PEOPLES BANCORP OF NORTH CAROLINA INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following is a discussion of the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company’s Annual Report of Form 10-K and the Company’s Consolidated Financial Statements and Notes thereto on pages A-20 through A-63 of the Company’s 2024 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2025 Annual Meeting of Shareholders. Introduction Management’s discussion and analysis of earnings and related data are presented to assist in understanding the consolidated financial condition and results of operations of the Company. The Company is the parent company of the Bank and a registered bank holding company operating under the supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is a North Carolina-chartered bank, with offices in Catawba, Lincoln, Alexander, Mecklenburg, Iredell, Wake, Rowan and Forsyth counties, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”). Overview Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses. Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve, inflation, interest rates, market and monetary fluctuations. Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered. Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating the allowance for credit losses (“ACL”, “allowance for credit losses”, or “allowance”) and changes in these economic factors could result in increases or decreases to the provision for loan losses. The Federal Reserve Federal Open Market Committee (“FOMC”) increased the target federal funds rate 500 basis points between March 2022 and July 2023 to address the supply-chain disruption and rising inflation that had developed in the markets prior to the increases in the target rate. In 2024, the FOMC reduced the target federal funds rate to a range of 4.25% to 4.50% at June 30, 2025. Subsequently, economic conditions have stabilized such that businesses in our market area are growing and investing again. The uncertainty expressed in the local, national and international markets through the primary economic indicators of activity are now sufficiently stable to allow for reasonable economic growth in our markets. 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. Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plants and inventories. During periods of high inflation there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits. Also, general increases in the price of goods and services can be expected to result in increased operating expenses. 28 Table of Contents Our business emphasis has been and continues to be to operate as a well-capitalized, profitable and independent community-oriented financial institution dedicated to providing quality customer service. We are committed to meeting the financial needs of the communities in which we operate. We expect growth to be achieved in our local markets and through expansion opportunities in contiguous or nearby markets. While we would be willing to consider growth by acquisition in certain circumstances, we do not consider the acquisition of another company to be necessary for our continued ability to provide a reasonable return to our shareholders. We believe that we can be more effective in serving our customers than many of our non-local competitors because of our ability to quickly and effectively provide senior management responses to customer needs and inquiries. Our ability to provide these services is enhanced by the stability and experience of our Bank officers and managers. 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. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. A 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 2024 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2025 Annual Meeting of Shareholders. There have been no significant changes to the application of significant accounting policies since December 31, 2024. Results of Operations Summary. Net earnings were $5.2 million or $0.97 per share and $0.95 per diluted share for the three months ended June 30, 2025, as compared to $4.9 million or $0.93 per share and $0.89 per diluted share for the prior year period. The increase in second quarter net earnings is primarily attributable to increases in net interest income and non-interest income, which were partially offset by 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 $9.5 million or $1.79 per share and $1.74 per diluted share for the six months ended June 30, 2025, as compared to $8.8 million or $1.67 per share and $1.61 per diluted share for the prior year period. The increase in year to date net earnings is primarily attributable to increases in net interest income and non-interest income, which were partially offset by an increase in the provision for credit losses and an increase in non-interest expense, compared to the prior year period, as discussed below. The annualized return on average assets was 1.15% for the six months ended June 30, 2025, compared to 1.08% for the same period one year ago, and annualized return on average shareholders’ equity was 14.06% for the six months ended June 30, 2025, compared to 14.69% for the same period one year ago. Net Interest Income. Net interest income, the major component of the Company’s net income, is the amount by which interest and fees generated by interest-earning assets exceed the total cost of funds used to carry them. Net interest income is affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned and rates paid. 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 $14.6 million for the three months ended June 30, 2025, compared to $13.4 million for the three months ended June 30, 2024. The increase in net interest income is due to a $650,000 increase in interest income and a $531,000 decrease in interest expense. The increase in interest income is primarily due to a $1.1 million increase in interest income and fees on loans, which was partially offset by a $19,000 decrease in interest income on balances due from banks and a $408,000 decrease in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans. The decrease in interest income on balances due from banks is primarily due to rate decreases implemented by the FOMC from September 2024 through December 2024. The decrease in interest income on investment securities is primarily due to a reduction in balances outstanding. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. Net interest income after the provision for credit losses was $14.8 million for the three months ended June 30, 2025, compared to $13.9 million for the three months ended June 30, 2024. The provision for credit losses for the three months ended June 30, 2025 was a recovery of $213,000, compared to a recovery of $468,000 for the three months ended June 30, 2024. The decrease in the recovery for credit losses is primarily attributable to a smaller reduction in reserves on construction loans during the three months ended June 30, 2025, as compared to the reduction in reserves on construction loans during the three months ended June 30, 2024. The reduction in reserves on construction loans during the three months ended June 30, 2024 was primarily due to a decrease in construction loan balances outstanding and unfunded construction loan balances during the second quarter of 2024. 29 Table of Contents Interest income was $20.7 million for the three months ended June 30, 2025, compared to $20.1 million for the three months ended June 30, 2024. The increase in interest income is primarily due to a $1.1 million increase in interest income and fees on loans, which was partially offset by a $19,000 decrease in interest income on balances due from banks and a $408,000 decrease in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans. The decrease in interest income on balances due from banks is primarily due to rate decreases implemented by the FOMC from September 2024 through December 2024. The decrease in interest income on investment securities is primarily due to a reduction in balances outstanding. During the three months ended June 30, 2025, average loans were $1.16 billion, an increase of $47.5 million from average loans of $1.11 billion for the three months ended June 30, 2024. During the three months ended June 30, 2025, average investment securities available for sale were $415.9 million, a decrease of $29.2 million from average investment securities available for sale of $445.1 million for the three months ended June 30, 2024. The average yield on loans for the three months ended June 30, 2025 and 2024 was 5.78% and 5.65%, respectively. The average yield on investment securities available for sale was 3.21% and 3.36% for the three months ended June 30, 2025 and 2024, respectively. The average yield on earning assets was 5.07% and 5.01% for the three months ended June 30, 2025 and 2024, respectively. Interest expense was $6.1 million for the three months ended June 30, 2025, compared to $6.7 million for the three months ended June 30, 2024. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the three months ended June 30, 2025, average interest-bearing non-maturity deposits were $750.3 million, an increase of $65.5 million from average interest-bearing non-maturity deposits of $684.8 million for the three months ended June 30, 2024. During the three months ended June 30, 2025, average certificates of deposit were $353.3 million, an increase of $3.8 million from average certificates of deposit of $349.5 million for the three months ended June 30, 2024. The average rate paid on interest-bearing checking and savings accounts was 1.46% and 1.43% for the three months ended June 30, 2025 and 2024, respectively. The average rate paid on certificates of deposit was 3.58% for the three months ended June 30, 2025, compared to 4.17% for the same period one year ago. The average rate paid on interest-bearing liabilities was 2.19% for the three months ended June 30, 2025, compared to 2.46% 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 June 30, 2025 and 2024. 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 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 June 30, 2025 and 2024 have been adjusted to a tax equivalent basis using an effective tax rate of 22.78% for securities that are both federal and state tax exempt and an effective tax rate of 20.53% 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. 30 Table of Contents Three months ended Three months ended June 30, 2025 June 30, 2024 (Dollars in thousands) Average Balance Interest Yield / Rate Average Balance Interest Yield / Rate Interest-earning assets: Loans receivable $ 1,156,140 $ 16,648 5.78 % $ 1,108,684 $ 15,571 5.65 % Investments - taxable 283,382 2,652 3.75 % 308,105 3,031 3.96 % Investments - nontaxable* 135,660 720 2.13 % 140,252 749 2.15 % Due from banks 64,293 706 4.40 % 53,770 725 5.42 % Total interest-earning assets 1,639,475 20,726 5.07 % 1,610,811 20,076 5.01 % Non-interest earning assets: Cash and due from banks 28,773 29,695 Allowance for credit losses (10,065 ) (10,795 ) Other assets 22,671 20,297 Total assets $ 1,680,854 $ 1,650,008 Interest-bearing liabilities: Interest-bearing demand, MMDA & savings deposits $ 750,322 $ 2,729 1.46 % $ 684,782 $ 2,438 1.43 % Time deposits 353,303 3,152 3.58 % 349,514 3,628 4.17 % Junior subordinated debentures 15,464 242 6.28 % 15,464 283 7.36 % Other - - - 39,431 305 3.11 % Total interest-bearing liabilities 1,119,089 6,123 2.19 % 1,089,191 6,654 2.46 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 409,894 427,299 Other liabilities 14,648 14,075 Shareholders' equity 137,223 119,443 Total liabilities and shareholders' equity $ 1,680,854 $ 1,650,008 Net interest spread $ 14,603 2.88 % $ 13,422 2.55 % Net yield on interest-earning assets 3.57 % 3.35 % Taxable equivalent adjustment Investment securities $ 6 $ 6 Net interest income $ 14,597 $ 13,416 *Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $6.1 million in 2025 and $10.4 million in 2024. Tax rates of 2.25% and 2.50% were used to calculate the tax equivalent yields on these securities in 2025 and 2024, respectively. Year to date net interest income was $28.5 million for the six months ended June 30, 2025, compared to $26.7 million for the six months ended June 30, 2024. The increase in net interest income is due to a $810,000 increase in interest income and a $1.0 million decrease in interest expense. The increase in interest income is primarily due to a $2.0 million increase in interest income and fees on loans, which was partially offset by a $576,000 decrease in interest income on balances due from banks and a $569,000 decrease in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans. The decrease in interest income on balances due from banks is due to a reduction in balances outstanding and rate decreases implemented by the FOMC from September 2024 through December 2024. The decrease in interest income on investment securities is primarily due to a reduction in balances outstanding. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. Net interest income after the provision for credit losses was $28.5 million for the six months ended June 30, 2025, compared to $27.1 million for the six months ended June 30, 2024. The provision for credit losses for the six months ended June 30, 2025 was an expense of $55,000, compared to a recovery of $377,000 for the six months ended June 30, 2024. The increase in the provision for credit losses is primarily attributable to a reduction in reserves on construction loans during the six months ended June 30, 2024, which was primarily due to a decrease in construction loan balances outstanding, combined with an increase in provision expense for unfunded construction loans during the six months ended June 30, 2025 resulting from an increase in unfunded commitments on construction loans. 31 Table of Contents Interest income was $40.7 million for the six months ended June 30, 2025, compared to $39.9 million for the six months ended June 30, 2024. The increase in net interest income is due to a $810,000 increase in interest income and a $1.0 million decrease in interest expense. The increase in interest income is primarily due to a $2.0 million increase in interest income and fees on loans, which was partially offset by a $576,000 decrease in interest income on balances due from banks and a $569,000 decrease in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans. The decrease in interest income on balances due from banks is due to a reduction in balances outstanding and rate decreases implemented by the FOMC from September 2024 through December 2024. The decrease in interest income on investment securities is primarily due to a reduction in balances outstanding. During the six months ended June 30, 2025, average loans were $1.15 billion, an increase of $48.6 million from average loans of $1.10 billion for the six months ended June 30, 2024. During the six months ended June 30, 2025, average investment securities available for sale were $424.5 million, a decrease of $19.8 million from average investment securities available for sale of $444.3 million for the six months ended June 30, 2024. The average yield on loans for the six months ended June 30, 2025 and 2024 was 5.73% and 5.61%, respectively. The average yield on investment securities available for sale was 3.23% and 3.36% for the six months ended June 30, 2025 and 2024, respectively. The average yield on earning assets was 5.05% and 4.99% for the six months ended June 30, 2025 and 2024, respectively. Interest expense was $12.1 million for the six months ended June 30, 2025, compared to $13.2 million for the six months ended June 30, 2024. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the six months ended June 30, 2025, average interest-bearing non-maturity deposits were $748.6 million, an increase of $82.1 million from average interest-bearing non-maturity deposits of $666.5 million for the six months ended June 30, 2024. During the six months ended June 30, 2025, average certificates of deposit were $347.3 million, a decrease of $3.6 million from average certificates of deposit of $350.9 million for the six months ended June 30, 2024. The average rate paid on interest-bearing checking and savings accounts was 1.45% and 1.36% for the six months ended June 30, 2025 and 2024, respectively. The average rate paid on certificates of deposit was 3.65% for the six months ended June 30, 2025, compared to 4.19% for the same period one year ago. The average rate paid on interest-bearing liabilities was 2.20% for the six months ended June 30, 2025, compared to 2.43% 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 six months ended June 30, 2025 and 2024. 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 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 six months ended June 30, 2025 and 2024 have been adjusted to a tax equivalent basis using an effective tax rate of 22.78% for securities that are both federal and state tax exempt and an effective tax rate of 20.53% 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. 32 Table of Contents Six months ended Six months ended June 30, 2025 June 30, 2024 (Dollars in thousands) Average Balance Interest Yield / Rate Average Balance Interest Yield / Rate Interest-earning assets: Loans receivable $ 1,149,274 32,664 5.73 % $ 1,100,671 30,709 5.61 % Investments - taxable 294,651 5,516 3.78 % 311,064 6,040 3.90 % Investments - nontaxable* 132,997 1,466 2.22 % 136,517 1,512 2.23 % Due from banks 48,702 1,056 4.37 % 60,144 1,632 5.46 % Total interest-earning assets 1,625,624 40,702 5.05 % 1,608,396 39,893 4.99 % Non-interest earning assets: Cash and due from banks 29,139 30,870 Allowance for credit losses (10,026 ) (10,929 ) Other assets 21,440 20,568 Total assets $ 1,666,177 $ 1,648,905 Interest-bearing liabilities: Interest-bearing demand, MMDA & savings deposits $ 748,650 5,381 1.45 % $ 666,544 4,498 1.36 % Time deposits 347,333 6,285 3.65 % 350,881 7,309 4.19 % Junior subordinated debentures 15,464 483 6.30 % 15,464 567 7.37 % Other - - - 56,063 786 2.82 % Total interest-bearing liabilities 1,111,447 12,149 2.20 % 1,088,952 13,160 2.43 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 406,250 427,524 Other liabilities 10,396 11,502 Shareholders' equity 136,373 120,927 Total liabilities and shareholders' equity $ 1,664,466 $ 1,648,905 Net interest spread $ 28,553 2.85 % $ 26,733 2.56 % Net yield on interest-earning assets 3.54 % 3.34 % Taxable equivalent adjustment Investment securities $ 12 $ 13 Net interest income $ 28,541 $ 26,720 *Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $7.3 million in 2025 and $10.6 million in 2024. Tax rates of 2.25% and 2.50% were used to calculate the tax equivalent yields on these securities in 2025 and 2024, respectively. Changes in interest income and interest expense can result from variances in both volume and rates. The following table describes the impact on the Company’s tax equivalent net interest income resulting from changes in average balances and average rates for the periods indicated. 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. 33 Table of Contents Three months ended June 30, 2025 compared to three months ended June 30, 2024 Six months ended June 30, 2025 compared to six months ended June 30, 2024 (Dollars in thousands) Changes in average volume Changes in average rates Total Increase (Decrease) Changes in average volume Changes in average rates Total Increase (Decrease) Interest income: Loans: Net of unearned income $ 675 402 1,077 1,369 586 1,955 Investments - taxable (237 ) (142 ) (379 ) (313 ) (211 ) (524 ) Investments - nontaxable (24 ) (5 ) (29 ) (39 ) (7 ) (46 ) Due from banks 129 (148 ) (19 ) (279 ) (297 ) (576 ) Total interest income 543 107 650 738 71 809 Interest expense: Interest-bearing demand, MMDA & savings deposits 236 55 291 572 311 883 Time deposits 37 (513 ) (476 ) (69 ) (955 ) (1,024 ) Junior subordinated debentures - (41 ) (41 ) - (84 ) (84 ) Other (153 ) (152 ) (305 ) (393 ) (393 ) (786 ) Total interest expense 120 (651 ) (531 ) 110 (1,121 ) (1,011 ) Net interest income $ 423 758 1,181 628 1,192 1,820 Provision for Credit Losses. The provision for credit losses for the three months ended June 30, 2025 was a recovery of $213,000, compared to a recovery of $468,000 for the three months ended June 30, 2024. The decrease in the recovery for credit losses is primarily attributable to a smaller reduction in reserves on construction loans during the three months ended June 30, 2025, as compared to the reduction in reserves on construction loans during the three months ended June 30, 2024. The reduction in reserves on construction loans during the three months ended June 30, 2024 was primarily due to a decrease in construction loan balances outstanding and unfunded construction loan balances during the second quarter of 2024. The provision for credit losses for the six months ended June 30, 2025 was an expense of $55,000, compared to a recovery of $377,000 for the six months ended June 30, 2024. The increase in the provision for credit losses is primarily attributable to a reduction in reserves on construction loans during the six months ended June 30, 2024, which was primarily due to a decrease in construction loan balances outstanding, combined with an increase in provision expense for unfunded construction loans during the six months ended June 30, 2025 resulting from an increase in unfunded commitments on construction loans. Non-Interest Income. Non-interest income was $7.7 million for the three months ended June 30, 2025, compared to $7.5 million for the three months ended June 30, 2024. The increase in non-interest income is primarily attributable to a $792,000 increase in appraisal management fee income due to an increase in appraisal volume, which was partially offset by a $628,000 decrease in miscellaneous non-interest income primarily due to a decrease in income on small business investment company (SBIC) investments. Non-interest income was $14.2 million for the six months ended June 30, 2025, compared to $13.6 million for the six months ended June 30, 2024. The increase in non-interest income is primarily attributable to a $1.4 million increase in appraisal management fee income due to an increase in appraisal volume, which was partially offset by a $802,000 decrease in miscellaneous non-interest income primarily due to a decrease in income on small business investment company (SBIC) investments. Non-Interest Expense. Non-interest expense was $15.8 million for the three months ended June 30, 2025, compared to $15.1 million for the three months ended June 30, 2024. The increase in non-interest expense is primarily attributable to a $633,000 increase in appraisal management fee expense due to an increase in appraisal volume, a $341,000 increase in salaries and employee benefits expense primarily due to an increase in salary and insurance expense, and a $150,000 increase in advertising expense, which were partially offset by a $198,000 decrease in debit card expense, a $95,000 decrease in miscellaneous non-interest expense, a $76,000 decrease in professional fees, and a $47,000 decrease in occupancy expense. 34 Table of Contents Non-interest expense was $30.4 million for the six months ended June 30, 2025, compared to $29.6 million for the six months ended June 30, 2024. The increase in non-interest expense is primarily attributable to a $1.1 million increase in appraisal management fee expense due to an increase in appraisal volume, a $149,000 increase in salaries and employee benefits expense primarily due to an increase in salary expense, and a $121,000 increase in advertising expense, which were partially offset by a $286,000 decrease in miscellaneous non-interest expense primarily due to a decrease in deferred compensation expense, a $274,000 decrease in debit card expense, and a $130,000 decrease in occupancy expense primarily due to a decrease in equipment maintenance expense. Income Taxes. Income tax expense was $1.5 million for the three months ended June 30, 2025, compared to $1.4 million for the three months ended June 30, 2024. The effective tax rate was 22.56% for the three months ended June 30, 2025, compared to 22.09% for the three months ended June 30, 2024. Income tax expense was $2.8 million for the six months ended June 30, 2025, compared to $2.2 million for the six months ended June 30, 2024. The effective tax rate was 22.69% for the six months ended June 30, 2025, compared to 19.74% for the six months ended June 30, 2024. The increase in the effective tax rate is primarily due to a $322,000 interest receivable booked during the six months ended June 30, 2024 on a deposit for taxes paid prior to a 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 $371.6 million as of June 30, 2025, compared to $388.0 million as of December 31, 2024. Average investment securities available for sale for the six months ended June 30, 2025 were $424.5 million, compared to $442.1 million for the year ended December 31, 2024. Loans. Total loans were $1.16 billion as of June 30, 2025, compared to $1.14 billion at December 31, 2024. Average loans represented 71% and 69% of average earning assets for the six months ended June 30, 2025 and the year ended December 31, 2024, respectively. The Bank had $1.5 million and $1.4 million in mortgage loans held for sale as of June 30, 2025 and December 31, 2024, 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 June 30, 2025, the Bank had $128.8 million in residential mortgage loans, $116.4 million in home equity loans and $712.1 million in commercial mortgage loans, which include $562.7 million secured by commercial property and $149.4 million secured by residential property. All residential mortgage loans are originated as fully amortizing loans, with no negative amortization. The Bank also had construction and land development loans totaling $122.1 million at June 30, 2025. Allowance for Credit Losses (ACL). 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 that management believes will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, size, quality and risk of loans in the portfolio are reviewed. The allowance for credit losses on loans is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. 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 June 30, 2025. 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 Weighted Average Remaining Maturity (“WARM”) methodology. 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. These qualitative adjustments may increase or decrease reserve levels and include adjustments for: local, state and national economic outlook; levels and trends of delinquencies; trends in volume, mix and size of loans; seasoning of the loan portfolio; experience of staff; concentrations of credit; and interest rate risk. The portion of the ACL balance attributable to qualitative factors was $5.1 million and $5.2 million at June 30, 2025 and December 31, 2024, respectively. The risk factors are weighted as follows: Local, State and National Economic Outlook – 30%, Concentrations of Credit – 5%, Interest Rate Risk – 5%, Trends in Terms of Volume, Mix and Size of Loans – 15%, Seasoning of the Loan Portfolio – 10%, Experience of Staff – 10%, and Levels and Trends of Delinquencies – 25%. No changes to the risk status of any of the risk factors was made during the six months ended June 30, 2025. 35 Table of Contents 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 date adjusted for selling costs as appropriate. 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. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments represents the contractual amount of those instruments. Such financial instruments are recorded when they are funded. The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets. The allowance for credit losses on loans was $9.8 million or 0.85% of total loans at June 30, 2025, compared to $10.0 million or 0.88% of total loans at December 31, 2024. The allowance for credit losses on loans decreased $203,000 primarily due to a $90,000 decrease in the allowance on construction loans from December 31, 2024 to June 30, 2025 and the removal of the $60,000 Hurricane Helene reserve included in the allowance for credit losses at December 31, 2024. The allowance for credit losses on unfunded commitments was $1.3 million at June 30, 2025, compared to $1.1 million at December 31, 2024. The increase in the allowance for credit losses on unfunded commitments was primarily due to a $161,000 increase in the allowance for unfunded construction loans resulting from a $2.8 million increase in unfunded commitments on construction loans during the six months ended June 30, 2025. 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. Upon loan origination, the Bank’s originating loan officer evaluates the quality of the loan and assigns one of eight risk grades. The loan officer monitors the loan’s performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank’s Credit Administration. Before making any changes in these risk grades, management considers assessments as determined by the third-party credit review firm (as described below), regulatory examiners and the Bank’s Credit Administration. Any issues regarding the risk assessments are addressed by the Bank’s senior credit administrators and factored into management’s decision to originate or renew the loan. The board of directors of the Bank (the “Bank Board”) reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration. As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. 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 Bank Board. Since the adoption of Current Expected Credit Loss (“CECL”) methodology on January 1, 2023, the allowance for credit losses represents management’s estimate of credit losses for the remaining estimated life of the Bank’s financial assets, including loan receivables and some off-balance sheet credit exposures. Estimating the amount of the allowance for credit losses requires significant judgment and the use of estimates related to historical experience, current conditions, reasonable and supportable forecasts, and the value of collateral on collateral-dependent loans. The loan portfolio also represents the largest asset type on our consolidated balance sheet. 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. There are many factors affecting the allowance for credit losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and is susceptible to significant change. 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. 36 Table of Contents Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations. Management believes it has established the allowance for credit losses pursuant to CECL, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date of the financial statements. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company. Non-performing Assets. Non-performing assets were $4.8 million or 0.28% of total assets at June 30, 2025, compared to $4.8 million or 0.29% of total assets at December 31, 2024. Non-performing assets include $4.2 million in residential mortgage loans, $442,000 in commercial mortgage loans and $216,000 in other loans at June 30, 2025, compared to $3.7 million in residential mortgage loans, $463,000 in commercial mortgage loans, $257,000 in other loans, and $369,000 in other real estate owned at December 31, 2024. The Bank had no repossessed assets as of June 30, 2025 and 2024. Deposits. Deposits were $1.51 billion as of June 30, 2025, compared to $1.48 billion as of December 31, 2024. 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 $1.36 billion at June 30, 2025, compared to $1.34 billion at December 31, 2024. 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 $150.6 million at June 30, 2025, compared to $145.9 million December 31, 2024. Estimated uninsured deposits totaled $348.6 million, or 23.03% of total deposits, at June 30, 2025, compared to $396.5 million, or 26.71% of total deposits, at December 31, 2024. 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 June 30, 2025. Borrowed Funds. There were no borrowed funds outstanding at June 30, 2025 and December 31, 2024. Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were $15.5 million at June 30, 2025 and December 31, 2024. Asset Liability and Interest Rate Risk Management. The objective of the Company’s Asset Liability and Interest Rate Risk strategies is to identify and manage the sensitivity of net interest income to changing interest rates and to minimize the interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities. This is done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income. The Company manages its exposure to fluctuations in interest rates through policies established by the Asset/Liability Committee (“ALCO”) of the Bank. The ALCO meets quarterly and has the responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company. ALCO seeks to minimize interest rate risk between interest-earning assets and interest-bearing liabilities by attempting to minimize wide fluctuations in net interest income due to interest rate movements. The ability to control these fluctuations has a direct impact on the profitability of the Company. Management monitors this activity on a regular basis through analysis of its portfolios to determine the difference between rate sensitive assets and rate sensitive liabilities. The Company’s rate sensitive assets are those earning interest at variable rates and those with contractual maturities within one year. Rate sensitive assets therefore include both loans and available for sale securities. 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 six months ended June 30, 2025 totaled $1.63 billion, exceeding average rate sensitive liabilities of $1.11 billion by $514.2 million. Included in the rate sensitive assets are $174.8 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the FOMC. Certain variable rate loans are structured to establish floors on interest rates charged to protect against downward movements in the prime rate. At June 30, 2025, the Company had $121.6 million in loans with interest rate floors. No floors were in effect on loans with floors on interest rates charged at June 30, 2025. 37 Table of Contents Liquidity. 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. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. 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 June 30, 2025, such unfunded commitments to extend credit were $350.0 million, while commitments in the form of standby letters of credit totaled $1.6 million. As of December 31, 2024, such unfunded commitments to extend credit were $348.9 million, while commitments in the form of standby letters of credit totaled $1.7 million. The Bank uses several sources to meet its liquidity requirements. The primary source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposit of denominations less than $250,000. 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 June 30, 2025, the Bank’s core deposits, a non-GAAP measure, totaled $1.36 billion, or 90% of total deposits. As of December 31, 2024, the Bank’s core deposits totaled $1.34 billion, or 90% of total deposits. The other sources of funding for the Company are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreement to repurchase and FHLB borrowings. The Bank is also able to borrow from the Federal Reserve Bank (“FRB”) on a short-term basis. The Bank’s policies include the ability to access wholesale funding up to 40% of total assets. The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits and internet certificates of deposit. The Bank did not have any wholesale funding at June 30, 2025 and December 31, 2024. 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 June 30, 2025 and December 31, 2024. At June 30, 2025, the carrying value of loans pledged as collateral to the FHLB totaled $228.8 million compared to $232.9 million at December 31, 2024. The remaining availability under the line of credit with the FHLB was $138.9 million at June 30, 2025 compared to $131.9 million at December 31, 2024. The Bank had no borrowings from the FRB at June 30, 2025 or December 31, 2024. FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At June 30, 2025, the carrying value of loans pledged as collateral to the FRB totaled $651.7 million compared to $637.9 million at December 31, 2024. Availability under the line of credit with the FRB was $540.0 million at June 30, 2025 compared to $511.9 million at December 31, 2024. 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 June 30, 2025. 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 29.56% at June 30, 2025 and 28.16% at December 31, 2024. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at June 30, 2025 and December 31, 2024. Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit. Capital Resources. Shareholders’ equity was $144.0 million, or 8.50% of total assets, at June 30, 2025, compared to $130.6 million, or 7.90% of total assets, at December 31, 2024. The increase in shareholders’ equity is primarily due to a decrease in the unrealized loss on investment securities available for sale due to rate changes between December 31, 2024 and June 30, 2025. Annualized return on average equity for the six months ended June 30, 2025 was 14.06%, compared to 14.69% for the six months ended June 30, 2024. Total cash dividends paid on common stock were $3.1 million for the six months ended June 30, 2025, compared to $3.0 million for the six months ended June 30, 2024. In June of 2024, 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 had not repurchased any shares of its common stock under this stock repurchase program through February 28, 2025, when the program expired. 38 Table of Contents In March of 2025, the Board of Directors authorized a stock repurchase program, whereby up to $3.0 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 had not repurchased any shares of its common stock under this stock repurchase program as of June 30, 2025. 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. The Basel III capital standards, which became effective January 1, 2015, include new risk-based capital and leverage ratios, which were phased in from 2015 to 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are as follows: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total risk based capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% (unchanged from previous rules). An additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes beginning on January 1, 2016 and was phased in through 2019 (increasing by 0.625% on January 1, 2016 and each subsequent January 1, until it reached 2.5% on January 1, 2019). This resulted in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained earnings that could be utilized for such actions. Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. 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 June 30, 2025 and December 31, 2024. The Company’s Tier 1 capital ratio was 14.92% and 14.47% at June 30, 2025 and December 31, 2024, respectively. Total risk-based capital is defined as Tier 1 capital plus supplementary capital. Supplementary capital, or Tier 2 capital, consists of the Company’s allowance for credit losses, not exceeding 1.25% of the Company’s risk-weighted assets. 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 15.78% and 15.34% at June 30, 2025 and December 31, 2024, 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 13.75% and 13.29% at June 30, 2025 and December 31, 2024, 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 11.14% and 10.88% at June 30, 2025 and December 31, 2024, respectively. The Bank’s Tier 1 risk-based capital ratio was 14.79% and 14.35% at June 30, 2025 and December 31, 2024, respectively. The total risk-based capital ratio for the Bank was 15.65% and 15.22% at June 30, 2025 and December 31, 2024, respectively. The Bank’s common equity Tier 1 capital ratio was 14.79% and 14.35% at June 30, 2025 and December 31, 2024, respectively. The Bank’s Tier 1 leverage capital ratio was 10.95% and 10.71% at June 30, 2025 and December 31, 2024, 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 June 30, 2025. 39 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable