NEW PEOPLES BANKSHARES INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Caution About Forward Looking Statements We make forward looking statements in this quarterly report on Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include statements regarding expectations, intentions, projections and beliefs concerning our profitability, liquidity, and allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward looking statements. The forward-looking information is based on various factors and was derived using numerous assumptions. Important factors that may cause actual results to differ from projections include: the success or failure of our efforts to implement our business plan; any required increase in our regulatory capital ratios; satisfying other regulatory requirements that may arise from examinations, changes in the law and other similar factors; deterioration of asset quality; changes in the level of our nonperforming assets and charge-offs; fluctuations of real estate values in our markets; our ability to attract and retain talent; demographical changes in our markets which negatively impact the local economy; the uncertain outcome of current or future legislation or regulations or policies of state and federal regulators; the successful management of interest rate risk; the successful management of liquidity; changes in general economic and business conditions in our market area and the United States in general; credit risks inherent in making loans such as changes in a borrower’s ability to repay and our management of such risks; competition with other banks and financial institutions, and companies outside of the banking industry, including online lenders and those companies that have substantially greater access to capital and other resources; demand, development and acceptance of new products and services we have offered or may offer; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve, inflation, interest rate, market and monetary fluctuations; the occurrence of significant natural disasters, including severe weather conditions, floods, health related issues (including the ongoing novel coronavirus (COVID-19) outbreak and the associated efforts to limit the spread of the disease), and other catastrophic events; technology utilized by us; our ability to successfully manage cyber security; our reliance on third-party vendors and correspondent banks; changes in generally accepted accounting principles; changes in governmental regulations, tax rates and similar matters; and, other risks, which may be described, from time to time, in our filings with the SEC. Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. 28 Critical Accounting Policies For discussion of our significant accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2020 (the 2020 10-K). Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements. Our most critical accounting policies relate to our provision for loan losses and the calculation of our deferred tax asset and related valuation allowance. The provision for loan losses reflects the estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our borrowers were to further deteriorate, resulting in an impairment of their ability to make payments, our estimates would be updated, and additional provisions could be required. Deferred tax assets or liabilities are computed based upon the difference between financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. In the past, the Company provided a valuation allowance on its net deferred tax assets where it was deemed more likely than not such assets would not be realized. At September 30, 2021 and December 31, 2020, the Company had no valuation allowance on its net deferred tax assets. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. For further discussion of the deferred tax asset and valuation allowance, we refer you to the section on “Deferred Tax Asset and Income Taxes” below. COVID-19 Pandemic Since the first quarter of 2020, COVID-19 has adversely affected, and will continue to adversely affect, economic activity globally, nationally and locally. Market interest rates declined significantly and remain at historically low levels. In early 2020, the Federal Open Market Committee (FOMC) reduced the target federal funds rate twice by a total of 150 basis points (bps). As a result of these actions the target federal funds rate now stands at 0.00% - 0.25% and the prime interest rate stands at 3.25%. While the FOMC has recently signaled its intention to ease interest rate accommodations, it is expected that it will be mid-2022 before overt action is taken to raise interest rates. State and local governments have eased many of their executive orders relating to mask-wearing, social distancing, and attendance limitations. However, with the rise in instances of the Delta variant of COVID-19, some of these executive orders have been reinstated. During the third quarter of 2021, supply chain constraints became more prevalent, adversely affecting many businesses. Price inflation is also being seen in many types of consumer products, including groceries and fuel. Although there are signs of economic improvement; specifically, improved employment statistics, it appears the improvement may be uneven, and the expectation of any sustained recovery is impossible to predict. Previously, economic conditions such as these have led certain industries and individual businesses to reduce operations and staffing, and in some cases to close, either temporarily or permanently. As the uncertainty created by the pandemic persists, we continue to meet the needs of our customers. Since the first quarter of 2020, we have maintained a committee dedicated to managing our response to the pandemic. This has included marshalling supplies and personal protective equipment, coordinating employee and customer communications, evaluating staffing and maintaining compliance with various mandates and regulations. All of our branch offices have been fully open since April 2021. We continue to maintain diligence, including the practices of daily self-assessments and temperature monitoring for all employees prior to entering their worksite. Even so, we have had exposure instances that cause us to temporarily close offices, or reduce service to drive-thru only, and quarantine employees. Several departments have reinstituted remote work protocols with employees alternating weeks working on and off site. Additionally, we encourage our employees to be vaccinated. Last year, as part of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), the Small Business Administration (SBA) was authorized to guarantee Paycheck Protection Program (PPP) loans used by borrowers for payroll and other permitted purposes. The SBA provided a 100% guarantee and paid originators a processing fee ranging from 1% to 5%, based on the loan amount. We funded a total of $44.5 million of these loans (Round 1) for our customers through August 2020, when the funding period closed, and received $1.6 million in net fees from the SBA, which is being recognized as income over the terms of these loans. 29 In December 2020, the Consolidated Appropriations Act, 2021 was enacted providing additional economic relief related to the COVID-19 pandemic. This legislation included a second round (Round 2) of PPP loans. We participated in this program and funded 568 Round 2 loans totaling $25.3 million through June 30, 2021. The total remaining balances of PPP loans, including both Round 1 and Round 2, at September 30, 2021 was $9.6 million. Of the combined $69.8 million loans funded in both Round 1 and Round 2, 1,144 loans have received full or partial forgiveness payments from the SBA totaling $60.2 million, of which 1,004 loans totaling $50.4 million received forgiveness during the first nine months of 2021. With the end of the second round of the PPP loan program, our efforts are now focused on assisting borrowers in applying for and obtaining forgiveness through the SBA of the $9.6 million of PPP loans remaining at September 30, 2021. In response to the economic impact brought on by the COVID-19 pandemic, banking and financial regulators provided guidance to financial institutions regarding borrower requests for forbearance. In general, short-term deferrals or other minor modifications extended to borrowers who were current in their loan obligations at December 31, 2019, were not considered troubled debt restructurings (TDRs) or impairments. These accommodations have been provided in the form of payment deferrals or conversion to interest only for a period of time, generally three to six months. As of September 30, 2021, of the 648 loans, totaling $103.4 million, which received some form of forbearance in accordance with the applicable legislative and regulatory guidelines, none remain in forbearance. In summary, the lingering, adverse economic impact of the COVID-19 pandemic has been extensive and wide ranging, resulting in a steep decline in interest rates, reduced participation in the labor force and supply chain backlogs resulting in a decline in economic output, and we cannot reasonably estimate the term or intensity of any prolonged adverse impact on our financial position, operations or liquidity. London Interbank Offering Rate The use of the London Interbank Offering Rate (LIBOR) as a benchmark interest rate will be ending later in 2021, and this may impact our future interest rate structure. We use LIBOR in pricing some of our interest earning assets and liabilities, including our trust preferred securities. At this time, it appears that LIBOR will be replaced by the Secured Overnight Financing Rate (SOFR), which is a transparent measure of the cost of borrowing cash overnight collateralized by Treasury securities, as SOFR is now being listed on quotation systems and is being incorporated into instruments and transactions previously tied to LIBOR. The United Kingdom’s Financial Conduct Authority (FCA), who is the regulator of LIBOR, announced on March 5, 2021, that they will no longer require any panel bank to continue to submit LIBOR after December 31, 2021. As it pertains to U.S. dollar LIBOR, the FCA will consider the case to require continued publication, on a synthetic basis, of 1-month, 3-month and 6-month LIBOR settings through June 30, 2023. After such date, the LIBOR settings will no longer be representative and this index will not be restored. It should be noted, however, that United States bank regulators, in a joint statement, have urged banks to stop using LIBOR altogether on new transactions by the end of 2021 to avoid the creation of safety and soundness risk. The Federal Reserve Bank of New York has created a working group called the Alternative Reference Rate Committee (ARRC) to assist U.S. institutions in transitioning away from LIBOR as a benchmark interest rate. The ARRC has recommended the use of the SOFR as a replacement index for LIBOR. Because there is not yet a consensus as to what rate or rates may become acceptable alternatives to LIBOR, we cannot predict the effect of any such alternatives on the value of our LIBOR-based variable-rate loans, as well as LIBOR-based securities, trust preferred securities, or other securities or financial arrangements. Regardless of whether SOFR or some other benchmark rate replaces LIBOR, we do not anticipate that the change will have a material impact on our ability to negotiate and price earning assets and liabilities. However, the transition to an alternative reference rate for new contracts, or the implementation of a substitute index or indices for the calculation of interest rates under the Company’s existing loan agreements with borrowers or other financial arrangements, could change the Company’s market risk profile, interest margin, interest spread and pricing models. This may cause the Company to incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept a substitute index or indices, and may result in disputes or litigation with customers or other counterparties over the appropriateness or comparability to LIBOR of any substitute index or indices. Overview and Highlights For the nine months ended September 30, 2021, we earned net income of $5.1 million, which equates to $0.21 per share, and is $3.6 million higher than the $1.5 million net income we earned during the same period in 2020. Most components of the income statement improved. Net interest income grew $1.8 million, provision for loan losses decreased $1.6 million, and non-interest income increased $1.6 million. Non-interest expense increased $415 thousand as we absorbed losses on disposals of three former branch offices. Consequently, income tax expense increased $969 thousand due to the increase in net income before income taxes. Although interest rates are generally lower, net interest income increased due to the reduction in interest expense with interest income improving slightly due to the accelerated accretion of fee income from PPP loan forgiveness offsetting the impact of lower interest rates. 30 The balance sheet grew to $800.8 million as of September 30, 2021, from $756.3 million as of December 31, 2020, with deposit growth providing funds for investment growth. Our Boone, North Carolina, loan production office, which opened in the fourth quarter of 2020, is positively affecting originations of commercial and commercial real estate loans, as well as residential mortgage loan originations brokered through or sold into the secondary market. Deposit growth is primarily due to stimulus payments and PPP funds received by our customers, which has helped to drive down our cost of funds, as these deposit accounts are generally non-interest bearing. As a result of the improved earnings, we returned to a positive retained earnings position at September 30, 2021, after several years of being a deficit balance. As a follow-on to the operational assessment initiated in 2019 and implemented in 2021, we have identified several areas to assess our current position and develop means of improvements. The areas we are assessing include reducing the level of nonperforming assets, improving our secondary mortgage origination operations, improving marketing and development to better align with bank-wide and individual market goals; reviewing compensation structure to better align with bank-wide goals, and improving operations and efficiencies in the loan origination and operations functions. As part of the initiative to reduce nonearning assets, three former branch office sites were sold during the third quarter, resulting in net gains of $190 thousand, and three more were transferred to OREO, after writedowns of $1.1 million. Since September 30, 2021, an additional former branch office site was auctioned successfully, and one of the sites transferred to OREO is under a sales agreement, with both transactions expected to close during the fourth quarter. As part of our efforts to enhance our mortgage operations, we have implemented a new compensation plan for mortgage originators and realigned the department to improve both origination efforts and backroom support. Comparison of the nine months ended September 30, 2021 to September 30, 2020 Overall, during the nine months ended September 30, 2021, compared to the same period in 2020, net income has improved 240% to $5.1 million, or $0.21 per share, from $1.5 million, or $0.06 per share. Interest income was up and interest expense was down, resulting in an improvement of $1.8 million in net interest income. Other primary drivers of the improvement were provision for loan losses, which was down $1.6 million, and non-interest income, which was up $1.6 million. Year-to-date highlights include: · Net interest income improved to $20.5 million for the first nine months of 2021, an improvement of $1.8 million, or 9.6%, compared to the same period in 2020; · Net interest margin was 3.68% for the first nine months of 2021, an increase of 3 basis points compared to 3.65% for the first nine months of 2020; · Investment securities totaling $77.2 million were purchased during the first nine months of 2021, accounting for the $56.8 million growth of that portfolio; · Investment securities totaling $7.7 million were sold during the third quarter of 2021, resulting in gains of $322 thousand; · Provision for loans losses was $372 thousand for the first nine months of 2021, a reduction of $1.6 million, or 81.4%, compared to the first nine months of 2020; · Noninterest income was $7.5 million, an increase of $1.6 million, or 26.5%, compared to the first nine months of 2020; · Total noninterest expense was $21.1 million, an increase of $415 thousand, or 2.0%, compared to the first nine months of 2020; and · Occupancy and equipment expense was $4.6 million, an increase of $1.2 million, or 34.8%, compared to the nine months of 2020. · Retained earnings returned to a positive balance in the third quarter of 2021, after several years of being a deficit balance. During the first nine months of 2021 compared to the first nine months of 2020, the increase of $1.8 million in net interest income was due primarily to a reduction in interest expense on deposits of $1.6 million. This reduction in interest expense on deposits was driven mainly by a reduction in the average cost of retail time deposits, which declined 60 basis points, to 1.00% from 1.60%, plus a decrease in average balances of $34.7 million. Interest income on earning assets was essentially unchanged, as an increase of $1.3 million in loan fees offset a decrease of $1.3 million in interest income on loans. The increase in loan fee income is a result of recognition of deferred fees on PPP loans forgiven. As the PPP portfolio stands at $9.6 million at September 30, 2021, we expect the fee revenue earned from these loans to have largely run its course by year-end. Although average loan balances grew $9.6 million, average yields decreased to 4.40% from 4.78%, which caused the decrease in interest income. The yield on PPP loans is 1.00% (excluding the impact of deferred fee income), which also negatively affects our loan yields. 31 While interest income on deposits with other banks decreased $122 thousand, it was more than offset by increased interest income on investment securities of $137 thousand. The primary driver of the reduced interest income on deposits with other banks was the reduction in average yields to 0.11% from 0.44%. The improvement in interest income on investment securities was mainly a result of $24.0 million of increased average balances, although yields declined to 1.94% from 2.51%. The reduction in both interest income, excluding fees, and interest expense was driven mainly by lower market rates, which have fallen throughout 2020 and 2021. Our total average yield on earning assets was 4.06% during the first nine months of 2021, compared to 4.40% during the same period in 2020. The reduction in our average cost of funds to 0.39% during the first nine months of 2021, compared to 0.77% during the same period in 2020, more than offset the reduced yield on average assets. In summary, the net interest margin for the first nine months of 2021 was 3.68%, a reduction of 3 basis points compared to 3.65% for the first nine months of 2020. The provision for loan losses for the first nine months of 2021 was down $1.6 million compared to the same period in 2020, to $372 thousand from $2.0 million, due to a combination of factors, including the limited risk associated with PPP loans, improving economic trends, such as improving employment statistics, combined with the liquidity provided to customers through stimulus payments and the aforementioned funding and forgiveness of PPP loans. For more information on the factors affecting the allowance for loan losses, including provision expense, refer to Note 7, Allowance for loan Losses, in Item 1 of this Form 10-Q. Depending on the length of the economic downturn, and the nature and speed of any future recovery, it is possible that additional provisions may be needed beyond those necessary to support organic growth of the loan portfolio. Total non-interest income for the first nine months of 2021 compared to the same period in 2020 grew by $1.6 million to $7.5 million. This improvement was driven by increases in service charges and fees, card processing and interchange income, insurance and investment fees, and gains on sales of investment securities, of $436 thousand, $438 thousand, $276 thousand, and $318 thousand respectively. The improvement in service charges and fees resulted from the fee schedule changes we made in August 2020. The improvement in card processing and interchange income resulted from increased volume and the related increase in interchange fees received. Efforts to increase noninterest income revenues from financial services drove the improvement in insurance and investment fees. Gains of $322 thousand were realized from sales of securities during the first nine months of 2021 versus $4 thousand during the same period in 2020. Other non-interest income also increased, to $840 thousand from $744 thousand, driven by the $190 thousand gains on sales of former branch offices and $111 thousand from commissions on and gains on originations and sales of mortgage loans, even when the $220 thousand bonus payment from a service provider in 2020 is considered. For the nine months ended September 30, 2021, compared to the same period in 2020, total non-interest expense increased $415 thousand, to $21.1 million, primarily because of a $1.2 million increase in occupancy and equipment expense, which was partially offset by an $883 thousand decrease in salaries and employee benefits. The increase in occupancy and equipment expense was driven nearly entirely by $1.1 million in asset disposal costs, a result of the three former branch office locations transferred to OREO, as previously discussed. We expect some modest expense reductions associated with the sales and disposals of former branch office locations. The reduction in salaries and benefits expense is due to the restructuring implemented during the second quarter of 2020. Data processing and telecommunications expense is down $46 thousand due to changes in the related agreements with some of those service providers. Other operating expenses were up $164 thousand due to higher loan and other real estate expenses of $173 thousand and $184 thousand, respectively, increased internal and external audit and accounting expenses of $87 thousand, other professional fees of $32 thousand, and advertising and promotions of $37 thousand. These increases offset decreases in FDIC insurance, consulting, data processing, and travel, which decreased $79 thousand, $237 thousand, $67 thousand, and $55 thousand, respectively. FDIC premiums decreased due to improvements in our risk assessment. Consulting decreased due to costs incurred in 2020, which were not repeated in 2021. Travel reflects the impact of the pandemic. In addition, 2021 includes a $61 thousand increase in bank franchise taxes due to the increased tax base and added taxes for other states. The efficiency ratio, a non-GAAP measure, improved to 76.4% for the first nine months of 2021 from 84.2% for the first nine months of 2020, due to improvements discussed above. We re-engaged the firm that assisted in the operational assessment in 2019 and 2020 to review our efforts to date and work toward enhancing our revenue and cost control structure. 32 Comparison of the Three Months ended September 30, 2021 to September 30, 2020 Overall, during the quarter ended September 30, 2021, compared to the same quarter in 2020, net income improved 29.6% to $1.8 million, or $0.08 per share, from $1.4 million, or $0.06 per share. Contributing to this improvement was higher interest income, lower interest expense, lower provision for loan loss expense and higher non-interest income. Although non-interest expense was higher, it was more than offset by improvements in every other major category of the income statement. Quarter-to-date highlights include: · Net interest income was $7.4 million for the third quarter of 2021, an improvement of $1.0 million, or 15.7%, compared to the third quarter of 2020; · Net interest margin was 3.93% for the third quarter of 2021, an increase of 27 basis points compared to 3.66% in the third quarter of 2020; · Provision for loan losses was zero for the third quarter of 2021 compared to $450 thousand for the third quarter of 2020; · Noninterest income was $3.0 million, an increase of $854 thousand, or 40.4%, during the third quarter of 2021 compared to the third quarter of 2020; and · Noninterest expense was $8.1 million, an increase of $1.8 million, or 28.4%, for the third quarter of 2021 compared to the third quarter of 2020. During the third quarter of 2021, compared to the third quarter of 2020, net interest income increased $1.0 million, the result of a $478 thousand increase in interest income on earning assets, and a $526 thousand decrease in interest expense on interest-bearing liabilities. The primary driver was an improvement of $695 thousand in loan fees, which was mainly due to recognition of deferred fees on PPP loans forgiven, which more than offset a decrease in interest income on loans of $364 thousand. The impact of the increased loan fee income will not continue, as only 14% of the original portfolio remains outstanding at September 30, 2021. The reduced interest income on loans was a result of both lower average balances and reduced average yields, to 4.40% from 4.61%. Also driving the improvement in interest income was an increase of $134 thousand in interest income on investment securities. Although the average yield on investment securities declined to 1.72% from 2.39%, average balances increased by $49.3 million, as we redeployed lower yielding deposits in other banks into investment securities providing a higher return. Overall, our yield on earning assets declined to 4.26% from 4.31%. On the interest expense side of net interest income, the primary driver of the $526 thousand reduction in interest expense was a $472 thousand decrease in interest expense on retail time deposits. The decrease in interest expense on retail time deposits was primarily due to a reduction in average cost to 0.90% from 1.52%, combined with a reduction in average balances of $40.1 million. Also contributing to the reduced interest expense was an increase in average balances of non-interest-bearing deposits of $48.6 million, a result of liquidity provided to customers through stimulus payments and the funding of PPP loans. Overall, our average cost of funds has declined to 0.34% from 0.66%. In summary, our net interest margin for the third quarter of 2021 was 3.93% compared to 3.66% for the third quarter of 2020. The reduction in yields and costs has been driven by decreases in general market rates, as previously discussed. The provision for loan losses was zero in the third quarter of 2021 compared to $450 thousand for the same quarter in 2020, due to a combination of factors, including the limited risk associated with PPP loans, improving economic trends, including improving employment statistics, combined with the liquidity provided to customers through stimulus payments and the aforementioned funding and forgiveness of PPP loans. For more information on the factors affecting the allowance for loan losses, including provision expense, refer to Note 7, Allowance for loan Losses, in Item 1 of this Form 10-Q. Depending on the length of the economic downturn and the nature and speed of any future recovery, it is possible that additional provisions may be needed beyond those necessary to support organic growth of the loan portfolio. Total non-interest income increased $854 thousand in the third quarter of 2021 compared to the third quarter of 2020, primarily due to $322 thousand of net gains on sales of investment securities, an increase of $284 thousand in other non-interest income, an increase of $142 thousand in service charges and fees, and an increase of $90 thousand in card processing and interchange income. During the third quarter of 2021, we sold $7.7 million of securities and realized gains of $322 thousand. The increase in other non-interest income is primarily a result of $190 thousand of net gains on sales of three former branch office locations. As part of the project to improve earnings, fee schedule changes were implemented in August of 2020, and this contributed to the increase in service charges and fees. Card processing revenue increased due to increased volume and the related incremental increase in interchange income received. In addition, efforts to increase noninterest income revenues from financial services drove the improvement in insurance and investment fees. Commissions and gains on originations and sales of mortgage loans also increased. 33 Total non-interest expense increased $1.8 million for the third quarter of 2021 compared to the third quarter of 2020, primarily due to an increase of $1.1 million in occupancy and equipment expense, which was driven nearly entirely by $1.1 million in disposal costs of three former branch office locations, which were transferred to OREO. Otherwise, we expect some modest expense reductions associated with the sales and disposals of former branch office locations. Salaries and benefits expense increased $258 thousand, due to an increase of $183 thousand for general wage increases and additional employees hired to staff our loan production office in Boone, NC, which opened in the fourth quarter of 2020; and our new branch office in Bristol, VA which opened in October 2021; an increase of $31 thousand in bonus accruals related to a new incentive plan, an increase of $29 thousand in commissions for mortgage personnel, and an increase of $27 thousand in group insurance due to changes made in the employer contribution formula. These were partially offset by contra expense of $106 thousand related to mortgage originations. Other operating expenses increased $439 thousand, primarily due to increases in other real estate expense, which increased $242 thousand, and loan related expenses, which increased $110 thousand. Other real estate owned expenses increased due to write-downs of $395 thousand. Loan related expenses increased due to costs associated with processing PPP loan forgiveness. The efficiency ratio, a non-GAAP measure, improved to 76.4% for the third quarter of 2021 compared to 84.2% for the third quarter of 2020. This ratio has been positively affected by earnings improvement projects. As discussed above, we are continuing our operational assessments and have implemented several to date, which we anticipate will help improve the efficiency ratio by increasing earnings or controlling costs. Balance Sheet During the nine months ended September 30, 2021, the balance sheet grew to $800.8 million. Highlights include: · Total assets grew by $44.5 million, or 5.9%, during the first nine months of 2021, to $800.8 million; · Interest bearing deposits in other banks decreased by $6.5 million, to $69.6 million; · Loans decreased by $1.5 million, or 0.26%, to $574.1 million; · Securities available for sale increased $56.8 million, or 117.4%, to $105.2 million; · Total deposits increased $45.5 million, or 6.8%, to $713.5 million; · Book value per share increased to $2.61 at September 30, 2021 as compared to $2.43 at December 31, 2020. The growth in total assets was primarily driven by the growth in deposits, which funded investment purchases. During the first nine months of 2021, investment purchases totaling $77.2 million and sales of $7.7 million were made. Also, during this period, 568 loans totaling $25.3 million were funded in Round 2 of the PPP program. Cumulatively through September 30, 2021, $60.2 million of all PPP loans originated in both rounds have received full or partial SBA forgiveness, of which $50.4 received forgiveness during the first nine months of 2021. Excluding the net impact of $25.3 million PPP loan originations and $50.4 million of repayments, loan growth totaled $23.7 million during the first nine months of 2021. This loan growth has resulted in an increase in commercial real estate and multi-family loans, which have been positively impacted by our new Boone, NC, loan production office, which opened during the fourth quarter of 2020. These increases were offset primarily by decreases in commercial loans, which declined $28.8 million, a result of PPP loan forgiveness. At September 30, 2021, approximately $21.4 million in new loan originations were in the pipeline. Through November 8, 2021, approximately $16.0 million, of these loans have closed. There were $109 thousand of loans held for sale at September 30, 2021. Efforts to reduce non-earning assets have resulted in the sale of three former branch office sites during the quarter, with two other sites sold or pending sale since September 30, 2021, with closings expected during the fourth quarter. pending closing. The increase in total deposits was primarily driven by an increase of $35.9 million, or 16.4%, in noninterest-bearing demand deposits, a result of the federal stimulus payments received by customers and PPP loan funds, which are typically deposited into a customer’s checking account. Also, interest-bearing demand deposits increased $13.0 million, or 25.7%. Savings and money market accounts grew $34.2 million, or 22.7%. This growth was partially reduced by a decrease of $27.8 million in retail time deposits. Although we have lowered deposit rates, we continue to maintain core deposits through attractive consumer and commercial deposit products and strong ties with our customer base and communities. Total borrowings were reduced by $5 million as we repaid a maturing FHLB advance in June 2021. Trust preferred securities of $16.5 million at September 30, 2021 were unchanged compared to December 31, 2020. Since December 31, 2020, total capital grew $4.7 million, as year-to-date earnings added $5.1 million, while investment securities caused other comprehensive losses of $752 thousand. During the quarter, our retained deficit has been mitigated and we now report retained earnings. Consequently, book value per share has increased to $2.61 at September 30, 2021 compared to $2.43 at December 31, 2020. The bank remains well capitalized per regulatory guidance. 34 Asset Quality Nonperforming assets include nonaccrual loans, other real estate owned (OREO) and loans past due more than 90 days which are still accruing interest. Our policy is to place loans on nonaccrual status once they reach 90 days past due. The makeup of the nonaccrual loans is primarily those secured by residential mortgages and commercial real estate. OREO is primarily made up of commercial and single-family residential properties, plus four former branch office locations. At September 30, 2021, the former branch offices comprised $1.4 million of the OREO balance. Nonperforming assets decreased $3.4 million, or 38.7%, during the first nine months of 2021, driven by a decrease in non-accruing loans of $2.4 million and a decrease in other real estate owned of $1.0 million. No accruing loans are more than 90 days past due. As a result, the ratio of nonperforming assets to total assets decreased to 0.68% at September 30, 2021 compared to 1.17% at December 31, 2020. Nonperforming assets consisted of the following as of September 30, 2021, and December 31, 2020: September 30, 2021 December 31, 2020 Nonaccrual loans $ 3,126 $ 5,548 Loans past due more than 90 days, still accruing — — Nonperforming loans 3,126 5,548 Other real estate owned 2,318 3,334 Nonperforming assets $ 5,444 $ 8,882 Nonperforming loans/Total loans at period end 0.54 % 0.96 % Nonperforming assets/Total assets at period end 0.68 % 1.17 % All OREO properties are available for sale by commercial and residential realtors under the direction of our Special Assets division. During the first nine months of 2021, $566 thousand of OREO was acquired as a result of settlement of foreclosed loans and three former branch office locations worth $950 thousand were transferred into OREO. Sales of OREO for the first nine months of 2021 totaled $2.1 million, resulting in a net gain of $73 thousand. As part of our continuing effort to reduce OREO, we made valuation adjustments of $423 thousand during the first nine months of 2021, based on updated property valuations. As we continue these efforts, additional losses could occur, while reducing future carrying costs. Due to sales of foreclosed properties we no longer have any foreclosures generating rental income. Rental income was $24 thousand for the first nine months of 2021 compared to $47 thousand for the first nine months of 2020. We continue extensive efforts to work through problem credits and liquidate foreclosed properties and other parcels of other real estate owned, to reduce the level of nonperforming assets. These efforts include price adjustments and property auctions to expedite sales. Since September 30, 2021, one of the former branch sites which was transferred to OREO is under a purchase agreement. We are mindful of the impact on earnings and capital as we work to achieve this goal. However, we may recognize future losses on sales of OREO and reductions in the allowance for loan losses as we expedite the resolution of these assets. Loans rated substandard or below totaled $3.1 million at September 30, 2021, a decrease of $2.3 million from $5.4 million at December 31, 2020. Total past due loans decreased to $2.7 million at September 30, 2021 from $8.6 million at December 31, 2020. Our allowance for loan losses at September 30, 2021 was $6.7 million, or 1.16% of total loans (1.18% when excluding PPP loans) as compared to $7.2 million, or 1.25% (1.33% when excluding PPP loans) of total loans at December 31, 2020. Impaired loans totaled $3.1 million with an estimated related specific allowance of $193 thousand for potential losses at September 30, 2021 as compared to $5.1 million of impaired loans with an estimated related allowance of $1.1 million at the end of 2020. A provision of $372 thousand was recorded for the first nine months of 2021 compared to $2.0 million during the first nine months of 2020. In the first nine months of 2021, net charge-offs totaled $906 thousand, or 0.31% of average loans, annualized, as compared to $381 thousand, or 0.07%, of average loans for the same period in 2020. Included in the net charge-offs are two loans to the same borrower, previously modified as TDRs, totaling $1.1 million that defaulted during the second quarter of 2021, resulting in charge-offs totaling $835 thousand. The allowance for loan losses is maintained at a level that management deems appropriate to absorb any potential future losses and known impairments within the loan portfolio, whether or not the losses are actually ever realized. Through our quarterly assessment, we continue to adjust the allowance for loan loss model to best reflect the risks in the portfolio and the improvements made in our internal policies and procedures; however, future provisions may be deemed necessary. During the first nine months of 2021, we adjusted our external qualitative factors to reflect the improving economic trends, including positive employment and home sales statistics, combined with the liquidity provided to customers through stimulus payments and forgiveness of PPP loans. Those changes along with the assessment of the inherent and specific risks associated with the loan portfolio resulted in a provision to the allowance of $372 thousand for the first nine months 2021. The following table summarizes components of the allowance for loan losses and the related loans as of September 30, 2021 and December 31, 2020: 35 (Dollars in thousands) September 30, 2021 December 31, 2020 Specific allowance $ 193 $ 1,052 General allowance 6,464 6,139 Total allowance $ 6,657 $ 7,191 Impaired loans $ 3,133 $ 5,082 Other loans 570,920 570,484 Total loans $ 574,053 $ 575,566 Total allowance/Total loans 1.16 % 1.25 % General allowance/Other loans 1.13 % 1.08 % Deferred Tax Asset and Income Taxes Due to timing differences between book and tax treatment of several income and expense items, a net deferred tax asset of $2.0 million and $3.1 million existed at September 30, 2021 and December 31, 2020, respectively. Our income tax expense was computed at the corporate income tax rate of 21% of taxable income. We have no significant nontaxable income or nondeductible expenses. Capital Resources Total stockholders’ equity at September 30, 2021, was $62.5 million compared to $58.2 million at December 31, 2020, an increase of $4.3 million. The increase was due to net income of $5.1 million, which drove retained earnings into positive territory. Due to modest rate increases during September 2021, unrealized losses of $752 thousand, net of tax were recorded for the available-for-sale investment portfolio. The Company meets the eligibility criteria to be classified as a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement issued in February 2015 and is therefore not obligated to report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies. The Bank’s capital ratios along with the minimum regulatory thresholds to be considered well-capitalized are presented in the following table: Well-Capitalized Regulatory Threshold September 30, 2021 December 31, 2020 Tier 1 leverage 5.00 % 9.53 % 9.49 % Common equity Tier 1 6.50 % 15.11 % 15.16 % Tier 1 risk-based capital 8.00 % 15.11 % 15.16 % Total risk-based capital 10.00 % 16.37 % 16.41 % At September 30 2021, the Bank remains well capitalized under the regulatory framework for prompt corrective action. The ratios mentioned above for the Bank comply with the Federal Reserve rules to align with the Basel III Capital requirements. Book value was $2.61 per common share at September 30, 2021, and $2.43 per common share at December 31, 2020. Other key performance indicators are as follows: 36 Three months ended September 30, Nine months ended September 30, 2021 2020 2021 2020 Return on average assets 1 0.91% 0.02% 0.85% 0.02% Return on average equity 1 11.75% 0.21% 11.30% 0.27% Average equity to average assets 7.76% 7.32% 7.56% 7.50% 1 - Annualized Based on current economic conditions, we believe it is prudent to continue to maintain the Bank’s capital ratios at levels commensurate with the Bank’s risk profile. With recent capital stress testing and projected growth, we believe our capital levels and liquidity will be sufficient to support planned asset growth and any continued downturn in economic conditions. Those expectations could be impacted if actual deterioration in economic conditions is more severe than the assumptions included in the stress testing. Accordingly, management is working on various strategies for more efficient use of liquidity and to improve capital and stock performance, including continuation of the operational assessments discussed earlier. Cash dividends have not been paid by the Company historically due to a retained deficit. Due to increased earnings, the retained deficit has been eliminated this quarter and we now have retained earnings of $114 thousand. With the return to a retained earnings position, we may be able to consider payment of a cash dividend in the future. The payment of cash dividends will depend on a number of factors including our ability to maintain capital ratios at or above current levels with consideration of strategic plans and an acceptable risk profile. Liquidity Throughout the pandemic, we elevated our monitoring of liquidity, including consideration of leveraging or selling illiquid assets, and deem liquidity adequate to meet potential needs. Liquid assets include cash, due from banks, federal funds sold, and unpledged available for sale investments. Collectively, those balances were $186.6 million at September 30, 2021, an increase from $134.0 million at December 31, 2020. Sufficient short-term assets are maintained at levels management deems adequate to meet potential liquidity needs. At September 30, 2021, all of our investment securities were classified as available-for-sale. These investments provide a source of liquidity in the amount of $100.0 million, net of the $5.2 million of securities pledged as collateral. Investment securities available for sale serve as a source of liquidity while yielding a higher return versus other short-term investment options, such as federal funds sold and overnight deposits with the Federal Reserve Bank of Richmond. Our loan to deposit ratio was 80.5% at September 30, 2021 and 86.2% at December 31, 2020. We anticipate this ratio to remain at or below 90% for the foreseeable future. Available third-party sources of liquidity to the Bank at September 30, 2021 include the following: a line of credit with the FHLB, access to brokered certificates of deposit markets and the discount window at the Federal Reserve Bank of Richmond. We also have the ability to cumulatively borrow $20.0 million in unsecured federal funds credit facilities extended by three correspondent banks. The Bank’s total line of credit with the FHLB is $199.1 million, with unused availability at September 30, 2021, of $107.4 million. This line secures letters of credit totaling $12.0 million. No advances were outstanding at September 30, 2021. Any borrowings, plus the letters of credit, are secured by a blanket lien on our residential real estate loans which amounted to $119.4 million at September 30, 2021. While we do not foresee a need to borrow funds up to the available capacity, should borrowings exceed the available pledged collateral, additional collateral would need to be provided to FHLB. The Bank also has access to the brokered deposits market and the Certificate of Deposit Registry Service (CDARS). At September 30, 2021, we held no brokered deposits and $7.0 million in CDARS reciprocal time deposits. Additional liquidity is available through the Federal Reserve Bank discount window for overnight funding needs. We may collateralize this line with investment securities and loans at our discretion; however, we do not anticipate using this funding source except as a last resort. With the on-balance sheet liquidity and other external sources of funding, we believe the Bank has adequate liquidity and capital resources to meet our requirements and needs for the foreseeable future. However, liquidity can be further affected by a number of factors, such as counterparty willingness or ability to extend credit, regulatory actions and customer preferences, etc., some of which are beyond our control. 37 The bank holding company has approximately $180 thousand in cash on deposit at the Bank at September 30, 2021. Additionally, $430 thousand in dividend payments from the Bank have been received in the first nine months of 2020. These funds are used to pay operating expenses and trust preferred interest payments. The Company makes quarterly interest payments on the trust preferred securities. Off Balance Sheet Items and Contractual Obligations There have been no material changes during the nine months ended September 30, 2021, to the off-balance sheet items and the contractual obligations disclosed in our 2020 Form 10-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not Applicable.