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EX-23.0 - EXHIBIT 23.0 - Auburn Bancorp, Inc.ex23-0.htm
EX-32.2 - EXHIBIT 32.2 - Auburn Bancorp, Inc.ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - Auburn Bancorp, Inc.ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Auburn Bancorp, Inc.ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - Auburn Bancorp, Inc.ex32-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC   20549
 
FORM 10-K
 
x          Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the fiscal year ended June 30, 2011
 
o          Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission File Number 0-53370
 
  Auburn Bancorp, Inc.  
(Exact name of registrant as specified in its charter) 
 
United States
 
26-2139168
(State or other jurisdiction
 
(IRS Employer
of incorporation)
 
Identification No.)
 
  256 Court Street, P.O. Box 3157, Auburn, Maine 04212  
  (Address and zip code of principal executive offices)   
     
  (207) 782-0400  
  (Registrant’s telephone number, including area code)  
 
  None  
  (Former name, former address and former fiscal year, if changed since last report)  
 
Securities Registered Pursuant to Section 12(b) of the Exchange Act:
 
None
 
Securities Registered Pursuant to Section 12(g) of the Exchange Act:
 
Common Stock, par value $0.01 per share
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
o Yes  x No
 
Indicate by check mark if the registrant is not required to file pursuant to Section 13 or Section 15(d) of the Act.
o Yes  x No
 
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. x  Yes  o  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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). o  Yes  o  No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
 
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.
 
Large accelerated filer o                                                    Accelerated filer o
 
Non-accelerated filer o                                                      Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
Based upon the closing price of the registrant’s common stock as of December 31, 2010 the aggregate market value of the voting common equity held by non-affiliates was $1,261,991.  For purposes of the calculation, all directors and executive officers were deemed to be affiliates of the registrant.  
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $0.01 par value, 503,284 outstanding as of September 27, 2011, 276,806 of which are owned by Auburn Bancorp, MHC, our federally chartered mutual holding company.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
List hereunder the following documents if incorporated by reference and the Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is incorporated:
 
(1)      Portions of the Company’s definitive Proxy Statement for its 2011 Annual Meeting of Stockholders (the “Proxy Statement”) are incorporated by reference in Part III of this Form 10-K.
 
 
 

 
 
Auburn Bancorp, Inc.
Form 10-K
 
PART I
   
Item 1.
Business
1
Item 1A
Risk Factors
30
Item 1B.
Unresolved Staff Comments
31
Item 2.
Properties
31
Item 3.
Legal Proceedings
31
Item 4.
[Removed and Reserved]
31
     
PART II
   
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
32
Item 6.
Selected Financial Data
33
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
33
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
46
Item 8.
Financial Statements and Supplementary Data
46
Item 9.
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
46
Item 9A.
Controls and Procedures
46
Item 9B.
Other Information
47
     
PART III
   
Item 10.
Directors, Executive Officers and Corporate Governance
47
Item 11.
Executive Compensation
47
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
47
Item 13.
Certain Relationships and Related Transactions, and Director Independence
47
Item 14.
Principal Accounting Fees and Services
47
     
PART IV
   
Item 15.
Exhibits, Financial Statement Schedules
48
     
Signatures
 
49
 
 
 

 
 
PART I
 
Item 1. Business
 
The terms “we,” “our,” “our company,” and “us” refer, unless the context suggests otherwise, to Auburn Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Auburn Savings Bank, FSB (the “Bank”).
 
Forward-Looking Statements.
 
Certain statements herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the beliefs and expectations of management, as well as the assumptions made using information currently available to management. Since these statements reflect the views of management concerning future events, these statements involve risks, uncertainties and assumptions. As a result, actual results may differ from those contemplated by these statements. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe”, “expect”, “anticipate”, “estimate”, and “intend” or future or conditional verbs such as “will”, “would”, “should”, “could”, or “may.” Certain factors that could have a material adverse affect on the operations of Auburn Savings Bank include, but are not limited to, increased competitive pressure among financial service companies, national and regional economic conditions, changes in interest rates, changes in consumer spending, borrowing and savings habits, legislative and regulatory changes, adverse changes in the securities markets, inability of key third-party providers to perform their obligations to Auburn Savings Bank and changes in relevant accounting principles and guidelines.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We disclaim any intent or obligation to update any forward-looking statements, whether in response to new information, future events or otherwise.
 
Business of Auburn  Bancorp, Inc.
 
The Company was organized as a federal corporation in connection with the reorganization of the Bank from the mutual form of organization to the mutual holding company form of organization. The reorganization was completed on August 15, 2008. In the reorganization, the Company issued a total of 503,284 shares of common stock, 226,478 shares of which were sold to eligible depositors and other members of the Bank, an employee stock ownership plan and members of the general public and 276,806 shares of which were issued to Auburn Bancorp, MHC, a federally-chartered mutual holding company.
 
As a result of the reorganization, the Company owns all of the issued and outstanding common stock of the Bank.  In the future, the Company, as the holding company of the Bank, will be authorized to pursue other business activities permitted by applicable laws and regulations for savings and loan holding companies, which may include the acquisition of banking and financial services companies. We have no plans for any mergers or acquisitions or other diversification of the activities of the Company at the present time.
 
Our cash flow will depend on earnings from the investment of the net proceeds we retained from the stock offering and any dividends received from the Bank. Currently, the Company neither owns nor leases any property, but will instead use the premises, equipment and furniture of the Bank. At the present time, the Company employs only persons who are officers of the Bank as officers of the Company. We will, however, use the support staff of the Bank from time to time. All of these persons are paid by the Bank under the terms of a management agreement with the Company.  The Company may hire additional employees, as appropriate, to the extent it expands its business in the future.
 
 
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Business of Auburn Savings Bank, FSB
 
The Bank is a community-oriented savings bank.  We were originally established in 1887 as a state-chartered loan and building association named “Auburn Loan and Building Association” and later converted to a state-chartered savings and loan association named “Auburn Savings and Loan Association.”  In July 2006, the Bank converted from a state-chartered savings and loan association to a federal mutual savings bank and changed its name to “Auburn Savings Bank, FSB.”  On August 15, 2008, the Bank reorganized into the mutual holding company form of organization and became a stock form federal savings institution.
 
Our principal business consists of attracting retail deposits from the general public in the areas surrounding our main office in Auburn, Maine and our branch office in Lewiston, Maine and investing those deposits, together with funds generated from operations, primarily in one- to four-family residential mortgage loans and home equity loans and lines of credit, commercial and multi-family real estate loans, and, to a lesser extent, commercial business loans, construction loans, consumer loans, and investment securities. Our revenues are derived principally from interest on loans and securities. We also generate revenues from fees and service charges and other income. Our primary sources of funds are deposits, borrowings and principal and interest payments on loans and securities.
 
Our website address is www.auburnsavings.com. Information on our website should not be considered a part of this Annual Report on Form 10-K.  
 
Market Area
 
We primarily serve communities located in Androscoggin County, Maine. We are headquartered in Auburn, Maine.  In addition to our main office, we operate a full-service branch office in Lewiston, Maine.  Lewiston and Auburn are in Androscoggin County, Maine, approximately 35 miles northeast of Portland, Maine. Historically, substantially all of our loans have been made to borrowers who resided within Androscoggin County.  Androscoggin County is also the same geographic area as the Lewiston-Auburn metropolitan statistical area (the “Lewiston-Auburn MSA”).
 
During the past several years, the population in the Lewiston-Auburn area as well as in Androscoggin County has increased moderately.  As of 2010, the most recent date for which data is available, Androscoggin County’s total population increased by 4.03% from the county’s population in 2000.  The total population of the city of Lewiston decreased by 0.7% from 2000 to 2010, while the total population of the city of Auburn increased by 2.4% over the same time period.
 
The largest industries in Androscoggin County are educational services, health care and social assistance.  The two largest employers in the area, Central Maine Medical Center and St. Mary’s Health Systems, are both health service providers.  The median household income in Androscoggin County in 2010 was $43,416 which is below the state and national median household incomes of $46,353 and $54,442, respectively.  As of July 2010, the unemployment rate in Androscoggin County was 8.5%, above the state unemployment rate of 7.9% and below the United States unemployment rate of 9.5%.
 
 
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Competition
 
We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from the many financial institutions operating in our market area and, to a lesser extent, from other financial service companies such as brokerage firms and insurance companies.  Federal and state credit unions accounted for approximately a quarter of the total deposits in Androscoggin County, and have the competitive advantage of not paying state and federal income tax while having a broad range of banking powers.  In addition, several large holding companies operate banks in our market area, including Toronto Dominion Bank, Bank of America and Key Bank, as well as several Maine-based banks including Androscoggin Savings Bank, Bangor Savings Bank, Mechanics Savings Bank and Northeast Bank.  Most of these institutions are significantly larger than us and, therefore, have significantly greater resources.  We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2010, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation, we held 4.80% of the deposits in Androscoggin County.
 
Our competition for loans comes primarily from financial institutions in our market area and, to a lesser extent, from other financial service providers, such as mortgage companies and mortgage brokers.  Competition for loans also comes from the increasing number of non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.
 
We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Changes in federal law permit affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could limit our growth in the future.
 
Lending Activities
 
We originate one- to four-family residential loans and home equity loans.  We also originate commercial and multi-family real estate loans and, to a lesser extent, commercial business loans, construction loans and consumer loans.  We believe that originating a limited amount of non-residential and multi-family loans allows us to provide more comprehensive financial services to families and businesses within our community as well as increase the yield and interest rate sensitivity of our loan portfolio.  
 
 
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Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan as of the dates indicated.
                         
    At June 30,  
   
2011
   
2010
 
   
Amount
   
Percent
   
Amount
   
Percent
 
    (Dollars in Thousands)  
                         
Mortgage loans:
                       
One- to four-family residential
  $ 40,549       59.3 %   $ 36,418       52.4 %
Commercial
    11,310       16.5 %     15,136       21.8 %
Construction
    156       0.2 %     410       0.6 %
Equity lines of credit and loans
    11,141       16.3 %     11,436       16.4 %
Undisbursed portion of construction loan
    (112 )     -0.2 %     (97 )     -0.1 %
                                 
Total mortgage loans on real estate
  $ 63,044       92.1 %   $ 63,303       91.1 %
                                 
Other loans:
                               
Commercial loans
    4,485       6.6 %     5,267       7.5 %
Consumer loans
    897       1.3 %     952       1.4 %
                                 
Total loans
  $ 68,426       100.0 %   $ 69,522       100.0 %
                                 
Other loans:
                               
Deferred loan origination costs
  $ 161             $ 165          
Deferred loan origination fees
    (284 )             (312 )        
Allowance for loan losses
    (907 )             (492 )        
                                 
Total loans, net
  $ 67,396             $ 68,883          
 
One- to Four-Family Residential Loans. Our primary lending activity consists of the origination of one- to four-family residential mortgage loans, substantially all of which are secured by properties located in our primary market area.  We offer fixed-rate mortgage loans, which generally have terms of 15, 20 or 30 years.   We no longer offer adjustable-rate mortgage loans (“ARMs”), however, interest rates and payments on our existing portfolio of adjustable-rate loans generally are adjusted to a rate equal to a percentage above the one-year U.S. Treasury index, in the case of one-year ARMs, and the three-year U.S. Treasury index, in the case of three-year ARMs. The maximum amount by which the interest rate may be increased or decreased is generally 1% per adjustment period with a lifetime interest rate cap of 5% over the initial interest rate of the loan on one-year ARM loans and 2% per adjustment period with a lifetime rate cap of 6% over the initial interest rate of the loan on three-year ARM loans.
 
At June 30, 2011, $40.5 million, or 59.3% of our loan portfolio, consisted of one- to four-family residential mortgage loans.  Of the one- to four-family residential mortgage loans outstanding on June 30, 2011, $31.2 million were fixed-rate mortgage loans with an average yield of 6.06%, and $9.3 million were adjustable-rate loans with an average yield of 4.17%.
 
We generally underwrite all residential real estate loans to secondary market credit standards.  While one- to four-family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
 
 
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We do not offer loans with negative amortization and generally do not offer interest only loans.  We generally do not make loans known as subprime or Alt-A loans.
 
We generally do not make loans with a loan-to-value ratio of more than 80% without private mortgage insurance. We make first mortgage loans on owner-occupied one-to-four family dwellings up to 85% of value and loans on condominium units up to 80% of value.  We generally require all properties securing mortgage loans to be appraised by a board-approved independent appraiser. We generally require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.  
 
Our residential mortgage loans customarily include due-on-sale clauses giving us the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage and the loan is not repaid.
 
At June 30, 2011, our largest one-to four-family residential real estate loan had a principal balance of $320,980, was secured by a residence located in Scarborough, Maine, and was performing in accordance with its original terms.
 
Home Equity Loans. We offer home equity lines of credit and home equity loans.  At June 30, 2011, we had $11.1 million of home equity lines-of-credit and loans outstanding, representing 16.3% of our loan portfolio.  At June 30, 2011, the unadvanced amounts of home equity lines of credit totaled $3.5 million.
 
Home equity lines of credit and loans are secured by a mixture of first and second mortgages on one- to four-family owner occupied properties.  The procedures for underwriting home equity lines of credit and loans include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan.  We generally require all properties securing second mortgage loans to be appraised by a board-approved independent appraiser unless the first mortgage is also held by Auburn Savings Bank.  Home equity lines of credit and loans are made in amounts such that the combined first and second mortgage balances do not exceed 90% of value.
 
Home equity loans are offered with fixed interest rates and generally have terms of 5, 10 or 15 years.  Our home equity lines of credit have adjustable rates of interest, which are adjusted monthly to a rate equal to a half of a percentage above the Prime Rate as published by The Wall Street Journal on the last business day of the month.  Home equity lines of credit have a maturity of 40 years with a five-year draw period.
 
Commercial and Multi-Family Real Estate Loans. We offer commercial real estate loans, including commercial business, and multi-family real estate loans that are generally secured by five or more unit apartment buildings and properties used for business purposes such as small office buildings or retail facilities substantially all of which are located in our primary market area.  We have placed increasing emphasis on commercial real estate loans over the past several years.  As a result, these loans have grown from $5.0 million at December 31, 2005 to $11.3 million at June 30, 2011.  At June 30, 2011, commercial and multi-family real estate loans represented 16.5% of our loan portfolio.  We intend to further grow these segments of our loan portfolio, both in absolute terms and as a percentage of our loan portfolio.   
 
 
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We typically offer adjustable rate commercial and multi-family real estate loans with terms of up to 20 years. Interest rates on our commercial and multi-family real estate loans adjust annually from the outset of the loan or after a five-year initial fixed rate period.  In general, rates on commercial and multi-family real estate loans are initially priced at a percentage above the corresponding Federal Home Loan Bank borrowing rate and, thereafter, interest rate adjustments are based upon a percentage above either the Prime Rate published by The Wall Street Journal on the last business day of the month or the corresponding Federal Home Loan Bank borrowing rate. Commercial and multi-family real estate loan amounts generally do not exceed 80% of the lesser of the property’s appraised value or sales price.
 
We generally require title insurance for commercial and multi-family real estate loans, an appraisal on all such loans if the total amount of loans with that borrower is in excess of $250,000, and an evaluation of the property by an approved appraiser for loans between $100,000 and $250,000.  We may require a full appraisal on property securing any loan less than $250,000.
 
In reaching a decision on whether to make a multi-family or commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise and credit history, and the profitability of the underlying business and the value of the underlying property. In addition, with respect to real estate rental properties, we will also consider the term of the lease and the quality of the tenants. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.2 times. Generally, multi-family and commercial real estate loans made to corporations, partnerships and other business entities require the principals to execute the loan agreements in their individual capacity as well as signing on behalf of such business entity.
 
A commercial borrower’s financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviews and periodic face-to-face meetings with the borrower. We generally require commercial borrowers to provide federal tax returns and financial statements annually. These requirements also apply to the individual principals of our commercial borrowers. We may require borrowers with rental investment property to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable.
 
Loans secured by commercial real estate, including multi-family properties, generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate, including multi-family properties, are often dependent on successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.
 
At June 30, 2011, our largest commercial real estate loan was for $544,000 and was secured by real estate in Lisbon, Maine and 80% is guaranteed by the Finance Authority of Maine (FAME). This loan was performing according to its original repayment terms at June 30, 2011.  Our largest multi-family real estate loan was for $295,000, was secured by real estate in Auburn, Maine and was performing according to its original repayment terms at June 30, 2011.
 
Construction Loans. We also offer construction loans for the development of one- to four-family residential properties located in our primary market area.  Residential construction loans are generally offered to individuals for construction of their personal residences.  Our construction loans were $2.6 million at December 31, 2005 as compared to $156,000 at June 30, 2011.  At June 30, 2011, residential and commercial construction loans represented 0.2% of our loan portfolio.  At June 30, 2011, the unadvanced portion of these construction loans totaled $112,000.
 
Our residential construction loans generally provide for the payment of interest only during the construction phase, which is usually six months. In the case of construction loans to individuals for the construction of their primary residences, our policies require that the loan convert to a permanent mortgage loan at the end of the construction phase. Residential construction loans can be made with a maximum loan-to-value ratio of 95%, provided that the borrower obtains private mortgage insurance on the loan if the loan balance exceeds 80% of the appraised value of the secured property.
 
 
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At June 30, 2011, there was only one residential construction loan commitment for $156,000 of which $44,000 was outstanding. This loan was performing according to its terms at June 30, 2011. Residential construction loans are generally made on the same terms as our one- to four-family mortgage loans.
 
Before making a commitment to fund a residential construction loan, we require an appraisal on the property by an independent licensed appraiser. We also review and inspect each property before disbursement of funds during the terms of the construction loan. Loan proceeds are disbursed after inspection based on the percentage of completion method.
 
Construction and development financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value proves to be inaccurate, we may be confronted with a project, when completed, having a value which is insufficient to assure full repayment.
 
Commercial Loans. We make commercial business loans primarily in our market area to a variety of small businesses, professionals and sole proprietorships.  Our commercial business loan portfolio has grown from $1.3 million at December 31, 2005 to $4.5 million at June 30, 2011.  At June 30, 2011, commercial business loans represented 6.6% of our loan portfolio.
 
Commercial lending products include term loans and revolving lines of credit. The maximum amount of a commercial business loan is limited by our loans-to-one-borrower limit of 15% of unimpaired capital, which at June 30, 2011 was $1 million.  Commercial loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. Commercial loans are made with either adjustable or fixed rates of interest. Adjustable rate loans are based on the Prime Rate, as published in The Wall Street Journal, plus a margin.  The rate adjusts monthly from the outset of the loan.  Our adjustable rate commercial business loans amortize over terms up to 15 years and may carry prepayment penalties. Fixed rate commercial loans are set at percentage above either the corresponding Federal Home Loan Bank borrowing rate or the Prime Rate.
 
When making commercial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral. Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and we also require the business principals to execute such loans in their individual capacities. Depending on the amount of the loan and the collateral used to secure the loan, commercial loans are made in amounts of up to 50-80% of the value of the collateral securing the loan, or up to 100% of the value of the collateral securing the loan if the collateral consists of cash or cash equivalents. We generally do not make unsecured commercial loans.  We require adequate insurance coverage including, where applicable, title insurance, flood insurance, builder’s risk insurance and environmental insurance.
 
Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. We seek to minimize these risks through our underwriting standards.
 
 
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At June 30, 2011, our largest commercial loan was a $752,000 loan to a public accounting firm located in Scarborough, Maine.  This loan is secured by business assets and 90% is guaranteed by the Small Business Association (SBA).  This loan was performing according to its terms at June 30, 2011.
 
Consumer Loans. We offer a limited range of consumer loans, primarily to our customers residing in our primary market area.  Our consumer loans generally consist of loans on new and used automobiles, loans secured by deposit accounts and unsecured personal loans.  As of June 30, 2011, these loans totaled $897,000, or 1.3% of our loan portfolio.
 
Our automobile loans have fixed interest rates and generally have terms up to five years for new automobiles and four years for used automobiles. We will generally offer automobile loans with a maximum loan-to-value ratio of 80% of the base vehicle price plus accessories or, if less for used cars, the average retail value taken from a current month’s issue of the “NADA Used Car Guide.”
 
The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.
 
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as motor vehicles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
 
Origination, Sale and Servicing of Loans. We originate real estate and other loans through marketing efforts, our customer base, walk-in customers and referrals from real estate brokers, builders and attorneys.  We generally do not purchase loans or participation interests in loans.
 
Generally, we sell a portion of the fixed-rate one- to four-family mortgages that we originate to the Federal Home Loan Bank of Boston.  We generally make decisions regarding the amount of loans that we wish to sell based on an evaluation of asset/liability position and similar factors.  See “Management’s Discussion and Analysis of Financial Condition and Operating Results – Management of Market Risk.”  During the fiscal years 2011 and 2010, we sold $2.2 million and $2.6 million, respectively, of fixed-rate one-to-four family mortgage loans to the Federal Home Loan Bank of Boston.  We retained servicing on all of those loans. At June 30, 2011, we serviced $9.8 million of mortgage loans that were sold by us to the Federal Home Loan Bank of Boston.
 
We account for a transfer of financial assets, or a portion of a financial asset, as a sale when we surrender control of the transferred assets. Servicing rights and other retained interests in the sold assets are recorded by allocating the previously recorded investment between the assets sold and interest retained based on their relative fair values at the date of transfer. We determine the fair values of servicing rights and other retained interests at the date of transfer using a method that approximates the present value of estimated future cash flows, using assumptions that market participants would use in their estimates of values.
 
 
8

 
 
Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by the board of directors of Auburn Savings Bank. The board of directors has granted loan approval authority to certain officers up to prescribed individual limits based on the type and amount of the loan request, whether the loan is secured or unsecured, and the officer’s position at Auburn Savings Bank. Residential mortgage loans over $225,000, home equity loans over $125,000, commercial mortgage loans over $300,000, secured commercial business loans over $125,000 and unsecured commercial business loans over $15,000 must be approved by the management loan committee of Auburn Savings Bank, which consists of the President, Senior Loan Officer and Commercial Loan Officer.  Residential mortgage loans over $300,000, home equity loans over $150,000, commercial mortgage loans over $400,000, secured commercial business loans over $150,000 and unsecured commercial business loans over $20,000 must be approved by either the loan committee of the board of directors or the full board of directors of Auburn Savings Bank based upon the type and amount of the loan request. 
 
Loans to One Borrower.  The maximum amount that we may lend to one borrower and the borrower’s related entities is limited by regulation generally, with certain exceptions, to 15% of our unimpaired capital and reserves. At June 30, 2011, our largest relationship exposure was $802,000 with a public accounting firm, secured by business assets and personal real estate. This relationship includes an individual loan balance of $752,000 of which 90% ($677,000) is guaranteed by the Small Business Association (SBA).  This loan was performing according to its terms at June 30, 2011.
 
Loan Commitments. We issue commitments for fixed- and adjustable-rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers. Generally, our loan commitments expire after 45 days.
 
Loan Maturity.  The following table sets forth certain information at June 30, 2011 regarding the dollar amount of loan principal repayments becoming due during the periods indicated.  The table does not reflect scheduled principal payments, unscheduled prepayments, or the ability of certain loans to reprice prior to maturity dates. Demand loans, loans having no stated repayment schedule, and overdraft loans are reported as being due in one year or less.
 
 
9

 
 
    Mortgage loans                    
   
One- to four-family
residential
   
Commercial
   
Construction
   
Home Equity Loans and
Lines of Credit
   
Undisbursed portion of
construction loan
   
Commercial
   
Consumer
    Total  
         
Weighted
         
Weighted
         
Weighted
         
Weighted
         
Weighted
         
Weighted
         
Weighted
             
         
Average
         
Average
         
Average
         
Average
         
Average
         
Average
         
Average
         
Weighted
 
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Average Rate
 
Due
                                                                                               
Within 1 year
  $ -       0.00 %   $ -       0.00 %   $ 156,000       5.00 %   $ 21,361       6.22 %   $ (112,094 )     5.00 %   $ 2,112,539       4.49 %   $ 44,017       5.76 %   $ 2,221,823       4.54 %
After 1 year through 3 years
    259,454       6.30 %     610,166       5.81 %     -       0.00 %     642,221       5.13 %     -       0.00 %     860,903       6.87 %     369,612       7.48 %     2,742,356       6.25 %
After 3 years through 5 years
    682,580       6.61 %     1,993,729       6.04 %     -       0.00 %     211,328       5.88 %     -       0.00 %     702,377       6.26 %     232,154       6.07 %     3,822,168       6.18 %
After 5 years through 10 years
    5,020,012       6.51 %     6,424,889       6.96 %     -       0.00 %     1,920,282       6.17 %     -       0.00 %     752,339       6.00 %     106,080       8.39 %     14,223,602       6.65 %
After 10 years through 15 years
    4,283,771       5.69 %     1,221,322       5.76 %     -       0.00 %     3,350,043       6.17 %     -       0.00 %     -       0.00 %     79,610       7.44 %     8,934,746       5.90 %
After 15 years
    30,302,775       5.44 %     1,059,576       6.30 %     -       0.00 %     4,996,650       3.76 %     -       0.00 %     56,699       5.71 %     65,547       9.92 %     36,481,247       5.24 %
                                                                                                                                 
Total
  $ 40,548,592       5.62 %     $ 11,309,681       6.54 %   $ 156,000       5.00 %   $ 11,141,885       5.02 %   $ (112,094 )     5.00 %   $ 4,484,857       5.49 %   $ 897,020       7.31 %   $ 68,425,942       5.69 %
 
 
10

 
 
Asset Quality
 
General.  One of our most important operating objectives is to maintain a high level of asset quality.  Management uses a number of strategies in furtherance of this goal including maintaining sound credit standards in loan originations, monitoring the loan portfolio through internal and third-party loan reviews, and employing active collection and workout processes for delinquent or problem loans.
 
Delinquency Procedures. Management performs a monthly review of all delinquent loans.  The actions taken with respect to delinquencies vary depending upon the nature of the delinquent loans and the period of delinquency.  When a borrower fails to make a required payment on a loan, we attempt to cause the delinquency to be cured by contacting the borrower. A late notice is generated and is sent to all mortgage loans 15 days delinquent and to all consumer loans 15 days delinquent. The borrower is contacted by the collections officer between 30 and 45 days after the due date of all loans. Another late notice along with any required demand letters as set forth in the loan contract are sent up to 90 days after the due date. Additional written and verbal contacts may be made with the borrower between 60 and 90 days after the due date.  If the delinquency is not cured by the 91st day, the customer is normally provided 30 days written notice that the account will be referred to counsel for collection and foreclosure, if necessary. If it becomes necessary to foreclose, the property is sold at public sale and we may bid on the property to protect our interest. The decision to foreclose is made by our Executive Vice President and Senior Loan Officer.
 
Non-Performing Assets.  The table below sets forth the amounts and categories of non-performing assets in our loan portfolio at the dates indicated.  Loans are placed on non-accrual status when reasonable doubt exists as to the full timely collection of interest and principal or when a loan becomes 90 days past due unless an evaluation clearly indicates that the loan is well-secured and in the process of collection.  When a loan is placed on non-accrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans generally is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
 
Real estate we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold.  When property is acquired, it is recorded at the lower of its cost, which is the unpaid balance of the loan plus foreclosure costs, or fair market value at the date of foreclosure.  Holding costs and declines in fair market value after acquisition of the property result in charges against income.  At each of the dates presented below, we did not have any troubled debt restructurings that involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates or any accruing loans past due 90 days or more.
 
 
11

 
 
 
   
At June 30,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
Non-accrual loans:
           
Mortgage loans
  $ 138     $ 457  
Commercial loans
    328       91  
Consumer loans
    2       3  
Total non-accrual loans
  $ 468     $ 551  
                 
Loans greater than 90 days delinquent and still accruing:
               
Mortgage loans
  $ -     $ -  
Commercial loans
    -       -  
Consumer loans
    -       -  
Total loans greater than 90 days delinquent and still accruing:
  $ -     $ -  
                 
Other real estate owned
  $ 1,220     $ 731  
Total non-performing assets
  $ 1,908     $ 1,282  
                 
Ratios:
               
Non-performing assets to total loans
    2.79 %     1.84 %
Non-performing assets to total assets
    2.45 %     1.59 %
 
Interest income of $37,866 would have been recorded for fiscal year 2011 had our non-accruing loans been current in accordance with their original terms and we recorded interest income of $24,492.
 
Delinquent Loans.  The following table sets forth our loan delinquencies by type and amount at the dates indicated.
 
    At June 30,  
    2011     2010  
               
Over 90
               
Over 90
 
   
30-59 days
   
60-89 days
   
days past
   
30-59 days
   
60-89 days
   
days past
 
   
past due
   
past due
   
due
   
past due
   
past due
   
due
 
    (Dollars in Thousands)  
Mortgage Loans:
                                   
One- to four-family residential
  $ 621     $ 220     $ 138     $ 395     $ 337     $ 425  
Commercial
    203       83       271       110       46       -  
Construction
    -       -       -       -       -       -  
Equity lines of credit
    12       85       -       171       -       32  
Undisbursed portion of construction loan
    -       -       -       -       -       -  
Commercial loans
    19       -       -       -       -       91  
Consumer loans
    94       -       2       6       -       3  
                                                 
Total:
  $ 949     $ 388     $ 411     $ 682     $ 383     $ 551  
 
 
12

 
 
Classified Assets.
 
Federal regulations require us to review and classify our assets on a regular basis. In addition, the Office of Thrift Supervision has the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also provide for a “special mention” category, described as assets that do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention. When we classify an asset as substandard or doubtful we establish a specific allowance for loan losses. If we classify an asset as loss, we charge off an amount equal to 100% of the portion of the asset classified loss.
 
The aggregate amount of our classified assets at the dates indicated were as follows:
 
   
At June 30,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
Special Mention                                                           
  $ 1,568     $ 1,400  
Substandard                                                           
    836       324  
Doubtful                                                           
    834       303  
Loss                                                           
    59       3  
Total Classified Assets                                                     
  $ 3,297     $ 2,030  
 
Other than disclosed in the table above, there were no other loans that management has serious doubts about the ability of the borrowers to comply with the present loan repayment terms and would result in disclosure as nonaccrual, 90 days past due, restructured or impaired.
 
Allowance for Loan Losses.  In originating loans, we recognize that losses will be experienced on loans and that the risk of loss will vary with many factors, including the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan over the term of the loan. We maintain an allowance for loan losses that is intended to absorb losses inherent in the loan portfolio, and as such, this allowance represents management’s best estimate of the probable known and inherent credit losses in the loan portfolio as of the date of the financial statements. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
 
The allowance for loan losses is evaluated on a quarterly basis by management and is based on management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
 
The allowance consists of specific and general components.  The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component relates to pools of non-impaired loans and is based on historical loss experience adjusted for qualitative factors, such as delinquency trends, changes in portfolio mix and current economic conditions.
 
 
13

 
 
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Management considers factors including payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due when determining impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.  Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment disclosures.  The following is a summary of information pertaining to impaired loans as of June 30, 2011 and 2010:
 
   
2011
   
2010
 
Impaired loans without a valuation allowance
  $ -     $ 516,137  
Impaired loans with a valuation allowance
    892,914       372,307  
Total impaired loans
  $ 892,914     $ 888,444  
                 
Valuation allowance allocated to impaired loans
  $ 214,080     $ 43,368  
                 
Average investment in impaired loans
  $ 894,628     $ 335,440  
 
The Office of the Comptroller of the Currency (“OCC”) which effective July 21, 2011 succeeded the Office of Thrift Supervision as our primary federal regulator, as an integral part of its examination process, periodically reviews our allowance for loan losses. The OCC may require us to make additional provisions for loan losses based on their judgments of information available to them at the time of their examination.
 
At June 30, 2011, our allowance for loan losses represented 1.33% of total gross loans, an increase from 0.71% at June 30, 2010.  The allowance for loan losses increased by $415,000 from June 30, 2010 to June 30, 2011, due primarily to a provision for loan loss of $567,000 and recoveries of $4,000, offset by charge-offs of $156,000.  The decision to increase the allowance from June 30, 2010 to June 30, 2011 reflected an increase in classified loans and the change in the mixture of loans in our portfolio.
 
 
14

 
 
The following table sets forth activity in our allowance for loan losses for the periods indicated:
 
   
For the Years Ended June 30,
 
   
2011
   
2010
 
   
(Dollars in Thousands)
 
Balance at beginning of period
  $ 492     $ 385  
                 
Charge-offs:
               
Mortgage loans:
               
One- to four-family residential
    (15 )     -  
Commercial
    (93 )     -  
Construction
            -  
Equity lines of credit
            -  
Undisbursed portion of construction loan
            -  
Commercial loans
    (42 )     -  
Consumer loans
    (6 )     (2 )
Total charge-offs
    (156 )     (2 )
                 
Recoveries:
               
Mortgage loans:
               
One- to four-family residential
    -       -  
Commercial
    -       -  
Construction
    -       -  
Equity lines of credit
    -       -  
Undisbursed portion of construction loan
    -       -  
Commercial loans
    2       -  
Consumer loans
    2       -  
Total recoveries
    4       -  
                 
Net charge-offs
    (152 )     (2 )
Provision for loan loss
    567       109  
                 
Balance at end of period
  $ 907     $ 492  
                 
Ratios:
               
Net charge-offs to average loans outstanding
    0.222 %     0.003 %
Allowance for loan losses to non-performing loans at end of year
    220.53 %     38.38 %
Allowance for loan losses to total loans at end of year
    1.33 %     0.71 %
 
 
15

 
 
The following table sets forth the allowance for loan losses by loan category, the total loan balances by category, and the percent of loans in each category to total loans at the dates indicated.  The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
 
    At June 30,  
    (Dollars in Thousands)  
    2011     2010  
               
% of Loans
               
% of Loans
 
   
Allowance
   
Loan
   
in each
   
Allowance
   
Loan
   
in each
 
   
for Loan
   
Balance by
   
Category to
   
for Loan
   
Balance by
   
Category to
 
   
Losses
   
Category
   
Total Loans
   
Losses
   
Category
   
Total Loans
 
Mortgage loans:
                                   
One- to four-family residential
  $ 311     $ 46,658       68.3 %   $ 203     $ 36,325       52.5 %
Commercial
    246       11,263       16.5 %     157       15,082       21.7 %
Construction
    -       156       0.2 %     3       410       0.6 %
Equity lines of credit & loans
    17       4,956       7.3 %     56       11,436       16.5 %
Undisbursed portion of construction loan
    -       (112 )     -0.2 %     (1 )     (97 )     -0.1 %
Subtotal
    574       62,921       92.1 %     418       63,156       91.2 %
                                                 
Commercial loans
    167       4,485       6.6 %     66       5,267       7.4 %
Consumer loans
    13       897       1.3 %     8       952       1.4 %
Unallocated Reserve
    153       -       -       -       -       -  
                                                 
Total loans
  $ 907     $ 68,303       100.0 %   $ 492     $ 69,375       100.0 %
 
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with U.S. generally accepted accounting principles, there can be no assurance that regulators, in reviewing our loan portfolio, will not require us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
 
Investment Activities
 
We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions, overnight and short-term loans to other banks, corporate debt instruments and Fannie Mae and Freddie Mac equity securities.  Within certain regulatory limits, we also may invest a portion of our assets in corporate securities and mutual funds. We also are required to maintain an investment in Federal Home Loan Bank of Boston stock.
 
At June 30, 2011, our available for sale investment portfolio totaled $1.1 million, or 1.4% of total assets.  Our securities held to maturity totaled $972,000, or 1.2% of total assets.  We also held $495,000 in certificates of deposit and $1.3 million in Federal Home Loan Bank of Boston stock at June 30, 2011.  Our available for sale investment portfolio at June 30, 2011, at amortized cost, consisted of $1 million in corporate debt obligations, $77,000 of mortgage-backed securities and $10,000 of corporate common stock.  The entire securities held to maturity consist of municipal bonds.
 
 
16

 
 
Our investment objectives are to maintain high asset quality, provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return.  Our board of directors has the overall responsibility for the investment portfolio, including approval of our investment policy. The board of directors is also responsible for implementation of the investment policy and monitoring our investment performance. Our board of directors reviews the status of our investment portfolio on a monthly basis, or more frequently if warranted.
 
The following table sets forth certain information regarding the amortized cost and market values of our securities at the dates indicated:
 
    June 30, 2011     June 30, 2010  
         
Gross
   
Gross
               
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
         
Amortized
   
Unrealized
   
Unrealized
       
   
Cost
   
Gains
   
Losses
   
Fair Value
   
Cost
   
Gains
   
Losses
   
Fair Value
 
Securities available for sale
                                               
Corporate bonds and other obligations
  $ 1,015,749     $ 4,073     $ (7,500 )   $ 1,012,322     $ 982,415     $ 13,366     $ (15,640 )   $ 980,141  
FNMA mortgage-backed securities
    77,244       2,812       (1,030 )     79,026       118,017       3,499       -       121,516  
U.S. Government sponsored enterprise securities
    2       675       -       677       2       848       -       850  
Corporate common stock
    10,000       -       -       10,000       10,000       -       -       10,000  
Total
  $ 1,102,995     $ 7,560     $ (8,530 )   $ 1,102,025     $ 1,110,434     $ 17,713     $ (15,640 )   $ 1,112,507  
                                                                 
Securities held to maturity
                                                               
Municipal bonds
  $ 971,984     $ 7,800     $ (8,878 )   $ 970,906     $ -     $ -     $ -     $ -  
Total
  $ 971,984     $ 7,800     $ (8,878 )   970,906     $ -     $ -     $ -     $ -  
 
As of June 30, 2011, Auburn Savings Bank did not own any securities from any single issuer where the aggregate book value exceeds 10% of stockholders’ equity.
 
 
17

 
 
The table below sets forth certain information regarding the amortized cost, weighted average yields and contractual maturities of the Bank’s debt securities portfolio at June 30, 2011. In the case of mortgage-backed securities, this table does not reflect scheduled principal payments, unscheduled prepayments, or the ability of certain of these securities to reprice prior to their contractual maturity:
 
   
One Year or Less
   
More than One Year Through
Five Years
   
More than Five Years Through
Ten Years
   
More than Ten Years
   
Total Securities
 
    (Dollars in Thousands)  
       
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average Yield
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average
Yield
   
Amortized
Cost
   
Weighted
Average Yield
 
Corporate bonds and other obligations
  $ 766       1.27 %   $ 250       3.35 %   $ -       -     $ -       -     $ 1,016       1.78 %
Municipal bonds
    -       0.00 %     -       0.00 %     -       -       972       3.67 %     972       3.67 %
Mortgage-backed securities
    -       0.00 %     13       4.26 %     64       3.826 %     -       -       77       3.90 %
Total debt securities
  $ 766             $ 263             $ 64             $ 972             $ 2,065          
 
 
18

 

As of June 30, 2011, Auburn Savings Bank did not have any interest-bearing assets that would be classified as non-accrual or past due if they were loans.
 
Sources of Funds
 
General. Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.
 
Deposit Accounts. Most of our consumer and commercial deposits are gathered from our primary market area through the offering of a broad selection of deposit instruments, including interest-bearing demand accounts (such as NOW and money market accounts), savings accounts and certificates of deposit. In addition to accounts for individuals, we also offer business advantage and commercial checking accounts designed for the businesses operating in our market area. We have never and currently do not have any brokered deposits.
 
Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, and customer preferences and concerns. We generally review our deposit mix and pricing weekly.  Our deposit pricing strategy has generally been based on current market conditions, demand for loans, liquidity levels and Federal Home Loan Bank of Boston advance rates.
 
The following table sets forth certain information relative to the composition of our average deposit accounts and the weighted average interest rate on each category of deposits:
 
    Years Ended June 30,  
    2011     2010    
                                     
                Weighted                
Weighted
 
   
Average
          Average    
Average
         
Average
 
   
Balance
   
Percent
    Rate    
Balance
   
Percent
   
Rate
 
    (Dollars in Thousands)  
Deposit type:
                                   
Demand deposits
  $ 3,231       5.86 %     0.04 %   $ 3,261       6.31 %     0.05 %
Savings deposits
    4,274       7.76 %     0.46 %     3,709       7.17 %     0.87 %
Money Market
    12,872       23.36 %     0.70 %     12,855       24.85 %     1.12 %
NOW accounts
    2,999       5.44 %     0.47 %     2,600       5.03 %     0.73 %
Total transaction accounts
    23,376       42.42 %     0.53 %     22,425       43.36 %     0.88 %
Certificates of deposit
    31,735       57.58 %     1.87 %     29,299       56.64 %     2.35 %
Total deposits
  $ 55,111       100.00 %     1.30 %   $ 51,724       100.00 %     1.72 %
 
 
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As of June 30, 2011, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $12.2 million. The following table sets forth the maturity of those certificates as of June 30, 2011:
 
   
At June 30, 2011
 
   
(Dollars in Thousands)
 
       
Three months or less
  $ 1,425  
Over three months through six months
    1,192  
Over six months through one year
    2,995  
Over one year through three years
    5,163  
Over three years
    1,393  
         
Total
  $ 12,168  
 
Borrowings. We utilize advances from the Federal Home Loan Bank of Boston to supplement our investable funds. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities that are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness.
 
The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank of Boston advances at the dates and for the periods indicated:
 
     At or For the Fiscal Years Ended June 30,  
   
2011
   
2010
 
    (Dollars in Thousands)  
                         
   
Long-Term
   
Short-Term
   
Long-Term
   
Short-Term
 
   
Borrowings
   
Borrowings(1)
   
Borrowings
   
Borrowings(1)
 
                         
Balance at end of year
  $ 17,634     $ -     $ 18,431     $ -  
Average balance during year
  $ 18,951     $ -     $ 18,055     $ 362  
Maximum outstanding at any month end
  $ 19,894     $ -     $ 17,800     $ 3,500  
Weighted average interest rate at end of year
    2.82 %     -       3.11 %     -  
Average interest rate during year
    2.95 %     -       3.71 %     0.29 %
 

(1) Represents short-term borrowings of less than one year.
 
 
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Regulation and Supervision
 
As previously disclosed in a Current Report on Form 8-K filed with the SEC on January 31, 2011 (the “Form 8-K”), on January 26, 2011, the Bank entered into a Memorandum of Understanding (the “Bank MOU”) with the OTS, our former principal federal banking regulator.  On that same date, the Company and the mutual holding company parent, Auburn Bancorp, MHC (collectively, the “Holding Companies”), jointly entered into a separate Memorandum of Understanding (the “Holding Company MOU”) with the OTS.

The Bank MOU and the Holding Company MOU (collectively, the “MOUs”) require the Bank and the Holding Companies to take certain measures to improve their safety and soundness.  The following description of the MOUs is qualified in its entirety by reference thereto, copies of which are attached to the Form 8-K as Exhibits 10.1 and 10.2.  The MOUs impose no fines or penalties upon the Bank or the Holding Companies.

Under the Bank MOU, the Bank has agreed, among other things, to:

(i)  
develop and implement a Business Plan/Risk Reduction Plan that, among other things, (1) establishes projected capital levels sufficient to support the Bank’s existing and prospective risk profile and comply with the requirements in the Bank MOU to reduce concentrations in classified assets, criticized assets and higher risk loans; (2) contains a detailed discussion of the Bank’s plan to limit higher risk activities; (3) realistically assesses and recognizes increased operating expenses related to staffing and establishing compliance with the Bank MOU; (4) includes a prohibition against materially deviating from the Plan without the prior non-objection of the OTS; and (5) includes a detailed budget;

(ii)  
develop and implement a written program to reduce and control concentration risk;

(iii)  
obtain the non-objection of the OTS before making any additional commercial real estate loans or commercial and industrial loans;

(iv)  
make certain revisions to its loan underwriting, appraisal, and credit administration policies and procedures;

(v)  
develop and implement a revised internal loan review program;

(vi)  
develop and implement a revised Allowance for Loan and Lease Losses (“ALLL”) Policy;

(vii)  
develop and implement Real Estate Owned (“REO”) policies and procedures consistent with regulatory requirements;

(viii)  
develop and implement a plan to reduce criticized assets;

(ix)  
not increase its brokered deposits without the prior non-objection of the OTS; and

(x)  
hold board of directors meetings, and record minutes from such meetings, that are separate from those of the Holding Companies.
 
 
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Under the Holding Company MOU, the Holding Companies have agreed, among other things, to:

(i)  
develop and implement a financial plan designed to: (1) support the Bank in complying with all applicable laws, rules and regulations and the terms and conditions of the Bank MOU;  (2) cause the Holding Companies to maintain a capital position that is commensurate with their risk profiles and  minimize their dependency on capital distributions from the Bank; and (3) address the Holding Companies’ cash flow needs;

(ii)  
not incur any debt without the prior non-objection of the OTS;

(iii)  
not make any capital distributions without the prior non-objection of the OTS;

(iv)  
conduct an analysis of the allocation of expenses between the Holding Companies and the Bank; and

(v)  
hold board of directors meetings, and record minutes from such meetings, that are separate from those of the Bank.

General
 
As savings and loan holding companies, Auburn Bancorp, MHC and Auburn Bancorp, Inc. are required by federal law to report to, and otherwise comply with the rules and regulations of, the Board of Governors of the Federal Reserve Board (“FRB”).

The Bank is examined, regulated and supervised by the Office of Comptroller of the Currency (“OCC”) and is subject to examination by the FDIC.  This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the FDIC’s deposit insurance fund, the banking system and depositors.  Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates.  Following completion of its examination, the federal agency critiques the institution’s operations and assigns its rating (known as an institution’s CAMELS rating).  Under federal law, an institution may not disclose its CAMELS rating to the public.  The Bank also is a member of and owns stock in the Federal Home Loan Bank of Boston, which is one of the twelve regional banks in the Federal Home Loan Bank System.  The Bank also is currently regulated to a lesser extent by the Federal Reserve Board governing reserves to be maintained against deposits and other matters.  The OCC examines the Bank and prepares reports for the consideration of its board of directors on any operating deficiencies.  The Bank’s relationship with its depositors and borrowers also is regulated to a great extent by federal law and, to a much lesser extent, state law, especially in matters concerning the ownership of deposit accounts and the form and content of the Bank’s mortgage documents.
 
The Dodd-Frank Act and the extensive new regulations implementing the Act, will significantly affect our business and operating results, and any future laws or regulations, whether enacted by Congress or implemented by the FDIC, the OCC or the Federal Reserve Board, could have a material adverse impact on Auburn Bancorp, MHC, Auburn Bancorp, Inc. and the Bank.
 
Set forth below is a brief description of certain regulatory requirements applicable to Auburn Bancorp, MHC, Auburn Bancorp, Inc. and the Bank.  The description below is limited to certain material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on Auburn Bancorp, Inc. and the Bank.

 
22

 
 
New Federal Legislation

The Dodd-Frank Act has significantly changed the current bank regulatory structure and affected the lending, investment, trading and operating activities of financial institutions and their holding companies.  The Dodd-Frank Act eliminated our former primary federal regulator, the Office of Thrift Supervision, and require the Bank to be regulated by the Office of the Comptroller of the Currency (the primary federal regulator for national banks). The Dodd-Frank Act also authorizes the Federal Reserve Board to supervise and regulate all savings and loan holding companies, including mutual holding companies, like Auburn Bancorp, Inc. and Auburn Bancorp, MHC, in addition to bank holding companies that it currently regulates.  As a result, the Federal Reserve Board’s current regulations applicable to bank holding companies, including holding company capital requirements, apply to savings and loan holding companies like Auburn Bancorp, Inc. and Auburn Bancorp, MHC.  These capital requirements are substantially similar to the capital requirements currently applicable to the Bank, as described in “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”  Moreover, Auburn Bancorp, MHC will require the approval of the Federal Reserve Board before it may waive the receipt of any dividends from Auburn Bancorp, Inc., and there is no assurance that the Federal Reserve Board will approve future dividend waivers or what conditions it may impose on such waivers.  The Dodd-Frank Act also requires the Federal Reserve Board to set minimum capital levels for bank holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital would be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions.  Bank holding companies with assets of less than $500 million are exempt from these capital requirements.  Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets.  The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
 
The Dodd-Frank Act also creates a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws.  The Consumer Financial Protection Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as the Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices.  The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets.  Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators.  The new legislation also weakens the federal preemption available for national banks and federal savings associations, and gives state attorneys general the ability to enforce applicable federal consumer protection laws.
 
The legislation also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.  Lastly, the Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials.  The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded.
 
 
23

 
 
Regulation of Federal Savings Associations.

Capital Requirements. The applicable capital regulations require federal savings institutions to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The OCC regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

The risk-based capital standard requires federal savings institutions to maintain Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 100%, assigned by the OCC capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

The OCC also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular circumstances. At June 30, 2010, the Bank exceeded each of these capital requirements.

Prompt Corrective Regulatory Action. The OCC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be “undercapitalized.” A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be “significantly undercapitalized” and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the OCC is required to appoint a receiver or conservator within specified time frames for an institution that is “critically undercapitalized.” An institution must file a capital restoration plan with the OCC within 45 days of the date it receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. “Significantly undercapitalized” and “critically undercapitalized” institutions are subject to more extensive mandatory regulatory actions. The OCC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
 
 
24

 
 
Standards for Safety and Soundness. As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard. The Bank has not received any notice from the OCC that it has failed to meet any standard prescribed by the guidelines.

Limitation on Capital Distributions. OCC regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the OCC is required before any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under OCC regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OCC. If an application is not required, the institution must still provide prior notice to the OCC of the capital distribution if, like the Bank, it is a subsidiary of a holding company. If the Bank’s capital were ever to fall below its regulatory requirements or the OCC notified it that it was in need of increased supervision, its ability to make capital distributions could be restricted. In addition, the OCC could prohibit a proposed capital distribution that would otherwise be permitted by the regulation, if the agency determines that such distribution would constitute an unsafe or unsound practice.

Qualified Thrift Lender Test. Federal law requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. Education loans, consumer loans, credit card loans and small business loans may be considered “qualified thrift investments.” A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of June 30, 2010, the Bank maintained 99.94% of its portfolio assets in qualified thrift investments.

Asset Composition Limits. Some of the types of loans and other investments in which a federal savings institution, such as the Bank, may invest, sell or otherwise deal are limited to a percentage of the savings institution’s assets or capital under federal law. For example, the amount of commercial non-real estate loans in which the Bank may invest or sell is limited to up to 20% of assets, with the amount over 10% of assets limited to small business loans only, the amount of nonresidential real property loans is limited to 400% of the savings institution’s capital, unless the OCC permits them to exceed this limit, investments in tangible personal property are limited to 10% of assets and other loans for personal, family or household purposes are limited to between 30 and 35% of assets.  Some other loans or investments are limited to five percent of the savings institution’s assets, including community development investments, and construction loans without security, among others, in which the Bank, as a federal savings institution, may invest or sell are all limited to a percentage of their assets fixed by statute.
 
 
25

 
 
Grandfathering.  Federal law permits a federal savings bank formerly chartered or designated as a mutual savings bank under state law, such as the Bank, which converted from a Maine-state chartered savings institution to a federal savings institution in July 2006, to continue to exercise any authority it was authorized to exercise as a mutual savings bank under state law at the time of its conversion from a state mutual savings bank to a Federal charter. Unless otherwise determined by the OCC, a savings association, in the exercise of this grandfathered authority, may continue to follow applicable state laws and regulations in effect at the time of its conversion.  A Federal savings association may also enjoy grandfathered rights under the Maine state law that were available only upon the occurrence of specific preconditions, such as the attainment of a particular future date or specified level of regulatory capital, which had not occurred at the time of conversion from a state mutual savings bank, provided they occur thereafter.

Transactions with Related Parties. Federal law limits the Bank’s authority to lend to, and engage in certain other transactions with (collectively, “covered transactions”), “affiliates” (e.g., any company that controls or is under common control with an institution, including the Company, the MHC and their non-savings institution subsidiaries). The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution’s capital and surplus. Loans and other specified transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.

The Sarbanes-Oxley Act generally prohibits loans by the Company to its executive officers and directors. However, the Sarbanes-Oxley Act contains a specific exemption from such prohibition for loans by the Bank to its executive officers and directors in compliance with federal banking regulations. Federal regulations require that all loans or extensions of credit to executive officers and directors of insured institutions must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and must not involve more than the normal risk of repayment or present other unfavorable features. The Bank is therefore prohibited from making any new loans or extensions of credit to executive officers and directors at different rates or terms than those offered to the general public. Notwithstanding this rule, federal regulations permit the Bank to make loans to executive officers and directors at reduced interest rates if the loan is made under a benefit program generally available to all other employees and does not give preference to any executive officer or director over any other employee. In addition, loans made to a director or executive officer in an amount that, when aggregated with the amount of all other loans to the person and his or her related interests, are in excess of the greater of $25,000 or 5% of the Bank’s capital and surplus, up to a maximum of $500,000, must be approved in advance by a majority of the disinterested members of the board of directors.

Insurance of Deposit Accounts. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institution and credit unions to $250,000 per depositor.  Non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2013.  Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. An institution is assigned an assessment rate from 7 to 77.5 basis points based upon the risk category to which it is assigned.
 
 
26

 
 
The FDIC is authorized to set the reserve ratio for the Deposit Insurance Fund annually at between 1.15% and 1.5% of estimated insured deposits.  The Dodd-Frank Act mandates that the statutory minimum reserve ratio of the Deposit Insurance Fund increase from 1.15% to 1.35% of insured deposits by September 30, 2020.  Banks with assets of less than $10 billion are exempt from any additional assessments necessary to increase the reserve fund above 1.15%.  As part of a plan to restore the reserve ratio to 1.15%, in 2009 the FDIC imposed a special assessment on all insured institutions equal to five basis points of assets less Tier 1 capital as of June 30, 2009, payable on September 30, 2009, in order to cover losses to the Deposit Insurance Fund resulting from bank failures.  The Bank recorded an expense of approximately $34,000 during the quarter ended June 30, 2009, to reflect the special assessment.  In addition, the FDIC increased its quarterly deposit insurance assessment rates and amended the method by which rates are calculated.
 
In addition, in lieu of further special assessments, the FDIC required all insured depository institutions to prepay on December 30, 2009 their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012.   Estimated assessments for the fourth quarter of 2009 and for all of 2010 were based upon the assessment rate in effect on September 30, 2009, with 3 basis points added for the 2011 and 2012 assessment rates.  In addition, a 5% annual growth in the assessment base was assumed.  Prepaid assessments are to be applied against the actual quarterly assessments until exhausted, and may not be applied to any special assessments that may occur in the future.  Any unused prepayments will be returned to the institution on June 30, 2013.  On December 30, 2009, the Bank prepaid approximately $323,000 in estimated assessment fees.  Because the prepaid assessments represent the prepayment of future expense, they do not affect the Bank’s capital (the prepaid asset will have a risk-weighting of 0%) or tax obligations.
 
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.
 
In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. For the quarter ended June 30, 2010, the annualized FICO assessment rate equaled 0.20 basis points for each $100 in domestic deposits maintained at an institution.  The bonds issued by the FICO are due to mature in 2017 through 2019.

Temporary Liquidity Guarantee Program.  On October 14, 2008, the Federal Deposit Insurance Corporation adopted an optional TLGP under which, for a fee, noninterest-bearing transaction accounts would receive unlimited insurance coverage until June 30, 2010, subsequently extended to December 31, 2010, with an additional possible extension up to December 31, 2011.  The Bank opted to participate in the unlimited noninterest-bearing transaction account coverage. The Temporary Liquidity Guarantee Program also included a debt component under which certain senior unsecured debt issued by institutions and their holding companies between October 13, 2008 and October 31, 2009 would be guaranteed by the FDIC through June 30, 2012, or in some cases, December 31, 2012. In return for the Federal Deposit Insurance Corporation’s guarantee, participating institutions will pay the Federal Deposit Insurance Corporation a fee based on the amount and maturity of the debt.  The Company did not opt to participate in this component of the TLGP opting out of the unsecured debt guarantee program.
 
 
27

 
 
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Banks provide a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank of Boston, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. The Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at June 30, 2011 of $1,251,700.

The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank’s net interest income would likely also be reduced.

Community Reinvestment Act. Under the Community Reinvestment Act, as implemented by Office of Thrift Supervision regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the Office of Thrift Supervision, in connection with its examination of a savings association, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution.

The Community Reinvestment Act requires public disclosure of an institution’s rating and requires the Office of Thrift Supervision to provide a written evaluation of an association’s Community Reinvestment Act performance utilizing a four-tiered descriptive rating system. The Bank received an “Outstanding” rating as a result of its most recent Community Reinvestment Act assessment.

Privacy. Under the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”), all financial institutions are required to establish policies and procedures to restrict the sharing of nonpublic customer data with nonaffiliated parties at the customer’s request and to protect customer data from unauthorized access.  In addition, the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) includes many provisions concerning national credit reporting standards and permits consumers, including customers of the Bank, to opt out of information-sharing for marketing purposes among affiliated companies.  The FACT Act also requires banks and other financial institutions to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available.  The Federal Reserve Board and the Federal Trade Commission have extensive rulemaking authority under the FACT Act, to which the MHC, the Company and the Bank are subject.  The Bank may also be subject to Maine state law restrictions on the disclosure of customer information.

Consumer Laws and Regulations. In addition to the laws and regulations discussed herein, the Bank is also subject to certain laws and regulations designed to protect consumers in transactions with banks.  While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act and Regulation E promulgated thereunder, the Expedited Funds Availability Act, Check Clearing for the 21st Century Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, Fair Debt Collection Practices Act, Home Mortgage Disclosure Act of 1975, the Real Estate Settlement Procedures Act, Right to Financial Privacy Act and Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”) and related regulations, among others.  These laws and regulations require certain disclosures and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans to or engaging in other types of transactions with such customers.  Failure to comply with these laws and regulations could lead to substantial monetary damages, penalties, operating restrictions and reputational damage to the financial institution.  Interest and other charges collected or contracted for by the Bank are subject to federal laws concerning interest rates and, as applicable, state usury laws.
 
 
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Holding Company Regulation.

General. The Company and the MHC are savings and loan holding companies within the meaning of federal law. As such, they are subject to FRB regulations, examinations, supervision, reporting requirements and regulations concerning corporate governance and activities. In addition, the FRB has enforcement authority over the Company and the MHC and any non-savings institution subsidiaries they may have in the future. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a serious risk to the Bank.

Restrictions Applicable to Mutual Holding Companies. According to federal law and FRB regulations, a mutual holding company, such as the MHC, may generally engage in the following activities: (1) investing in the stock of a savings institution; (2) acquiring a mutual association through the merger of such association into a savings institution subsidiary of such holding company or an interim savings institution subsidiary of such holding company and (3) merging with or acquiring another holding company, one of whose subsidiaries is a savings institution. In some circumstances, a savings and loan holding company, such as the MHC, may also engage in activities approved by the Federal Reserve Board for a bank holding company under Section 4(c) of the Bank Holding Company Act (other than activities begun by an acquisition, in whole or in part, of a going concern) if previously approved by Office of Thrift Supervision or if the savings and loan holding company receives a rating of “satisfactory” or above prior to January 1, 2008, or a composite rating of “1” or “2” thereafter, in its most recent examination and is not in a troubled condition.  In certain circumstances, a mutual holding company, such as the MHC, may also engage in activities permitted for financial holding companies, including certain insurance and securities activities.

Federal law prohibits a savings and loan holding company, including a federal mutual holding company, from directly or indirectly, or through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings institution, or its holding company, without prior written approval of the FRB. Federal law also prohibits a savings and loan holding company from acquiring more than 5% of a company engaged in activities other than those authorized for savings and loan holding companies by federal law; or acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the FRB must consider the financial and managerial resources and future prospects of the Company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.

The FRB is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, except: (1) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (2) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

If the savings institution subsidiary of a savings and loan holding company fails to meet the qualified thrift lender test, the holding company must register with the Federal Reserve Board as a bank holding company within one year of the savings institution’s failure to so qualify.
 
Stock Holding Company Subsidiary Regulation. Federal regulations govern the two-tier mutual holding company form of organization and subsidiary stock holding companies that are controlled by mutual holding companies. The Bank has adopted this form of organization. The Company is the stock holding company subsidiary of the MHC. The Company is permitted to engage in activities that are permitted for the MHC subject to the same restrictions and conditions.
 
Capital.  Savings and loan holding companies are not currently subject to specific regulatory capital requirements.  The Dodd-Frank Act, however, requires the FRB to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves.  Instruments such as cumulative preferred stock and trust preferred securities will no longer be includable as Tier 1 capital, which is currently permitted for bank holding companies. Instruments issued by May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less.  There is a five-year transition period (from the July 21, 2010 effective date of the Dodd-Frank Act) before the capital requirements will apply to savings and loan holding companies.
 
 
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Dividends.  The FRB has issued a policy statement regarding the payment of dividends by bank holding companies that is expected to apply to savings and loan holding companies as well.  In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition.  FRB guidance provides for prior regulatory review of capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition.  The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized.  These regulatory policies could affect the ability of Auburn Bancorp, Inc. to pay dividends or otherwise engage in capital distributions.
 
Source of Strength.  The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies.  The regulatory agencies must issue regulations requiring that all bank and savings and loan holding companies serve as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
 
Waivers of Dividends by Auburn Bancorp, MHC. Federal regulations require Auburn Bancorp, MHC to notify the FRB of any proposed waiver of its receipt of dividends from Auburn Bancorp, Inc.  The Office of Thrift Supervision, the previous regulator for Auburn Bancorp, MHC, allowed dividend waivers where the mutual holding company’s board of directors determined that the waiver was consistent with its fiduciary duties and the waiver would not be detrimental to the safety and soundness of the institution.  The FRB has recently issued an interim final rule providing that, pursuant to a Dodd-Frank Act grandfathering provision, it may not object to dividend waivers under similar circumstances, but adding the requirement that a majority of the mutual holding company’s members eligible to vote have approved a waiver of dividends by the company within 12 months prior to the declaration of the dividend being waived.  The FRB has typically not allowed dividend waivers by mutual bank holding companies and, therefore, the ability of Auburn Bancorp, MHC to waive dividends for in the future is uncertain.
 
Conversion of the MHC to Stock Form. Regulations permit the MHC to convert from the mutual form of organization to the capital stock form of organization. There can be no assurance when, if ever, a conversion transaction will occur, and the Board of Directors has no current intention or plan to undertake a conversion transaction. In a conversion transaction a new holding company would be formed as the successor to the Company, the MHC’s corporate existence would end, and certain depositors of the Bank would receive the right to subscribe for additional shares of the new holding company. In a conversion transaction, each share of common stock held by stockholders other than the MHC would be automatically converted into a number of shares of common stock of the new holding company based on an exchange ratio determined at the time of conversion that ensures that stockholders other than the MHC own the same percentage of common stock in the new holding company as they owned in the Company immediately before conversion. The total number of shares held by stockholders other than the MHC after a conversion transaction would be increased by any purchases by such stockholders in the stock offering conducted as part of the conversion transaction.

Acquisition of Control. Under the federal Change in Bank Control Act, a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company or savings association. An acquisition of “control” can occur upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or savings institution or as otherwise defined by the FRB. Under the Change in Bank Control Act, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

Personnel

As of June 30, 2011, we had 16 full-time employees and two part-time employees, none of whom is represented by a collective bargaining unit. We believe our relationship with our employees is good.

Item 1A. Risk Factors.

Not applicable.
 
 
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Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

We conduct our business through our main office in Auburn, Maine and our branch office in Lewiston, Maine, both of which we own. The following is a list of our locations:

Location
 
Year Acquired
     
256 Court Street
Auburn, ME 04212
 
1957
     
325 Sabattus St.
Lewiston, ME 04240
 
2003

Item 3. Legal Proceedings.

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

Item 4.  [Removed and Reserved]

 
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PART II
 
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
 
Common Stock Performance by Quarter*  

      Fiscal Year 2011  
                         
   
1st Qtr
   
2nd Qtr
   
3rd Qtr
   
4th Qtr
 
                         
Bid Price *
                       
High
  $ 7.15     $ 6.80     $ 7.25     $ 8.00  
Low
    6.65       6.30       6.80       7.05  
 
      Fiscal Year 2010  
                         
   
1st Qtr
   
2nd Qtr
   
3rd Qtr
   
4th Qtr
 
Bid Price *
                       
High
  $ 7.05     $ 8.50     $ 7.50     $ 7.50  
Low
    6.75       7.25       6.30       6.50  
 
*There is no established public trading market for the Company’s common stock.  Trade price  information is based on high and low bid prices reported in the OTC Bulletin Board, and may not represent all trades effected during the relevant periods.
 
Shares of the Company’s common stock are traded on the OTC Bulletin Board under the symbol “ABBB”.
 
The Company had approximately 128 holders of record as of September 27, 2011.  Certain shares of the Company’s common stock are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number.
 
The Company currently is not paying cash dividends on its common stock.
 
 
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Equity Compensation Plans.  Other than our employee stock ownership plan, we do not have any equity compensation plans that were not approved by stockholders.  The following table sets forth information with respect to the Company’s equity compensation plans effective June 30, 2011.
 
   
Number of securities to
   
Weighted average
   
Number of securities
 
   
be issured upon exercise
   
exercise price of
   
remaining available for
 
   
of outstanding options,
   
outstanding options,
   
future issurance under
 
   
warrants and rights
   
warrants and rights
   
equity compensation plan
 
                   
2009 Equity Incentive Plan (approved by stockholders on November 17, 2009)
    -    
NA
      7,398  
                         
Equity Incentive Compensation Plans not approved by security holders
    -    
NA
   
NA
 
                         
Total
    -    
NA
      7,398  
 
The Company did not repurchase any shares of its common stock during the quarter ended June 30, 2011.
 
Item 6. Selected Financial Data.
 
Not required for smaller reporting companies.
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Overview
 
Our principal business is to acquire deposits from individuals and businesses in the communities surrounding our offices and to use these deposits to fund loans.  We focus on providing our products and services to two segments of customers: individuals and businesses.
 
Income.  Our primary source of income is net interest income.  Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings.  Changes in levels of interest rates affect our net interest income.  The narrowing of the spread in recent years between the interest we earn on loans and investments and the interest we pay on deposits has negatively affected our net interest income. A secondary source of income is non-interest income, which includes revenue that we receive from providing products and services.  The majority of our non-interest income generally comes from loan service charges and service charges on deposit accounts.
 
Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio.  We evaluate the need to establish allowances against losses on loans on a regular basis.  When additional allowances are necessary, a provision for loan losses is charged to earnings.
 
 
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Expenses.  The non-interest expenses we incur in operating our business consist of expenses for salaries and employee benefits, occupancy and equipment, data processing, marketing and advertising, professional services and various other miscellaneous expenses.  Our largest non-interest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. 
 
As a result of the mutual holding company reorganization and minority stock offering, we have incurred additional non-interest expenses as a result of operating as a public company.  These additional expenses consist primarily of legal and accounting fees and expenses of stockholder communications and meetings.
 
Critical Accounting Policies
 
We consider accounting policies that require management to exercise significant judgment or discretion, or make significant assumptions that have or could have a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies.
 
Allowance for loan losses.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.  The allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of the underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.  The allowance consists of specific and general components.  The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component relates to pools of non-impaired loans and is based on historical loss experience adjusted for qualitative factors such as delinquency trends, changes in portfolio mix, and current economic conditions.
 
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Management considers factors including payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due when determining impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer and residential loans for impairment disclosures.
 
Actual loan losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.
 
Securities.  The Company’s investment securities are classified into two categories: securities available for sale and securities held to maturity. Investment securities available for sale are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income or loss.  Debt securities which the Company has the positive intent and ability to hold to maturity, specifically  the Company’s municipal bond holdings,  are classified as held to maturity and reported at amortized cost.
 
 
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Premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of individual equity securities that are deemed to be other than temporary are reflected in earnings when identified. For individual debt securities where the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary decline in the fair value of the debt security related to 1) credit loss is recognized in earnings and 2) other factors is recognized in other comprehensive income or loss. Credit loss is deemed to exist if the present value of expected future cash flows is less than the amortized cost basis of the debt security. For individual debt securities where the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost, the other-than-temporary impairment is recognized in earnings equal to the entire difference between the security’s cost basis and its fair value at the balance sheet date.
 
In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
 
Loans.  Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized over the contractual life of the loans as an adjustment of the related loan yield using the interest method.
 
Loans past due 30 days or more are considered delinquent. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection.  Consumer loans are typically charged off when they are no more than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
 
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. Cash payments on these loans are applied to principal balances until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Operating Strategy
 
Our mission is to operate and grow a profitable community-oriented financial institution.  We plan to achieve this by executing on our strategy of:
 
 Remaining a community-oriented institution;
 
 Continuing to use conservative underwriting practices to maintain the high quality of our loan portfolios;
 
 Building core and other deposits;
 
 
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 Continuing to grow our commercial real estate and commercial business loan portfolios; and
 
 Continuing to emphasize the origination of one- to four-family residential real estate lending.
 
Remaining a community-oriented institution.  We were established in Auburn, Maine in 1887 and have been operating continuously since that time. We have been, and continue to be, committed to meeting the financial needs of the communities in which we operate and remain dedicated to providing customer service as a means to attract and retain customers. We deliver personalized service and respond promptly to customer needs and inquiries. We believe that our community orientation is attractive to our customers and distinguishes us from the larger banks that operate in our area.
 
Continue to use conservative underwriting practices to maintain the high quality of our loan portfolio.  We believe that maintaining high asset quality is a key to long-term financial success. We have sought to grow our loan portfolio while keeping nonperforming assets to a minimum. We use underwriting standards that we believe are conservative, and we diligently monitor collection efforts. At June 30, 2011, we had four non-performing loans totaling approximately $411,000 in our total loan portfolio. We have nine real estate and two commercial real estate owned and in process of foreclosure totaling $1,081,000 and $138,000, respectively.  Although we intend to continue our efforts to originate commercial and multi-family loans, we intend to maintain our philosophy of managing loan exposure through our conservative approach to lending.
 
Building Core and Other Deposits.  We offer checking accounts, NOW accounts and savings accounts, which generally are lower-cost sources of funds than certificate of deposits and are less sensitive to withdrawal when interest rates fluctuate.  In order to build our core deposit base, we intend to continue to offer a broad range of deposit products.  As we grow our commercial loan portfolio, we expect to attract core deposits from our new commercial loan customers.  We also intend to allocate additional marketing funds for advertisements targeted toward core deposit growth.
 
Continuing to maintain strong commercial real estate and commercial business loan portfolios.  We intend to continue to focus on maintaining strong commercial real estate and commercial business loans.  These loans provide higher returns than loans secured by one- to four-family real estate.  Commercial real estate and commercial business loans, however, involve a greater degree of credit risk than one- to four-family residential mortgage loans.  Because payments on these loans are often dependent on the successful operation or management of the properties or business, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.  Commercial loans, including both commercial real estate and commercial business loans, decreased $4.6 million, or 22.6%, from June 30, 2010 to June 30, 2011 and at June 30, 2011 comprised approximately 23.1% of total loans. In the future, as commercial development of industrial parks, new office space and retail shopping areas in Lewiston and Auburn creates new jobs and supports new and existing small businesses, we anticipate that there will be many commercial real estate and commercial business loan opportunities that we may pursue with a prudent balance sheet management strategy and with what we believe are our conservative underwriting guidelines. We believe that our customer service in the commercial loan area will distinguish us from the larger banks that operate in this area.
 
Continue to emphasize the origination of one- to four-family residential real estate lending.  Our primary lending activity is the origination of residential real estate loans secured by homes in our market area. We intend to continue emphasizing the origination of residential real estate loans.  At June 30, 2011, 59.3% of our total loans were one- to four-family residential real estate loans. We believe our emphasis on residential real estate lending, which carries a lower credit risk than commercial and multi-family real estate lending, contributes to our high asset quality.   
 
 
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Comparison of Financial Condition at June 30, 2011 and June 30, 2010
 
  Total Assets. Total assets decreased by $2.7 million, or 3.3%, from $80.6 million at June 30, 2010 to $77.9 million at June 30, 2011. This decrease in total assets resulted largely from decreases in the cash and cash equivalents and loans.
 
  Cash and Cash Equivalents. Cash and correspondent bank balances decreased by $2.2 million, or 41.2%, from $5.3 million at June 30, 2010 to $3.1 million at June 30, 2011.  This decrease was largely the result of the decrease in deposits.
 
Certificates of deposit.  Certificate of deposit balances in other banks decreased by $350,000, or 41.4%, from $845,000 at June 30, 2010 to $495,000 at June 30, 2011.  This decrease was largely the result of management’s decision to re-invest in certificate of deposits which matured during the fiscal year.
 
Securities Available for Sale. The investment portfolio available for sale totaled $1.1 million at June 30, 2011, a decrease of $10,000, or 0.9% from June 30, 2010.  Mortgage-backed securities decreased $42,000, or 35.0%, and corporate bonds increased $32,000, or 3.3%.
 
Securities Held to Maturity. The investment portfolio held to maturity totaled $972,000 and $0 at June 30, 2011 and June 30, 2010, respectively.  This increase was a result of purchases of municipal bonds during the fiscal year ended June 20, 2011.
 
Net Loans. Net loans decreased $1.5 million, or 2.2%, from $68.9 million at June 30, 2010 to $67.4 million at June 30, 2011 as a result of a decrease in commercial real estate, commercial, construction, home equity and consumer loans.  Residential mortgage loans increased $4.1 million, or 11.3%.  Commercial real estate loans decreased $3.8 million, or 25.3%.  The changes were largely due to a reclassification of $4.2 million from commercial real estate to residential mortgage loans offset by new commercial real estate loans originated of $1.9 million in the first quarter of fiscal year June 30, 2011. Investor-owned one-to-four family residential mortgage loans were reclassified from commercial real estate to residential mortgage loans to be consistent with the regulatory reporting requirements.  Home equity loans decreased $295,000, or 2.6%.  Construction loans decreased $254,000, or 62.0%, due primarily to a net decrease in loan volume.  Commercial loans decreased $783,000, or 14.9%, and consumer installment loans decreased $55,000, or 5.8%.
 
      Foreclosed Real Estate. Foreclosed real estate, net of allowance increased $515,000 from $681,000 at June 30, 2010 to $1.2 million at June 30, 2011.  This increase was due to the number of foreclosed real estate properties increasing from 6 at June 30, 2010 to 11 at June 30, 2011.
 
Deposits and Borrowed Funds. Deposits decreased $1.9 million, or 3.4% from $55.8 million at June 30, 2010 to $53.9 million at June 30, 2011.  Demand accounts decreased $485,000, or 15.6%, NOW accounts increased $319,000, or 11.0%, savings accounts increased $615,000, or 15.6%, money market accounts decreased $487,000, or 3.5%, and certificates of deposit decreased $1.9 million, or 5.8%.  The decrease in demand accounts resulted from a transfer of a substantial deposit relationship account swept to a money market account.  Even with this transfer, an overall decrease was shown in money market accounts, resulting from a large withdrawal upon the death of a customer with a substantial deposit relationship.  The majority of the decrease in certificates of deposit resulted from a $1 million withdrawal from a certificate which matured in fiscal year June 30, 2011.
 
Total borrowings from the Federal Home Loan Bank of Boston decreased $796,000, or 4.3%, from $18.4 million at June 30, 2010 to $17.6 million at June 30, 2011. This decrease was due to paydowns of advance maturities.
 
 
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Total Stockholders’ Equity.  Total equity increased $70,000, or 1.2% to $6.1 million at June 30, 2011, from $6.0 million at June 30, 2010, primarily as a result of the net income of $65,000.
 
Comparison of Operating Results for the Years Ended June 30, 2011 and June 30, 2010
 
Net Income. Net income decreased $43,000, or 40.4%, to $64,000 for the year ended June 30, 2011 compared to $108,000 for the year ended June 30, 2010. The decrease was primarily the net result of an increase in net interest income of $312,000 and an increase in non-interest income of $301,000, offset by an increase in non-interest expenses of $128,000 and an increase in the provision for loan losses of $458,000.
 
Net Interest Income. The tables on pages 7 and 8 set forth the components of our net interest income, yields on interest-earning assets and interest-bearing liabilities, and the effect on net interest income arising from changes in volume and rate. Net interest income increased $312,000, or 12.7%, from $2.5 million for the year ended June 30, 2010 to $2.8 million for the year ended June 30, 2011.
 
The increase in volume of interest-earning assets increased interest income by $188,000, while the increase in the volume of interest-bearing liabilities increased interest expense by $53,000. The changes in volume had the effect of increasing net interest income by $135,000. Net interest margin increased from 3.38% for the year ended June 30, 2010 to 3.68% for the year ended June 30, 2011.
 
Interest and Dividend Income. Total interest and dividend income increased from $4.14 million for the year ended June 30, 2010 to $4.18 million for the year ended June 30, 2011. This increase of $41,000, or 1.0%, was due primarily to an increase in interest income on fixed-rate residential loans, although total interest-earning assets decreased from $75.8 million for the year ended June 30, 2010 to $72.9 million for the year ended June 30, 2011. Interest income on loans increased overall by $90,000, or 2.2%, interest income on securities and interest-bearing deposits decreased by $51,000, or 50.7%, and dividends on Federal Home Loan Bank stock increased from $0 for the year ended June 30, 2010 to $2,000 for the year ended June 30, 2011.
 
Interest Expense. Interest expense decreased by $271,000, or 16.1%, from $1.7 million for the year ended June 30, 2010 to $1.4 million for the year ended June 30, 2011.  While average deposit balances increased $3.4 million, average rates decreased from 2.07% to 1.63% due to increases in balances with lower cost of funds as well as the lower market interest rate environment generally.   Average borrowings decreased $400,000 from $19.3 million to $18.9 million and the average rate on borrowings decreased from 3.51% to 2.99%.
 
   Provision for Loan Losses.  The Company’s provision for loan losses was $567,000 and $109,000 for the fiscal years ended June 30, 2011 and 2010, respectively.  There was an increase in valuation reserves of $415,000, or 84.3% from June 30, 2010 to June 30, 2011, due largely to the current economic conditions, including declining real estate values and loan performance challenges across all segments of the loan portfolio. The Bank has completed a comprehensive review of the loan portfolio and related allowance for loan losses, and has increased its allowance for loan losses to $907,000 at June 30, 2011 which now represents 1.33% of total loans, compared to an allowance of $492,000, representing 0.71% of total loans at June 30, 2010.  Our analysis of the adequacy of the allowance considers economic conditions, historical losses and management’s estimate of losses inherent in the portfolio. For further discussion of our current methodology, please refer to “Critical Accounting Policies—Allowance for Loan Losses.”
 
Non-interest Income. Total non-interest income increased from $93,000 for the year ended June 30, 2010 to $301,000 for the year ended June 30, 2011. The increase was a result of having recognized no other than temporary impairment of investment securities for the fiscal year ended June 30, 2011 compared to a $126,000 loss for the fiscal year ended June 30, 2010.
 
 
38

 
 
Non-interest Expense. Non-interest expense increased $128,000, or 5.6%, to $2.4 million for the year ended June 30, 2011 as compared to $2.3 million for the year ended June 30, 2010. The increase was due to an $81,000 increase in consulting expenses as a result of additional loan review, policy development and executive search expense, a $40,000 increase in salaries and benefits which was partially offset by a $93,000 reduction in the net provision for losses on foreclosed real estate.
 
In addition, other operating expenses increased $129,000 resulting from an increase of $42,000 on losses on other assets, an increase of $31,000 in other real estate owned expense, an increase of $39,000 in accounting expense and an increase of $17,000 in loan related costs.
 
Income Taxes.  Income tax expense was $32,000 for the year ended June 30, 2011, reflecting an effective tax rate of 33.4%, compared to $53,000 for the year ended June 30, 2010, reflecting an effective tax rate of 33.1%.
 
Analysis of Net Interest Income
 
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities, and the interest rates earned or paid on them.
 
The tables on pages 38 and 39 set forth average balance sheets, average yields and costs, and certain other information for the periods indicated.  All average balances are daily average balances.  The yields set forth below include the effect of deferred fees, and discounts and premiums that are amortized or accreted to interest income or expense.  We do not accrue interest on loans in non-accrual status, however, the balance of these loans is included in the total average balance, which has the effect of lowering average loan yields.
 
 
39

 
 
      Fiscal Years Ended June 30,  
                                     
      2011       2010  
   
Average
               
Average
             
 
Outstanding
               
Outstanding
         
Average
 
   
Balance
   
Interest
   
Yield/Rate
   
Balance
   
Interest
   
Yield/Rate
 
      (Dollars in Thousands)  
Interest-earning assets:
                                   
Loans
  $ 69,528     $ 4,128       5.94 %   $ 66,522     $ 4,038       6.07 %
Investment securities (1)
    1,690       43       2.54 %     931       39       4.14 %
Federal Home Loan Bank stock
    1,252       2       0.16 %     1,231       -       0.00 %
Interest-earning deposits
    2,750       7       0.25 %     3,972       62       1.57 %
Total interest-earning assets
    75,220       4,180       5.56 %     72,656       4,139       5.70 %
Non-interest-earning assets
    5,220                       4,639                  
Total assets
    80,440                       77,295                  
                                                 
Interest-bearing liabilities:
                                               
Savings deposits
  $ 4,274     $ 24       0.56 %   $ 3,709     $ 33       0.88 %
NOW accounts
    2,999       17       0.57 %     2,600       20       0.76 %
Money market accounts
    12,872       105       0.82 %     12,855       179       1.39 %
Certificate of deposit
    31,735       701       2.21 %     29,299       773       2.64 %
Total interest bearing deposits
    51,880       847       1.63 %     48,463       1,005       2.07 %
FHLB advances
    18,873       564       2.99 %     19,304       677       3.51 %
Total interest-bearing liabilities
    70,753       1,411       1.99 %     67,767       1,682       2.48 %
                                                 
Non-interest-bearing liabilities:
                                               
Demand deposits
    3,231                       3,261                  
Other non-interest bearing liabilities
    230                       223                  
Total liabilities
    74,214                       71,251                  
Retained earnings
    6,226                       6,044                  
Total liabilities and capital
    80,440                       77,295                  
                                                 
Net interest income
          $ 2,769                     $ 2,457          
Net interest rate spread (2)
                    3.57 %                     3.21 %
Net interest earning assets (3)
  $ 4,467                     $ 4,889                  
Net interest margin (4)
                    3.68 %                     3.38 %
Average of interest earning assets to interest bearing liabilities
    106.31 %                     107.21 %                
 
(1)
Consists of taxable investment securities and eight municipal bonds.  The municipal bonds are presented on a fully taxable basis as the tax equivalent adjustments are not material to the yield.
(2)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)
Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
 
 
40

 
 
Rate/Volume Analysis
 
The following table presents the dollar amount of changes in interest income and interest expense for the major categories of our interest-earning assets and interest-bearing liabilities. Information is provided for each category of interest-earning assets and interest-bearing liabilities with respect to (i) changes attributable to changes in volume (i.e., changes in average balances multiplied by the prior-period average rate) and (ii) changes attributable to rate (i.e., changes in average rate multiplied by prior-period average balances). Changes due to the interaction between volume and rate were allocated pro rata between volume and rate.
 
   
Fiscal Years Ended June 30, 2011 vs. 2010
 
                   
   
Increase (Decrease) Due to
       
               
Net
 
               
Increase
 
   
Volume
   
Rate
   
(Decrease)
 
Interest-earning assets:
                 
Loans
  $ 180     $ (90 )   $ 90  
Investment securities
    23       (19 )     4  
Federal Home Loan Bank stock
    -       2       2  
Interest earning deposits
    (15 )     (40 )     (55 )
Total interest-earning assets
  $ 188     $ (147 )   $ 41  
                         
Interest-bearing liabilities:
                       
Savings deposits
  $ 4     $ (13 )   $ (9 )
NOW accounts
    3       (6 )     (3 )
Money market accounts
    -       (74 )     (74 )
Certificates of deposit
    61       (133 )     (72 )
Total deposits
    68       (226 )     (158 )
Federal Home Loan Bank of Boston advances
    (15 )     (98 )     (113 )
Total interest-bearing liabilities
  $ 53     $ (324 )   $ (271 )
Change in net interest income
  $ 135     $ 177     $ 312  
 
Management of Market Risk
 
General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Committee that is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives and for managing this risk consistent with the guidelines approved by the Board of Directors. Senior management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least on a quarterly basis to review our asset/liability policies and interest rate risk position.
 
 
41

 
 
 We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates.  In order to mitigate the potential effects of dramatic increases in market rates of interest, we have, among other things, implemented or will implement a number of strategies, including the following:
 
emphasize growth of less interest rate sensitive and lower cost “core deposits” in the form of transaction accounts, such as checking and savings accounts;
sell a portion of Auburn Savings Bank’s newly originated fixed-rate residential mortgage loans;
reduce the interest rate sensitivity of interest-bearing liabilities through utilization of fixed rate borrowings with terms of more than one year;
use interest rate caps and floors, as determined by the Asset Liability Management Committee, to attempt to preserve net interest income in periods of rising or declining short-term interest rates; and
maintain a level of assets in shorter-term securities and adjustable-rate mortgage-backed securities.
 
 Depending on market conditions, we often place more emphasis on enhancing net interest margin rather than matching the interest rate sensitivity of our assets and liabilities. In particular, we believe that the increased net interest income resulting from a mismatch in the maturity of our asset and liabilities portfolios can, during periods of stable or declining interest rates provide high enough returns to justify increased exposure to sudden and unexpected increases in interest rates. As a result of this philosophy, our results of operations and the economic value of our equity will remain vulnerable to increases in interest rates and to declines in the difference between long- and short-term interest rates.
 
 We have not engaged in hedging through the use of financial futures or interest rate swaps.  However, in the past we have entered into interest rate cap and floor agreements as part of our interest rate risk management process. These agreements are used to manage the effect of fluctuating interest rates on net interest income.  We currently have no such agreements.
 
 Net Portfolio Value Simulation Analysis. An important measure of interest risk is the amount by which the net present value of an institution’s cash flow from assets, liabilities and off balance sheet items (the institution’s net portfolio value or “NPV”) changes in the event of a range of assumed changes in market interest rates. The Office of Thrift Supervision provides us with the information presented in the following table, which is based on information provided to the Office of Thrift Supervision by Auburn Savings Bank.  It presents the estimated changes in Auburn Savings Bank’s net portfolio value at June 30, 2011 that would occur upon the assumed instantaneous changes in interest rates based on Office of Thrift Supervision assumptions and without giving effect to any steps that management might take, within the parameters established by our asset/liability management committee, to counter the effect of such interest rate changes.  The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings banks.  These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios.
 
 
42

 
 
                       
NPV as a Percentage of
 
     
Net Portfolio Value
   
Present Value of Assets
 
                             
Increase
 
                             
(Decrease)
 
 
Change in Interest Rates
             
Percent
   
NPV
   
(basis
 
 
(basis points)
 
Amount
   
Change
   
Change
   
Ratio
   
points)
 
        (Dollars in Thousands)  
                                 
 
+300
  $ 7,129     $ (1,338 )     (16 %)     9.13 %     (119 )
 
+200
    7,982       (485 )     (6 %)     10.01 %     (32 )
 
+100
    8,404       (63 )     (1 %)     10.37 %     5  
 
+50
    8,502       35       0 %     10.42 %     10  
 
0
    8,467       0       0 %     10.33 %     0  
 
-50
    8,304       (163 )     (2 %)     10.09 %     (23 )
 
-100
    8,352       (115 )     (1 %)     10.11 %     (22 )
 
As indicated in the table above, the result of a 100 basis point increase in interest rates is estimated to decrease net portfolio value by 1%, 6% for a 200 basis point increase and 16% for a 300 basis point increase over a 12-month horizon, when compared to the flat rate scenario. There is a 1% decrease in net portfolio value from the flat rate scenario to a 100 basis point decrease in interest rates.   Inherent in these estimates is the assumption that interest rates on interest bearing liabilities would change in direct proportion to changes in the U.S. Treasury yield curve. In all simulations, the lowest possible interest rate would be zero.
 
There are shortcomings inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net portfolio value table provides an indication of our interest rate risk exposures at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
 
Liquidity Management. Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, loan sales and maturities of investment securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage and mortgage-backed security prepayments are greatly influenced by general interest rates, economic conditions and competition.
 
We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and federal funds sold. Our most liquid assets are cash and cash equivalents and interest-bearing deposits. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2011, cash and cash equivalents totaled $3.1 million, including interest-earning deposits of $1.6 million.  Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $1.1 million at June 30, 2011.  On June 30, 2011, we had $17.6 million of outstanding borrowings from the Federal Home Loan Bank of Boston, and the ability to borrow an additional $4.1 million from the Federal Home Loan Bank of Boston.
 
 
43

 
 
At June 30, 2011, we had $173,000 in loan commitments outstanding and $4.2 million in unused lines of credit, letters of credit and unadvanced portions of construction loans.
 
Certificates of deposit due within one year of June 30, 2011 totaled $14.7 million, or 27.3% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and lines of credit. We believe, however, based on past experience, that a significant portion of our certificates of deposit will remain with us.
 
Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activities consist of activity in deposit accounts. However, we may from time to time utilize borrowings to fund a portion of our operations where the cost of such borrowings is more favorable than that of deposits of a similar duration. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive and to increase core deposits. Occasionally, we offer promotional rates to attract certain deposit products.
 
We are not aware of any known trends, events or uncertainties that will have or are reasonably likely to have a material effect on our liquidity, capital or operations, nor are we aware of any current recommendations by regulatory authorities, which if implemented, would have a material effect on liquidity, capital or operations.
 
               Capital Management. We are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2011, Auburn Savings Bank exceeded all of its regulatory capital requirements. Auburn Savings Bank is considered “well-capitalized” under regulatory guidelines. See “Regulation and Supervision — Regulation of Federal Savings Associations — Capital Requirements,” and Note 12 to the Financial Statements attached hereto.
 
The capital from the stock offering increased our liquidity and capital resources. Over time, the initial level of liquidity will be reduced as net proceeds from the stock offering are used for general corporate purposes, including repaying a portion of our borrowings. Our financial condition and results of operations have been enhanced by the capital from the stock offering, resulting in increased net interest-earning assets and net income.  However, due to the increase in equity resulting from the capital raised in the stock offering, return on equity will be adversely affected by the stock offering.
 
Impact of Inflation and Changing Prices
 
The financial statements, accompanying notes, and related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollar amounts without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Most of our assets and liabilities are monetary in nature, and, therefore, the impact of interest rates has a greater impact on its performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
 
 
44

 
 
Impact of Recent Accounting Standards
 
In January 2010, the Financial Accounting Standard Board (FASB) issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance is effective for the Company with the reporting period beginning July 1, 2010, except for the disclosure on the roll forward activities for any Level 3 fair value measurements, which will become effective for the Company with the reporting period beginning July 1, 2011. Other than requiring additional disclosures, adoption of this new guidance does not have a material effect on the Company’s consolidated financial statements.
 
In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The guidance is effective for interim and annual reporting periods ending after December 15, 2010. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on the Company’s consolidated financial statements.
 
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  This ASU provides guidance on determining whether a restructuring of a receivable meets the criteria to be considered a Troubled Debt Restructuring (TDR).  The new guidance is required to be adopted for the first interim or annual reporting period beginning after June 15, 2011, and is to be applied retrospectively to the beginning of the annual reporting period of adoption.  Early adoption is permitted.  The Company intends to adopt the provisions of this ASU when required, and is evaluating its potential impact on the Company’s consolidated financial statements.
 
In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.  This ASU is a result of joint efforts by the FASB and the International Accounting Standards Board (IASB) to develop a single, converged fair value framework for measuring fair value and for disclosing information about fair value measurements in accordance with accounting principals generally accepted in the United States of America (GAAP) and International Financial Reporting Standards (IFRSs).  This ASU is largely consistent with existing fair value measurement principles in GAAP; however, some of the components of this ASU could change how fair value measurement guidance in ASC 820, Fair Value Measurements and Disclosures, is applied.  This ASU does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting.  ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011, which is January 1, 2012 for the Company, and should be applied retrospectively. Since the applicable provisions of ASU 2011-04 are disclosure-related, the Company’s adoption of this guidance is not expected to have an impact to its financial condition or results of operations.
 
In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, which revises how entities present comprehensive income in their financial statements.  The ASU requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements.  In a continuous statement of comprehensive income, an entity would be required to present the components of the income statement as presented today, along with the components of other comprehensive income.  In the two-statement approach, an entity would be required to present a statement that is consistent with the income statement format used today, along with a second statement, which would immediately follow the income statement that would include the components of other comprehensive income.  The ASU does not change the items that an entity must report in other comprehensive income.  ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which is July 1, 2012 for the Company, and should be applied retrospectively for all periods presented in the financial statements.  The Company has not yet decided which statement format it will adopt.
 
 
45

 
 
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
 
Not required for smaller reporting companies.
 
Item 8. Financial Statements and Supplementary Data.
 
The information required by this Item is included at the end of this Annual Report on Form 10-K beginning on page F-1.
 
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
 
None.
 
Item 9A. Controls and Procedures.
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
 
There has been no change in the Company’s internal control over financial reporting during the Company’s fourth quarter of fiscal year 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
 
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of June 30, 2011, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of June 30, 2011 is effective.
 
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.
 
 
46

 
 
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
 
Item 9B. Other Information.
 
None.
 
PART III
 
Item 10. Directors, Executive Officers and Corporate Governance.
 
Information required by this Item is incorporated by reference herein from the Company’s definitive Proxy Statement relating to the 2011 Annual Meeting of Stockholders of the Company (the “Proxy Statement”).
 
Item 11. Executive Compensation.
 
Information required by this Item is incorporated by reference herein from the Company’s Proxy Statement.
 
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
Information required by this Item is incorporated by reference herein from the Company’s Proxy Statement.
 
Item 13. Certain Relationships and Related Transactions, and Director Independence.
 
Information required by this Item is incorporated by reference herein from the Company’s Proxy Statement.
 
Item 14. Principal Accounting Fees and Services.
 
Information required by Item 14 of this Form is incorporated by reference herein from the Company’s Proxy Statement.
 
 
47

 
 
PART IV
 
Item 15. Exhibits, Financial Statement Schedules.
 
(a)      The following documents are filed as part of this report:
 
(1)   Financial Statements: The financial statements, including notes thereto, and financial schedules required in response to this Item are set forth in Part II, Item 8 of this Annual Report on Form 10-K, and can be found on the following pages:
 
 
Page
Report of Independent Registered Public Accounting Firm
F-1
Balance Sheets as of June 30, 2011 and 2010
F-2
Statements of Income for the years ended June 30, 2011 and 2010
F-3
Statements of Changes in Stockholders’ Equity for the years ended June 30, 2011 and 2010
F-4
Statements of Cash Flows for the years ended June 30, 2011 and 2010
F-5
 
(2)   Financial Statement Schedules: Schedules to the financial statements required by Regulation S-X and all other schedules to the financial statements have been omitted because they are either not required, are not applicable or are included in the financial statements or notes thereto, which  can be found in this Annual Report on Form 10-K in Part II, Item 8.
 
(3)   Exhibits:
 
2.0
Plan of Reorganization from Mutual Savings Bank to Mutual Holding Company and Stock Issuance Plan **
3.1
Charter of Auburn Bancorp, Inc. **
3.2
Bylaws of Auburn Bancorp, Inc. **
4.0
Specimen Stock Certificate of Auburn Bancorp, Inc. **
10.1
Auburn Savings Bank Employee Stock Ownership Plan and Trust *
10.2
ESOP Loan Commitment Letter and ESOP Loan Documents *
10.3
Employment Agreement between Auburn Savings Bank and Allen T. Sterling *
14.0
Code of Ethics *
21.1
Subsidiaries of Auburn Bancorp, Inc. **
23.0
Consents of Experts and Counsel
31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer of the Company
31.2
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer of the Company
32.1
Section 1350 Certification of Chief Executive Officer of the Company in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Section 1350 Certification of Chief Financial Officer of the Company in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
 
* Incorporated by reference into this document from the Exhibits filed with the Securities and Exchange Commission to the Company’s Form 10-K filed on September 29, 2008 (File Number 000-53370).
 
** Incorporated by reference into this document from the Exhibits filed with the Securities and Exchange Commission on the Company’s Registration Statement on Form S-1, as amended, initially filed on March 14, 2008 and declared effective on May 13, 2008 (File Number 333-149723).
 
 
48

 
 
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 Bancorp, Inc.
   
(Registrant)
     
Date: September 27, 2011
By:
 /s/ Allen T. Sterling
   
Allen T. Sterling
   
President and Chief Executive Officer
     
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.  
 
Name
 
Title
 
Date
         
/s/ Allen T. Sterling
 
President and Chief Executive Officer
 
September 27, 2011
Allen T. Sterling
       
         
/s/ Rachel A. Haines
 
Principal Financial Officer
 
September 27, 2011
Rachel A. Haines
       
         
/s/ Claire D. Thompson
 
Director
 
September 27, 2011
Claire D. Thompson
       
         
/s/ Philip R. St. Pierre
 
Director
 
September 27, 2011
Philip R. St. Pierre
       
         
/s/ Bonnie G. Adams
 
Director
 
September 27, 2011
Bonnie G. Adams
       
         
/s/ Thomas J. Dean
 
Director
 
September 27, 2011
Thomas J. Dean
       
         
/s/ Peter E. Chalke
 
Director
 
September 27, 2011
Peter E. Chalke
       
         
/s/ M. Kelly Matzen
 
Director
 
September 27, 2011
M. Kelly Matzen
       
         
/s/ Sharon A. Millett
 
Director
 
September 27, 2011
Sharon A. Millett
       
 
 
49

 
 
GRAPHIC
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
Board of Directors
Auburn Bancorp, Inc. and Subsidiary
 
We have audited the accompanying consolidated balance sheets of Auburn Bancorp, Inc and Subsidiary as of June 30, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Auburn Bancorp, Inc. and Subsidiary as of June 30, 2011 and 2010, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
 
 
GRAPHIC
 
Portland, Maine
September 27, 2011
 
 
 
 
 
 
GRAPHIC
 
 
F-1

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Balance Sheets
 
June 30, 2011 and 2010
 
ASSETS
 
   
2011
   
2010
 
             
Cash and due from banks
  $ 1,457,220     $ 1,573,526  
Interest-earning deposits
    1,648,411       3,705,910  
Total cash and cash equivalents
    3,105,631       5,279,436  
                 
Certificates of deposit
    495,000       845,000  
                 
Investment securities available for sale, at fair value
    1,102,025       1,112,507  
                 
Investment securities held to maturity, fair value of $970,906 at June 30, 2011 and $0 at June 30, 2010
    971,985       -  
                 
Federal Home Loan Bank stock, at cost
    1,251,700       1,251,700  
                 
Loans
    68,303,266       69,374,825  
Less allowance for loan losses
    (906,989 )     (492,112 )
Net loans
    67,396,277       68,882,713  
                 
Property and equipment, net
    1,799,455       1,852,414  
                 
Foreclosed real estate, net of allowance of $23,508 at June 30, 2011 and $50,333 at June 30, 2010
    1,196,183       680,712  
                 
Accrued interest receivable
               
Investments
    16,526       13,820  
Mortgage-backed securities
    363       573  
Loans
    265,563       263,353  
                 
Prepaid expenses and other assets
    311,456       405,246  
                 
Total assets
  $ 77,912,164     $ 80,587,474  
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Liabilities
               
Deposits
  $ 53,876,926     $ 55,769,248  
Federal Home Loan Bank advances
    17,634,474       18,430,662  
Accrued interest and other liabilities
    280,552       337,611  
Total liabilities
    71,791,952       74,537,521  
                 
Commitments (Notes 8,9,10,12 and 13)
               
                 
Stockholders’ Equity
               
Preferred Stock, 1,000,000 shares authorized, no shares issued or outstanding
    -       -  
Common Stock, $.01 par value per share, 10,000,000 shares authorized, 503,284 shares issued and outstanding at June 30, 2011 and 2010
    5,033       5,033  
Additional paid-in-capital
    1,465,501       1,468,928  
Retained earnings
    4,783,236       4,719,099  
Accumulated other comprehensive income (loss)
    (641 )     1,368  
Unearned compensation (ESOP shares)
    (132,917 )     (144,475 )
Total stockholders equity
    6,120,212       6,049,953  
                 
Total liabilities and stockholders’ equity
  $ 77,912,164     $ 80,587,474  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-2

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Income
 
Years Ended June 30, 2011 and 2010
 
   
2011
   
2010
 
Interest and dividend income:
           
Interest on loans
  $ 4,128,026     $ 4,038,078  
Interest on investments and other interest-earning deposits
    49,805       100,963  
Dividends on Federal Home Loan Bank stock
    1,903       -  
Total interest and dividend income
    4,179,734       4,139,041  
                 
Interest expense:
               
Interest on deposits and escrow accounts
    846,913       1,004,758  
Interest on Federal Home Loan Bank advances
    564,094       677,439  
Total interest expense
    1,411,007       1,682,197  
                 
Net interest income
    2,768,727       2,456,844  
                 
Provision for loan losses
    566,942       109,195  
                 
Net interest income after provision for loan losses
    2,201,785       2,347,649  
                 
Non-interest income:
               
Net gain on sales of loans
    108,536       78,203  
Net gain (loss) on sale of investment securities
    23,145       (126,269 )
Other non-interest income
    169,735       140,572  
Total non-interest income
    301,416       92,506  
                 
Non-interest expenses:
               
Salaries and employee benefits
    1,001,945       962,009  
Occupancy expense
    102,847       92,169  
Depreciation
    95,586       96,501  
Federal deposit insurance premiums
    121,677       142,414  
Computer charges
    176,141       174,724  
Advertising expense
    60,427       80,696  
Consulting expense
    130,541       48,805  
Net provision for losses on foreclosed real estate
    11,084       104,518  
Other operating expenses
    706,621       577,327  
Total non-interest expenses
    2,406,869       2,279,163  
                 
Income before income taxes
    96,332       160,992  
                 
Income tax expense
    32,195       53,363  
                 
Net income
  $ 64,137     $ 107,629  
                 
Net income per common share
  $ 0.13     $ 0.22  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-3

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Statements of Changes in Stockholders’ Equity
 
Years Ended June 30, 2011 and 2010
 
                     
Accumulated
             
                     
Other
             
         
Additional Paid-
   
Retained
   
Comprehensive
   
Unearned
       
   
Common Stock
   
in-Capital
   
Earnings
   
Income (Loss)
   
ESOP shares
   
Total
 
                                     
Balance, June 30, 2009
  $ 5,033     $ 1,470,790     $ 4,611,470     $ (26,225 )   $ (157,189 )   $ 5,903,879  
Comprehensive income
                                               
Net income
    -       -       107,629       -       -       107,629  
Other comprehensive income
                                               
Unrealized holding loss on securities, net of taxes of $(28,716)
    -       -       -       (55,745 )     -       (55,745 )
Less reclassification adjustment for items included in net income, net of taxes of $42,931
    -       -       -       83,338       -       83,338  
                                                 
Total comprehensive income
    -       -       107,629       27,593       -       135,222  
                                                 
Common stock held by ESOP committed to be released (1,271 shares)
    -       (1,862 )     -       -       12,714       10,852  
                                                 
Balance, June 30, 2010
  $ 5,033     $ 1,468,928     $ 4,719,099     $ 1,368     $ (144,475 )   $ 6,049,953  
                                                 
Comprehensive income
                                               
Net income
    -       -       64,137       -       -       64,137  
Other comprehensive loss
                                               
Unrealized holding gain on securities, net of taxes of $6,834
    -       -       -       13,267       -       13,267  
Less reclassification adjustment for items included in net income, net of taxes of $(7,869)
    -       -       -       (15,276 )     -       (15,276 )
                                                 
Total comprehensive income
    -       -       64,137       (2,009 )     -       62,128  
                                                 
Common stock held by ESOP committed to be released (1,156 shares)
    -       (3,427 )     -       -       11,558       8,131  
                                                 
Balance, June 30, 2011
  $ 5,033     $ 1,465,501     $ 4,783,236     $ (641 )   $ (132,917 )   $ 6,120,212  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-4

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY
 
Consolidated Statements of Cash Flows
 
Years Ended June 30, 2011 and 2010
 
 
 
 
      2011       2010   
Cash flows from operating activities:
               
Net income
  $ 64,137     $ 107,629  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    95,586       96,501  
Net amortization (accretion) of discounts and premiums on investment securities
    31,598       (1,682 )
Provision for loan losses
    566,942       109,195  
Net provision for losses on foreclosed real estate
    11,084       104,518  
Deferred income tax benefit
    (151,021 )     (38,746 )
Net loss (gain) on investment securities
    (23,145 )     126,269  
Gain on sales of loans
    (108,536 )     (78,203 )
Proceeds from sale of loans
    2,337,395       2,671,142  
Originations of loans sold
    (2,245,000 )     (2,604,191 )
Loss on foreclosed real estate
    33,598       -  
ESOP compensation expense
    8,131       10,852  
Net (increase) decrease in prepaid expenses and other assets
    93,790       (223,118 )
Net decrease in accrued interest receivable
    (4,706 )     (733 )
Net increase in accrued interest payable and other liabilities
    94,997       84,332  
                 
Net cash provided by operating activities
    804,850       363,765  
                 
Cash flows from investing activities:
               
Purchase of investment securities available for sale
    (525,351 )     (537,265 )
Purchase of investment securities held to maturity
    (971,925 )     -  
Proceeds from maturities, calls and principal paydowns on investment securities available for sale
    524,276       800,499  
Proceeds from sale of other real estate owned
    221,958       105,360  
Net change in certificates of deposit
    350,000       3,607,000  
Net decrease (increase) in loans to customers
    153,524       (7,239,710 )
Purchase of Federal Home Loan Bank stock
    -       (104,700 )
Capital expenditures
    (42,627 )     (41,038 )
                 
Net cash used in investing activities
    (290,145 )     (3,409,854 )
                 
Cash flows from financing activities:
               
Advances from Federal Home Loan Bank
    3,000,000       7,150,000  
Repayment of advances from Federal Home Loan Bank
    (3,650,000 )     (5,869,338 )
Net change in short-term borrowings
    (146,188 )     (3,000,000 )
Net increase (decrease) in deposits
    (1,892,322 )     7,670,227  
                 
Net cash provided by (used in) financing activities
    (2,688,510 )     5,950,889  
                 
Net (decrease) increase in cash and cash equivalents
    (2,173,805 )     2,904,800  
                 
Cash and cash equivalents, beginning of year
    5,279,436       2,374,636  
                 
Cash and cash equivalents, end of year
  $ 3,105,631     $ 5,279,436  
                 
Supplementary cash flow information:
               
Cash paid during the year for:
               
Interest
  $ 1,288,874     $ 1,695,431  
Taxes
  $ 93,886     $ 26,177  
Transfer of loans to foreclosed real estate
  $ 700,019     $ 448,172  
Financed sale of foreclosed real estate
  $ -     $ 100,000  
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
F-5

 
 
AUBURN BANCORP, INC. AND SUBSIDIARY

Notes to Financial Statements

Years Ended June 30, 2011 and 2010
 
Nature of Business
 
Auburn Bancorp, Inc. (the Company), through its subsidiary, Auburn Savings Bank, FSB (the Bank) grants residential, consumer and commercial loans to customers primarily throughout the Lewiston/Auburn, Maine area. The Company is subject to competition from other financial institutions. The Company is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.
 
The Company is a majority-owned subsidiary of Auburn Bancorp, MHC (the MHC).  In 2008, the  Company conducted a minority stock offering pursuant to which the Company sold 226,478 shares, or 45% of its common stock, at a price of $10.00 per share to eligible depositors and other members of the Company, an employee stock ownership plan (ESOP) and members of the general public in a subscription and community offering. In addition, the Company issued 276,806 shares, or 55% of its common stock, to the MHC.
 
Basis of Presentation
 
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank.  All significant intercompany transactions and balances have been eliminated.
 
1.
Summary of Significant Accounting Policies
 
The accounting policies of the Company are in conformity with accounting principles generally accepted in the United States of America (GAAP) and general practices within the banking industry. The following is a description of the significant accounting policies.
 
Use of Estimates
 
In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and foreclosed real estate. In connection with the determination of the allowance for loan losses and foreclosed real estate, management obtains independent appraisals for significant properties.
 
Significant Group Concentrations of Credit Risk
 
A substantial portion of loans are secured by real estate in the Lewiston/Auburn, Maine area. Accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio is susceptible to changes in market conditions in the Lewiston/Auburn, Maine area.
 
The Company’s policy for requiring collateral is to obtain security in excess of the amount borrowed. The amount of collateral obtained is based on management’s credit evaluation of the borrower. The Company requires appraisals of real property held as collateral. For consumer loans, collateral varies depending on the purpose of the loan. Collateral held for commercial loans consists primarily of real estate.
 
 
F-6

 
 
Cash and Cash Equivalents
 
For purposes of the statements of cash flows, cash and cash equivalents include cash and due from banks and interest-bearing deposits.
 
The Company’s due from bank accounts, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant risk on cash and cash equivalents.
 
Securities
 
The Company classifies its investments as available for sale or held to maturity. Investment securities available for sale are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income or loss.  Debt securities the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost.
 
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of individual equity securities that are deemed to be other than temporary are reflected in earnings when identified. For individual debt securities where the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary decline in the fair value of the debt security related to 1) credit loss is recognized in earnings and 2) other factors is recognized in other comprehensive income or loss. Credit loss is deemed to exist if the present value of expected future cash flows is less than the amortized cost basis of the debt security. For individual debt securities where the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost, the other-than-temporary impairment is recognized in earnings equal to the entire difference between the security’s cost basis and its fair value at the balance sheet date.
 
In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
 
Federal Home Loan Bank Stock
 
Federal Home Loan Bank (FHLB) stock is a non-marketable equity security carried at cost and evaluated for impairment.
 
Loans
 
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method over the contractual life of the loans.
 
Loans past due 30 days or more are considered delinquent. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection. Consumer loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
 
 
F-7

 
 
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. Cash payments on these loans are applied to principal balances until qualifying for return to accrual. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
Loans Held for Sale
 
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
 
Allowance for Loan Losses
 
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
 
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
 
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component relates to pools of non-impaired loans and is based on historical loss experience adjusted for qualitative factors.
 
Credit Related Financial Instruments
 
In the ordinary course of business, the Company has entered into commitments to extend credit. Such financial instruments are recorded in the financial statements when they are funded.
 
Loan Servicing
 
The Company capitalizes mortgage servicing rights at their fair value upon sale of the related loans. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost.
 
Property and Equipment
 
Land is carried at cost. Buildings, furniture and fixtures, and land improvements are carried at cost, less accumulated depreciation computed on the declining balance and straight-line methods over the estimated useful lives of the assets.
 
Foreclosed Real Estate
 
Real estate properties acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed real estate.
 
 
F-8

 
 
Income Taxes

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on investment securities available for sale, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Employee Stock Ownership Plan (ESOP)

Shares of the Company’s common stock purchased by the ESOP are held in a suspense account until released for allocation to participants.  Shares released are allocated to each eligible participant based on the ratio of each such participant’s compensation, as defined in the ESOP, to the total compensation of all eligible plan participants.  As the unearned shares are released from suspense, the Company recognizes compensation expense equal to the fair value of the ESOP shares committed to be released during the period.  To the extent that the fair value of the ESOP shares differs from the cost of such shares, the difference is charged or credited to equity as additional paid-in-capital.  Allocated and committed-to-be-released ESOP shares are considered outstanding for earnings per share calculations based on debt service payments.  Other ESOP shares are excluded from earnings per share.  The cost of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders’ equity.

Advertising

Advertising costs are expensed as incurred.

Earnings Per Share

Basic earnings per share is determined by dividing net income available to common stockholders by the adjusted weighted average number of common shares outstanding during the period. The adjusted outstanding common shares equals the gross number of common shares issued less unallocated shares of the ESOP.
 
Earnings per share for the fiscal years ended June 30 is based on the following:
 
   
2011
   
2010
 
             
Net income
  $ 64,137     $ 107,629  
                 
Weighted average common shares outstanding
    503,284       503,284  
Less: Average unallocated ESOP shares
    (13,824 )     (15,004 )
                 
Adjusted weighted average common shares outstanding
    489,460       488,280  
                 
Earnings per common share
  $ 0.13     $ 0.22  

The Company does not have any potential common shares, therefore diluted earnings per share is not applicable.
 
 
F-9

 
 
Impact of Recent Accounting Standards

In January 2010, the Financial Accounting Standards Board (FASB) issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance is effective for the Company with the reporting period beginning July 1, 2010, except for the disclosure on the roll forward activities for any Level 3 fair value measurements, which will become effective for the Company with the reporting period beginning July 1, 2011. Other than requiring additional disclosures, adoption of this new guidance does not have a material effect on the Company’s consolidated financial statements.

In July 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This ASU is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The guidance is effective for interim and annual reporting periods ending after December 15, 2010. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  This ASU provides guidance on determining whether a restructuring of a receivable meets the criteria to be considered a Troubled Debt Restructuring (TDR).  The new guidance is required to be adopted for the first interim or annual reporting period beginning after June 15, 2011, and is to be applied retrospectively to the beginning of the annual reporting period of adoption.  Early adoption is permitted.  The Company intends to adopt the provisions of this ASU when required, and is evaluating its potential impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRSs.  This ASU is a result of joint efforts by the FASB and the International Accounting Standards Board (IASB) to develop a single, converged fair value framework for measuring fair value and for disclosing information about fair value measurements in accordance with GAAP and International Financial Reporting Standards (IFRSs).  This ASU is largely consistent with existing fair value measurement principles in U.S. GAAP; however, some of the components of this ASU could change how fair value measurement guidance in Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, is applied.  This ASU does not require additional fair value measurements and is not intended to establish valuation standards or affect valuation practices outside of financial reporting.  ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011, which is January 1, 2012 for the Company, and should be applied retrospectively.  Since the applicable provisions of ASU 2011-04 are disclosure-related, the Company’s adoption of this guidance is not expected to have an impact to its financial condition or results of operations.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, which revises how entities present comprehensive income in their financial statements.  The ASU requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements.  In a continuous statement of comprehensive income, an entity would be required to present the components of the income statement as presented today, along with the components of other comprehensive income.  In the two-statement approach, an entity would be required to present a statement that is consistent with the income statement format used today, along with a second statement, which would immediately follow the income statement, that would include the components of other comprehensive income.  The ASU does not change the items that an entity must report in other comprehensive income.  ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which is July 1, 2012 for the Company, and should be applied retrospectively for all periods presented in the financial statements.  The Company has not yet decided which statement format it will adopt.
 
 
F-10

 
 
2.
Cash and Due from Banks

The Company is required to maintain certain reserves of vault cash or deposits with the Federal Reserve Bank. The amount of this reserve requirement, included in cash and due from banks, was approximately $250,000 as of June 30, 2011 and 2010, respectively.

3.
Securities

The amortized cost and fair value of investment securities, with gross unrealized gains and losses, are as follows:
 
    June 30, 2011     June 30, 2010  
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Value
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Value
 
Securities available for sale
                                               
Corporate bonds and other obligations
  $ 1,015,749     $ 4,073     $ (7,500 )   $ 1,012,322     $ 982,415     $ 13,366     $ (15,640 )   $ 980,141  
FNMA mortgage-backed securities
    77,244       2,812       (1,030 )     79,026       118,017       3,499       -       121,516  
U.S. Government sponsored enterprise securities
    2       675       -       677       2       848       -       850  
Corporate common stock
    10,000       -       -       10,000       10,000       -       -       10,000  
Total
  $ 1,102,995     $ 7,560     $ (8,530 )   $ 1,102,025     $ 1,110,434     $ 17,713     $ (15,640 )   $ 1,112,507  
                                                                 
Securities held to maturity
                                                               
Municipal bonds
  $ 971,985     $ 7,800     $ (8,878 )   $ 970,907     $ -     $ -     $ -     $ -  
Total
  $ 971,985     $ 7,800     $ (8,878 )   $ 970,907     $ -     $ -     $ -     $ -  
 
Investments with a fair value of approximately $2,063,000 and $1,103,000 at June 30, 2011 and 2010, respectively, are held in a custody account to secure certain deposits.  In addition to the investments held in custody, two loans guaranteed by the Small Business Administration and Finance Authority of Maine totaled $1,176,000 and $1,343,000, and certificate of deposits totaled $495,000 and $845,000 at June 30, 2011 and 2010 respectively, are held to secure other deposits.

The amortized cost and fair value of debt securities by contractual maturity follow. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
   
June 30, 2011
   
June 30, 2010
 
                         
   
Amortized
Cost
   
Fair Value
   
Amortized
Cost
   
Fair Value
 
                         
One year or less
  $ 765,749     $ 769,823     $ -     $ -  
Over 1 year through 5 years
    250,000       242,500       782,415       766,775  
After 5 years through 10 years
    -       -       200,000       213,366  
After 10 years
    971,985       970,906       -       -  
      1,987,734       1,983,229       982,415       980,141  
Mortgage-backed securities
    77,244       79,026       118,017       121,516  
                                 
Total debt securities
  $ 2,064,978     $ 2,062,255     $ 1,100,432     $ 1,101,657  
 
 
F-11

 
 
Information pertaining to securities with gross unrealized losses at June 30, 2011 and 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
 
   
Less Than 12 Months
   
12 Months or Greater
    Total  
                                     
   
Fair Value
   
Gross
Unrealized
Losses
   
Fair Value
   
Gross
Unrealized
Losses
   
Fair Value
   
Gross
Unrealized
Losses
 
June 30, 2011
                                   
Municipal bonds
  $ -     $ -     $ 594,927     $ 8,878     $ 594,927     $ 8,878  
Corporate bonds
    -       -       242,500       7,500       242,500       7,500  
FNMA mortgage-backed securities
    -       -       43,461       1,030       43,461       1,030  
Total
  $ -     $ -     $ 880,888     $ 17,408     $ 880,888     $ 17,408  
                                                 
June 30, 2010
                                               
Corporate bonds
  $ 530,525     $ 1,890     $ 236,250     $ 13,750     $ 766,775     $ 15,640  
Total
  $ 530,525     $ 1,890     $ 236,250     $ 13,750     $ 766,775     $ 15,640  
 
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

At June 30, 2011, seven debt securities with unrealized losses have depreciated 2% in total from the amortized cost basis. These unrealized losses related principally to current interest rates for similar types of securities compared to the underlying yields on these securities. At June 30, 2010, the three debt securities with unrealized losses had depreciated 2% in total from the amortized cost basis. These unrealized losses related principally to current interest rates for similar types of securities compared to the underlying yields on these securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition and the Company’s ability to hold such securities.  At June 30, 2011, no unrealized losses are deemed by management to be other-than-temporary.

For the year ended June 30, 2011, proceeds from sales of securities available for sale amounted to $228,005. Gross realized gains amounted to $23,145 and there were no gross realized losses for the year ended June 30, 2011.  For the year ended June 30, 2010, proceeds from sales of securities available for sale amounted to $800,499.  Gross realized gains amounted to $32,894 and gross realized losses amounted to $159,163 for the year ended June 30, 2010.
 
 
F-12

 
 
4.
Loans

A summary of the balances of loans follows:
 
   
2011
   
2010
 
Mortgage loans:
           
One to four family residential
  $ 40,548,592     $ 36,417,972  
Commercial
    11,309,682       15,135,502  
Construction
    156,000       410,000  
Equity lines of credit and loans
    11,141,885       11,436,398  
Undisbursed portion of construction loan
    (112,094 )     (97,083 )
Subtotal
    63,044,065       63,302,789  
                 
Commercial loans
    4,484,857       5,267,408  
Consumer loans
    897,020       951,559  
Deferred loan origination costs
    161,266       165,268  
Deferred loan origination fees
    (283,942 )     (312,199 )
                 
Total loans
    68,303,266       69,374,825  
                 
Allowance for loan losses
    (906,989 )     (492,112 )
                 
Total loans, net
  $ 67,396,277     $ 68,882,713  

Credit Quality and Allowance for Credit Losses

One of the Bank’s most important operating objectives is to maintain a high level of asset quality.  Management uses a number of strategies in furtherance of this goal including maintaining sound credit standards in loan originations, monitoring the loan portfolio through internal and third-party loan reviews, and employing active collection and workout processes for delinquent or problem loans.
 
Credit risk arises from the inability of a borrower to meet its obligations. The Bank attempts to manage the risk characteristics of the loan portfolio through various control processes defined in part through the Loan Policy, such as credit evaluation of borrowers, establishment of lending limits, and application of lending procedures, including the holding of adequate collateral and the maintenance of compensating balances. Loan origination processes include evaluation of the risk profile of the borrower, repayment sources, the nature of the underlying collateral, and other support given current events, conditions, and expectations. The Bank seeks to rely primarily on the cash flow of borrowers as the principal source of repayment.

Although credit policies and evaluation processes are designed to minimize risk, Management recognizes that loan losses will occur and the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio, as well as general and regional economic conditions.
 
The Bank provides for loan losses through the establishment of an allowance for loan losses which represents an estimated reserve for existing losses in the loan portfolio. On an on-going basis, loans are monitored by loan officers and are subject to periodic independent outsourced loan reviews, and delinquency and watch lists are regularly reviewed. At the end of each quarter, the Bank deploys a systematic methodology for determining credit quality that includes formalization and documentation of this review process. In particular, any bankruptcy and foreclosure activity is reviewed along with delinquency watch list issues. Management also classifies the loan portfolio specifically by loan type and monitors credit risk separately as discussed under Credit Quality Indicators below.

Management evaluates the adequacy of the allowance continually based on a review of all significant loans, via delinquency reports and a watch list that strives to identify, track and monitor credit risk, historical losses and current economic conditions.
 
 
F-13

 
 
The allowance calculation includes general reserves as well as specific reserves and valuation allowances for individual credits. The specific component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component relates to pools of non-impaired loans. On a quarterly basis, management assesses the adequacy of the general reserve allowances based on 1) national, state and local economic factors; 2) interest rate environment and trends; 3) delinquency metrics, including the Bank’s historical loss experience; 4) Bank-specific factors such as changes in lending personnel; 5) changes in the loan review system and related ratings; 6) the bank’s current underwriting standards; and 7) peer statistics; 8) concentrations of commercial credits.

An analysis of the allowance for loan losses follows:
 
   
2011
   
2010
 
             
Balance at beginning of year
  $ 492,112     $ 385,181  
Provision for loan losses
    566,942       109,195  
Loans charged off, net of recoveries
    (152,065 )     (2,264 )
                 
Balance at end of year
  $ 906,989     $ 492,112  
 
The following tables provide information relative to credit quality and allowance for loan losses as of and for the year ended June 30, 2011.
 
   
Commercial
                               
   
Non-Real
   
Commercial
   
Residential
                   
   
Estate
   
Real Estate
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Year ended June 30, 2011
                                   
                                     
Allowance for loan losses:
                                   
Beginning balance
  $ 65,874     $ 157,173     $ 261,246     $ 7,819     $ -     $ 492,112  
Charge-offs
    (42,290 )     (92,438 )     (14,953 )     (6,149 )     -       (155,830 )
Recoveries
    1,500       -       -       2,265       -       3,765  
Provision
    142,775       181,162       81,145       8,698       153,162       566,942  
Ending balance
  $ 167,859     $ 245,897     $ 327,438     $ 12,633     $ 153,162     $ 906,989  
                                                 
As of June 30, 2011
                                               
                                                 
Allowance for loan losses:
                                               
Ending balance
  $ 167,859     $ 245,897     $ 327,438     $ 12,633     $ 153,162     $ 906,989  
Individually evaluated for impairment
    107,057       85,219       19,606       2,198       -       214,080  
Collectively evaluated for impairment
    60,802       160,678       307,832       10,435       153,162       692,909  
                                                 
Loans
                                               
Ending balance:
  $ 4,484,857     $ 11,262,751     $ 51,658,638     $ 897,020     $ -     $ 68,303,266  
Individually evaluated for impairment
    356,700       417,211       116,805       2,198       -       892,914  
Collectively evaluated for impairment
    4,128,157       10,845,540       51,541,833       894,822       -       67,410,352  

The Bank’s provision for loan losses was $566,942 and $109,195 for the years ended June 30, 2011 and 2010, respectively.  The increase to the provision is the result of an increase in specific reserves of $171,000 and an increase in general valuation reserve of $244,000 due largely to current economic conditions, including declining real estate values and loan performance challenges across all segments of the loan portfolio.  The Bank has completed a comprehensive review of the loan portfolio and related allowance for loan losses, and has increased its allowance for loan losses to $906,989 at June 30, 2011 which now represents 1.33% of total loans, compared to an allowance of $492,112, representing 0.71% of total loans at June 30, 2010.

Risk by Portfolio Segment
 
One- to Four-Family Residential Loans. The Bank’s primary lending activity consists of the origination of one- to four-family residential mortgage loans, substantially all of which are secured by properties located in its primary market area.  The Bank offers fixed-rate mortgage loans, which generally have terms of 15, 20 or 30 years.  The Bank no longer offers adjustable-rate mortgage loans (“ARMs”).
 
 
F-14

 
 
Home Equity Loans.  Home equity lines of credit and loans are secured by a mixture of first and second mortgages on one- to four-family owner occupied properties.  The procedures for underwriting home equity lines of credit and loans include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan.  All properties securing second mortgage loans are generally required to be appraised by a board-approved independent appraiser unless the first mortgage is also held by the Bank.  Home equity lines of credit and loans are made in amounts such that the combined first and second mortgage balances do not exceed 85% of value.
 
Commercial and Multi-Family Real Estate Loans. The Bank offers commercial real estate loans, including commercial business, and multi-family real estate loans that are generally secured by five or more unit apartment buildings and properties used for business purposes such as small office buildings or retail facilities substantially all of which are located in its primary market area.
 
Commercial and multi-family real estate loan amounts generally do not exceed 80% of the lesser of the property’s appraised value or sales price.
 
The Bank generally requires title insurance for commercial and multi-family real estate loans, an appraisal on all such loans if the total amount of loans with that borrower is in excess of $250,000, and an evaluation of the property by an approved appraiser for loans between $100,000 and $250,000.  The Bank may require a full appraisal on property securing any loan less than $250,000.
 
Loans secured by commercial real estate, including multi-family properties, generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate, including multi-family properties, are often dependent on successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.
 
Construction Loans. The Bank offers construction loans for the development of one- to four-family residential properties located in the Bank’s primary market area.  Residential construction loans are generally offered to individuals for construction of their personal residences.
 
Residential construction loans can be made with a maximum loan-to-value ratio of 95%, provided that the borrower obtains private mortgage insurance on the loan if the loan balance exceeds 80% of the appraised value of the secured property.
 
Construction and development financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value proves to be inaccurate, the Bank may be confronted with a project, when completed, having a value which is insufficient to assure full repayment.  
 
Commercial Loans.  The Bank makes commercial business loans primarily in its market area to a variety of small businesses, professionals and sole proprietorships.  Commercial lending products include term loans and revolving lines of credit. Commercial business loans are generally used for longer-term working capital purposes such as purchasing equipment or furniture. When making commercial loans, the Bank considers the financial statements of the borrower, its lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral. Commercial loans are generally secured by a variety of collateral, primarily accounts receivable, inventory and equipment, and the Bank also requires the business principals to execute such loans in their individual capacities. Depending on the amount of the loan and the collateral used to secure the loan, commercial loans are made in amounts of up to 50-80% of the value of the collateral securing the loan, or up to100% of the value of the collateral securing the loan if the collateral consists of cash or cash equivalents. The Bank generally does not make unsecured commercial loans.  The Bank requires adequate insurance coverage including, where applicable, title insurance, flood insurance, builder’s risk insurance and environmental insurance.
 
 
F-15

 
 
Commercial loans generally have greater credit risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans generally are made on the basis of the borrower’s ability to repay the loan from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The Bank seeks to minimize these risks through its underwriting standards.
 
Consumer Loans. The Bank offers a limited range of consumer loans, primarily to customers residing in its primary market area.  Consumer loans generally consist of loans on new and used automobiles, loans secured by deposit accounts and unsecured personal loans.
 
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as motor vehicles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
 
Credit Quality Indicators – Loan Rating Methodology
 
The Bank’s Loan Review Policy contains a rating system for credit risk. Loans reviewed are graded based on both risk of default as well as risk of loss. The policy defines risk of default as the risk that the borrower will not be able to make timely payments. This risk is assessed based on the capacity to service debt as structured, repayment history, and current status. The policy defines risk of loss as the assessment of the probability that the Bank will incur a loss of capital on a loan due to repayment default. This risk is assessed based on collateral position and net worth of the borrowing and supporting entities.

The rating system is based on the following categories. Loans included as acceptable in the table below represent an aggregation of loans from four categories:

1)  Superior - Well established national companies and loans secured by cash or marketable securities;
2)  Excellent - Well established local companies and loans secured by cash or marketable securities;
3)  Good – Assets secured by well to recently established businesses whose performance is average and whose industry conditions are fair to good; and
4)  Pass - Assets secured by well to recently established businesses whose performance is average and whose industry conditions are fair to good.  Borrower’s financial condition shows deterioration.
 
 
 

 
 
The other line items in the table are defined within the Loan Review Policy as follows;
 
 
-
Pass/Watch: Cash flow may be temporarily inadequate to cover the debt, projected primary source of repayment has not been verified or a deterioration in the financial condition of the customer that is not yet reflected in the status of the loan.
 
-
Special Mention: Assets are protected but potentially weak. Borrower is experiencing adverse trends or balance sheet issues which have not yet reached a point of jeopardizing loan repayment.
 
-
Substandard: Inadequately protected assets that exhibit one or more well defined weaknesses that jeopardize full collection or liquidation of assets.
 
-
Doubtful: Same standards as “substandard” with added characteristics that current facts, conditions and values make full collection highly improbable.
 
-
Loss: Assets that are considered uncollectible and are not warranted as a bank asset.
 
Credit Risk Profile by Internally Assigned Grade
       
             
   
Commercial
   
Commerical
 
   
Non-Real
   
Real Estate
 
 
 
Estate
   
Other
 
Grade:
               
Acceptable
  $ 2,587,881     $ 7,469,883  
Pass/Watch
    940,264       2,801,893  
Special mention
    600,012       -  
Substandard
    -       573,764  
Doubtful
    300,000       417,211  
Loss
    56,700       -  
Total
  $ 4,484,857     $ 11,262,751  
                 
Residential/Consumer Credit Exposure
               
Credit Risk Profile by Internally Assigned Grade
         
                 
   
Residential
         
 
 
(1st & 2nd)
   
Consumer
 
Grade:
           
Acceptable
  $ 49,749,667     $ 880,802  
Pass/Watch
    561,626       14,020  
Special mention
    968,470       -  
Substandard
    262,070       -  
Doubtful
    116,805       -  
Loss
    -       2,198  
Total
  $ 51,658,638     $ 897,020  
 
Impaired Loans
 
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Management considers factors including payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due when determining impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
 
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures.
 
 
F-17

 
 
The following is a summary of information pertaining to impaired loans:
 
   
2011
   
2010
 
Impaired loans without a valuation allowance
  $ -     $ 516,137  
Impaired loans with a valuation allowance
    892,914       372,307  
                 
Total impaired loans
  $ 892,914     $ 888,444  
Valuation allowance allocated to impaired loans
  $ 214,080     $ 43,368  
                 
Average investment in impaired loans
  $ 894,628     $ 335,440  

Impaired Loans
As of and for the Year Ended June 30, 2011
                               
                     
Year ended June 30, 2011
 
         
Unpaid
         
Average
   
Interest
 
   
Recorded
   
Principal
   
Related
   
Recorded
   
Income
 
   
Investment
   
Balance
   
Allowance
   
Investment
   
Recognized
 
                               
With no related allowance recorded:
                             
Commercial non-real estate
  $ -     $ -     $ -     $ -     $ -  
Commercial real estate
    -       -       -       -       -  
Residential real estate
    -       -       -       -       -  
Consumer
    -       -       -       -       -  
                                         
With an allowance recorded:
                                       
Commercial non-real estate
  $ 356,700     $ 356,700     $ 107,057     $ 357,780     $ 12,841  
Commercial real estate
    417,211       417,211       85,219       417,326       28,001  
Residential real estate
    116,805       116,805       19,606       117,091       8,709  
Consumer
    2,198       2,198       2,198       2,431       77  
                                         
Total:
                                       
Commercial non-real estate
  $ 356,700     $ 356,700     $ 107,057     $ 357,780     $ 12,841  
Commercial real estate
    417,211       417,211       85,219       417,326       28,001  
Residential real estate
    116,805       116,805       19,606       117,091       8,709  
Consumer
    2,198       2,198       2,198       2,431       77  
    $ 892,914     $ 892,914     $ 214,080     $ 894,628     $ 49,628  

Non-performing Loans

Loans are placed on non-accrual status when reasonable doubt exists as to the full timely collection of interest and principal or when a loan becomes 90 days past due unless an evaluation clearly indicates that the loan is well-secured and in the process of collection.  When a loan is placed on non-accrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans generally is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is reasonably assured.  These policies apply to all types of loans, including commercial and residential/consumer.
 
 
F-18

 
 
Real estate acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold.  When property is acquired, it is recorded at fair value at the date of foreclosure.  Holding costs and declines in fair value after acquisition of the property result in charges against income.
 
As of June 30, 2011, the Bank did not have any troubled debt restructurings that involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates or any accruing loans past due 90 days or more.
 
Age Analysis of Past Due Loans
As of June 30, 2011
                                                 
                                       
Recorded
       
                                       
Investment
   
Recorded
 
               
Greater
                     
Loans > 90
   
Investment
 
   
30-59 Days
   
60-89 Days
   
Than 90
   
Total Past
               
Days and
   
Loans on Non-
 
   
Past Due
   
Past Due
   
Days
   
Due
   
Current
   
Total Loans
   
Accruing
   
Accrual Status
 
Commercial non-real estate
  $ 19,022     $ -     $ -     $ 19,022     $ 4,465,835     $ 4,484,857     $ -     $ 56,700  
Commercial real estate
    203,355       83,375       271,464       558,194       10,704,557       11,262,751       -       271,464  
Residential real estate
    633,042       305,068       137,618       1,075,728       50,582,910       51,658,638       -       357,656  
Consumer
    94,176       -       2,198       96,374       800,646       897,020       -       2,198  
                                                                 
    $ 949,595     $ 388,443     $ 411,280     $ 1,749,318     $ 66,553,948     $ 68,303,266     $ -     $ 688,018  
 
Nonaccrual loans amounted to $688,018 and $551,402 at June 30, 2011 and 2010, respectively. Interest income of $13,374 and $22,971 would have been recognized on these loans if interest had been accrued at June 30, 2011 and 2010, respectively.

Interest income recognized on impaired loans was not material in 2010 and 2011.
 
The Company was servicing for others mortgage loans of approximately $9,844,000 and $9,818,000 at June 30, 2011 and 2010, respectively.

The balance of mortgage servicing rights was $67,906 and $74,056 at June 30, 2011 and 2010, respectively.

There were no loans held for sale at June 30, 2011 and 2010.

5.         Property and Equipment

A summary of the cost and accumulated depreciation of property and equipment is as follows:
             
   
2011
   
2010
 
             
Land and land improvements
  $ 407,780     $ 407,780  
Buildings
    1,950,328       1,950,328  
Furniture and fixtures
    605,666       563,039  
                 
      2,963,774       2,921,147  
Less accumulated depreciation
    1,164,319       1,068,733  
                 
Net property and equipment
  $ 1,799,455     $ 1,852,414  
 
 
F-19

 
 
Following is a summary of estimated useful lives by asset category:
 
Estimated Useful Lives (Years)
     
       
Land and land improvements
  15  
Buildings
  5 - 40  
Furniture and fixtures
  1 – 10  
 
6.       Deposits

 
A summary of deposit balances, by type, follows:
 
   
2011
   
2010
 
Demand accounts
  $ 2,615,452     $ 3,100,136  
Money market accounts
    13,332,530       13,819,929  
NOW accounts
    3,213,503       2,894,440  
Savings accounts
    4,566,028       3,951,404  
Certificates of deposit
    17,981,509       19,747,048  
Certificates of deposit, $100,000 and over
    12,167,904       12,256,291  
                 
Total Deposits
  $ 53,876,926     $ 55,769,248  
 
The scheduled maturities of time deposits are as follows:
             
   
2011
   
2010
 
             
2011
  $ -     $ 20,857,486  
2012
    14,717,765       4,760,682  
2013
    8,917,205       1,560,092  
2014
    1,171,044       765,375  
2015
    4,113,790       4,059,704  
2016
    1,229,609       -  
                 
    $ 30,149,413     $ 32,003,339  
 
A summary of interest expense on deposits is as follows:
             
   
2011
   
2010
 
Demand accounts
  $ 1,257     $ 1,598  
Money market accounts
    104,855       179,089  
NOW accounts
    15,454       17,997  
Savings accounts
    24,308       32,732  
Certificates of deposit
    701,039       773,342  
                 
    $ 846,913     $ 1,004,758  
 
 
F-20

 
 
The Company maintains collateralization agreements with certain depositors whose aggregate deposits exceed the federally insured limit. Excess amounts  are secured under these agreements by an interest in the Company’s investment instruments maintained in a separate third-party custodial account. As part of the collateralization agreement, the Company agrees to maintain the value of the collateral in the custodial account at a minimum level at least equal to 100% of the uninsured portion of these deposits. At June 30, 2011, the value of the collateral in the custodial account was approximately $3.3 million and the uninsured portion of the deposits was approximately $4.4 million. The difference resulted from the Company’s determination to remove approximately $1.2 million of FHLB stock which was previously placed into the custodial account. Subsequent to June 30, 2011, upon the determination to remove the FHLB stock, the Company added additional securities into the custodial account in accordance with the collateralization agreements.
 
7.
Federal Home Loan Bank Advances

Pursuant to collateral agreements with the FHLB, advances are collateralized by all stock in the FHLB and qualifying first mortgages.

The Company’s fixed-rate advances of $17,634,474 and $18,430,662 at June 30, 2011 and 2010, respectively, mature through 2016. At June 30, 2011 and 2010, the interest rates on fixed-rate advances ranged from 1.71 percent to 5.95 percent and 1.67 percent to 5.95 percent, respectively.

The Company’s advances include one callable advance of $1,000,000 at June 30, 2011 which matures in 2012. The rate is based on the three-month London Interbank Offer Rate (LIBOR). At June 30, 2011, the interest rate on this advance was 4.99 percent. The advance is callable on August 15, 2011 if LIBOR reaches 5.75 percent and quarterly thereafter through its maturity date.  

At June 30, 2011 and 2010, the Company also had $661,000 available under a long-term line of credit from the FHLB. There were no amounts drawn under this line at June 30, 2011 and 2010.

The contractual maturities of advances are as follows:

   
2011
   
2010
 
             
2011
  $ -     $ 3,650,000  
2012
    4,500,000       4,500,000  
2013
    2,250,000       2,250,000  
2014
    3,500,000       3,000,000  
2015
    4,884,474       5,030,662  
2016
    2,500,000       -  
                 
    $ 17,634,474     $ 18,430,662  
 
 
F-21

 
 
8.
Income Taxes
  
Allocation of federal and state income taxes between current and deferred portions is as follows:
             
   
2011
   
2010
 
Current tax provision
           
Federal
  $ 175,531     $ 84,144  
State
    7,685       7,965  
      183,216       92,109  
                 
Deferred federal tax benefit
    (151,021 )     (38,746 )
Change in valuation reserve
    -       -  
Deferred federal tax benefit, net
    (151,021 )     (38,746 )
                 
Income tax expense
  $ 32,195     $ 53,363  
 
The income tax provision differs from the expense that would result from applying federal statutory rates to income before income taxes, as follows:
 
   
2011
   
2010
 
             
Expected income tax expense at federal tax rate (34%)
  $ 32,753     $ 54,737  
Increase (reduction) in income taxes resulting from:
               
State tax, net of federal tax benefit
    5,072       5,257  
Valuation reserve
    -       -  
Other
    (5,630 )     (6,631 )
Income tax expense
  $ 32,195     $ 53,363  
                 
Effective income tax rate
    33.4 %     33.1 %
 
The components of the net deferred tax asset (liability), included in other assets, are as follows:
             
   
2011
   
2010
 
Deferred tax assets:
           
Allowance for loan losses
  $ 308,376     $ 152,554  
Impairment loss on investments
    35,993       35,280  
Expense accruals
    17,703       19,154  
Unrealized losses on investment securities available for sale
    330       -  
Other
    14,002       3,370  
Total deferred tax assets
    376,404       210,358  
                 
Valuation reserve against capital losses
    (27,917 )     (27,917 )
                 
Total deferred tax assets, net of valuation reserve
    348,487       182,441  
                 
Deferred tax liabilities:
               
Difference between tax and book bases of property and equipment
    (153,325 )     (135,841 )
Deferred loan fees
    (84,542 )     (87,462 )
Mortgage servicing rights
    (23,088 )     (22,957 )
Unrealized gains on investment securities available for sale
    -       (704 )
Other
    -       -  
Total deferred tax liabilities
    (260,955 )     (246,964 )
                 
Net deferred tax asset (liability)
  $ 87,532     $ (64,523 )
 
 
F-22

 
 
The change in the valuation reserve applicable to the net deferred tax asset is as follows:

   
2011
   
2010
 
             
Balance at beginning of year
  $ 27,917     $ 27,917  
Change generated by current year’s operations
    -       -  
                 
Balance at end of year
  $ 27,917     $ 27,917  
 
The Bank has sufficient refundable taxes paid in available carryback years to fully realize its recorded deferred tax assets, net of valuation reserve for capital losses.

The Bank used the percentage of taxable income bad debt deduction to calculate its bad debt expense for tax purposes as was permitted by the Internal Revenue Code. The cumulative effect of this deduction of approximately $421,000 is subject to recapture, if used for purposes other than to absorb loan losses. Deferred taxes of $143,000 have not been provided on this amount because the Bank does not intend to use the tax reserve other than to absorb loan losses.

FASB ASC Topic 740, Income Taxes, defines the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. Topic 740 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those tax positions to be recognized in the financial statements. Effective July 1, 2008, the Company has adopted these provisions and there was no material effect on the financial statements, and no cumulative effect.
 
The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ended June 30, 2008 through 2010.  If the Company, as a result of an audit, was assessed interest and penalties, the amounts would be recorded through income tax expense.

9.
Financial Instruments with Off-Balance-Sheet Risk

The Company is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.

At June 30, 2011 and 2010, the following financial instruments were outstanding whose contract amounts represent credit risk:
 
   
2011
   
2010
 
             
Commitments to originate loans
  $ 273,000     $ 2,308,000  
Unadvanced portions of construction loans
    112,000       97,000  
Unadvanced portions of home equity loans
    3,482,000       2,917,000  
Unadvanced portions of commercial lines of credit
    567,000       1,573,000  
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Unfunded commitments under commercial lines of credit are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
 
 
F-23

 
 
Included in the above commitments to extend credit at June 30, 2011 was a fixed rate commitment to grant a loan of approximately $173,000 which expires in 30 days. Interest rates on this fixed rate commitment is 5.00%.

Included in the above commitments to extend credit at June 30, 2010 were fixed commitments to grant loans of approximately $360,000 which expire in 30 days. Interest rates on these fixed rate commitments range from 5.00% to 8.00%.

The Company has sold mortgage loans to the FHLB with a total outstanding balance of approximately $9,844,000 and $9,818,000 at June 30, 2011 and 2010, respectively. Under the terms of the agreement with the FHLB, the Company has a limited recourse obligation to the FHLB in the event the borrower defaults. At June 30, 2011 and 2010, the maximum recourse obligation totaled approximately $322,000 and $355,000, respectively.

10.       Legal Contingencies

Various legal claims arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.
 
11.
Other Non-interest Income and Other Operating Expense
 
Other non-interest income and other operating expense include the following items greater than 1% of revenues.

   
2011
   
2010
 
Other non-interest income:
           
Deposit fee income
  $ 65,000     $ 50,000  
                 
Other operating expense:
               
Audits and examinations
  $ 162,000     $ 176,000  
Accounting expense
    82,000       n/a  
Legal fees
    67,000       70,000  
 
12.
Minimum Regulatory Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy requires the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to total assets (as defined). Management believes, as of June 30, 2011 and 2010, that the Company and the Bank met all capital adequacy requirements to which they are subject.

As of June 30, 2011 and 2010, the most recent notification from the Office of Thrift Supervision categorized the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Company’s and the Bank’s category. Actual capital amounts and ratios as of June 30, 2011 and 2010 are also presented in the table.
 
 
F-24

 
 
The actual and minimum capital amounts and ratios for the Bank are presented in the following table:

                           
Minimum
 
                           
To Be Well
 
               
Minimum
   
Capitalized Under
 
               
Capital
   
Prompt Corrective
 
   
Actual
   
Requirement
   
Action Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
June 30, 2011
                                   
                                     
Total capital to risk weighted assets
  $ 6,272,000       12.79 %   $ 3,922,000       8.00 %   $ 4,902,000       10.00 %
Tier 1 capital to risk weighted assets
  $ 5,981,000       11.54 %   $ 1,961,000       4.00 %   $ 2,941,000       6.00 %
Tier 1 capital to total assets
  $ 5,981,000       7.65 %   $ 3,127,000       4.00 %   $ 3,909,000       5.00 %
                                                 
June 30, 2010
                                               
                                                 
Total capital to risk weighted assets
  $ 5,933,000       11.67 %   $ 4,069,000       8.00 %   $ 5,086,000       10.00 %
Tier 1 capital to risk weighted assets
  $ 5,838,000       11.48 %   $ 2,034,000       4.00 %   $ 3,052,000       6.00 %
Tier 1 capital to total assets
  $ 5,838,000       7.24 %   $ 3,224,000       4.00 %   $ 4,031,000       5.00 %

The actual and minimum capital amounts and ratios for the Company, on a consolidated basis, are presented in the following table:
 
                           
Minimum
 
                           
To Be Well
 
               
Minimum
   
Capitalized Under
 
               
Capital
   
Prompt Corrective
 
   
Actual
   
Requirement
   
Action Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
June 30, 2011
                                   
                                     
Total capital to risk weighted assets
  $ 6,412,000       13.08 %   $ 3,922,000       8.00 %   $ 4,902,000       10.00 %
Tier 1 capital to risk weighted assets
  $ 6,121,000       11.83 %   $ 1,961,000       4.00 %   $ 2,941,000       6.00 %
Tier 1 capital to total assets
  $ 6,121,000       7.83 %   $ 3,127,000       4.00 %   $ 3,909,000       5.00 %
                                                 
June 30, 2010
                                               
                                                 
Total capital to risk weighted assets
  $ 6,144,000       12.08 %   $ 4,069,000       8.00 %   $ 5,086,000       10.00 %
Tier 1 capital to risk weighted assets
  $ 6,049,000       11.89 %   $ 2,034,000       4.00 %   $ 3,052,000       6.00 %
Tier 1 capital to total assets
  $ 6,049,000       7.50 %   $ 3,224,000       4.00 %   $ 4,031,000       5.00 %
 

 
F-25

 
 
The following table presents a reconciliation of capital determined using accounting principles generally accepted in the United States of America (GAAP) and regulatory capital amounts:
                         
   
2011
   
2010
 
   
Consolidated
   
Bank
   
Consolidated
   
Bank
 
                         
GAAP capital
  $ 6,120,000     $ 5,980,000     $ 6,050,000     $ 5,839,000  
                                 
Net unrealized (gain) loss on certain securities for sale, net of available income taxes
    1,000       1,000       (1,000 )     (1,000 )
                                 
Tier 1 Capital
    6,121,000       5,981,000       6,049,000       5,838,000  
                                 
Allowance for loan losses-excluding specific reserves (limited to 1.25% of risk weighted assets)
    613,000       613,000       449,000       449,000  
                                 
Deduction for low-level recourse and residual interests
    (322,000 )     (322,000 )     (354,000 )     (354,000 )
                                 
Total Risk-Based Capital
  $ 6,412,000     $ 6,272,000     $ 6,144,000     $ 5,933,000  
 
13.
Employee Benefit Plans

 
401 (k) Plan
The Company has a 401(k) Plan whereby substantially all employees participate in the Plan. Employees may contribute up to 15 percent of their compensation subject to certain limits based on federal tax laws. The Company makes matching contributions equal to 50 percent of the employee’s contribution, up to a maximum of 3 percent of an employee’s compensation contributed to the Plan. Matching contributions vest to the employee equally over a five-year period. For the years ended June 30, 2011 and 2010, expense attributable to the Plan amounted to $19,298 and $19,054, respectively.

Employee Stock Ownership Plan
All Bank employees meeting certain age and service requirements are eligible to participate in the ESOP. In August 2008, the Bank’s ESOP purchased 17,262 shares of common stock for $172,620.  The Auburn Savings Bank ESOP Trust (the ESOP Trust) borrowed the loan amount of $172,620 from Auburn Bancorp, Inc., and the loan is repayable annually with a fixed interest rate of 5% for the term of fifteen years. The loan is secured by the shares purchased by the ESOP Trust. Participants’ benefits become fully vested after 5 years of service. The Bank’s contributions are the primary source of funds for the ESOP’s repayment of the loan. Principal and interest payments for the years ended June 30, 2011 and 2010 totaled $16,631 for each year.
 
As of June 30, 2011, the remaining principal balance is payable as follows:
       
2012
  $ 9,261  
2013
    9,724  
2014
    10,210  
2015
    10,721  
2016
    11,257  
Thereafter
    96,227  
         
Total
  $ 147,400  
 
Shares held by the ESOP include the following at June 30:
             
   
2011
   
2010
 
             
Allocated
    3,392       2,237  
Unallocated
    13,870       15,025  
Total
    17,262       17,262  
 
 
F-26

 
 
Expense related to the ESOP for the years ended June 30, 2011 and 2010 totaled approximately $8,000 and $11,000 respectively.  The fair value of the unallocated shares as of June 30, 2011 and 2010 was $132,917 and $144,475, respectively.

14.
Related Party Transactions

In the ordinary course of business, the Company has granted loans to principal officers and directors and their affiliates amounting to $644,800 at June 30, 2011 and $256,200 at June 30, 2010. During the years ended June 30, 2011 and 2010, total principal additions were $474,300 and $19,300, respectively, and total principal payments and deletions were $85,700 and $66,400, respectively.

Deposits from related parties held by the Company at June 30, 2011 and 2010 amounted to $1,144,600 and $1,061,000, respectively.

15.
Fair Value of Financial Instruments

GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The balances of assets measured at fair value on a recurring basis are as follows:

         
Fair Value Measurements Using
 
         
Quoted Prices
   
Significant
       
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
         
Identical Assets
   
Inputs
   
Inputs
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
June 30, 2011
                       
Investment securities available for sale
                       
Corporate bonds and other obligations
  $ 1,012,322     $ -     $ 1,012,322     $ -  
FNMA mortgage-backed securities
    79,026       -       79,026       -  
U.S. Government sponsored enterprise securities
    677       -       677       -  
Corporate common stock
    10,000       -       10,000       -  
                                 
June 30, 2010
                               
Investment securities available for sale
                               
Corporate bonds and other obligations
  $ 980,141     $ -     $ 980,141     $ -  
FNMA mortgage-backed securities
    121,516       -       121,516       -  
U.S. Government sponsored enterprise securities
    850       -       850       -  
Corporate common stock
    10,000       -       10,000       -  
 
 
F-27

 
 
The balances of assets measured at fair value on a nonrecurring basis are as follows:

         
Fair Value Measurements Using
 
         
Quoted Prices
   
Significant
       
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
         
Identical Assets
   
Inputs
   
Inputs
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
June 30, 2011
                       
Assets:
                       
Impaired loans
  $ 678,834     $ -     $ 678,834     $ -  
Foreclosed real estate
    1,196,183       -       1,196,183       -  
                                 
June 30, 2010
                               
Assets:
                               
Impaired loans
  $ 328,939     $ -     $ 328,939     $ -  
Foreclosed real estate
    680,712       -       680,712       -  
 
Impaired loans were reduced from their carrying amount of $892,914 and $372,307 to their fair value of $678,834 and $328,939 at June 30, 2011 and 2010, respectively, resulting in an impairment reserve through the allowance for loan losses.   Foreclosed real estate was reduced from its carrying amount of $1,219,691 to its fair value of $1,196,183 and $731,045 to its fair value of $680,712 at June 30, 2011 and June 30, 2010, respectively.

GAAP requires disclosure of estimated fair values of all financial instruments where it is practicable to estimate such values. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The disclosure requirements exclude certain financial instruments and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

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

Cash and cash equivalents and certificates of deposit: The carrying amounts of cash, due from banks, deposits with the FHLB, federal funds sold and certificates of deposit approximate fair values as these financial instruments have short maturities.
 
Securities: The fair value of securities, excluding Federal Home Loan Bank stock, are determined by obtaining quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities.  The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the FHLB.

Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for nonperforming loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturity.
 
 
F-28

 
 
Federal Home Loan Bank advances: The fair values of these borrowings are estimated using discounted cash flow analyses based on the Companys current incremental borrowing rates for similar types of borrowing arrangements.
 
Accrued interest: The carrying amounts of accrued interest approximate fair value.
 
Off-balance-sheet instruments: The Companys off-balance-sheet instruments consist of loan commitments. Fair values for loan commitments have not been presented as the future revenue derived from such financial instruments is not significant.
 
The estimated fair values, and related carrying or notional amounts, of the Companys financial instruments are as follows:
                         
   
June 30, 2011
   
June 30, 2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
   
(In thousands)
         
(In thousands)
       
Financial assets
                       
Cash and cash equivalents
  $ 3,106     $ 3,106     $ 5,279     $ 5,279  
Certificates of deposit
    495       495       845       845  
Investment securities available for sale
    1,102       1,102       1,113       1,113  
Investment securities held to maturity
    972       971       -       -  
Federal Home Loan Bank stock
    1,252       1,252       1,252       1,252  
Loans, net
    67,396       70,381       68,883       71,067  
Accrued interest receivable
    282       282       278       278  
                                 
Financial liabilities
                               
Deposits
    53,877       53,308       55,769       55,396  
Federal Home Loan Bank advances
    17,634       18,118       18,431       19,010  
 
 
F-29

 
 
16.       Condensed Financial Information (Parent Company Only)
 
The following financial statements are for Auburn Bancorp, Inc. (Parent Company Only), and should be read in conjunction with the consolidated financial statements of Auburn Bancorp, Inc. and Subsidiary.
 
AUBURN BANCORP, INC. (PARENT COMPANY ONLY)
Balance Sheets
June 30, 2011 and 2010
 
   
2011
   
2010
 
ASSETS  
             
Assets:
           
Cash and due from banks
  $ 16,224     $ 107,226  
Due from subsidiary - Auburn Savings Bank
    123,808       125,948  
Investment in subsidiary - Auburn Savings Bank
    5,980,180       5,839,493  
                 
Total assets
  $ 6,120,212     $ 6,072,667  
                 
LIABILITIES AND STOCKHOLDERS EQUITY
 
                 
Liabilities:
               
Accrued interest and other liabilities
  $ -     $ 22,714  
Total liabilities
    -       22,714  
                 
Stockholders’ equity:
               
Preferred stock, 1,000,000 shares authorized, no shares issued or outstanding
    -       -  
Common stock, $.01 par value per share, 10,000,000 shares authorized, 503,284 shares issued and outstanding at June 30, 2011 and 2010.
    5,033       5,033  
Additional paid-in-capital
    1,465,501       1,468,928  
Retained earnings
    4,783,236       4,719,099  
Accumulated other comprehensive income (loss)
    (641 )     1,368  
Unearned compensation (ESOP shares)
    (132,917 )     (144,475 )
                 
Total stockholders’ equity
    6,120,212       6,049,953  
                 
Total liabilities and stockholders’ equity
  $ 6,120,212     $ 6,072,667  
 
The investment in the subsidiary bank is carried under the equity method of accounting.  The intercompany transactions and cash, which is on deposit with the Bank, have been eliminated in consolidation.
 
 
F-30

 
 
AUBURN BANCORP, INC. (PARENT COMPANY ONLY)
Condensed Statements of Income
Years Ended June 30, 2011 and 2010
 
   
2011
   
2010
 
Expense
           
Administrative and other
  $ 88,633     $ 188,698  
Total expense
    88,633       188,698  
                 
Loss before applicable income tax benefit and equity in undistributed net income of subsidiary
    (88,633 )     (188,698 )
                 
Applicable income tax benefit
    10,074       64,801  
                 
Loss before equity in undistributed net income of subsidiary
    (78,559 )     (123,897 )
Equity in undistributed net income of subsidiary
    142,696       231,526  
                 
Net income
  $ 64,137     $ 107,629  
 
 
F-31

 
 
AUBURN BANCORP, INC. (PARENT COMPANY ONLY)
Condensed Statements of Cash Flows  
Years Ended June 30, 2011 and 2010
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net income
  $ 64,137     $ 107,629  
Adjustments to reconcile net income to net cash used by operating activities:
               
Equity in undistributed net income of subsidiary
    (142,696 )     (231,526 )
ESOP compensation expense
    8,131       10,852  
Net decrease in accrued expenses and other liabilities
    (22,714 )     (5,732 )
                 
Net cash flows provided by (used in) operating activities
    (93,142 )     (118,777 )
                 
Cash flows from financing activities:
               
Repayments from (advances to) subsidiary
    2,140       (64,888 )
                 
Net cash provided by (used in) financing activities
    2,140       (64,888 )
                 
Net decrease in cash
    (91,002 )     (183,665 )
                 
Cash at beginning of year
    107,226       290,891  
                 
Cash at end of year
  $ 16,224     $ 107,226  
 
 
F-32

 
 
17.       Subsequent Events
 
Subsequent events represent events or transactions occurring after the balance sheet date but before the financial statements are issued. Financial statements are considered “issued” when they are widely distributed to stockholders and others for general use and reliance in a form and format that complies with GAAP.
 
Specifically, there are two types of subsequent events:
 
 
Those comprising events or transactions providing additional evidence about conditions that existed at the balance sheet date, including estimates inherent in the financial statement preparation process (referred to as recognized subsequent events).
 
 
Those comprising events that provide evidence about conditions not existing at the balance sheet date but, rather, that arose after such date (referred to as non-recognized subsequent events).
 
Subsequent events have been evaluated and management determined there were no subsequent events to disclose.
 
 
F-33