PEOPLES BANCORP OF NORTH CAROLINA INC 10-Q

Item 1. Financial Statements PEOPLES BANCORP OF NORTH CAROLINA, INC. Consolidated Balance Sheets September 30, 2022 and December 31, 2021 (Dollars in thousands) September 30, December 31, Assets 2022 2021 (Unaudited) (Audited) Cash and due from banks, including reserve requirements of $ 0 at both 9/30/22 and 12/31/21 $ 55,063 44,711 Interest-bearing deposits 100,398 232,788 Cash and cash equivalents 155,461 277,499 Investment securities available for sale 444,367 406,549 Other investments 2,762 3,668 Total securities 447,129 410,217 Mortgage loans held for sale 975 3,637 Loans 1,004,907 884,869 Less allowance for loan losses ( 10,030 ) ( 9,355 ) Net loans 994,877 875,514 Premises and equipment, net 18,508 16,104 Cash surrender value of life insurance 17,601 17,365 Right of use lease asset 5,770 4,612 Accrued interest receivable and other assets 35,969 19,245 Total assets $ 1,676,290 1,624,193 Liabilities and Shareholders' Equity Deposits: Noninterest-bearing demand $ 563,142 514,319 Interest-bearing demand, MMDA & savings 839,532 797,179 Time, $ 250,000 or more 30,118 26,333 Other time 68,299 74,917 Total deposits 1,501,091 1,412,748 Securities sold under agreements to repurchase 37,986 37,094 Junior subordinated debentures 15,464 15,464 Lease liability 5,847 4,677 Accrued interest payable and other liabilities 11,978 11,841 Total liabilities 1,572,366 1,481,824 Commitments Shareholders' equity: Preferred stock, no par value; authorized 5,000,000 shares; no shares issued and outstanding - - Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 5,641,030 shares at September 30, 2022 and 5,661,569 shares at December 31, 2021 52,752 53,305 Common stock held by deferred compensation trust, at cost; 167,889 shares at September 30, 2022 and 162,193 shares at December 31, 2021 ( 2,150 ) ( 1,992 ) Deferred compensation 2,150 1,992 Retained earnings 97,029 88,968 Accumulated other comprehensive income (loss) ( 45,857 ) 96 Total shareholders' equity 103,924 142,369 Total liabilities and shareholders' equity $ 1,676,290 1,624,193 See accompanying Notes to Consolidated Financial Statements. 4 Table of Contents PEOPLES BANCORP OF NORTH CAROLINA, INC. Consolidated Statements of Earnings Three and Nine Months Ended September 30, 2022 and 2021 (Dollars in thousands, except per share amounts) Three months ended Nine months ended September 30, September 30, 2022 2021 2022 2021 (Unaudited) (Unaudited) (Unaudited) (Unaudited) Interest income: Interest and fees on loans $ 11,051 9,807 30,727 31,474 Interest on due from banks 900 89 1,453 172 Interest on investment securities: U.S. Government sponsored enterprises 1,580 679 2,676 1,899 State and political subdivisions 1,056 825 3,009 2,222 Other 24 21 67 93 Total interest income 14,611 11,421 37,932 35,860 Interest expense: NOW, MMDA & savings deposits 494 577 1,263 1,617 Time deposits 134 181 421 584 Junior subordinated debentures 146 69 324 211 Other 44 34 117 106 Total interest expense 818 861 2,125 2,518 Net interest income 13,793 10,560 35,807 33,342 Provision for (recovery of) loan losses 408 ( 182 ) 889 ( 863 ) Net interest income after provision for loan losses 13,385 10,742 34,918 34,205 Non-interest income: Service charges 1,458 1,023 4,000 2,859 Other service charges and fees 169 187 540 570 Mortgage banking income 59 516 358 2,109 Insurance and brokerage commissions 213 266 709 764 Appraisal management fee income 2,711 1,954 9,656 5,775 Gain on sale of other assets - 104 - 104 Gain on sale of other real estate - - - 21 Miscellaneous 2,183 1,990 5,904 5,751 Total non-interest income 6,793 6,040 21,167 17,953 Non-interest expense: Salaries and employee benefits 6,177 6,054 18,469 17,903 Occupancy 2,038 1,999 5,886 5,891 Professional fees 413 582 1,241 1,354 Advertising 175 91 509 388 Debit card expense 228 244 826 740 FDIC Insurance 121 108 346 304 Appraisal management fee expense 2,151 1,556 7,680 4,646 Miscellaneous 2,152 1,934 6,082 5,742 Total non-interest expense 13,455 12,568 41,039 36,968 Earnings before income taxes 6,723 4,214 15,046 15,190 Income tax expense 1,416 824 3,070 3,064 Net earnings $ 5,307 3,390 11,976 12,126 Basic net earnings per share $ 0.96 0.61 2.18 2.16 Diluted net earnings per share $ 0.93 0.59 2.11 2.10 Cash dividends declared per share $ 0.18 0.17 0.69 0.49 See accompanying Notes to Consolidated Financial Statements. 5 Table of Contents PEOPLES BANCORP OF NORTH CAROLINA, INC. Consolidated Statements of Comprehensive Income (Loss) Three and Nine Months Ended September 30, 2022 and 2021 (Dollars in thousands) Three months ended Nine months ended September 30, September 30, 2022 2021 2022 2021 (Unaudited) (Unaudited) (Unaudited) (Unaudited) Net earnings $ 5,307 3,390 11,976 12,126 Other comprehensive loss: Unrealized holding losses on securities available for sale ( 16,578 ) ( 844 ) ( 59,661 ) ( 2,714 ) Income tax benefit related to other comprehensive loss: Unrealized holding losses on securities available for sale ( 3,808 ) ( 194 ) ( 13,708 ) ( 624 ) Total other comprehensive loss, net of tax ( 12,770 ) ( 650 ) ( 45,953 ) ( 2,090 ) Total comprehensive income (loss) $ ( 7,463 ) 2,740 ( 33,977 ) 10,036 See accompanying Notes to Consolidated Financial Statements. 6 Table of Contents PEOPLES BANCORP OF NORTH CAROLINA, INC. Consolidated Statements of Changes in Shareholders' Equity Three and Nine Months Ended September 30, 2022 and 2021 (Dollars in thousands) Common Stock Held By Accumulated Deferred Other Common Stock Retained Deferred Compensation Comprehensive Shares Amount Earnings Compensation Trust Income (Loss) Total (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) Balance, December 31, 2021 5,661,569 $ 53,305 88,968 1,992 ( 1,992 ) 96 142,369 Common stock repurchase ( 7,000 ) ( 199 ) - - - - ( 199 ) Cash dividends declared on common stock - - ( 1,877 ) - - - ( 1,877 ) Restricted stock units exercised 1,461 41 - - - - 41 Equity incentive plan, net - - - 50 ( 50 ) - - Net earnings - - 3,452 - - - 3,452 Change in accumulated other comprehensive loss, net of tax - - - - - ( 18,342 ) ( 18,342 ) Balance, March 31, 2022 5,656,030 $ 53,147 90,543 2,042 ( 2,042 ) ( 18,246 ) 125,444 Common stock repurchase ( 15,000 ) ( 395 ) - - - - ( 395 ) Cash dividends declared on common stock - - ( 1,019 ) - - - ( 1,019 ) Equity incentive plan, net - - - 57 ( 57 ) - - Net earnings - - 3,217 - - - 3,217 Change in accumulated other comprehensive loss, net of tax - - - - - ( 14,841 ) ( 14,841 ) Balance, June 30, 2022 5,641,030 $ 52,752 92,741 2,099 ( 2,099 ) ( 33,087 ) 112,406 Cash dividends declared on common stock - - ( 1,019 ) - - - ( 1,019 ) Equity incentive plan, net - - - 51 ( 51 ) - - Net earnings - - 5,307 - - - 5,307 Change in accumulated other comprehensive loss, net of tax - - - - - ( 12,770 ) ( 12,770 ) Balance, September 30, 2022 5,641,030 $ 52,752 97,029 2,150 ( 2,150 ) ( 45,857 ) 103,924 Balance, December 31, 2020 5,787,504 $ 56,871 77,628 1,796 ( 1,796 ) 5,400 139,899 Cash dividends declared on common stock - - ( 930 ) - - - ( 930 ) Restricted stock units exercised 1,662 39 - - - - 39 Equity incentive plan, net - - - 53 ( 53 ) - - Net earnings - - 4,121 - - - 4,121 Change in accumulated other comprehensive loss, net of tax - - - - - ( 3,100 ) ( 3,100 ) Balance, March 31, 2021 5,789,166 56,910 80,819 1,849 ( 1,849 ) 2,300 140,029 Cash dividends declared on common stock - - ( 930 ) - - - ( 930 ) Equity incentive plan, net - - - 52 ( 52 ) - - Net earnings - - 4,615 - - - 4,615 Change in accumulated other comprehensive income, net of tax - - - - - 1,660 1,660 Balance, June 30, 2021 5,789,166 $ 56,910 84,504 1,901 ( 1,901 ) 3,960 145,374 Common stock repurchase ( 127,597 ) ( 3,605 ) - - - - ( 3,605 ) Cash dividends declared on common stock - - ( 967 ) - - - ( 967 ) Equity incentive plan, net - - - 45 ( 45 ) - - Net earnings - - 3,390 - - - 3,390 Change in accumulated other comprehensive loss, net of tax - - - - - ( 650 ) ( 650 ) Balance, September 30, 2021 5,661,569 $ 53,305 86,927 1,946 ( 1,946 ) 3,310 143,542 See accompanying Notes to Consolidated Financial Statements. 7 Table of Contents PEOPLES BANCORP OF NORTH CAROLINA, INC. Consolidated Statements of Cash Flows Nine Months Ended September 30, 2022 and 2021 (Dollars in thousands) 2022 2021 (Unaudited) (Unaudited) Cash flows from operating activities: Net earnings $ 11,976 12,126 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation, amortization and accretion 4,914 3,991 Provision for (recovery of) loan losses 889 ( 863 ) Deferred income taxes ( 31 ) ( 27 ) Gain on sale of other real estate - ( 21 ) Gain on sale of other assets - ( 104 ) Restricted stock expense ( 95 ) ( 166 ) Proceeds from sales of mortgage loans held for sale 20,475 76,086 Origination of mortgage loans held for sale ( 17,813 ) ( 76,033 ) Change in: Cash surrender value of life insurance ( 301 ) ( 297 ) Right of use lease asset 568 562 Other assets ( 2,944 ) 455 Lease liability ( 556 ) ( 549 ) Other liabilities 232 2,138 Net cash provided by operating activities 17,314 17,298 Cash flows from investing activities: Purchases of investment securities available for sale ( 139,657 ) ( 186,793 ) Proceeds from sales, calls and maturities of investment securities available for sale 7,870 6,010 Proceeds from paydowns of investment securities available for sale 31,186 18,335 Proceeds from paydowns on other investments 1,011 132 Redemptions (purchases) of FHLB stock ( 105 ) 331 Net change in loans ( 120,252 ) 57,552 Purchases of premises and equipment ( 4,196 ) ( 379 ) Proceeds from sale of other assets - 515 Proceeds from sale of other real estate - 149 Proceeds from bank owned life insurance 65 - Net cash used by investing activities ( 224,078 ) ( 104,148 ) Cash flows from financing activities: Net change in deposits 88,343 188,879 Net change in securities sold under agreement to repurchase 892 6,131 Common stock repurchased ( 594 ) ( 3,605 ) Cash dividends paid on common stock ( 3,915 ) ( 2,827 ) Net cash provided by financing activities 84,726 188,578 Net change in cash and cash equivalents ( 122,038 ) 101,728 Cash and cash equivalents at beginning of period 277,499 161,580 Cash and cash equivalents at end of period $ 155,461 263,308 8 Table of Contents PEOPLES BANCORP OF NORTH CAROLINA, INC. Consolidated Statements of Cash Flows, continued Nine Months Ended September 30, 2022 and 2021 (Dollars in thousands) 2022 2021 (Unaudited) (Unaudited) Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $ 2,112 1,658 Income taxes $ 3,069 3,221 Noncash investing and financing activities: Change in unrealized loss on investment securities available for sale, net $ ( 45,953 ) ( 2,090 ) Issuance of accrued restricted stock units $ 41 39 Transfer of premises and equipment to other assets held for sale $ - 408 Initial recognition of lease right-of-use asset and lease liability $ 1,726 952 See accompanying Notes to Consolidated Financial Statements. 9 Table of Contents PEOPLES BANCORP OF NORTH CAROLINA, INC. Notes to Consolidated Financial Statements ( Unaudited ) (1) Summary of Significant Accounting Policies The Consolidated Financial Statements include the financial statements of Peoples Bancorp of North Carolina, Inc. (the “Company”) and its wholly owned subsidiary, Peoples Bank (the “Bank”), along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc. (“PIS”), Real Estate Advisory Services, Inc. (“REAS”), Community Bank Real Estate Solutions, LLC (“CBRES”) and PB Real Estate Holdings, LLC. All significant intercompany balances and transactions have been eliminated in consolidation. In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), to facilitate the issuance of $ 20.6 million of trust preferred securities. PEBK Trust II is not included in the Consolidated Financial Statements. The Bank operates three banking offices focused on the Latino population that were formerly operated as a separate division of the Bank under the name Banco de la Gente (“Banco”). These offices, which offer the same banking services as our other branches offer, now operate under the same name as our other offices; however, we continue to separately categorize mortgage loans originated from these offices. The Consolidated Financial Statements in this report (other than the Consolidated Balance Sheet at December 31, 2021) are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these Consolidated Financial Statements in conformity with generally accepted accounting principles in the United States (“GAAP”). Actual results could differ from those estimates. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of the specific accounting guidance. A description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders. Recent Accounting Pronouncements The following table provides a summary of Accounting Standards Updates (“ASUs”) issued by the Financial Accounting Standards Board (“FASB”) that the Company has not adopted as of September 30, 2022, which may impact the Company’s financial statements. Recently Issued Accounting Guidance Not Yet Adopted ASU Description Effective Date Effect on Financial Statements or Other Significant Matters ASU 2016-13: Measurement of Credit Losses on Financial Instruments Provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. See ASU 2019-10 below. The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company has developed CECL model assumptions and is comparing results to current allowance for loan loss calculations. Parallel processing of the existing allowance for loan losses model with the CECL model will occur during the fourth quarter of 2022. The Company is currently evaluating the impact of this adoption on its financial statements and disclosures and currently expects to record a one-time adjustment to retained earnings to increase the allowance for loan losses. In addition to the Company’s allowance for loan losses, it will also review an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time. Based on implementation progress to date, the Company believes the capital adequacy requirements to which it and the Bank are subject to, and its business strategies and practices, will not be materially impacted following the adoption on January 1, 2023. 10 Table of Contents ASU Description Effective Date Effect on Financial Statements or Other Significant Matters ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic. See ASU 2019-10 below. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above. ASU 2019-04: Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments Addresses unintended issues accountants flagged when implementing ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, ASU 2016-13, Measurement of Credit Losses on Financial Instruments, and ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. See ASU 2019-10 below. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above. ASU 2019-05: Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief Guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. See ASU 2019-10 below. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above. ASU 2019-10: Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates Guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (CECL), leases and hedging. January 1, 2023 The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2019-11: Codification Improvements to Topic 326, Financial Instruments—Credit Losses Guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the ASC. January 1, 2023 The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2020-03: Codification Improvements to Financial Instruments Guidance to clarify that the contractual term of a net investment in a lease, determined in accordance with the leases standard, should be the contractual term used to measure expected credit losses under ASC 326. January 1, 2023 The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2020-04: Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting Guidance that provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The ASU is intended to help stakeholders during the global market-wide reference rate transition period. Therefore, it will be in effect for a limited time through December 31, 2022. March 12, 2020 through December 31, 2022 The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. ASU 2022-02: Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures Eliminates the guidance on troubled debt restructurings (TDRs) for creditors in ASC 310-40 2 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination. January 1, 2023 The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. 11 Table of Contents Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures. (2) Investment Securities Investment securities available for sale at September 30, 2022 and December 31, 2021 are as follows: (Dollars in thousands) September 30, 2022 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value U.S. Treasuries $ 10,946 - 1,169 9,777 U.S. Government sponsored enterprises 12,827 - 685 12,142 Mortgage-backed securities 296,204 271 24,576 271,899 State and political subdivisions 183,924 14 33,389 150,549 Total $ 503,901 285 59,819 444,367 (Dollars in thousands) December 31, 2021 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value U.S Treasuries $ 7,964 - 75 7,889 U.S. Government sponsored enterprises 14,252 200 185 14,267 Mortgage-backed securities 218,402 1,769 3,019 217,152 State and political subdivisions 165,804 3,694 2,257 167,241 Total $ 406,422 5,663 5,536 406,549 The current fair value and associated unrealized losses on investments in securities with unrealized losses at September 30, 2022 and December 31, 2021 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position. (Dollars in thousands) September 30, 2022 Less than 12 Months 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses U.S. Treasuries $ 2,868 109 6,909 1,060 9,777 1,169 U.S. Government sponsored enterprises 5,098 513 7,044 172 12,142 685 Mortgage-backed securities 136,374 9,243 109,222 15,333 245,596 24,576 State and political subdivisions 90,030 14,557 57,040 18,832 147,070 33,389 Total $ 234,370 24,422 180,215 35,397 414,585 59,819 12 Table of Contents (Dollars in thousands) December 31, 2021 Less than 12 Months 12 Months or More Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses U.S. Treasuries $ 7,889 75 - - 7,889 75 U.S. Government sponsored enterprises 5,232 15 3,263 170 8,495 185 Mortgage-backed securities 131,483 2,477 19,632 542 151,115 3,019 State and political subdivisions 80,076 1,981 5,922 276 85,998 2,257 Total $ 224,680 4,548 28,817 988 253,497 5,536 At September 30, 2022, unrealized losses in the investment securities portfolio relating to debt securities totaled $ 59.8 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the September 30, 2022 tables above, all three U.S. Treasury securities, 152 out of 166 securities issued by state and political subdivisions and 127 out of 139 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed. At December 31, 2021, unrealized losses in the investment securities portfolio relating to debt securities totaled $ 5.5 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the December 31, 2021 tables above, both of the U.S. Treasury securities, 70 of the 146 securities issued by state and political subdivisions contained unrealized losses and 54 of the 99 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed. The amortized cost and estimated fair value of investment securities available for sale at September 30, 2022, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. September 30, 2022 (Dollars in thousands) Amortized Cost Fair Value Due within one year $ 2,395 2,396 Due from one to five years 9,173 8,962 Due from five to ten years 59,376 51,386 Due after ten years 136,753 109,724 Mortgage-backed securities 296,204 271,899 Total $ 503,901 444,367 No securities available for sale were sold during the three and nine months ended September 30, 2022 and 2021. Securities with a fair value of approximately $ 101.8 million and $ 98.6 million at September 30, 2022 and December 31, 2021, respectively, were pledged to secure public deposits and for other purposes as required by law. 13 Table of Contents (3) Loans Major classifications of loans at September 30, 2022 and December 31, 2021 are summarized as follows: (Dollars in thousands) September 30, 2022 December 31, 2021 Real estate loans: Construction and land development $ 112,854 95,760 Single-family residential 312,208 266,111 Single-family residential - Banco de la Gente non-traditional 20,469 23,147 Commercial 399,015 337,841 Multifamily and farmland 62,040 58,366 Total real estate loans 906,586 781,225 Loans not secured by real estate: Commercial loans 76,434 91,172 Farm loans 961 796 Consumer loans 6,438 6,436 All other loans 14,488 5,240 Total loans 1,004,907 884,869 Less allowance for loan losses ( 10,030 ) ( 9,355 ) Total net loans $ 994,877 875,514 The Bank makes loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Wake, Rowan and Forsyth counties of North Carolina. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market. Risk characteristics of the major components of the Bank’s loan portfolio are discussed below: · Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. · Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. · Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over the loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. · Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. · Multifamily and farmland loans – Decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. Loans are considered past due if the required principal and interest payments have not been received within 30 days of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Generally, a loan is placed on non-accrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. 14 Table of Contents The following tables present an age analysis of past due loans, by loan type, as of September 30, 2022 and December 31, 2021: September 30, 2022 (Dollars in thousands) Loans 30-89 Days Past Due Loans 90 or More Days Past Due Total Past Due Loans Total Current Loans Total Current Loans Total Loans Accruing Loans 90 or More Days Past Due Real estate loans: Construction and land development $ 513 - 513 112,341 - 112,854 - Single-family residential 1,050 158 1,208 311,000 - 312,208 - Single-family residential - Banco de la Gente non-traditional 602 191 793 19,676 - 20,469 - Commercial 123 - 123 398,892 - 399,015 - Multifamily and farmland - - - 62,040 - 62,040 - Total real estate loans 2,288 349 2,637 903,949 - 906,586 - Loans not secured by real estate: Commercial loans 1,237 - 1,237 75,197 - 76,434 - Farm loans - - - 961 - 961 - Consumer loans 41 3 44 6,394 - 6,438 - All other loans - - - 14,488 - 14,488 - Total loans $ 3,566 352 3,918 1,000,989 - 1,004,907 - December 31, 2021 (Dollars in thousands) Loans 30-89 Days Past Due Loans 90 or More Days Past Due Total Past Due Loans Total Current Loans Total Loans Accruing Loans 90 or More Days Past Due Real estate loans: Construction and land development $ - - - 95,760 95,760 - Single-family residential 2,323 634 2,957 263,154 266,111 - Single-family residential - Banco de la Gente non-traditional 2,593 112 2,705 20,442 23,147 - Commercial 488 - 488 337,353 337,841 - Multifamily and farmland - - - 58,366 58,366 - Total real estate loans 5,404 746 6,150 775,075 781,225 - Loans not secured by real estate: Commercial loans 43 - 43 91,129 91,172 - Farm loans - - - 796 796 - Consumer loans 38 - 38 6,398 6,436 - All other loans - - - 5,240 5,240 - Total loans $ 5,485 746 6,231 878,638 884,869 - 15 Table of Contents The following table presents non-accrual loans as of September 30, 2022 and December 31, 2021: (Dollars in thousands) September 30, 2022 December 31, 2021 Real estate loans: Construction and land development $ - - Single-family residential 1,999 1,642 Single-family residential - Banco de la Gente non-traditional 1,462 1,232 Commercial 133 200 Multifamily and farmland 96 105 Total real estate loans 3,690 3,179 Loans not secured by real estate: Commercial loans - 49 Consumer loans 18 2 Total $ 3,708 3,230 At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral less estimated selling costs. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $ 250,000 are not individually evaluated for impairment with the exception of the Bank’s Troubled Debt Restructurings (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Impaired loans were $ 15.7 million and $ 18.3 million at September 30, 2022 and December 31, 2021, respectively. Interest income recognized on accruing impaired loans was $ 649,000 and $ 754,000 for the nine months ended September 30, 2022 and 2021, respectively. Interest income recognized on accruing impaired loans was $ 217,000 and $253,000 for the three months ended September 30, 2022 and the three months ended September 30, 2021, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual. The following table presents impaired loans as of September 30, 2022: September 30, 2022 (Dollars in thousands) Unpaid Contractual Principal Balance Recorded Investment With No Allowance Recorded Investment With Allowance Recorded Investment in Impaired Loans Related Allowance Real estate loans: Construction and land development $ 59 - 59 59 1 Single-family residential 3,929 240 3,381 3,621 62 Single-family residential - Banco de la Gente non-traditional 10,557 - 9,890 9,890 619 Commercial 1,996 426 1,502 1,928 9 Multifamily and farmland 107 - 96 96 - Total impaired real estate loans 16,648 666 14,928 15,594 691 Loans not secured by real estate: Commercial loans 130 - 130 130 1 Consumer loans 21 - 20 20 - Total impaired loans $ 16,799 666 15,078 15,744 692 16 Table of Contents The following table presents impaired loans as of and for the year ended December 31, 2021: December 31, 2021 (Dollars in thousands) Unpaid Contractual Principal Balance Recorded Investment With No Allowance Recorded Investment With Allowance Recorded Investment in Impaired Loans Related Allowance Real estate loans: Construction and land development $ 73 - 73 73 3 Single-family residential 5,138 524 4,374 4,898 86 Single-family residential - Banco de la Gente non-traditional 11,753 - 10,922 10,922 687 Commercial 2,138 435 1,608 2,043 11 Multifamily and farmland 113 - 105 105 - Total impaired real estate loans 19,215 959 17,082 18,041 787 Loans not secured by real estate: Commercial loans 282 49 170 219 2 Consumer loans 8 - 4 4 - Total impaired loans $ 19,505 1,008 17,256 18,264 789 The following table presents the average impaired loan balance and the interest income recognized by loan class for the three and nine months ended September 30, 2022 and 2021. (Dollars in thousands) Three months ended Nine months ended September 30, 2022 September 30, 2021 September 30, 2022 September 30, 2021 Average Balance Interest Income Recognized Average Balance Interest Income Recognized Average Balance Interest Income Recognized Average Balance Interest Income Recognized Real estate loans: Construction and land development $ 60 1 76 1 65 4 91 5 Single-family residential 1,393 51 5,875 49 1,131 150 5,683 166 Single-family residential - Banco de la Gente stated income 12,487 134 10,349 140 13,454 407 11,090 477 Commercial 1,939 25 2,280 20 1,985 75 2,617 85 Multifamily and farmland 97 1 110 2 100 4 113 4 Total impaired real estate loans 15,976 212 18,690 212 16,735 640 19,594 737 Loans not secured by real estate: Commercial loans 138 3 248 5 163 7 330 16 Farm loans (non RE) - - - - - - - Consumer loans 21 1 9 - 14 2 19 1 Total impaired loans $ 16,135 216 18,947 217 16,912 649 19,943 754 Impaired loans collectively evaluated for impairment totaled $ 5.1 million at September 30, 2022 and December 31, 2021 and are included in the tables above. Allowance on impaired loans collectively evaluated for impairment totaled $ 44,000 and $ 52,000 at September 30, 2022 and December 31, 2021, respectively. The following tables present changes in the allowance for loan losses for the three and nine months ended September 30, 2022 and 2021. Unallocated balances in the following tables include allowance for loan losses based on qualitative factors such as economic outlook, concentrations of credit, interest rate risk and loan volume trends. Paycheck Protection Program (“PPP”) loans are excluded from the allowance for loan losses as PPP loans are 100 percent guaranteed by the Small Business Administration (“SBA”). 17 Table of Contents (Dollars in thousands) Real Estate Loans Construction and Land Development Single-Family Residential Single-Family Residential - Banco de la Gente Non-traditional Commercial Multifamily and Farmland Commercial Farm Consumer and All Other Unallocated Total Nine months ended September 30, 2022: Allowance for loan losses: Beginning balance $ 1,193 2,013 864 2,234 150 711 - 110 2,080 9,355 Charge-offs - ( 120 ) - - - ( 20 ) - ( 450 ) - ( 590 ) Recoveries - 219 - 6 - 64 - 87 - 376 Provision 180 78 ( 101 ) 885 5 ( 14 ) - 467 ( 611 ) 889 Ending balance $ 1,373 2,190 763 3,125 155 741 - 214 1,469 10,030 Three months ended September 30, 2022: Allowance for loan losses: Beginning balance $ 1,272 2,171 813 3,156 157 633 - 216 1,371 9,789 Charge-offs - ( 89 ) - - - ( 13 ) - ( 204 ) - ( 306 ) Recoveries - 92 - 2 - 8 - 37 - 139 Provision 101 16 ( 50 ) ( 33 ) ( 2 ) 113 - 165 98 408 Ending balance $ 1,373 2,190 763 3,125 155 741 - 214 1,469 10,030 Allowance for loan losses at September 30, 2022: Ending balance: individually evaluated for impairment $ - 37 605 6 - - - - - 648 Ending balance: collectively evaluated for impairment 1,373 2,153 158 3,119 155 741 - 214 1,469 9,382 Ending balance $ 1,373 2,190 763 3,125 155 741 - 214 1,469 10,030 Loans at September 30, 2022: Ending balance $ 112,854 312,208 20,469 399,015 62,040 76,434 961 20,926 - 1,004,907 Ending balance: individually evaluated for impairment $ - 547 8,703 1,401 - - - - - 10,651 Ending balance: collectively evaluated for impairment $ 112,854 311,661 11,766 397,614 62,040 76,434 961 20,926 - 994,256 (Dollars in thousands) Real Estate Loans Construction and Land Development Single-Family Residential Single-Family Residential - Banco de la Gente Non-traditional Commercial Multifamily and Farmland Commercial Farm Consumer and All Other Unallocated Total Nine months ended September 30, 2021: Allowance for loan losses: Beginning balance $ 1,196 1,843 1,052 2,212 122 1,345 - 128 2,010 9,908 Charge-offs - - - - - ( 293 ) - ( 249 ) - ( 542 ) Recoveries 121 165 - 50 3 7 - 114 - 460 Provision (421 ) ( 306 ) ( 162 ) 46 22 ( 153 ) - 98 13 ( 863 ) Ending balance $ 896 1,702 890 2,308 147 906 - 91 2,023 8,963 Three months ended September 30, 2021: Allowance for loan losses: Beginning balance $ 1,038 1,723 980 2,180 148 996 - 89 2,133 9,287 Charge-offs - - - - - ( 215 ) - ( 91 ) - ( 306 ) Recoveries 31 86 - 2 4 1 - 40 - 164 Provision (173 ) ( 107 ) ( 90 ) 126 ( 5 ) 124 - 53 ( 110 ) ( 182 ) Ending balance $ 896 1,702 890 2,308 147 906 - 91 2,023 8,963 Allowance for loan losses at September 30, 2021: Ending balance: individually evaluated for impairment $ 1 58 710 7 - - - - - 776 Ending balance: collectively evaluated for impairment 895 1,644 180 2,301 147 906 - 91 2,023 8,187 Ending balance $ 896 1,702 890 2,308 147 906 - 91 2,023 8,963 Loans at September 30, 2021: Ending balance $ 80,009 258,403 24,043 363,174 58,856 94,376 633 11,511 - 891,005 Ending balance: individually evaluated for impairment $ 6 1,398 10,236 1,450 - 54 - - - 13,144 Ending balance: collectively evaluated for impairment $ 80,003 257,005 13,807 361,724 58,856 94,322 633 11,511 - 877,861 18 Table of Contents The Bank utilizes an internal risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 8. These risk grades are evaluated on an ongoing basis. A description of the general characteristics of the eight risk grades is as follows: · Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade. · Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Bank’s range of acceptability. The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes. · Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Bank’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change). PPP loans are classified as risk grade 3. · Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course. · Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank’s position at some future date. · Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any). There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. · Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off. · Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off. The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of September 30, 2022 and December 31, 2021: September 30, 2022 (Dollars in thousands) Real Estate Loans Construction and Land Development Single-Family Residential Single-Family Residential - Banco de la Gente non-traditional Commercial Multifamily and Farmland Commercial Farm Consumer All Other Total 1- Excellent Quality $ - 3,808 - - - 1,381 - 523 - 5,712 2- High Quality 18,162 129,784 - 30,197 17 16,163 - 2,064 1,427 197,814 3- Good Quality 93,266 163,179 7,777 334,206 59,539 56,973 961 3,600 12,782 732,283 4- Management Attention 1,307 11,046 9,130 31,732 1,869 1,127 - 225 133 56,569 5- Watch 60 915 1,150 2,321 519 786 - - 146 5,897 6- Substandard 59 3,476 2,412 559 96 4 - 26 - 6,632 7- Doubtful - - - - - - - - - - 8- Loss - - - - - - - - - - Total $ 112,854 312,208 20,469 399,015 62,040 76,434 961 6,438 14,488 1,004,907 19 Table of Contents December 31, 2021 (Dollars in thousands) Real Estate Loans Construction and Land Development Single-Family Residential Single-Family Residential - Banco de la Gente non-traditional Commercial Multifamily and Farmland Commercial Farm Consumer All Other Total 1- Excellent Quality $ - 5,923 - - - 371 - 581 - 6,875 2- High Quality 11,752 109,337 - 28,546 19 16,177 - 2,039 1,309 169,179 3- Good Quality 80,325 129,856 8,712 272,786 54,945 68,183 792 3,510 3,931 623,040 4- Management Attention 3,534 14,964 10,478 30,937 2,754 5,214 4 284 - 68,169 5- Watch 76 2,464 1,703 4,938 543 1,177 - 1 - 10,902 6- Substandard 73 3,567 2,254 634 105 50 - 21 - 6,704 7- Doubtful - - - - - - - - - - 8- Loss - - - - - - - - - - Total $ 95,760 266,111 23,147 337,841 58,366 91,172 796 6,436 5,240 884,869 There were no new TDR modifications during the three and nine months ended September 30, 2022 and 2021. There were no loans modified as TDR loans that defaulted during the nine months ended September 30, 2022 and 2021, which were within 12 months of their modification date. On March 27, 2020, President Trump signed the CARES Act, which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the PPP . Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals were able to apply for loans from existing SBA lenders and other approved regulated lenders, subject to certain limitations and eligibility criteria. A second round of PPP funding provided a total of $320 billion additional funding for the PPP . The Bank participated as a lender in the PPP. Total PPP loans originated during the years ended December 31, 2020 and 2021 amounted to $ 128.1 million. The outstanding balance of PPP loans was $ 103,000 and $ 18.0 million at September 30, 2022 and December 31, 2021, respectively. These loans are classified as commercial loans in the tables above. The Bank recognized $ 54,000 and $ 489,000 of PPP loan fee income for the three months ended September 30, 2022 and the three months ended September 30, 2021, respectively. The Bank recognized $ 948,000 and $ 3.0 million of PPP loan fee income for the nine months ended September 30, 2022 and nine months ended September 30, 2021, respectively. (4) Net Earnings Per Share Net earnings per share is based on the weighted average number of shares outstanding during the period while the effects of potential shares outstanding during the period are included in diluted earnings per share. The average market price during the applicable period is used to compute equivalent shares. The reconciliation of the amounts used in the computation of both “basic earnings per share” and “diluted earnings per share” for the three and nine months ended September 30, 2022 and 2021 is as follows: For the three months ended September 30, 2022 Net Earnings (Dollars in thousands) Weighted Average Number of Shares Per Share Amount Basic earnings per share $ 5,307 5,473,443 $ 0.96 Effect of dilutive securities: Restricted stock units - unvested 17,188 Shares held in deferred comp plan by deferred compensation trust 166,937 Diluted earnings per share $ 5,307 5,657,568 $ 0.93 20 Table of Contents For the nine months ended September 30, 2022 Net Earnings (Dollars in thousands) Weighted Average Number of Shares Per Share Amount Basic earnings per share $ 11,976 5,484,063 $ 2.18 Effect of dilutive securities: Restricted stock units - unvested 15,090 Shares held in deferred comp plan by deferred compensation trust 165,041 Diluted earnings per share $ 11,976 5,664,194 $ 2.11 For the three months ended September 30, 2021 Net Earnings (Dollars in thousands) Weighted Average Number of Shares Per Share Amount Basic earnings per share $ 3,390 5,544,596 $ 0.61 Effect of dilutive securities: Restricted stock units - unvested - 14,690 Shares held in deferred comp plan by deferred compensation trust 159,797 Diluted earnings per share $ 3,390 5,719,083 $ 0.59 For the nine months ended September 30, 2021 Net Earnings (Dollars in thousands) Weighted Average Number of Shares Per Share Amount Basic earnings per share $ 12,126 5,601,879 $ 2.16 Effect of dilutive securities: Restricted stock units - unvested - 13,190 Shares held in deferred comp plan by deferred compensation trust 158,039 Diluted earnings per share $ 12,126 5,773,108 $ 2.10 (5) Fair Value The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance. The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: · Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets. · Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. · Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. Cash and Cash Equivalents For cash, due from banks and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value. Cash and cash equivalents are reported in the Level 1 fair value category. 21 Table of Contents Investment Securities Available for Sale Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using 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. Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category. Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category. All other fair value measurements are reported in the Level 3 fair value category. Other Investments For other investments, the carrying value is a reasonable estimate of fair value. Other investments are reported in the Level 3 fair value category. Mortgage Loans Held for Sale Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value. Mortgage loans held for sale are reported in the Level 3 fair value category. Loans The fair value of loans, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated using discounted cash flow analyses. The discount rates used to determine fair value use interest rate spreads that reflect factors such as liquidity, credit, and nonperformance risk of the loans. Loans are reported in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments. Mutual Funds For mutual funds held in the deferred compensation trust, the carrying value is a reasonable estimate of fair value. Mutual funds held in the deferred compensation trust are included in other assets on the balance sheet and reported in the Level 2 fair value category. Deposits The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Deposits are reported in the Level 3 fair value category. Securities Sold Under Agreements to Repurchase For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value. Securities sold under agreements to repurchase are reported in the Level 2 fair value category. FHLB Borrowings The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 3 fair value category. Junior Subordinated Debentures Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value. Junior subordinated debentures are reported in the Level 2 fair value category. Commitments to Extend Credit and Standby Letters of Credit Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial. Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. 22 Table of Contents Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. The tables below present all financial instruments measured at fair value on a recurring basis by level within the fair value hierarchy, as of September 30, 2022 and December 31, 2021. (Dollars in thousands) September 30, 2022 Fair Value Level 1 Valuation Level 2 Valuation Level 3 Valuation U.S. Treasuries $ 9,777 - 9,777 - U.S. Government sponsored enterprises $ 12,142 - 12,142 - Mortgage-backed securities $ 271,899 - 271,899 - State and political subdivisions $ 150,549 - 150,549 - Mutual funds held in deferred compensation trust $ 1,218 - 1,218 (Dollars in thousands) December 31, 2021 Fair Value Level 1 Valuation Level 2 Valuation Level 3 Valuation U.S. Treasuries $ 7,889 - 7,889 - U.S. Government sponsored enterprises $ 14,267 - 14,267 - Mortgage-backed securities $ 217,152 - 217,152 - State and political subdivisions $ 167,241 - 167,241 - Mutual funds held in deferred compensation trust $ 1,510 - 1,510 - The fair value measurements for mortgage loans held for sale and impaired loans on a non-recurring basis at September 30, 2022 and December 31, 2021 are presented below. The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of, and judgment about, current market conditions, specific issues relating to the collateral and other matters. As a result, all fair value measurements for impaired loans and other real estate are considered Level 3. 23 Table of Contents (Dollars in thousands) Fair Value Measurements September 30, 2022 Level 1 Valuation Level 2 Valuation Level 3 Valuation Mortgage loans held for sale $ 975 - - 975 Impaired loans $ 15,052 - - 15,052 (Dollars in thousands) Fair Value Measurements December 31, 2021 Level 1 Valuation Level 2 Valuation Level 3 Valuation Mortgage loans held for sale $ 3,637 - - 3,637 Impaired loans $ 17,475 - - 17,475 (Dollars in thousands) Fair Value September 30, 2022 Fair Value December 31, 2021 Valuation Technique Significant Unobservable Inputs General Range of Significant Unobservable Input Values Mortgage loans held for sale $ 975 3,637 Rate lock commitment N/A N/A Impaired loans $ 15,052 17,475 Appraised value and discounted cash flows Discounts to reflect current market conditions and ultimate collectability 0 - 25 % The carrying amount and estimated fair value of financial instruments at September 30, 2022 and December 31, 2021 are as follows: (Dollars in thousands) Fair Value Measurements at September 30, 2022 Carrying Amount Level 1 Level 2 Level 3 Total Assets: Cash and cash equivalents $ 155,461 155,461 - - 155,461 Investment securities available for sale 444,367 - 444,367 - 444,367 Other investments 2,762 - - 2,762 2,762 Mortgage loans held for sale 975 - - 975 975 Loans, net 994,877 - - 970,038 970,038 Mutual funds held in deferred compensation trust 1,288 - 1,288 - 1,288 Liabilities: Deposits $ 1,501,091 - - 1,500,613 1,500,613 Securities sold under agreements to repurchase 37,986 - 37,986 - 37,986 Junior subordinated debentures 15,464 - 15,464 - 15,464 24 Table of Contents (Dollars in thousands) Fair Value Measurements at December 31, 2021 Carrying Amount Level 1 Level 2 Level 3 Total Assets: Cash and cash equivalents $ 277,499 277,499 - - 277,499 Investment securities available for sale 406,549 - 406,549 - 406,549 Other investments 3,668 - - 3,668 3,668 Mortgage loans held for sale 3,637 - - 3,637 3,637 Loans, net 875,514 - - 855,814 855,814 Mutual funds held in deferred compensation trust 1,510 - 1,510 - 1,510 Liabilities: Deposits $ 1,412,748 - - 1,401,833 1,401,833 Securities sold under agreements to repurchase 37,094 - 37,094 - 37,094 Junior subordinated debentures 15,464 - 15,464 - 15,464 (6) Leases As of September 30, 2022, the Bank had operating right of use assets of $ 5.8 million and operating lease liabilities of $ 5.8 million. The Bank maintains operating leases on land and buildings for some of the Bank’s branch facilities and loan production offices. Most leases include one option to renew, with renewal terms extending up to 15 years. The exercise of renewal options is based on the judgment of management as to whether or not the renewal option is reasonably certain to be exercised. Factors in determining whether an option is reasonably certain of exercise include, but are not limited to, the value of leasehold improvements, the value of renewal rates compared to market rates, and the presence of factors that would cause a significant economic penalty to the Bank if the option is not exercised. Leases with a term of 12 months or less are not recorded on the balance sheet and instead are recognized in lease expense on a straight-line basis over the lease term. The following table presents lease cost and other lease information as of September 30, 2022 and 2021. (Dollars in thousands) September 30, 2022 September 30, 2021 Operating lease cost $ 617 $ 538 Other information: Cash paid for amounts included in the measurement of lease liabilities 605 520 Operating cash flows from operating leases - - Right-of-use assets obtained in exchange for new lease liabilities - operating leases 1,726 952 Weighted-average remaining lease term - operating leases 9.01 6.72 Weighted-average discount rate - operating leases 2.30 % 2.71 % The following table presents lease maturities as of September 30, 2022 and December 31, 2021. 25 Table of Contents (Dollars in thousands) Maturity Analysis of Operating Lease Liabilities: September 30,2022 2022 $ 229 2023 922 2024 867 2025 812 2026 694 Thereafter 2,975 Total 6,499 Less: Imputed Interest ( 652 ) Operating Lease Liability $ 5,847 (7) Subsequent Events The Company has reviewed and evaluated subsequent events and transactions for material subsequent events through the date the financial statements are issued. Management has concluded that there were no material subsequent events. 26 Table of Contents