10-Q

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended September 30, 2020

☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period __________ to __________

Commission File Number: 0-26486

Auburn National Bancorporation, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware

(State or other jurisdiction of

incorporation or organization)

63-0885779

(I.R.S. Employer

Identification No.)

100 N. Gay Street

Auburn, Alabama 36830

(334) 821-9200

(Address and telephone number of principal executive offices)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer ☐

Accelerated filer ☒

Non-accelerated filer ☐

Smaller reporting company ☒

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)		Name of each exchange on which registered
Common Stock, par value $0.01	AUBN		NASDAQ Global Market

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class		Outstanding at October 29,
Common Stock, $0.01 par value per share		3,566,276 shares

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION			PAGE

Item 1	Financial Statement
		Consolidated Balance Sheets (Unaudited) as of September 30, 2020 and December 31, 2019			3
		Consolidated Statements of Earnings (Unaudited) for the quarter and nine months ended September 30, 2020 and 2019			4
		Consolidated Statements of Comprehensive Income (Unaudited) for the quarter and nine months ended September 30, 2020 and 2019			5
		Consolidated Statements of Stockholders’ Equity (Unaudited) for the quarter and nine months ended September 30, 2020 and 2019			6
		Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2020 and 2019			7
		Notes to Consolidated Financial Statements (Unaudited)			8
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
		Table 1 – Explanation of Non-GAAP Financial Measures			50
		Table 2 – Selected Quarterly Financial Data			51
		Table 3 – Selected Financial Data			52
		Table 4 – Average Balances and Net Interest Income Analysis – for the quarter ended September 30, 2020 and 2019			53
		Table 5 – Average Balances and Net Interest Income Analysis – for the nine months ended September 30, 2020 and 2019			54
		Table 6 – Loan Portfolio Composition			55
		Table 7 – Allowance for Loan Losses and Nonperforming Assets			56
		Table 8 – Allocation of Allowance for Loan Losses			57
		Table 9 – CDs and Other Time Deposits of $100,000 or more			58
Item 3	Quantitative and Qualitative Disclosures About Market Risk			59
Item 4	Controls and Procedures			59

PART II. OTHER INFORMATION

Item 1	Legal Proceedings			59
Item 1A	Risk Factors			59
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds			63
Item 3	Defaults Upon Senior Securities			63
Item 4	Mine Safety Disclosures			63
Item 5	Other Information			63
Item 6	Exhibits			64

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

				September 30,		December 31,
(Dollars in thousands, except share data)				2020		2019
Assets:
Cash and due from banks			$	17,079	$	15,172
Federal funds sold				29,182		25,944
Interest-bearing bank deposits				56,412		51,327
		Cash and cash equivalents		102,673		92,443
Securities available-for-sale				320,922		235,902
Loans held for sale				4,765		2,202
Loans, net of unearned income				472,453		460,901
	Allowance for loan losses			(5,575)		(4,386)
		Loans, net		466,878		456,515
Premises and equipment, net				15,473		14,743
Bank-owned life insurance				19,124		19,202
Other assets				8,055		6,872
		Total assets	$	937,890	$	827,879
Liabilities:
Deposits:
	Noninterest-bearing		$	238,482	$	196,218
	Interest-bearing			585,498		527,934
		Total deposits		823,980		724,152
Federal funds purchased and securities sold under agreements to repurchase				2,070		1,069
Accrued expenses and other liabilities				5,526		4,330
		Total liabilities		831,576		729,551
Stockholders' equity:
Preferred stock of $.01 par value; authorized 200,000 shares;
	no shares issued			—		—
Common stock of $.01 par value; authorized 8,500,000 shares;
	issued 3,957,135 shares			39		39
Additional paid-in capital				3,789		3,784
Retained earnings				104,471		101,801
Accumulated other comprehensive income, net				7,369		2,059
Less treasury stock, at cost - 390,859 shares and 390,989 at September 30, 2020
	and December 31, 2019, respectively			(9,354)		(9,355)
		Total stockholders’ equity		106,314		98,328
		Total liabilities and stockholders’ equity	$	937,890	$	827,879
See accompanying notes to consolidated financial statements

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

(Unaudited)

					Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands, except share and per share data)					2020		2019		2020		2019
Interest income:
	Loans, including fees			$	5,453	$	5,787	$	16,359	$	17,277
	Securities:
		Taxable			913		997		3,080		2,997
		Tax-exempt			461		526		1,390		1,619
	Federal funds sold and interest-bearing bank deposits				26		335		332		998
			Total interest income		6,853		7,645		21,161		22,891
Interest expense:
	Deposits				983		1,076		3,005		3,101
	Short-term borrowings				2		2		6		6
			Total interest expense		985		1,078		3,011		3,107
	Net interest income				5,868		6,567		18,150		19,784
Provision for loan losses					250		—		1,100		—
		Net interest income after provision for loan losses			5,618		6,567		17,050		19,784

Noninterest income:
	Service charges on deposit accounts				139		182		437		542
	Mortgage lending				702		263		1,615		639
	Bank-owned life insurance				109		109		615		326
	Other				408		393		1,202		1,472
	Securities gains, net				16		44		103		57
		Total noninterest income			1,374		991		3,972		3,036

Noninterest expense:
	Salaries and benefits				2,802		2,894		8,230		8,631
	Net occupancy and equipment				457		387		1,974		1,152
	Professional fees				230		195		877		698
	Other				1,164		1,348		3,387		3,583
		Total noninterest expense			4,653		4,824		14,468		14,064

		Earnings before income taxes			2,339		2,734		6,554		8,756
Income tax expense					403		527		1,156		1,699

		Net earnings		$	1,936	$	2,207	$	5,398	$	7,057

Net earnings per share:
	Basic and diluted			$	0.54	$	0.62	$	1.51	$	1.97

Weighted average shares outstanding:
	Basic and diluted				3,566,239		3,568,287		3,566,184		3,586,642
See accompanying notes to consolidated financial statements

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Unaudited)



				Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands)				2020		2019		2020		2019
Net earnings			$	1,936	$	2,207	$	5,398	$	7,057

Other comprehensive income (loss), net of tax:
	Unrealized net holding (loss) gain on securities			(5)		1,596		5,387		6,049
	Reclassification adjustment for net gain on securities
		recognized in net earnings		(12)		(33)		(77)		(43)
Other comprehensive (loss) income				(17)		1,563		5,310		6,006

Comprehensive income			$	1,919	$	3,770	$	10,708	$	13,063
See accompanying notes to consolidated financial statements

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

(Unaudited)

								Accumulated
	Common			Additional				other
	Shares		Common	paid-in		Retained		comprehensive			Treasury
(Dollars in thousands, except share data)	Outstanding		Stock	capital		earnings		income (loss)			stock		Total
Quarter ended September 30, 2020
Balance, June 30, 2020	3,566,176	$	39	$	3,785	$	103,444		$	7,386	$	(9,355)	$	105,299
Net earnings	—		—		—		1,936			—		—		1,936
Other comprehensive loss	—		—		—		—			(17)		—		(17)
Cash dividends paid ($.255 per share)	—		—		—		(909)			—		—		(909)
Sale of treasury stock	100		—		4		—			—		1		5
Balance, September 30, 2020	3,566,276	$	39	$	3,789	$	104,471		$	7,369	$	(9,354)	$	106,314

Quarter ended September 30, 2019
Balance, June 30, 2019	3,571,828	$	39	$	3,783	$	98,694		$	680	$	(9,131)	$	94,065
Net earnings	—		—		—		2,207			—		—		2,207
Other comprehensive income	—		—		—		—			1,563		—		1,563
Cash dividends paid ($.25 per share)	—		—		—		(892)			—		—		(892)
Stock repurchases	(5,702)		—		—		—			—		(224)		(224)
Sale of treasury stock	20		—		1		—			—		—		1
Balance, September 30, 2019	3,566,146	$	39	$	3,784	$	100,009		$	2,243	$	(9,355)	$	96,720

Nine months ended September 30, 2020
Balance, December 31, 2019	3,566,146	$	39	$	3,784	$	101,801		$	2,059	$	(9,355)	$	98,328
Net earnings	—		—		—		5,398			—		—		5,398
Other comprehensive income	—		—		—		—			5,310		—		5,310
Cash dividends paid ($.765 per share)	—		—		—		(2,728)			—		—		(2,728)
Sale of treasury stock	130		—		5		—			—		1		6
Balance, September 30, 2020	3,566,276	$	39	$	3,789	$	104,471		$	7,369	$	(9,354)	$	106,314

Nine months ended September 30, 2019
Balance, December 31, 2018	3,643,868	$	39	$	3,779	$	95,635		$	(3,763)	$	(6,635)	$	89,055
Net earnings	—		—		—		7,057			—		—		7,057
Other comprehensive income	—		—		—		—			6,006		—		6,006
Cash dividends paid ($.75 per share)	—		—		—		(2,683)			—		—		(2,683)
Stock repurchases	(77,907)		—		—		—			—		(2,721)		(2,721)
Sale of treasury stock	185		—		5		—			—		1		6
Balance, September 30, 2019	3,566,146	$	39	$	3,784	$	100,009		$	2,243	$	(9,355)	$	96,720
See accompanying notes to consolidated financial statements

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

				Nine months ended September 30,
(Dollars in thousands)				2020		2019
Cash flows from operating activities:
Net earnings			$	5,398	$	7,057
Adjustments to reconcile net earnings to net cash provided by
operating activities:
	Provision for loan losses			1,100		—
	Depreciation and amortization			1,336		705
	Premium amortization and discount accretion, net			1,950		1,365
	Net gain on securities available-for-sale			(103)		(57)
	Net gain on sale of loans held for sale			(1,569)		(382)
	Net gain on other real estate owned			(52)		(59)
	Loans originated for sale			(60,173)		(22,051)
	Proceeds from sale of loans			58,707		21,585
	Increase in cash surrender value of bank-owned life insurance			(334)		(326)
	Income recognized from death benefit on bank-owned life insurance			(282)		—
	Net increase in other assets			(1,241)		(1,009)
	Net (decrease) increase in accrued expenses and other liabilities			(585)		1,671
		Net cash provided by operating activities		4,152		8,499

Cash flows from investing activities:
Proceeds from sales of securities available-for-sale				21,029		12,159
Proceeds from prepayments and maturities of securities available-for-sale				39,909		38,413
Purchase of securities available-for-sale				(140,714)		(55,212)
(Increase) decrease in loans, net				(11,562)		11,735
Net purchases of premises and equipment				(1,527)		(1,604)
Proceeds from bank-owned life insurance death benefit				694		—
(Increase) decrease in FHLB stock				(9)		32
Proceeds from sale of other real estate owned				151		394
		Net cash (used in) provided by investing activities		(92,029)		5,917

Cash flows from financing activities:
Net increase in noninterest-bearing deposits				42,264		1,630
Net increase (decrease) in interest-bearing deposits				57,564		(2,752)
Net increase (decrease) in federal funds purchased and securities sold
	under agreements to repurchase			1,001		(1,328)
Proceeds from sale of treasury stock				6		6
Stock repurchases				—		(2,721)
Dividends paid				(2,728)		(2,683)
		Net cash provided by (used in) financing activities		98,107		(7,848)

Net change in cash and cash equivalents				10,230		6,568
Cash and cash equivalents at beginning of period				92,443		65,076
Cash and cash equivalents at end of period			$	102,673	$	71,644

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest			$	3,011	$	3,037
Income taxes				678		1,499
Supplemental disclosure of non-cash transactions:
Initial recognition of operating lease right of use assets				—		891
Initial recognition of operating lease liabilities				—		889
Real estate acquired through foreclosure				99		82
See accompanying notes to consolidated financial statements

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AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General

Auburn National Bancorporation, Inc. (the “Company”) provides a full range of banking services to individual and corporate customers in Lee County, Alabama and surrounding counties through its wholly owned subsidiary, AuburnBank (the “Bank”). The Company does not have any segments other than banking that are considered material.

Basis of Presentation and Use of Estimates

The unaudited consolidated financial statements in this report have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited consolidated financial statements include, in the opinion of management, all adjustments necessary to present a fair statement of the financial position and the results of operations for all periods presented. All such adjustments are of a normal recurring nature. The results of operations in the interim statements are not necessarily indicative of the results of operations that the Company and its subsidiaries may achieve for future interim periods or the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

The unaudited consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant intercompany transactions and accounts are eliminated in consolidation.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include other-than-temporary impairment on investment securities, the determination of the allowance for loan losses, fair value of financial instruments, and the valuation of deferred tax assets and other real estate owned (“OREO”).

Revenue Recognition

On January 1, 2018, the Company implemented Accounting Standards Update (“ASU” or “updates”) 2014-09, Revenue from Contracts with Customers, codified at Accounting Standards Codification (“ASC”) 606. The Company adopted ASC 606 using the modified retrospective transition method. The majority of the Company’s revenue stream is generated from interest income on loans and deposits which are outside the scope of ASC 606.

The Company’s sources of income that fall within the scope of ASC 606 include service charges on deposits, investment services, interchange fees and gains and losses on sales of other real estate, all of which are presented as components of noninterest income. The following is a summary of the revenue streams that fall within the scope of ASC 606:

 Service charges on deposits, investment services, ATM and interchange fees – Fees from these services are either transaction-based, for which the performance obligations are satisfied when the individual transaction is processed, or set periodic service charges, for which the performance obligations are satisfied over the period the service is provided. Transaction-based fees are recognized at the time the transaction is processed, and periodic service charges are recognized over the service period.

 Gains on sales of OREO – A gain on sale should be recognized when a contract for sale exists and control of the asset has been transferred to the buyer. ASC 606 lists several criteria required to conclude that a contract for sale exists, including a determination that the institution will collect substantially all of the consideration to which it is entitled. In addition to the loan-to-value, the analysis is based on various other factors, including the credit quality of the borrower, the structure of the loan, and any other factors that may affect collectability.

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Reclassifications

Certain amounts reported in the prior period have been reclassified to conform to the current-period presentation. These reclassifications had no impact on the Company’s previously reported net earnings or total stockholders’ equity.

Subsequent Events

The Company has evaluated the effects of events and transactions through the date of this filing that have occurred subsequent to September 30, 2020. The Company does not believe there were any material subsequent events during this period that would have required further recognition or disclosure in the unaudited consolidated financial statements included in this report.

Accounting Developments

In the first nine months of 2020, the Company adopted new guidance related to the following ASUs:

 ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement; and

 ASU 2018-15, Intangibles – Goodwill and Other – Internal Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract.

Information about these pronouncements is described in more detail below.

ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, improves the disclosure requirements on fair value measurements by eliminating the requirements to disclose (i) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) the policy for timing of transfers between levels; and (iii) the valuation processes for Level 3 fair value measurements. This ASU also added specific disclosure requirements for fair value measurements for public entities including the requirement to disclose the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements.

The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2019, and all interim periods within those fiscal years. Early adoption was permitted upon issuance of the ASU. Entities are permitted to early adopt amendments that remove or modify disclosures and delay the adoption of the additional disclosures until their effective date. The Company adopted this ASU on January 1, 2020. Adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

ASU 2018- 15, Intangibles – Goodwill and Other – Internal Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include internal-use software license). This ASU requires entities to use the guidance in FASB ASC 350-40, Intangibles - Goodwill and Other - Internal Use Software, to determine whether to capitalize or expense implementation costs related to the service contract. This ASU also requires entities to (i) expense capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement; (ii) present the expense related to the capitalized implementation costs in the same line item on the income statement as fees associated with the hosting element of the arrangement; (iii) classify payments for capitalized implementation costs in the statement of cash flows in the same manner as payments made for fees associated with the hosting element; and (iv) present the capitalized implementation costs in the same balance sheet line item that a prepayment for the fees associated with the hosting arrangement would be presented.

The amendments in this ASU are effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption was permitted. The Company adopted this ASU on January 1, 2020. Adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

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NOTE 2: BASIC AND DILUTED NET EARNINGS PER SHARE

Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for the respective period. Diluted net earnings per share reflect the potential dilution that could occur upon exercise of securities or other rights for, or convertible into, shares of the Company’s common stock. At September 30, 2020 and 2019, respectively, the Company had no such securities or rights issued or outstanding, and therefore, no dilutive effect to consider for the diluted net earnings per share calculation.

The basic and diluted net earnings per share computations for the respective periods are presented below.

				Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands, except share and per share data)				2020		2019		2020		2019
Basic and diluted:
	Net earnings		$	1,936	$	2,207	$	5,398	$	7,057
	Weighted average common shares outstanding			3,566,239		3,568,287		3,566,184		3,586,642
		Net earnings per share	$	0.54	$	0.62	$	1.51	$	1.97

NOTE 3: SECURITIES

At September 30, 2020 and December 31, 2019, respectively, all securities within the scope of ASC 320, Investments – Debt and Equity Securities, were classified as available-for-sale. The fair value and amortized cost for securities available-for-sale by contractual maturity at September 30, 2020 and December 31, 2019, respectively, are presented below.

			1 year	1 to 5	5 to 10	After 10	Fair	Gross Unrealized		Amortized
(Dollars in thousands)			or less	years	years	years	Value	Gains	Losses	Cost
September 30, 2020
Agency obligations (a)		$	5,011	29,994	55,660	5,389	96,054	3,396	19	$	92,677
Agency RMBS (a)			—	1,302	8,292	145,053	154,647	3,415	285		151,517
State and political subdivisions			96	1,168	6,712	62,245	70,221	3,345	13		66,889
	Total available-for-sale	$	5,107	32,464	70,664	212,687	320,922	10,156	317	$	311,083

December 31, 2019
Agency obligations (a)		$	4,993	27,245	18,470	—	50,708	215	98	$	50,591
Agency RMBS (a)			—	560	4,510	118,207	123,277	798	261		122,740
State and political subdivisions			—	1,355	6,166	54,396	61,917	2,104	9		59,822
	Total available-for-sale	$	4,993	29,160	29,146	172,603	235,902	3,117	368	$	233,153
(a) Includes securities issued by U.S. government agencies or government-sponsored entities.

Securities with aggregate fair values of $162.4 million and $147.8 million at September 30, 2020 and December 31, 2019, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances, and for other purposes required or permitted by law.

Included in other assets on the accompanying consolidated balance sheets are non-marketable equity investments. The carrying amounts of non-marketable equity investments were $1.4 million at September 30, 2020 and December 31, 2019, respectively. Non-marketable equity investments include FHLB of Atlanta Stock, Federal Reserve Bank (“FRB”) stock, and stock in a privately held financial institution.

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Gross Unrealized Losses and Fair Value

The fair values and gross unrealized losses on securities at September 30, 2020 and December 31, 2019, respectively, segregated by those securities that have been in an unrealized loss position for less than 12 months and 12 months or longer, are presented below.

			Less than 12 Months		12 Months or Longer			Total
			Fair	Unrealized	Fair	Unrealized		Fair	Unrealized
(Dollars in thousands)			Value	Losses	Value	Losses		Value	Losses
September 30, 2020:
Agency obligations		$	5,013	19	—	—	$	5,013	19
Agency RMBS			30,819	285	—	—		30,819	285
State and political subdivisions			2,868	13	—	—		2,868	13
	Total	$	38,700	317	—	—	$	38,700	317


December 31, 2019:
Agency obligations		$	24,734	97	4,993	1	$	29,727	98
Agency RMBS			40,126	98	21,477	163		61,603	261
State and political subdivisions			2,741	9	—	—		2,741	9
	Total	$	67,601	204	26,470	164	$	94,071	368

For the securities in the previous table, the Company does not have the intent to sell and has determined it is not more likely than not that the Company will be required to sell the securities before recovery of the amortized cost basis, which may be maturity. On a quarterly basis, the Company assesses each security for credit impairment. For debt securities, the Company evaluates, where necessary, whether credit impairment exists by comparing the present value of the expected cash flows to the securities’ amortized cost basis.

In determining whether a loss is temporary, the Company considers all relevant information including:

 the length of time and the extent to which the fair value has been less than the amortized cost basis;

 adverse conditions specifically related to the security, an industry, or a geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, in the financial condition of the underlying loan obligors, including changes in technology or the discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security or changes in the quality of the credit enhancement);

 the historical and implied volatility of the fair value of the security;

 the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future;

 failure of the issuer of the security to make scheduled interest or principal payments;

 any changes to the rating of the security by a rating agency; and

 recoveries or additional declines in fair value subsequent to the balance sheet date.

Agency obligations

The unrealized losses associated with agency obligations were primarily driven by declines in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

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Agency RMBS

The unrealized losses associated with agency residential mortgage-backed securities (“RMBS”) were primarily driven by declines in interest rates and not due to the credit quality of the securities. These securities were issued by U.S. government agencies or government-sponsored entities and did not have any credit losses given the explicit government guarantee or other government support.

Securities of U.S. states and political subdivisions

The unrealized losses associated with securities of U.S. states and political subdivisions were primarily driven by declines in interest rates and were not due to the credit quality of the securities. Some of these securities are guaranteed by a bond insurer, but management did not rely on the guarantee in making its investment decision. These securities will continue to be monitored as part of the Company’s quarterly impairment analysis, but are expected to perform even if the rating agencies reduce the credit rating of the bond insurers. As a result, the Company expects to recover the entire amortized cost basis of these securities.

The carrying values of the Company’s investment securities could decline in the future if the financial condition of an issuer deteriorates and the Company determines it is probable that it will not recover the entire amortized cost basis for the security. As a result, there is a risk that other-than-temporary impairment charges may occur in the future.

Other-Than-Temporarily Impaired Securities

Credit-impaired debt securities are debt securities where the Company has written down the amortized cost basis of a security for other-than-temporary impairment and the credit component of the loss is recognized in earnings. At September 30, 2020 and December 31, 2019, the Company had no credit-impaired debt securities and there were no additions or reductions in the credit loss component of credit-impaired debt securities during the nine months ended September 30, 2020 and 2019, respectively.

Realized Gains and Losses

The following table presents the gross realized gains and losses on sales of securities.

			Quarter ended September 30,			Nine months ended September 30,
(Dollars in thousands)			2020	2019		2020	2019
Gross realized gains		$	78	44	$	184	76
Gross realized losses			(62)	—		(81)	(19)
	Realized gains, net	$	16	44	$	103	57

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NOTE 4: LOANS AND ALLOWANCE FOR LOAN LOSSES

				September 30,		December 31,
(Dollars in thousands)				2020		2019
Commercial and industrial			$	98,244	$	56,782
Construction and land development				31,651		32,841
Commercial real estate:
	Owner occupied			48,955		48,860
	Hotel/motel			43,111		43,719
	Multi-family			32,608		44,839
	Other			126,318		132,900
		Total commercial real estate		250,992		270,318
Residential real estate:
	Consumer mortgage			37,577		48,923
	Investment property			47,477		43,652
		Total residential real estate		85,054		92,575
Consumer installment				7,731		8,866
		Total loans		473,672		461,382
Less: unearned income				(1,219)		(481)
		Loans, net of unearned income	$	472,453	$	460,901

Loans secured by real estate were approximately 77.6%of the Company’s total loan portfolio at September 30, 2020. At September 30, 2020, the Company’s geographic loan distribution was concentrated primarily in Lee County, Alabama, and surrounding areas.

In accordance with ASC 310, a portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan losses. As part of the Company’s quarterly assessment of the allowance, the loan portfolio is disaggregated into the following portfolio segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment. Where appropriate, the Company’s loan portfolio segments are further disaggregated into classes. A class is generally determined based on the initial measurement attribute, risk characteristics of the loan, and an entity’s method for monitoring and determining credit risk.

The following describes the risk characteristics relevant to each of the portfolio segments and classes.

Commercial and industrial (“C&I”) — includes loans to finance business operations, equipment purchases, or other needs for small and medium-sized commercial customers. Also included in this category are loans to finance agricultural production. Generally, the primary source of repayment is the cash flow from business operations and activities of the borrower. We are a participating lender in the Paycheck Protection Program (“PPP”). PPP loans are forgivable in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. As of September 30, 2020, the Company has 422 PPP loans with an aggregate outstanding principal balance of $36.5 million included in this category.

Construction and land development (“C&D”) — includes both loans and credit lines for the purpose of purchasing, carrying, and developing land into commercial developments or residential subdivisions. Also included are loans and credit lines for construction of residential, multi-family, and commercial buildings. Generally, the primary source of repayment is dependent upon the sale or refinance of the real estate collateral.

Commercial real estate (“CRE”) — includes loans disaggregated into three classes: (1) owner occupied, (2) multifamily and (3) other.

Owner occupied – includes loans secured by business facilities to finance business operations, equipment and owner-occupied facilities primarily for small and medium-sized commercial customers. Generally, the primary source of repayment is the cash flow from business operations and activities of the borrower, who owns the property.

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Hotel/motel – includes loans for hotels and motels. Generally, the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

Multi-family – primarily includes loans to finance income-producing multi-family properties. Loans in this class include loans for 5 or more unit residential property and apartments leased to residents. Generally, the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

Other – primarily includes loans to finance income-producing commercial properties that are not owner occupied. Loans in this class include loans for neighborhood retail centers, medical and professional offices, single retail stores, industrial buildings, and warehouses leased to local businesses. Generally, the primary source of repayment is dependent upon income generated from the real estate collateral. The underwriting of these loans takes into consideration the occupancy and rental rates, as well as the financial health of the borrower.

Residential real estate (“RRE”) — includes loans disaggregated into two classes: (1) consumer mortgage and (2) investment property.

Consumer mortgage – primarily includes first or second lien mortgages and home equity lines of credit to consumers that are secured by a primary residence or second home. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history, and property value.

Investment property – primarily includes loans to finance income-producing 1-4 family residential properties. Generally, the primary source of repayment is dependent upon income generated from leasing the property securing the loan. The underwriting of these loans takes into consideration the rental rates and property value, as well as the financial health of the borrower.

Consumer installment — includes loans to individuals both secured by personal property and unsecured. Loans include personal lines of credit, automobile loans, and other retail loans. These loans are underwritten in accordance with the Bank’s general loan policies and procedures which require, among other things, proper documentation of each borrower’s financial condition, satisfactory credit history, and, if applicable, property value.

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The following is a summary of current, accruing past due, and nonaccrual loans by portfolio segment and class as of September 30, 2020 and December 31, 2019.

					Accruing	Accruing	Total
					30-89 Days	Greater than	Accruing	Non-		Total
(Dollars in thousands)			Current		Past Due	90 days	Loans	Accrual		Loans
September 30, 2020:
Commercial and industrial			$	98,196	48	—	98,244	—	$	98,244
Construction and land development				31,651	—	—	31,651	—		31,651
Commercial real estate:
	Owner occupied			48,955	—	—	48,955	—		48,955
	Hotel/motel			43,111	—	—	43,111	—		43,111
	Multi-family			32,608	—	—	32,608	—		32,608
	Other			126,102	—	—	126,102	216		126,318
		Total commercial real estate		250,776	—	—	250,776	216		250,992
Residential real estate:
	Consumer mortgage			37,179	106	71	37,356	221		37,577
	Investment property			47,366	—	—	47,366	111		47,477
		Total residential real estate		84,545	106	71	84,722	332		85,054
Consumer installment				7,724	6	—	7,730	1		7,731
		Total	$	472,892	160	71	473,123	549	$	473,672


December 31, 2019:
Commercial and industrial			$	56,758	24	—	56,782	—	$	56,782
Construction and land development				32,385	456	—	32,841	—		32,841
Commercial real estate:
	Owner occupied			48,860	—	—	48,860	—		48,860
	Hotel/motel			43,719	—	—	43,719	—		43,719
	Multi-family			44,839	—	—	44,839	—		44,839
	Other			132,900	—	—	132,900	—		132,900
		Total commercial real estate		270,318	—	—	270,318	—		270,318
Residential real estate:
	Consumer mortgage			47,151	1,585	—	48,736	187		48,923
	Investment property			43,629	23	—	43,652	—		43,652
		Total residential real estate		90,780	1,608	—	92,388	187		92,575
Consumer installment				8,802	64	—	8,866	—		8,866
		Total	$	459,043	2,152	—	461,195	187	$	461,382

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect a borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred, which serves to validate that full repayment pursuant to the terms of the loan is unlikely.

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The Company deems loans impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, the impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, construction and land development, commercial real estate, residential real estate, and consumer installment. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for each loan segment. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At September 30, 2020 and December 31, 2019, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures, and other factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

The Company regularly re-evaluates its practices in determining the allowance for loan losses. Since the fourth quarter of 2016, the Company has increased its look-back period each quarter to incorporate the effects of at least one economic downturn in its loss history. The Company believes the extension of its look-back period is appropriate due to the risks inherent in the loan portfolio. Absent this extension, the early cycle periods in which the Company experienced significant losses would be excluded from the determination of the allowance for loan losses and its balance would decrease. For the quarter ended September 30, 2020, the Company increased its look-back period to 46 quarters to continue to include losses incurred by the Company beginning with the first quarter of 2009. The Company will likely continue to increase its look-back period to incorporate the effects of at least one economic downturn in its loss history. During the first nine months of 2020, the Company adjusted certain qualitative and economic factors related to changes in economic conditions driven by the impact of the novel strain of coronavirus (“COVID-19 pandemic”) and resulting adverse economic conditions, including higher unemployment in our primary market area.

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The following table details the changes in the allowance for loan losses by portfolio segment for the respective periods.

			September 30, 2020
(Dollars in thousands)		Commercial and industrial		Construction and land development	Commercial real estate	Residential real estate	Consumer installment		Total
Quarter ended:
Beginning balance		$	679	613	2,915	954	147	$	5,308
Charge-offs			—	—	—	—	(4)		(4)
Recoveries			8	—	—	8	5		21
	Net recoveries		8	—	—	8	1		17
Provision for loan losses			111	(31)	205	(8)	(27)		250
Ending balance		$	798	582	3,120	954	121	$	5,575

Nine months ended:
Beginning balance		$	577	569	2,289	813	138	$	4,386
Charge-offs			(4)	—	—	—	(36)		(40)
Recoveries			63	—	—	53	13		129
	Net recoveries (charge-offs)		59	—	—	53	(23)		89
Provision for loan losses			162	13	831	88	6		1,100
Ending balance		$	798	582	3,120	954	121	$	5,575

			September 30, 2019
(Dollars in thousands)		Commercial and industrial		Construction and land development	Commercial real estate	Residential real estate	Consumer installment		Total
Quarter ended:
Beginning balance		$	726	781	2,287	904	153	$	4,851
Charge-offs			(128)	—	—	(1)	(2)		(131)
Recoveries			59	—	—	12	16		87
	Net (charge-offs) recoveries		(69)	—	—	11	14		(44)
Provision for loan losses			28	(51)	67	(25)	(19)		—
Ending balance		$	685	730	2,354	890	148	$	4,807

Nine months ended:
Beginning balance		$	778	700	2,218	946	148	$	4,790
Charge-offs			(128 )	—	—	(1 )	(18)		(147)
Recoveries			83	—	1	59	21		164
	Net (charge-offs) recoveries		(45)	—	1	58	3		17
Provision for loan losses			(48)	30	135	(114)	(3)		—
Ending balance		$	685	730	2,354	890	148	$	4,807

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The following table presents an analysis of the allowance for loan losses and recorded investment in loans by portfolio segment and impairment methodology as of September 30, 2020 and 2019.

			Collectively evaluated (1)		Individually evaluated (2)		Total
			Allowance	Recorded	Allowance	Recorded	Allowance	Recorded
			for loan	investment	for loan	investment	for loan	investment
(Dollars in thousands)			losses	in loans	losses	in loans	losses	in loans
September 30, 2020:
Commercial and industrial (3)		$	798	98,244	—	—	798	98,244
Construction and land development			582	31,651	—	—	582	31,651
Commercial real estate			3,120	250,776	—	216	3,120	250,992
Residential real estate			954	84,943	—	111	954	85,054
Consumer installment			121	7,731	—	—	121	7,731
	Total	$	5,575	473,345	—	327	5,575	473,672

September 30, 2019:
Commercial and industrial		$	685	52,288	—	—	685	52,288
Construction and land development			730	41,599	—	—	730	41,599
Commercial real estate			2,354	267,346	—	—	2,354	267,346
Residential real estate			890	95,215	—	—	890	95,215
Consumer installment			148	9,148	—	—	148	9,148
	Total	$	4,807	465,596	—	—	4,807	465,596

(1)	Represents loans collectively evaluated for impairment in accordance with ASC 450-20, Loss Contingencies, and
	pursuant to amendments by ASU 2010-20 regarding allowance for non-impaired loans.
(2)	Represents loans individually evaluated for impairment in accordance with ASC 310-30, Receivables, and
	pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
(3)	Includes $36.5 million of PPP loans for which no loan loss reserve was allocated due to 100% SBA guarantee

Credit Quality Indicators

The credit quality of the loan portfolio is summarized no less frequently than quarterly using categories similar to the standard asset classification system used by the federal banking agencies. The following table presents credit quality indicators for the loan portfolio segments and classes. These categories are utilized to develop the associated allowance for loan losses using historical losses adjusted for qualitative and environmental factors and are defined as follows:

 Pass – loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral.

 Special Mention – loans with potential weakness that may, if not reversed or corrected, weaken the credit or inadequately protect the Company’s position at some future date. These loans are not adversely classified and do not expose an institution to sufficient risk to warrant an adverse classification.

 Substandard Accruing – loans that exhibit a well-defined weakness which presently jeopardizes debt repayment, even though they are currently performing. These loans are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected.

 Nonaccrual – includes loans where management has determined that full payment of principal and interest is not expected.

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(Dollars in thousands)				Pass	Special Mention	Substandard Accruing	Nonaccrual		Total loans
September 30, 2020:
Commercial and industrial			$	95,824	2,190	230	—	$	98,244
Construction and land development				31,088	—	563	—		31,651
Commercial real estate:
	Owner occupied			45,089	3,723	143	—		48,955
	Hotel/motel			43,111	—	—	—		43,111
	Multi-family			29,078	3,530	—	—		32,608
	Other			125,574	483	45	216		126,318
		Total commercial real estate		242,852	7,736	188	216		250,992
Residential real estate:
	Consumer mortgage			34,682	398	2,276	221		37,577
	Investment property			46,654	502	210	111		47,477
		Total residential real estate		81,336	900	2,486	332		85,054
Consumer installment				7,673	15	42	1		7,731
		Total	$	458,773	10,841	3,509	549	$	473,672

December 31, 2019:
Commercial and industrial			$	54,340	2,176	266	—	$	56,782
Construction and land development				31,798	—	1,043	—		32,841
Commercial real estate:
	Owner occupied			47,865	917	78	—		48,860
	Hotel/motel			43,719	—	—	—		43,719
	Multi-family			44,839	—	—	—		44,839
	Other			132,030	849	21	—		132,900
		Total commercial real estate		268,453	1,766	99	—		270,318
Residential real estate:
	Consumer mortgage			45,247	962	2,527	187		48,923
	Investment property			42,331	949	372	—		43,652
		Total residential real estate		87,578	1,911	2,899	187		92,575
Consumer installment				8,742	60	64	—		8,866
		Total	$	450,911	5,913	4,371	187	$	461,382

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Impaired loans

The following tables present details related to the Company’s impaired loans. Loans that have been fully charged-off are not included in the following tables. The related allowance generally represents the following components that correspond to impaired loans:

 Individually evaluated impaired loans equal to or greater than $500,000 secured by real estate (nonaccrual construction and land development, commercial real estate, and residential real estate loans).

 Individually evaluated impaired loans equal to or greater than $250,000 not secured by real estate (nonaccrual commercial and industrial and consumer installment loans).

The following tables set forth certain information regarding the Company’s impaired loans that were individually evaluated for impairment at September 30, 2020 and December 31, 2019.


				September 30, 2020
(Dollars in thousands)				Unpaid principal balance (1)	Charge-offs and payments applied (2)	Recorded investment (3)		Related allowance
With no allowance recorded:
Commercial real estate:
	Other		$	218	(2)	216	$	—
		Total commercial real estate		218	(2)	216		—
Residential real estate:
	Investment property			111	—	111		—
		Total residential real estate		111	—	111		—
		Total impaired loans	$	329	(2)	327	$	—

(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been
	applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before
	any related allowance for loan losses.

				December 31, 2019
(Dollars in thousands)				Unpaid principal balance (1)	Charge-offs and payments applied (2)	Recorded investment (3)		Related allowance
With no allowance recorded:
Commercial and industrial			$	335	(236)	99	$	—
		Total impaired loans	$	335	(236)	99	$	—

(1) Unpaid principal balance represents the contractual obligation due from the customer.
(2) Charge-offs and payments applied represents cumulative charge-offs taken, as well as interest payments that have been
	applied against the outstanding principal balance subsequent to the loans being placed on nonaccrual status.
(3) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before
	any related allowance for loan losses.

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The following table provides the average recorded investment in impaired loans, if any, by portfolio segment, and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class during the respective periods.

				Quarter ended September 30, 2020		Nine months ended September 30, 2020
				Average	Total interest	Average	Total interest
				recorded	income	recorded	income
(Dollars in thousands)				investment	recognized	investment	recognized
Impaired loans:
Commercial real estate:
	Other		$	217	—	87	—
		Total commercial real estate		217	—	87	—
Residential real estate:
	Investment property			111	—	44	—
		Total residential real estate		111	—	44	—
		Total	$	328	—	131	—

				Quarter ended September 30, 2019		Nine months ended September 30, 2019
				Average	Total interest	Average	Total interest
				recorded	income	recorded	income
(Dollars in thousands)				investment	recognized	investment	recognized
Impaired loans:
Commercial real estate:
	Owner occupied		$	—	—	31	9
		Total commercial real estate		—	—	31	9
		Total	$	—	—	31	9

Troubled Debt Restructurings

Impaired loans also include troubled debt restructurings (“TDRs”). On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law. Section 4013 of the CARES Act, “Temporary Relief From Troubled Debt Restructurings,” provides banks the option to temporarily suspend certain requirements under ASC 340-10 TDR classifications for a limited period of time to account for the effects of COVID-19. On April 7, 2020, the Federal Reserve and the other banking agencies and regulators issued a statement, “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)” (the “Interagency Statement on COVID-19 Loan Modifications”), to encourage banks to work prudently with borrowers and to describe the agencies’ interpretation of how accounting rules under ASC 310-40, “Troubled Debt Restructurings by Creditors,” apply to certain COVID-19-related modifications. The Interagency Statement on COVID-19 Loan Modifications was supplemented on June 23, 2020 by the Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions. If a loan modification is eligible, a bank may elect to account for the loan under section 4013 of the CARES Act. If a loan modification is not eligible under section 4013, or if the bank elects not to account for the loan modification under section 4013, the Revised Statement includes criteria when a bank may presume a loan modification is not a TDR in accordance with ASC 310-40.

The Company evaluates loan extensions or modifications not qualified under Section 4013 of the CARES Act or under the Interagency Statement on COVID-19 Loan Modifications in accordance with FASB ASC 340-10 with respect to the classification of the loan as a TDR. In the normal course of business, management may grant concessions to borrowers that are experiencing financial difficulty. A concession may include, but is not limited to, delays in required payments of principal and interest for a specified period, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date, or reduction of the face amount or maturity amount of the debt. A concession has been granted when, as a result of the restructuring, the Bank does not expect to collect, when due, all amounts owed, including interest at the original stated rate. A concession may have also been granted if the debtor is not able to access funds elsewhere at a market rate for debt with similar risk characteristics as the restructured debt. In making the determination of whether a loan modification is a TDR, the Company considers the individual facts and circumstances surrounding each modification. As part of the credit approval process, the restructured loans are evaluated for adequate collateral protection in determining the appropriate accrual status at the time of restructure.

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Similar to other impaired loans, TDRs are measured for impairment based on the present value of expected payments using the loan’s original effective interest rate as the discount rate, or the fair value of the collateral, less selling costs if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, impairment is recognized by establishing a valuation allowance as part of the allowance for loan losses or a charge-off to the allowance for loan losses. In periods subsequent to the modification, all TDRs are individually evaluated for possible impairment.

The following is a summary of accruing and nonaccrual TDRs, which are included in the impaired loan totals, and the related allowance for loan losses, by portfolio segment and class as of September 30, 2020. The company had no TDRs as of December 31, 2019.

				TDRs
								Related
(Dollars in thousands)				Accruing	Nonaccrual	Total		Allowance
September 30, 2020
Commercial real estate:
	Other		$	—	216	216	$	—
		Total commercial real estate		—	216	216		—
Residential real estate:
	Investment property			—	111	111		—
		Total residential real estate		—	111	111		—
		Total	$	—	327	327	$	—

At September 30, 2020, there were no significant outstanding commitments to advance additional funds to customers whose loans had been restructured.

The following table summarizes loans modified in a TDR during the respective periods both before and after their modification.

			Quarter ended September 30,				Nine months ended September 30,
					Pre-	Post -			Pre-	Post -
					modification	modification			modification	modification
			Number		outstanding	outstanding	Number		outstanding	outstanding
			of		recorded	recorded	of		recorded	recorded
(Dollars in thousands)			contracts		investment	investment	contracts		investment	investment
2020:
Commercial real estate:
	Other		—	$	—	—	1	$	216	216
		Total commercial real estate	—		—	—	1		216	216
Residential real estate:
	Investment property		—		—	—	3		111	111
		Total residential real estate	—		—	—	3		111	111
		Total	—	$	—	—	4	$	327	327

Four loans were modified in a TDR during the nine months ended September 30, 2020. The only concession granted by the Company was related to a delay in the required payment of principal and interest. There were no loans modified in a TDR during the quarter and nine months ended September 30, 2019.

During the quarter and nine months ended September 30, 2020 and 2019, respectively, there were no loans modified in a TDR within the previous 12 months for which there was a payment default (defined as 90 days or more past due).

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NOTE 6: MORTGAGE SERVICING RIGHTS, NET

Mortgage servicing rights (“MSRs”) are recognized based on the fair value of the servicing rights on the date the corresponding mortgage loans are sold. An estimate of the fair value of the Company’s MSRs is determined using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rates, default rates, costs to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Under the amortization method, MSRs are amortized in proportion to, and over the period of, estimated net servicing income.

The Company has recorded MSRs related to loans sold without recourse to Fannie Mae. The Company generally sells conforming, fixed-rate, closed-end, residential mortgages to Fannie Mae. MSRs are included in other assets on the accompanying consolidated balance sheets.

The Company evaluates MSRs for impairment on a quarterly basis. Impairment is determined by stratifying MSRs into groupings based on predominant risk characteristics, such as interest rate and loan type. If, by individual stratum, the carrying amount of the MSRs exceeds fair value, a valuation allowance is established. The valuation allowance is adjusted as the fair value changes. Changes in the valuation allowance are recognized in earnings as a component of mortgage lending income.

The following table details the changes in amortized MSRs and the related valuation allowance for the respective periods.

		Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands)		2020		2019		2020		2019
MSRs, net:
Beginning balance	$	1,271	$	1,355	$	1,299	$	1,441
Additions, net		234		80		471		160
Amortization expense		(183)		(109)		(448)		(275)
Ending balance	$	1,322	$	1,326	$	1,322	$	1,326

Valuation allowance included in MSRs, net:
Beginning of period	$	—	$	—	$	—	$	—
End of period		—		—		—		—

Fair value of amortized MSRs:
Beginning of period	$	1,690	$	2,333	$	2,111	$	2,697
End of period		1,521		2,068		1,521		2,068

NOTE 7: FAIR VALUE

Fair Value Hierarchy

“Fair value” is defined by ASC 820, Fair Value Measurements and Disclosures, as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for an asset or liability at the measurement date. GAAP establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1—inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets.

Level 2—inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs that are observable for the asset or liability, either directly or indirectly.

Level 3—inputs to the valuation methodology are unobservable and reflect the Company’s own assumptions about the inputs market participants would use in pricing the asset or liability.

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Level changes in fair value measurements

Transfers between levels of the fair value hierarchy are generally recognized at the end of each reporting period. The Company monitors the valuation techniques utilized for each category of financial assets and liabilities to ascertain when transfers between levels have been affected. The nature of the Company’s financial assets and liabilities generally is such that transfers in and out of any level are expected to be infrequent. For the nine months ended September 30, 2020, there were no transfers between levels and no changes in valuation techniques for the Company’s financial assets and liabilities.

Assets and liabilities measured at fair value on a recurring basis

Securities available-for-sale

Fair values of securities available for sale were primarily measured using Level 2 inputs. For these securities, the Company obtains pricing from third party pricing services. These third party pricing services consider observable data that may include broker/dealer quotes, market spreads, cash flows, benchmark yields, reported trades for similar securities, market consensus prepayment speeds, credit information, and the securities’ terms and conditions. On a quarterly basis, management reviews the pricing received from the third party pricing services for reasonableness given current market conditions. As part of its review, management may obtain non-binding third party broker quotes to validate the fair value measurements. In addition, management will periodically submit pricing provided by the third party pricing services to another independent valuation firm on a sample basis. This independent valuation firm will compare the price provided by the third party pricing service with its own price and will review the significant assumptions and valuation methodologies used with management.

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The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019, respectively, by caption, on the accompanying consolidated balance sheets by ASC 820 valuation hierarchy (as described above).

					Quoted Prices in	Significant
					Active Markets	Other	Significant
					for	Observable	Unobservable
					Identical Assets	Inputs	Inputs
(Dollars in thousands)				Amount	(Level 1)	(Level 2)	(Level 3)
September 30, 2020:
Securities available-for-sale:
	Agency obligations		$	96,054	—	96,054	—
	Agency RMBS			154,647	—	154,647	—
	State and political subdivisions			70,221	—	70,221	—
Total securities available-for-sale				320,922	—	320,922	—
		Total assets at fair value	$	320,922	—	320,922	—


December 31, 2019:
Securities available-for-sale:
	Agency obligations		$	50,708	—	50,708	—
	Agency RMBS			123,277	—	123,277	—
	State and political subdivisions			61,917	—	61,917	—
Total securities available-for-sale				235,902	—	235,902	—
		Total assets at fair value	$	235,902	—	235,902	—

Assets and liabilities measured at fair value on a nonrecurring basis

Loans held for sale

Loans held for sale are carried at the lower of cost or fair value. Fair values of loans held for sale are determined using quoted market secondary market prices for similar loans. Loans held for sale are classified within Level 2 of the fair value hierarchy.

Impaired Loans

Loans considered impaired under ASC 310-10-35, Receivables, are loans for which, based on current information and events, it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans can be measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent.

The fair value of impaired loans was primarily measured based on the value of the collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. The Company determines the value of the collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors discussed above.

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Other real estate owned

Other real estate owned (“OREO”), consisting of properties obtained through foreclosure or in satisfaction of loans, is initially recorded at the lower of the loan’s carrying amount or the fair value of collateral less costs to sell upon transfer of the loans to other real estate. Subsequently, OREO is carried at the lower of carrying value or fair value less costs to sell. Fair values are generally based on third party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes further discounted based on management’s historical knowledge, and/or changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts are typically significant unobservable inputs for determining fair value. In cases where the carrying amount exceeds the fair value, less costs to sell, a loss is recognized in noninterest expense.

Mortgage servicing rights, net

MSRs, net, included in other assets on the accompanying consolidated balance sheets, are carried at the lower of cost or estimated fair value. MSRs do not trade in an active market with readily observable prices. To determine the fair value of MSRs, the Company engages an independent third party. The independent third party’s valuation model calculates the present value of estimated future net servicing income using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rates, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. Periodically, the Company will review broker surveys and other market research to validate significant assumptions used in the model. The significant unobservable inputs include prepayment speeds or the constant prepayment rate (“CPR”) and the weighted average discount rate. Because the valuation of MSRs requires the use of significant unobservable inputs, all of the Company’s MSRs are classified within Level 3 of the valuation hierarchy.

The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2020 and December 31, 2019, respectively, by caption, on the accompanying consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above):

				Quoted Prices in
				Active Markets	Other	Significant
				for	Observable	Unobservable
			Carrying	Identical Assets	Inputs	Inputs
(Dollars in thousands)			Amount	(Level 1)	(Level 2)	(Level 3)
September 30, 2020:
Loans held for sale		$	4,765	—	4,765	—
Loans, net⁽¹⁾			327	—	—	327
Other assets ⁽²⁾			1,322	—	—	1,322
	Total assets at fair value	$	6,414	—	4,765	1,649
December 31, 2019:
Loans held for sale		$	2,202	—	2,202	—
Loans, net⁽¹⁾			99	—	—	99
Other assets ⁽²⁾			1,299	—	—	1,299
	Total assets at fair value	$	3,600	—	2,202	1,398
⁽¹⁾Loans considered impaired under ASC 310-10-35 Receivables. This amount reflects the recorded investment in impaired loans, net
of any related allowance for loan losses
⁽²⁾Represents MSRs, net and other real estate owned, both of which are carried at lower of cost or estimated fair value.

Quantitative Disclosures for Level 3 Fair Value Measurements

At September 30, 2020, the Company had no Level 3 assets measured at fair value on a recurring basis. For Level 3 assets measured at fair value on a non-recurring basis at September 30, 2020, the significant unobservable inputs used in the fair value measurements are presented below.

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									Weighted
		Carrying		Significant					Average
(Dollars in thousands)		Amount	Valuation Technique	Unobservable Input	Range				of Input
September 30, 2020:
Impaired loans	$	327	Appraisal	Appraisal discounts	10.0	-	10.0	%	10.0	%
Mortgage servicing rights, net		1,322	Discounted cash flow	Prepayment Speed or CPR	17.7	-	20.9	%	20.2	%
				Discount rate	10.0	-	12.0	%	10.0	%

December 31, 2019:
Impaired loans	$	99	Appraisal	Appraisal discounts					10.0	%
Mortgage servicing rights, net		1,299	Discounted cash flow	Prepayment Speed or CPR					11.6	%
				Discount rate					10.0	%

Fair Value of Financial Instruments

ASC 825, Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow analyses. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather are a good-faith estimate of the fair value of financial instruments held by the Company. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements.

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The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

Loans, net

Fair values for loans were calculated using discounted cash flows. The discount rates reflected current rates at which similar loans would be made for the same remaining maturities. Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments. The fair value of loans was measured using an exit price notion.

Loans held for sale

Fair values of loans held for sale are determined using quoted secondary market prices for similar loans.

Time Deposits

Fair values for time deposits were estimated using discounted cash flows. The discount rates were based on rates currently offered for deposits with similar remaining maturities.

The carrying value, related estimated fair value, and placement in the fair value hierarchy of the Company’s financial instruments at September 30, 2020 and December 31, 2019 are presented below. This table excludes financial instruments for which the carrying amount approximates fair value. Financial assets for which fair value approximates carrying value included cash and cash equivalents. Financial liabilities for which fair value approximates carrying value included noninterest-bearing demand deposits, interest-bearing demand deposits, and savings deposits. Fair value approximates carrying value in these financial liabilities due to these products having no stated maturity. Additionally, financial liabilities for which fair value approximates carrying value included overnight borrowings such as federal funds purchased and securities sold under agreements to repurchase.

							Fair Value Hierarchy
			Carrying		Estimated		Level 1		Level 2		Level 3
(Dollars in thousands)			amount		fair value		inputs		inputs		Inputs
September 30, 2020:
Financial Assets:
	Loans, net (1)	$	466,878	$	468,317	$	—	$	—	$	468,317
	Loans held for sale		4,765		4,969		—		4,969		—
Financial Liabilities:
	Time Deposits	$	163,294	$	165,024	$	—	$	165,024	$	—

December 31, 2019:
Financial Assets:
	Loans, net (1)	$	456,515	$	453,705	$	—	$	—	$	453,705
	Loans held for sale		2,202		2,251		—		2,251		—
Financial Liabilities:
	Time Deposits	$	167,199	$	168,316	$	—	$	168,316	$	—

(1) Represents loans, net of unearned income and the allowance for loan losses. The fair value of loans was measured using an exit price notion.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of the Company and the Bank. This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters and nine months ended September 30, 2020 and 2019, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2019 and our interim reports on Form 10-Q for the quarters ended March 31, 2020 and June 30, 2020.

Special Notice Regarding Forward-Looking Statements

Certain of the statements made in this discussion and analysis and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance, achievements, or financial condition of the Company to be materially different from future results, performance, achievements, or financial condition expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

• the effects of future economic, business, and market conditions and changes, domestic and foreign, including seasonality;

• the significant disruptive effects of the COVID-19 pandemic, and local, state, national and international economic activity, including decreases in gross domestic product (“GDP”) and increases in unemployment;

• governmental monetary and fiscal policies, generally, and reductions of market interest rates, injections of liquidity by the Federal Reserve, Federal Reserve lending and market support programs and facilities, government spending and aid to businesses and consumers as a result of the COVID-19 pandemic, and the COVID-19 pandemic’s effects and public health and economic activity;

• the effects of public health, economic activity and measures taken to restore public health in light of the COVID-19 pandemic;

• legislative and regulatory changes, including the CARES Act, 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 temporary other changes in accounting and capital requirements to address the effects of the COVID-19 pandemic and stabilize and stimulate the economy and delays in PPP loan forgiveness rules and processing;

• changes in accounting policies, rules, and practices;

• the risks of changes in interest rates on the levels, composition, and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable;

• changes in borrower credit risks and payment behaviors, especially in light of the economic effects of COVID-19;

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• 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;

• the failure of assumptions and estimates underlying the establishment of allowances for possible loan and other asset impairments, losses, valuations of assets and liabilities and other estimates, including the timing and effect of the implementation of the current expected credit losses model to financial instruments, and the significant changes in economic conditions, unemployment and GDP resulting from the COVID-19 pandemic, local and state shelter in place orders and other national health initiatives that result in workplace shutdowns, supply chain failures and economic and personal disruption;

• 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 our technology or products that may be more difficult, costly, or less effective than anticipated;

• our business continuity planning, and changes in the ways we communicate with, and provide services to our customers, implemented during the COVID-19 pandemic;

• the effects of war, or other conflicts, acts of terrorism, pandemics or other catastrophic events that may affect general economic conditions;

• cyber attacks and data breaches that may compromise our systems or customers’ information, including increased fraud during the COVID-19 pandemic;

• 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 stress tests and other evaluations, including price and market volatility, deferrals on loans, suspension of residential mortgage foreclosure and liquidity issues resulting from the COVID-19 pandemic;

• the risk that our deferred tax assets, 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, if any, that we may be able to utilize for income tax purposes; and

• other factors and information in this report and other filings that we make with the SEC under the Exchange Act, including our Annual Report on Form 10-K for the year ended December 31, 2019 and subsequent quarterly and current reports. See Part II, Item 1A. “RISK FACTORS”.

All written or oral forward-looking statements that are made by or 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.

Business

The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank holding company after it acquired its Alabama predecessor, which was a bank holding company established in 1984. The Bank, the Company’s principal subsidiary, is an Alabama state-chartered bank that is a member of the Federal Reserve System and has operated continuously since 1907. Both the Company and the Bank are headquartered in Auburn, Alabama. The Bank conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank operates 8 full-service branches in Auburn, Opelika, Notasulga, and Valley, Alabama. The Bank also operates loan production offices in Auburn and Phenix City, Alabama.

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Summary of Results of Operations

			Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands, except per share amounts)			2020		2019		2020		2019
Net interest income (a)		$	5,990	$	6,707	$	18,519	$	20,215
Less: tax-equivalent adjustment			122		140		369		431
	Net interest income (GAAP)		5,868		6,567		18,150		19,784
Noninterest income			1,374		991		3,972		3,036
	Total revenue		7,242		7,558		22,122		22,820
Provision for loan losses			250		—		1,100		—
Noninterest expense			4,653		4,824		14,468		14,064
Income tax expense			403		527		1,156		1,699
	Net earnings	$	1,936	$	2,207	$	5,398	$	7,057

Basic and diluted earnings per share		$	0.54	$	0.62	$	1.51	$	1.97
(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 2020, compared to $7.1 million for the first nine months of 2019. Basic and diluted earnings per share were $1.51 per share for the first nine months of 2020, compared to $1.97 per share for the first nine months of 2019.

Net interest income (tax-equivalent) was $18.5 million for the first nine months of 2020, an 8% decrease compared to $20.2 million for the first nine months of 2019. This decrease was primarily due to the lower interest rate environment, including a 150 basis point reduction in the federal funds rate that occurred late in the first quarter of 2020. Average loans were also down 3% to $461.2 million in the first nine months of 2020, compared to $474.4 million in the first nine months of 2019. The Company’s net interest margin (tax-equivalent) decreased to 2.96% in the first nine months of 2020, compared to 3.48% for the first nine months of 2019 primarily due to the lower interest rate environment and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

At September 30, 2020, the Company’s allowance for loan losses was $5.6 million, or 1.18% of total loans, compared to $4.4 million, or 0.95% of total loans, at December 31, 2019, and $4.8 million, or 1.03% of total loans, at September 30, 2019. At September 30, 2020, the Company’s allowance for loan losses was 1.28% of total loans, excluding PPP loans. The provision for loan losses was $1.1 million for the first nine months of 2020, compared to no provision for loan losses during the first nine months of 2019. The increase in the provision for loan losses was related to changes in economic conditions and portfolio trends driven by the impact of COVID-19 and resulting adverse economic conditions, including higher unemployment in our primary market area. The provision for loan losses is based upon various estimates and judgements, including the absolute level of loans, loan growth, credit quality and the amount of net charge-offs.

Noninterest income was $4.0 million for the first nine months of 2020 compared to $3.0 million for the first nine months of 2019. The increase was primarily due to an increase in mortgage lending income of $1.0 million during first nine months of 2020 compared to the first nine months of 2019. The increase was primarily due to an increase in mortgage lending income as lower interest rates for mortgage loans positively affected refinance activity and pricing margins improved.

Noninterest expense was $14.5 million for the first nine months of 2020 compared to $14.1 million for the first nine months of 2019. The increase was primarily due to $0.8 million of various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn, including revised depreciation estimates and temporary relocation costs. The Company expects it will incur additional expense in 2020 related to this redevelopment project.

Income tax expense was $1.2 million and $1.7 million for the first nine months of 2020 and 2019, respectively, reflecting an effective tax rate of 17.64% and 19.40%, respectively. This change was primarily due to a decrease in the level of earnings before taxes relative to tax-exempt sources of income. The Company’s effective income tax rate is principally impacted by tax-exempt earnings from the Company’s investments in municipal securities and bank-owned life insurance.

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The Company paid cash dividends of $0.765 per share in the first nine months of 2020, an increase of 2% from the same period of 2019. At September 30, 2020, the Bank’s regulatory capital ratios were well above the minimum amounts required to be “well capitalized” under current regulatory standards with a total risk-based capital ratio of 18.77%, a tier 1 leverage ratio of 10.38% and a common equity tier 1 (“CET1”) ratio of 17.70% at September 30, 2020.

For the third quarter of 2020, net earnings were $1.9 million, or $0.54 per share, compared to $2.2 million, or $0.62 per share, for the third quarter of 2019. Net interest income (tax-equivalent) was $6.0 million for the third quarter of 2020 compared to $6.7 million for the third quarter of 2019. The Company’s net interest margin (tax-equivalent) decreased to 2.72% in the third quarter of 2020, compared to 3.41% for the third quarter of 2019 primarily due to the lower rate environment and changes in our asset mix from the significant short-term liquidity increase in customer deposits. The Company recorded a provision for loan losses of $0.3 million during the third quarter of 2020 and no provision during the third quarter 2019. Noninterest income was $1.4 million in the third quarter of 2020 and $1.0 million in the third quarter of 2019. The increase was primarily due to an increase in mortgage lending income as lower interest rates for mortgage loans positively affected refinance activity and pricing margins improved. Noninterest expense was $4.7 million in the third quarter of 2020 compared to $4.8 million during the third quarter of 2019. Income tax expense was $0.4 million for the third quarter of 2020 compared to $0.5 million during third quarter of 2019. The Company's effective tax rate for the third quarter of 2020 was 17.23%, compared to 19.28% in the third quarter of 2019.

COVID-19 Impact Assessment

In December 2019, COVID-19 was first reported in China and has since spread to a number of other countries, including the United States. In March 2020, the World Health Organization declared COVID-19 a global pandemic and the United States declared a National Public Health Emergency. The COVID-19 pandemic has severely restricted the level of economic activity in our markets. In response to the COVID-19 pandemic, the State of Alabama, and most other states, have taken preventative or protective actions to prevent the spread of the virus, including imposing restrictions on travel and business operations and a statewide mask mandate, advising or requiring individuals to limit or forego their time outside of their homes, limitations on gathering of people and social distancing, and causing temporary closures of businesses that have been deemed to be non-essential. Though certain of these measures have been relaxed or eliminated, increases in reported cases could cause these measures to be reestablished. Auburn University, a major source of economic activity in Lee County, went to remote instruction on March 16, 2020. Auburn University announced its guidelines for the fall semester of 2020, which involves both remote and in person instruction as well as other social distancing measures. The economic effects of these measures are not presently known.

COVID-19 has significantly affected local state, national and global health and economic activity and its future effects are uncertain and will depend on various factors, including, among others, the duration and scope of the pandemic, the development and distribution of COVID-19 testing and contact tracing, effective drug treatments and vaccines, together with governmental, regulatory and private sector responses. COVID-19 has had continuing significant effects on the economy, financial markets and our employees, customers and vendors. Our business, financial condition and results of operations generally rely upon the ability of our borrowers to make deposits and repay their loans, the value of collateral underlying our secured loans, market value, stability and liquidity and demand for loans and other products and services we offer, all of which are affected by the pandemic.

We have implemented a number of procedures in response to the pandemic to support the safety and well-being of our employees, customers and shareholders.

•We believe our business continuity plan has worked to provide essential banking services to our communities and customers, while protecting our employees’ health. As part of our efforts to exercise social distancing in accordance with the guidelines of the Centers for Disease Control, starting March 23, we limited branch lobby service to appointment only while continuing to operate our branch drive-thru facilities and automated teller machines (“ATMs”). On June 1, 2020, we re-opened some of our branch lobbies as permitted by state public health guidelines. We continue to provide services through our online and other electronic channels. In addition, we established remote work access to help employees stay at home where job duties permit.

•We are focused on servicing the financial needs of our commercial and consumer clients with extensions and deferrals to loan customers effected by COVID-19, provided such customers were not more than 30 days past due at the time of the request; and

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•We are a participating lender in the Paycheck Protection Program (“PPP”). PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the Small Business Administration (“SBA”) remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10-month period. We believe these loans and our participation in the program is good for our customers and the communities we serve. A summary of our PPP loans as of September 30, 2020 follows:

(Dollars in thousands)	# of SBA Approved	Mix			$ of SBA Approved	Mix
SBA Tier:
$2 million to $10 million	—	—	%	$	—	—	%
$350,000 to less than $2 million	22	5			14,687	40
Up to $350,000	400	95			21,784	60
Total	422	100	%	$	36,471	100	%

The PPP closed on August 8, 2020 and the SBA no longer accepts PPP applications from participating lenders. The Company extended $36.5 million in loans to 422 small businesses under the PPP during the second quarter of 2020. We collected approximately $1.5 million in fees related to our PPP loans, which will be recognized net of related costs, as a yield adjustment over the life of the underlying PPP loans.

We continue to closely monitor this pandemic, and are working to continue our services during the pandemic and to address developments as those occur. Our results of operations for the nine months ended September 30, 2020, and our financial condition at that date reflect only the initial effects of the pandemic, and may not be indicative of future results or financial conditions, including possible additional monetary or fiscal stimulus, and the possible effects of the expiration or extension of temporary accounting and bank regulatory relief measures in response to the COVID-19 pandemic.

As of September 30, 2020, all of our capital ratios were in excess of all regulatory requirements to be well capitalized. The effects of the COVID-19 pandemic on our borrowers could result in adverse changes to credit quality and our regulatory capital ratios. We continue to closely monitor this pandemic, and are working to continue our services during the pandemic and to address developments as those occur.

CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. GAAP and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements and the valuation of OREO and deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations.

Allowance for Loan Losses

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In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that it will be able to collect all amounts due according to the contractual terms of a loan.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures, and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

The Company regularly re-evaluates its practices in determining the allowance for loan losses. Since the fourth quarter of 2016, the Company has increased its look-back period each quarter to incorporate the effects of at least one economic downturn in its loss history. The Company believes the extension of its look-back period is appropriate due to the risks inherent in the loan portfolio. Absent this extension, the early cycle periods in which the Company experienced significant losses would be excluded from the determination of the allowance for loan losses and its balance would decrease. For the quarter ended September 30, 2020, the Company increased its look-back period to 46 quarters to continue to include losses incurred by the Company beginning with the first quarter of 2009. The Company will likely continue to increase its look-back period to incorporate the effects of at least one economic downturn in its loss history. During the first nine months of 2020, the Company adjusted certain qualitative and economic factors related to changes in economic conditions and portfolio trends driven by the impact of the COVID-19 pandemic and resulting adverse economic conditions, including higher unemployment in our primary market area. Further adjustments may be made in the future as a result of the continuing COVID-19 pandemic.

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Assessment for Other-Than-Temporary Impairment of Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell a debt security, (2) it is more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that it will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

Fair Value Determination

U.S. GAAP requires management to value and disclose certain of the Company’s assets and liabilities at fair value, including investments classified as available-for-sale and derivatives. ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. GAAP and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 7, Fair Value, of the consolidated financial statements that accompany this report.

Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have readily available active market pricing. However, some of the Company’s assets or liabilities lack an available or comparable trading market characterized by frequent transactions between willing buyers and sellers. In these cases, fair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility, and other factors, taking into account current observable market data and experience.

These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Other Real Estate Owned

OREO consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value of collateral, less estimated costs to sell at the date acquired, with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal of OREO are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO. At September 30, 2020 and December 31, 2019 the Company had no OREO properties.

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Deferred Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences at September 30, 2020. The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced.

Under the CARES Act, net operating losses arising in tax years beginning after December 31, 2017, and before January 1, 2021 may be carried back to each of the five tax years preceding the tax year of such loss. Since the enactment of the Tax Cuts and Jobs Act, net operating losses generally could not be carried back but could be carried forward indefinitely. Further, the Tax Cuts and Jobs Act limited net operating loss absorption to 80% of taxable income. The CARES Act temporarily removes the 80% limitation, reinstating it for tax years beginning after 2020.

RESULTS OF OPERATIONS

Average Balance Sheet and Interest Rates
			Nine months ended September 30,
			2020			2019
			Average		Yield/	Average		Yield/
(Dollars in thousands)			Balance		Rate	Balance		Rate
Loans and loans held for sale			$	463,581	4.71%	$	475,467	4.86%
Securities - taxable				225,234	1.83%		175,703	2.28%
Securities - tax-exempt				62,930	3.73%		67,964	4.03%
		Total securities		288,164	2.24%		243,667	2.77%
Federal funds sold				30,739	0.51%		19,552	2.32%
Interest bearing bank deposits				53,834	0.53%		37,094	2.38%
		Total interest-earning assets		836,318	3.44%		775,780	4.02%
Deposits:
	NOW			153,767	0.37%		134,368	0.53%
	Savings and money market			234,533	0.46%		218,284	0.43%
	Time Deposits			166,115	1.43%		171,804	1.45%
		Total interest-bearing deposits		554,415	0.72%		524,456	0.79%
Short-term borrowings				1,721	0.50%		1,503	0.50%
		Total interest-bearing liabilities		556,136	0.72%		525,959	0.79%
Net interest income and margin (tax-equivalent)			$	18,519	2.96%	$	20,215	3.48%

Net Interest Income and Margin

Net interest income (tax-equivalent) was $18.5 million for the first nine months of 2020 compared to $20.2 million for the first nine months of 2019. This decrease was due to a decline in the Company’s net interest margin (tax-equivalent).

The tax-equivalent yield on total interest-earning assets decreased by 58 basis points to 3.44% in the first nine months of 2020 compared to 4.02% in the first nine months of 2019. This decrease was primarily due to the lower rate environment, including a 150 basis point reduction in the federal funds rate that occurred late in the first quarter of 2020 and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

The cost of total interest-bearing liabilities was 0.72% and 0.79%, for the first nine months of 2020 and 2019, respectively. Such costs declined less than the declines in rates earned on our interest earning assets.

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The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations. The Company’s net interest margin could continue to experience pressure due to reduced earning asset yields and increased competition for quality loan opportunities. Management anticipates the Company’s net interest income and margin will likely continue to decrease in 2020 compared to 2019 as the Company’s ability to lower its deposit costs will likely continue to lag the current decrease in earning asset yields.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that management believes, based on its processes and estimates, should be adequate to provide for the probable losses on outstanding loans. The provision for loan losses was $1.1 million for the first nine months of 2020, compared to no provision for loan losses for the first nine months of 2019. The increase in the provision for loan losses was related to adverse changes in economic conditions and portfolio trends driven by the impact of COVID-19 pandemic, including higher unemployment in our primary market area. The provision for loan losses is based upon various factors, including the absolute level of loans, loan growth, the credit quality, and the amount of net charge-offs or recoveries.

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover its estimate of probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 1.18% at September 30, 2020, compared to 0.95% at December 31, 2019. At September 30, 2020, the Company’s allowance for loan losses was 1.28% of total loans, excluding PPP loans. While the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are based on estimates and judgments and are therefore approximate and imprecise. Factors beyond our control (such as conditions in the local and national economy, local real estate markets, or industries) may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses resulting in significant increases in the provision for loan losses.

Noninterest Income
		Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands)			2020		2019		2020		2019
Service charges on deposit accounts		$	139	$	182	$	437	$	542
Mortgage lending income			702		263		1,615		639
Bank-owned life insurance			109		109		615		326
Securities gains, net			16		44		103		57
Other			408		393		1,202		1,472
	Total noninterest income	$	1,374	$	991	$	3,972	$	3,036

The decrease in service charges on deposit accounts was driven by a decline in consumer spending activity as a result of the COVID-19 pandemic.

The Company’s income from mortgage lending was primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains or losses from the sale of the mortgage loans originated, origination fees, underwriting fees, and other fees associated with the origination of loans, which are netted against the commission expense associated with these originations. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either sell or retain the associated MSRs when the loan is sold.

MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense.

MSRs are also evaluated 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.

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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)			2020		2019		2020		2019
Origination income		$	722	$	194	$	1,569	$	382
Servicing fees, net			(20)		69		46		257
	Total mortgage lending income	$	702	$	263	$	1,615	$	639

The increase in mortgage lending income was primarily due to an increase in mortgage refinance activity. The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to the origination and sale of new mortgage loans. The increase in mortgage lending income was partially offset by a decrease in servicing fees, net of related amortization expense as prepayment speeds increased in the first nine months of 2020, resulting in increased amortization expense.

Income from bank-owned life insurance increased primarily due to $0.3 million in non-taxable death benefits received in the first nine months of 2020. The assets that support these policies are administered by the life insurance carriers and the income we receive (i.e., increases or decreases in the cash surrender value of the policies and death benefits received) on these policies is dependent upon the returns the insurance carriers are able to earn on the underlying investments that support these policies. Earnings on these policies are generally not taxable.

The decrease in other noninterest income was primarily due to a $0.3 million pre-tax gain from an insurance recovery received in the first quarter of 2019.

Noninterest Expense
		Quarter ended September 30,				Nine months ended September 30,
(Dollars in thousands)			2020		2019		2020		2019
Salaries and benefits		$	2,802	$	2,894	$	8,230	$	8,631
Net occupancy and equipment			457		387		1,974		1,152
Professional fees			230		195		877		698
Other			1,164		1,348		3,387		3,583
	Total noninterest expense	$	4,653	$	4,824	$	14,468	$	14,064

The decrease in salaries and benefits expense was primarily due to lower full-time equivalent employees, incentive accruals and an increase in deferred costs related to the PPP loan program.

The increase in net occupancy and equipment expense was primarily due to various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn. This amount includes revised depreciation estimates and other temporary relocation costs. The Company expects it will incur additional expense in the fourth quarter of 2020 related to the redevelopment project.

Income Tax Expense

Income tax expense was $1.2 million and $1.7 million for the first nine months of 2020 and 2019 reflecting an effective tax rate of 17.64% and 19.40%, respectively. This change was primarily due to a decrease in the level of earnings before taxes relative to tax-exempt sources of income. The Company’s effective income tax rate is principally impacted by tax-exempt earnings from the Company’s investments in municipal securities and bank-owned life insurance.

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BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $320.9 million at September 30, 2020 compared to $235.9 million at December 31, 2019. This increase reflects an increase in the amortized cost basis of securities available-for-sale of $77.9 million, and an increase of $7.1 million in the fair value of securities available-for-sale. The increase in the amortized cost basis of securities available-for-sale was primarily attributable to management allocating more funding to the investment portfolio following the significant increase in customer deposits. The increase in the fair value of securities was primarily due to a decrease in long-term interest rates. The average annualized tax-equivalent yields earned on total securities were 2.24% in 2020 and 2.77% in 2019.

Loans
			2020			2019
			Third	Second	First	Fourth	Third
(In thousands)			Quarter	Quarter	Quarter	Quarter	Quarter
Commercial and industrial		$	98,244	87,754	56,447	56,782	52,288
Construction and land development			31,651	32,967	32,302	32,841	41,599
Commercial real estate			250,992	250,588	256,099	270,318	267,346
Residential real estate			85,054	85,825	91,010	92,575	95,215
Consumer installment			7,731	8,631	8,424	8,866	9,148
	Total loans		473,672	465,765	444,282	461,382	465,596
Less: unearned income			(1,219)	(1,491)	(414)	(481)	(488)
	Loans, net of unearned income	$	472,453	464,274	443,868	460,901	465,108

Total loans, net of unearned income, were $472.5 million at September 30, 2020, an increase of $11.6 million, or 3%, from $460.9 million at December 31, 2019. Excluding PPP loans, total loans net of unearned income, were $436.0 million, a decrease of $24.9 million, or 5% from December 31, 2019. This decrease was primarily due to a decrease in commercial real estate loans and residential real estate loans of $19.3 million and $7.5 million, respectively, as lower rates increased refinance activity and payoffs for multi-family residential and consumer mortgage loans. Four loan categories represented the majority of the loan portfolio at September 30, 2020: commercial real estate (53%), residential real estate (18%), commercial and industrial (21%) and construction and land development (7%). Approximately 20% of the Company’s commercial real estate loans were classified as owner-occupied at September 30, 2020.

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $9.8 million, or 2% of total loans, at September 30, 2020, compared to $10.8 million, or 2% of total loans, at December 31, 2019. For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required interest-only payments at September 30, 2020, compared to $0.8 million at December 31, 2019. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high-risk consumer mortgage products.

The average yield earned on loans and loans held for sale was 4.71% in the first nine months of 2020 and 4.86% in the first nine months of 2019.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions, including the COVID-19 pandemic’s effects, on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, competitive pressures from a wide range of other lenders, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations.

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The Company attempts to reduce these economic and credit risks through its loan-to-value guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we have established and periodically review, lending policies and procedures. Banking regulations limit a bank’s credit exposure by prohibiting unsecured loan relationships that exceed 10% of its capital; or 20% of capital, if loans in excess of 10% of capital are fully secured. Under these regulations, we are prohibited from having secured loan relationships in excess of approximately $20.2 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $18.1 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, 2020, the Bank had no relationships exceeding these limits.

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, 2020 (and related balances at December 31, 2019).

		September 30,		December 31,
(Dollars in thousands)		2020		2019
Lessors of 1 to 4 family residential properties	$	47,477	$	43,652
Hotel/motel		43,111		43,719
Shopping centers		33,630		30,407
Multi-family residential properties		32,608		44,839
Office buildings		20,507		29,548

Supplemental COVID-19 Industry Exposure

We have identified certain commercial sectors with enhanced risk resulting from the impact of COVID-19. Loans within these sectors represent 49% of the Company’s total COVID-19 related modifications at September 30, 2020. The table below summarizes the loans outstanding for these sectors at September 30, 2020.

		Portfolio Segment
(Dollars in thousands)		Commercial and industrial	Construction and land development	Commercial real estate		Total	% of Total Loans
September 30, 2020:
Hotel/motel	$	753	9,890	43,111	$	53,754	11	%
Shopping centers		13	—	33,630		33,643	7
Retail, excluding shopping centers		283	161	18,149		18,593	4
Restaurants		1,516	—	13,306		14,822	4
Total	$	2,565	10,051	108,196	$	120,812	26	%

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In light of disruptions in economic conditions caused by COVID-19, the financial regulators have issued guidance encouraging banks to work constructively with borrowers affected by the virus in our community. This guidance, including the Interagency Statement on COVID-19 Loan Modifications and the Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions, provides that the agencies will not criticize financial institutions that mitigate credit risk through prudent actions consistent with safe and sound practices. Specifically, examiners will not criticize institutions for working with borrowers as part of a risk mitigation strategy intended to improve existing loans, even if the restructured loans have or develop weaknesses that ultimately result in adverse credit classification. Upon demonstrating the need for payment relief, the bank will work with qualified borrowers that were otherwise current before the pandemic to determine the most appropriate deferral option. For residential mortgage and consumer loans the borrower may elect to defer payments for up to three months. Interest continues to accrue and the amount due at maturity increases. Commercial real estate, commercial, and small business borrowers may elect to defer payments for up to three months or pay scheduled interest payments for a six-month period. The bank recognizes that a combination of the payment relief options may be prudent dependent on a borrower’s business type. As of September 30, 2020 we have granted loan payment deferrals or payments of interest-only primarily on commercial and industrial and commercial real estate loans totaling $87.1 million, or 18% of total loans, compared to $112.7 million, or 24% of total loans at June 30, 2020. The tables below provide information concerning the composition of these COVID-19 modifications as of September 30, 2020.

COVID-19 Modifications					Modification Types
(Dollars in thousands)		Balance	% of Portfolio Modified		Interest Only Payment		P&I Payments Deferred
Commercial and industrial	$	1,541	2	%	37	%	63	%
Construction and land development		45	—		—		100
Commercial real estate		82,491	33		32		68
Residential real estate		2,874	3		5		95
Consumer installment		117	2		—		100
Total	$	87,068	24	%	24	%	76	%

COVID-19 Modifications within Commercial Real Estate Segments
(Dollars in thousands)					Balance of Loans Modified		% of Total Segment Loans
Hotel/motel				$	42,018		78	%
Shopping centers					6,938		21
Retail, excluding shopping centers					3,033		16
Restaurants					7,523		51

Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP. In addition, the Interagency Statement on COVID-19 Loan Modifications provides circumstances in which a loan modification is not subject to classification as a TDR if such loan is not eligible for modification under Section 4013.

Allowance for Loan Losses

The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover the Company’s estimate of probable losses inherent in the loan portfolio. The allowance for loan losses was $5.6 million at September 30, 2020 compared to $4.4 million at December 31, 2019, which management believed to be adequate at each of the respective dates. The judgments and estimates associated with the determination of the allowance for loan losses are described under “Critical Accounting Policies.”

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A summary of the changes in the allowance for loan losses and certain asset quality ratios for the third quarter of 2020 and the previous four quarters is presented below.

				2020				2019
				Third		Second	First	Fourth	Third
(Dollars in thousands)				Quarter		Quarter	Quarter	Quarter	Quarter
Balance at beginning of period			$	5,308		4,867	4,386	4,807	4,851
Charge-offs:
	Commercial and industrial			—		(3)	—	(236)	(128)
	Residential real estate			—		—	—	(5)	(1)
	Consumer installment			(4)		(28)	(5)	(20)	(2)
		Total charge-offs		(4)		(31)	(5)	(261)	(131)
Recoveries				21		22	86	90	87
		Net recoveries (charge-offs)		17		(9)	81	(171)	(44)
Provision for loan losses				250		450	400	(250)	—

Ending balance			$	5,575		5,308	4,867	4,386	4,807
	as a % of loans			1.18	%	1.14	1.10	0.95	1.03
	as a % of nonperforming loans			1,015	%	783	4,196	2,345	2,763
Net (recoveries) charge-offs as % of average loans (a)				(0.01)	%	0.01	(0.07)	0.15	0.04

(a) Net (recoveries) charge-offs are annualized.

As described under “Critical Accounting Policies,” management assesses the adequacy of the allowance prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates, and other pertinent factors. This evaluation is inherently subjective as it requires various material estimates and judgments, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The ratio of our allowance for loan losses to total loans outstanding was 1.18% at September 30, 2020, compared to 0.95% at December 31, 2019. At September 30, 2020, the Company’s allowance for loan losses was 1.28% of total loans, excluding PPP loans. In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment, including the duration and magnitude of COVID-19 effects, in their entirety either improve or weaken. In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for loan losses based on their judgment about information available to them at the time of their examinations.

Our allowance for loan losses is expected to increase as the cumulative effects of the COVID-19 pandemic affect our customers for a longer period and are more fully realized as a result.

Nonperforming Assets

The Company had $0.5 million and $0.2 million in nonperforming assets at September 30, 2020 and December 31, 2019, respectively.

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the third quarter of 2020 and the previous four quarters.

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			2020				2019
			Third		Second	First	Fourth	Third
(Dollars in thousands)			Quarter		Quarter	Quarter	Quarter	Quarter
Nonperforming assets:
Nonaccrual loans		$	549		678	116	187	174
Other real estate owned			—		—	99	—	—
Total nonperforming assets		$	549		678	215	187	174
	as a % of loans and other real estate owned		0.12	%	0.15	0.05	0.04	0.04
	as a % of total assets		0.06	%	0.07	0.03	0.02	0.02
Nonperforming loans as a % of total loans			0.12	%	0.15	0.03	0.04	0.04

The table below provides information concerning the composition of nonaccrual loans for the third quarter of 2020 and the previous four quarters.

			2020			2019
			Third	Second	First	Fourth	Third
(In thousands)			Quarter	Quarter	Quarter	Quarter	Quarter
Nonaccrual loans:
Commercial real estate		$	216	218	—	—	—
Residential real estate			332	459	112	187	174
Consumer installment			1	1	4	—	—
	Total nonaccrual loans	$	549	678	116	187	174

The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is 90 days or more past due, unless the loan is both well-secured and in the process of collection. At September 30, 2020, the Company had $0.5 million in loans on nonaccrual status compared to $0.2 million at December 31, 2019.

The Company had $71 thousand in loans 90 days or more past due and still accruing at September 30, 2020 compared to no such loans at December 31, 2019.

The table below provides information concerning the composition of OREO for the third quarter of 2020 and the previous four quarters.

			2020			2019
			Third	Second	First	Fourth	Third
(In thousands)			Quarter	Quarter	Quarter	Quarter	Quarter
Other real estate owned:
Residential		$	—	—	99	—	—
	Total other real estate owned	$	—	—	99	—	—

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of a borrower has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. This definition is believed to be substantially consistent with the standards established by the Federal Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans. Potential problem loans, which are not included in nonperforming assets, amounted to $3.5 million, or 0.7% of total loans at September 30, 2020, and $4.4 million, or 1.0% of total loans at December 31, 2019.

The table below provides information concerning the composition of potential problem loans for the third quarter of 2020 and the previous four quarters.

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			2020			2019
			Third	Second	First	Fourth	Third
(In thousands)			Quarter	Quarter	Quarter	Quarter	Quarter
Potential problem loans:
Commercial and industrial		$	230	211	246	266	500
Construction and land development			563	568	910	1,043	660
Commercial real estate			188	165	170	99	102
Residential real estate			2,486	2,645	2,913	2,899	3,460
Consumer installment			42	55	63	64	45
	Total potential problem loans	$	3,509	3,644	4,302	4,371	4,767

At September 30, 2020 the Company had $101 thousand in potential problem loans that were past due at least 30 days, but less than 90 days.

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The following table is a summary of the Company’s performing loans that were past due at least 30 days, but less than 90 days, for the third quarter of 2020 and the previous four quarters.

			2020			2019
			Third	Second	First	Fourth	Third
(In thousands)			Quarter	Quarter	Quarter	Quarter	Quarter
Performing loans past due 30 to 89 days:
Commercial and industrial		$	48	83	4	24	53
Construction and land development			—	—	8	456	449
Commercial real estate			—	168	—	—	—
Residential real estate			106	620	922	1,608	94
Consumer installment			6	8	19	64	21
	Total	$	160	879	953	2,152	617

Deposits

Total deposits were $824.0 million at September 30, 2020, compared to $724.2 million at December 31, 2019. Noninterest-bearing deposits were $238.5 million, or 28.9% of total deposits, at September 30, 2020, compared to $196.2 million, or 27.1% of total deposits at December 31, 2019. These increases reflect deposits from customers who received PPP loans, the impact of government stimulus checks, delayed tax payments and less customer spending during the COVID-19 pandemic.

The average rate paid on total interest-bearing deposits was 0.72% in the first nine months of 2020 compared to 0.79% in the first nine months of 2019.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings generally consist of federal funds purchased and agreements with certain customers to sell certain securities under agreements to repurchase with an original maturity less than one year. The Bank had available federal funds lines totaling $41.0 million with none outstanding at September 30, 2020, and at December 31, 2019, respectively. Securities sold under agreements to repurchase totaled $2.1 million at September 30, 2020, compared to $1.1 million at December 31, 2019.

The average rate paid on short-term borrowings was 0.50% in the first nine months of 2020 and 2019.

The Company had no long-term debt at September 30, 2020 and December 31, 2019.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity was $106.3 million and $98.3 million as of September 30, 2020 and December 31, 2019, respectively. The increase from December 31, 2019 was primarily driven by net earnings of $5.4 million and other comprehensive income due to the change in unrealized gains on securities available-for-sale, net of tax of $5.3 million, partially offset by cash dividends paid of $2.7 million.

On January 1, 2015, the Company and Bank became subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act changes. The rules included the implementation of a capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. The capital conservation buffer was subject to a three year phase-in period that began on January 1, 2016 and was fully phased-in on January 1, 2019 at 2.5%. A banking organization with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At September 30, 2020, the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer.

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Effective March 20, 2020, the Federal Reserve and the other federal banking regulators adopted an interim final rule that amended the capital conservation buffer. The interim final rule was adopted as a final rule on August 26, 2020. The new rule revises the definition of “eligible retained income” for purposes of the maximum payout ratio to allow banking organizations to more freely use their capital buffers to promote lending and other financial intermediation activities, by making the limitations on capital distributions more gradual. The eligible retained income is now the greater of (i) net income for the four preceding quarters, net of distributions and associated tax effects not reflected in net income; and (ii) the average of all net income over the preceding four quarters. The interim final rule only affects the capital buffers, and banking organizations were encouraged to make prudent capital distribution decisions.

The Federal Reserve has treated us as a “small bank holding company’ under the Federal Reserve’s policy. Accordingly, our capital adequacy is evaluated at the Bank level, and not for the Company and its consolidated subsidiaries. The Bank’s tier 1 leverage ratio was 10.62%, CET1 risk-based capital ratio was 17.70%, tier 1 risk-based capital ratio was 17.70%, and total risk-based capital ratio was 18.77% at September 30, 2020. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio, 8.0% for tier 1 risk-based capital ratio, and 10.0% for total risk-based capital ratio to be considered “well capitalized.” The Bank’s capital conservation buffer was 10.38% at September 30, 2020.

MARKET AND LIQUIDITY RISK MANAGEMENT

Management’s objective is to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies. The Bank’s Asset Liability Management Committee (“ALCO”) is charged with the responsibility of monitoring these policies, which are designed to ensure an acceptable asset/liability composition. Two critical areas of focus for ALCO are interest rate risk and liquidity risk management.

Interest Rate Risk Management

In the normal course of business, the Company is exposed to market risk arising from fluctuations in interest rates. ALCO measures and evaluates interest rate risk so that the Bank can meet customer demands for various types of loans and deposits. Measurements used to help manage interest rate sensitivity include an earnings simulation model and an economic value of equity (“EVE”) model.

Earnings simulation. Management believes that interest rate risk is best estimated by our earnings simulation modeling. Forecasted levels of earning assets, interest-bearing liabilities, and off-balance sheet financial instruments are combined with ALCO forecasts of market interest rates for the next 12 months and other factors in order to produce various earnings simulations and estimates. To help limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income from gradual changes in interest rates. For changes up or down in rates from management’s flat interest rate forecast over the next 12 months, policy limits for net interest income variances are as follows:

 +/- 20% for a gradual change of 400 basis points

 +/- 15% for a gradual change of 300 basis points

 +/- 10% for a gradual change of 200 basis points

 +/- 5% for a gradual change of 100 basis points

At September 30, 2020, our earnings simulation model indicated that we were in compliance with the policy guidelines noted above.

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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, 2020, our EVE model indicated that we were in compliance with the policy guidelines noted above.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates, and other economic and market factors, including market perceptions. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”) which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates or economic stress, which may differ across industries and economic sectors. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios in seeking satisfactory, consistent levels of profitability within the framework of the Company’s established liquidity, loan, investment, borrowing, and capital policies.

The Company may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities, and as a tool to manage interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. From time to time, the Company may enter into interest rate swaps to facilitate customer transactions and meet their financing needs. These interest rate swaps qualify as derivatives, but are not designated as hedging instruments. At September 30, 2020 and December 31, 2019, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.

Liquidity Risk Management

Liquidity is the Company’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand and maturing obligations. Without proper management of its liquidity, the Company could experience higher costs of obtaining funds due to insufficient liquidity, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.

Liquidity is managed at two levels. The first is the liquidity of the Company. The second is the liquidity of the Bank. The management of liquidity at both levels is essential, because the Company and the Bank are separate and distinct legal entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements. The Company depends upon dividends from the Bank for liquidity to pay its operating expenses, debt obligations and dividends. The Bank’s payment of dividends depends on its earnings, liquidity, capital and the absence of any regulatory restrictions.

The primary source of funding and liquidity for the Company has been dividends received from the Bank. If needed, the Company could also issue common stock or other securities. Primary uses of funds by the Company include dividends paid to stockholders and stock repurchases.

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Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and the sale and repayment of loans. The Bank has access to federal funds lines from various banks and borrowings from the Federal Reserve discount window. In addition to these sources, the Bank may participate in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and may be taken out with varying maturities. At September 30, 2020, the Bank had a remaining available line of credit with the FHLB of $282.9 million. At September 30, 2020, the Bank also had $41.0 million of available federal funds lines with no borrowings outstanding. Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.

Management believes that the Company and the Bank have adequate sources of liquidity to meet all their respective known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.

Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual Obligations

At September 30, 2020, the Bank had outstanding standby letters of credit of $1.1 million and unfunded loan commitments outstanding of $75.5 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank could liquidate federal funds sold or a portion of securities available-for-sale, or draw on its available credit facilities.

Mortgage lending activities

Since 2009, we have primarily sold 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, 2020, the unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights was $266.4 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 2020 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, 2020.

We service all residential mortgage loans originated and sold by us to Fannie Mae. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans or take other actions to mitigate the potential losses to investors consistent with the agreements governing our rights and duties as servicer.

The agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by us in such capacity and provides protection against expenses and liabilities incurred by us when acting in compliance with the respective servicing agreements. However, if we commit a material breach of our obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards are determined by servicing guides issued by Fannie Mae as well as the contract provisions established between Fannie Mae and the Bank. Remedies could include repurchase of an affected loan.

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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, 2020, we do not believe that this exposure is material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99% of our residential mortgage loans serviced for Fannie Mae were current as of such date. We maintain ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor portfolios.

Section 4021 of the CARES Act allows borrowers under 1-to-4 family residential mortgage loans sold to Fannie Mae to request forbearance to the servicer after affirming that such borrower is experiencing financial hardships during the COVID-19 emergency. Such forbearance will be up to 180 days, subject to up to a 180 day extension. During forbearance, no fees, penalties or interest shall be charged beyond those applicable if all contractual payments were fully and timely paid. Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on similar procedures or related evictions or sales until December 31, 2020. The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual basis. As a result, the Bank is not obligated to make any advances to Fannie Mae on principal and interest on such mortgage loans where the borrower is entitled to forbearance.

Effects of Inflation and Changing Prices

The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with U.S. GAAP and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

CURRENT ACCOUNTING DEVELOPMENTS

The following ASUs have been issued by the FASB but are not yet effective.

 ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments;

Information about these pronouncements is described in more detail below.

ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): - Measurement of Credit Losses on Financial Instruments, amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, the new standard eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses using a broader range of information regarding past events, current conditions and forecasts assessing the collectability of cash flows. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however the new standard will require that credit losses be presented as an allowance rather than as a write-down. The new guidance affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. For public business entities, the new guidance was originally effective for annual and interim periods in fiscal years beginning after December 15, 2019. The Company has developed an implementation team that is following a general timeline. The team has been working with an advisory consultant, with whom a third-party software license has been purchased. The Company’s preliminary evaluation indicates the provisions of ASU No. 2016-13 are expected to impact the Company’s consolidated financial statements, in particular the level of the reserve for credit losses. The Company is continuing to evaluate the extent of the potential impact and expects that portfolio composition and economic conditions at the time of adoption will be a factor. On October 16, 2019, the FASB approved a previously issued proposal granting smaller reporting companies a postponement of the required implementation date for ASU 2016-13. The Company will now be required to implement the new standard in January 2023, with early adoption permitted in any period prior to that date.

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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.

		2020				2019
		Third	Second	First		Fourth	Third
(in thousands)		Quarter	Quarter	Quarter		Quarter	Quarter
Net interest income (GAAP)	$	5,868	6,070	6,212		6,280	6,567
Tax-equivalent adjustment		122	127	120		126	140
Net interest income (Tax-equivalent)	$	5,990	6,197	6,332		6,406	6,707

						Nine months ended September 30,
(In thousands)						2020	2019
Net interest income (GAAP)					$	18,150	19,784
Tax-equivalent adjustment						369	431
Net interest income (Tax-equivalent)					$	18,519	20,215

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Table 2 - Selected Quarterly Financial Data

				2020				2019
				Third		Second	First	Fourth	Third
(Dollars in thousands, except per share amounts)				Quarter		Quarter	Quarter	Quarter	Quarter
Results of Operations
Net interest income (a)			$	5,990		6,197	6,332	6,406	6,707
Less: tax-equivalent adjustment				122		127	120	126	140
	Net interest income (GAAP)			5,868		6,070	6,212	6,280	6,567
Noninterest income				1,374		1,363	1,235	2,458	991
	Total revenue			7,242		7,433	7,447	8,738	7,558
Provision for loan losses				250		450	400	(250)	—
Noninterest expense				4,653		4,959	4,856	5,633	4,824
Income tax expense				403		363	390	671	527
Net earnings			$	1,936		1,661	1,801	2,684	2,207

Per share data:
Basic and diluted net earnings			$	0.54		0.47	0.50	0.76	0.62
Cash dividends declared				0.255		0.255	0.255	0.25	0.25
Weighted average shares outstanding:
	Basic and diluted			3,566,239		3,566,166	3,566,146	3,566,146	3,568,287
Shares outstanding, at period end				3,566,276		3,566,176	3,566,146	3,566,146	3,566,146
Book value			$	29.81		29.53	29.04	27.57	27.12
Common stock price
	High		$	56.80		63.40	59.99	53.90	47.38
	Low			26.26		36.81	24.11	40.00	32.33
	Period end:			36.26		57.09	41.98	53.00	47.38
		To earnings ratio		15.97	x	24.29	16.66	19.49	18.08
		To book value		122	%	193	145	192	175
Performance ratios:
Return on average equity				7.26	%	6.34	7.24	10.86	9.25
Return on average assets				0.84	%	0.74	0.86	1.30	1.06
Dividend payout ratio				47.22	%	54.26	51.00	32.89	40.32
Asset Quality:
Allowance for loan losses as a % of:
	Loans			1.18	%	1.14	1.10	0.95	1.03
	Nonperforming loans			1,015	%	783	4,196	2,345	2,763
Nonperforming assets as a % of:
	Loans and foreclosed properties			0.12	%	0.15	0.05	0.04	0.04
	Total assets			0.06	%	0.07	0.03	0.02	0.02
Nonperforming loans as a % of total loans				0.12	%	0.15	0.03	0.04	0.04
Annualized net (recoveries) charge-offs as % of average loans				(0.01)	%	0.01	(0.07)	—	0.04
Capital Adequacy: (c)
CET 1 risk-based capital ratio				17.70	%	18.00	17.77	17.28	17.06
Tier 1 risk-based capital ratio				17.70	%	18.00	17.77	17.28	17.06
Total risk-based capital ratio				18.77	%	19.04	18.72	18.12	17.96
Tier 1 leverage ratio				10.38	%	10.62	11.17	11.23	11.22
Other financial data:
Net interest margin (a)				2.72	%	2.95	3.23	3.27	3.41
Effective income tax rate				17.23	%	17.93	17.80	20.00	19.28
Efficiency ratio (b)				63.19	%	65.60	64.17	63.55	62.67
Selected average balances:
Securities			$	315,542		291,333	257,317	249,106	247,114
Loans, net of unearned income				465,285		466,971	451,210	469,579	472,747
Total assets				924,949		893,720	838,725	827,684	829,761
Total deposits				810,747		782,381	734,047	723,557	729,608
Total stockholders’ equity				106,709		104,820	99,560	98,887	95,400
Selected period end balances:
Securities			$	320,922		302,193	280,435	235,902	251,152
Loans, net of unearned income				472,453		464,274	443,868	460,901	465,108
Allowance for loan losses				5,575		5,308	4,867	4,386	4,807
Total assets				937,890		942,887	856,475	828,570	824,963
Total deposits				823,980		829,810	746,785	724,152	723,071
Total stockholders’ equity				106,314		105,299	103,563	98,328	96,720
(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures."
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.
(c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank.

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Table 3 - Selected Financial Data

				Nine months ended September 30,
(Dollars in thousands, except per share amounts)				2020		2019
Results of Operations
Net interest income (a)			$	18,519		20,215
Less: tax-equivalent adjustment				369		431
	Net interest income (GAAP)			18,150		19,784
Noninterest income				3,972		3,036
	Total revenue			22,122		22,820
Provision for loan losses				1,100		—
Noninterest expense				14,468		14,064
Income tax expense				1,156		1,699
Net earnings			$	5,398		7,057

Per share data:
Basic and diluted net earnings			$	1.51		1.97
Cash dividends declared				0.765		0.75
Weighted average shares outstanding:
	Basic and diluted			3,566,184		3,586,642
Shares outstanding, at period end				3,566,276		3,566,146
Book value			$	29.81		27.12
Common stock price
	High		$	63.40		47.38
	Low			24.11		30.61
	Period end			36.26		47.38
		To earnings ratio		15.97	x	18.08
		To book value		122	%	175
Performance ratios:
Return on average equity				6.94	%	10.17
Return on average assets				0.81	%	1.14
Dividend payout ratio				50.66	%	38.07
Asset Quality:
Allowance for loan losses as a % of:
	Loans			1.18	%	1.03
	Nonperforming loans			1,015	%	2,763
Nonperforming assets as a % of:
	Loans and other real estate owned			0.12	%	0.04
	Total assets			0.06	%	0.02
Nonperforming loans as a % of total loans				0.12	%	0.04
Annualized net recoveries as a % of average loans				(0.03)	%	—
Capital Adequacy: (c)
CET 1 risk-based capital ratio				17.70	%	17.06
Tier 1 risk-based capital ratio				17.70	%	17.06
Total risk-based capital ratio				18.77	%	17.96
Tier 1 leverage ratio				10.38	%	11.22
Other financial data:
Net interest margin (a)				2.96	%	3.48
Effective income tax rate				17.64	%	19.40
Efficiency ratio (b)				64.33	%	60.49
Selected average balances:
Securities			$	288,164		243,666
Loans, net of unearned income				461,170		474,438
Total assets				885,941		826,213
Total deposits				775,853		729,126
Total stockholders’ equity				103,707		92,555
Selected period end balances:
Securities			$	320,922		251,152
Loans, net of unearned income				472,453		465,108
Allowance for loan losses				5,575		4,807
Total assets				937,890		824,963
Total deposits				823,980		723,071
Total stockholders’ equity				106,314		96,720
(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures."
(b) Efficiency ratio is the result of noninterest expense divided by the sum of noninterest income and tax-equivalent net interest income.
(c) Regulatory capital ratios presented are for the Company's wholly-owned subsidiary, AuburnBank.

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Table 4 - Average Balances and Net Interest Income Analysis

				Quarter ended September 30,
						2020					2019
						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)			$	468,203	$	5,453	4.63%	$	474,293	$	5,787	4.84%
Securities - taxable				252,398		913	1.44%		179,981		997	2.20%
Securities - tax-exempt (2)				63,144		583	3.67%		67,133		665	3.93%
		Total securities		315,542		1,496	1.89%		247,114		1,662	2.67%
Federal funds sold				30,784		9	0.12%		20,250		114	2.23%
Interest bearing bank deposits				60,698		17	0.11%		37,902		221	2.31%
		Total interest-earning assets		875,227	$	6,975	3.17%		779,559	$	7,784	3.96%
Cash and due from banks				13,196					13,923
Other assets				36,526					36,279
		Total assets	$	924,949				$	829,761
Interest-bearing liabilities:
Deposits:
	NOW		$	157,689	$	100	0.25%	$	134,615	$	178	0.52%
	Savings and money market			250,938		285	0.45%		222,992		265	0.47%
	Time deposits			164,988		598	1.44%		168,619		632	1.49%
		Total interest-bearing deposits		573,615		983	0.68%		526,226		1,075	0.81%
Short-term borrowings				2,368		2	0.50%		1,281		2	0.50%
		Total interest-bearing liabilities		575,983	$	985	0.68%		527,507	$	1,077	0.81%
Noninterest-bearing deposits				237,132					203,382
Other liabilities				5,125					3,472
Stockholders' equity				106,709					95,400
		Total liabilities and stockholders' equity	$	924,949				$	829,761

Net interest income and margin (tax-equivalent)					$	5,990	2.72%			$	6,707	3.41%

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included
	in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using a federal income
	tax rate of 21%.

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Table 5 - Average Balances and Net Interest Income Analysis

				Nine months ended September 30,
						2020					2019
						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)			$	463,581	$	16,359	4.71%	$	475,467	$	17,277	4.86%
Securities - taxable				225,234		3,080	1.83%		175,703		2,997	2.28%
Securities - tax-exempt (2)				62,930		1,759	3.73%		67,964		2,049	4.03%
		Total securities		288,164		4,839	2.24%		243,667		5,046	2.77%
Federal funds sold				30,739		118	0.51%		19,552		339	2.32%
Interest bearing bank deposits				53,834		214	0.53%		37,094		659	2.38%
		Total interest-earning assets		836,318	$	21,530	3.44%		775,780	$	23,321	4.02%
Cash and due from banks				13,579					14,120
Other assets				36,044					36,313
		Total assets	$	885,941				$	826,213
Interest-bearing liabilities:
Deposits:
	NOW		$	153,767	$	426	0.37%	$	134,368	$	537	0.53%
	Savings and money market			234,533		801	0.46%		218,284		705	0.43%
	Time deposits			166,115		1,778	1.43%		171,804		1,858	1.45%
		Total interest-bearing deposits		554,415		3,005	0.72%		524,456		3,100	0.79%
Short-term borrowings				1,721		6	0.50%		1,503		6	0.50%
		Total interest-bearing liabilities		556,136	$	3,011	0.72%		525,959	$	3,106	0.79%
Noninterest-bearing deposits				221,438					204,670
Other liabilities				4,659					3,029
Stockholders' equity				103,707					92,555
		Total liabilities and stockholders' equity	$	885,940				$	826,213

Net interest income and margin (tax-equivalent)					$	18,519	2.96%			$	20,215	3.48%

(1) Average loan balances are shown net of unearned income and loans on nonaccrual status have been included
	in the computation of average balances.
(2) Yields on tax-exempt securities have been computed on a tax-equivalent basis using a federal income
	tax rate of 21%.

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Table 6 - Loan Portfolio Composition

			2020			2019
			Third	Second	First	Fourth	Third
(In thousands)			Quarter	Quarter	Quarter	Quarter	Quarter
Commercial and industrial		$	98,244	87,754	56,447	56,782	52,288
Construction and land development			31,651	32,967	32,302	32,841	41,599
Commercial real estate			250,992	250,588	256,099	270,318	267,346
Residential real estate			85,054	85,825	91,010	92,575	95,215
Consumer installment			7,731	8,631	8,424	8,866	9,148
	Total loans		473,672	465,765	444,282	461,382	465,596
Less: unearned income			(1,219)	(1,491)	(414)	(481)	(488)
	Loans, net of unearned income		472,453	464,274	443,868	460,901	465,108
Less: allowance for loan losses			(5,575)	(5,308)	(4,867)	(4,386)	(4,807)
	Loans, net	$	466,878	458,966	439,001	456,515	460,301

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Table 7 - Allowance for Loan Losses and Nonperforming Assets

				2020				2019
				Third		Second	First	Fourth	Third
(Dollars in thousands)				Quarter		Quarter	Quarter	Quarter	Quarter
Allowance for loan losses:
Balance at beginning of period			$	5,308		4,867	4,386	4,807	4,851
Charge-offs:
	Commercial and industrial			—		(3)	—	(236)	(128)
	Residential real estate			—		—	—	(5)	(1)
	Consumer installment			(4)		(28)	(5)	(20)	(2)
		Total charge-offs		(4)		(31)	(5)	(261)	(131)
Recoveries				21		22	86	90	87
		Net recoveries (charge-offs)		17		(9)	81	(171)	(44)
Provision for loan losses				250		450	400	(250)	—

Ending balance			$	5,575		5,308	4,867	4,386	4,807
	as a % of loans			1.18	%	1.14	1.10	0.95	1.03
	as a % of loans (excluding PPP loans)			1.28	%	1.24	n/a	n/a	n/a
	as a % of nonperforming loans			1,015	%	783	4,196	2,345	2,763
Net (recoveries) charge-offs as % of avg. loans (a)				(0.01)	%	0.01	(0.07)	0.15	0.04

Nonperforming assets:
Nonaccrual loans			$	549		678	116	187	174
Other real estate owned				—		—	99	—	—
Total nonperforming assets			$	549		678	215	187	174
	as a % of loans and foreclosed properties			0.12	%	0.15	0.05	0.04	0.04
	as a % of total assets			0.06	%	0.07	0.03	0.02	0.02
Nonperforming loans as a % of total loans				0.12	%	0.15	0.03	0.04	0.04
Accruing loans 90 days or more past due			$	71		49	—	—	94

(a) Net (recoveries) charge-offs are annualized.

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Table 8 - Allocation of Allowance for Loan Losses

				2020									2019
				Third Quarter			Second Quarter			First Quarter			Fourth Quarter			Third Quarter
(Dollars in thousands)				Amount	%*		Amount	%*		Amount	%*		Amount	%*		Amount	%*
Commercial and industrial			$	798	20.7	$	679	18.8	$	675	12.7	$	577	12.3	$	685	11.2
Construction and land
	development			582	6.7		613	7.1		582	7.3		569	7.1		730	8.9
Commercial real estate				3,120	53.0		2,915	53.8		2,596	57.6		2,289	58.6		2,354	57.5
Residential real estate				954	18.0		954	18.4		877	20.5		813	20.1		890	20.5
Consumer installment				121	1.6		147	1.9		137	1.9		138	1.9		148	2.0
	Total allowance for
		loan losses	$	5,575		$	5,308		$	4,867		$	4,386		$	4,807

* Loan balance in each category expressed as a percentage of total loans.

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Table 9 - CDs and Other Time Deposits of $100,000 or More

(Dollars in thousands)		September 30, 2020
Maturity of:
3 months or less			$	24,269
Over 3 months through 6 months				6,299
Over 6 months through 12 months				27,444
Over 12 months				48,749
	Total CDs and other time deposits of $100,000 or more		$	106,761

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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.

ITEM 4. CONTROLS AND PROCEDURES

The Company, with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation and as of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to allow timely decisions regarding disclosure in its reports that the Company files or submits to the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. There have been no changes in the Company’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the normal course of its business, the Company and the Bank are, from time to time, involved in legal proceedings. The Company’s and Bank’s management believe there are no pending or threatened legal, governmental, or regulatory proceedings that, upon resolution, are expected to have a material adverse effect upon the Company’s or the Bank’s financial condition or results of operations. See also, Part I, Item 3 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report and the risk factors discussed below, you should carefully consider the factors discussed in Part I, Item 1A. “RISK FACTORS” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, which could materially affect our business, financial condition or future results. The risks described in our annual report on Form 10-K and below are not the only the risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results in the future.

The COVID-19 pandemic is expected to continue to adversely affect our business, financial condition and results of operations. The ultimate effects of the pandemic on our business, financial condition and results of operations will depend on the severity, scope and duration of the pandemic, its cumulative economic effects, and the effectiveness of governmental actions in response to the pandemic.

The ongoing COVID-19 national health emergency has significantly disrupted the United States and international economies and financial markets. We expect that the COVID-19 pandemic and its effects will continue to adversely affect our business, financial condition and results of operations in future periods. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reductions in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability. The State of Alabama and many other states have taken preventative and protective actions, such as imposing a statewide mask mandate, restrictions on travel, business operations, public gatherings, social distancing, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of non-essential businesses. Though certain of these measures have been relaxed or eliminated, recent increases in reported cases could cause these measures to be re-established.

The travel, hospitality and food and beverage industries, restaurants, retailers and auto manufacturers, and their suppliers have been severely affected. A significant number of layoffs, furloughs of employees, as well as remote work have occurred in these and other industries, including government offices, schools and universities. Auburn University held virtual classes only from March 16, 2020 through the summer session. Auburn University’s guidelines for the fall semester of 2020 involve both remote and in person instructions as well as social distancing measures. The economic impact of these measures is not presently known. Hyundai’s Montgomery and Kia’s West Point, Georgia plants were closed for a portion of the first quarter of 2020, but began a phased reopen in the second quarter of 2020 in response to COVID-19.

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The ultimate effects of the COVID-19 pandemic on the economy, generally, our markets, and on us cannot be predicted. The timing and effects of the COVID-19 pandemic on our business, results of operations and financial condition may include, among various other consequences, the following. These effects depend on the severity, scope and duration of the pandemic, its cumulative economic effects, and the effectiveness of healthcare, business and governmental actions addressing the pandemic’s effects.

• Employees’ health could be adversely affected, necessitating their recovery away from work;

• Unavailability of key personnel necessary to conduct our business activities;

• Our operating effectiveness may be reduced as our employees work from home or suffer from the COVID-19 virus;

• Shelter in place, or other restrictions and interruptions of our business and contact with our customers;

• Sustained closures of our branch lobbies or the offices of our customers;

• Declines in demand for loans and other banking services and products, and reduced interchange fees on payment cards;

• Additional stimulus efforts have been agreed to by the Congress and the executive branch and the related uncertainty may increase economic and market risks and volatility;

• Reduced consumer spending and economic activity due to both job losses, health concerns and required practices, such as social distancing and shelter in place, attributable to the COVID-19 pandemic, and to the discontinuation of Federal stimulus payments on July 25, 2020;

• Reduced interchange revenue from reduced retail sales, travel and payment card usage, generally;

• Significant volatility in United States financial markets and our investment securities portfolio, including credit concerns over state, county and municipal securities;

• Our growth has been slowed, and may slow further, or our asset size may decline;

• Reduced economic activity and reduced customer income and cash flows from normal business and employment could reduce the amounts of our deposits, increase deposit costs, and adversely affect our liquidity, financial condition and results of operations;

• Declines in the credit quality of our loan portfolio, owing to the effects of the COVID-19 pandemic in the markets we serve, leading to increased provisions for loan losses and increases in our allowance for possible credit losses;

• Declines in the value of collateral for loans, including real estate collateral, especially in industries such as travel, hospitality, restaurants and retailers;

• Declines in the net worth and liquidity of borrowers, impairing their ability to pay timely their loan obligations to us;

• Decreases in market interest rates that are expected to reduce our net interest income and our profitability;

• Loan deferrals and loan modifications, and mortgage foreclosure moratoria, including those mandated by law, or which are encouraged by our regulators, may increase our expense and risks of collectability, reduce our cash flows and liquidity and adversely affect our results of operations and financial condition;

• The end of temporary regulatory accounting and capital relief for banks regarding the effects of the COVID-19 pandemic, including loan deferrals and modifications, could increase our TDRs and require additions to our allowance for loan losses, which may adversely affect our income, financial condition and capital;

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• Our waiver of various fees and service charges to support our customers and communities will adversely affect our results of operation and our liquidity and financial position;

• The COVID-19 pandemic may change customer financial behaviors and payment practices. Electronic banking could become more popular with less customers doing business at our offices;

• Certain of our assets, including loans and securities, may become impaired, which would adversely affect our results of operation and financial condition and mortgage loan foreclosure moratoria may limit our ability to timely act to protect our interests in the loan collateral;

• Reductions in income or losses will adversely affect our capital and growth of capital, including our capital for bank regulatory purposes;

• Losses or reductions in net income may adversely affect the growth or amount of dividends we can pay on our common stock;

• The effects of government fiscal and monetary policies, including changes in such policies, or the effects of discontinuing COVID-19 relief programs, on the economy and financial stability, generally, and on our business, results of operations and financial condition cannot be predicted;

• The restoration of financial stability and economic growth may depend on the health care system developing and deploying COVID-19 testing and contact tracing, and drugs that better address COVID-19, and vaccines to prevent COVID-19, which promote consumer and employee health and confidence in the economy.

These factors, together or in combination with other events or occurrences that are unknown or anticipated, may materially and adversely affect our business, financial condition and results of operations.

Our stock price may reflect securities market conditions

The ongoing COVID-19 pandemic has resulted in substantial securities market losses, especially for bank stocks and has, and may continue to, adversely affect the market of our common stock. The spread, intensification and duration of COVID-19 pandemic, as well as the effectiveness of governmental, fiscal and monetary policies, and regulatory responses to the pandemic, further affect the financial markets and the market prices for securities generally, and the market prices for bank stocks, including our common stock. Uncertainty and volatility in the capital markets may increase as a result of the 2020 federal and state elections.

The COVID-19 global pandemic could result in deterioration of asset quality and an increase in credit losses.

Many businesses have or will have lower revenues and cash flows and many consumers will have lower income. These could result in an inability to repay loans timely in full, reduce our asset quality and reduce our deposits. Loan modifications and payment deferrals may also increase our credit risks, especially if temporary regulatory relief for these actions expires. Our business, results of operations, liquidity and financial condition could be adversely affected.

The COVID-19 pandemic has resulted in increased operational risks.

The COVID-19 pandemic has resulted in heightened operational risks. Much of our workforce has been working remotely, and increased levels of remote access create additional cybersecurity risk and opportunities for cybercriminals to exploit vulnerabilities. Cybercriminals may increase their attempts to compromise business and consumer emails, including an increase in phishing attempts, and fraudulent vendors or other parties may view the pandemic as an opportunity to prey upon consumers and businesses during this time. This could result in increased fraud losses to us or our clients. The increase in online and remote banking activities may also increase the risk of fraud against our customers. State and local orders and regulations regarding the conduct of in-person business operations have affected and may continue to affect our ability to operate at normal levels and to restore operations to their pre-pandemic level for an unknown period of time. Separately, our third-party service providers have also been affected by the pandemic. To date, these disruptions have not been material and we have developed solutions to these disruptions, but we may experience additional disruption in the future, which could adversely affect our business, results of operations and financial condition.

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The COVID-19 global pandemic may continue to cause uncertainty in markets and may result in an increase in our cost of funds.

The COVID-19 global pandemic has caused a great amount of uncertainty in markets, causing credit markets to seize and forcing companies, including our clients, to seek liquidity in the face of uncertain future cash flows. To the extent the clients’ funds are not used as working capital and not placed on deposit with us, we could be faced with funding draws of committed lending facilities, along with requests for new credit facilities from our clients. As clients use deposit balances to fund their businesses, this may put funding pressure on us, which may cause us to pay higher rates than normal for deposits and other funding.

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

The CARES Act and the PPP and Healthcare Enhancement Act included an approximately $659 billion loan for the PPP administered through by the SBA and the U.S. Department of the Treasury. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved PPP lenders, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. As of September 30, 2020, we have secured funding of approximately 422 loans totaling $36.5 million through the PPP program. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Congress approved approximately $310 billion of additional funding for the PPP on April 24, 2020. The PPP closed on August 8, 2020 and the SBA no longer accepts PPP applications from participating lenders, and proposed extension of the PPP have not been approved by Congress through mid-October, 2020. Since the opening of the PPP, various other banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. We may be exposed to the risk of litigation, from both customers and non-customers that approached the Bank regarding PPP loans, regarding its procedures used in processing applications for the PPP. If any such litigation is filed against the Bank and is not resolved favorably to the Bank, it may result in financial liability or adversely affect our reputation. Litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse effect on our business, financial condition and results of operations.

The Bank also has credit risk on PPP loans, if the SBA determines deficiencies in the manner in which PPP loans were originated, funded or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, or obtain forgiveness of a PPP properly, including those related to the ambiguity in the laws, rules and guidance regarding the PPP’s operation. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there were one or more deficiencies in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the PPP loan guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company. Similar issues may also result in the denial of forgiveness of PPP loans, which would adversely affect and could result in losses, including possible bankruptcies, which may expose us to further costs and potential losses.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company’s repurchases of its common stock during the third quarter of 2020 were as follows:


Period	Total Number of Shares Purchased		Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs ⁽¹⁾
July 1 - July 31, 2020	—	$	—	—	$	5,000,000
August 1 - August 31, 2020	—		—	—		5,000,000
September 1 - September 30, 2020	—		—	—		5,000,000
Total	—		—	—		5,000,000

⁽¹⁾ On March 10, 2020 the Company adopted a $5 million stock repurchase program that become effective April 1, 2020.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS

Exhibit

NumberDescription

3.1		Certificate of Incorporation of Auburn National Bancorporation, Inc. and all amendments thereto.*

3.2		Amended and Restated Bylaws of Auburn National Bancorporation, Inc., adopted as of November 13, 2007. **

31.1		Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by Robert W. Dumas, Chairman, President and Chief Executive Officer.

31.2		Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, As Adopted Pursuant To Section 302 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Executive Vice President and Chief Financial Officer.

32.1	Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by Robert W. Dumas, Chairman, President and Chief Executive Officer.***

32.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley Act of 2002, by David A. Hedges, Executive Vice President and Chief Financial Officer.***


101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

Incorporated by reference from Registrant’s Form 10-Q dated June 30, 2002.

Incorporated by reference from Registrant’s Form 10-K dated March 31, 2008.

***

The certifications attached as exhibits 32.1 and 32.2 to this quarterly report on Form 10-Q are “furnished” to the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

AUBURN NATIONAL BANCORPORATION, INC.

(Registrant)

Date: October 30, 2020		By: /s/ Robert W. Dumas
		Robert W. Dumas
		Chairman, President and CEO

Date: October 30, 2020		By: /s/ David A. Hedges
		David A. Hedges
		Executive Vice President and Chief Financial Officer