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 six months ended June 30, 2024 and 2023, as well as the information contained in our Annual Report on Form 10-K for the year ended December 31, 2023 and our Quarterly Reports on Form 10-Q. 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,” “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 inflation, seasonality, natural disasters or climate change, such as rising sea and water levels, hurricanes and tornados, COVID-19 or other health crises, 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 (including tariffs), sanctions or other events that may affect general economic conditions; Table of Contents 28 ● governmental monetary and fiscal policies, including the amount and costs of borrowing by the federal government and its agencies, the continuing effects of COVID-19 fiscal and monetary stimuli, and subsequent changes in monetary policies 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 through quantitative tightening; and the duration that the Federal Reserve will keep its targeted federal funds rates at or above current rates to meet its long term inflation target of 2%; ● 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; ● changes in accounting pronouncements and interpretations, including the required use, beginning January 1, 2023,of Financial Accounting Standards Board’s (“FASB”) Accounting Standards Update (ASU) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” as well as the updates issued since June 2016 (collectively, FASB ASC Topic 326) on Current Expected Credit Losses (“CECL”), and ASU 2022-02, Troubled Debt Restructurings and Vintage Disclosures, which eliminates troubled debt restructurings (“TDRs”) and related guidance; ● the failure of assumptions and estimates, including those used in the Company’s CECL models to establish our allowance for credit losses and estimate asset impairments, as well as differences in, and changes to, economic, market and credit conditions, including unemployment rates, changes in borrowers’ credit risks and payment behaviors from those used in our CECL models and loan portfolio reviews; ● the risks of changes in market interest rates and the shape of the yield curve on customer behaviors; the levels, composition and costs of deposits, loan demand and mortgage loan originations; the values and liquidity of loan collateral, our securities portfolio and interest-sensitive assets and liabilities; and the risks and uncertainty of the amounts realizable on collateral; ● the risks of increases in market interest rates or the continuation of restrictive monetary policies creating unrealized losses on our securities available for sale, which adversely affect our stockholders’ equity for financial reporting purposes and our tangible equity; ● 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 regulation, including capital, and supervision and examination, as the Company and the Bank and credit unions, which are not subject to federal income taxation; ● 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; Table of Contents 29 ● 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; ● the risks that our dividends, share repurchases and discretionary bonuses are limited by regulation to the maintenance of a capital conservation buffer of 2.5% and our future earnings and “eligible retained earnings” over rolling four calendar quarter periods; ● other factors and risks described under “Risk Factors” herein, in our Annual Report on Form 10-K as of and for the year ended December 31, 2023 filed with the United States Securities and Exchange Commission (the “Commission” or “SEC”), and in any of our subsequent reports that we make with the 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 June 30, Six months ended June 30, (Dollars in thousands, except per share amounts) 2024 2023 2024 2023 Net interest income (a) $ 6,728 $ 6,994 $ 13,405 $ 14,211 Less: tax-equivalent adjustment 19 106 39 214 Net interest income (GAAP) 6,709 6,888 13,366 13,997 Noninterest income 896 791 1,783 1,583 Total revenue 7,605 7,679 15,149 15,580 Provision for (reversal of) credit losses (123) (362) 211 (296) Noninterest expense 5,519 5,825 11,194 11,429 Income tax expense 475 288 639 555 Net earnings $ 1,734 $ 1,928 $ 3,105 $ 3,892 Basic and diluted earnings per share $ 0.50 $ 0.55 $ 0.89 $ 1.11 (a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." Financial Summary The Company’s net earnings were $3.1 million for the first six months of 2024, compared to $3.9 million for the first six months of 2023. Basic and diluted earnings per share were $0.89 per share for the first six months of 2024, compared to $1.11 per share for the first six months of 2023. Net interest income (tax-equivalent) was $13.4 million for the first six months of 2024, a 6% decrease compared to $14.2 million for the first six months of 2023. This decrease was primarily due to a smaller balance sheet and a decrease in the Company’s net interest margin. The Company’s net interest margin (tax-equivalent) was 3.05% for the first six months of 2024 compared to 3.10% for the first six months of 2023. This decrease was primarily due to increased cost of interest bearing deposits, which was partially offset by a more favorable asset mix and higher yields on interest earning assets. Average loans for the first six months of 2024 were $567.4 million, a 12% increase from the first six months of 2023 . Average total securities for the first six months of 2024 were $262.9 million compared to $402.8 million for the first six months of 2023. The decrease was primarily the result of the Company’s balance sheet repositioning strategy in the fourth quarter of 2024. See “Results of Operations – Average Balance Sheet and Interest Rates” and “Net Interest Income and Margin” below. At June 30, 2024, the Company’s allowance for credit losses was $7.1 million, or 1.24% of total loans, compared to $6.9 million, or 1.23% of total loans, at December 31, 2023, and $6.6 million, or 1.27% of total loans, at June 30, 2023. Table of Contents 30 The Company recorded a provision for credit losses during the first six months of 2024 of $0.2 million, compared to a negative provision of $0.3 million during the first six months of 2023. The provision for credit losses under CECL reflects the Company’s evaluation of its credit risk profile and its future economic outlook and forecasts. Our CECL model is largely influenced by economic factors including, most notably, the anticipated unemployment rate. The increase in the provision for credit losses during the first six months of 2024, as compared to the first six months of 2023, was related to changes in the composition of, and increases in, loans as well as changes in the economic forecasts used in our CECL model. Noninterest income was $1.8 million in the first six months of 2024, compared to $1.6 million in the first six months of 2023. The increase was primarily related to an increase in mortgage lending income and other noninterest income. Noninterest expense was $11.2 million in the first six months of 2024, compared to $11.4 million for the first six months of 2023. The decrease was primarily related to decreases in net occupancy and equipment expense and other noninterest expense. These decreases were partially offset by an increase in salaries and benefits expense. Income tax expense was $0.6 million for both the first six months of 2024 and 2023. The Company's effective tax rate for the first six months of 2024 was 17.07%, compared to 12.48% in the first six months of 2023. The Company’s effective income tax rate is affected principally by tax-exempt earnings from the Company’s investment in municipal securities, bank-owned life insurance (“BOLI”), and New Markets Tax Credits (“NMTCs”). The effective tax rate increased primarily due to a decrease in the Company’s investment in municipal securities following the balance sheet restructuring in the fourth quarter of 2023, and the adoption of FASB ASU 2023-02 Investments – Equity Method and Joint Ventures (Topic 323) which allows the proportional amortization method for our NMTC investments, on January 1, 2024. With the adoption of this ASU, amortization of NMTCs are now included in income tax expense rather than noninterest expense. The Company paid cash dividends of $0.27 per share in the first six months of 2024 and 2023. At June 30, 2024, 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 15.49%, a tier 1 leverage ratio of 10.39% and a common equity tier 1 (“CET1”) ratio of 14.47% at June 30, 2024. For the second quarter of 2024, net earnings were $1.7 million, or $0.50 per share, compared to $1.9 million, or $0.55 per share, for the second quarter of 2023. Net interest income (tax-equivalent) was $6.7 million for the second quarter of 2024 compared to $7.0 million for the second quarter of 2023. This decrease was primarily due to increases in the cost of interest bearing deposits. The Company’s net interest margin (tax-equivalent) was 3.06% in the second quarter of 2024 compared to 3.03% in the second quarter of 2023. The increase was primarily due a more favorable asset mix and higher yields on interest earning assets. The Company recorded a negative provision for credit losses during the second quarter of 2024 of $0.1 million, compared to a negative provision of $0.4 million for the second quarter of 2023. Noninterest income was $0.9 million for the second quarter of 2024 compared to $0.8 million for the second quarter of 2023. Noninterest expense was $5.5 million in the second quarter of 2024 compared to $5.8 million for the second quarter of 2023. Income tax expense was $0.5 million for the second quarter of 2024, compared to $0.3 million for the second quarter of 2023. This increase was primarily due to an increase in the Company’s effective tax rate, which increased to 21.50% in the second quarter of 2024 from 13.00% in the second quarter of 2023. This increase was related to a decrease in the Company’s investment in municipal securities, and the adoption of ASU 2023-02, as described above. 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. There have been no significant changes to our Critical Accounting Estimates as described in our Form 10-K. Table of Contents 31 RESULTS OF OPERATIONS Average Balance Sheet and Interest Rates Six months ended June 30, 2024 2023 Average Yield/ Average Yield/ (Dollars in thousands) Balance Rate Balance Rate Loans and loans held for sale $ 567,434 5.12% $ 507,176 4.68% Securities - taxable 252,623 2.21% 348,066 2.14% Securities - tax-exempt 10,294 3.65% 54,741 3.76% Total securities 262,917 2.27% 402,807 2.36% Federal funds sold 17,669 5.50% 5,619 4.77% Interest bearing bank deposits 36,171 5.33% 9,805 4.61% Total interest-earning assets 884,191 4.29% 925,407 3.67% Deposits: NOW 193,755 1.37% 188,491 0.57% Savings and money market 248,227 0.71% 296,425 0.48% Time deposits 195,863 3.34% 160,102 1.71% Total interest-bearing deposits 637,845 1.72% 645,018 0.81% Short-term borrowings 1,262 0.48% 3,443 1.82% Total interest-bearing liabilities 639,107 1.71% 648,461 0.82% Net interest income and margin (tax-equivalent) $ 13,405 3.05% $ 14,211 3.10% Net Interest Income and Margin Net interest income (tax-equivalent) was $13.4 million for the first six months of 2024, a 6% decrease compared to $14.2 million for the first six months of 2023. This decrease was primarily due to a decline in the Company’s net interest margin (tax-equivalent). The Company’s net interest margin (tax-equivalent) was 3.05% in the first six months of 2024 compared to 3.10% in the first six months of 2023. This decrease was primarily due to higher market interest rates, which increased our cost of funds, generally, and changes in our deposit mix to higher cost interest bearing deposits, which was partially offset by a more favorable asset mix and higher yields on interest-earning assets. The cost of interest-bearing liabilities increased to 171 basis points in the first six months ended months of 2024, compared to 82 basis points in the first six months ended months of 2023. Average interest bearing deposits were $637.5 million during the six months ended June 30, 2024, a 1% decrease compared to $7.2 million during the first six months of 2023. As of June 30, 2024, interest bearing deposits were 72% of total deposits compared to 70% on June 30, 2023. Since March 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 62 basis points to 4.29% in the first six months of 2024 compared to 3.67% in the first six months of 2023. This increase was primarily due to the Company’s balance sheet repositioning strategy in the fourth quarter of 2023, which improved our asset mix, and higher market interest rates on interest earning assets. The cost of total interest-bearing liabilities increased by 89 basis points to 1.71% in the first six months of 2024 compared to 0.82% in the first six months of 2023. 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 2024. Our ability to compete and manage our deposit costs until our interest-earning assets reprice and we generate new loans with current market interest rates will be important to our net interest margin during 2024. Table of Contents 32 Provision for Credit Losses On January 1, 2023, we adopted ASC 326 and its CECL methodology, which 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 provision for credit losses during the first six months of 2024 of $0.2 million, compared to a negative provision for credit losses of $0.3 million during the first six months of 2023. 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 increase in the provision for credit losses in the first quarter of 2024, as compared to the first quarter of 2023, was related to changes in the composition of, and increases in, loans as well as changes in the economic forecasts used in our CECL model. 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 June 30, 2024, the Company’s allowance for credit losses was $7.1 million, or 1.24% of total loans, compared to $6.9 million, or 1.23% of total loans, at December 31, 2023, and $6.6 million, or 1.27% of total loans, at June 30, 2023. Noninterest Income Quarter ended June 30, Six months ended June 30, (Dollars in thousands) 2024 2023 2024 2023 Service charges on deposit accounts $ 153 $ 154 $ 309 $ 308 Mortgage lending income 180 142 330 235 Bank-owned life insurance 99 68 201 224 Other 464 427 943 816 Total noninterest income $ 896 $ 791 $ 1,783 $ 1,583 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 June 30, Six months ended June 30, (Dollars in thousands) 2024 2023 2024 2023 Origination income $ 85 $ 57 $ 142 $ 61 Servicing fees, net 95 85 188 174 Total mortgage lending income $ 180 $ 142 $ 330 $ 235 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. The increase in mortgage lending income was primarily related to the Company increasing the number of mortgage loans held for sale during 2024 relative to the number of mortgage loans held for investment during 2023. Table of Contents 33 Income from bank-owned life insurance was $201 thousand and $224 thousand for the first six months of 2024, and 2023 respectively. Excluding a $52 thousand non-taxable death benefit received during the first quarter of 2023, income from bank-owned life insurance would have been $172 thousand for the first six months of 2023. Other noninterest income was $943 thousand for the first six months of 2024, compared to $816 thousand for the first six months of 2023. The increase in other noninterest income was primarily due to increased fee income on one-way sell reciprocal deposits sold through the Intrafi network. Noninterest Expense Quarter ended June 30, Six months ended June 30, (Dollars in thousands) 2024 2023 2024 2023 Salaries and benefits $ 3,140 $ 3,038 $ 6,211 $ 5,965 Net occupancy and equipment 603 787 1,366 1,586 Professional fees 314 299 640 637 Other 1,462 1,701 2,977 3,241 Total noninterest expense $ 5,519 $ 5,825 $ 11,194 $ 11,429 The increase in salaries and benefits was primarily due to routine annual increases in salaries and wages. The decrease in net occupancy and equipment expense was primarily due to an increase in leasing income. The decrease in other noninterest expense was primarily due to the Company’s adoption of ASU 2023-02 which allows the proportional amortization method for our NMTC investments, on January 1, 2024 . With the adoption of this ASU, amortization of NMTCs are now included in income tax expense. During the first six months of 2023, other noninterest expense included $204 thousand related to our equity method investment in NMTCs. Income Tax Expense Income tax expense was $0.6 million for both the first six months of both 2024 and 2023. The Company's effective tax rate for the first six months of 2024 was 17.07%, compared to 12.48% in the first six months of 2023. The Company’s effective income tax rate is affected principally by tax-exempt earnings from the Company’s investment in municipal securities, BOLI, and NMTCs. The effective tax rate increased primarily due to a decrease in the Company’s investment in municipal securities following the balance sheet restructuring in the fourth quarter of 2023, and the adoption of FASB ASU 2023-02 Investments – Equity Method and Joint Ventures (Topic 323) which allows the proportional amortization method for our NMTC investments, on January 1, 2024. With the adoption of this ASU, amortization of NMTCs are now included in income tax expense rather than noninterest expense. BALANCE SHEET ANALYSIS Securities Securities available-for-sale were $254.4 million at June 30, 2024, compared to $270.9 million at December 31, 2023. This decrease reflects a $13.5 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 $3.0 million. The average annualized tax-equivalent yields earned on total securities were 2.27% in the first six months of 2024 and 2.36% in the first six months of 2023. Table of Contents 34 Loans 2024 2023 Second First Fourth Third Second (In thousands) Quarter Quarter Quarter Quarter Quarter Commercial and industrial $ 77,627 78,920 73,374 66,014 61,880 Construction and land development 73,688 58,909 68,329 70,129 63,874 Commercial real estate 297,232 300,484 287,307 281,964 275,801 Residential real estate 119,427 118,240 117,457 117,150 109,834 Consumer installment 10,094 10,967 10,827 10,353 9,022 Total loans $ 578,068 567,520 557,294 545,610 520,411 Total loans were $578.1 million at June 30, 2024, a 4% increase compared to $557.3 million at December 31, 2023. Four loan categories represented the majority of the loan portfolio at June 30, 2024: commercial real estate (51%), residential real estate (21%), commercial and industrial (13%) and construction and land development (13%). Approximately 21% of the Company’s commercial real estate loans were classified as owner-occupied at June 30, 2024. Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $10.1 million, or 2% of total loans, and $8.7 million, or 2%, of total loans at June 30, 2024 and December 31, 2023, respectively. For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required interest only payments at June 30, 2024 and December 31, 2023. 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 5.12% in the first six months of 2024 and 4.68% in the first six months of 2023. 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 rates 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 $22.4 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $20.2 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At June 30, 2024, the Bank had one loan relationship exceeding our internal limit. Table of Contents 35 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 June 30, 2024 and December 31, 2023. June 30, December 31, (Dollars in thousands) 2024 2023 Lessors of 1-4 family residential properties $ 58,470 $ 56,912 Multi-family residential properties 44,135 45,841 Hotel/motel 38,542 39,131 Office Buildings 30,554 30,871 Allowance for Credit Losses On January 1, 2023, we adopted ASC 326, which introduced the current expected loss (“CECL”) methodology, which 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 June 30, 2024 and December 31, 2023, our allowance for credit losses was approximately $7.1 million and $6.9 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 June 30, 2024, compared to 1.23% at December 31, 2023. 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. 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 June 30, 2024, reasonable and supportable periods of 4 quarters were utilized followed by an 8 quarter straight line reversion period to long term averages. A summary of the changes in the allowance for credit losses and certain asset quality ratios for the second quarter of 2024 and the previous four quarters is presented below. 2024 2023 Second First Fourth Third Second (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Balance at beginning of period $ 7,215 6,863 6,778 6,634 6,821 Charge-offs: Commercial and industrial (9) — (164) — — Consumer installment (19) (24) (20) (18) (56) Total charge -offs (28) (24) (184) (18) (56) Recoveries 19 91 11 4 200 Net recoveries (charge-offs) (9) 67 (173) (14) 144 Provision for (reversal of) credit losses (64) 285 258 158 (331) Ending balance $ 7,142 7,215 6,863 6,778 6,634 as a % of loans 1.24 % 1.27 1.23 1.24 1.27 as a % of nonperforming loans 900 % 822 753 559 577 Net (recoveries) charge-offs as % of average loans (a) 0.01 % (0.05) 0.13 0.01 (0.11) (a) Net (recoveries) charge-offs are annualized. Table of Contents 36 Nonperforming Assets At June 30, 2024 and December 31, 2023, the Company had $0.8 million and $0.9 million, respectively, in nonperforming assets. The table below provides information concerning total nonperforming assets and certain asset quality ratios for the second quarter of 2024 and the previous four quarters. 2024 2023 Second First Fourth Third Second (Dollars in thousands) Quarter Quarter Quarter Quarter Quarter Nonperforming assets: Nonaccrual loans $ 794 878 911 1,213 1,149 Total nonperforming assets $ 794 878 911 1,213 1,149 as a % of loans and other real estate owned 0.14 % 0.15 0.16 0.22 0.22 as a % of total assets 0.08 % 0.09 0.09 0.12 0.11 Nonperforming loans as a % of total loans 0.14 % 0.15 0.16 0.22 0.22 The table below provides information concerning the composition of nonaccrual loans for the second quarter of 2024 and the previous four quarters. 2024 2023 Second First Fourth Third Second (In thousands) Quarter Quarter Quarter Quarter Quarter Nonaccrual loans: Commercial and industrial $ — — — 162 178 Commercial real estate 753 765 783 801 819 Residential real estate 41 97 128 250 152 Consumer installment — 16 — — — Total nonaccrual loans $ 794 878 911 1,213 1,149 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 June 30, 2024 and December 31, 2023, respectively. The Company had no OREO at June 30, 2024 or December 31, 2023. Deposits June 30, December 31, (In thousands) 2024 2023 Noninterest bearing demand $ 263,105 270,723 NOW 195,259 190,724 Money market 205,652 148,040 Savings 86,097 88,541 Certificates of deposit under $250,000 100,209 100,572 Certificates of deposit and other time deposits of $250,000 or more 96,083 97,643 Total deposits $ 946,405 896,243 Table of Contents 37 Total deposits were $946.4 million at June 30, 2024, compared to $896.2 million at December 31, 2023. The increase in deposits compared to December 31, 2023 was primarily related to a decrease in reciprocal customer deposits in the one-way sell program through the Intrafi network. At June 30, 2024 the Company had no reciprocal deposits sold, compared to $59.0 million at December 31, 2023. The Company had no brokered deposits at June 30, 2024 or December 31, 2023 compared to $16.0 million one year earlier. Noninterest-bearing deposits were $263.1 million, or 28% of total deposits, at June 30, 2024, compared to $270.7 million, or 30% of total deposits at December 31, 2023. The average rate paid on total interest-bearing deposits was 1.72% in the first six months of 2024, compared to 0.81% in first six months of 2023. At June 30, 2024, estimated uninsured deposits totaled $364.9 million, or 39% of total deposits, compared to $356.3 million, or 40% of total deposits at December 31, 2023. 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 improving the FDIC insurance coverage for our depositors. The total of reciprocal deposits at June 30, 2024 was $55.6 million, compared to none at December 31, 2023. Uninsured amounts are estimated based on the portion of account balances in excess of FDIC insurance limits. The Bank’s uninsured deposits at June 30, 2024 and December 31, 2023 include approximately $222.1 million and $206.2 million, respectively, of deposits of state, county and local governments that are collateralized by securities having an equal fair value to such deposits. The estimated uninsured time deposits by maturity as of June 30, 2024 is presented below. (Dollars in thousands) June 30, 2024 Maturity of: 3 months or less $ 25,659 Over 3 months through 6 months 36,405 Over 6 months through 12 months 4,667 Over 12 months 2,102 Total estimated uninsured time deposits $ 68,833 The FDIC issued a special assessment of 3.36 basis points for a projected eight quarters on large banks with more than $5 billion of uninsured deposits as a result of the systemic risk determination to insure all depositors in connection with the March 2023 failures of Silicon Valley Bank and Signature Bank. These special assessments do not apply to the Bank. Other Borrowings and Available Credit The Company had no long-term debt at June 30, 2024 and December 31, 2023. 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 June 30, 2024, and December 31, 2023, respectively. The Company had no securities sold under agreements to repurchase, which were entered into on behalf of certain customers at June 30, 2024 compared to $1.5 million at December 31, 2023. At June 30, 2024 and December 31, 2023, the Bank had no borrowings from the Federal Reserve discount window and never had any borrowings under the Federal Reserve’s Bank Term Facility Program (“BTFP”). The BTFP ceased making new loans on March 11, 2024. 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 June 30, 2024 and December 31, 2023, respectively. At those dates, the Bank had $293.7 million and $309.1 million, respectively, of available lines of credit at the FHLB of Atlanta. Advances include both fixed and variable interest rates and varying maturities may be used. The Bank also has access to the FRB discount window. The average rate paid on the Bank’s short-term borrowings was 0.48% in the first six months of 2024 compared to 1.82% in the first six months of 2023. The Bank had average short term borrowings of $1.3 million in the first six months of 2024, a 62% decrease compared to $2.1 million during the first six months of 2023. Table of Contents 38 CAPITAL ADEQUACY The Company’s consolidated stockholders’ equity was $75.2 million and $76.5 million as of June 30, 2024 and December 31, 2023, respectively. The decrease from December 31, 2023 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 $2.2 million, cash dividends of $1.9 million, and the cumulative effect of adopting NMTC accounting standard of $0.3 million, partially offset by net earnings of $3.1 million. Total unrealized losses, net of tax, on available-for-sale securities increased from $29.0 million on December 31, 2023 to $31.2 million June 30, 2024. These unrealized losses do not affect the Bank’s capital for regulatory capital purposes. The Company paid cash dividends of $0.54 per share for both the first six months of 2024 and first six months of 2023. 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 June 30, 2024, the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer, and did not limit capital distributions or discretionary bonuses. 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. 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 10.39%, CET1 risk-based capital ratio was 14.47%, tier 1 risk-based capital ratio was 14.47%, and total risk-based capital ratio was 15.49% at June 30, 2024. 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 7.49% at June 30, 2024. 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; ● 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 . The Federal Reserve has indicated that it is revising and expects to re-propose these rules applicable to larger organizations than the Company. 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. Table of Contents 39 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 June 30, 2024, our earnings simulation model indicated that we were in compliance with the policy guidelines noted above. 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: ● 35% for an instantaneous change of +/- 400 basis points ● 30% 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 June 30, 2024, 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. Table of Contents 40 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 June 30, 2024 and December 31, 2023, 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 payment of Company expenses, dividends paid to stockholders and Company stock repurchases. 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. 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 June 30, 2024, the Bank had no FHLB of Atlanta advances outstanding and available credit from the FHLB of $293.7 million. At June 30, 2024, 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. The Company also has access to the FRB discount window. 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 June 30, 2024, the Bank had outstanding standby letters of credit of $0.5 million and unfunded loan commitments outstanding of $63.8 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 use its cash and cash equivalents , deposits with other banks, 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 customary 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. Table of Contents 41 As of June 30, 2024, the aggregate unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights, was $212.1 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 six months of 2024 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 June 30, 2024. 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. 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 June 30, 2024, 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. Table of Contents 42 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 continued to be inverted on June 30, 2024, which means shorter term interest rates are higher than longer term 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 reductions in the securities held by the Federal Reserve to reduce inflation generally reduce economic activity and may reduce loan demand and growth, and may adversely affect unemployment rates. 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 has been running at levels unseen in decades and, while it has declined beginning in the latter part of 2023, it has been persistent through June 30, 2024 and 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 goals of (i) 2% target inflation rate over the longer term and (ii) maximum employment goals. Following its May 1, 2024 meeting, the Federal Reserve’s Open Market Committee (“FOMC”) reaffirmed its commitment to the 2% inflation objective and announced that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving substantially toward 2%.” Further, the FOMC reduced its monthly reduction of Treasury securities from $60 billion to $25 billion, and was maintaining the monthly reduction on agency debt and agency mortgage-backed securities at $35 billion. 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 seeking 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. CURRENT ACCOUNTING DEVELOPMENTS The following ASU has been issued by the FASB but is not yet effective. ● ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax disclosures ASU 2023-09 seeks to enhance the transparency and decision usefulness of income tax disclosures. For public business entities, the new standard is effective for annual periods beginning after December 15, 2024. The Company does not expect the new standard to have a material impact on the Company’s consolidated financial statements. Table of Contents 43 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. 2024 2023 Second First Fourth Third Second (In thousands) Quarter Quarter Quarter Quarter Quarter Net interest income (GAAP) $ 6,709 6,657 6,059 6,272 6,888 Tax-equivalent adjustment 19 20 95 108 106 Net interest income (Tax -equivalent) $ 6,728 6,677 6,154 6,380 6,994 Six months ended June 30, (In thousands) 2024 2023 Net interest income (GAAP) $ 13,366 13,997 Tax-equivalent adjustment 39 214 Net interest income (Tax -equivalent) $ 13,405 14,211 Table of Contents 44 Table 2 - Selected Quarterly Financial Data 2024 2023 Second First Fourth Third Second (Dollars in thousands, except per share amounts) Quarter Quarter Quarter Quarter Quarter Results of Operations Net interest income (a) $ 6,728 6,677 6,154 6,380 6,994 Less: tax-equivalent adjustment 19 20 95 108 106 Net interest income (GAAP) 6,709 6,657 6,059 6,272 6,888 Noninterest income 896 887 (5,429) 865 791 Total revenue 7,605 7,544 630 7,137 7,679 Provision for (reversal of) credit losses (123) 334 326 105 (362) Noninterest expense 5,519 5,675 5,803 5,362 5,825 Income tax expense 475 164 (1,514) 182 288 Net earnings $ 1,734 1,371 (3,985) 1,488 1,928 Per share data: Basic and diluted net earnings $ 0.50 0.39 (1.14) 0.43 0.55 Cash dividends declared 0.27 0.27 0.27 0.27 0.27 Weighted average shares outstanding: Basic and diluted 3,493,699 3,493,663 3,493,614 3,496,411 3,500,064 Shares outstanding 3,493,699 3,493,699 3,493,614 3,493,614 3,499,412 Book value $ 21.53 21.32 21.90 17.59 20.28 Common stock price High $ 19.25 21.55 21.99 22.80 24.32 Low 16.63 18.82 19.72 20.85 18.80 Period end 18.29 19.27 21.28 21.50 21.26 To earnings ratio (b) 101.61 x 83.78 53.20 7.65 7.21 To book value 85 % 90 97 122 105 Performance ratios: Return on average equity 9.63 % 7.13 (26.40) 8.59 10.37 Return on average assets 0.71 % 0.56 (1.56) 0.58 0.75 Dividend payout ratio 54.00 % 69.23 (23.68) 62.79 49.09 Asset Quality: Allowance for credit losses as a % of: Loans 1.24 % 1.27 1.23 1.24 1.27 Nonperforming loans 900 % 822 753 559 577 Nonperforming assets as a % of: Loans and other real estate owned 0.14 % 0.15 0.16 0.22 0.22 Total assets 0.08 % 0.09 0.09 0.12 0.11 Nonperforming loans as a % of total loans 0.14 % 0.15 0.16 0.22 0.22 Annualized net (recoveries) charge-offs as a % of average loans 0.01 % (0.05) 0.13 0.01 (0.11) Capital Adequacy: (c) CET 1 risk-based capital ratio 14.47 % 14.62 14.52 15.01 15.33 Tier 1 risk-based capital ratio 14.47 % 14.62 14.52 15.01 15.33 Total risk-based capital ratio 15.49 % 15.69 15.52 15.98 16.31 Tier 1 leverage ratio 10.39 % 10.34 9.72 10.26 10.23 Other financial data: Net interest margin (a) 3.06 % 3.04 2.65 2.73 3.03 Effective income tax rate 21.50 % 10.68 (27.53) 10.90 13.00 Efficiency ratio (d) 72.39 % 75.03 800.41 74.01 74.82 Selected average balances: Securities $ 258,228 267,606 354,065 390,772 402,929 Loans, net of unearned income 573,443 560,757 550,938 529,382 512,066 Total assets 978,107 976,930 1,020,476 1,020,980 1,022,874 Total deposits 900,673 897,051 953,674 942,533 942,552 Total stockholders’ equity 72,059 76,948 60,372 69,269 74,404 Selected period end balances: Securities $ 254,359 260,770 270,910 373,286 394,079 Loans, net of unearned income 578,068 567,520 557,294 545,610 520,411 Allowance for credit losses 7,142 7,215 6,863 6,778 6,634 Total assets 1,025,054 979,039 975,255 1,030,724 1,026,130 Total deposits 946,405 899,673 896,243 964,602 950,742 Total stockholders’ equity 75,209 74,489 76,507 61,451 70,976 (a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." (b) Calculated by dividing period end share price by earnings per share for the previous four quarters. (c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank. (d) 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 Measures. Table of Contents 45 Table 3 - Selected Financial Data Six months ended June 30, (Dollars in thousands, except per share amounts) 2024 2023 Results of Operations Net interest income (a) $ 13,405 14,211 Less: tax-equivalent adjustment 39 214 Net interest income (GAAP) 13,366 13,997 Noninterest income 1,783 1,583 Total revenue 15,149 15,580 Provision for (reversal of) credit losses 211 (296) Noninterest expense 11,194 11,429 Income tax expense 639 555 Net earnings $ 3,105 3,892 Per share data: Basic and diluted net earnings $ 0.89 1.11 Cash dividends declared 0.54 0.54 Weighted average shares outstanding: Basic and diluted 3,493,681 3,501,098 Shares outstanding, at period end 3,493,699 3,499,412 Book value $ 21.53 20.28 Common stock price: High $ 21.55 24.50 Low 16.63 18.80 Period end 18.29 21.26 To earnings ratio (b) 101.61 x 7.21 To book value 85 % 105 Performance ratios: Annualized return on average equity 8.34 % 10.91 Annualized return on average assets 0.64 % 0.76 Dividend payout ratio 60.67 % 48.65 Asset Quality: Allowance for credit losses as a % of: Loans 1.24 % 1.27 Nonperforming loans 900 % 577 Nonperforming assets as a % of: Loans and other real estate owned 0.14 % 0.22 Total assets 0.08 % 0.11 Nonperforming loans as a % of total loans 0.14 % 0.22 Annualized net recoveries as a % of average loans (0.02) % (0.06) Capital Adequacy: (c) CET 1 risk-based capital ratio 14.47 % 15.33 Tier 1 risk-based capital ratio 14.47 % 15.33 Total risk-based capital ratio 15.49 % 16.31 Tier 1 leverage ratio 10.39 % 10.23 Other financial data: Net interest margin (a) 3.05 % 3.10 Effective income tax rate 17.07 % 12.48 Efficiency ratio (d) 73.70 % 72.36 Selected average balances: Securities $ 262,917 402,807 Loans, net of unearned income 567,100 507,139 Total assets 977,518 1,022,906 Total deposits 898,862 945,456 Total stockholders’ equity 74,503 71,365 Selected period end balances: Securities $ 254,359 394,079 Loans, net of unearned income 578,068 520,411 Allowance for credit losses 7,142 6,634 Total assets 1,025,054 1,026,130 Total deposits 946,405 950,742 Total stockholders’ equity 75,209 70,976 (a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures." (b) Calculated by dividing period end share price by earnings per share for the previous four quarters. (c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank. (d) 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 Measures. Table of Contents 46 Table 4 - Average Balances and Net Interest Income Analysis Quarter ended June 30, 2024 2023 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) $ 573,926 $ 7,451 5.22% $ 512,139 $ 6,019 4.71% Securities - taxable (2) 248,018 1,371 2.22% 347,714 1,826 2.11% Securities - tax-exempt (2)(3) 10,210 93 3.66% 55,215 510 3.70% Total securities 258,228 1,464 2.28% 402,929 2,336 2.33% Federal funds sold 17,357 234 5.42% 3,943 48 4.88% Interest bearing bank deposits 34,553 454 5.28% 8,023 96 4.80% Total interest-earning assets 884,064 $ 9,603 4.37% 927,034 $ 8,499 3.68% Cash and due from banks 18,072 15,621 Other assets 75,971 80,219 Total assets $ 978,107 $ 1,022,874 Interest-bearing liabilities: Deposits: NOW $ 190,861 $ 676 1.42% $ 189,406 $ 287 0.61% Savings and money market 254,663 532 0.84% 292,238 414 0.57% Time deposits 192,164 1,666 3.49% 164,479 781 1.90% Total interest-bearing deposits 637,688 2,874 1.81% 646,123 1,482 0.92% Short-term borrowings 931 1 0.43% 3,835 23 2.41% Total interest-bearing liabilities 638,619 $ 2,875 1.81% 649,958 $ 1,505 0.93% Noninterest-bearing deposits 262,985 296,428 Other liabilities 4,444 2,084 Stockholders' equity 72,059 74,404 Total liabilities and stockholders' equity $ 978,107 $ 1,022,874 Net interest income and margin (tax-equivalent) $ 6,728 3.06% $ 6,994 3.03% (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 47 Table 5 - Average Balances and Net Interest Income Analysis Six months ended June 30, 2024 2023 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) $ 567,434 $ 14,441 5.12% $ 507,176 $ 11,773 4.68% Securities - taxable (2) 252,623 2,782 2.21% 348,066 3,691 2.14% Securities - tax-exempt (2)(3) 10,294 187 3.65% 54,741 1,021 3.76% Total securities 262,917 2,969 2.27% 402,807 4,712 2.36% Federal funds sold 17,669 483 5.50% 5,619 133 4.77% Interest bearing bank deposits 36,171 959 5.33% 9,805 224 4.61% Total interest-earning assets 884,191 $ 18,852 4.29% 925,407 $ 16,842 3.67% Cash and due from banks 17,922 15,574 Other assets 75,405 81,925 Total assets $ 977,518 $ 1,022,906 Interest-bearing liabilities: Deposits: NOW $ 193,755 $ 1,316 1.37% $ 188,491 $ 536 0.57% Savings and money market 248,227 872 0.71% 296,425 703 0.48% Time deposits 195,863 3,256 3.34% 160,102 1,361 1.71% Total interest-bearing deposits 637,845 5,444 1.72% 645,018 2,600 0.81% Short-term borrowings 1,262 3 0.48% 3,443 31 1.82% Total interest-bearing liabilities 639,107 $ 5,447 1.71% 648,461 $ 2,631 0.82% Noninterest-bearing deposits 261,017 300,439 Other liabilities 2,891 2,642 Stockholders' equity 74,503 71,364 Total liabilities and stockholders' equity $ 977,518 $ 1,022,906 Net interest income and margin (tax-equivalent) $ 13,405 3.05% $ 14,211 3.10% (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 48 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.