Auburn National Bancorporation 10Q 2021 Q3 Quarterly report

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, 2021

☐

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

check

mark

whether

the

registrant

(1) has

filed

all

reports

required

filed

Section 13

15(d)

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

☒

☐

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

☒

☐

Indicate by check

mark whether the

registrant is a

large accelerated filer,

an accelerated filer,

a non-accelerated filer,

a smaller reporting

company

emerging

growth

company.

See

the

definitions

“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

☐

emerging

growth

company,

indicate

check

mark

the

registrant

has

elected

not

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

☐

☒

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 28, 2021

Common Stock, $0.01 par value per share

3,527,654

Table of Contents

AUBURN NATIONAL BANCORPORATION, INC. AND

SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION

PAGE

Item 1

Financial Statement

Consolidated Balance Sheets (Unaudited) as of September 30, 2021 and December 31, 2020

Consolidated Statements of Earnings (Unaudited) for the quarter and nine months ended September 30, 2021

and 2020

Consolidated Statements of Comprehensive Income (Unaudited) for the quarter and nine months ended

September 30, 2021 and 2020

Consolidated Statements of Stockholders’ Equity (Unaudited) for the quarter and nine months ended September

30, 2021 and 2020

Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2021 and 2020

Notes to Consolidated Financial Statements (Unaudited

)

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Table 1 – Explanation of Non-GAAP Financial Measures

Table 2 – Selected Quarterly Financial Data

Table 3 – Selected Financial Data

Table 4 – Average Balances and Net Interest Income Analysis – for the quarter ended September 30, 2021 and

2020

Table 5 – Average Balances and Net Interest Income Analysis – for the nine months ended September 30, 2021

and 2020

Table 6 – Loan Portfolio Composition

Table 7 – Allowance for Loan Losses and Nonperforming Assets

Table 8 – Allocation of Allowance for Loan Losses

Table 9 – CDs and Other Time Deposits of $100,000 or more

Item 3

Quantitative and Qualitative Disclosures About Market Risk

Item 4

Controls and Procedures

PART II. OTHER INFORMATION

Item 1

Legal Proceedings

Item

Risk Factors

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3

Defaults Upon Senior Securities

Item 4

Mine Safety Disclosures

Item 5

Other Information

Item 6

Exhibits

Table of Contents

PART

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)

2021

2020

Assets:

Cash and due from banks

21,363

14,868

Federal funds sold

38,616

28,557

Interest-bearing bank deposits

87,405

69,150

Cash and cash equivalents

147,384

112,575

Securities available-for-sale

407,474

335,177

Loans held for sale

577

3,418

Loans, net of unearned income

453,232

461,700

Allowance for loan losses

(5,119)

(5,618)

Loans, net

448,113

456,082

Premises and equipment, net

34,994

22,193

Bank-owned life insurance

19,534

19,232

Other assets

7,795

7,920

Total assets

1,065,871

956,597

Liabilities:

Deposits:

Noninterest-bearing

299,150

245,398

Interest-bearing

655,821

594,394

Total deposits

954,971

839,792

Federal funds purchased and securities sold under agreements to repurchase

3,310

2,392

Accrued expenses and other liabilities

2,661

6,723

Total liabilities

960,942

848,907

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

Additional paid-in capital

3,794

3,789

Retained earnings

109,018

105,617

Accumulated other comprehensive income, net

2,751

7,599

Less treasury stock, at cost -

427,797

shares and

390,859

at September 30, 2021

and December 31, 2020, respectively

(10,673)

(9,354)

Total stockholders’ equity

104,929

107,690

Total liabilities and stockholders’

equity

1,065,871

956,597

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)

2021

2020

2021

2020

Interest income:

Loans, including fees

5,127

5,453

15,417

16,359

Securities:

Taxable

1,048

913

3,006

3,080

Tax-exempt

441

461

1,337

1,390

Federal funds sold and interest-bearing bank deposits

105

332

Total interest income

6,665

6,853

19,865

21,161

Interest expense:

Deposits

620

983

1,900

3,005

Short-term borrowings

Total interest expense

624

985

1,912

3,011

Net interest income

6,041

5,868

17,953

18,150

Provision for loan losses

250

(600)

1,100

Net interest income after provision for loan

losses

6,041

5,618

18,553

17,050

Noninterest income:

Service charges on deposit accounts

149

139

419

437

Mortgage lending

268

702

1,241

1,615

Bank-owned life insurance

100

109

302

615

Other

397

408

1,244

1,202

Securities gains, net

103

Total noninterest income

929

1,374

3,221

3,972

Noninterest expense:

Salaries and benefits

2,893

2,802

8,641

8,230

Net occupancy and equipment

436

457

1,292

1,974

Professional fees

232

230

814

877

Other

1,148

1,164

3,547

3,387

Total noninterest expense

4,709

4,653

14,294

14,468

Earnings before income taxes

2,261

2,339

7,480

6,554

Income tax expense

386

403

1,313

1,156

Net earnings

1,875

1,936

6,167

5,398

Net earnings per share:

Basic and diluted

0.53

0.54

1.74

1.51

Weighted average shares

outstanding:

Basic and diluted

3,536,320

3,566,239

3,552,387

3,566,184

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)

2021

2020

2021

2020

Net earnings

1,875

1,936

6,167

5,398

Other comprehensive (loss) income, net of tax:

Unrealized net holding (loss) gain on securities

(1,493)

(5)

(4,837)

5,387

Reclassification adjustment for net gain on securities

recognized in net earnings

(11)

(12)

(11)

(77)

Other comprehensive (loss) income

(1,504)

(17)

(4,848)

5,310

Comprehensive income

371

1,919

1,319

10,708

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

Common

paid-in

Retained

comprehensive

Treasury

(Dollars in thousands, except share data)

Outstanding

Stock

capital

earnings

income (loss)

stock

Total

Quarter ended September 30, 2021

Balance, June 30, 2021

3,545,855

3,792

108,060

4,255

(10,103)

106,043

Net earnings

—

1,875

Other comprehensive loss

—

(1,504)

Cash dividends paid ($

.26

per share)

—

(917)

Stock repurchases

(16,582)

(570)

Sale of treasury stock

Balance, September 30, 2021

3,529,338

3,794

109,018

2,751

(10,673)

104,929

Quarter ended September 30, 2020

Balance, June 30, 2020

3,566,176

3,785

103,444

7,386

(9,355)

105,299

Net earnings

—

1,936

Other comprehensive loss

—

(17)

Cash dividends paid ($

.255

per share)

—

(909)

Sale of treasury stock

100

Balance, September 30, 2020

3,566,276

3,789

104,471

7,369

(9,354)

106,314

Nine months ended September 30, 2021

Balance, December 31, 2020

3,566,276

3,789

105,617

7,599

(9,354)

107,690

Net earnings

—

6,167

Other comprehensive loss

—

(4,848)

Cash dividends paid ($

.78

per share)

—

(2,766)

Stock repurchases

(37,093)

(1,320)

Sale of treasury stock

155

Balance, September 30, 2021

3,529,338

3,794

109,018

2,751

(10,673)

104,929

Nine months ended September 30, 2020

Balance, December 31, 2019

3,566,146

3,784

101,801

2,059

(9,355)

98,328

Net earnings

—

5,398

Other comprehensive income

—

5,310

Cash dividends paid ($

.765

per share)

—

(2,728)

Sale of treasury stock

130

Balance, September 30, 2020

3,566,276

3,789

104,471

7,369

(9,354)

106,314

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)

2021

2020

Cash flows from operating activities:

Net earnings

6,167

5,398

Adjustments to reconcile net earnings to net cash provided by

operating activities:

Provision for loan losses

(600)

1,100

Depreciation and amortization

967

1,336

Premium amortization and discount accretion, net

2,954

1,950

Net gain on securities available-for-sale

(15)

(103)

Net gain on sale of loans held for sale

(1,168)

(1,569)

Net gain on other real estate owned

(52)

Loans originated for sale

(39,632)

(60,173)

Proceeds from sale of loans

43,234

58,707

Increase in cash surrender value of bank-owned life insurance

(302)

(334)

Income recognized from death benefit on bank-owned life insurance

(282)

Net increase in other assets

(216)

(1,235)

Net decrease in accrued expenses and other liabilities

(2,430)

(585)

Net cash provided by operating activities

8,959

4,158

Cash flows from investing activities:

Proceeds from sales of securities available-for-sale

21,029

Proceeds from prepayments and maturities of securities available-for-sale

53,724

39,909

Purchase of securities available-for-sale

(135,434)

(140,714)

Decrease (increase) in loans, net

8,569

(11,562)

Net purchases of premises and equipment

(13,287)

(1,527)

Proceeds from bank-owned life insurance death benefit

694

Decrease (increase) in FHLB stock

267

(9)

Proceeds from sale of other real estate owned

151

Net cash used in investing activities

(86,161)

(92,029)

Cash flows from financing activities:

Net increase in noninterest-bearing deposits

53,752

42,264

Net increase in interest-bearing deposits

61,427

57,564

Net increase in federal funds purchased and securities sold

under agreements to repurchase

918

1,001

Stock repurchases

(1,320)

Dividends paid

(2,766)

(2,728)

Net cash provided by financing activities

112,011

98,101

Net change in cash and cash equivalents

34,809

10,230

Cash and cash equivalents at beginning of period

112,575

92,443

Cash and cash equivalents at end of period

147,384

102,673

Supplemental disclosures of cash flow information:

Cash paid during the period for:

Interest

1,914

3,011

Income taxes

2,145

1,956

Supplemental disclosure of non-cash transactions:

Real estate acquired through foreclosure

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, 2020.

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 securities 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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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, 2021. 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 2021, the Company did not adopt any new accounting

guidance.

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, 2021 and

2020, respectively, the Company

had no such securities or rights issued or outstanding, and therefore, no dilutive effect

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)

2021

2020

2021

2020

Basic and diluted:

Net earnings

1,875

1,936

6,167

5,398

Weighted average common

shares outstanding

3,536,320

3,566,239

3,552,387

3,566,184

Net earnings per share

0.53

0.54

1.74

1.51

NOTE 3: SECURITIES

At September 30, 2021 and December 31, 2020, 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, 2021 and December

31, 2020, respectively, are

presented below.

1 year

1 to 5

5 to 10

After 10

Fair

Gross Unrealized

Amortized

(Dollars in thousands)

or less

years

Value

Gains

Losses

Cost

September 30, 2021

Agency obligations (a)

10,033

39,042

70,434

119,509

1,657

1,492

119,344

Agency MBS (a)

779

31,041

181,794

213,614

2,188

1,840

213,266

State and political subdivisions

381

979

14,916

58,075

74,351

3,440

280

71,191

Total available-for-sale

10,414

40,800

116,391

239,869

407,474

7,285

3,612

403,801

December 31, 2020

Agency obligations (a)

5,048

24,834

55,367

12,199

97,448

3,156

94,390

Agency MBS (a)

1,154

20,502

141,814

163,470

3,245

133

160,358

State and political subdivisions

477

632

8,405

64,745

74,259

3,988

70,282

Total available-for-sale

5,525

26,620

84,274

218,758

335,177

10,389

242

325,030

(a) Includes securities issued by U.S. government agencies or government-sponsored

entities.

Securities with aggregate fair values of $

173.0

million and $

166.9

million at September 30, 2021 and December 31, 2020,

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.

Table of Contents

Included in other assets on the accompanying consolidated balance sheets are non-marketable

equity investments.

The

carrying amounts of non-marketable equity investments were $

1.2

million and $

1.4

million at September 30, 2021 and

December 31, 2020, respectively.

Non-marketable equity investments include FHLB of Atlanta Stock, Federal

Reserve

Bank (“FRB”) stock, and stock in a privately held financial institution.

Gross Unrealized Losses and Fair Value

The fair values and gross unrealized losses on securities at September 30,

2021 and December 31, 2020, 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, 2021:

Agency obligations

50,658

1,051

15,002

441

65,660

1,492

Agency MBS

122,322

1,678

10,810

162

133,132

1,840

State and political subdivisions

10,249

177

2,104

103

12,353

280

Total

183,229

2,906

27,916

706

211,145

3,612

December 31, 2020:

Agency obligations

15,416

Agency MBS

41,488

133

41,488

133

State and political subdivisions

2,945

Total

59,849

242

59,849

242

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.

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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.

Agency mortgage-backed securities (“MBS”)

The unrealized losses associated with agency MBS were primarily driven by changes

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, 2021 and December 31, 2020, 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 quarters

ended September 30, 2021 and

2020, 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)

2021

2020

2021

2020

Gross realized gains

184

Gross realized losses

(62)

(81)

Realized gains, net

103

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NOTE 4: LOANS AND ALLOWANCE

FOR LOAN LOSSES

September 30,

December 31,

(Dollars in thousands)

2021

2020

Commercial and industrial

79,202

82,585

Construction and land development

34,890

33,514

Commercial real estate:

Owner occupied

57,138

54,033

Hotel/motel

44,412

42,900

Multi-family

41,291

40,203

Other

109,957

118,000

Total commercial real estate

252,798

255,136

Residential real estate:

Consumer mortgage

32,558

35,027

Investment property

47,647

49,127

Total residential real estate

80,205

84,154

Consumer installment

7,060

7,099

Total loans

454,155

462,488

Less: unearned income

(923)

(788)

Loans, net of unearned income

453,232

461,700

Loans secured by real estate were approximately

81.0%

of the Company’s total loan portfolio

at September 30, 2021.

September 30, 2021, 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 participated

as a lender in the Paycheck Protection Program (“PPP”), which ended May 31, 2021.

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.

The Company had

178

and

265

PPP loans with an aggregate outstanding principal balance of

13.3

million and $

19.0

million, included in this category, as

of September 30, 2021 and December 31, 2020, respectively.

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 four classes: (1) owner occupied, (2)

hotel/motel,

(3) multifamily and (4) 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

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, 2021 and December 31, 2020.

Accruing

Total

30-89 Days

Greater than

Accruing

Non-

Total

(Dollars in thousands)

Current

Past Due

90 days

Loans

Accrual

Loans

September 30, 2021:

Commercial and industrial

79,134

79,202

Construction and land development

34,890

Commercial real estate:

Owner occupied

57,138

Hotel/motel

44,412

Multi-family

41,291

Other

109,764

193

109,957

Total commercial real estate

252,605

193

252,798

Residential real estate:

Consumer mortgage

32,273

32,358

200

32,558

Investment property

47,161

393

47,554

47,647

Total residential real estate

79,434

409

79,912

293

80,205

Consumer installment

7,035

7,060

Total

453,098

502

453,669

486

454,155

December 31, 2020:

Commercial and industrial

82,355

230

82,585

Construction and land development

33,453

33,514

Commercial real estate:

Owner occupied

54,033

Hotel/motel

42,900

Multi-family

40,203

Other

117,759

117,788

212

118,000

Total commercial real estate

254,895

254,924

212

255,136

Residential real estate:

Consumer mortgage

33,169

1,503

140

34,812

215

35,027

Investment property

49,014

49,020

107

49,127

Total residential real estate

82,183

1,509

140

83,832

322

84,154

Consumer installment

7,069

7,099

Total

459,955

1,858

141

461,954

534

462,488

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 evaluates the loan portfolio’s

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, 2021 and December 31, 2020, and for the periods then ended, the Company adjusted

its

historical loss rates for the commercial real estate portfolio segment based, in part,

on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s

estimate of

probable losses for several “qualitative and environmental” factors. The allocation

for qualitative and environmental factors

is particularly subjective and does not lend itself to exact mathematical calculation. This amount

represents estimated

probable inherent credit losses which exist, but have not yet been identified,

as of the balance sheet date, and are based

upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration

changes, prevailing economic

conditions, changes in lending personnel experience, changes in lending policies or

procedures, and other 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, 2021, the Company increased its look-back period

to 50 quarters to continue to include losses

incurred by the Company beginning with the first quarter of 2009.

The Company will likely continue to increase its look-

back period to incorporate the effects of at least one economic downturn

in its loss history.

During 2020, the Company

adjusted certain qualitative and economic factors related to changes in economic conditions

driven by the impact of the

COVID-19 pandemic and resulting adverse economic conditions, including

higher unemployment in our primary market

area.

During the second quarter of 2021, the Company adjusted certain qualitative and economic factors

to reflect

improvements in economic conditions 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, 2021

(Dollars in thousands)

Commercial and

industrial

Construction

and land

development

Commercial

real estate

Residential

real estate

Consumer

installment

Total

Quarter ended:

Beginning balance

829

639

2,704

838

5,107

Charge-offs

Recoveries

Net recoveries

Provision for loan losses

(14)

(49)

119

(46)

(10)

Ending balance

816

590

2,823

799

5,119

Nine months ended:

Beginning balance

807

594

3,169

944

104

5,618

Charge-offs

(1)

(5)

(6)

Recoveries

107

Net recoveries

101

Provision for loan losses

(46)

(4)

(346)

(177)

(27)

(600)

Ending balance

816

590

2,823

799

5,119

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)

Recoveries

Net recoveries

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

129

Net recoveries (charge-offs)

(23)

Provision for loan losses

162

831

1,100

Ending balance

798

582

3,120

954

121

5,575

Table of Contents

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, 2021 and 2020.

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, 2021:

Commercial and industrial (3)

816

79,202

816

79,202

Construction and land development

590

34,890

590

34,890

Commercial real estate

2,823

252,605

193

2,823

252,798

Residential real estate

799

80,112

799

80,205

Consumer installment

7,060

Total

5,119

453,869

286

5,119

454,155

September 30, 2020:

Commercial and industrial (4)

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

(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 $13.3 million of PPP loans for which no allowance

for loan losses was allocated due to 100% SBA guarantee.

(4)

Includes $36.5 million of PPP loans for which no allowance

for loan losses 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, 2021:

Commercial and industrial

78,786

142

274

79,202

Construction and land development

34,656

231

34,890

Commercial real estate:

Owner occupied

55,570

1,438

130

57,138

Hotel/motel

36,649

7,763

44,412

Multi-family

37,765

3,526

41,291

Other

107,818

1,904

193

109,957

Total commercial real estate

237,802

14,631

172

193

252,798

Residential real estate:

Consumer mortgage

30,516

317

1,525

200

32,558

Investment property

47,095

136

323

47,647

Total residential real estate

77,611

453

1,848

293

80,205

Consumer installment

7,036

7,060

Total

435,891

15,234

2,544

486

454,155

December 31, 2020:

Commercial and industrial

79,984

2,383

218

82,585

Construction and land development

33,260

254

33,514

Commercial real estate:

Owner occupied

51,265

2,627

141

54,033

Hotel/motel

35,084

7,816

42,900

Multi-family

36,673

3,530

40,203

Other

116,498

1,243

212

118,000

Total commercial real estate

239,520

15,216

188

212

255,136

Residential real estate:

Consumer mortgage

32,518

397

1,897

215

35,027

Investment property

48,501

187

332

107

49,127

Total residential real estate

81,019

584

2,229

322

84,154

Consumer installment

7,069

7,099

Total

440,852

18,190

2,912

534

462,488

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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).

●

All troubled debt restructurings.

The following tables set forth certain information regarding the Company’s

impaired loans that were individually evaluated

for impairment at September 30, 2021 and December 31, 2020.

September 30, 2021

(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

208

(15)

193

Total commercial real estate

208

(15)

193

Residential real estate:

Investment property

101

(8)

Total residential real estate

101

(8)

Total

impaired loans

309

(23)

286

(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, 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

216

(4)

212

Total commercial real estate

216

(4)

212

Residential real estate:

Investment property

109

(2)

107

Total residential real estate

109

(2)

107

Total

impaired loans

325

(6)

319

(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, 2021

Nine months ended September 30, 2021

Average

Total interest

Average

Total interest

recorded

income

recorded

income

(Dollars in thousands)

investment

recognized

investment

recognized

Impaired loans:

Commercial real estate:

Other

196

202

Total commercial real estate

196

202

Residential real estate:

Investment property

100

Total residential real estate

100

Total

291

302

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

Total commercial real estate

217

Residential real estate:

Investment property

111

Total residential real estate

111

Total

328

131

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’s

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 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.

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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.

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,

2021 and December 31, 2020,

respectively.

TDRs

(Dollars in thousands)

Accruing

Nonaccrual

Total

Allowance

September 30, 2021

Commercial real estate:

Other

193

Total commercial real estate

193

Residential real estate:

Investment property

Total residential real estate

Total

286

TDRs

(In thousands)

Accruing

Nonaccrual

Total

Allowance

December 31, 2020

Commercial real estate:

Other

212

Total commercial real estate

212

Investment property

107

Total residential real estate

107

Total

319

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At September 30, 2021 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

modiciation.

Quarter ended September 30,

Nine months ended September 30,

Pre-

Post -

Pre-

Post -

modification

Number

outstanding

Number

outstanding

recorded

(Dollars in thousands)

contracts

investment

contracts

investment

2020:

Commercial real estate:

Other

—

216

Total commercial real estate

—

216

Residential real estate:

Investment property

—

111

Total residential real estate

—

111

Total

—

327

There were no loans modified in a TDR during the quarter and nine

months ended September 30, 2021.

During the quarter and nine months ended September 30, 2021 and 2020,

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).

NOTE 5: 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.

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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)

2021

2020

2021

2020

MSRs, net:

Beginning balance

1,360

1,271

1,330

1,299

Additions, net

234

407

471

Amortization expense

(127)

(183)

(411)

(448)

Ending balance

1,326

1,322

1,326

1,322

Valuation

allowance included in MSRs, net:

Beginning of period

End of period

Fair value of amortized MSRs:

Beginning of period

1,833

1,690

1,489

2,111

End of period

1,776

1,521

1,776

1,521

NOTE 6: 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.

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 ended September 30, 2021,

there were no transfers between levels and no changes in valuation techniques for

the Company’s financial assets and

liabilities.

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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

the third party pricing service with its own price and will review the significant assumptions

and valuation methodologies

used with management.

The following table presents the balances of the assets and liabilities measured at fair value

on a recurring basis as of

September 30, 2021 and December 31, 2020, 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

(Dollars in thousands)

Amount

(Level 1)

(Level 2)

(Level 3)

September 30, 2021:

Securities available-for-sale:

Agency obligations

119,509

Agency RMBS

213,614

State and political subdivisions

74,351

Total securities available-for-sale

407,474

Total

assets at fair value

407,474

December 31, 2020:

Securities available-for-sale:

Agency obligations

97,448

Agency RMBS

163,470

State and political subdivisions

74,259

Total securities available-for-sale

335,177

Total

assets at fair value

335,177

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.

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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

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.

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, 2021 and December 31, 2020, 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

(Dollars in thousands)

Amount

(Level 1)

(Level 2)

(Level 3)

September 30, 2021:

Loans held for sale

577

Loans, net

(1)

286

Other assets

(2)

1,326

Total assets at fair value

2,189

577

1,612

December 31, 2020:

Loans held for sale

3,418

Loans, net

(1)

319

Other assets

(2)

1,322

Total assets at fair value

5,059

3,418

1,641

(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.

These are carried at lower of cost or estimated

fair value.

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Quantitative Disclosures for Level 3 Fair Value

Measurements

At September 30, 2021 and December 31, 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, 2021 and December 31, 2021,

the significant unobservable inputs used in the fair value measurements are presented

below.

Weighted

Carrying

Significant

Average

(Dollars in thousands)

Amount

Valuation Technique

Unobservable Input

Range

of Input

September 30, 2021:

Impaired loans

286

Appraisal

Appraisal discounts

10.0

Mortgage servicing rights, net

1,326

Discounted cash flow

Prepayment speed or CPR

13.0

15.8

15.2

Discount rate

9.5

11.5

9.5

December 31, 2020:

Impaired loans

319

Appraisal

Appraisal discounts

10.0

Mortgage servicing rights, net

1,330

Discounted cash flow

Prepayment speed or CPR

18.2

36.4

20.7

Discount rate

10.0

12.0

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.

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.

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The carrying value,

related estimated fair value, and placement in the fair value hierarchy of the Company’s

financial

instruments at September 30, 2021 and December 31, 2020 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

September 30, 2021:

Financial Assets:

Loans, net (1)

448,113

443,166

Loans held for sale

577

595

Financial Liabilities:

Time Deposits

159,285

160,372

December 31, 2020:

Financial Assets:

Loans, net (1)

456,082

451,816

Loans held for sale

3,418

3,509

Financial Liabilities:

Time Deposits

160,401

162,025

(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

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, 2021 and 2020,

as well as the information contained in our

annual report on Form 10-K for the year ended December 31, 2020 and our

interim reports on Form 10-Q for the quarters

ended March 31, 2021 and June 30, 2021.

Special Notice Regarding Forward-Looking Statements

Various

of the statements made herein under the captions “Management’s

Discussion and Analysis of Financial Condition

and Results of Operations”, “Quantitative and Qualitative Disclosures about

Market Risk”, “Risk Factors” and elsewhere,

are “forward-looking statements” within the meaning and protections of Section

27A of the Securities Act of 1933, 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, foreign, domestic and locally,

including seasonality, natural

disasters or climate change, such as rising sea and water levels, hurricanes and

tornados, coronavirus or other epidemics or pandemics;

●

the effects of war or other conflicts, acts of terrorism, or other events that

may affect general economic conditions;

●

governmental monetary and fiscal policies;

●

legislative and regulatory changes, including changes in banking, securities and

tax laws, regulations and rules and

their application by our regulators, including capital and liquidity requirements,

and changes in the scope and cost

of FDIC insurance;

●

the failure of assumptions and estimates, as well as differences in, and changes to,

economic, market and credit

conditions, including changes in borrowers’ credit risks and payment behaviors

from those used in our loan

portfolio reviews;

●

the risks of changes in interest rates on the levels, composition and costs of deposits, loan

demand, and the values

and liquidity of loan collateral, securities, and interest-sensitive assets and liabilities, and

the risks and uncertainty

of the amounts realizable;

●

changes in borrower credit risks and payment behaviors;

●

changes in the availability and cost of credit and capital in the financial markets, and the types

of instruments that

may be included as capital for regulatory purposes;

●

changes in the prices, values and sales volumes of residential and commercial real estate;

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●

the effects of competition from a wide variety of local, regional, national

and other providers of financial,

investment and insurance services, including the disruption effects of

financial technology and other competitors

who are not subject to the same regulations as the Company and the Bank;

●

the failure of assumptions and estimates underlying the establishment of allowances

for possible loan losses and

other asset impairments, losses valuations of assets and liabilities and other estimates;

●

the costs of redeveloping our headquarters and the timing and amount of rental income

upon completion of the

project;

●

the risks of mergers, acquisitions and divestitures, including,

without limitation, the related time and costs of

implementing such transactions, integrating operations as part of these transactions

and possible failures to achieve

expected gains, revenue growth and/or expense savings from such transactions;

●

changes in technology or products that may be more difficult,

costly, or less effective than

anticipated;

●

cyber-attacks and data breaches that may compromise our systems,

our vendor systems

or customers’

information;

●

the risks that our deferred tax assets (“DTAs”),

if any, could be reduced

if estimates of future taxable income from

our operations and tax planning strategies are less than currently estimated, and sales

of our capital stock could

trigger a reduction in the amount of net operating loss carry-forwards that we

may be able to utilize for income tax

purposes; and

●

other factors and information in this report and other filings that we make with the SEC

under the Exchange Act,

including our Annual Report on Form 10-K for the year ended December 31,

2020 and subsequent quarterly and

current reports. See Part II, Item 1A. “RISK FACTORS”.

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

to us are expressly qualified in their

entirety by this cautionary notice.

We have no obligation and

do not undertake to update, revise or correct any of the

forward-looking statements after the date of this report, or after the respective dates on which

such statements otherwise are

made.

ITEM 1.

BUSINESS

Auburn National Bancorporation, Inc. (the “Company”) is a bank holding company registered

with the Board of Governors

of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding

Company Act of 1956, as amended (the

“BHC Act”). The Company was incorporated in Delaware in 1990, and

in 1994 it succeeded its Alabama predecessor as the

bank holding company controlling AuburnBank, an Alabama state

member bank with its principal office in Auburn,

Alabama (the “Bank”). The Company and its predecessor have controlled the Bank

since 1984.

As a bank holding

company, the Company

may diversify into a broader range of financial services and other business activities than currentl

are permitted to the Bank under applicable laws and regulations.

The holding company structure also provides greater

financial and operating flexibility than is presently permitted to the Bank.

The Bank has operated continuously since 1907 and currently conducts its business

primarily in East Alabama, including

Lee County and surrounding areas.

The Bank has been a member of the Federal Reserve System since April 1995.

The

Bank’s primary regulators are the Federal

Reserve and the Alabama Superintendent of Banks (the “Alabama

Superintendent”).

The Bank has been a member of the Federal Home Loan Bank of Atlanta (the “FHLB”)

since 1991.

Certain of the statements made in this discussion and analysis and elsewhere, including information

incorporated herein by

reference to other documents, are “forward-looking statements” within the

meaning of, and subject to, the protections of

Section 27A of the Securities

Act.

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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)

2021

2020

2021

2020

Net interest income (a)

6,158

5,990

18,308

18,519

Less: tax-equivalent adjustment

117

122

355

369

Net interest income (GAAP)

6,041

5,868

17,953

18,150

Noninterest income

929

1,374

3,221

3,972

Total revenue

6,970

7,242

21,174

22,122

Provision for loan losses

—

250

(600)

1,100

Noninterest expense

4,709

4,653

14,294

14,468

Income tax expense

386

403

1,313

1,156

Net earnings

1,875

1,936

6,167

5,398

Basic and diluted earnings per share

0.53

0.54

1.74

1.51

(a) Tax-equivalent.

See "Table 1 - Explanation of Non-GAAP

Financial Measures."

Financial Summary

The Company’s net earnings were $6.2

million for the first nine months of 2021, compared to $5.4 million for the first nine

months of 2020.

Basic and diluted earnings per share were $1.74 per share for the first nine

months of 2021, compared to

$1.51 per share for the first nine months of 2020.

Net interest income (tax-equivalent) was $18.3 million for the first nine

months of 2021, a 1% decrease compared to $18.5

million for the first nine months of 2020.

This decrease was primarily due to net interest margin compression

resulting

from the Federal Reserve’s interest

rate reductions and bond purchases in response to the COVID-19 pandemic.

Our

securities holdings, which generally yield less than loans, increased as a percentage

of our total assets reflecting deployment

of increased deposits. Net interest margin (tax-equivalent) de

creased to 2.59% in the first nine months of 2021, compared to

2.96%

for the first nine months of 2020,

primarily due to the continued lower interest rate environment and changes in our

asset mix resulting from the significant increase in deposits from government

stimulus and relief programs and customers’

increased savings.

Net interest income (tax-equivalent) included $0.8

million in PPP loan fees, net of related costs for the

nine months ended of 2021, compared to $0.5 million for the the nine months ended

of 2020.

At September 30, 2021, the Company’s

allowance for loan losses was $5.1 million, or 1.13% of total loans, compared

$5.6 million, or 1.22%

of total loans, at December 31, 2020, and $5.6 million, or 1.18% of total loans, at September 30,

2020.

Excluding PPP loans, which are guaranteed by the SBA, the Company’s

allowance for loan losses was 1.16% of

total loans at September 30, 2021.

The Company recorded a negative provision for loan losses of $0.6 million during the

first nine months of 2021,

compared to a provision for loan losses of $1.1 million during the first nine months of 2020.

The

negative provision for loan losses was primarily related to improvements in economic conditions

in our primary market

area, and related improvements in our asset quality.

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 $3.2 million for the first nine months of 2021 compared

to $4.0 million for the first nine months of

2020.

The decrease was primarily due to a $0.3 million non-taxable death benefit from bank-owned

life insurance received

in 2020

and a $0.4 million decrease in mortgage lending income in 2021 as refinance activity declined

in our primary

market area.

Noninterest expense was $14.3 million for the first nine months of 2021

compared to $14.5 million for the first nine months

of 2020.

The decrease was primarily due to a reduction of $0.7

million in various expenses related to the redevelopment of

the Company’s headquarters in downtown

Auburn.

This decrease was mostly offset by increases in salaries and benefits

expense of $0.3 million and other noninterest expense of $0.2 million during the

first nine months of 2021.

Income tax expense was $1.3 million for the first nine months of 2021

compared to $1.2 million during the first nine

months of 2020,

reflecting an increase in earnings before taxes and an effective tax rate of 17.

55% and 17.64%,

respectively.

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The Company paid cash dividends of $0.78 per share in the first nine months of 2021,

an increase of 2% from the same

period of 2020.

The Company’s share repurchases of $1.3

million since December 31, 2020 resulted in 37,093 fewer

outstanding common shares at September 30, 2021.

At September 30, 2021, the Bank’s regulatory

capital ratios were well

above the minimum amounts required to be “well capitalized” under current regulatory

standards with a total risk-based

capital ratio of 17.72%, a tier 1 leverage ratio of 9.57%

and a common equity

tier 1 (“CET1”) ratio of 16.82% at September

30, 2021.

For the third quarter of 2021, net earnings were $1.9 million, or $0.53 per

share, compared to $1.9 million, or $0.54 per

share, for the third quarter of 2020.

Net interest income (tax-equivalent) was $6.2 million for the third quarter of 2021,

3% increase compared to $6.0

million for the third quarter of 2020.

This increase was primarily due to balance sheet

growth, partially offset by a decrease in net interest margin.

The Company’s net interest margin

(tax-equivalent) decreased

to 2.51%

in the third quarter of 2021,

compared to 2.72% for the third quarter of 2020 primarily due to the lower interest

rate environment and changes in our asset mix resulting from the significant increase

in deposits from government stimulus

and relief programs and customers’ increased savings. Net interest income (tax-equivalent)

included $0.3 million in PPP

loan fees, net of related costs for both the third quarter of 2021 and 2020.

The Company had no provision for loan losses

during the third quarter of 2021 compared to $0.3 million in provision for loan losses during

the third quarter 2020.

Noninterest income was $1.0 million in the third quarter of 2021, compared to

$1.4 million in the third quarter of 2020.

The decrease in noninterest income was primarily due to a decrease in mortgage lending

income of $0.4 million as

refinance activity slowed in our primary market area.

Noninterest expense was $4.7 million in the third quarter of 2021,

largely unchanged, compared to the third quarter of 2020.

Income tax expense was $0.4

million for the third quarter of

2021 and 2020, respectively.

The Company's effective tax rate for the third quarter of 2021

was 17.07%, compared to

17.23%

in the third quarter of 2020.

COVID-19 Impact Assessment

In December 2019, COVID-19 was first reported in China and has since spread

globally. 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, at times, especially in 2020, 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 has guidelines for the remainder of the 2021 school year,

which

involves resumption of full on-site operations as well as other measures.

COVID-19 has significantly affected local state, national and

global health and economic activity and its future effects are

uncertain and will depend on various factors, including, among others, the duration

and scope of the pandemic, the

development and distribution of COVID-19 testing and contact tracing, effective

drug treatments and vaccines, together

with governmental, regulatory and private sector responses.

COVID-19 has had continuing significant effects on the

economy, financial

markets and our employees, customers and vendors. Our business, financial condition

and results of

operations generally rely upon the ability of our borrowers to make deposits and

repay their loans, the value of collateral

underlying our secured loans, market value, stability and liquidity and demand

for loans and other products and services we

offer, all of which are affected

by the pandemic.

See “Balance Sheet Analysis – Loans” for supplemental COVID-19

disclosures.

We have implemented

a number of procedures in response to the pandemic to support the safety and

well-being of our

employees, customers and shareholders.

•

We believe our business continuity

plan has worked to provide essential banking services to our

communities and

customers, while protecting our employees’ health.

As part of our efforts to exercise social distancing in accordance with

the guidelines of the Centers for Disease Control, starting March 23,

2020, we limited branch lobby service to appointment

only while continuing to operate our branch drive-thru facilities and

ATMs.

As permitted by state public health guidelines,

on June 1, 2020, we re-opened some of our branch lobbies.

In 2021, we opened our remaining branch lobbies. 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.

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•

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

•

were a participating lender in the PPP.

PPP loans are forgivable, in whole or in part, if the proceeds are used

for payroll and other permitted purposes in accordance with the requirements

of the PPP.

These loans carry a fixed rate of

1.00% and a term of two years (loans made before June 5, 2020)

or five years (loans made on or after June 5, 2020), if not

forgiven, in whole or in part.

Payments are deferred until either the date on which the Small Business

Administration

(“SBA”) remits the amount of forgiveness proceeds to the lender or

the date that is 10 months after the last day of the

covered period if the borrower does not apply for forgiveness

within that 10-month period.

We believe these loans

and our

participation in the program is good for our customers and the communities we

serve.

A summary of PPP loans extended during 2020 follows:

(Dollars in thousands)

# of SBA

Approved

Mix

$ of SBA

Approved

Mix

SBA Tier:

$2 million to $10 million

—

$350,000 to less than $2 million

14,691

Up to $350,000

400

21,784

Total

423

100

36,475

100

We collected

approximately $1.5 million in fees related to our PPP loans during 2020. Through September 30,

2021, we

have recognized substantially all of these fees, net of related costs.

As of September 30, 2021, we have received payments

and forgiveness on all but one loan with a remaining balance of approximately

$20 thousand.

On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits,

and Venues

Act (the “Economic Aid

Act”) was signed into law.

The Economic Aid Act provides a second $900 billion stimulus

package, including $325 billion

in additional PPP loans.

The Economic Aid Act also permits the collection of a higher amount of PPP

loan fees by

participating banks.

A summary of PPP loans extended during the nine months ended September 30,

2021 under the Economic Aid Act follows:

(Dollars in thousands)

# of SBA

Approved

Mix

$ of SBA

Approved

Mix

SBA Tier:

$2 million to $10 million

—

$350,000 to less than $2 million

6,494

Up to $350,000

242

13,757

Total

254

100

20,251

100

We collected

approximately $1.0 million in fees related to PPP loans under the Economic Aid Act.

Through September 30,

2021, we have recognized $0.5 million of these fees, net of related costs.

As of September 30, 2021, we have received

payments and forgiveness on 77 PPP loans under the Economic

Aid Act, totaling $7.0 million.

The outstanding balance for

the remaining 177 PPP loans under the Economic Aid Act was approximately

$13.3 million at September 30, 2021.

We continue to closely

monitor this pandemic, and are working to continue our services during the pandemic

and to address

developments as those occur.

Our results of operations for the nine months ended September 30, 2021,

and our financial

condition at that date reflect only the ongoing effects of the pandemic, and

may not be indicative of future results or

financial conditions, including possible changes in 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, 2021, all of our capital ratios were in excess of all regulatory requirements to be

well capitalized.

The

effects of the COVID-19 pandemic on our borrowers could result in adverse changes

to credit quality and our regulatory

capital ratios.

We continue to

closely monitor this pandemic, and are working to continue our services during the pandemic

and to address developments as those occur.

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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

The Company assesses the adequacy of its allowance for loan losses prior

to the end of each calendar quarter. Determining

the amount of the allowance for loan losses is considered a critical accounting estimate

because the level of the allowance is

based upon management’s 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.

The Company deems loans impaired when, based on current information and events, it is

probable that the Company will

be unable to collect all amounts due according to the contractual terms of the loan agreement.

Collection of all amounts due

according to the contractual terms means that both the interest and principal payments of a

loan will be collected as

scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded

investment in the loan. The

impairment is recognized through the allowance. Loans that are impaired

are recorded at the present value of expected

future cash flows discounted at the loan’s effective

interest rate, or if the loan is collateral dependent, the impairment

measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate

to absorb probable losses inherent in the

portfolio at the balance sheet date. The allowance is increased by provisions charged

to expense and decreased by charge-

offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its

ongoing internal and independent

loan review processes. The Company’s loan

review process assists in determining whether there are loans in the portfolio

whose credit quality has weakened over time and evaluating the risk characteristics of the

entire loan portfolio. The

Company’s loan review process includes the judgment

of management, the input from our independent loan reviewers, and

reviews that may have been conducted by bank regulatory agencies as part of their examination

process. The Company

incorporates loan review results in the determination of whether or not it is probable

that it will be able to collect all

amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment

of the allowance, management divides the loan portfolio into five segments:

commercial and industrial, construction and land development, commercial real estate, residential

real estate, and consumer

installment. The Company analyzes each segment and estimates an allowance allocation

for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the

probable losses inherent for each

loan segment. The estimates for these loans are established by category and based

on the Company’s internal system of

credit risk ratings and historical loss data.

The estimated loan loss allocation rate for the Company’s

internal system of

credit risk grades is based on its experience with similarly graded loans. For

loan segments where the Company believes it

does not have sufficient historical loss data, the Company may

make adjustments based, in part, on loss rates of peer bank

groups.

At September 30, 2021 and December 31, 2020, and for the periods then ended, the Company adjusted

its

historical loss rates for the commercial real estate portfolio segment based, in part, on loss

rates of peer bank groups.

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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, 2021, the Company increased its look-back

period to 50 quarters to continue to include losses

incurred by the Company beginning with the first quarter

of 2009.

The Company will likely continue to increase its look-

back period to incorporate the effects of at least one economic downturn in

its loss history.

During 2020, the Company

adjusted certain qualitative and economic factors related to changes in economic conditions

driven by the impact of the

COVID-19 pandemic and resulting adverse economic conditions, including

higher unemployment in our primary market

area.

During the second quarter of 2021,

the Company adjusted certain qualitative and economic factors to reflect

improvements in economic conditions in our primary market area.

Further adjustments may be made in the future as a

result of the continuing COVID-19 pandemic.

Assessment for Other-Than-Temporary

Impairment of Securities

On a quarterly basis, management makes an assessment to determine

whether there have been events or economic

circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily

impaired.

For debt securities with an unrealized loss, an other-than-temporary

impairment write-down is triggered when (1) the

Company has the intent to sell a debt security,

(2) it is more likely than not that the Company will be required to sell the

debt security before recovery of its amortized cost basis, or (3) the Company does not expect

to recover the entire amortized

cost basis of the debt security.

If the Company has the intent to sell a debt security or if it is more likely than not that it

will

be required to sell the debt security before recovery,

the other-than-temporary write-down is equal to the entire difference

between the debt security’s amortized cost

and its fair value.

If the Company does not intend to sell the security or it is not

more likely than not that it will be required to sell the security before recovery,

the other-than-temporary impairment write-

down is separated into the amount that is credit related (credit loss component) and the amount due to all other

factors.

The

credit loss component is recognized in earnings and is the difference between

the security’s amortized

cost basis and the

present value of its expected future cash flows.

The remaining difference between the security’s

fair value and the present

value of future expected cash flows is due to factors that are not credit related and is recognized in other

comprehensive

income, net of applicable taxes.

The Company is required to own certain stock as a condition of membership, such as

Federal Home Loan Bank (“FHLB”)

and Federal Reserve Bank (“FRB”).

These non-marketable equity securities are accounted for at cost

which equals par or

redemption value.

These securities do not have a readily determinable fair value as their ownership is restricted

and there is

no market for these securities.

The Company records these non-marketable equity securities as a component

of other

assets, which are periodically evaluated for impairment. Management considers

these non-marketable equity securities to

be long-term investments. Accordingly,

when evaluating these securities for impairment, management considers

the

ultimate recoverability of the par value rather than by recognizing temporary declines in

value.

Fair Value

Determination

U.S. GAAP requires management to value and disclose certain of the Company’s

assets and liabilities at fair value,

including investments classified as available-for-sale and derivatives.

ASC 820,

Fair Value

Measurements and Disclosures

which defines fair value, establishes a framework for measuring fair value in accordance

with U.S. GAAP and expands

disclosures about fair value measurements.

For more information regarding fair value measurements and disclosures,

please refer to Note 6, Fair Value,

of the consolidated financial statements that accompany this report.

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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, 2021 and December 31, 2020 the Company had no OREO properties.

Deferred Tax

Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available

evidence, it is more-likely-

than-not that some portion or the entire deferred tax asset will not be realized. The ultimate

realization of deferred tax assets

is dependent upon the generation of future taxable income during the periods

in which those temporary differences become

deductible. Management considers the scheduled reversal of deferred

tax liabilities, projected future taxable income, and

tax planning strategies in making this assessment. Based upon the level of taxable

income over the last three years and

projections for future taxable income over the periods in which the deferred tax assets are

deductible, management believes

it is more likely than not that we will realize the benefits of these deductible differences

at September 30, 2021. The amount

of the deferred tax assets considered realizable, however,

could be reduced if estimates of future taxable income are

reduced.

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RESULTS

OF OPERATIONS

Average Balance

Sheet and Interest Rates

Nine months ended September 30,

2021

2020

Average

Yield/

Average

Yield/

(Dollars in thousands)

Balance

Rate

Balance

Rate

Loans and loans held for sale

460,732

4.47%

463,581

4.71%

Securities - taxable

310,288

1.30%

225,234

1.83%

Securities - tax-exempt

62,915

3.60%

62,930

3.73%

Total securities

373,203

1.68%

288,164

2.24%

Federal funds sold

36,821

0.14%

30,739

0.51%

Interest bearing bank deposits

75,170

0.12%

53,834

0.53%

Total interest-earning assets

945,926

2.86%

836,318

3.44%

Deposits:

NOW

176,242

0.12%

153,767

0.37%

Savings and money market

289,758

0.23%

234,533

0.46%

Time Deposits

159,412

1.05%

166,115

1.43%

Total interest-bearing deposits

625,412

0.41%

554,415

0.72%

Short-term borrowings

3,329

0.50%

1,721

0.50%

Total interest-bearing liabilities

628,741

0.41%

556,136

0.72%

Net interest income and margin (tax-equivalent)

18,308

2.59%

18,519

2.96%

Net Interest Income and Margin

Net interest income (tax-equivalent) was $18.3 million for the first nine

months of 2021 compared to $18.5 million for the

first nine months of 2020.

This decrease was due to a decline in the Company’s

net interest margin (tax-equivalent),

partially offset by balance sheet growth.

The tax-equivalent yield on total interest-earning assets decreased by 58 basis points

to 2.86% in the first nine months of

2021 compared to 3.44% in the first nine months of 2020.

This decrease was primarily due to the lower interest rate

environment and changes in our asset mix resulting from the significant increase

in deposits from government stimulus and

relief programs and customers’ increased savings.

The cost of total interest-bearing liabilities decreased by 31 basis points to 0.41%

in the first nine months of 2021 compared

to 0.72% in the first nine months of 2020.

The net decrease in our funding costs was primarily due to lower prevailing

market interest rates.

Our funding costs declined less than the rates earned on our interest earning assets.

The Company continues to deploy various asset liability management strategies

to manage its risk to interest rate

fluctuations. The Company’s

net interest margin could continue to experience pressure due to

reduced earning asset yields

and increased competition for quality loan opportunities.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide

an allowance for loan losses that

management believes, based on its processes and estimates, should be adequate

to provide for the probable losses on

outstanding loans.

The Company recorded a negative provision for loan losses of $0.6 million for the

first nine months of

2021, compared to $1.1 million in provision for loan losses for the first nine months

of 2020.

The negative provision for

loan losses was primarily related to improvements in economic conditions 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.

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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 1.13% at September 30,

2021, compared to 1.22% at December 31, 2020.

At September 30, 2021, the Company’s

allowance for loan losses was 1.16% of total loans, excluding PPP

loans, which are

guaranteed by the SBA.

While the policies and procedures used to estimate the allowance for loan losses, as

well as the

resulting provision for loan losses charged to operations, are considered

adequate by management and are reviewed from

time to time by our regulators, they are based on estimates and judgments and are therefore

approximate and imprecise.

Factors beyond our control (such as conditions in the local and national economy,

local real estate markets, or industries)

may have a material adverse effect on our asset quality and the adequacy of our

allowance for loan losses resulting in

significant increases in the provision for loan losses.

Noninterest Income

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands)

2021

2020

2021

2020

Service charges on deposit accounts

149

139

419

437

Mortgage lending income

268

702

1,241

1,615

Bank-owned life insurance

100

109

302

615

Securities gains, net

103

Other

397

408

1,244

1,202

Total noninterest income

929

1,374

3,221

3,972

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.

The Company evaluates MSRs for impairment on a quarterly basis.

Impairment is determined by grouping MSRs by

common predominant characteristics, such as interest rate and loan type.

If the aggregate carrying amount of a particular

group of MSRs exceeds the group’s aggregate fair

value, a valuation allowance for that group is established.

The valuation

allowance is adjusted as the fair value changes.

An increase in mortgage interest rates typically results in an increase in the

fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease

in the fair value of MSRs.

The following table presents a breakdown of the Company’s

mortgage lending income.

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands)

2021

2020

2021

2020

Origination income

233

722

1,168

1,569

Servicing fees, net

(20)

Total mortgage lending income

268

702

1,241

1,615

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. Origination income decreased

in 2021 compared to 2020 due

to a decrease in refinance activity in our primary market area.

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Income from bank-owned life insurance decreased primarily due to $0.3

million in non-taxable death benefits received in

2020. The assets that support these policies are administered by the life insurance carriers

and the income we receive (i.e.,

increases or decreases in the cash surrender value of the policies and death benefits received)

on these policies is dependent

upon the returns the insurance carriers are able to earn on the underlying investments that

support these policies. Earnings

on these policies are generally not taxable.

Noninterest Expense

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands)

2021

2020

2021

2020

Salaries and benefits

2,893

2,802

8,641

8,230

Net occupancy and equipment

436

457

1,292

1,974

Professional fees

232

230

814

877

Other

1,148

1,164

3,547

3,387

Total noninterest expense

4,709

4,653

14,294

14,468

The increase in salaries and benefits was primarily due to a decrease in deferred costs related

to the PPP loan program,

routine annual wage and benefit increases, and management increasing the

minimum hourly wage for banking positions to

$15.

The decrease in net occupancy and equipment expense was primarily due to

a reduction of 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.

Income Tax

Expense

Income tax expense was $1.3 million for the first nine months of 2021

compared to $1.2 million for the first nine months of

2020,

reflecting an increase in earnings before taxes and an effective tax rate of 17.55%

and 17.64%, respectively.

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $407.5

million at September 30, 2021 compared to $335.2 million at December 31, 2020.

This increase reflects an increase in the amortized cost basis of securities available-for-sale

of $78.8 million, and a decrease

of $6.5 million in the fair value of securities available-for-sale.

The increase in the amortized cost basis of securities

available-for-sale was primarily attributable to management

allocating more funding to the investment portfolio following

the significant increase in customer deposits.

The decrease in the fair value of securities was primarily due to an increase

long-term interest rates.

The average annualized tax-equivalent yields earned on total securities

were 1.68%

in the first

nine months of 2021 and 2.24% in the first nine months of 2020.

Loans

2021

2020

Third

Second

First

Fourth

Third

(In thousands)

Quarter

Commercial and industrial

79,202

87,933

88,687

82,585

98,244

Construction and land development

34,890

37,477

30,332

33,514

31,651

Commercial real estate

252,798

242,845

254,731

255,136

250,992

Residential real estate

80,205

82,164

82,848

84,154

85,054

Consumer installment

7,060

7,762

6,524

7,099

7,731

Total loans

454,155

458,181

463,122

462,488

473,672

Less:

unearned income

(923)

(1,197)

(1,243)

(788)

(1,219)

Loans, net of unearned income

453,232

456,984

461,879

461,700

472,453

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Total loans, net of unearned income,

were $453.2 million at September 30, 2021, a decrease of $8.5 million from $461.7

million at December 31, 2020.

Excluding PPP loans, total loans net of unearned income, were $440.4

million, a decrease

of $1.9 million from $442.3 million at December 31, 2020.

Four loan categories represented approximately 98% of the

loan portfolio at September 30, 2021: commercial real estate (56%),

residential real estate (18%), commercial and industrial

(17%) and construction and land development (8%).

Approximately 23% of the Company’s commercial

real estate loans

were classified as owner-occupied at September 30, 2021.

Within the residential real estate portfolio segment, the Company

had junior lien mortgages of approximately $8.1 million,

or 2% of total loans, at September 30, 2021, compared to $8.7 million, or 2% of total loans, at December

31, 2020.

For

residential real estate mortgage loans with a consumer purpose, the Company

had no loans that required interest-only

payments at September 30, 2021 and December 31, 2020. 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 4.47%

in the first nine months of 2021 and 4.71% in the first

nine months of 2020.

The specific economic and credit risks associated with our loan portfolio include,

but are not limited to, the effects of

current economic conditions, including the COVID-19 pandemic’s

effects, on our borrowers’ cash flows, real estate market

sales volumes, valuations, availability and cost of financing properties,

real estate industry concentrations, competitive

pressures from a wide range of other lenders, deterioration in certain credits, interest rate

fluctuations, reduced collateral

values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration

of borrowers, fraud, and any

violation of applicable laws and regulations.

The Company attempts to reduce these economic and credit risks through its loan-to-value

guidelines for collateralized

loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial

position. Also, we have

established and periodically review,

lending policies and procedures. Banking regulations limit a bank’s

credit exposure by

prohibiting unsecured loan relationships that exceed 10% of its capital; or 20%

of capital, if loans in excess of 10% of

capital are fully secured. Under these regulations, we are prohibited from having secured

loan relationships in excess of

approximately $20.9 million.

Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding

plus

unfunded commitments) to a single borrower of $18.8 million. Our loan policy requires

that the Loan Committee of the

Board of Directors approve any loan relationships that exceed this internal limit.

At September 30, 2021, the Bank had no

relationships exceeding these limits.

We periodically analyze

our commercial and industrial and commercial real estate loan portfolios to determine if

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, 2021 and December 31, 2020.

September 30,

December 31,

(Dollars in thousands)

2021

2020

Lessors of 1-4 family residential properties

47,647

49,127

Hotel/motel

44,412

42,900

Multi-family residential properties

41,291

40,203

Shopping centers

29,411

30,000

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COVID-19 Modifications

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.

of September 30, 2021, we had no COVID-19 loan deferrals outstanding, compared

to $32.3 million, or 7% of total loans at

December 31, 2020.

The tables below provide information concerning the composition of these COVID-19

modifications as of December 31,

2020.

Modification Types

(Dollars in thousands)

# of Loans

Modified

Balance

% of Portfolio

Modified

Interest Only

Payment

P&I

Payments

Deferred

December 31, 2020:

Commercial and industrial

741

—

100

—

Commercial real estate

31,399

100

—

Residential real estate

133

—

100

Total

32,273

COVID-19 Modifications within Commercial Real Estate

Segment

(Dollars in thousands)

# of Loans

Modified

Balance of

Loans Modified

% of Total

Loan Class

December 31, 2020:

Hotel/motel

26,427

Multifamily

3,530

Restaurants

1,442

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 $5.1

million at

September 30, 2021 compared to $5.6 million at December 31, 2020,

which management believed to be adequate at each of

the respective dates. The judgments and estimates associated

with the determination of the allowance for loan losses are

described under “Critical Accounting Policies.”

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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 2021 and

the previous four quarters is presented below.

2021

2020

Third

Second

First

Fourth

Third

(Dollars in thousands)

Quarter

Balance at beginning of period

5,107

5,682

5,618

5,575

5,308

Charge-offs:

Commercial and industrial

—

(4)

—

Residential real estate

—

(1)

—

Consumer installment

—

(5)

(1)

(4)

Total charge

-offs

—

(1)

(5)

(4)

Recoveries

Net recoveries

Provision for loan losses

—

(600)

—

250

Ending balance

5,119

5,107

5,682

5,618

5,575

as a % of loans

1.13

1.12

1.23

1.22

1.18

as a % of nonperforming loans

1,053

813

726

1,052

1,015

Net (recoveries) charge-offs as % of average loans (a)

(0.01)

(0.02)

(0.06)

(0.04)

(0.01)

(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 1.13%

at September 30, 2021, compared to 1.22% at December 31,

2020.

At September 30, 2021, the Company’s allowance

for loan losses was 1.16% of total loans, excluding PPP loans. In

the future, the allowance to total loans outstanding ratio will increase or decrease

to the extent the factors that influence our

quarterly allowance assessment, including the duration and magnitude

of COVID-19 effects, in their entirety either improve

or weaken.

In addition, our regulators, as an integral part of their examination process, will periodically

review the

Company’s allowance for loan losses,

and may require the Company to make additional provisions to the allowance

for

loan losses based on their judgment about information

available to them at the time of their examinations.

Nonperforming Assets

The Company had $0.5

million in nonperforming assets at September 30, 2021 and December 31,

2020, respectively.

The table below provides information concerning total nonperforming assets

and certain asset quality ratios for the third

quarter of 2021 and the previous four quarters.

2021

2020

Third

Second

First

Fourth

Third

(Dollars in thousands)

Quarter

Nonperforming assets:

Nonaccrual loans

486

628

783

534

549

Total nonperforming assets

486

628

783

534

549

as a % of loans and other real estate owned

0.11

0.14

0.17

0.12

as a % of total assets

0.05

0.06

0.08

0.06

Nonperforming loans as a % of total loans

0.11

0.14

0.17

0.12

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The table below provides information concerning the composition of nonaccrual

loans for the third quarter of 2021 and the

previous four quarters.

2021

2020

Third

Second

First

Fourth

Third

(In thousands)

Quarter

Nonaccrual loans:

Commercial real estate

193

199

206

212

216

Residential real estate

293

429

577

322

332

Consumer installment

—

Total nonaccrual loans

486

628

783

534

549

The Company discontinues the accrual of interest income when (1) there is a significant

deterioration in the financial

condition of the borrower and full repayment of principal and interest is not expected or

(2) the principal or interest is

90 days or more past due, unless the loan is both well-secured and in the process of collection

The Company had $0.5

million in loans on nonaccrual status at September 30, 2021 and December 31,

2020, respectively.

The Company had $0.1 million of loans 90 days or more past due and still accruing at September

30, 2021 and December

31, 2020, respectively.

The Company had no OREO at September 30, 2021 or December 31, 2020.

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and

where information about possible credit

problems of a borrower has caused management to have serious doubts about the borrower’s

ability to comply with present

repayment terms.

This definition is believed to be substantially consistent with the standards

established by the Federal

Reserve, the Company’s primary regulator,

for loans classified as substandard, excluding nonaccrual loans.

Potential

problem loans, which are not included in nonperforming assets, amounted to $2.5

million, or 0.6% of total loans at

September 30, 2021, and $2.9 million, or 0.6% of total loans at December 31, 2020.

The table below provides information concerning the composition of potential problem

loans for the third quarter of 2021

and the previous four quarters.

2021

2020

Third

Second

First

Fourth

Third

(In thousands)

Quarter

Potential problem loans:

Commercial and industrial

274

291

299

218

230

Construction and land development

231

239

247

254

563

Commercial real estate

172

178

173

188

Residential real estate

1,848

2,096

2,092

2,229

2,486

Consumer installment

Total potential problem loans

2,544

2,811

2,820

2,912

3,509

At September 30, 2021 the Company had $0.1 million 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 2021 and the previous four quarters.

2021

2020

Third

Second

First

Fourth

Third

(In thousands)

Quarter

Performing loans past due 30 to 89 days:

Commercial and industrial

230

Construction and land development

—

204

—

Commercial real estate

—

205

180

—

Residential real estate

409

399

1,509

106

Consumer installment

Total

502

485

667

1,858

160

Deposits

Total deposits increased

$115.2 million, or 14% to $955.0 million at September 30,

2021, compared to $839.8 million at

December 31, 2020.

Noninterest-bearing deposits were $299.1 million, or 31% of total deposits, at September

30, 2021,

compared to $245.4 million, or 29% of total deposits at December 31, 2020.

These increases reflect deposits from

customers who received PPP loans, the impact of government stimulus checks,

delayed tax payments and less customer

spending and greater savings during the COVID-19 pandemic.

The average rate paid on total interest-bearing deposits was 0.41% in the first nine

months of 2021 compared to 0.72% in

the first nine months of 2020.

The decline in average rates paid on total interest-bearing deposits was largely

driven by

generally lower market interest rates.

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, 2021, and at December 31, 2020, respectively.

Securities sold under agreements to repurchase

totaled $3.3 million at September 30, 2021, compared to $2.4 million at December

31, 2020.

The average rate paid on short-term borrowings was 0.50% in the first nine months of 2021

and 2020, respectively.

The Company had no long-term debt at September 30, 2021 and December 31, 2020.

CAPITAL ADEQUACY

The Company’s consolidated

stockholders’ equity was $104.9 million and $107.7

million as of September 30, 2021 and

December 31, 2020, respectively.

The decrease from December 31, 2020 was primarily driven by an other comprehensive

loss due to the change in unrealized gains (losses) on securities available-for-sale,

net of tax of $4.8 million, cash dividends

paid of $2.8 million, and repurchases of the Company’s

stock of $1.3 million.

During the first nine months of 2021, the

Company repurchased 37,093 shares under the Company’s

current stock repurchase program.

These shares were

repurchased at an average cost per share of $34.36 and a total cost of $1.3 million.

These decreases in the Company’s

consolidated stockholders’ equity were partially offset

by net earnings of $6.2 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, 2021, 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 9.57%, CET1 risk-based capital ratio was 16.82%, tier 1 risk-based

capital ratio was 16.82%, and

total risk-based capital ratio was 17.72% at September 30, 2021. These

ratios exceed the minimum regulatory capital

percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio,

8.0% for tier 1 risk-based capital ratio,

and 10.0% for total risk-based capital ratio to be considered “well capitalized.”

The Bank’s capital conservation buffer

was

9.72%

at September 30, 2021.

MARKET AND LIQUIDITY RISK MANAGEMENT

Management’s objective is to manage assets and

liabilities to provide a satisfactory,

consistent level of profitability within

the framework of established liquidity,

loan, investment, borrowing, and capital policies. The Bank’s

Asset Liability

Management Committee (“ALCO”) is charged with the responsibility

of monitoring these policies, which are designed to

ensure an acceptable asset/liability composition. Two

critical areas of focus for ALCO are interest rate risk and liquidity

risk management.

Interest Rate Risk Management

In the normal course of business, the Company is exposed to market risk arising from

fluctuations in interest rates. ALCO

measures and evaluates interest rate risk so that the Bank can meet customer demands for

various types of loans and

deposits. Measurements used to help manage interest rate sensitivity include an earnings

simulation model and an economic

value of equity (“EVE”) model.

Earnings simulation

. Management believes that interest rate risk is best estimated by our earnings simulation

modeling.

Forecasted levels of earning assets, interest-bearing liabilities, and off

-balance sheet financial instruments are combined

with ALCO forecasts of market interest rates for the next 12 months and other

factors in order to produce various earnings

simulations and estimates. To

help limit interest rate risk, we have guidelines for earnings at risk which seek to limit the

variance of net interest income from gradual changes in interest rates.

For changes up or down in rates from management’s

flat interest rate forecast over the next 12 months, policy limits for net interest income variances

are as follows:

●

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

●

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

●

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

●

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

At September 30, 2021, 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, 2021, our EVE model indicated that we were in compliance

with our policy guidelines.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income

will be affected by

changes in interest rates. Income associated with interest-earning assets and costs associated

with interest-bearing liabilities

may not be affected uniformly by changes in interest rates. In addition,

the magnitude and duration of changes in interest

rates may have a significant impact on net interest income. For example, although certain

assets and liabilities may have

similar maturities or periods of repricing, they may react in different

degrees to changes in market interest rates, and other

economic and market factors, including market perceptions.

Interest rates on certain types of assets and liabilities fluctuate

in advance of changes in general market rates, while interest rates on other types of assets

and liabilities may lag behind

changes in general market rates. In addition, certain assets, such as adjustable rate

mortgage loans, have features (generally

referred to as “interest rate caps and floors”) which limit changes in interest rates.

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, 2021 and December 31, 2020, the Company

had no derivative contracts designated

as part of a hedging relationship to assist in managing its interest rate sensitivity.

Liquidity Risk Management

Liquidity is the Company’s ability to convert

assets into cash equivalents in order to meet daily cash flow requirements,

primarily for deposit withdrawals, loan demand and maturing obligations. Without

proper management of its liquidity,

the

Company could experience higher costs of obtaining funds due to insufficient liquidity,

while excessive liquidity can lead

to a decline in earnings due to the cost of foregoing alternative higher-yielding

investment opportunities.

Liquidity is managed at two levels. The first is the liquidity of the Company.

The second is the liquidity of the Bank. The

management of liquidity at both levels is essential, because the Company and the Bank are

separate and distinct legal

entities with different funding needs and sources, and each are subject

to regulatory guidelines and requirements.

The

Company depends upon dividends from the Bank for liquidity to pay its operating expenses,

debt obligations and

dividends.

The Bank’s payment of dividends depends

on its earnings, liquidity, capital

and the absence of any regulatory

restrictions.

The primary source of funding and liquidity for the Company has been dividends received

from the Bank.

If needed, the

Company could also issue common stock or other securities.

Primary uses of funds by the Company include dividends paid

to stockholders, Company stock repurchases, and Company expenses.

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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, 2021, the Bank had a remaining

available line of credit with the FHLB

of $310.7 million. At September 30, 2021, the Bank also had $41.0

million of available federal funds lines with no

borrowings outstanding. Primary uses of funds include repayment of maturing obligations

and growing the loan portfolio.

Management believes that the Company and the Bank have adequate sources of liquidity

to meet all their respective known

contractual obligations and unfunded commitments, including loan commitments

and reasonable borrower, depositor,

and

creditor requirements over the next twelve months.

Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual

Obligations

At September 30, 2021, the Bank had outstanding standby letters of credit of $1.

million and unfunded loan commitments

outstanding of $70.5 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 our securities available-

for-sale, or draw on its available credit facilities.

Mortgage lending activities

We primarily sell residential

mortgage loans in the secondary market to Fannie Mae while retaining the servicing of these

loans. The sale agreements for these residential mortgage loans with Fannie Mae

and other investors include various

representations and warranties regarding the origination and characteristics of the

residential mortgage loans.

Although the

representations and warranties vary among investors, they typically cover ownership

of the loan, validity of the lien

securing the loan, the absence of delinquent taxes or liens against the property securing the

loan, compliance with loan

criteria set forth in the applicable agreement, compliance with applicable federal,

state, and local laws, among other

matters.

As of September 30, 2021, the unpaid principal balance of residential mortgage loans,

which we have originated and sold,

but retained the servicing rights, was $256.4 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 2021 as a result of representation

and warranty provisions contained in the Company’s

sale agreements with Fannie Mae, and had no pending repurchase or

make-whole requests at September 30, 2021.

We service all residential

mortgage loans originated and sold by us to Fannie Mae.

As servicer, our primary duties are to:

(1) collect payments due from borrowers;

(2) advance certain delinquent payments of principal and interest;

(3) maintain

and administer any hazard, title, or primary mortgage insurance policies relating to the

mortgage loans;

(4) maintain any

required escrow accounts for payment of taxes and insurance and administer

escrow payments;

and (5) foreclose on

defaulted mortgage loans or take other actions to mitigate the potential losses to investors

consistent with the agreements

governing our rights and duties as servicer.

The agreement under which we act as servicer generally specifies 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, 2021, we do not believe that this exposure is material due to the historical

level

of repurchase requests and loss trends, in addition to the fact that 99% of our residential

mortgage loans serviced for Fannie

Mae were current as of such date.

We maintain ongoing communications

with our investors and will continue to evaluate

this exposure by monitoring the level and number of repurchase requests as well as the delinquency

rates in our investor

portfolios.

Section 4021 of the CARES Act allows borrowers under 1-4 family residential

mortgage loans sold to Fannie Mae to

request forbearance to the servicer after affirming that such borrower

is experiencing financial hardships during the

COVID-19 emergency.

Such forbearance will be up to 180 days, subject to up to a 180 day extension.

During forbearance,

no fees, penalties or interest shall be charged beyond those applicable

if all contractual payments were fully and timely

paid.

Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures

on similar procedures

or related evictions or sales until December 31, 2020.

The Bank sells mortgage loans to Fannie Mae and services these on

an actual/actual basis. As a result, the Bank is not obligated to make any advances to Fannie

Mae on principal and interest

on such mortgage loans where the borrower is entitled to 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. As a result of government

monetary policies and fiscal stimulus,

as well as demand for goods ad services and COVID-19 pandemic related supply chain

disruptions, inflation has increased

during 2021.

This may result in increased noninterest operating expenses and building costs.

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.

Table of Contents

Table 1

– Explanation of Non-GAAP Financial Measures

In addition to results presented in accordance with U.S. generally accepted accounting principles

(GAAP), this quarterly

report on Form 10-Q includes certain designated net interest income amounts

presented on a tax-equivalent basis, a non-

GAAP financial measure, including the presentation and calculation of the efficiency

ratio.

The Company believes the presentation of net interest income on a tax-equivalent

basis provides comparability of net

interest income from both taxable and tax-exempt sources and facilitates comparability

within the industry. Although the

Company believes these non-GAAP financial measures enhance investors’

understanding of its business and performance,

these non-GAAP financial measures should not be considered

an alternative to GAAP.

The reconciliations

of these non-

GAAP financial measures to their most directly comparable GAAP financial

measures are presented below.

2021

2020

Third

Second

First

Fourth

Third

(in thousands)

Quarter

Net interest income (GAAP)

6,041

5,975

5,937

6,188

5,868

Tax-equivalent adjustment

117

118

120

123

122

Net interest income (Tax

-equivalent)

6,158

6,093

6,057

6,311

5,990

Nine months ended September 30,

(In thousands)

2021

2020

Net interest income (GAAP)

17,953

18,150

Tax-equivalent adjustment

355

369

Net interest income (Tax

-equivalent)

18,308

18,519

Table of Contents

Table 2

- Selected Quarterly Financial Data

2021

2020

Third

Second

First

Fourth

Third

(Dollars in thousands, except per share amounts)

Quarter

Results of Operations

Net interest income (a)

6,158

6,093

6,057

6,311

5,990

Less: tax-equivalent adjustment

117

118

120

123

122

Net interest income (GAAP)

6,041

5,975

5,937

6,188

5,868

Noninterest income

929

1,110

1,182

1,403

1,374

Total revenue

6,970

7,085

7,119

7,591

7,242

Provision for loan losses

—

(600)

—

250

Noninterest expense

4,709

4,895

4,690

5,086

4,653

Income tax expense

386

504

423

449

403

Net earnings

1,875

2,286

2,006

2,056

1,936

Per share data:

Basic and diluted net earnings

0.53

0.65

0.56

0.58

0.54

Cash dividends declared

0.26

0.255

Weighted average shares outstanding:

Basic and diluted

3,536,320

3,554,871

3,566,299

3,566,276

3,566,239

Shares outstanding, at period end

3,529,338

3,545,855

3,566,326

3,566,276

Book value

29.73

29.91

29.06

30.20

29.81

Common stock price:

High

35.36

38.90

48.00

43.00

56.80

Low

33.25

34.50

37.55

36.75

26.26

Period end:

33.80

35.46

38.37

42.29

36.26

To earnings ratio

14.57

15.22

17.85

20.23

15.97

To book value

114

119

132

140

122

Performance ratios:

Return on average equity

7.01

8.74

7.37

7.63

7.26

Return on average assets

0.72

0.91

0.82

0.87

0.84

Dividend payout ratio

49.06

40.00

46.43

43.97

47.22

Asset Quality:

Allowance for loan losses as a % of:

Loans

1.13

1.12

1.23

1.22

1.18

Nonperforming loans

1,053

813

726

1,052

1,015

Nonperforming assets as a % of:

Loans and foreclosed properties

0.11

0.14

0.17

0.12

Total assets

0.05

0.06

0.08

0.06

Nonperforming loans as a % of total loans

0.11

0.14

0.17

0.12

Annualized net recoveries as % of average loans

(0.01)

(0.02)

(0.06)

(0.04)

(0.01)

Capital Adequacy: (c)

CET 1 risk-based capital ratio

16.82

17.03

17.21

17.27

17.70

Tier 1 risk-based capital ratio

16.82

17.03

17.21

17.27

17.70

Total risk-based capital ratio

17.72

17.94

18.25

18.31

18.77

Tier 1 leverage ratio

9.57

9.81

9.99

10.32

10.38

Other financial data:

Net interest margin (a)

2.51

2.60

2.66

2.81

2.72

Effective income tax rate

17.07

18.06

17.41

17.92

17.23

Efficiency ratio (b)

66.45

67.96

64.79

65.93

63.19

Selected average balances:

Securities

395,529

370,582

353,031

325,102

315,542

Loans, net of unearned income

452,668

460,672

463,424

466,704

465,285

Total assets

1,040,985

1,005,041

980,884

944,439

924,949

Total deposits

927,368

894,757

863,194

828,801

810,747

Total stockholders’ equity

106,936

104,591

108,890

107,791

106,709

Selected period end balances:

Securities

407,474

384,865

359,630

335,177

320,922

Loans, net of unearned income

453,232

456,984

461,879

461,700

472,453

Allowance for loan losses

5,119

5,107

5,682

5,618

5,575

Total assets

1,065,871

1,036,232

993,263

956,597

937,890

Total deposits

954,971

923,462

880,590

839,792

823,980

Total stockholders’ equity

104,929

106,043

103,639

107,689

106,314

(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures."

(b) Efficiency ratio is the result of noninterest expense divided

by the sum of noninterest income and tax-equivalent net interest

income.

See

"Table 1 - Explanation of Non-GAAP Financial Measures."

wholly-owned subsidiary, AuburnBank.

Table of Contents

Table 3

- Selected Financial Data

Nine months ended September 30,

(Dollars in thousands, except per share amounts)

2021

2020

Results of Operations

Net interest income (a)

18,308

18,519

Less: tax-equivalent adjustment

355

369

Net interest income (GAAP)

17,953

18,150

Noninterest income

3,221

3,972

Total revenue

21,174

22,122

Provision for loan losses

(600)

1,100

Noninterest expense

14,294

14,468

Income tax expense

1,313

1,156

Net earnings

6,167

5,398

Per share data:

Basic and diluted net earnings

1.74

1.51

Cash dividends declared

0.78

0.765

Weighted average shares outstanding:

Basic and diluted

3,552,387

3,566,184

Shares outstanding, at period end

3,529,338

3,566,276

Book value

29.73

29.81

Common stock price:

High

48.00

63.40

Low

33.25

24.11

Period end

33.80

36.26

To earnings ratio

14.57

15.97

To book value

114

122

Performance ratios:

Return on average equity

7.70

6.94

Return on average assets

0.81

Dividend payout ratio

44.83

50.66

Asset Quality:

Allowance for loan losses as a % of:

Loans

1.13

1.18

Nonperforming loans

1,053

1,015

Nonperforming assets as a % of:

Loans and other real estate owned

0.11

0.12

Total assets

0.05

0.06

Nonperforming loans as a % of total loans

0.11

0.12

Annualized net recoveries as a % of average loans

(0.03)

Capital Adequacy: (c)

CET 1 risk-based capital ratio

16.82

17.70

Tier 1 risk-based capital ratio

16.82

17.70

Total risk-based capital ratio

17.72

18.77

Tier 1 leverage ratio

9.57

10.38

Other financial data:

Net interest margin (a)

2.59

2.96

Effective income tax rate

17.55

17.64

Efficiency ratio (b)

66.39

64.33

Selected average balances:

Securities

373,203

288,164

Loans, net of unearned income

458,882

461,170

Total assets

1,009,131

885,941

Total deposits

895,342

775,853

Total stockholders’ equity

106,798

103,707

Selected period end balances:

Securities

407,474

320,922

Loans, net of unearned income

453,232

472,453

Allowance for loan losses

5,119

5,575

Total assets

1,065,871

937,890

Total deposits

954,971

823,980

Total stockholders’ equity

104,929

106,314

(a) Tax-equivalent. See "Table 1 - Explanation of Non-GAAP Financial Measures."

(b) Efficiency ratio is the result of noninterest expense divided

by the sum of noninterest income and tax-equivalent net interest

income.

See

"Table 1 - Explanation of Non-GAAP Financial Measures."

wholly-owned subsidiary, AuburnBank.

Table of Contents

Table 4

- Average Balances

and Net Interest Income Analysis

Quarter ended September 30,

2021

2020

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)

453,649

5,127

4.48%

468,203

5,453

4.63%

Securities - taxable

332,474

1,048

1.25%

252,398

913

1.44%

Securities - tax-exempt (2)

63,055

558

3.51%

63,144

583

3.67%

Total securities

395,529

1,606

1.61%

315,542

1,496

1.89%

Federal funds sold

40,995

0.15%

30,784

0.12%

Interest bearing bank deposits

82,878

0.16%

60,698

0.11%

Total interest-earning assets

973,051

6,782

2.77%

875,227

6,975

3.17%

Cash and due from banks

14,326

13,196

Other assets

53,608

36,526

Total assets

1,040,985

924,949

Interest-bearing liabilities:

Deposits:

NOW

182,417

0.11%

157,689

100

0.25%

Savings and money market

300,746

167

0.22%

250,938

285

0.45%

Time deposits

159,423

402

1.00%

164,988

598

1.44%

Total interest-bearing deposits

642,586

620

0.38%

573,615

983

0.68%

Short-term borrowings

3,454

0.50%

2,368

0.50%

Total interest-bearing liabilities

646,040

624

0.38%

575,983

985

0.68%

Noninterest-bearing deposits

284,781

237,132

Other liabilities

3,228

5,125

Stockholders' equity

106,936

106,709

Total liabilities and stockholders'

equity

1,040,985

924,949

Net interest income and margin (tax-equivalent)

6,158

2.51%

5,990

2.72%

(1) Average loan balances are

shown net of unearned income and loans on nonaccrual status have been included

in the computation of average balances.

(2) Yields on tax-exempt securities have been

computed on a tax-equivalent basis using a federal income

tax rate of 21%.

Table of Contents

Table 5

- Average Balances

and Net Interest Income Analysis

Nine months ended September 30,

2021

2020

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)

460,732

15,417

4.47%

463,581

16,359

4.71%

Securities - taxable

310,288

3,006

1.30%

225,234

3,080

1.83%

Securities - tax-exempt (2)

62,915

1,692

3.60%

62,930

1,759

3.73%

Total securities

373,203

4,698

1.68%

288,164

4,839

2.24%

Federal funds sold

36,821

0.14%

30,739

118

0.51%

Interest bearing bank deposits

75,170

0.12%

53,834

214

0.53%

Total interest-earning assets

945,926

20,220

2.86%

836,318

21,530

3.44%

Cash and due from banks

14,345

13,579

Other assets

48,860

36,044

Total assets

1,009,131

885,941

Interest-bearing liabilities:

Deposits:

NOW

176,242

161

0.12%

153,767

426

0.37%

Savings and money market

289,758

488

0.23%

234,533

801

0.46%

Time deposits

159,412

1,251

1.05%

166,115

1,778

1.43%

Total interest-bearing deposits

625,412

1,900

0.41%

554,415

3,005

0.72%

Short-term borrowings

3,329

0.50%

1,721

0.50%

Total interest-bearing liabilities

628,741

1,912

0.41%

556,136

3,011

0.72%

Noninterest-bearing deposits

269,930

221,438

Other liabilities

3,662

4,659

Stockholders' equity

106,798

103,708

Total liabilities and stockholders'

equity

1,009,131

885,941

Net interest income and margin (tax-equivalent)

18,308

2.59%

18,519

2.96%

(1) Average loan balances are

shown net of unearned income and loans on nonaccrual status have been included

in the computation of average balances.

(2) Yields on tax-exempt securities have been

computed on a tax-equivalent basis using a federal income

tax rate of 21%.

Table of Contents

Table 6

- Loan Portfolio Composition

2021

2020

Third

Second

First

Fourth

Third

(In thousands)

Quarter

Commercial and industrial

79,202

87,933

88,687

82,585

98,244

Construction and land development

34,890

37,477

30,332

33,514

31,651

Commercial real estate

252,798

242,845

254,731

255,136

250,992

Residential real estate

80,205

82,164

82,848

84,154

85,054

Consumer installment

7,060

7,762

6,524

7,099

7,731

Total loans

454,155

458,181

463,122

462,488

473,672

Less:

unearned income

(923)

(1,197)

(1,243)

(788)

(1,219)

Loans, net of unearned income

453,232

456,984

461,879

461,700

472,453

Less: allowance for loan losses

(5,119)

(5,107)

(5,682)

(5,618)

(5,575)

Loans, net

448,113

451,877

456,197

456,082

466,878

Table of Contents

Table 7

- Allowance for Loan Losses and Nonperforming Assets

2021

2020

Third

Second

First

Fourth

Third

(Dollars in thousands)

Quarter

Allowance for loan losses:

Balance at beginning of period

5,107

5,682

5,618

5,575

5,308

Charge-offs:

Commercial and industrial

—

(4)

—

Construction and land development

—

Commercial real estate

—

Residential real estate

—

(1)

—

Consumer installment

—

(5)

(1)

(4)

Total charge

-offs

—

(1)

(5)

(4)

Recoveries

Net recoveries

Provision for loan losses

—

(600)

—

250

Ending balance

5,119

5,107

5,682

5,618

5,575

as a % of loans

1.13

1.12

1.23

1.22

1.18

as a % of loans (excluding PPP loans)

1.16

1.17

1.31

1.27

1.28

as a % of nonperforming loans

1,053

813

726

1,052

1,015

Net recoveries as % of avg. loans (a)

(0.01)

(0.02)

(0.06)

(0.04)

(0.01)

Nonperforming assets:

Nonaccrual loans

486

628

783

534

549

Total nonperforming assets

486

628

783

534

549

as a % of loans and foreclosed properties

0.11

0.14

0.17

0.12

as a % of total assets

0.05

0.06

0.08

0.06

Nonperforming loans as a % of total loans

0.11

0.14

0.17

0.12

Accruing loans 90 days or more past due

—

(a) Net recoveries are annualized.

Table of Contents

Table 8

- Allocation of Allowance for Loan Losses

2021

2020

Third Quarter

Second Quarter

First Quarter

Fourth Quarter

Third Quarter

(Dollars in thousands)

Amount

Commercial and industrial

816

17.4

829

19.2

828

19.1

807

17.9

798

20.7

Construction and land

development

590

7.7

639

8.2

551

6.5

594

7.2

582

6.7

Commercial real estate

2,823

55.6

2,704

53.0

3,259

55.1

3,169

55.2

3,120

53.0

Residential real estate

799

17.7

838

17.9

951

17.9

944

18.2

954

18.0

Consumer installment

1.6

1.7

1.4

104

1.5

121

1.6

Total allowance for

loan losses

5,119

5,107

5,682

5,618

5,575

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

Table of Contents

Table 9

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

(Dollars in thousands)

September 30, 2021

Maturity of:

3 months or less

22,908

Over 3 months through 6 months

9,425

Over 6 months through 12 months

44,371

Over 12 months

30,377

Total CDs and other time deposits of $100,000

or more

107,081

Table of Contents

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, 2020.

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, 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, 2020,

which could materially affect our business, financial condition

or future results. The risks described in our annual report on

Form 10-K 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.

Table of Contents

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company’s repurchases of its common stock

during the third quarter of 2021 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, 2021

4,540

34.47

4,540

4,093,535

August 1 - August 31, 2021

12,042

34.32

12,042

3,680,278

September 1 - September 30, 2021

—

3,680,278

Total

16,582

34.36

16,582

3,680,278

(1)

On March 9, 2021, the Company adopted a $5 million stock repurchase program that become effective April 1, 2021.

ITEM 3.

DEFAULTS

UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.

OTHER INFORMATION

Not applicable.

Table of Contents

ITEM 6.

EXHIBITS

Exhibit

Number

Description

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

104

Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

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.

Table of Contents

SIGNATURES

Pursuant to

the requirements

of the

Securities Exchange

Act of

1934, the

registrant has

duly caused

this report

be signed on its behalf by the undersigned thereunto duly authorized.

AUBURN NATIONAL

BANCORPORATION,

INC.

(Registrant)

Date:

October 29, 2021

By:

/s/ Robert W.

Dumas

Robert W.

Dumas

Chairman, President and CEO

Date:

October 29, 2021

By:

/s/ David A. Hedges

David A. Hedges

Executive Vice President and Chief Financial

Officer

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Auburn National Bancorporation (AUBN) 10-Q2021 Q3 Quarterly report

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