratio 15.98 % 16.31 16.48 16.25 16.16 Tier 1 leverage ratio 10.26 % 10.23 10.07 10.01 9.29 Other financial data: Net interest margin (a) 2.73 % 3.03 3.17 3.27 3.00 Effective income tax rate 10.90 % 13.00 11.97 24.56 17.78 Efficiency ratio (b) 74.01 % 74.82 69.97 38.73 65.94 Selected average balances: Securities $ 390,772 402,929 402,684 407,792 432,393 Loans, net of unearned income 529,382 512,066 502,158 490,163 457,722 Total assets 1,020,980 1,022,874 1,022,938 1,022,863 1,069,973 Total deposits 942,533 942,552 948,393 951,122 987,614 Total stockholders’ equity 69,269 74,404 68,655 63,283 77,191 Selected period end balances: Securities $ 373,286 394,079 405,692 405,304 411,538 Loans, net of unearned income 545,610 520,411 505,041 504,458 474,035 Allowance for credit losses 6,778 6,634 6,821 5,765 4,966 Total assets 1,030,724 1,026,130 1,017,746 1,023,888 1,042,559 Total deposits 964,602 950,742 939,190 950,337 977,938 Total stockholders’ equity 61,451 70,976 73,640 68,041 59,793 (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. See "Table 1 - Explanation of Non-GAAP Financial Measures." (c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank. Table of Contents 47 Table 3 - Selected Financial Data Nine months ended September 30, (Dollars in thousands, except per share amounts) 2023 2022 Results of Operations Net interest income (a) $ 20,591 20,034 Less: tax-equivalent adjustment 322 339 Net interest income (GAAP) 20,269 19,695 Noninterest income 2,448 2,608 Total revenue 22,717 22,303 Provision for credit losses (191) — Noninterest expense 16,791 15,374 Income tax expense 737 1,049 Net earnings $ 5,380 5,880 Per share data: Basic and diluted net earnings $ 1.54 1.67 Cash dividends declared 0.81 0.795 Weighted average shares outstanding: Basic and diluted 3,499,518 3,513,068 Shares outstanding, at period end 3,493,614 3,505,355 Book value $ 17.59 17.06 Common stock price: High $ 24.50 34.49 Low 18.80 23.02 Period end 21.50 23.02 To earnings ratio 7.65 x 10.46 To book value 122 % 135 Performance ratios: Annualized return on average equity 10.15 % 8.76 Annualized return on average assets 0.70 % 0.72 Dividend payout ratio 52.60 % 47.60 Asset Quality: Allowance for credit losses as a % of: Loans 1.24 % 1.05 Nonperforming loans 559 % 1,431 Nonperforming assets as a % of: Loans and other real estate owned 0.22 % 0.07 Total assets 0.12 % 0.03 Nonperforming loans as a % of total loans 0.22 % 0.07 Annualized net recoveries as a % of average loans (0.03) % (0.01) Capital Adequacy: (c) CET 1 risk-based capital ratio 15.01 % 15.39 Tier 1 risk-based capital ratio 15.01 % 15.39 Total risk-based capital ratio 15.98 % 16.16 Tier 1 leverage ratio 10.26 % 9.29 Other financial data: Net interest margin (a) 2.97 % 2.67 Effective income tax rate 12.05 % 15.14 Efficiency ratio (b) 72.88 % 67.90 Selected average balances: Securities $ 398,751 431,629 Loans, net of unearned income 514,635 442,081 Total assets 1,022,257 1,092,216 Total deposits 944,471 996,900 Total stockholders’ equity 70,659 89,544 Selected period end balances: Securities $ 373,286 411,538 Loans, net of unearned income 545,610 474,035 Allowance for credit losses 6,778 4,966 Total assets 1,030,724 1,042,559 Total deposits 964,602 977,938 Total stockholders’ equity 61,451 59,793 (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. See "Table 1 - Explanation of Non-GAAP Financial Measures." (c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank. Table of Contents 48 Table 4 - Average Balances and Net Interest Income Analysis Quarter ended September 30, 2023 2022 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) $ 529,521 $ 6,373 4.77% $ 457,861 $ 5,097 4.42% Securities - taxable (2) 336,406 1,783 2.10% 373,529 1,808 1.92% Securities - tax-exempt (2)(3) 54,366 510 3.72% 58,864 558 3.76% Total securities 390,772 2,293 2.33% 432,393 2,366 2.17% Federal funds sold 1,918 26 5.38% 38,994 200 2.03% Interest bearing bank deposits 4,799 59 4.88% 45,343 226 1.98% Total interest-earning assets 927,010 $ 8,751 3.75% 974,591 $ 7,889 3.21% Cash and due from banks 14,345 14,503 Other assets 79,625 80,879 Total assets $ 1,020,980 $ 1,069,973 Interest-bearing liabilities: Deposits: NOW $ 191,849 $ 534 1.10% $ 195,655 $ 70 0.14% Savings and money market 283,152 661 0.93% 328,555 163 0.20% Time deposits 183,539 1,139 2.46% 151,785 291 0.76% Total interest-bearing deposits 658,540 2,334 1.41% 675,995 524 0.31% Short-term borrowings 4,347 37 3.38% 3,759 5 0.50% Total interest-bearing liabilities 662,887 $ 2,371 1.42% 679,754 $ 529 0.31% Noninterest-bearing deposits 283,993 311,619 Other liabilities 4,831 1,409 Stockholders' equity 69,269 77,191 Total liabilities and stockholders' equity $ 1,020,980 $ 1,069,973 Net interest income and margin (tax-equivalent) $ 6,380 2.73% $ 7,360 3.00% (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) Includes average net unrealized gains (losses) on investment securities available for sale (3) Yields on tax-exempt securities have been computed on a tax-equivalent basis using a federal income tax rate of 21%. Table of Contents 49 Table 5 - Average Balances and Net Interest Income Analysis Nine months ended September 30, 2023 2022 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) $ 514,706 $ 18,146 4.71% $ 442,613 $ 14,638 4.42% Securities - taxable (2) 344,136 5,474 2.13% 371,595 4,691 1.69% Securities - tax-exempt (2)(3) 54,615 1,531 3.75% 60,034 1,614 3.59% Total securities 398,751 7,005 2.35% 431,629 6,305 1.95% Federal funds sold 4,372 159 4.86% 54,924 313 0.76% Interest bearing bank deposits 8,118 283 4.66% 73,630 454 0.82% Total interest-earning assets 925,947 $ 25,593 3.70% 1,002,796 $ 21,710 2.89% Cash and due from banks 15,160 15,029 Other assets 81,150 74,391 Total assets $ 1,022,257 $ 1,092,216 Interest-bearing liabilities: Deposits: NOW $ 189,586 $ 1,067 0.75% $ 201,792 $ 189 0.13% Savings and money market 291,988 1,368 0.63% 335,005 494 0.20% Time deposits 168,000 2,499 1.99% 155,824 978 0.84% Total interest-bearing deposits 649,574 4,934 1.02% 692,621 1,661 0.32% Short-term borrowings 3,748 68 2.43% 3,969 15 0.50% Total interest-bearing liabilities 653,322 $ 5,002 1.02% 696,590 $ 1,676 0.32% Noninterest-bearing deposits 294,897 304,279 Other liabilities 3,379 1,803 Stockholders' equity 70,659 89,544 Total liabilities and stockholders' equity $ 1,022,257 $ 1,092,216 Net interest income and margin (tax-equivalent) $ 20,591 2.97% $ 20,034 2.67% (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) Includes average net unrealized gains (losses) on investment securities available for sale (3) 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 6 - Allocation of Allowance for Credit Losses 2023 2022 Third Quarter Second Quarter First Quarter Fourth Quarter Third Quarter (Dollars in thousands) Amount %* Amount %* Amount %* Amount %* Amount %* Commercial and industrial $ 1,215 12.1 $ 1,198 11.9 $ 1,232 11.8 $ 747 13.1 $ 732 14.9 Construction and land development 1,073 12.9 1,005 12.3 1,021 13.2 949 13.2 789 11.6 Commercial real estate 3,803 51.6 3,788 53.0 3,966 53.0 3,109 52.4 2,561 52.6 Residential real estate 551 21.5 529 21.1 497 20.2 828 19.4 783 19.3 Consumer installment 136 1.9 114 1.7 105 1.8 132 1.9 101 1.6 Total allowance for credit losses $ 6,778 $ 6,634 $ 6,821 $ 5,765 $ 4,966 * Loan balance in each category expressed as a percentage of total loans. Table of Contents 51 Table 7 – Estimated Uninsured Time Deposits by Maturity (Dollars in thousands) September 30, 2023 Maturity of: 3 months or less $ 17,953 Over 3 months through 6 months 5,154 Over 6 months through 12 months 36,255 Over 12 months 11,099 Total estimated uninsured time deposits $ 70,461 Table of Contents 52 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.