AUBURN NATIONAL BANCORPORATION, INC - Quarter Report: 2011 March (Form 10-Q)

Large Accelerated filer

Accelerated filer

Non-accelerated filer

x (Do not check if a smaller reporting company)

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2011

¨	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

63-0885779

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

100 N. Gay Street

Auburn, Alabama 36830

(334) 821-9200

(Address and telephone number of principal executive offices)

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

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

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, 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 and post such files).

Yes ¨ No ¨

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

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

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 April 30,2011
Common Stock, $0.01 par value per share		3,642,738 shares

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

INDEX


PART I. FINANCIAL INFORMATION		PAGE

Item 1	Financial Statements

	Condensed Consolidated Balance Sheets (Unaudited) as of March 31, 2011 and December 31, 2010	3

	Condensed Consolidated Statements of Earnings (Unaudited) for the quarter ended March 31, 2011 and 2010	4

	Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Unaudited) for the quarter ended March 31, 2011 and 2010	5

	Condensed Consolidated Statements of Cash Flows (Unaudited) for the quarter ended March 31, 2011 and 2010	6

	Notes to Condensed Consolidated Financial Statements (Unaudited)	7

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

	Table 1 – Explanation of Non-GAAP Financial Measures	45

	Table 2 – Selected Quarterly Financial Data	46

	Table 3 – Average Balances and Net Interest Income Analysis – for the quarter ended March 31, 2011 and 2010	47

	Table 4 – Loan Portfolio Composition	48

	Table 5 – Allowance for Loan Losses and Nonperforming Assets	49

	Table 6 – Allocation of Allowance for Loan Losses	50

	Table 7 – CDs and Other Time Deposits of $100,000 or more	51

Item 3	Quantitative and Qualitative Disclosures About Market Risk	52

Item 4	Controls and Procedures	52

PART II. OTHER INFORMATION

Item 1	Legal Proceedings	52

Item 1A	Risk Factors	52

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	52

Item 3	Defaults Upon Senior Securities	53

Item 4	Removed and Reserved	53

Item 5	Other Information	53

Item 6	Exhibits	53

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Unaudited)


(Dollars in thousands, except share data)	March 31, 2011			December 31, 2010

Assets:
Cash and due from banks	$	14,690		$	11,432
Federal funds sold		21,250			7,500
Interest bearing bank deposits		3,403			2,492

Cash and cash equivalents		39,343			21,424

Securities available-for-sale		321,098			315,220
Loans held for sale		1,256			4,281
Loans, net of unearned income		368,909			374,215
Allowance for loan losses		(7,855	)		(7,676	)

Loans, net		361,054			366,539

Premises and equipment, net		8,032			8,105
Bank-owned life insurance		16,278			16,171
Other real estate		8,450			8,125
Other assets		26,046			23,964

Total assets	$	781,557		$	763,829


Liabilities:
Deposits:
Noninterest-bearing	$	94,849		$	87,660
Interest-bearing		536,545			519,467

Total deposits		631,394			607,127
Federal funds purchased and securities sold under agreements to repurchase		2,221			2,685
Long-term debt		85,327			93,331
Accrued expenses and other liabilities		4,814			4,318

Total liabilities		723,756			707,461


Stockholders’ equity:
Preferred stock of $.01 par value; authorized 200,000 shares; no issued shares		—			—
Common stock of $.01 par value; authorized 8,500,000 shares; issued 3,957,135 shares		39			39
Additional paid-in capital		3,753			3,752
Retained earnings		62,242			61,421
Accumulated other comprehensive loss, net		(1,590	)		(2,201	)
Less treasury stock, at cost - 314,397 shares and 314,417 shares for March 31, 2011 and December 31, 2010, respectively		(6,643	)		(6,643	)

Total stockholders’ equity		57,801			56,368

Total liabilities and stockholders’ equity	$	781,557		$	763,829

See accompanying notes to condensed consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Earnings

(Unaudited)


	Quarter ended March 31,
(Dollars in thousands, except share and per share data)	2011			2010

Interest income:
Loans, including fees	$	5,287		$	5,433
Securities		2,538			3,219
Federal funds sold and interest bearing bank deposits		9			7

Total interest income		7,834			8,659


Interest expense:
Deposits		2,170			2,640
Short-term borrowings		3			11
Long-term debt		847			1,177

Total interest expense		3,020			3,828


Net interest income		4,814			4,831
Provision for loan losses		600			1,450

Net interest income after provision for loan losses		4,214			3,381


Noninterest income:
Service charges on deposit accounts		291			314
Mortgage lending		440			482
Bank-owned life insurance		107			126
Other		353			324
Securities (losses) gains, net:
Realized gains, net		5			1,100
Total other-than-temporary-impairments		(261	)		(240	)
Non-credit portion of other-than-temporary impairments recognized in other comprehensive income		210			190

Total securities (losses) gains, net		(46	)		1,050

Total noninterest income		1,145			2,296


Noninterest expense:
Salaries and benefits		1,986			1,905
Net occupancy and equipment		346			384
Professional fees		171			176
FDIC and other regulatory assessments		282			276
Other real estate owned, net		(17	)		61
Other		882			834

Total noninterest expense		3,650			3,636


Earnings before income taxes		1,709			2,041
Income tax expense		160			424


Net earnings	$	1,549		$	1,617


Net earnings per share:
Basic and diluted	$	0.43		$	0.44


Weighted average shares outstanding:
Basic and diluted		3,642,728			3,643,116

See accompanying notes to condensed consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income

(Unaudited)


					Additional paid-in capital		Retained earnings			Accumulated other comprehensive income (loss)			Treasury stock			Total
	Common Stock
(Dollars in thousands, except share data)	Shares		Amount

Balance, December 31, 2009		3,957,135	$	39	$	3,751	$	58,917		$	111			$ (6,635	)	$	56,183
Comprehensive income:
Net earnings		—		—		—		1,617			—			—			1,617
Other comprehensive loss due to change in other-than-temporary impairment losses related to factors other than credit on available-for- sale, net		—		—		—		—			(120	)		—			(120	)
Other comprehensive income due to change in all other unrealized gains (losses) on securities available-for- sale, net		—		—		—		—			809			—			809

Total comprehensive income		—		—		—		1,617			689			—			2,306

Cash dividends paid ($0.195 per share)		—		—		—		(711	)		—			—			(711	)

Balance, March 31, 2010		3,957,135	$	39	$	3,751	$	59,823		$	800		$	(6,635	)	$	57,778


Balance, December 31, 2010		3,957,135	$	39	$	3,752	$	61,421		$	(2,201	)	$	(6,643	)	$	56,368
Comprehensive income:
Net earnings		—		—		—		1,549			—			—			1,549
Other comprehensive loss due to change in other-than-temporary impairment losses related to factors other than credit on available-for- sale, net		—		—		—		—			(133	)		—			(133	)
Other comprehensive income due to change in all other unrealized gains (losses) on securities available-for- sale, net		—		—		—		—			744			—			744

Total comprehensive income		—		—		—		1,549			611			—			2,160

Cash dividends paid ($0.20 per share)		—		—		—		(728	)		—			—			(728	)
Sale of treasury stock (20 shares)		—		—		1		—			—			—			1

Balance, March 31, 2011		3,957,135	$	39	$	3,753	$	62,242		$	(1,590	)	$	(6,643	)	$	57,801

See accompanying notes to condensed consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)


	Quarter ended March 31,
(In thousands)	2011			2010

Cash flows from operating activities:
Net earnings	$	1,549		$	1,617
Adjustments to reconcile net earnings to net cash provided by operating activities:
Provision for loan losses		600			1,450
Depreciation and amortization		154			133
Premium amortization and discount accretion, net		636			442
Net loss (gain) on securities		46			(1,050	)
Net gain on sale of loans held for sale		(344	)		(392	)
Net loss (gain) on other real estate		17			(37	)
Loans originated for sale		(11,417	)		(15,460	)
Proceeds from sale of loans		14,748			16,707
Increase in cash surrender value of bank owned life insurance		(107	)		(126	)
Net increase in other assets		(2,475	)		(1,064	)
Net increase in accrued expenses and other liabilities		496			725

Net cash provided by operating activities		3,903			2,945


Cash flows from investing activities:
Proceeds from sales of securities available-for-sale		6,706			59,994
Proceeds from maturities of securities available-for-sale		11,777			47,840
Purchase of securities available-for-sale		(24,073	)		(105,033	)
Net decrease (increase) in loans		4,065			(6,102	)
Net purchases of premises and equipment		(9	)		(24	)
Proceeds from sale of other real estate		478			435

Net cash used in investing activities		(1,056	)		(2,890	)


Cash flows from financing activities:
Net increase in noninterest-bearing deposits		7,189			5,952
Net increase in interest-bearing deposits		17,078			23,227
Net decrease in federal funds purchased and securities sold under agreements to repurchase		(464	)		(13,553	)
Repayments or retirement of long-term debt		(8,004	)		(4	)
Proceeds from sale of treasury stock		1			—
Dividends paid		(728	)		(711	)

Net cash provided by financing activities		15,072			14,911


Net change in cash and cash equivalents		17,919			14,966
Cash and cash equivalents at beginning of period		21,424			12,395

Cash and cash equivalents at end of period	$	39,343		$	27,361



Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	3,188		$	4,048
Income taxes		332			120
Supplemental disclosure of non-cash transactions:
Real estate acquired through foreclosure		820			187

See accompanying notes to condensed consolidated financial statements

AUBURN NATIONAL BANCORPORATION, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

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 condensed consolidated financial statements in this report have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. Accordingly, these financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The unaudited condensed 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 as of and for the quarter ended March 31, 2011 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, 2010.

Subsequent Events

The Company has evaluated the effects of events or transactions through the date of this filing that have occurred subsequent to March 31, 2011. The Company does not believe there are any material subsequent events that would require further recognition or disclosure.

Accounting Developments

In the first quarter of 2011, the Company adopted new guidance related to the following Codification topic:

•

Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements.

Information about this pronouncement is described in more detail below.

ASU 2010-06, Improving Disclosures about Fair Value Measurements, amends the disclosure requirements for fair value measurements. Companies are required to disclose significant transfers in and out of Levels 1 and 2 of the fair value hierarchy. The ASU also clarifies that fair value measurement disclosures should be presented for each asset and liability class, which is generally a subset of a line item in the statement of financial position. In the rollforward of Level 3 activity, companies must present information on purchases, sales, issuances, and settlements on a gross basis rather than on a net basis. Companies should also provide information about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring instruments classified as either Level 2 or Level 3. In the first quarter of 2011, the Company adopted the requirement for gross presentation in the Level 3 rollforward with prospective application. The remaining provisions were effective for the Company in the first quarter of 2010. Adoption of the ASU did not have a significant impact on the consolidated financial statements of the Company since it amends only the disclosure requirements for fair value measurements.

NOTE 2: BASIC AND DILUTED EARNINGS PER SHARE

Basic net earnings per share is computed by dividing net earnings by the weighted average common shares outstanding for the quarters ended March 31, 2011 and 2010, respectively. Diluted net earnings per share reflect the potential dilution that could occur if the Company’s potential common stock was issued. At March 31, 2011 and 2010, respectively, the Company had no options issued or outstanding, and therefore, no dilutive effect to consider for the diluted earnings per share calculation.

A reconciliation of the numerator and denominator of the basic and diluted earnings per share computation for the quarter ended March 31, 2011 and 2010 is presented below.


	Quarter ended March 31,
(Dollars in thousands, except share and per share data)		2011		2010
Basic and diluted:
Net earnings	$	1,549	$	1,617
Weighted average common shares outstanding		3,642,728		3,643,116
Earnings per share	$	0.43	$	0.44

NOTE 3: COMPREHENSIVE INCOME

Comprehensive income is defined as the change in equity from all transactions other than those with shareholders, and it includes net earnings and other comprehensive income (loss). Comprehensive income for the quarter ended March 31, 2011 and 2010 is presented below.


	Quarter ended March 31,
(In thousands)		2011			2010
Comprehensive income:
Net earnings	$	1,549		$	1,617
Other comprehensive income (loss):
Due to change in other-than-temporary impairment losses related to factors other than credit on securities available-for-sale, net of tax		(133	)		(120	)
Due to change in all other unrealized gains (losses) on securities available-for-sale, net of tax		744			809
Total comprehensive income	$	2,160		$	2,306

NOTE 4: VARIABLE INTEREST ENTITIES

The Company is involved in various entities that are considered to be VIEs, as defined by authoritative accounting literature. Generally, a VIE is a corporation, partnership, trust or other legal structure that does not have equity investors with substantive or proportional voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

At March 31, 2011, the Company did not have any consolidated VIEs to disclose but did have certain nonconsolidated VIEs, discussed below.

Trust Preferred Securities

The Company owns the common stock of a subsidiary business trust, Auburn National Bancorporation Capital Trust I, which issued mandatorily redeemable preferred capital securities (“trust preferred securities”) in the aggregate of approximately $7.0 million at the time of issuance. This trust meets the definition of a VIE of which the Company is not the primary beneficiary; the trust’s only assets are junior subordinated debentures issued by the Company, which were acquired by the trust using the proceeds from the issuance of the trust preferred securities and common stock. The junior subordinated debentures of approximately $7.2 million are included in long-term debt and the Company’s equity interest in the business trust is included in other assets. Interest expense on the junior subordinated debentures is reported in interest expense on long-term debt. For regulatory reporting and capital adequacy purposes, the Federal Reserve Board has indicated that such trust preferred securities will continue to constitute Tier 1 Capital until further notice.

Affordable Housing Investments

Periodically, the Company may invest in various limited partnerships that sponsor affordable housing projects in its primary markets and surrounding areas as a means of supporting local communities. These investments are designed to generate a return primarily through the realization of federal tax credits. These projects are funded through a combination of debt and equity and the partnerships meet the definition of a VIE. While the Company’s investment as a limited partner in a single entity may at times exceed 50% of the outstanding equity interests, the Company does not consolidate the partnerships due to the nature of the management activities of the general partner and the performance guaranties provided by the project sponsors. The Company typically provides financing during the construction and development of the properties; however, permanent financing is generally obtained from independent parties upon completion of a project.

At March 31, 2011 and December 31, 2010, the Company had limited partnership investments of $5.9 million and $3.4 million, respectively, related to these projects, which are included in other assets on the Consolidated Balance Sheets. At March 31, 2011 and December 31, 2010, the Company had unfunded commitments related to affordable housing investments of $2.5 million and $1.9 million, respectively, included in accrued expenses and other liabilities on the Consolidated Balance Sheets.

Additionally, the Company had outstanding loan commitments with certain of the partnerships totaling $11.4 million at March 31, 2011 and December 31, 2010, respectively. The funded portion of these loans was approximately $7.6 and $8.9 million at March 31, 2011 and December 31, 2010, respectively. The funded portions of these loans are included in loans, net of unearned income on the Consolidated Balance Sheets.

The following table summarizes VIEs that are not consolidated by the Company as of March 31, 2011.

(Dollars in thousands)

Maximum
Loss
Exposure

Liability
Recognized

Classification

Type:

Affordable housing investments (a)

5,877

2,507

Other assets

Trust preferred issuances

N/A

7,217

Long-term debt

(a)	Maximum loss exposure represents the Company’s current investment of $5.9 million included in other assets. The current investment of $5.9 million includes $2.5 million of unfunded commitments related to affordable housing investments included in accrued expenses and other liabilities.

NOTE 5: SECURITIES

At March 31, 2011 and December 31, 2010, respectively, all securities within the scope of FASB 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 March 31, 2011 and December 31, 2010, respectively, are presented below.


	March 31, 2011
	1 year		1 to 5		5 to 10		After 10		Fair		Gross Unrealized				Amortized
(Dollars in thousands)	or less		years		years		years		Value		Gains		Losses		Cost
Available-for-sale:
Agency obligations (a)	$	—		—		48,561		49,423		97,983		99		1,312		99,196
Agency RMBS (a)		—		—		9,128		129,283		138,411		1,382		1,750		138,779
State and political subdivisions		20		935		12,321		69,195		82,471		778		1,490		83,183
Trust preferred securities:
Pooled		—		—		—		20		20		—		210		230
Individual issuer		—		—		—		2,213		2,213		129		146		2,230
Total available-for-sale	$	20		935		70,010		250,134		321,098		2,388		4,908		323,618

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

	December 31, 2010
	1 year		1 to 5		5 to 10		After 10		Fair		Gross Unrealized				Amortized
(Dollars in thousands)	or less		years		years		years		Value		Gains		Losses		Cost
Available-for-sale:
Agency obligations (a)	$	—		—		37,821		52,650		90,471		95		1,017		91,393
Agency RMBS (a)		—		—		9,976		133,168		143,144		1,566		1,441		143,019
State and political subdivisions		21		856		13,547		62,342		76,766		472		2,801		79,095
Trust preferred securities:
Pooled		—		—		—		20		20		—		210		230
Individual issuer		—		—		—		2,129		2,129		—		153		2,282
Corporate debt		—		2,690		—		—		2,690		—		—		2,690
Total available-for-sale	$	21		3,546		61,344		250,309		315,220		2,133		5,622		318,709

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

Securities with aggregate fair values of $198.7 million and $171.1 million at March 31, 2011 and December 31, 2010, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase, Federal Home Loan Bank (“FHLB”) advances, and for other purposes required or permitted by law.

Included in other assets on the Consolidated Balance Sheets are cost-method investments. The carrying amounts of cost-method investments were $5.8 million at March 31, 2011 and December 31, 2010, respectively. Cost-method investments primarily include non-marketable equity investments, such as FHLB of Atlanta stock and Federal Reserve Bank (“FRB”) stock.

Gross Unrealized Losses and Fair Value

The fair values and gross unrealized losses on securities at March 31, 2011 and December 31, 2010, respectively, segregated by those securities that have been in an unrealized loss position for less than twelve months and twelve months or more are presented below.


	Less than 12 Months				12 Months or Longer				Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
March 31, 2011
Agency obligations	$	58,813	$	1,312	$	—	$	—	$	58,813	$	1,312
Agency RMBS		99,805		1,750		—		—		99,805		1,750
State and political subdivisions		35,201		1,151		3,815		339		39,016		1,490
Trust preferred securities:
Pooled		—		—		20		210		20		210
Individual issuer		—		—		854		146		854		146
Total	$	193,819	$	4,213	$	4,689	$	695	$	198,508	$	4,908

December 31, 2010
Agency obligations	$	45,351	$	1,017	$	—	$	—	$	45,351		1,017
Agency RMBS		89,840		1,441		—		—		89,840		1,441
State and political subdivisions		49,176		2,323		3,207		478		52,383		2,801
Trust preferred securities:
Pooled		—		—		20		210		20		210
Individual issuer		—		—		847		153		847		153
Total	$	184,367	$	4,781	$	4,074	$	841	$	188,441		5,622

The applicable date for determining when securities are in an unrealized loss position is March 31, 2011. As such, it is possible that a security had a market value that exceeded its amortized cost on other days during the past twelve-month period.

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 security before recovery of the amortized cost basis, which may be maturity. The Company has assessed 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. For cost-method investments, the Company evaluates whether an event or change in circumstances has occurred during the reporting period that may have a significant adverse effect on the fair value of the investment.

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.

To the extent the Company estimates future expected cash flows, the Company considered all available information in developing those expected cash flows. For asset-backed securities such as pooled trust preferred securities, such information generally included:

•

remaining payment terms of the security (including as applicable, terms that require underlying obligor payments to increase in the future);

•

current delinquencies and nonperforming assets of underlying collateral;

•

expected future default rates; and

•

subordination levels or other credit enhancements.

Agency obligations

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

Agency residential mortgage-backed securities (“RMBS”)

The unrealized losses associated with Agency RMBS are primarily driven by changes in interest rates and not due to the credit quality of the securities. These securities are issued by U.S. government agencies or government-sponsored entities and do not have any credit losses given the explicit or implicit government guarantee.

Securities of U.S. states and political subdivisions

The unrealized losses associated with securities of U.S. states and political subdivisions are primarily driven by changes in interest rates and are not due to the credit quality of the securities. 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.

Pooled trust preferred securities

The unrealized losses associated with pooled trust preferred securities are primarily driven by higher projected collateral losses and wider credit spreads. Pooled trust preferred securities primarily consist of securities issued by community banks and thrifts. The Company assesses impairment for these securities using a cash flow model. The key assumptions include default probabilities of the underlying collateral and recoveries on collateral defaults. Based upon the Company’s assessment of the expected credit losses for these securities, and given the performance of the underlying collateral compared to the Company’s credit enhancement, the Company expects to recover the remaining amortized cost basis of these securities.

Individual issuer trust preferred securities

The unrealized losses associated with individual issuer trust preferred securities are primarily related to securities backed by individual issuer community banks. For individual issuers, management evaluates the financial performance of the issuer on a quarterly basis to determine if it is probable that the issuer can make all contractual principal and interest payments. Based upon its evaluation, the Company expects to recover the remaining amortized cost basis of these securities.

Cost-method investments

At March 31, 2011, cost-method investments with an aggregate cost of $5.8 million were not evaluated for impairment because the Company did not identify any events or changes in circumstances that may have a significant adverse effect on the fair value of these cost-method investments.

The carrying values of the Company’s investment securities could decline in the future if the underlying performance of the collateral for pooled trust preferred securities, the financial condition of individual issuers of trust preferred securities, or the credit quality of other securities deteriorate 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 significant other-than-temporary impairment charges may occur in the future.

The following tables show the applicable credit ratings, fair values, gross unrealized losses, and life-to-date impairment charges for pooled and individual issuer trust preferred securities at March 31, 2011 and December 31, 2010, respectively, segregated by those securities that have been in an unrealized loss position for less than twelve months and twelve months or more.

Trust Preferred Securities as of March 31, 2011


	Credit Rating				Fair Value		Unrealized losses						Life-to-date Impairment Charges
	Credit Rating						Less than 12 months		12 months or longer		Total
(Dollars in thousands)	Moody’s		Fitch				Less than 12 months		12 months or longer		Total
Pooled:
ALESCO Preferred Funding XVII Ltd (a)		C		CC	$	20	$	—		210		210	$	1,770
Individual issuers (b):
Carolina Financial Capital Trust I		n/a		n/a		275		—		—		—		175
Main Street Bank Statutory Trust I (c)		n/a		n/a		440		—		60		60		—
MNB Capital Trust I		n/a		n/a		138		—		—		—		362
PrimeSouth Capital Trust I		n/a		n/a		223		—		—		—		303
TCB Trust		n/a		n/a		414		—		86		86		—
United Community Capital Trust		n/a		n/a		723		—		—		—		379

Total individual issuer						2,213		—		146		146		1,219

Total trust preferred securities					$	2,233	$	—		356		356	$	2,989

n/a – not applicable securities not rated.

(a)	Class B Deferrable Third Priority Secured Floating Rate Notes. The underlying collateral is primarily composed of trust preferred activities issued by community banks and thrifts.

(b)	144A Floating Rate Capital Securities. Underlying issuer is a community bank holding company. Securities have no excess subordination or overcollateralization.

(c)	Now an obligation of BB&T Corporation.

Trust Preferred Securities as of December 31, 2010


	Credit Rating				Fair Value		Unrealized losses						Life-to-date Impairment Charges
	Credit Rating						Less than 12 months		12 months or longer		Total
(Dollars in thousands)	Moody’s		Fitch				Less than 12 months		12 months or longer		Total
Pooled:
ALESCO Preferred Funding XVII Ltd (a)		Ca		C	$	20	$	—		210		210	$	1,770
Individual issuers (b):
Carolina Financial Capital Trust I		n/a		n/a		312		—		—		—		138
Main Street Bank Statutory Trust I (c)		n/a		n/a		438		—		62		62		—
MNB Capital Trust I		n/a		n/a		152		—		—		—		348
PrimeSouth Capital Trust I		n/a		n/a		197		—		—		—		303
TCB Trust		n/a		n/a		409		—		91		91		—
United Community Capital Trust		n/a		n/a		621		—		—		—		379

Total individual issuer						2,129		—		153		153		1,168

Total trust preferred securities					$	2,149	$	—		363		363	$	2,938

n/a - not applicable securities not rated.

(a)	Class B Deferrable Third Priority Secured Floating Rate Notes. The underlying collateral is primarily composed of trust preferred activities issued by community banks and thrifts.

(b)	144A Floating Rate Capital Securities. Underlying issuer is a community bank holding company. Securities have no excess subordination or overcollateralization.

(c)	Now an obligation of BB&T Corporation.

For pooled trust preferred securities, the Company estimated expected future cash flows of the security by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordination interests owned by third parties, to the security. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which consider default probabilities derived from issuer credit ratings for the underlying collateral). The probability-weighted expected future cash flows of the security are then discounted at the interest rate used to recognize income on the security to arrive at a present value amount.

Excess subordination is defined as the amount of performing collateral that is in excess of what is needed to pay-off a specified class of securities and all classes senior to the specified class. Performing collateral is defined as total collateral minus all collateral that is currently deferring or currently in default. This definition assumes that all collateral that is currently deferring will default with a zero recovery rate. The underlying issuers can cure the deferral, or some portion greater than zero could be recovered on default of an underlying issuer. Excess subordination, as defined previously, does not consider any excess interest spread that is built into the structure of the security, which provides another source of repayment for the bonds.

At March 31, 2011 and December 31, 2010, respectively, there was no excess subordination for the Class B notes of ALESCO Preferred Funding XVII, Ltd.

Other-Than-Temporarily Impaired 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 equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses), net.

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, as a realized loss in securities gains (losses), 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 following table presents a roll-forward of the credit loss component of the amortized cost of debt securities that the Company has written down for other-than-temporary impairment and the credit component of the loss is recognized in earnings (referred to as “credit-impaired” debt securities). Other-than-temporary impairments recognized in earnings for the quarters ended March 31, 2011 and 2010 for credit-impaired debt securities are presented as additions in two components based upon whether the current year is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). The credit loss component is reduced if the Company sells, intends to sell or believes it will be required to sell previously credit-impaired debt securities. Additionally, the credit loss component is reduced if the Company receives cash flows in excess of what it expected to receive over the remaining life of the credit-impaired debt security, the security matures or is fully written-down and deemed worthless. Changes in the credit loss component of credit-impaired debt securities were:


	Quarter ended March 31,
(Dollars in thousands)	2011		2010
Balance, beginning of period	$	2,938	$	4,570
Additions:
Initial credit impairments		—		—
Subsequent credit impairments		51		50
Reductions:
Securities sold		—		—
Due to change in intent or requirement to sell		—		—
Securities fully written-down and deemed worthless		—		—
Increases in expected cash flows		—		—

Balance, end of period	$	2,989	$	4,620

Other-Than-Temporary-Impairment

The following table presents details of the other-than-temporary-impairment related to securities, including equity securities carried at cost, for the quarter ended March 31, 2011 and 2010.


	Quarter ended March 31,
(Dollars in thousands)	2011		2010
Other-than-temporary impairment charges (included in earnings):
Debt securities:
Pooled trust preferred securities	$	—	$	50
Individual issuer trust preferred securities		51		—

Total debt securities		51		50

Total other-than-temporary impairment charges	$	51	$	50

Other-than-temporary impairment on debt securities:
Recorded as part of gross realized losses:
Credit-related	$	51	$	50
Recorded directly to other comprehensive income for non-credit related impairment		210		190

Total other-than-temporary impairment on debt securities	$	261	$	240

Realized Gains and Losses

The following table presents the gross realized gains and losses on securities, including cost-method investments. Realized losses include other-than-temporary impairment charges.


	Quarter ended March 31,
(Dollars in thousands)	2011			2010
Gross realized gains	$	28		$	1,139
Gross realized losses		(74	)		(89	)

Realized losses (gains), net	$	(46	)	$	1,050

NOTE 6: LOANS AND ALLOWANCE FOR LOAN LOSSES


(In thousands)	March 31, 2011			December 31, 2010
Commercial and industrial	$	51,323		$	53,288
Construction and land development		48,814			47,850
Commercial real estate:
Owner occupied		75,062			76,252
Other		86,820			89,989

Total commercial real estate		161,882			166,241
Residential real estate:
Consumer mortgage		56,656			57,562
Investment property		39,341			38,679

Total residential real estate		95,997			96,241
Consumer installment		10,968			10,676

Total loans		368,984			374,296
Less: unearned income		(75	)		(81	)

Loans, net of unearned income	$	368,909		$	374,215

Loans secured by real estate were approximately 83.1% of the total loan portfolio at March 31, 2011. Due to declines in economic indicators and real estate values, loans secured by real estate may have a greater risk of non-collection than other loans. At March 31, 2011, 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. The Company’s 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. The Company’s loan portfolio segments were determined based on collateral type. 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 describe the risk characteristics relevant to each of the portfolio segments.

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.

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 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 two classes: (1) owner occupied and (2) 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.

•

Other – primarily includes loans to finance income-producing commercial and multi-family properties. Loans in this class include loans for neighborhood retail centers, hotels, medical and professional offices, single retail stores, industrial buildings, warehouses and apartments leased generally to local businesses and 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.

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

•

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

•

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

The following is a summary of current, accruing past due and nonaccrual loans by portfolio class as of March 31, 2011, and December 31, 2010.


(In thousands)	Current		Accruing 30-89 Days Past Due		Accruing Greater than 90 days		Total Accruing Loans		Non- Accrual		Total Loans
March 31, 2011:
Commercial and industrial	$	50,521		136		158		50,815		508	$	51,323
Construction and land development		44,279		492		—		44,771		4,043		48,814
Commercial real estate:
Owner occupied		72,359		256		—		72,615		2,447		75,062
Other		85,150		163		—		85,313		1,507		86,820

Total commercial real estate		157,509		419		—		157,928		3,954		161,882
Residential real estate:
Consumer mortgage		52,869		1,502		—		54,371		2,285		56,656
Investment property		38,617		499		—		39,116		225		39,341

Total residential real estate		91,486		2,001		—		93,487		2,510		95,997
Consumer installment		10,757		60		—		10,817		151		10,968

Total	$	354,552		3,108		158		357,818		11,166	$	368,984

December 31, 2010:
Commercial and industrial	$	52,643		124		—		52,767		521	$	53,288
Construction and land development		43,547		201		—		43,748		4,102		47,850
Commercial real estate:
Owner occupied		73,419		—		—		73,419		2,833		76,252
Other		88,087		—		—		88,087		1,902		89,989

Total commercial real estate		161,506		—		—		161,506		4,735		166,241
Residential real estate:
Consumer mortgage		53,225		2,219		—		55,444		2,118		57,562
Investment property		37,556		767		—		38,323		356		38,679

Total residential real estate		90,781		2,986		—		93,767		2,474		96,241
Consumer installment		10,646		29		—		10,675		1		10,676

Total	$	359,123		3,340		—		362,463		11,833	$	374,296

At March 31, 2011 and December 31, 2010, nonaccrual loans amounted to $11.2 million and $11.8 million, respectively. At March 31, 2011, there were $158,000 in loans 90 days past due and still accruing interest. At December 31, 2010, there were no loans 90 days past due and still accruing interest.

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 portfolios, past loan loss experience, current asset quality trends, 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 quality indications 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. Loan losses are charged off 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. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, is deemed to be uncollectible.

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 (recorded investment in the loan is the principal balance plus any accrued interest, net of deferred loan fees or costs and unamortized premium or discount). 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, impairment measurement is based on the fair value of the collateral, less estimated disposal costs. The Company believes it follows appropriate accounting and regulatory guidance in determining impairment and accrual status of impaired loans.

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 independent loan review process. 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 we 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 loans, construction and land development loans, commercial real estate, residential real estate, and consumer installment loans. 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 these types of loans. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At March 31, 2011 and December 31, 2010, 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 related adjustments increased the allowance for loan losses for this portfolio segment at March 31, 2011 and December 31, 2010.

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 maintains an unallocated amount for inherent factors that cannot be practically assigned to individual loan segments or categories. An example is the imprecision in the overall measurement process.

The following table presents an analysis of the allowance for loan losses by portfolio segment as of March 31, 2011 and December 31, 2010. The total allowance for loan losses is then disaggregated to show the amounts derived through individual evaluation and the amounts calculated through collective evaluation.


	March 31, 2011
(In thousands)	Commercial and industrial			Construction and land development			Commercial real estate			Residential real estate			Consumer installment			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	972			2,223			2,893			1,336			141			111	$	7,676
Charge-offs		(56	)		(33	)		(339	)		(57	)		(1	)		—		(486	)
Recoveries		11			1			—			49			4			—		65
Net (charge-offs) recoveries		(45	)		(32	)		(339	)		(8	)		3			—		(421	)
Provision		215			66			143			(44	)		58			162		600
Ending balance	$	1,142			2,257			2,697			1,284			202			273	$	7,855

Individually evaluated		263			89			438			165			—			—		955
Collectively evaluated		879			2,168			2,259			1,119			202			273		6,900
Total loans:	$	51,323			48,814			161,882			95,997			10,968				$	368,984

Individually evaluated		507			4,042			4,294			1,821			—					10,664
Collectively evaluated		50,816			44,772			157,588			94,176			10,968					358,320

	December 31, 2010
(In thousands)	Commercial and industrial			Construction and land development			Commercial real estate			Residential real estate			Consumer installment			Unallocated		Total
Allowance for loan losses	$	972			2,223			2,893			1,336			141			111	$	7,676

Individually evaluated		277			123			765			144			277			—		1,307
Collectively evaluated		695			2,100			2,128			1,192			141			111		6,367
Total loans	$	53,288			47,850			166,241			96,241			10,676				$	374,296

Individually evaluated		521			4,102			4,630			2,418			—					11,671
Collectively evaluated		52,767			43,748			161,611			93,823			10,676					362,625

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 current economic conditions 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.

•

Accruing Substandard – 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 in doubt.


	March 31, 2011
(In thousands)	Pass		Special Mention		Substandard Accruing		Nonaccrual		Total loans
Commercial and industrial	$	48,357		1,407		1,051		508	$	51,323
Construction and land development		39,142		602		5,027		4,043		48,814
Commercial real estate:
Owner occupied		65,929		1,618		5,068		2,447		75,062
Other		84,781		47		485		1,507		86,820
Total commercial real estate		150,710		1,665		5,553		3,954		161,882
Residential real estate:
Consumer mortgage		49,145		2,083		3,143		2,285		56,656
Investment property		34,926		1,676		2,514		225		39,341
Total residential real estate		84,071		3,759		5,657		2,510		95,997
Consumer installment		10,586		119		112		151		10,968
Total	$	332,866		7,552		17,400		11,166	$	368,984


	December 31, 2010
(In thousands)	Pass		Special Mention		Substandard Accruing		Nonaccrual		Total loans
Commercial and industrial	$	51,632		722		413		521	$	53,288
Construction and land development		38,301		4,372		1,075		4,102		47,850
Commercial real estate:
Owner occupied		67,702		716		5,001		2,833		76,252
Other		84,354		3,718		15		1,902		89,989

Total commercial real estate		152,056		4,434		5,016		4,735		166,241
Residential real estate:
Consumer mortgage		48,620		2,700		4,124		2,118		57,562
Investment property		34,221		1,626		2,476		356		38,679

Total residential real estate		82,841		4,326		6,600		2,474		96,241
Consumer installment		10,426		133		116		1		10,676

Total	$	335,256		13,987		13,220		11,833	$	374,296

Impaired loans

The following table presents details related to the Company’s impaired loans. Loans which have been fully charged-off do not appear in the following table. The related allowance generally represents the following components which 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 loans).

The following table sets forth certain information regarding the Company’s impaired loans that were individually evaluated for impairment at March 31, 2011 and December 31, 2010.


										Quarter ended
	March 31, 2011									March 31, 2011
(In thousands)	Unpaid principal balance (1)		Charge-offs and payments applied (2)			Recorded investment (3)		Related allowance		Average recorded investment		Interest income recognized (4)
With no allowance recorded:
Commercial and industrial	$	—		—			—			$	—	$	—
Construction and land development		2,499		(74	)		2,425				2,455		—
Commercial real estate:
Owner occupied		700		(1	)		699				730		3
Other		1,588		(81	)		1,507				1,524		—

Total commercial real estate		2,288		(82	)		2,206				2,254		3
Residential real estate:
Consumer mortgages		864		(34	)		830				939		—
Investment property		—		—			—				89		—

Total residential real estate		864		(34	)		830				1,028		—
Consumer installment		—		—			—				—		—

Total	$	5,651		(190	)		5,461			$	5,737	$	3

With allowance recorded:
Commercial and industrial	$	520		(13	)		507	$	263	$	514	$	—
Construction and land development		1,617		—			1,617		89		1,617		—
Commercial real estate:
Owner occupied		2,088		—			2,088		438		2,280		—
Other		—		—			—		—		—		—

Total commercial real estate		2,088		—			2,088		438		2,280		—
Residential real estate:
Consumer mortgages		1,064		(73	)		991		165		1,004		—
Investment property		—		—			—		—		—		—

Total residential real estate		1,064		(73	)		991		165		1,004		—
Consumer installment		—		—			—		—		—		—

Total	$	5,289		(86	)		5,203	$	955	$	5,415	$	—

Total impaired loans	$	10,940		(276	)		10,664	$	955	$	11,152	$	3

(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.

(3)	Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

(4)	Represents interest income related to accruing TDRs, which are considered impaired.


	December 31, 2010
(In thousands)	Unpaid principal balance (1)		Charge-offs and payments applied (2)			Recorded investment (3)		Related allowance
With no allowance recorded:
Commercial and industrial	$	—		—			—
Construction and land development		2,538		(54	)		2,484
Commercial real estate:
Owner occupied		—		—			—
Other		1,592		(51	)		1,541

Total commercial real estate		1,592		(51	)		1,541
Residential real estate:
Consumer mortgages		1,072		(27	)		1,045
Investment property		356		—			356

Total residential real estate		1,428		(27	)		1,401
Consumer installment		—		—			—

Total	$	5,558		(132	)		5,426

With allowance recorded:
Commercial and industrial	$	528		(7	)		521	$	277
Construction and land development		1,617		—			1,617		123
Commercial real estate:
Owner occupied		3,124		(35	)		3,089		765
Other		—		—			—		—

Total commercial real estate		3,124		(35	)		3,089		765
Residential real estate:
Consumer mortgages		1,073		(56	)		1,017		144
Investment property		—		—			—		—

Total residential real estate		1,073		(56	)		1,017		144
Consumer installment		—		—			—		—

Total	$	6,342		(98	)		6,244	$	1,309

Total impaired loans	$	11,900		(230	)		11,670	$	1,309

⁽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.

⁽³⁾	Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any related allowance for loan losses.

At March 31, 2011 and December 31, 2010, the Company had impaired loans classified as TDRs of $7.2 million and $7.6 million, respectively. At March 31, 2011 the Company had $0.3 million in accruing TDRs. The Company had no accruing TDRs at December 31, 2010. For impaired loans classified as TDRs, the related allowance for loan losses was approximately $0.7 million and $1.0 million at March 31, 2011 and December 31, 2010, respectively. At March 31, 2011, there were no significant outstanding commitments to advance additional funds to customers whose loans had been restructured.

NOTE 7: 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 Company’s MSRs is determined using assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, default rates, cost 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 change in amortized MSRs and the related valuation allowance for the quarter ended March 31, 2011 and 2010 are presented below.


	Quarter ended March 31,
(Dollars in thousands)	2011			2010
Beginning balance	$	1,189			834
Additions, net		87			49
Amortization expense		(50	)		(32	)

Ending balance	$	1,226			851

Fair value of amortized MSRs:
Beginning of period		1,335			978
End of period	$	1,491			1,030

At March 31, 2011 and 2010 there was no valuation allowance recorded for MSRs. The Company periodically evaluates mortgage servicing rights for impairment. 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 reserve is established. The valuation reserve is adjusted as the fair value changes.

NOTE 8: FAIR VALUE DISCLOSURES

“Fair value” is defined by FASB 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 between market participants at the measurement date. FASB ASC 820 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs 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, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The Company’s assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy in accordance with FASB ASC 820.

Securities – Securities available-for-sale are recorded at fair value on a recurring basis. Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government securities such as U.S. Treasuries and exchange-traded equity securities.

When instruments are traded in secondary markets and quoted market prices are not available, the Company generally relies on prices obtained from independent vendors. Vendors compile prices from various sources and often apply matrix pricing for similar securities when no price is observable. Securities measured with these valuation techniques are generally classified within Level 2 of the valuation hierarchy and often involve using quoted market prices for similar securities, pricing models or discounted cash flow analyses using inputs observable in the market where available. Examples include U.S. government agency securities and residential mortgage-backed securities.

Security fair value measurements using significant inputs that are unobservable in the market due to limited activity or a less liquid market are classified within Level 3 of the valuation hierarchy. Such measurements include securities valued using models or a combination of valuation techniques such as weighting of models and vendor or broker pricing, where the unobservable inputs are significant to the overall fair value measurement. Securities classified as Level 3 include pooled and individual issuer trust preferred securities.

Loans held for sale – Loans held for sale are carried at the lower of cost or estimated fair value and are subjected to nonrecurring fair value adjustments. Estimated fair value is determined on the basis of the current market value of similar loans. All of the Company’s loans held for sale are classified within Level 2 of the valuation hierarchy.

Loans, net — Loans considered impaired under FASB 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 amounts due according to the contractual terms of the loan agreement. Impaired loans are subject to nonrecurring fair value adjustments to reflect (1) partial write-downs that are based on the observable market price or current appraised value of the collateral, or (2) the full charge-off of the loan carrying value. All of the Company’s impaired loans are classified within Level 3 of the valuation hierarchy.

Other real estate — Other real estate, consisting of properties obtained through foreclosure or in satisfaction of loans, are initially recorded at the lower of the loan’s carrying amount or the fair value less costs to sell upon transfer of the loans to other real estate. Subsequently, other real estate is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs. All of the Company’s other real estate is classified within Level 3 of the valuation hierarchy.

Other assets – The Company has certain financial assets carried at fair value on a recurring basis, including interest rate swap agreements. The carrying amount of interest rate swap agreements is based on information obtained from a third party bank. The Company classified these derivative assets within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments. The Company had no derivative contracts to assist in managing interest rate sensitivity at March 31, 2011 or December 31, 2010.

Mortgage servicing rights, net, included in other assets on the accompanying consolidated balance sheets, are carried at the lower of cost or estimated fair value and are subjected to nonrecurring fair value adjustments. 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 rate, default rates, cost to service, escrow account earnings, contractual servicing fee income, ancillary income, and late fees. 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.

Other liabilities – The Company has certain financial liabilities carried at fair value on a recurring basis, including interest rate swap agreements. The carrying amount of interest rate swap agreements is based on information obtained from a third party bank. The Company classified these derivative liabilities within Level 2 of the valuation hierarchy. These swaps qualify as derivatives, but are not designated as hedging instruments. The Company had no derivative contracts to assist in managing interest rate sensitivity at March 31, 2011 or December 31, 2010.

Assets and liabilities measured at fair value on a recurring basis

The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010, respectively, by caption, on the consolidated balance sheets by FASB ASC 820 valuation hierarchy (as described above).


(Dollars in thousands)	Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2011
Securities available-for-sale:
Agency obligations	$	97,983		—		97,983		—
Agency RMBS		138,411		—		138,411		—
State and political subdivisions		82,471		—		82,471		—
Trust preferred securities:
Pooled		20		—		—		20
Individual issuer		2,213		—		—		2,213

Total securities available-for-sale		321,098		—		318,865		2,233
Other assets ⁽¹⁾		995		—		995		—

Total assets at fair value	$	322,093		—		319,860		2,233


Other liabilities⁽¹⁾		995		—		995		—

Total liabilities at fair value	$	995		—		995		—

December 31, 2010
Securities available-for-sale:
Agency obligations	$	90,471		—		90,471		—
Agency RMBS		143,144		—		143,144		—
State and political subdivisions		76,766		—		76,766		—
Trust preferred securities:
Pooled		20		—		—		20
Individual issuer		2,129		—		—		2,129
Corporate debt		2,690		2,690		—		—

Total securities available-for-sale		315,220		2,690		310,381		2,149
Other assets ⁽¹⁾		1,101		—		1,101		—

Total assets at fair value	$	316,321		2,690		311,482		2,149


Other liabilities⁽¹⁾		1,101		—		1,101		—

Total liabilities at fair value	$	1,101		—		1,101		—

⁽¹⁾	Represents the fair value of interest rate swap agreements

Level changes in fair value measurements

Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Corporation’s monthly and/or quarterly valuation process. 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 rare. For the quarter ended March 31, 2011, there were no transfers between levels.

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements for trust preferred securities recognized in the accompanying condensed consolidated balance sheets using Level 3 inputs:


	Quarter ended March 31,
(Dollars in thousands)	2011			2010
Beginning balance	$	2,149		$	1,463
Total realized and unrealized gains and (losses):
Included in net earnings		(51	)		(50	)
Included in other comprehensive income		135			187
Purchases		—			—
Issuances		—			—
Settlements		—			—
Transfers in and/or (out) of Level 3		—			—

Ending balance	$	2,233		$	1,600

Assets and liabilities measured at fair value on a nonrecurring basis

The following table presents the balances of the assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2011 and December 31, 2010, respectively, by caption, on the consolidated balance sheets and by FASB ASC 820 valuation hierarchy (as described above):


(Dollars in thousands)	Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2011:
Loans held for sale	$	1,256		—		1,256		—
Loans, net⁽¹⁾		9,709		—		—		9,709
Other real estate owned		8,450		—		—		8,450
Other assets ⁽²⁾		1,226		—		—		1,226

Total assets at fair value	$	20,641		—		1,256		19,385


December 31, 2010:
Loans held for sale	$	4,281		—		4,281		—
Loans, net⁽¹⁾		10,362		—		—		10,362
Other real estate owned		8,125		—		—		8,125
Other assets ⁽²⁾		1,189		—		—		1,189

Total assets at fair value	$	23,957		—		4,281		19,676

⁽¹⁾	Loans considered impaired under FASB ASC 310-10-35 Receivables. This amount reflects the recorded investment in impaired loans, net of any related allowance for loan losses.

⁽²⁾	Mortgage servicing rights, net included in this category

NOTE 9: FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB 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 and other valuation techniques. 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 a good–faith estimate of the fair value of financial instruments held by the Company. FASB 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:

Cash and cash equivalents

Due to their short-term nature, the carrying amounts reported in the balance sheet are assumed to approximate fair value for these assets. For purposes of disclosure, cash equivalents include federal funds sold and other interest bearing bank deposits.

Securities

Fair value measurement is based upon quoted prices if available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments. See Note 5 for additional disclosure related to fair value measurements for securities.

Loans held for sale

Loans held for sale are carried at the lower of cost or estimated fair value and are subjected to nonrecurring fair value adjustments. Estimated fair value is determined on the basis of the current market value of similar loans.

Loans, net

The fair value of loans is calculated using discounted cash flows. The discount rates used to determine the present value of the loan portfolio are estimated market discount rates that reflect the credit and interest rate risk inherent in the loan portfolio. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by FASB ASC 820 and generally produces a higher value than an exit-price approach. The estimated maturities are based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions.

Deposits

Under FASB ASC 825, the fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, interest bearing demand deposits and savings and certain types of money market accounts, is equal to the amount payable on demand at the reporting date (i.e., their carrying amount). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using discounted cash flows. The discount rates used are based on estimated market rates for deposits of similar remaining maturities.

Short-term borrowings

The fair value of federal funds purchased, securities sold under agreements to repurchase, and other short–term borrowings approximate their carrying value.

Long-term debt

The fair value of the Company’s fixed rate long-term debt is estimated using discounted cash flows based on estimated current market rates for similar types of borrowing arrangements. The carrying amount of the Company’s variable rate long-term debt approximates its fair value.

Derivative Instruments

From time to time, the Company enters into interest rate swaps to meet the financing, interest rate and equity risk management needs of its customers. The carrying amounts of these derivative instruments represent their fair value. Generally, the fair value of these instruments is based on an observable market price.

Off-balance sheet Instruments

The fair values of the Company’s off-balance-sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit do not represent a significant value to the Company until such commitments are funded. The Company has determined that the estimated fair value of commitments to extend credit approximates the carrying amount and is immaterial to the financial statements.

The carrying value and related estimated fair value of the Company’s financial instruments at March 31, 2011 and December 31, 2010 are presented below.


	March 31, 2011				December 31, 2010
(Dollars in thousands)	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
Financial Assets:
Cash and cash equivalents	$	39,343	$	39,343	$	21,424	$	21,424
Securities		321,098		321,098		315,220		315,220
Loans held for sale		1,256		1,256		4,281		4,281
Loans, net		361,054		366,886		366,539		372,869
Derivative assets		995		995		1,101		1,101
Financial Liabilities:
Deposits	$	631,394	$	638,879	$	607,127	$	615,300
Short-term borrowings		2,221		2,221		2,685		2,685
Long-term debt		85,327		90,499		93,331		99,505
Derivative liabilities		995		995		1,101		1,101

NOTE 10: DERIVATIVE INSTRUMENTS

Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as part of a hedging relationship, the gain or loss is recognized in current earnings. From time to time, the Company may enter into interest rate swaps (“swaps”) to facilitate customer transactions and meet their financing needs. Upon entering into these instruments to meet customer needs, the Company enters into offsetting positions in order to minimize the risk to the Company. These swaps qualify as derivatives, but are not designated as hedging instruments. At March 31, 2011, the Company had no derivative contracts to assist in managing its interest rate sensitivity.

Interest rate swap contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty or customer owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the customer or counterparty and therefore, has no credit risk.

A summary of the Company’s interest rate swaps as of and for the quarter ended March 31, 2011 is presented below.


			Other Assets		Other Liabilities		Other noninterest income
(Dollars in thousands)	Notional		Estimated Fair Value		Estimated Fair Value		Gains (Losses)
Interest rate swap agreements:
Pay fixed / receive variable	$	5,979		—		995	$	106
Pay variable / receive fixed		5,979		995		—		(106	)

Total interest rate swap agreements	$	11,958		995		995	$	—

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of the Auburn National Bancorporation, Inc. (the “Company”) and its wholly owned subsidiary, AuburnBank (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 quarter ended March 31, 2011 and 2010, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2010.

Certain of the statements made herein under the caption “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning of, and subject to, the protections of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such 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,” “desired,” “indicate,” “would,” “believe,” “deem,” “contemplate,” “expect,” “seek,” “estimate,” “evaluate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential,” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

•

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

•

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, and changes in the scope and cost of FDIC insurance and other coverage;

•

changes in accounting policies, rules and practices;

•

the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities, and the risks and uncertainty of the amounts realizable and the timing of dispositions of assets by the FDIC where we may have a participation or other interest;

•

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;

•

the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

•

the failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates, including estimates of potential losses due to claims from purchases of mortgages that we originated;

•

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;

•

the effects of war or other conflicts, acts of terrorism or other catastrophic events, such as the recent oil spill in the Gulf of Mexico, that may affect general economic conditions;

•

the failure of assumptions and estimates, as well as differences in, and changes to, economic, market and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress test;

•

the risks that our deferred tax assets 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, 2010 and subsequent quarterly and current reports. See Part II, Item 1A, “RISK FACTORS.”

All written or oral forward-looking statements that are made by or attributable to us are expressly qualified in their entirety by this cautionary notice. We have no obligation and do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

Business

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

Summary of Results of Operations


	Quarter ended March 31,
(Dollars in thousands, except per share amounts)	2011		2010
Net interest income (a)	$	5,249	$	5,268
Less: tax-equivalent adjustment		435		437

Net interest income (GAAP)		4,814		4,831
Noninterest income		1,145		2,296

Total revenue		5,959		7,127
Provision for loan losses		600		1,450
Noninterest expense		3,650		3,636
Income tax expense		160		424

Net earnings	$	1,549	$	1,617

Basic and diluted earnings per share	$	0.43	$	0.44

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

Financial Summary

The Company’s net earnings were $1.5 million for the first quarter of 2011, compared to $1.6 million for the first quarter of 2010. Basic and diluted earnings per share were $0.43 per share for the first quarter of 2011, compared to $0.44 per share for the first quarter of 2010.

Net interest income was $4.8 million for the first quarter of 2011, unchanged from the first quarter of 2010. Average loans were $372.3 million in the first quarter of 2011, a decrease of $6.8 million, or 2%, from the first quarter of 2010. Average deposits were $622.7 million in the first quarter of 2011, an increase of $23.7 million, or 4%, from the first quarter of 2010.

The provision for loan losses during the first quarter of 2011 was $0.6 million, compared to $1.5 million in the first quarter of 2010. The Company’s annualized net charge-off ratio was 0.45% in the first quarter of 2011, compared to 1.48% in the first quarter of 2010.

Noninterest income was $1.1 million for the first quarter of 2011, compared to noninterest income of $2.3 million in the first quarter of 2010. The decrease in noninterest income is primarily due to a decrease in net securities gains of $1.1 million.

Noninterest expense was $3.6 million during the first quarter of 2011, unchanged from the first quarter of 2010.

Income tax expense was approximately $0.2 million in the first quarter of 2011, compared to $0.4 million in the first quarter of 2010. The Company’s effective tax rate in the first quarter of 2011 was approximately 9.36%, compared to 20.77% in the first quarter of 2010. The decrease in the Company’s effective tax rate during the first quarter of 2011 when compared to the first quarter of 2010 is due to a decline in the level of earnings before taxes and an increase in federal tax credits related to the Company’s investments in affordable housing limited partnerships.

In the first quarter of 2011, the Company paid cash dividends of $0.7 million, or $0.20 per share. The Company’s balance sheet remains strong and well capitalized under current regulatory guidelines with a total risk-based capital ratio of 16.09% and a Tier 1 leverage ratio of 8.56% at March 31, 2011.

CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting principles 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, the valuation of other real estate owned, and the valuation of 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 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.

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 equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities for which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

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 entity will be required to sell the debt security before recovery of its amortized cost basis, or (3) the entity 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 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, as a realized loss in securities gains (losses), 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 assesses impairment for pooled trust preferred securities using a cash flow model. The key assumptions include default probabilities of the underlying collateral and recoveries on collateral defaults. These assumptions may have a significant effect on the determination of the present value of expected future cash flows and the resulting amount of other-than-temporary impairment. 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.

Fair Value Determination

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. FASB ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in accordance with U.S. generally accepted accounting principles and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 7 of the Condensed Consolidated Financial Statements.

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

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, 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 realized at the time of disposal 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 experienced during 2010 and 2009. 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.

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 the Company will realize the benefits of these deductible differences at March 31, 2011. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during future periods are reduced.

RESULTS OF OPERATIONS

Average Balance Sheet and Interest Rates


	Quarter ended March 31,
	2011					2010
(Dollars in thousands)	Average Balance		Yield/ Rate			Average Balance		Yield/ Rate
Loans and loans held for sale	$	374,325		5.73	%	$	381,784		5.77	%
Securities - taxable		240,342		2.86	%		250,286		3.84	%
Securities - tax-exempt		79,852		6.49	%		80,812		6.47	%

Total securities		320,194		3.77	%		331,098		4.48	%
Federal funds sold		17,864		0.20	%		12,832		0.22	%
Interest bearing bank deposits		2,295		—			1,076		—

Total interest-earning assets		714,678		4.69	%		726,790		5.08	%

Deposits:
NOW		91,975		0.67	%		93,348		0.76	%
Savings and money market		137,601		0.75	%		104,334		1.12	%
Certificates of deposits less than $100,000		115,295		2.07	%		113,699		2.64	%
Certificates of deposits and other time deposits of $100,000 or more		189,598		2.51	%		204,174		2.85	%

Total interest-bearing deposits		534,469		1.65	%		515,555		2.08	%
Short-term borrowings		2,477		0.49	%		6,256		0.71	%
Long-term debt		91,728		3.74	%		118,347		4.03	%

Total interest-bearing liabilities		628,674		1.95	%		640,158		2.43	%

Net interest income and margin	$	5,249		2.98	%	$	5,268		2.94	%

Net Interest Income and Margin

Net interest income (tax-equivalent) was $5.2 million in the first quarter of 2011, unchanged from the first quarter of 2010 as net interest margin improvement offset a decline in average interest-earnings assets of 2%. Net interest margin (tax-equivalent) was 2.98% for the first quarter of 2011, compared to 2.94% for the first quarter of 2010.

The tax-equivalent yield on total interest-earning assets decreased 39 basis points in the first quarter of 2011 from the first quarter of 2010 to 4.69%. This decrease was primarily driven by a 71 basis points decrease in the tax-equivalent yield on total securities to 3.77%.

The cost of total interest-bearing liabilities decreased 48 basis points in the first quarter of 2011 from the first quarter of 2010 to 1.95%. This decrease was primarily driven by a 43 basis point decrease in the cost of total interest-bearing deposits to 1.95% and a 29 basis point decrease in the cost of long-term debt to 3.74%.

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 coverage for the probable losses on outstanding loans. The provisions for loan losses amounted to $0.6 million and $1.5 million for the quarter ended March 31, 2011 and 2010, respectively. The decrease in the provision for loan losses was primarily due to a decrease in net charge-offs during the first quarter of 2011 when compared to the first quarter of 2010.

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 probable losses in the loan portfolio. The Company’s allowance for loan losses as a percentage of total loans was 2.13% at March 31, 2011, compared to 2.05% at December 31, 2010. Based upon our evaluation of the loan portfolio, management believes the allowance for loan losses to be adequate to absorb our estimate of probable losses existing in the loan portfolio at March 31, 2011. While our policies and procedures used to estimate the allowance for loan losses, as well as the resultant provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are necessarily

approximate and imprecise. Factors beyond our control (such as conditions in the local and national economy, local real estate market, or industry conditions) may have a material adverse effect on our asset quality and the adequacy of our allowance for loan losses resulting in significant increases in the provision for loan losses.

Noninterest Income


	Quarter ended March 31,
(Dollars in thousands)	2011			2010
Service charges on deposit accounts	$	291		$	314
Mortgage lending income		440			482
Bank-owned life insurance		107			126
Securities (losses) gains, net		(46	)		1,050
Other		353			324

Total noninterest income	$	1,145		$	2,296

The Company’s income from mortgage lending is primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing mortgage loans. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either release or retain the associated mortgage servicing rights (“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 following table presents a breakdown of the Company’s mortgage lending income.


	Quarter ended March 31,
(Dollars in thousands)	2011		2010
Origination income	$	344	$	392
Servicing fees, net		96		90

Total mortgage lending income	$	440	$	482

Mortgage lending income was $0.4 million in the first quarter of 2011, compared to $0.5 million in the first quarter of 2010. The slight decline in mortgage lending income was primarily due to a decrease in the volume of loans originated and sold as the level of mortgage refinance activity slowed during the first quarter of 2011, compared to the first quarter of 2010.

The Company recorded net securities losses of $0.1 million in the first quarter of 2011, compared to net securities gains of $1.1 million in the first quarter of 2010. The decrease was primarily due to $1.1 million in gains realized on the sale of securities during the first quarter of 2010, compared to nil in the first quarter of 2011.

Noninterest Expense


	Quarter ended March 31,
(Dollars in thousands)	2011			2010
Salaries and benefits	$	1,986		$	1,905
Net occupancy and equipment		346			384
Professional fees		171			176
FDIC and other regulatory assessments		282			276
Other real estate owned, net		(17	)		61
Other		882			834

Total noninterest expense	$	3,650		$	3,636

Salaries and benefits expense was $2.0 million for the first quarter of 2011, compared to $1.9 million for the first quarter of 2010. The slight increase was primarily due to normal increases in salaries and benefits expense, which were offset by a decline in commissions paid to our mortgage originators, as mortgage origination volume declined in the first quarter of 2011, compared to the first quarter of 2010.

Other real estate owned, net reduced noninterest expense by $17,000 in the first quarter of 2011, compared to net expenses of $61,000 in the first quarter of 2010. The decrease in expense related to OREO was due to rental income on certain OREO properties exceeding expenses for the first quarter of 2011.

Income Tax Expense

Income tax expense was approximately $0.2 million in the first quarter of 2011, compared to $0.4 million in the first quarter of 2010. The Company’s annualized effective tax rate for the first quarter of 2011 was 9.36%, compared to an annualized effective income tax rate of 20.77% for the first quarter of 2010. The decrease in the Company’s effective tax rate during the first quarter of 2011 when compared to the first quarter of 2010 was due to a decrease in the level of earnings before taxes and an increase in federal tax credits related to the Company’s investments in affordable housing limited partnerships.

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $321.1 million and $315.2 million as of March 31, 2011 and December 31, 2010, respectively. Unrealized net losses on securities available-for-sale were $2.5 million at March 31, 2011 compared to unrealized net losses of $3.5 million at December 31, 2010. The decrease in unrealized net losses on securities available-for-sale were due to the narrowing of credits spreads on municipals bonds and changes in interest rates.

The average tax-equivalent yields earned on total securities were 3.77% in the first quarter of 2011 and 4.48% in the first quarter of 2010.

Loans


	2011		2010
(In thousands)	First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Commercial and industrial	$	51,323		53,288		58,400		56,168		52,918
Construction and land development		48,814		47,850		46,928		48,758		57,945
Commercial real estate		161,882		166,241		161,676		159,367		158,781
Residential real estate		95,997		96,241		96,888		100,451		99,660
Consumer installment		10,968		10,676		11,312		12,037		11,475

Total loans		368,984		374,296		375,204		376,781		380,779
Less: unearned income		(75)		(81)		(106)		(157)		(160)

Loans, net of unearned income	$	368,909		374,215		375,098		376,624		380,619

Total loans, net of unearned income, were $368.9 million as of March 31, 2011, a decrease of $5.3 million from $374.2 million at December 31, 2010. Four loan categories represented the majority of the loan portfolio as of March 31, 2011. Commercial real estate loans represented 44%, residential real estate loans represented 26%, construction and land development loans represented 13% and commercial and industrial loans represented 14% of the Company’s total loans at March 31, 2011. Approximately 46% of the Company’s commercial real estate loans were classified as owner-occupied at March 31, 2011.

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $24.2 million at March 31, 2011, compared to $24.3 million at December 31, 2010. For residential real estate mortgage loans with a consumer purpose, approximately $2.2 million and $4.1 million required interest only payments at March 31, 2011 and December 31, 2010, respectively. 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.

Purchased loan participations included in the Company’s loan portfolio were approximately $3.8 million and $7.2 million at March 31, 2011 and December 31, 2010, respectively. All purchased loan participations are underwritten by the Company independent of the selling bank. In addition, all loans, including purchased participations, are evaluated for collectability during the course of the Company’s normal loan review procedures. If the Company deems a participation loan impaired, it applies the same accounting policies and procedures described under “CRITICAL ACCOUNTING POLICIES – Allowance for Loan Losses”.

The average yield earned on loans and loans held for sale was 5.73% in the first quarter of 2011 and 5.77% in the first quarter of 2010.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the impact of recessionary economic conditions on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, 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 laws and regulations.

The Company attempts to reduce these economic and credit risks by adhering to loan to value (“LTV”) guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we establish and periodically review our lending policies and procedures. Banking regulations limit our credit exposure by prohibiting unsecured loan relationships that exceed 10% of the capital accounts of the Bank; or 20% of the capital accounts if loans in excess of 10% are fully secured, the upper legal lending limit is approximately $13.6 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $12.2 million. Our loan policy requires that the Loan Committee of the Bank’s Board of Directors approve any loan relationships that exceed this internal limit. At March 31, 2011 and December 31, 2010, the Company had no loan relationships exceeding these limits.

We periodically analyze our commercial loan portfolio to determine if a concentration of credit risk exists in any one or more industries. We use broadly accepted industry classification systems in order to classify borrowers into various industry classifications. Loan concentrations to borrowers in the following industries exceeded 25% of the Bank’s total risk-based capital at March 31, 2011 (and related balances at December 31, 2010).


(In thousands)	March 31, 2011		December 31, 2010
Lessors of 1 to 4 family residential properties	$	39,341	$	38,679
Office buildings		20,288		24,185
Hotel/motel		17,050		16,150
Manufacturing/industrial facilities		17,015		17,327

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 in the loan portfolio. At March 31, 2011 and December 31, 2010, the allowance for loan losses was $7.9 million and $7.7 million, respectively, which management deemed 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.”

A summary of the changes in the allowance for loan losses and certain asset quality ratios for the first quarter of 2011 and the previous four quarters is presented below.


	2011			2010
(Dollars in thousands)	First Quarter			Fourth Quarter			Third Quarter			Second Quarter			First Quarter
Balance at beginning of period	$	7,676			7,181			6,580			6,546			6,495
Charge-offs:
Commercial and industrial		(56	)		(66	)		(77	)		(326	)		(68	)
Construction and land development		(33	)		(20	)		(5	)		(169	)		(1,293	)
Commercial real estate		(339	)		—			—			—			—
Residential real estate		(57	)		(153	)		(91	)		(262	)		(46	)
Consumer installment		(1	)		(9	)		(14	)		(83	)		(5	)

Total charge-offs		(486	)		(248	)		(187	)		(840	)		(1,412	)
Recoveries		65			93			58			124			13

Net charge-offs		(421	)		(155	)		(129	)		(716	)		(1,399	)
Provision for loan losses		600			650			730			750			1,450

Ending balance	$	7,855			7,676			7,181			6,580			6,546

as a % of loans		2.13	%		2.05			1.91			1.75			1.72
as a % of nonperforming loans		70	%		65			82			72			60
Net charge-offs as a % of average loans		0.45	%		0.16			0.14			0.76			1.48

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 quality indications 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 2.13% at March 31, 2011, compared to 2.05% at December 31, 2010. 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 in their entirety either improve or weaken.

Net charge-offs were $0.4 million, or 0.45% of average loans on an annualized basis, in the first quarter of 2011, compared to $1.4 million, or 1.48% of average loans on an annualized basis, in the first quarter of 2010. Approximately $1.3 million of the $1.4 million in net charge-offs during the first quarter of 2010 related to one construction and land development loan.

At March 31, 2011, the ratio of our allowance for loan losses as a percentage of nonperforming loans was 70%, compared to 65% at December 31, 2010. This ratio increased due to an increase in the allowance for loan losses and a decrease in nonperforming loans when compared to December 31, 2010.

At March 31, 2011, the Company’s recorded investment in loans considered impaired was $10.7 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $1.0 million. At December 31, 2010, the Company’s recorded investment in loans considered impaired was $11.7 million, with a corresponding valuation allowance (included in the allowance for loan losses) of $1.3 million.

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

At March 31, 2011, the Company had $19.6 million in nonperforming assets compared to $20.0 million at December 31, 2010. Included in nonperforming assets were nonperforming loans of $11.2 million and $11.8 million at March 31, 2011 and December 31, 2010, respectively. The majority of the balance in nonperforming assets at March 31, 2011 related to deterioration in the construction and land development loan portfolio.

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the first quarter of 2011 and the previous four quarters.


	2011			2010
(Dollars in thousands)	First Quarter			Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Nonperforming assets:
Nonaccrual loans	$	11,166			11,833		8,776		9,151		10,934
Other nonperforming assets (primarily other real estate owned)		8,450			8,125		8,163		6,341		7,081

Total nonperforming assets	$	19,616			19,958		16,939		15,492		18,015

as a % of loans and other real estate owned		5.20	%		5.22		4.42		4.05		4.65
as a % of total assets		2.51	%		2.61		2.18		1.98		2.28
Nonperforming loans as a % of total loans		3.03	%		3.16		2.34		2.43		2.87
Accruing loans 90 days or more past due	$	158			—		62		243		374

The Lee County Association of Realtors (“LCAR”) of Alabama reported that the average median selling price for residential homes during the quarter ended March 31, 2011 was $159,133 a decrease of 7.8% from the same quarter a year earlier. In addition to a decrease in selling prices, the supply of housing and the average number of days on the market remain elevated. LCAR reported that residential inventory at March 31, 2011 was 1,455 homes, an increase of 2.7% from a year earlier and the average number of days on the market for residential homes sold during the quarter ended March 31, 2011 was 180 days. Continued weakness in the real estate market and the overall economy could adversely affect the Company’s volume of nonperforming assets. For additional discussion of risk factors, see Part I “Item 1A. Risk Factors” on page 17 in our annual report on Form 10-K for the year ended December 31, 2010.

The table below provides information concerning the composition of nonaccrual loans for the first quarter of 2011 and the previous four quarters.


	2011		2010
(In thousands)	First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Nonaccrual loans:
Commercial and industrial		508		521		535		—		—
Construction and land development	$	4,043		4,102		2,689		4,686		6,500
Commercial real estate		3,954		4,735		2,688		2,326		1,730
Residential real estate		2,510		2,474		2,862		2,137		2,687
Consumer installment		151		1		2		2		17

Total nonaccrual loans	$	11,166		11,833		8,776		9,151		10,934

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 more than 90 days past due, unless the loan is both well-secured and in the process of collection. At March 31, 2011, the Company had $11.2 million in loans on nonaccrual, compared to $11.8 million at December 31, 2010.

Due to the weakening credit status of a borrower, the Company may elect to formally restructure certain loans to facilitate a repayment plan that minimizes the potential losses the Company might incur. Troubled debt restructurings (“TDRs”) are classified as impaired loans, and if the loans are on nonaccrual status as of the date of restructuring, the loans are included in the nonaccrual loan balances noted above. At March 31, 2011 the Company had $0.3 million in accruing TDRs. The Company had no accruing TDRs at December 31, 2010.

At March 31, 2011, the Company had approximately $158,000 in loans 90 days past due and still accruing interest. At December 31, 2010, there were no loans 90 days past due and still accruing interest.

The table below provides information concerning the composition of other real estate owned for the first quarter of 2011 and the previous four quarters.


	2011		2010
(In thousands)	First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Other real estate owned:
Residential condo development	$	5,494		5,494		5,449		3,810		4,329
New home construction		346		369		243		253		253
Developed lots		282		136		136		136		136
Undeveloped land		1,746		1,746		1,746		1,746		2,210
Other		582		380		589		396		153

Total other real estate owned	$	8,450		8,125		8,163		6,341		7,081

The Company held $8.5 million in OREO at March 31, 2011, which we had acquired from borrowers, compared to $8.1 million at December 31, 2010. OREO primarily relates to three properties with a total carrying value of $7.2 million at March 31, 2011. One of the properties is a completed condominium project on the Florida Gulf Coast. The Company had previously purchased a participation interest in the first lien mortgage loan on the condominium project on the Florida Gulf Coast from Silverton Bank. Subsequently, this loan defaulted and was foreclosed upon and the Company’s interest in the property is currently included in OREO. Following Silverton Bank’s failure on May 1, 2009, the FDIC has held this property as the receiver of Silverton Bank. CB Richard Ellis, a national real estate firm, has been managing this property and selling condominiums in the project as a FDIC contractor. The Company depends upon the FDIC and CB Richard Ellis for information regarding this property and its performance. Based upon the latest information available to us, including appraisals, current unit sales, and comparable sales, we believe that the fair value of the Company’s interest in these properties, less selling costs, is greater than or equal to the Company’s recorded investment at March 31, 2011. During the first quarter of 2011, the Company learned that the FDIC has approved a bulk sale of the condominiums and club amenities, which may speed the disposition of this property in which we hold an interest.

Potential Problem Loans

Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. Potential problem loans, which are not included in nonperforming assets, amounted to $17.4 million, or 4.7% of total loans outstanding, net of unearned income at March 31, 2011, compared to $13.2 million, or 3.5% of total loans outstanding, net of unearned income at December 31, 2010. The increase in potential problem loans from December 31, 2010 is primarily due to one construction and land development loan. Continued weakness in the real estate market and the overall economy has adversely affected the Company’s volume of potential problem loans, and these economic conditions are expected to persist for the foreseeable future.

The table below provides information concerning the composition of performing potential problem loans for the first quarter of 2011 and the previous four quarters.


	2011		2010
(In thousands)	First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Potential problem loans:
Commercial and industrial	$	1,051		413		658		1,295		1,430
Construction and land development		5,027		1,075		1,235		1,667		1,636
Commercial real estate		5,553		5,016		7,032		4,695		5,313
Residential real estate		5,657		6,600		5,425		6,059		5,981
Consumer installment		112		116		67		80		149

Total potential problem loans	$	17,400		13,220		14,417		13,796		14,509

At March 31, 2011, approximately $1.6 million or 9.3% of total potential problem loans were past due at least 30 days but less than 90 days.

The following table is a summary of the Company’s performing loans that were past due at least 30 days but less than 90 days for the first quarter of 2011 and the previous four quarters.


	2011		2010
(In thousands)	First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Performing loans past due 30 to 89 days:
Commercial and industrial	$	136		124		179		463		206
Construction and land development		493		201		—		246		20
Commercial real estate		419		—		361		1,026		1,658
Residential real estate		2,001		2,986		497		445		3,357
Consumer installment		60		29		102		87		3

Total	$	3,109		3,340		1,139		2,267		5,244

Deposits

Total deposits were $631.4 million at March 31, 2011, an increase of $24.3 million, or 4.0%, compared to $607.1 million at December 31, 2010. Approximately $20.4 million of the increase is due to seasonal fluctuations in public depositor balances as tax receipts are collected and expended.

The average rate paid on total interest-bearing deposits was 1.65% in the first quarter of 2011 and 2.08% in the first quarter of 2010.

Noninterest bearing deposits were 15% and 14% of total deposits as of March 31, 2011 and December 31, 2010, respectively.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt. Short-term borrowings consist of federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings. The Bank had available federal funds lines totaling $34.0 million with none outstanding at March 31, 2011 and December 31, 2010, respectively. Securities sold under agreements to repurchase totaled $2.2 million at March 31, 2011, compared to $2.7 million at December 31, 2010.

The average rate paid on short-term borrowings was 0.49% in the first quarter of 2011 and 0.71% in the first quarter of 2010.

Long-term debt includes FHLB advances with an original maturity greater than one year, securities sold under agreements to repurchase with an original maturity greater than one year, and subordinated debentures related to trust preferred securities. The Bank had $15.0 million at March 31, 2011 and December 31, 2010, respectively, in securities sold under agreements to repurchase with an original maturity greater than one year. The Bank had $63.1 million and $71.1 million in long-term FHLB advances at March 31, 2011 and December 31, 2010, respectively, and the Company had $7.2 million in junior subordinated debentures related to trust preferred securities outstanding at both March 31, 2011 and December 31, 2010.

The average rate paid on long-term debt was 3.74% in the first quarter of 2011 and 4.03% in the first quarter of 2010.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity balances were $57.8 million and $56.4 million as of March 31, 2011 and December 31, 2010, respectively. The increase from December 31, 2010 is primarily driven by net earnings of $1.5 million and other comprehensive income due to the change in net unrealized losses on securities available-for-sale of $0.6 million, which was offset by cash dividends paid of approximately $0.7 million.

The Company’s tier 1 leverage ratio was 8.56%, tier 1 risk-based capital ratio was 14.84% and total risk-based capital ratio was 16.09% at March 31, 2011. These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.0% for tier 1 risk-based capital ratio and 10.0% for total risk-based capital ratio to be considered “well-capitalized.” Based on current regulatory standards, the Company is classified as “well capitalized.”

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 acceptable composition of asset/liability mix. Two critical areas of focus for ALCO are interest rate sensitivity and liquidity risk management.

Interest Rate Sensitivity 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 model.

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 are combined with other factors in order to produce various earnings simulations and estimates. To limit interest rate risk, we have guidelines for earnings at risk which seek to limit the variance of net interest income to less than a 10 percent decline for a 200 basis point change up or down in rates from management’s flat interest rate forecast over the next twelve months. The results of our current simulation model would indicate that we are in compliance with our current guidelines at March 31, 2011.

Economic value of equity measures the extent that 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 economic value of equity. To help limit interest rate risk, we have a guideline stating that for a 200 basis point instantaneous change in interest rates up or down, the economic value of equity should not decrease by more than 30 percent. The results of our current economic value of equity model would indicate that we are in compliance with our guidelines at March 31, 2011.

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. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types 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 one 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 (“swaps”) to facilitate customer transactions and meet their financing needs. These swaps qualify as derivatives, but are not designated as hedging instruments. At March 31, 2011 and December 31, 2010, the Company had no derivative contracts to assist in managing 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 legal entities with different funding needs and sources, and each are subject to regulatory guidelines and requirements.

The primary source of funding and the primary source of liquidity for the Company include dividends received from the Bank, and secondarily proceeds from the possible issuance of common stock or other securities. Primary uses of funds for the Company include dividends paid to shareholders, stock repurchases, and interest payments on junior subordinated debentures issued by the Company in connection with trust preferred securities. The junior subordinated debentures are presented as long-term debt in the Consolidated Balance Sheets and the related trust preferred securities are includible in Tier 1 Capital for regulatory capital purposes.

Primary sources of funding for the Bank include customer deposits, other borrowings, repayment and maturity of securities, sales of securities, and 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 has participated in the FHLB’s advance program to obtain funding for its growth. Advances include both fixed and variable terms and are taken out with varying maturities. At March 31, 2011, the Bank had an available line of credit with the FHLB totaling $233.2 million with $63.1 million outstanding. At March 31, 2011, the Bank also had $34.0 million of federal funds lines with none 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 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 and Contingencies

At March 31, 2011, the Bank had outstanding standby letters of credit of $7.8 million and unfunded loan commitments outstanding of $41.4 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 has the ability to liquidate federal funds sold or securities available-for-sale, or draw on its available credit facilities.

The Company also has commitments to fund certain affordable housing investments. The Company invests in various limited partnerships that sponsor affordable housing projects in its primary markets and surrounding areas as a means of supporting local communities. These investments are designed to generate a return primarily through the realization of federal tax credits. The Company typically provides financing during the construction and development of the properties; however, permanent financing is generally obtained from independent parties upon completion of a project. As of March 31, 2011, the Company had investments of $5.9 million, related to these projects, which are included in other assets on the Consolidated Balance Sheets. At March 31, 2011, the Company had $2.5 million of unfunded commitments related to affordable housing investments included in other liabilities. Additionally, the Company had outstanding loan commitments with certain of the partnerships totaling $11.4 million at March 31, 2011. The funded portion of these loans was approximately $7.6 million at March 31, 2011. The funded portions of these loans are included in loans, net of unearned income on the Consolidated Balance Sheets.

The Company also makes various customary representations and warranties to the purchasers, including government agencies and government sponsored utilities such as Fannie Mae, of mortgage loans that the Company originates and sells in the secondary market. These representations and warranties may include, among other things:

•

ownership of the loan;

•

validity of the lien securing the loan;

•

the absence of delinquent taxes or liens against the property;

•

the process used to select the loan for inclusion in a transaction;

•

the loan’s compliance with any applicable loan criteria established by the buyer, including underwriting standards;

•

delivery of all required documents to the trust; and

•

the loan’s compliance with applicable federal, state and local laws.

A breach of these presentations and warranties with respect to a particular mortgage loan or mortgage loans could result in the Company being required to repurchase the loan. During the first quarter of 2011, no loans have been repurchased by the Company. At March 31, 2011, no reserves have been deemed necessary for potential repurchase claims.

Management believes that the Company’s foreclosure process related to mortgage loans continues to operate effectively, and reflects the Company’s interest in these loans and their status appropriately. Foreclosures are approved by Senior Vice Presidents and Division Managers in concert with collection personnel. All documents and activities related to the foreclosure process are completed by the Company’s attorneys.

Effects of Inflation and Changing Prices

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

CURRENT ACCOUNTING DEVELOPMENTS

The following accounting pronouncement has been issued by the FASB, but is not yet effective:

•

ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.

Information about this pronouncement is described in more detail below.

ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, provides guidance clarifying under what circumstances a creditor should classify a restructured loan as a TDR. A loan is a TDR if both of the following exist: (1) a creditor has granted a concession to the debtor, and (2) the debtor is experiencing financial difficulties. The ASU clarifies that a creditor should consider all aspects of a restructuring when evaluating whether it has granted a concession, which include determining whether a debtor can obtain funds from another source at market rates and assessing the value of additional collateral and guarantees obtained at the time of restructuring. The ASU also provides factors a creditor should consider when determining if a debtor is experiencing financial difficulties, such as probability of payment default and bankruptcy declarations. This new guidance is effective for the Company in the third quarter of 2011 with retrospective application to January 1, 2011. Management is evaluating the impact these accounting changes may have on the Company’s consolidated financial statements.

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 of total revenue and the 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 reconciliation of these non-GAAP financial measures from GAAP to non-GAAP is presented below.

2011

2010

(in thousands)

First
Quarter

Fourth
Quarter

Third
Quarter

Second
Quarter

First
Quarter

Net interest income (GAAP)

4,814

4,642

4,738

4,688

4,831

Tax-equivalent adjustment

435

441

449

438

437

Net interest income (Tax-equivalent)

5,249

5,083

5,187

5,126

5,268

Table 2 - Selected Quarterly Financial Data


	2011			2010
(Dollars in thousands, except per share amounts)	First Quarter			Fourth Quarter			Third Quarter		Second Quarter		First Quarter
Results of Operations
Net interest income (a)	$	5,249			5,083			5,187		5,126		5,268
Less: tax-equivalent adjustment		435			441			449		438		437

Net interest income (GAAP)		4,814			4,642			4,738		4,688		4,831
Noninterest income (loss)		1,145			321			1,857		2,792		2,296

Total revenue		5,959			4,963			6,595		7,480		7,127
Provision for loan losses		600			650			730		750		1,450
Noninterest expense		3,650			3,630			4,366		4,809		3,636
Income tax expense		160			(195	)		255		314		424

Net earnings	$	1,549			878			1,244		1,607		1,617

Per share data:
Basic and diluted net earnings	$	0.43			0.24			0.34		0.44		0.44
Cash dividends declared		0.20			0.195			0.195		0.195		0.195
Weighted average shares outstanding:
Basic and diluted		3,642,728			3,642,718			3,642,701		3,642,877		3,643,116
Shares outstanding, at period end		3,642,738			3,642,718			3,642,718		3,642,693		3,643,112
Book value	$	15.87			15.47			16.73		16.21		15.86
Common stock price
High	$	20.37			22.00			22.00		21.00		21.95
Low		19.51			19.50			18.08		16.86		17.61
Period end:		19.56			20.06			20.35		18.80		20.65
To earnings ratio		13.49 x			13.74			15.78		15.41		19.86
To book value		123	%		130			122		116		130
Performance ratios:
Return on average equity		10.84	%		5.68			8.31		10.96		11.31
Return on average assets		0.80	%		0.45			0.64		0.82		0.82
Dividend payout ratio		46.51	%		81.25			57.35		44.32		44.32
Asset Quality:
Allowance for loan losses as a % of:
Loans		2.13	%		2.05			1.91		1.75		1.72
Nonperforming loans		70	%		65			82		72		60
Nonperforming assets as a % of:
Loans and foreclosed properties		5.20	%		5.22			4.42		4.05		4.65
Total assets		2.51	%		2.61			2.18		1.98		2.28
Nonperforming loans as a % of total loans		3.03	%		3.16			2.34		2.43		2.87
Net charge-offs as a % of average loans		0.45	%		0.16			0.14		0.76		1.48
Capital Adequacy:
Tier 1 risk-based capital ratio		14.84	%		14.57			14.53		14.25		13.76
Total risk-based capital ratio		16.09	%		15.82			15.78		15.49		15.01
Tier 1 Leverage Ratio		8.56	%		8.47			8.39		8.27		8.17
Other financial data:
Net interest margin (a)		2.98	%		2.81			2.85		2.82		2.94
Effective income tax rate		9.36	%		NM			17.01		16.35		20.77
Efficiency ratio (b)		57.08	%		67.17			61.98		60.74		48.07
Selected average balances:
Securities	$	320,194			321,956			331,913		326,553		331,098
Loans, net of unearned income		372,319			376,861			374,224		378,491		379,092
Total assets		776,795			773,393			779,879		785,286		784,183
Total deposits		622,720			602,934			559,708		606,041		599,021
Long-term debt		91,728			103,061			113,120		114,880		118,347
Total stockholders’ equity		57,171			61,841			59,900		58,648		57,208
Selected period end balances:
Securities	$	321,098			315,220			322,118		333,107		333,660
Loans, net of unearned income		368,909			374,215			375,098		376,624		380,619
Allowance for loan losses		7,855			7,676			7,181		6,580		6,546
Total assets		781,557			763,829			777,846		784,124		791,324
Total deposits		631,394			607,127			602,508		605,755		608,588
Long-term debt		85,327			93,331			108,335		113,340		118,345
Total stockholders’ equity		57,801			56,368			60,937		59,042		57,778

(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.

NM- not meaningful

Table 3 - Average Balances and Net Interest Income Analysis


	Quarter ended March 31,
	2011							2010
(Dollars in thousands)	Average Balance		Interest Income/ Expense		Yield/ Rate			Average Balance		Interest Income/ Expense		Yield/ Rate
Interest-earning assets:
Loans and loans held for sale (1)	$	374,325	$	5,287		5.73	%	$	381,784	$	5,433		5.77	%
Securities - taxable		240,342		1,695		2.86	%		250,286		2,367		3.84	%
Securities - tax-exempt (2)		79,852		1,278		6.49	%		80,812		1,289		6.47	%

Total securities		320,194		2,973		3.77	%		331,098		3,656		4.48	%
Federal funds sold		17,864		9		0.20	%		12,832		7		0.22	%
Interest bearing bank deposits		2,295		—		—			1,076		—		—

Total interest-earning assets		714,678	$	8,269		4.69	%		726,790	$	9,096		5.08	%
Cash and due from banks		13,715							13,029
Other assets		48,402							44,364

Total assets	$	776,795						$	784,183
Interest-bearing liabilities:
Deposits:
NOW	$	91,975	$	152		0.67	%	$	93,348	$	176		0.76	%
Savings and money market		137,601		255		0.75	%		104,334		288		1.12	%
Certificates of deposits less than $100,000		115,295		588		2.07	%		113,699		740		2.64	%
Certificates of deposits and other time deposits of $100,000 or more		189,598		1,175		2.51	%		204,174		1,436		2.85	%

Total interest-bearing deposits		534,469		2,170		1.65	%		515,555		2,640		2.08	%
Short-term borrowings		2,477		3		0.49	%		6,256		11		0.71	%
Long-term debt		91,728		847		3.74	%		118,347		1,177		4.03	%

Total interest-bearing liabilities		628,674	$	3,020		1.95	%		640,158	$	3,828		2.43	%
Noninterest-bearing deposits		88,251							83,466
Other liabilities		2,699							3,351
Stockholders’ equity		57,171							57,208

Total liabilities and stockholders’ equity	$	776,795						$	784,183

Net interest income and margin			$	5,249		2.98	%			$	5,268		2.94	%

(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 an income tax rate of 34%.

Table 4 - Loan Portfolio Composition


	2011		2010
(In thousands)	First Quarter		Fourth Quarter		Third Quarter		Second Quarter		First Quarter
Commercial and industrial	$	51,323		53,288		58,400		56,168		52,918
Construction and land development		48,814		47,850		46,928		48,758		57,945
Commercial real estate		161,882		166,241		161,676		159,367		158,781
Residential real estate		95,997		96,241		96,888		100,451		99,660
Consumer installment		10,968		10,676		11,312		12,037		11,475

Total loans		368,984		374,296		375,204		376,781		380,779
Less: unearned income		(75)		(81)		(106)		(157)		(160)

Loans, net of unearned income		368,909		374,215		375,098		376,624		380,619
Less: allowance for loan losses		(7,855)		(7,676)		(7,181)		(6,580)		(6,546)

Loans, net	$	361,054		366,539		367,917		370,044		374,073

Table 5 - Allowance for Loan Losses and Nonperforming Assets


	2011			2010
(Dollars in thousands)	First Quarter			Fourth Quarter			Third Quarter			Second Quarter			First Quarter
Allowance for loan losses:
Balance at beginning of period	$	7,676			7,181			6,580			6,546			6,495
Charge-offs:
Commercial and industrial		(56	)		(66	)		(77	)		(326	)		(68	)
Construction and land development		(33	)		(20	)		(5	)		(169	)		(1,293	)
Commercial real estate		(339	)		—			—			—			—
Residential real estate		(57	)		(153	)		(91	)		(262	)		(46	)
Consumer installment		(1	)		(9	)		(14	)		(83	)		(5	)

Total charge-offs		(486	)		(248	)		(187	)		(840	)		(1,412	)
Recoveries		65			93			58			124			13

Net charge-offs		(421	)		(155	)		(129	)		(716	)		(1,399	)
Provision for loan losses		600			650			730			750			1,450


Ending balance	$	7,855			7,676			7,181			6,580			6,546

as a % of loans		2.13	%		2.05			1.91			1.75			1.72
as a % of nonperforming loans		70	%		65			82			72			60
Net charge-offs as a % of average loans		0.45	%		0.16			0.14			0.76			1.48


Nonperforming assets:
Nonaccrual loans	$	11,165			11,833			8,776			9,151			10,934
Other nonperforming assets (primarily other real estate owned)		8,450			8,125			8,163			6,341			7,081

Total nonperforming assets	$	19,615			19,958			16,939			15,492			18,015

as a % of loans and foreclosed properties		5.20	%		5.22			4.42			4.05			4.65
as a % of total assets		2.51	%		2.61			2.18			1.98			2.28
Nonperforming loans as a % of total loans		3.03	%		3.16			2.34			2.43			2.87
Accruing loans 90 days or more past due	$	158			—			62			243			374

Table 6 - Allocation of Allowance for Loan Losses


	2011				2010
	First Quarter				Fourth Quarter				Third Quarter				Second Quarter				First Quarter
(Dollars in thousands)	Amount		%*		Amount		%*		Amount		%*		Amount		%*		Amount		%*
Commercial and industrial	$	1,142		13.9	$	973		14.2	$	874		15.6	$	881		14.9	$	738		13.9
Construction and land development		2,257		13.2		2,223		12.8		2,177		12.5		1,092		12.9		1,180		15.2
Commercial real estate		2,697		43.9		2,893		44.4		2,308		43.1		2,178		42.3		1,972		41.7
Residential real estate		1,284		26.0		1,336		25.7		1,292		25.8		1,918		26.7		1,964		26.2
Consumer installment		202		3.0		141		2.9		133		3.0		198		3.2		207		3.0
Unallocated		273				110				397				313				485

Total allowance for loan losses	$	7,855			$	7,676			$	7,181			$	6,580			$	6,546

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

Table 7 - CDs and Other Time Deposits of $100,000 or More


(Dollars in thousands)	March 31, 2011
Maturity of:
3 months or less	$	12,301
Over 3 months through 6 months		16,892
Over 6 months through 12 months		53,681
Over 12 months		100,557

Total CDs and other time deposits of $100,000 or more	$	183,431

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 Principal Financial and Accounting 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 Principal Financial and Accounting 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 business, the Company and the Bank from time to time are involved in legal proceedings. The Company and Bank 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, 2010.

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 our annual report on Form 10-K for the year ended December 31, 2010, 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.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

ISSUER PURCHASES OF EQUITY SECURITIES


Period⁽¹⁾	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1 - January 31	—	—	—	—
February 1 - February 28	—	—	—	—
March 1 - March 31	—	—	—	—
Total		—	—	—

⁽¹⁾	Based on trade date, not settlement date.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

REMOVED AND RESERVED

ITEM 5.

OTHER INFORMATION

Not applicable.

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 E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.

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, Vice President, Controller and Chief Financial Officer (Principal Financial and Accounting 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 E.L. Spencer, Jr., President, Chief Executive Officer and Chairman of the Board.***

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, Vice President, Controller and Chief Financial Officer (Principal Financial and Accounting Officer).***

*	Incorporated by reference from Registrant’s Form 10-Q dated September 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.

SIGNATURES

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


		AUBURN NATIONAL BANCORPORATION, INC.
			(Registrant)

Date:	May 16, 2011	By:	/s/ E. L. Spencer, Jr.
			E. L. Spencer, Jr.
			President, Chief Executive
			Officer and Chairman of the Board

Date:	May 16, 2011	By:	/s/ David A. Hedges
			David A. Hedges
			VP, Controller and Chief Financial Officer
			(Principal Financial and Accounting Officer)