What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-05-02 compared with 2023-11-07 · 119 added, 239 removed, 222 unchanged (62% of the section changed)

20 unchanged sentences

The uncertainty expressed in the local, national and international markets through the primary economic indicators of activity were previously sufficiently stable to allow for reasonable economic growth in our markets.

Subsequently, continuing supply-chain disruption and rising inflation has caused the Federal Reserve Federal Open Market Committee (“FOMC”) to increase the target federal funds rate 500 basis points since March 1, 2022 to a range of 5.25% to 5.50% at September 30, 2023.

Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends.

10 unchanged sentences

Our ability to provide these services is enhanced by the stability and experience of our Bank officers and managers.

Summary of Significant Accounting Policies

Summary of Critical Accounting Policies

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.

2 unchanged sentences

A more complete 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 2023 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2024 Annual Meeting of Shareholders.

There have been no significant changes to the application of significant accounting policies since December 31, 2022, except for the adoption of ASC 326 noted in Note 1 above.

The allowance for credit losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio.

The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance credit losses that management believes will be adequate in light of anticipated risks and loan losses.

Many of the Company’s assets and liabilities are recorded using various techniques that require significant judgment as to recoverability.

The collectability of loans is reflected through the Company’s estimate of the allowance for credit losses.

The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability.

In addition, certain assets and liabilities are reflected at their estimated fair value in the Consolidated Financial Statements.

Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques.

The Company’s internal models generally involve present value of cash flow techniques.

The various techniques are discussed in greater detail elsewhere in this management’s discussion and analysis and the Notes to the Consolidated Financial Statements.

Fair value of the Company’s financial instruments is discussed in Note 5 of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report.

There are other complex accounting standards that require the Company to employ significant judgment in interpreting and applying certain of the principles prescribed by those standards.

These judgments include, but are not limited to, the determination of whether a financial instrument or other contract meets the definition of a derivative in accordance with U.S.

Generally Accepted Accounting Principles (“GAAP”).

Management of the Company has made a number of estimates and assumptions relating to reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the accompanying Consolidated Financial Statements in conformity with GAAP.

Actual results could differ from those estimates.

There have been no significant changes to the application of significant accounting policies since December 31, 2023.

Results of Operations

Net earnings were $4.1 million or $0.76 per share and $0.74 per diluted share for the three months ended September 30, 2023, as compared to $5.3 million or $0.96 per share and $0.93 per diluted share for the prior year period.

The decrease in third quarter net earnings is primarily the result of a decrease in net interest income, an increase in the provision for credit losses and an increase in non-interest expense, compared to the prior year period, as discussed below.

Net earnings were $12.1 million or $2.22 per share and $2.15 per diluted share for the nine months ended September 30, 2023, as compared to $12.0 million or $2.18 per share and $2.11 per diluted share for the prior year period.

The increase in year-to-date net earnings is primarily attributable to an increase in net interest income, which was partially offset by a decrease in non-interest income, an increase in non-interest expense and an increase in the provision for credit losses, compared to the prior year period, as discussed below.

The annualized return on average assets was 1.01% for the nine months ended September 30, 2023, compared to 0.96% for the same period one year ago, and annualized return on average shareholders’ equity was 13.97% for the nine months ended September 30, 2023, compared to 12.53% for the same period one year ago.

Net earnings were $3.9 million or $0.74 per share and $0.72 per diluted share for the three months ended March 31, 2024, compared to $3.2 million or $0.58 per share and $0.56 per diluted share for the prior year period.

The increase in first quarter 2024 net earnings is primarily the result of an increase in non-interest income and a decrease in the provision for credit losses, which were partially offset by a decrease in net interest income and an increase in non-interest expense, compared to the prior year period, as discussed below.

The annualized return on average assets was 0.96% for the three months ended March 31, 2024, compared to 0.81% for the same period one year ago, and annualized return on average shareholders’ equity was 13.51% for the three months ended March 31, 2024, compared to 11.78% for the same period one year ago.

Net Interest Income.

2 unchanged sentences

Net interest margin is calculated by dividing tax-equivalent net interest income by average interest-earning assets, and represents the Company’s net yield on its interest-earning assets.

Net interest income was $13.3 million for the three months ended September 30, 2023, compared to $13.8 million for the three months ended September 30, 2022.

Net interest income was $13.3 million for the three months ended March 31, 2024, compared to $14.3 million for the three months ended March 31, 2023.

The decrease in net interest income is due to a $4.0 million increase in interest expense, partially offset by a $3.0 million increase in interest income.

The increase in interest expense is primarily due to an increase in time deposits and an increase in rates paid on interest-bearing liabilities.

The increase in interest income is due to a $3.1 million increase in interest income and fees on loans and a $895,000 increase in interest income on investment securities, which were partially offset by a $294,000 decrease in interest income on balances due from banks.

The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a $54,000 decrease in fee income on SBA PPP loans.

The increase in interest income on investment securities is primarily due to higher yields on securities purchased during the third and fourth quarter of 2022.

The decrease in interest income on balances due from banks is primarily due to a reduction in balances outstanding.

Interest income was $18.3 million for the three months ended September 30, 2023, compared to $14.6 million for the three months ended September 30, 2022.

The increase in interest income on investment securities is primarily due to higher yields on securities purchased during the third and fourth quarter of 2022.

The decrease in interest income on balances due from banks is primarily due to a reduction in balances outstanding.

The Bank recognized zero and $54,000 of PPP loan fee income for the three months ended September 30, 2023 and the three months ended September 30, 2022, respectively.

During the three months ended September 30, 2023, average loans were $1.1 billion, an increase of $92.5 million from average loans of $971.6 million for the three months ended September 30, 2022.

During the three months ended September 30, 2023, average PPP loans were zero, compared to average PPP loans of $739,000 for the three months ended September 30, 2022.

During the three months ended September 30, 2023, average investment securities available for sale were $448.0 million, a decrease of $42.6 million from average investment securities available for sale of $490.6 million for the three months ended September 30, 2022.

The average yield on loans for the three months ended September 30, 2023 and 2022 was 5.27% and 4.51%, respectively.

The average yield on investment securities available for sale was 3.15% and 2.23% for the three months ended September 30, 2023 and 2022, respectively.

The average yield on earning assets was 4.65% and 3.59% for the three months ended September 30, 2023 and 2022, respectively.

Interest expense was $5.0 million for the three months ended September 30, 2023, compared to $818,000 for the three months ended September 30, 2022.

The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities and an increase in time deposits.

During the three months ended September 30, 2023, average interest-bearing non-maturity deposits were $652.7 million, a decrease of $191.1 million from average interest-bearing non-maturity deposits of $843.8 million for the three months ended September 30, 2022.

During the three months ended September 30, 2023, average certificates of deposit were $268.7 million, an increase of $168.8 million from average certificates of deposit of $99.9 million for the three months ended September 30, 2022.

The average rate paid on interest-bearing checking and savings accounts was 1.06% and 0.23% for the three months ended September 30, 2023 and 2022, respectively.

The average rate paid on certificates of deposit was 3.71% for the three months ended September 30, 2023, compared to 0.53% for the same period one year ago.

The average rate paid on interest-bearing liabilities was 1.92% for the three months ended September 30, 2023, compared to 0.33% for the same period one year ago.

The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the three months ended September 30, 2023 and 2022.

The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods.

Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity.

Yields and interest income on tax-exempt investments for the three months ended September 30, 2023 and 2022 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities.

Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported.

The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry.

Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP.

The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

Three months ended

September 30, 2023

September 30, 2022

(Dollars in thousands)

Average Balance

Interest-earning assets:

Loans receivable

Investments - taxable

Investments - nontaxable*

Due from banks

Total interest-earning assets

Non-interest earning assets:

Cash and due from banks

Allowance for credit losses

Interest-bearing liabilities:

Interest-bearing demand, MMDA & savings deposits

Time deposits

Junior subordinated debentures

Total interest-bearing liabilities

Non-interest bearing liabilities and shareholders' equity:

Demand deposits

Other liabilities

Shareholders' equity

Total liabilities and shareholders' equity

Net interest spread

Net yield on interest-earning assets

Taxable equivalent adjustment Investment securities

Net interest income

*Includes U.S.

Government agency securities that are non-taxable for state income tax purposes of $11.6 million in 2023 and $13.0 million in 2022.

A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities.

Year-to-date net interest income was $41.4 million for the nine months ended September 30, 2023, compared to $35.8 million for the nine months ended September 30, 2022.

The increase in net interest income is due to a $14.8 million increase in interest income, partially offset by a $9.1 million increase in interest expense.

The increase in interest income is due to a $10.0 million increase in interest income and fees on loans, a $53,000 increase in interest income on balances due from banks and a $4.8 million increase in interest income on investment securities.

The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a $893,000 decrease in fee income on SBA PPP loans.

The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve.

The increase in interest income on investment securities is primarily due to higher yields on securities purchased after June 30, 2022.

Net interest income after the provision for credit losses was $13.2 million for the three months ended March 31, 2024, compared to $14.1 million for the three months ended March 31, 2023.

The provision for credit losses for the three months ended March 31, 2024 was $91,000, compared to $224,000 for the three months ended March 31, 2023.

The decrease in the provision for credit losses is primarily attributable to a reduction in reserves on unfunded loan commitments, which was partially offset by reserves on loans individually evaluated at March 31, 2024.

Interest income was $19.8 million for the three months ended March 31, 2024, compared to $16.8 million for the three months ended March 31, 2023.

The increase in interest income is due to a $2.3 million increase in interest income and fees on loans, a $524,000 increase in interest income on balances due from banks and a $230,000 increase in interest income on investment securities.

The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve from February 2023 through July 2023.

The increase in interest income on balances due from banks is also due to an increase in balances outstanding and rate increases by the Federal Reserve.

The increase in interest income on investment securities is primarily due to higher yields on securities purchased during the three months ended March 31, 2024.

During the three months ended March 31, 2024, average loans were $1.09 billion, an increase of $55.5 million from average loans of $1.0 million for the three months ended March 31, 2023.

During the three months ended March 31, 2024, average investment securities available for sale were $443.5 million, a decrease of $32.8 million from average investment securities available for sale of $476.3 million for the three months ended March 31, 2023.

The average yield on loans for the three months ended March 31, 2024 and 2023 was 5.57% and 5.04%, respectively.

The average yield on investment securities available for sale was 3.36% and 2.98% for the three months ended March 31, 2024 and 2023, respectively.

The average yield on earning assets was 4.96% and 4.41% for the three months ended March 31, 2024 and 2023, respectively.

Interest expense was $6.5 million for the three months ended March 31, 2024, compared to $2.5 million for the three months ended March 31, 2023.

The increase in interest expense is primarily due to an increase in time deposits and an increase in rates paid on interest-bearing liabilities.

Interest income was $52.7 million for the nine months ended September 30, 2023, compared to $37.9 million for the nine months ended September 30, 2022.

The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve.

The increase in interest income on investment securities is primarily due to higher yields on securities purchased after June 30, 2022.

The Bank recognized zero and $893,000 of PPP loan fee income for the nine months ended September 30, 2023 and the nine months ended September 30, 2022, respectively.

During the nine months ended September 30, 2023, average loans were $1.1 billion, an increase of $127.4 million from average loans of $925.2 million for the nine months ended September 30, 2022.

During the nine months ended September 30, 2023, average PPP loans were zero, compared to average PPP loans of $9.1 million for the nine months ended September 30, 2022.

During the nine months ended September 30, 2023, average investment securities available for sale were $458.2 million, an increase of $4.8 million from average investment securities available for sale of $453.4 million for the nine months ended September 30, 2022.

The average yield on loans for the nine months ended September 30, 2023 and 2022 was 5.17% and 4.44%, respectively.

The average yield on investment securities available for sale was 3.05% and 1.75% for the nine months ended September 30, 2023 and 2022, respectively.

The average yield on earning assets was 4.54% and 3.20% for the nine months ended September 30, 2023 and 2022, respectively.

Interest expense was $11.3 million for the nine months ended September 30, 2023, compared to $2.1 million for the nine months ended September 30, 2022.

The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities and an increase in certificates of deposit.

During the nine months ended September 30, 2023, average interest-bearing non-maturity deposits were $710.0 million, a decrease of $112.3 million from average interest-bearing non-maturity deposits of $822.3 million for the nine months ended September 30, 2022.

During the nine months ended September 30, 2023, average certificates of deposit were $198.3 million, an increase of $97.7 million from average certificates of deposit of $100.6 million for the nine months ended September 30, 2022.

The average rate paid on interest-bearing checking and savings accounts was 0.92% and 0.21% for the nine months ended September 30, 2023 and 2022, respectively.

The average rate paid on certificates of deposit was 3.15% for the nine months ended September 30, 2023, compared to 0.56% for the same period one year ago.

The average rate paid on interest-bearing liabilities was 1.53% for the nine months ended September 30, 2023, compared to 0.29% for the same period one year ago.

During the three months ended March 31, 2024, average interest-bearing non-maturity deposits were $648.3 million, a decrease of $126.8 million from average interest-bearing non-maturity deposits of $775.1 million for the three months ended March 31, 2023.

During the three months ended March 31, 2024, average certificates of deposit were $352.2 million, an increase of $233.5 million from average certificates of deposit of $118.8 million for the three months ended March 31, 2023.

The average rate paid on interest-bearing checking and savings accounts was 1.28% and 0.78% for the three months ended March 31, 2024 and 2023, respectively.

The average rate paid on certificates of deposit was 4.20% for the three months ended March 31, 2024, compared to 1.76% for the same period one year ago.

The average rate paid on interest-bearing liabilities was 2.40% for the three months ended March 31, 2024, compared to 1.05% for the same period one year ago.

Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity.

Yields and interest income on tax-exempt investments for the nine months ended September 30, 2023 and 2022 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities.

Yield information does not give effect to changes in fair value of available for sale investment securities that are reflected as a component of shareholders’ equity.

Yields and interest income on tax-exempt investments for the three months ended March 31, 2024 and 2023 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities.

Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported.

2 unchanged sentences

The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

Three months ended

September 30, 2023

September 30, 2022

Three months ended March 31, 2024

Three months ended March 31, 2023

(Dollars in thousands)

22 unchanged sentences

Net yield on interest-earning assets

Taxable equivalent adjustment Investment securities

Taxable equivalent adjustment

Investment securities

Net interest income

5 unchanged sentences

The changes in net interest income due to both volume and rate changes have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each.

Three months ended September 30, 2023 compared to three months

ended September 30, 2022

Nine months ended September 30, 2023 compared to nine months

ended September 30, 2022

Three months ended March 31, 2024 compared to

three months ended March 31, 2023

Three months ended March 31, 2023 compared to

three months ended March 31, 2022

(Dollars in thousands)

4 unchanged sentences

Changes in average rates

Total Increase (Decrease)

Interest income:

5 unchanged sentences

Interest expense:

Interest-bearing demand, MMDA & savings deposits

Interest-bearing demand,

MMDA & savings deposits

Time deposits

3 unchanged sentences

Provision for Credit Losses.

The provision for credit losses for the three months ended September 30, 2023 was $562,000, compared to $408,000 for the three months ended September 30, 2022.

The increase in the provision for credit losses is primarily attributable to an increase in loan balances and in qualitative adjustments for economic conditions and other factors at September 30, 2023, compared to September 30, 2022.

The provision for credit losses for the three months ended September 30, 2023 includes a $127,000 credit to the provision on unfunded commitments.

The provision for credit losses for the nine months ended September 30, 2023 was $1.2 million, compared to $889,000 for the nine months ended September 30, 2022.

The provision for credit losses for the nine months ended September 30, 2023 includes a $146,000 credit to the provision on unfunded commitments.

The provision for credit losses for the three months ended March 31, 2024 was $91,000, compared to $224,000 for the three months ended March 31, 2023.

The decrease in the provision for credit losses is primarily attributable to a provision reduction of $337,000 for other construction loans and all land development and other land loans as a result of an overall decrease in funded loan balances and unfunded commitments in this category, a decrease in provision of $224,000 for loans secured by owner-occupied, nonfarm nonresidential properties as a result of a $200,000 recovery during the first quarter of 2024, partially offset by an increase in provision for individually evaluated loans of $321,000 for commercial and industrial loans and $94,000 for 1-4 family loans secured by first liens during the three months ended March 31, 2024.

Non-Interest Income.

Total non-interest income was $6.8 million for the three months ended September 30, 2023 and September 30, 2022.

Non-interest income was $16.8 million for the nine months ended September 30, 2023, compared to $21.2 million for the nine months ended September 30, 2022.

The decrease in non-interest income is primarily attributable to a $2.5 million net loss on the sale of securities and a $2.2 million decrease in appraisal management fee income due to a decrease in appraisal volume related to national trends in real estate purchases, which were partially offset by a $382,000 increase in miscellaneous non-interest income primarily due to an increase in deferred compensation income due to an increase in valuations for the assets in the deferred compensation plan.

The securities sales referenced above were executed in January and February 2023 to reduce risk in the investment portfolio, at a time when favorable sale conditions had developed for municipal securities.

These sales also provided the Bank with more flexibility to support loan growth and reduce the need for other borrowings.

Non-interest income was $6.0 million for the three months ended March 31, 2024, compared to $3.6 million for the three months ended March 31, 2023.

The increase in non-interest income is primarily attributable to a $2.5 million net loss on the sales of securities during the three months ended March 31, 2023, and no comparable losses in the three months ended March 31, 2024.

Non-Interest Expense.

Total non-interest expense was $14.3 million for the three months ended September 30, 2023, compared to $13.5 million for the three months ended September 30, 2022.

The increase in non-interest expense is primarily attributable to a $545,000 increase in salaries and employee benefits expense primarily due to a reduction in the amortization of loan origination costs, which was partially offset by a $164,000 increase in debit card expense and a $65,000 increase in FDIC insurance expense.

Non-interest expense was $41.6 million for the nine months ended September 30, 2023, compared to $41.0 million for the nine months ended September 30, 2022.

The increase in non-interest expense is primarily attributable to a $1.0 million increase in salaries and employee benefits expense primarily due to a reduction in the amortization of loan origination costs and an increase in supplemental retirement plan expense, and a $802,000 increase in other non-interest expenses primarily due to an increase in deferred compensation expense due to an increase in valuations for the assets in the deferred compensation plan, which were partially offset by a $1.8 million decrease in appraisal management fee expense due to a decrease in appraisal volume related to national trends in real estate purchases.

Non-interest expense was $14.5 million for the three months ended March 31, 2024, compared to $13.7 million for the three months ended March 31, 2023.

The increase in non-interest expense is primarily attributable to a $480,000 increase in salaries and employee benefits expense primarily due to an increase in insurance expense and a $254,000 increase in appraisal management fee expense due to an increase in appraisal volume.

Income Taxes.

Income tax expense was $1.2 million for the three months ended September 30, 2023, compared to $1.4 million for the three months ended September 30, 2022.

The effective tax rate was 22.09% for the three months ended September 30, 2023, compared to 21.06% for the three months ended September 30, 2022.

Income tax expense was $3.4 million for the nine months ended September 30, 2023, compared to $3.1 million for the nine months ended September 30, 2022.

The effective tax rate was 21.89% for the nine months ended September 30, 2023, compared to 20.40% for the nine months ended September 30, 2022.

The increase in the effective tax rate is primarily due to a reduction in non-taxable investments.

Income tax expense was $787,000 for the three months ended March 31, 2024, compared to $851,000 for the three months ended March 31, 2023.

The effective tax rate was 16.62% for the three months ended March 31, 2024, compared to 21.15% for the three months ended March 31, 2023.

The decrease in the effective tax rate is primarily due to a $322,000 interest receivable booked during the three months ended March 31, 2024 on a deposit for taxes paid prior to a recent settlement with the North Carolina Department of Revenue (“NCDOR”) to withdraw the disallowance of certain tax credits previously purchased by the Bank.

Analysis of Financial Condition

Investment Securities.

Available for sale securities were $378.8 million as of September 30, 2023, compared to $445.4 million as of December 31, 2022.

Average investment securities available for sale for the nine months ended September 30, 2023 were $458.2 million, compared to $467.5 million for the year ended December 31, 2022.

Total loans were $1.1 billion as of September 30, 2023, compared to $1.0 billion as of December 31, 2022.

Average loans represented 68% and 59% of average earning assets for the nine months ended September 30, 2023 and the year ended December 31, 2022, respectively.

The Bank had $1.8 million and $211,000 in mortgage loans held for sale as of September 30, 2023 and December 31, 2022, respectively.

Available for sale securities were $394.7 million as of March 31, 2024, compared to $391.9 million as of December 31, 2023.

Average investment securities available for sale for the three months ended March 31, 2024 were $443.5 million, compared to $454.8 million for the year ended December 31, 2023.

Total loans were $1.09 billion as of March 31, 2024, compared to $1.08 billion at December 31, 2023.

Average loans represented 68% of average earning assets for the three months ended March 31, 2024 and the year ended December 31, 2023.

The Bank had $1.3 million and $686,000 in mortgage loans held for sale as of March 31, 2024 and December 31, 2023, respectively.

Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market.

Real estate mortgage loans include both commercial and residential mortgage loans.

At September 30, 2023, the Bank had $107.1 million in residential mortgage loans, $103.1 million in home equity loans and $644.6 million in commercial mortgage loans, which include $493.6 million secured by commercial property and $151.0 million secured by residential property.

Residential mortgage loans at September 30, 2023 include $18.4 million in non-traditional mortgage loans from the former Banco division of the Bank.

At March 31, 2024, the Bank had $116.6 million in residential mortgage loans, $107.8 million in home equity loans and $659.5 million in commercial mortgage loans, which include $510.2 million secured by commercial property and $149.3 million secured by residential property.

At December 31, 2023, the Bank had $112.8 million in residential mortgage loans, $107.7 million in home equity loans and $639.9 million in commercial mortgage loans, which include $488.9 million secured by commercial property and $151.0 million secured by residential property.

Residential mortgage loans include $20.0 million in non-traditional mortgage loans from the former Banco division of the Bank.

All residential mortgage loans are originated as fully amortizing loans, with no negative amortization

7 unchanged sentences

Accrued interest receivable is excluded from the estimate of credit losses.

The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of September 30, 2023.

The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of March 31, 2024.

The allowance for credit losses is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.

The Company measures expected credit losses for loans on a pooled basis when similar risk characteristics exist.

The Company calculates the allowance for credit losses using a WARM methodology.

The Company calculates the allowance for credit losses using a Weighted Average Remaining Maturity (“WARM”) methodology.

The ACL balance was $10.8 million at March 31, 2024 as compared to $11.0 million at December 31, 2023.

The decrease is primarily composed of a $213,000 decrease in allowance for other construction loans all land development, and other land loans as a result of loan balance decreases in this category during the first quarter of 2024, a decrease of $57,000 in reserves in loans secured by owner-occupied, nonfarm nonresidential properties as a result of a $200,000 recovery during the first quarter of 2024, partially offset by an increase in reserves of $85,000 in loans secured by other nonfarm nonresidential properties caused by an increase in balances for loans in this category at March 31, 2024 as compared to December 31, 2023.

Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience.

7 unchanged sentences

and interest rate risk.

The portion of the ACL balance attributable to qualitative factors was $5.2 million at March 31, 2024 and December 31, 2023.

A decrease of $36,000 between these periods is mainly attributable to the decrease in reserves of $109,000 for other construction loans and all land development and other land loans as a result of decreases in loan balances for this category, partially offset by an increase in reserves of $84,000 for loans secured by other nonfarm nonresidential properties as a result of balance increases for this category.

No changes to the risk status of any of the risk factors was made during the first quarter of 2024.

Loans that do not share risk characteristics are evaluated on an individual basis.

When management determines that foreclosure is probable and the borrower is experiencing financial difficulty, the expected credit losses are based on the fair value of collateral at the reporting dated unadjusted for selling costs as appropriate.

The Company did not have any loans evaluated on an individual basis at September 30, 2023.

Three loans, totaling $891,000, were individually evaluated as of March 31, 2024, and two loans totaling $432,000 were individually evaluated as of December 31, 2023.

Reserves on individually evaluated loans were $424,000 and $432,000 at March 31, 2024 and December 31, 2023, respectively.

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs.

4 unchanged sentences

The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.

The allowance for credit losses on off-balance sheet credit exposures was $1.7 million and $1.8 million at March 31, 2024 and December 31, 2023, respectively.

The decrease of $72,000 in the first quarter of 2024 was the result of a decrease in the allowance balance of $69,000 for other construction loans and all land development and other land loans.

The overall balances in this category decreased in the first quarter of 2024.

Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectability becomes doubtful.

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This independent third party reviews and evaluates loan relationships greater than or equal to $1.5 million as well as a periodic sample of commercial relationships with exposures below $1.5 million, excluding loans in default, and loans in process of litigation or liquidation.

The third party’s evaluation and report is shared with management and the board of directors of the Bank (“Bank Board”).

The third party’s evaluation and report is shared with management and the board of directors of the Bank (the “Bank Board”).

Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral.

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The loan portfolio also represents the largest asset type on our consolidated balance sheet.

Loan losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance.

Credit losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance.

A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

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To the extent actual outcomes differ from management estimates, additional provision for credit losses could be required that could adversely affect our earnings or financial position in future periods.

Beginning December 31, 2012, certain mortgage loans from the former Banco division of the Bank were, prior to the adoption of CECL, analyzed separately from other single-family residential loans in the Bank’s loan portfolio.

These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg, North Carolina and surrounding counties.

These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers.

These loans are included in the single-family residential loan pool in the Company's CECL model.

The Company did not have any loans evaluated on an individual basis at 38 September 30, 2023.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance.

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Non-performing Assets.

Non-performing assets were $3.7 million or 0.23% of total assets at September 30, 2023 and December 31, 2022.

Non-accrual loans were $3.6 million at September 30, 2023 and $3.7 million at December 31, 2022.

As a percentage of total loans outstanding, non-accrual loans were 0.34% and 0.36% at September 30, 2023 and December 31, 2022, respectively.

Non-performing assets include $3.6 million in commercial and residential mortgage loans and $134,000 in other loans at September 30, 2023, compared to $3.7 million in commercial and residential mortgage loans and $9,000 in other loans at December 31, 2022.

The Bank had $99,000 in loans 90 days past due and still accruing at September 30, 2023, compared to zero at December 31, 2022.

The Bank had no other real estate owned at September 30, 2023 and December 31, 2022.

Total deposits were $1.4 billion at September 30, 2023 and December 31, 2022.

Core deposits, a non-GAAP measure, which include noninterest-bearing demand deposits, NOW, MMDA, savings and non-brokered certificates of deposit of denominations of $250,000 or less, were $1.2 billion at September 30, 2023, compared to $1.4 billion at December 31, 2022.

Non-performing assets were $4.0 million or 0.23% of total assets at March 31, 2024, compared to $3.9 million or 0.24% of total assets at December 31, 2023.

Non-accrual loans were $4.0 million at March 31, 2024, compared to $3.8 million at December 31, 2023.

As a percentage of total loans outstanding, non-accrual loans were 0.36% at March 31, 2024 and December 31, 2023.

Non-accrual loans over $250,000 are individually evaluated for impairment.

Non-performing assets include $3.4 million in commercial and residential mortgage loans and $553,000 in other loans at March 31, 2024, compared to $3.4 million in commercial and residential mortgage loans and $464,000 in other loans at December 31, 2023.

The Bank had no loans 90 days past due and still accruing at March 31, 2024 and December 31, 2023.

The Bank had no other real estate owned at March 31, 2024 and December 31, 2023.

Deposits were $1.45 billion as of March 31, 2024, compared to $1.39 billion as of December 31, 2023.

Core deposits, a non-GAAP measure, which include noninterest-bearing demand deposits, NOW, MMDA, savings and non-brokered certificates of deposit of denominations of $250,000 or less, were $1.30 billion at March 31, 2024, compared to $1.24 billion at December 31, 2023.

Management believes it is useful to calculate and present core deposits because of the positive impact this low cost funding source provides to the Bank’s overall cost of funds and profitability.

Certificates of deposit in amounts of more than $250,000 totaled $137.7 million at September 30, 2023, compared to $31.0 million at December 31, 2022.

Other time deposits totaled $165.4 million at September 30, 2023, compared to $67.0 million at December 31, 2022.

The increases in certificates of deposit in amounts of more than $250,000 and other time deposits are primarily due to promotional rates offered on select certificate of deposit products during the nine months ended September 30, 2023.

Estimated uninsured deposits totaled $376.6 million, or 27.27% of total deposits, at September 30, 2023, compared to $439.8 million, or 30.64% of total deposits, at December 31, 2022.

Certificates of deposit in amounts of more than $250,000 totaled $148.8 million at March 31, 2024, compared to $148.9 million December 31, 2023.

Estimated uninsured deposits totaled $390.2 million, or 26.86% of total deposits, at March 31, 2024, compared to $382.1 million, or 27.45% of total deposits, at December 31, 2023.

Uninsured amounts are estimated based on the portion of account balances in excess of FDIC insurance limits.

The Bank did not have any significant deposit concentrations at September 30, 2023.

The Bank did not have any significant deposit concentrations at March 31, 2024.

Borrowed Funds.

There were no FHLB borrowings outstanding at September 30, 2023 and December 31, 2022.

Securities sold under agreements to repurchase were $83.0 million at September 30, 2023, compared to $47.7 million at December 31, 2022.

The increase in securities sold under agreements to repurchase is primarily due to customers that transferred funds from deposits to securities sold under agreements to repurchase during the nine months ended September 30, 2023.

There were no FHLB borrowings outstanding at March 31, 2024 and December 31, 2023.

Securities sold under agreements to repurchase were $59.2 million at March 31, 2023, compared to $86.7 million at December 31, 2023.

The decrease in securities sold under agreements to repurchase is primarily due to customers transferring funds from securities sold under agreements to repurchase to deposits via the IntraFi network’s Insured Cash Sweep (“ICS”) during the three months ended March 31, 2024

Junior Subordinated Debentures (related to Trust Preferred Securities).

Junior subordinated debentures were $15.5 million at September 30, 2023 and December 31, 2022.

In June 2006, the Company formed a second wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures.

All of the common securities of PEBK Trust II are owned by the Company.

The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company.

The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes.

The debentures represent the sole assets of PEBK Trust II.

PEBK Trust II is not included in the consolidated financial statements.

The Company redeemed $5.0 million of outstanding trust preferred securities in 2019.

The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month United States Secured Overnight Financing Rate (SOFR) plus 189 basis points.

The Company has guaranteed distributions and other payments due on the trust preferred securities.

The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036.

The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

Prior to September 15, 2023, the trust preferred securities accrued and paid interest quarterly at a floating rate of three-month LIBOR plus 163 basis points.

The one-week and two-month U.S.

dollar-denominated (USD) LIBOR rates ceased to be published after December 31, 2021.

The overnight, one-month, three-month, nine-month, and 12-month USD LIBOR rates ceased to be published after June 30, 2023.

Effective September 15, 2023, the trust preferred securities accrue and pay interest quarterly at a floating rate of three-month SOFR plus 189 basis points, including a 26 basis point credit spread adjustment.

Junior subordinated debentures were $15.5 million at March 31, 2024 and December 31, 2023.

Asset Liability and Interest Rate Risk Management.

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Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds.

Average rate sensitive assets for the nine months ended September 30, 2023 totaled $1.6 billion, exceeding average rate sensitive liabilities of $985.9 million by $567.8 million.

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.

Average rate sensitive assets for the three months ended March 31, 2024 totaled $1.61 billion, exceeding average rate sensitive liabilities of $1.09 billion by $517.3 million.

The Company has an overall interest rate risk management strategy that may incorporate the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.

By using derivative instruments, the Company is exposed to credit and market risk.

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The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company.

The Company did not have any interest rate derivatives outstanding as of September 30, 2023.

The Company did not have any interest rate derivatives outstanding as of March 31, 2024.

Included in the rate sensitive assets are $184.6 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the FOMC.

The Company utilizes interest rate floors on certain variable rate loans to protect against downward movements in the prime rate.

At September 30, 2023, the Company had $114.8 million in loans with interest rate floors.

No floors were in effect on these loans at September 30, 2023.

Certain variable rate loans are structured to establish floors on interest rates charged to protect against downward movements in the prime rate.

At March 31, 2024, the Company had $118.7 million in loans with interest rate floors.

No floors were in effect on loans with floors on interest rates charged at March 31, 2024.

The objectives of the Company’s liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements.

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In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit.

As of September 30, 2023, such unfunded commitments to extend credit were $397.3 million, while commitments in the form of standby letters of credit totaled $4.3 million.

As of March 31, 2024, such unfunded commitments to extend credit were $370.5 million, while commitments in the form of standby letters of credit totaled $3.3 million.

As of December 31, 2023, such unfunded commitments to extend credit were $367.5 million, while commitments in the form of standby letters of credit totaled $3.7 million.

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The Bank considers these to be a stable portion of the Bank’s liability mix and the result of on-going consumer and commercial banking relationships.

As of September 30, 2023, the Bank’s core deposits, a non-GAAP measure, totaled $1.2 billion, or 90.03% of total deposits.

As of March 31, 2024, the Bank’s core deposits, a non-GAAP measure, totaled $1.30 billion, or 90% of total deposits.

As of December 31, 2023, the Bank’s core deposits totaled $1.24 billion, or 89% of total deposits.

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The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to the State of North Carolina.

The Bank’s ratio of wholesale funding to total assets was 1.86% and 0.92% as of September 30, 2023 and December 31, 2022, respectively.

The Bank’s ratio of wholesale funding to total assets was 0.49% and 0.50% as of March 31, 2024 and December 31, 2023, respectively.

The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets.

There were no FHLB borrowings outstanding at September 30, 2023 and December 31, 2022.

At September 30, 2023, the carrying value of loans pledged as collateral to the FHLB totaled $196.4 million compared to $149.4 million at December 31, 2022.

The remaining availability under the line of credit with the FHLB was $121.0 million at September 30, 2023 compared to $86.5 million at December 31, 2022.

The Bank had no borrowings from the FRB at September 30, 2023 or December 31, 2022.

There were no FHLB borrowings outstanding at March 31, 2024 and December 31, 2023.

At March 31, 2024, the carrying value of loans pledged as collateral to the FHLB totaled $217.4 million compared to $214.1 million at December 31, 2023.

The remaining availability under the line of credit with the FHLB was $126.5 million at March 31, 2024 compared to $122.2 million at December 31, 2023.

The Bank had no borrowings from the FRB at March 31, 2024 or December 31, 2023.

FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB.

At September 30, 2023, the carrying value of loans pledged as collateral to the FRB totaled $598.9 million compared to $585.0 million at December 31, 2022.

Availability under the line of credit with the FRB was $437.9 million and $445.1 million at September 30, 2023 and December 31, 2022, respectively.

The Bank has completed the necessary steps in order to access the FRB’s Bank Term Funding Program (“BTFP”), should it wish to do so at any time in the future.

The Bank has not pledged any collateral to the BTFP as of September 30, 2023.

The Bank also had the ability to borrow up to $90.5 million for the purchase of overnight federal funds from four correspondent financial institutions as of September 30, 2023.

The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 24.38% at September 30, 2023 and 30.32% at December 31, 2022.

The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at September 30, 2023 and December 31, 2022.

At March 31, 2024, the carrying value of loans pledged as collateral to the FRB totaled $612.1 million compared to $611.2 million at December 31, 2023.

Availability under the line of credit with the FRB was $477.0 million at March 31, 2024 compared to $445.1 million at December 31, 2023.

The Bank also had the ability to borrow up to $110.5 million for the purchase of overnight federal funds from five correspondent financial institutions as of March 31, 2024.

The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 27.33% at March 31, 2024 and 25.39% at December 31, 2023.

The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at March 31, 2024 and December 31, 2023.

Contractual Obligations and Off-Balance Sheet Arrangements.

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Capital Resources.

Shareholders’ equity was $107.4 million, or 6.68% of total assets, at September 30, 2023, compared to $105.2 million, or 6.49% of total assets, at December 31, 2022.

Annualized return on average equity for the nine months ended September 30, 2023 was 13.97%, compared to 12.53% for the nine months ended September 30, 2022.

Total cash dividends paid on common stock were $4.1 million and $3.9 million for the nine months ended September 30, 2023 and 2022, respectively.

In March of 2023, the Board of Directors authorized a stock repurchase program, whereby up to $2.0 million may be allocated to repurchase the Company’s common stock.

Any purchases under the Company’s stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately-negotiated transactions.

The timing and amount of any repurchase of shares will be determined by the Company’s management, based on its evaluation of market conditions and other factors.

The stock repurchase program may be suspended at any time or from time-to-time without prior notice.

The Company has repurchased approximately $1.7 million, or 87,222 shares of its common stock, under this stock repurchase program as of September 30, 2023.

Shareholders’ equity was $121.1 million, or 7.25% of total assets, at March 31, 2024, compared to $121.0 million, or 7.40% of total assets, at December 31, 2023.

Annualized return on average equity for the three months ended March 31, 2024 was 13.51%, compared to 11.78% for the three months ended March 31, 2023.

Total cash dividends paid on common stock were $1.9 million for the three months ended March 31, 2024 and 2023.

In the first quarter of 2023, the Board of Directors authorized a stock repurchase program, whereby up to $2.0 million was allocated to repurchase the Company’s common stock.

In the fourth quarter of 2023, the Board of Directors authorized an additional $2.0 million to be allocated to repurchase the Company’s common stock, which increased the total amount authorized in 2023 to $4.0 million.

The Company repurchased approximately $4.0 million, or 181,022 shares of its common stock, under this stock repurchase program through March 31, 2024, when the program expired.

In 2013, the FRB approved its final rule on the Basel III capital standards, which implement changes to the regulatory capital framework for banking organizations.

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Tier 1 capital is generally defined as shareholders’ equity and trust preferred securities less all intangible assets and goodwill.

Tier 1 capital includes $15.0 million in trust preferred securities at September 30, 2023 and December 31, 2022.

The Company’s Tier 1 capital ratio was 13.66% and 13.21% at September 30, 2023 and December 31, 2022, respectively.

Tier 1 capital includes $15.0 million in trust preferred securities at March 31, 2024 and December 31, 2023.

The Company’s Tier 1 capital ratio was 13.84% and 13.94% at March 31, 2024 and December 31, 2023, respectively.

Total risk-based capital is defined as Tier 1 capital plus supplementary capital.

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Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets.

The Company’s total risk-based capital ratio was 14.64% and 14.04% at September 30, 2023 and December 31, 2022, respectively.

The Company’s total risk-based capital ratio was 14.83% and 14.96% at March 31, 2024 and December 31, 2023, respectively.

The Company’s common equity Tier 1 capital consists of common stock and retained earnings.

The Company’s common equity Tier 1 capital ratio was 12.48% and 12.03% at September 30, 2023 and December 31, 2022, respectively.

The Company’s common equity Tier 1 capital ratio was 12.66% and 12.75% at March 31, 2024 and December 31, 2023, respectively.

Financial institutions are also required to maintain a leverage ratio of Tier 1 capital to total average assets of 4.0% or greater.

The Company’s Tier 1 leverage capital ratio was 10.52% and 9.82% at September 30, 2023 and December 31, 2022, respectively.

The Bank’s Tier 1 risk-based capital ratio was 13.55% and 13.10% at September 30, 2023 and December 31, 2022, respectively.

The total risk-based capital ratio for the Bank was 14.53% and 13.93% at September 30, 2023 and December 31, 2022, respectively.

The Bank’s common equity Tier 1 capital ratio was 13.55% and 13.10% at September 30, 2023 and December 31, 2022, respectively.

The Bank’s Tier 1 leverage capital ratio was 10.36% and 9.68% at September 30, 2023 and December 31, 2022, respectively.

The Company’s Tier 1 leverage capital ratio was 10.39% and 10.51% at March 31, 2024 and December 31, 2023, respectively.

The Bank’s Tier 1 risk-based capital ratio was 13.73% and 13.83% at March 31, 2024 and December 31, 2023, respectively.

The total risk-based capital ratio for the Bank was 14.72% and 14.85% at March 31, 2024 and December 31, 2023, respectively.

The Bank’s common equity Tier 1 capital ratio was 13.73% and 13.83% at March 31, 2024 and December 31, 2023, respectively.

The Bank’s Tier 1 leverage capital ratio was 10.23% and 10.35% at March 31, 2024 and December 31, 2023, respectively.

A bank is considered to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater.

Based upon these guidelines, the Bank was considered to be “well capitalized” at September 30, 2023.

Based upon these guidelines, the Bank was considered to be “well capitalized” at March 31, 2024.

Quantitative and Qualitative Disclosures About Market Risk

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis