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 credit 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, and other catastrophic events; technology utilized by us; our ability to successfully manage cybersecurity; 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 Securities and Exchange Commission. 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. 30 Critical Accounting Policies For discussion of our significant accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2022, and Note 2 Summary of Significant Accounting Policies, in Item 1 of this Form 10-Q. 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 allowance for credit losses. The allowance for credit losses represents an amount that, in the Company's judgment, will be adequate to absorb expected and estimable losses inherent in the loan portfolio. The judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs for relevant periods of time, changes in the nature and volume of the loan portfolio, current reasonable and supportable forecasts of economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. Overview and Highlights Net income for the three months ended September 30, 2023 was $1.9 million, a decrease of $96,000, or 4.83%, from the same period in 2022. Net interest income declined 2.21%, or $159,000, from $7.2 million for the quarter ended September 30, 2022 to $7.0 million for the quarter ended September 30, 2023. The decrease was primarily due to an increase in the cost of interest-bearing liabilities of 135 basis points (“bps”) to 2.05% during the quarter ended September 30, 2023 compared to 0.70% during the quarter ended September 30, 2022. The balance sheet grew to $800.0 million in total assets as of September 30, 2023, from $775.4 million as of December 31, 2022. Gross loans increased $41.6 million to $626.2 million as of September 30, 2023. Additionally, interest-bearing deposits in other banks decreased $9.6 million to $37.1 million as of September 30, 2023. During the second quarter of 2022, we initiated a previously announced stock repurchase program, which continues through March 31, 2024. Through September 30, 2023, the Company has repurchased 138,982 shares at an average price of $2.29 per share. Comparison of the Three Months ended September 30, 2023 and 2022 Quarter-to-date highlights include: · Returns on average assets and equity of 0.94% and 12.38% for the third quarter of 2023, compared to 0.94% and 13.70% for the third quarter of 2022, respectively; · Net interest income was $7.0 million for the third quarter of 2023, a decrease of $159,000, or 2.21%, compared to the third quarter of 2022; · Provision for credit losses was $155,000 for the third quarter of 2023, a decrease of $70,000, or 31.11%, compared to the third quarter of 2022; · Noninterest income was $2.4 million, an increase of $247,000, or 11.28%, during the third quarter of 2023 compared to the third quarter of 2022; and · Noninterest expense was $6.9 million, an increase of $284,000, or 4.30%, for the third quarter of 2023 compared to the third quarter of 2022. The Company’s primary source of income is net interest income, which decreased by $159,000, or 2.21%, to $7.0 million for the third quarter of 2023 compared to $7.2 million for the third quarter of 2022. Interest income increased $1.5 million due to higher yielding loans and interest-bearing deposits with banks resulting from the increase in the fed funds rate. Total interest expense increased $1.6 million driven primarily by the increase in the cost of interest-bearing liabilities, which rose 135 basis points (“bps”) to 2.05% from 0.70% for the comparative three months ended September 30, 2023 and 2022. The certificates of deposit portfolio was the primary contributor to the decline in net interest income, due to an increase of 197 bps in the quarterly cost on certificates of deposit to 2.72% and a $44.4 million increase in the average balance of certificates of deposit due to a shift in the mix from lower cost deposit products. Additionally, the cost of borrowed funds increased, as trust preferred securities costs rose 342 bps to 8.27% and Federal Home Loan Bank (“FHLB”) advance costs rose 117 bps to 3.57%. The impact of the FHLB advances rate increase was more than offset by a reduction of $36.8 million in the average outstanding balance, as borrowings advanced in response to the cybersecurity incident in 2022, were repaid and a separate advance of $10.0 million was taken in the second quarter of 2023. The increase in the cost of funds was offset by an increase of 95 bps in the yield on earning assets. The yield on loans increased 71 bps to 5.43%, helping to offset the increased cost of funding during the quarter ended September 30, 2023. These rate and volume activities combined to result in a decrease in net interest income of $159,000, while the net interest margin increased 8 bps, to 3.63% for the quarter ended September 30, 2023 as compared to the 3.55% margin for the same period in 2022. There was one increase in the federal funds interest rate by the Federal Reserve’s Open Market Committee (“FOMC”) during the quarter ended September 30, 2023, raising the rate to 5.50%. Through September 30, 2023, the FOMC has increased this rate six times since the quarter ended September 30, 2022. The Company continues to evaluate rate adjustments for factors, including competitive pressure within the local markets, funding needs to support growth, and other needs. 31 The following table shows the rates paid on earning assets and interest-bearing liabilities for the periods indicated: Net Interest Margin Analysis Average Balances, Income and Expense, and Yields and Rates Three Months Ended September 30, 2023 2022 Average Income/ Yields/ Average Income/ Yields/ (Dollars in thousands) Balance Expense Rates Balance Expense Rates ASSETS Loans (1) (2) (3) $ 618,008 $ 8,453 5.43% $ 590,090 $ 7,010 4.72% Federal funds sold 306 4 5.19% 353 2 2.34% Interest-bearing deposits in other banks 42,493 559 5.22% 98,657 559 2.25% Taxable investment securities 108,253 569 2.09% 117,628 539 1.83% Total earning assets 769,060 9,585 4.94% 806,728 8,110 3.99% Less: Allowance for credit losses (6,930) (6,738) Non-earning assets 37,104 41,134 Total assets $ 799,234 $ 841,124 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing demand deposits $ 72,208 $ 123 0.68% $ 75,151 $ 23 0.12% Savings and money market deposits 167,796 436 1.03% 192,550 52 0.11% Time deposits 225,921 1,551 2.72% 181,480 343 0.75% Total interest-bearing deposits 465,925 2,110 1.80% 449,181 418 0.37% FHLB advances 10,000 90 3.57% 46,793 287 2.40% Trust preferred securities 16,496 344 8.27% 16,496 205 4.85% Total interest-bearing liabilities 492,421 2,544 2.05% 512,470 910 0.70% Non-interest-bearing deposits 237,516 - -% 262,244 - -% Total deposit liabilities and cost of funds 729,937 2,544 1.38% 774,714 910 0.46% Other liabilities 8,712 8,904 Total liabilities 738,649 783,618 Shareholders’ equity 60,585 57,506 Total liabilities and shareholders’ equity $ 799,234 $ 841,124 Net interest income $ 7,041 $ 7,200 Net interest margin 3.63% 3.55% Net interest spread 2.89% 3.29% (1) Nonaccrual loans and loans held for sale have been included in average loan balances. (2) Tax exempt income is not significant and has been treated as fully taxable. (3) Includes mortgage loans held for sale. Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the three months ended September 30, 2023, as compared to the three months ended September 30, 2022. 32 Volume and Rate Analysis Increase (decrease) Three Months Ended September 30, 2023 versus 2022 (Dollars in thousands) Volume Effect Rate Effect Change in Interest Income/ Expense Interest income: Loans $ 348 $ 1,095 $ 1,443 Federal funds sold — 2 2 Interest-bearing deposits in other banks (445 ) 445 — Taxable investment securities (22 ) 52 30 Total earning assets (119 ) 1,594 1,475 Interest expense: Interest-bearing demand deposits — 100 100 Savings and money market deposits (2 ) 386 384 Time deposits 159 1,049 1,208 FHLB advances (291 ) 94 (197 ) Trust preferred securities — 139 139 Total interest-bearing liabilities (134 ) 1,768 1,634 Change in net interest income $ 15 $ (174 ) $ (159 ) Based on our current assessment of the loan portfolio and related unfunded commitments, a provision for credit losses of $155,000 was made in the third quarter of 2023. The allowance for credit losses as a percentage of loans decreased from 1.15% as of December 31, 2022 to 1.10% as of September 30, 2023. For a discussion of the factors affecting the allowance for credit losses, including provision expense, refer to Note 2, Summary of Significant Accounting Policies and Note 7, Allowance for Credit Losses for Loans, in Item 1 of this Form 10-Q. Non-interest income increased $247,000 to $2.4 million for the quarter ended September 30, 2023 from $2.2 million for the comparable quarter in 2022. The increase is due largely to the increase in financial services revenue and other noninterest income. Financial services revenue was impacted in the third quarter of 2022, due to the effect on production after the cybersecurity incident in June 2022, especially new account activity immediately after the disruption. For the three months ended September 30, 2023, insurance and investment fees increased $101,000, or 60.5%, compared to the three months ended September 30, 2022. Other noninterest income increased $168,000, or 442.1% due to a $100,000 nonrecurring write-down of bank owned life insurance recorded during the third quarter of 2022. Non-interest expense was $6.9 million for the quarter ended September 30, 2023 compared to $6.6 million for the quarter ended September 30, 2022. The $284,000 increase was impacted by the $277,000 increase in salaries and employee benefits, as well as other operating expenses, which increased $300,000. The increase in salaries and employee benefits was related to performance raises and benefits enhancements initiated in the first quarter of 2023. The increase in other noninterest expenses was due to increases in deposit insurance premium, professional fees, and marketing and business development costs. These increases were due to adjustments for contractual or inflationary factors, along with decisions to increase or incur certain costs as part of our overall strategic plan. The increases in salaries and employee benefits and other operating expenses were partially offset by a $232,000 decrease in occupancy costs, due largely to a write-down taken during the third quarter of 2022 related to the closure of two branches. The efficiency ratio, a non-GAAP measure, which is defined as noninterest expense divided by the sum of net interest income plus noninterest income, increased to 72.62% during the third quarter of 2023 from 70.25% for the third quarter of 2022. We continue to assess our operational procedures and structure to improve efficiencies and contain costs. Income tax expense for the third quarter of 2023 totaled $549,000, a decrease of $30,000, or 5.18% from $579,000 recorded during the same period in 2022. The effective tax rate for the three months ended September 30, 2023, was 22.51%, compared to 22.57% for the same period in 2022. 33 Comparison of the Nine Months ended September 30, 2023 and 2022 Year-to-date highlights include: · Net interest income increased to $21.1 million for the nine months ended September 30, 2023, an improvement of $443,000, or 2.14%, compared to the nine months ended September 30, 2022; · Net interest margin was 3.73% for the nine months ended September 30, 2023, an increase of 20 bps compared to 3.53% for the same period of 2022; · Provision for credit losses was $304,000 for the nine months ended September 30, 2023, a reduction of $96,000, or 24.00%, compared to the nine months ended September 30, 2022; · Noninterest income was $7.2 million, an increase of $331,000, or 4.79%, compared to the nine months ended September 30, 2022; · Salaries and employee benefits expense was $10.8 million, an increase of $821,000, or 8.25%, compared to the nine months ended September 30, 2022; and · Total noninterest expense was $20.8 million, an increase of $1.1 million, or 5.53%, compared to the nine months ended September 30, 2022 During the nine months ended September 30, 2023, compared to the same period in 2022, net income decreased 3.34% to $5.6 million from $5.8 million. Although net interest income and non-interest income increased, total non-interest expense increased more and at a greater percentage. The following table presents the rates earned on earning assets and paid on interest-bearing liabilities for the periods indicated. Net Interest Margin Analysis Average Balances, Income and Expense, and Yields and Rates Nine months Ended September 30, 2023 2022 Average Income/ Yields/ Average Income/ Yields/ (Dollars in thousands) Balance Expense Rates Balance Expense Rates ASSETS Loans (1) (2) (3) $ 601,729 $ 23,711 5.27% $ 594,593 $ 20,476 4.61% Federal funds sold 536 20 4.99% 254 3 1.36% Interest-bearing deposits in other banks 44,901 1,642 4.89% 73,752 738 1.34% Taxable investment securities 110,547 1,752 2.12% 115,349 1,510 1.74% Total earning assets 757,713 27,125 4.79% 783,948 22,727 3.88% Less: Allowance for credit losses (6,869) (6,824) Non-earning assets 37,273 44,582 Total assets $ 788,117 $ 821,706 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing demand deposits $ 76,099 $ 331 0.58% $ 71,420 $ 58 0.11% Savings and money market deposits 165,670 951 0.77% 194,691 130 0.09% Time deposits 213,365 3,620 2.27% 188,497 1,064 0.75% Total interest-bearing deposits 455,134 4,902 1.44% 454,608 1,252 0.37% FHLB advances 6,007 165 3.67% 20,000 358 2.36% Trust preferred securities 16,496 950 7.70% 16,496 452 3.61% Total interest-bearing liabilities 477,637 6,017 1.68% 491,104 2,062 0.36% Non-interest-bearing deposits 242,139 - -% 263,083 - -% Total deposit liabilities and cost of funds 719,776 6,017 1.12% 754,187 2,062 0.36% Other liabilities 8,657 8,235 Total liabilities 728,433 762,422 Shareholders’ equity 59,684 59,284 Total liabilities and shareholders’ equity $ 788,117 $ 821,706 Net interest income $ 21,108 $ 20,665 Net interest margin 3.73% 3.53% Net interest spread 3.67% 3.32% 34 (1) Nonaccrual loans and loans held for sale have been included in average loan balances. (2) Tax exempt income is not significant and has been treated as fully taxable. (3) Includes mortgage loans held for sale Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. Volume and Rate Analysis Increase (decrease) Nine months Ended September 30, 2023 versus 2022 (Dollars in thousands) Volume Effect Rate Effect Change in Interest Income/ Expense Interest income: Loans $ 82 $ 3,153 $ 3,235 Federal funds sold 5 12 17 Interest-bearing deposits in other banks (387 ) 1,291 904 Taxable investment securities 2 240 242 Total earning assets (298 ) 4,696 4,398 Interest expense: Interest-bearing demand deposits 7 266 273 Savings and money market deposits (19 ) 840 821 Time deposits 214 2,342 2,556 FHLB advances (292 ) 99 (193 ) Trust preferred securities — 498 498 Total interest-bearing liabilities (90 ) 4,045 3,955 Change in net interest income $ (208 ) $ 651 $ 443 Based on our current assessment of the loan portfolio and related unfunded commitments, a provision of $304,000 was made for the nine months ended September 30, 2023. The allowance for credit losses as a percentage of loans decreased from 1.15% at December 31, 2022 to 1.10% as of September 30, 2023. For a discussion of the factors affecting the allowance for credit losses, including provision expense, refer to Note 2, Summary of Significant Accounting Policies and Note 7, Allowance for Credit Losses, in Item 1 of this Form 10-Q. Non-interest income increased $331,000 to $7.2 million for the nine months ended September 30, 2023 from $6.9 million for the comparable period in 2022. The primary drivers of the increase were the sales of a former operations facility and branch location, during the first quarter of 2023, resulting in a combined gain of $130,000; and an increase in financial services revenue of $180,000. This was offset by decreases in service charge income and card processing fees totaling a combined $151,000 during the period. Service charge income decreased due to changes made in 2022 in assessing certain charges that reduced the number of transactions subject to such fees. Fees from debit card activity declined as customer deposit balances have begun to return to pre-pandemic levels and customer spending habits have also begun to normalize. Additional changes to our service charge structure will take effect during the fourth quarter of 2023. The elimination of these charges is not expected to have a material impact on operations or liquidity. Non-interest expense was $20.8 million for the nine months ended September 30, 2023 compared to $19.7 million for the nine months ended September 30, 2022. The $1.1 million increase was impacted by increases in salaries and employee benefits of $821,000 as well as professional fees of $269,000, and deposit insurance of $106,000. These increases were partially offset by decreases in occupancy expenses of $319,000, data processing and telecommunication costs of $115,000, and costs associated with other real estate owned, which decreased $87,000 over the comparative nine-month period. The efficiency ratio, a non-GAAP measure, increased to 73.33% for the nine months ended September 30, 2023 from 71.44% for the nine months ended September 30, 2022. 35 Income tax expense for the nine months ended September 30, 2023 totaled $1.6 million, a decrease of $24,000, or 1.46%, from $1.6 million recorded during the same period in 2022. The effective tax rate for the nine months ended September 30, 2023, was 22.34%, compared to 22.01% for the same period in 2022. Balance Sheet Total assets as of September 30, 2023 were $800.0 million, an increase of $24.6 million, or 3.2%, from $775.4 million as of December 31, 2022. Gross loans increased $41.6 million, or 7.1%, during 2023 due to continuing strong loan demand, combined with reductions in additional principal payments and refinancing due to the general increase in interest rates. Investment securities decreased $8.6 million during 2023 primarily due to et amortization, principal repayments of amortizing investments, and other security maturities of $7.7 million; combined with an increase of $1.4 million in the unrealized loss position, partially offset by $500,000 in purchases. All of the Company’s investments are designated as available-for-sale. Gross loans receivable increased $41.6 million to $626.2 million as of September 30, 2023 from $584.6 million as of December 31, 2022. Commercial real estate loans increased $25.1 million, or 12.7%, from December 31, 2022 to September 30, 2023. Residential 1-4 family loans and multifamily loans increased $8.4 million and $4.4 million, respectively, from December 31, 2022 to September 30, 2023. These increases were a result of continuing strong loan demand. Total deposits were $704.8 million as of September 30, 2023 compared to $692.7 million as of December 31, 2022. The increase of $12.1 million, or 1.7%, was due to efforts to attract and retain time deposits in an extremely competitive environment for deposits, combined with cyclical funds inflows. As a result of these efforts, total time deposits increased $36.6 million during the first nine months of 2023. The increase in time deposits contributed to the increase in our cost of funds, as previously discussed, due to the rising interest rate environment experienced over the past eighteen months. In May 2023, an advance from the Federal Home Loan Bank (“FHLB”) in the amount of $10.0 million was taken with an interest rate of 3.51% and a maturity date of May 4, 2028, to support pending loan closings. There were no FHLB advances outstanding as of December 31, 2022. Trust preferred securities of $16.5 million as of September 30, 2023 remained unchanged in comparison to December 31, 2022. During the first nine months of 2023 total shareholders’ equity increased $2.7 million to $60.0 million as of September 30, 2023, due to the year-to-date earnings of $5.6 million which was partially offset by the $1.1 million increase in the net unrealized loss on available-for-sale investment securities, a cash dividend payment of $1.4 million and the repurchase of common stock totaling $147,000. Additionally, the implementation of the current expected credit loss (“CECL”) methodology resulted in a one-time net of tax, direct charge to retained earnings of $212,000. Consequently, book value per share increased to $2.52 as of September 30, 2023 compared to $2.40 as of December 31, 2022. The Bank remains well capitalized per regulatory guidance. Asset Quality Nonperforming assets, which include nonaccrual loans and other real estate owned (“OREO”), totaled $3.1 million as of September 30, 2023, a decline of $601,000, or 16.36%, since year-end 2022. Nonperforming assets as a percentage of total assets were 0.38% as of September 30, 2023, and 0.47% as of December 31, 2022. Other real estate owned of $261,000 as of September 30, 2023, which consists primarily of residential and commercial lots, is unchanged from December 31, 2022. Expenses associated with other real estate owned were $23,000 for the nine months ended September 30, 2023, compared to $110,000 during the nine months ended September 30, 2022, due to costs associated with sale of other real estate owned during the first nine months of 2022. Nonaccrual loans decreased $601,000 to $2.8 million as of September 30, 2023 from $3.4 million at December 31, 2022, as we continue to work to reduce nonperforming and under-performing assets. For detailed information on nonaccrual loans and other real estate owned as of September 30, 2023 and December 31, 2022, refer to Note 6 Loans and Note 10 Other Real Estate Owned in Item 1 of this Form 10-Q. Loans rated substandard or below totaled $2.8 million as of September 30, 2023, a decrease of $600,000 from $3.4 million as of December 31, 2022. Total past due loans decreased to $4.5 million as of September 30, 2023 from $5.5 million as of December 31, 2022. 36 Our allowance for credit losses as of September 30, 2023 was $6.9 million or 1.10% of total loans as compared to $6.7 million, or 1.15% of total loans, at December 31, 2022. Individually evaluated loans totaled $346,000 with an estimated related specific allowance of $115,000 as of September 30, 2023, as compared to $2.7 million as of December 31, 2022 with an estimated related specific allowance of $86,000 of impaired loans at the end of 2022. A provision of $304,000 was recorded for the first nine months of 2023 compared to $400,000 during the first nine months of 2022. Annualized net charge-offs, as a percentage of average loans, was 0.03% during the first nine months of 2023, compared to 0.12% for the same period of 2022. The allowance for credit 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 CECL model to best reflect the risks in the portfolio. However, future provisions may be deemed necessary. During the first nine months of 2023, we made modest adjustments to our qualitative factors to consider risk factors associated with commercial real estate and residential mortgage loans. Those changes, along with the assessment of the historical and specific risks associated with the loan portfolio, resulted in a net provision for credit losses of $304,000, of which $377,000 was provided for the loan portfolio; offset by a reduction of the allowance for unfunded commitments of $73,000. The following table summarizes components of the allowance for credit losses and related loans as of September 30, 2023 and December 31, 2022: Selected Credit Ratios September 30, December 31, (Dollars in thousands) 2023 2022 Allowance for credit losses $ 6,908 $ 6,727 Total loans 626,203 584,613 Allowance for credit losses to total loans 1.10 % 1.15 % Nonaccrual loans $ 2,812 $ 3,413 Nonaccrual loans to total loans 0.45 % 0.58 % Ratio of allowance for credit losses to nonaccrual loans 2.46 X 1.97 X Charge-offs net of recoveries 1 $ 116 $ 633 Average loans $ 601,729 $ 591,179 Net charge-offs to average loans 1 0.03 % 0.11 % 1 - Annualized 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, excluding the deferred tax asset on the unrealized loss on securities available-for-sale, of $5.0 million and $4.6 million existed as of September 30, 2023 and December 31, 2022, 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. The implementation of the CECL methodology resulted in a one-time deferred tax charge of $56,000. Refer to Note 2 Summary of Significant Accounting Policies in Part 1 of this Form 10-Q. Capital Resources 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 Note 4 in Item 1 of this Form 10-Q. As of September 30, 2023, 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 per common share was $2.52 and $2.40 as of September 30, 2023 and December 31, 2022, respectively. Other key performance indicators are as follows: 37 Three months ended September 30, Nine months ended September 30, 2023 2022 2023 2022 Return on average assets 1 0.94 % 0.94 % 0.96 % 0.95 % Return on average shareholders’ equity 1 12.38 % 13.70 % 12.62 % 13.15 % Average equity to average assets 7.58 % 6.84 % 7.57 % 7.21 % 1 - Annualized Under current economic conditions, we believe it is prudent to continue to retain capital sufficient to support planned asset growth while being able to absorb potential losses that may occur if asset quality deteriorates, and based upon projections, we believe our current capital levels will be sufficient. During the first quarter of 2023, the Company paid a cash dividend of $0.06 per common share to our shareholders. Future payments of cash dividends will depend on a number of factors including but not limited to maintaining positive retained earnings, compliance with regulatory rules governing the payment of dividends, strategic plans, and sufficient capital at the Bank to allow payment of dividends to the Company. On April 28, 2022 the board of directors of the Company authorized the repurchase of up to 500,000 shares of the Company’s outstanding common stock through March 31, 2023. As previously reported, this plan was extended by the Board of Directors through March 31, 2024. The actual means and timing of any purchases, number of shares and prices or range of prices will be determined by the Company in its discretion and will depend on a number of factors, including the market price of the Company’s common stock, general market and economic conditions, and applicable legal and regulatory requirements. As of September 30, 2023, the Company has repurchased 138,982 shares at an average price of $2.29 per share. During the quarter ended September 30, 2023, the Company repurchased 19,753 shares at an average price of $2.29 per share. There is no assurance that the Company will purchase any additional shares under this program. Liquidity We closely monitor our liquidity and our liquid assets in the form of cash, due from banks, federal funds sold, and unpledged available-for-sale securities. As of September 30, 2023, all of our investment securities were classified as available-for-sale. These investments provide a source of liquidity in the amount of $52.2 million, which is net of the $35.3 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. Due to the unrealized loss on securities available-for-sale, the sale of investments would not be considered a primary source of liquidity due to the immediate impact on regulatory capital; however, the majority of the portfolio is considered high credit quality investments and would be available to pledge against borrowings. Our loan to deposit ratio was 88.85% and 84.40% as of September 30, 2023 and December 31, 2022, respectively. Generally, our policy has been to manage this ratio at or below 90.00%. Available third-party sources of liquidity as of September 30, 2023 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. Additionally, in March 2023, the FRB, initiated a supplemental term funding program offering borrowings, of up to one year, secured by securities valued at par rather than market value. This program offers an additional source of liquidity against high quality securities, rather than liquidating securities should a need for additional funds arise. We also have the ability to borrow $30.0 million in unsecured federal funds through credit facilities extended by correspondent banks. We have used our line of credit with the FHLB to issue a letter of credit totaling $12.0 million to the Treasury Board of Virginia for collateral on public funds. No draws on these letters of credit have been issued. The letters of credit are considered to be draws on our FHLB line of credit. In May 2023, we borrowed $10.0 million from FHLB, through a fixed rate 5-year advance, to support loan fundings and other general liquidity needs. An additional $178.8 million was available as of September 30, 2023 on the $200.8 million line of credit, of which $99.7 million is secured by a blanket lien on our residential real estate loans. We held no brokered deposits as of September 30, 2023 and December 31, 2022. Internet accounts are limited to customers located in our primary market area and the surrounding geographical area. The average balance of and the rate paid on deposits is shown in the net interest margin analysis tables. Total Certificate of Deposit Registry Services (“CDARS”) time deposits were $2.7 million and $1.4 million as of September 30, 2023 and December 31, 2022, respectively. Aside from the availability of CDARS time deposits, we also offer a similar deposit product for transaction account customers through Intrafi Cash Service (“ICS”). As of September 30, 2023 approximately $27.0 million were placed in this product as compared to $23.9 million at December 31, 2022. Both the CDARS and ICS offerings assist us in maintaining deposit relationships, while assuring the depositors’ funds retain federal deposit insurance coverage. 38 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, while we do not anticipate using this as a primary funding source, securities with an estimated market value of $35.3 million were pledged as of September 30, 2023. In March and May of 2023, three regional banks, each with assets in excess of $100.0 billion, were taken into receivership through FDIC and were sold in-whole, or in part to other financial institutions. Two of these banks, Silicon Valley Bank (“SVB”) headquartered in Santa Clara, California, and First Republic Bank headquartered in San Francisco, California, experienced significant outflows of deposit funds fueled by concerns of large commercial and retail deposit customers holding funds far in excess of the FDIC insured limits at both institutions. These concerns, in SVB’s case, related to unrealized losses in SVB’s investment portfolio combined with the long-term maturities of the investments and other earning assets held by SVB. The concerns for First Republic Bank related to exposure to long-term jumbo mortgages made to preferred deposit customers and the impact to net interest income and the value of those mortgages in the rising rate environment. While we, or any other financial institution, can be impacted by sudden changes in market conditions or customer sentiment, we believe that our funding and liquidity management strategies and procedures are sound. In addition, our deposit customer base is diverse without significant exposure to uninsured deposit relationships. Prior to receivership of these financial institutions our deposit fluctuations were largely tied to cyclical events and inflows and outflows related to customers seeking higher interest rates. Since the date of these receiverships, we have not experienced any significant or unusual deposit outflows and we took steps to successfully test certain liquidity facilities in the event of any future deposit outflows. Time deposits of $250,000 or more equaled approximately 5.97% of total deposits at September 30, 2023 and 3.87% of deposits at December 31, 2022. 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. The bank holding company has approximately $743,000 in cash on deposit at the Bank at September 30, 2023. The holding company receives periodic dividend payments from the Bank which are used to pay operating expenses, to pay trust preferred interest payments and discretionary principal payments, and to fund dividend payments to shareholders and repurchase shares. The Company makes quarterly interest payments on the trust preferred securities. As discussed in the Capital Resources section, the Company is authorized to repurchase up to 500,000 shares of the Company’s outstanding common stock through March 31, 2024. Payments for any repurchases will be distributed from available funds, or from dividend payments from the Bank, and are not expected to have a material impact on available liquidity. Off Balance Sheet Items and Contractual Obligations There have been no material changes during the nine months ended September 30, 2023, to the off-balance sheet items and the contractual obligations disclosed in our 2022 Form 10-K. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not Applicable.