10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2018

Peoples Bancorp of North Carolina, Inc.

( Exact Name of Registrant as Specified in Its Charter)

North Carolina

 (State or Other Jurisdiction of Incorporation)

000-27205	56-2132396
(Commission File No.)	(IRS Employer Identification No.)

518 West C Street, Newton, North Carolina	28658
(Address of Principal Executive Offices)	(Zip Code)

(828) 464-5620

(Registrant’s Telephone Number, Including Area Code)

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, no par value

(title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 

Yes☒ No ☐

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in

Part III of this Form 10-K or any amendment to this Form 10-K.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒
Non-accelerated filer☐	Smaller reporting company☒
	Emerging growth company☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) ☐ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $147,933,656 based on the closing price of such common stock on June 30, 2018, which was $32.03 per share.

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 5,997,136 shares of common stock, outstanding at February 28, 2019.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report of Peoples Bancorp of North Carolina, Inc. for the year ended December 31, 2018 (the “Annual Report”), which will be included as Appendix A to the Proxy Statement for the 2019 Annual Meeting of Shareholders, are incorporated by reference into Part II and included as Exhibit 13 to this Form 10-K.

Portions of the Proxy Statement for the 2019 Annual Meeting of Shareholders of Peoples Bancorp of North Carolina, Inc. to be held on May 2, 2019 (the “Proxy Statement”), are incorporated by reference into Part III.

This report contains certain forward-looking statements with respect to the financial condition, results of operations and business of Peoples Bancorp of North Carolina, Inc. (the “Company”). These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on the information available to management at the time that these disclosures were prepared. These statements can be identified by the use of words like “expect,” “anticipate,” “estimate” and “believe,” variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the markets served by Peoples Bank, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environment and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in the Company’s other filings with the Securities and Exchange Commission. The Company undertakes no obligation to update any forward-looking statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

FORM 10-K CROSS REFERENCE INDEX

	2018 Form 10-K	Notice of 2019 Annual Meeting, Proxy Statement and Annual Report
	Page	Page
PART I
Item 1 - Business	4 - 11	N/A
Item 1A - Risk Factors	11 - 19	N/A
Item 1B - Unresolved Staff Comments	19	N/A
Item 2 - Properties	20	N/A
Item 3 - Legal Proceedings	21	N/A
Item 4 - Mine Safety Disclosures	21	N/A
PART II
Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	21-23	N/A
Item 6 - Selected Financial Data	23	A-4
Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	23	A-4 - A-23
Item 7A - Quantitative and Qualitative Disclosures About Market Risk	24	A-22 - A-23
Item 8 - Financial Statements and Supplementary Data	24	A-24 - A-68
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	24	N/A
Item 9A - Controls and Procedures	24 - 25	N/A
Item 9B - Other Information	25	N/A
PART III
Item 10 - Directors and Executive Officers and Corporate Governance	25	12 and A-69
Item 11 - Executive Compensation	25	14 - 24
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	26	5 - 7
Item 13 - Certain Relationships and Related Transactions and Director Independence	26	11 and 27
Item 14 - Principal Accountant Fees and Services	26	30
PART IV
Item 15 - Exhibits and Financial Statement Schedules	27 - 30	N/A
Signatures	31	N/A

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PART I

ITEM 1.

BUSINESS

General

Peoples Bancorp of North Carolina, Inc. (“Bancorp”), was formed in 1999 to serve as the holding company for Peoples Bank (the “Bank”). Bancorp is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). Bancorp’s principal source of income is dividends declared and paid by the Bank on its capital stock, if any. Bancorp has no operations and conducts no business of its own other than owning the Bank. Accordingly, the discussion of the business which follows concerns the business conducted by the Bank, unless otherwise indicated. Bancorp and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries are collectively called the “Company”.

The Bank, founded in 1912, is a state-chartered commercial bank serving the citizens and business interests of the Catawba Valley and surrounding communities through 20 banking offices, as of December 31, 2018, located in Lincolnton, Newton, Denver, Catawba, Conover, Maiden, Claremont, Hiddenite, Hickory, Charlotte, Cornelius, Mooresville, Raleigh, and Cary North Carolina. The Bank also operates loan production offices in Denver and Durham, North Carolina. At December 31, 2018, the Company had total assets of $1.1 billion, net loans of $797.6 million, deposits of $877.2 million, total securities of $198.9 million, and shareholders’ equity of $123.6 million.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a division of the Bank under the name Banco de la Gente (“Banco”). These offices are now branded as Bank branches and considered a separate market territory of the Bank as they offer normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans.

The Bank has a diversified loan portfolio, with no foreign loans and few agricultural loans. Real estate loans are predominately variable rate and fixed rate commercial property loans, which include residential development loans to commercial customers. Commercial loans are spread throughout a variety of industries with no one particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio. The majority of the Bank’s deposit and loan customers are individuals and small to medium-sized businesses located in the Bank’s market area. The Bank’s loan portfolio also includes Individual Taxpayer Identification Number (ITIN) mortgage loans generated thorough the Bank’s Banco offices. Additional discussion of the Bank’s loan portfolio and sources of funds for loans can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-23 of the Annual Report, which is included in this Form 10-K as Exhibit (13).

The operations of the Bank and depository institutions in general are significantly influenced by general economic conditions and by related monetary and fiscal policies of depository institution regulatory agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Commissioner of Banks (the “Commissioner”).

The Company’s fiscal year ends December 31. This Form 10-K is also being used as the Bank’s Annual Disclosure Statement under FDIC Regulations. This Form 10-K has not been reviewed, or confirmed for accuracy or relevance by the FDIC.

At December 31, 2018, the Company employed 310 full-time employees and 35 part-time employees, which equated to 334 full-time equivalent employees.

Subsidiaries

The Bank is a subsidiary of the Company. At December 31, 2018, the Bank had four subsidiaries, Peoples Investment Services, Inc., Real Estate Advisory Services, Inc., Community Bank Real Estate Solutions, LLC (“CBRES”) and PB Real Estate Holdings, LLC. Through a relationship with Raymond James Financial Services, Inc., Peoples Investment Services, Inc. provides the Bank’s customers access to investment counseling and non-deposit investment products such as stocks, bonds, mutual funds, tax deferred annuities, and related brokerage services. Real Estate Advisory Services, Inc. provides real estate appraisal and real estate brokerage services. CBRES serves as a “clearing-house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property to be appraised is located. This type of service ensures that the appraisal process remains independent from the financing process within the Bank. PB Real Estate Holdings, LLC acquires, manages and disposes of real property, other collateral and other assets obtained in the ordinary course of collecting debts previously contracted.

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In June 2006, the Company formed a 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, which pay a floating rate equal to three-month LIBOR plus 163 basis points. The proceeds received by the Company from the sale of the junior subordinated debentures were used in December 2006 to repay 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 asset of PEBK Trust II. PEBK Trust II is not included in the consolidated financial statements.

The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. The net combined effect of the trust preferred securities transaction is that the Company is obligated 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, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

Market Area

The Bank’s primary market consists of the communities in an approximate 50-mile radius around its headquarters office in Newton, North Carolina. This area includes Catawba County, Alexander County, Lincoln County, Iredell County and portions of northeast Gaston County, North Carolina. The Bank is located only 40 miles north of Charlotte, North Carolina, and the Bank’s primary market area is and will continue to be significantly affected by its close proximity to this major metropolitan area.

Employment in the Bank’s primary market area is diversified among manufacturing, retail and wholesale trade, technology, services and utilities. Catawba County’s largest employers include Catawba County Schools, Frye Regional Medical Center, Catawba Valley Medical Center, Merchant Distributors, Inc. (wholesale food distributor), Catawba County, CommScope, Inc. (manufacturer of fiber optic cable and accessories), Corning Optical Communications (manufacturer of fiber optic cable and accessories), Ethan Allen (furniture manufacturer), HSM (manufacturing) and Advance Pierre Foods (restaurants and bakeries). Lincoln County’s largest employers include Lincoln County Schools, County of Lincoln, Charlotte Mecklenburg Hospital, RSI Home Products (manufacturing), Wal-Mart Associates Inc., The Timken Company (manufacturing), Julius Blum Inc. (manufacturing), Lowes Home Centers Inc., Cataler North America (manufacturing) and Congruity HR (professional & business services).

Competition

The Bank has operated in the Catawba Valley region of North Carolina for over 100 years and is the only financial institution headquartered in Newton, North Carolina. Nevertheless, the Bank faces strong competition both in attracting deposits and making loans. Its most direct competition for deposits has historically come from other commercial banks, credit unions and brokerage firms located in its primary market area, including large financial institutions. One national money center commercial bank is headquartered in Charlotte, North Carolina. Based upon June 30, 2018 comparative data, the Bank had 22.57% of the deposits in Catawba County, placing it second in deposit size among a total of 11 banks with branch offices in Catawba County; 10.47% of the deposits in Lincoln County, placing it fifth in deposit size among a total of ten banks with branch offices in Lincoln County; and 13.67% of the deposits in Alexander County, placing it fifth in deposit size among a total of six banks with branch offices in Alexander County.

The Bank also faces additional significant competition for investors’ funds from short-term money market securities and other corporate and government securities. The Bank’s core deposit base has grown principally due to economic growth in the Bank’s market area coupled with the implementation of new and competitive deposit products. The ability of the Bank to attract and retain deposits depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.

The Bank experiences strong competition for loans from commercial banks and mortgage banking companies. The Bank competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides to borrowers. Competition is increasing as a result of the continuing reduction of restrictions on the interstate operations of financial institutions.

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Supervision and Regulation

Bank holding companies and commercial banks are extensively regulated under both federal and state law. The following is a brief summary of certain statutes and rules and regulations that affect or will affect the Company, the Bank and their subsidiaries. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company, the Bank and their subsidiaries. Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than shareholders of the Company. Statutes and regulations which contain wide-ranging proposals for altering the structures, regulations and competitive relationship of financial institutions are introduced regularly. The Company cannot predict whether or in what form any proposed statute or regulation will be adopted or the extent to which the business of the Company and the Bank may be affected by such statute or regulation.

General. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance funds in the event the depository institution becomes in danger of default or in default. For example, to mitigate the risk of failure, bank holding companies are required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” with the terms of the capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the bank’s total assets at the time the bank became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all capital standards as of the time the bank fails to comply with such capital restoration plan. The Company, as a registered bank holding company, is subject to the regulation of the Federal Reserve. Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve under the BHCA also has the authority to require a bank holding company to terminate any activity or to relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

In addition, insured depository institutions under common control are required to reimburse the FDIC for any loss suffered by its deposit insurance funds as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the deposit insurance funds. The FDIC’s claim for damages is superior to claims of stockholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

As a result of the Company’s ownership of the Bank, the Company is also registered under the bank holding company laws of North Carolina. Accordingly, the Company is also subject to regulation and supervision by the Commissioner.

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Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).The Dodd-Frank Act significantly changed bank regulation and has affected the lending, investment, trading and operating activities of depository institutions and their holding companies.

The Dodd-Frank Act also created the Consumer Financial Protection Bureau (the “Bureau”) with extensive powers to supervise and enforce consumer protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Bureau also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, such as the Bank, will continue to be examined by their applicable federal bank regulators. The Dodd-Frank Act also gave state attorneys general the ability to enforce applicable federal consumer protection laws.

The Dodd-Frank Act broadened the base for FDIC assessments for deposit insurance and permanently increased the maximum amount of deposit insurance to $250,000 per depositor. The legislation also, among other things, requires originators of certain securitized loans to retain a portion of the credit risk, stipulates regulatory rate-setting for certain debit card interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contains a number of reforms related to mortgage originations. The Dodd-Frank Act increased the ability of shareholders to influence boards of directors by requiring companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to company executives, regardless of whether the company is publicly traded or not. Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates or require the implementing regulations and, therefore, their impact on the Company’s and the Bank’s operations cannot be fully determined at this time. However, it is likely that the Dodd-Frank Act will increase the regulatory burden, compliance costs and interest expense for the Bank and the Company.

 

Capital Adequacy. At December 31, 2018, the Bank exceeded each of its capital requirements with a Tier 1 leverage capital ratio of 12.76%, common equity Tier 1 risk-based capital ratio of 15.21%, Tier 1 risk-based capital ratio of 15.21% and total risk-based capital ratio of 15.91%. At December 31, 2018, the Company also exceeded each of its capital requirements with a Tier 1 leverage capital ratio of 13.05%, common equity Tier 1 risk-based capital ratio of 13.29%, Tier 1 risk-based capital ratio of 15.46% and total risk-based capital ratio of 16.15%.

On July 2, 2013, the Federal Reserve approved a final rule that establishes an integrated regulatory capital framework that addresses shortcomings in certain capital requirements. The rule, which became effective on January 1, 2015, implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Act. The final rule:

●

established a new minimum common equity Tier 1 risk-based capital ratio (common equity Tier 1 capital to total risk-weighted assets) of 4.5% and increased the minimum Tier 1 risk-based capital ratio from 4.0% to 6.0%, while maintaining the minimum total risk-based capital ratio of 8.0% and the minimum Tier 1 leverage capital ratio of 4.0%;

●

revised the rules for calculating risk-weighted assets to enhance their risk sensitivity;

●

phased out trust preferred securities and cumulative perpetual preferred stock as Tier 1 capital;

●

added a requirement to maintain a minimum conservation buffer, composed of common equity Tier 1 capital, of 2.5% of risk-weighted assets, to be applied to the new common equity Tier 1 risk-based capital ratio, the Tier 1 risk-based capital ratio and the Total risk-based capital ratio, which means that banking organizations, on a fully phased in basis no later than January 1, 2019, must maintain a minimum common equity Tier 1 risk-based capital ratio of 7.0%, a minimum Tier 1 risk-based capital ratio of 8.5% and a minimum Total risk-based capital ratio of 10.5%; and

●

changed the definitions of capital categories for insured depository institutions for purposes of the Federal Deposit Insurance Corporation Improvement Act of 1991 prompt corrective action provisions.  Under these revised definitions, to be considered well-capitalized, an insured depository institution must have a Tier 1 leverage capital ratio of at least 5.0%, a common equity Tier 1 risk-based capital ratio of at least 6.5%, a Tier 1 risk-based capital ratio of at least 8.0% and a total risk-based capital ratio of at least 10.0%.

The new minimum regulatory capital ratios and changes to the calculation of risk-weighted assets became effective for the Bank and the Company on January 1, 2015. The required minimum conservation buffer was phased in incrementally, starting at 0.625% on January 1, 2016 and increased to 1.25% on January 1, 2017, 1.875% on January 1, 2018, and 2.5% on January 1, 2019.

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The final rule established common equity Tier 1 capital as a new capital component. Common equity Tier 1 capital consists of common stock instruments that meet the eligibility criteria in the final rule, retained earnings, accumulated other comprehensive income/loss and common equity Tier 1 minority interest. As a result, Tier 1 capital has two components: common equity Tier 1 capital and additional Tier 1 capital. The final rule also revised the eligibility criteria for inclusion in additional Tier 1 and Tier 2 capital. As a result of these changes, certain non-qualifying capital instruments, including cumulative preferred stock and trust preferred securities, are excluded as a component of Tier 1 capital for institutions of the size of the Company.

The final rule further requires that certain items be deducted from common equity Tier 1 capital, including (1) goodwill and other intangible assets, other than mortgage servicing rights, net of deferred tax liabilities (“DTLs”); (2) deferred tax assets that arise from operating losses and tax credit carryforwards, net of valuation allowances and DTLs; (3) after-tax gain-on-sale associated with a securitization exposure; and (4) defined benefit pension fund assets held by a depository institution holding company, net of DTLs. In addition, banking organizations must deduct from common equity Tier 1 capital the amount of certain assets, including mortgage servicing assets, that exceed certain thresholds. The final rule also allows all but the largest banking organizations to make a one-time election not to recognize unrealized gains and losses on available for sale debt securities in regulatory capital, as under prior capital rules.

The final rule provides that the failure to maintain the minimum conservation buffer will result in restrictions on capital distributions and discretionary cash bonus payments to executive officers. If a banking organization’s conservation buffer is less than 0.625%, the banking organization may not make any capital distributions or discretionary cash bonus payments to executive officers. If the conservation buffer is greater than 0.625% but not greater than 1.25%, capital distributions and discretionary cash bonus payments are limited to 20% of net income for the four calendar quarters preceding the applicable calendar quarter (net of any such capital distributions), or eligible retained income. If the conservation buffer is greater than 1.25% but not greater than 1.875%, the limit is 40% of eligible retained income, and if the conservation buffer is greater than 1.875% but not greater than 2.5%, the limit is 60% of eligible retained income. The preceding thresholds for the conservation buffer and related restrictions represent the fully phased in rules effective no later than January 1, 2019. Such thresholds were phased in incrementally throughout the phase in period, with the lowest thresholds having become effective January 1, 2016.

Dividend and Repurchase Limitations. Federal regulations provide that the Company must obtain Federal Reserve approval prior to repurchasing its common stock for consideration in excess of 10% of its net worth during any twelve-month period unless the Company (i) both before and after the redemption satisfies capital requirements for a “well capitalized” bank holding company; (ii) received a one or two rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues.

The ability of the Company to pay dividends or repurchase shares may be dependent upon the Company’s receipt of dividends from the Bank. North Carolina commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay. Also, an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations).

 

Deposit Insurance. The assessment paid by each Deposit Insurance Fund member institution is based on its relative risks of default as measured by regulatory capital ratios and other factors. Specifically, the assessment rate is based on the institution’s capitalization risk category and supervisory subgroup category. An institution’s capitalization risk category is based on the FDIC’s determination of whether the institution is well capitalized, adequately capitalized or less than adequately capitalized.

An institution’s supervisory subgroup category is based on the FDIC’s assessment of the financial condition of the institution and the probability that FDIC intervention or other corrective action will be required. The FDIC may terminate insurance of deposits upon a finding that an institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

The Dodd-Frank Act expanded the base for FDIC insurance assessments, requiring that assessments be based on the average consolidated total assets less tangible equity capital of a financial institution. On February 7, 2011, the FDIC approved a final rule to implement the foregoing provision of the Dodd-Frank Act. Among other things, the final rule revises the assessment rate schedule to provide assessments ranging from five to 35 basis points, with the initial assessment rates subject to adjustments which could increase or decrease the total base assessment rates. The FDIC has three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points (or 50% of the initial base assessment rate) for long-term unsecured debt, including senior unsecured debt and subordinated debt; (ii) an increase for holding long-term unsecured or subordinated debt issued by other insured depository institutions known as the Depository Institution Debt Adjustment and (iii) for institutions not well rated and well capitalized, an increase not to exceed ten basis points for brokered deposits in excess of ten percent of domestic deposits.

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Federal Home Loan Bank System. The Federal Home Loan Bank (“FHLB”) system provides a central credit facility for member institutions. As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta in an amount at least equal to 0.20% (or 20 basis points) of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta under the new activity-based stock ownership requirement. On December 31, 2018, the Bank was in compliance with this requirement.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the FDIC, an insured institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination, which was conducted during February 2017.

Changes in Control. The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or savings bank or merging or consolidating with another bank or financial holding company or savings bank holding company without prior approval of the Federal Reserve. Similarly, Federal Reserve approval (or, in certain cases, non-objection) must be obtained prior to any person acquiring control of the Company. Control is deemed to exist if, among other things, a person acquires 25% or more of any class of voting stock of the Company or controls in any manner the election of a majority of the directors of the Company. Control is presumed to exist if a person acquires 10% or more of any class of voting stock and the stock is registered under Section 12 of the Securities Exchange Act of 1934, as amended from time to time (the “Exchange Act”), or the acquiror will be the largest shareholder after the acquisition.

Federal Securities Law. The Company has registered its common stock with the Securities and Exchange Commission (“SEC”) pursuant to Section 12(g) of the Exchange Act. As a result of such registration, the proxy and tender offer rules, insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to the Company.

Transactions with Affiliates.Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans-to-one-borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The FDIC has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits on the amount a bank can loan to an executive officer.

 

Loans to One Borrower.The Bank is subject to the loans-to-one-borrower limits imposed by North Carolina law, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any borrower outstanding at one time and not fully secured by readily marketable collateral shall exceed 15% of the Bank’s total equity capital. At December 31, 2018, this limit was $22.0 million. This limit is increased by an additional 10% of the Bank’s total equity capital, or $36.7 million as of December 31, 2018, for loans and extensions of credit that are fully secured by readily marketable collateral.

 9

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act (the “GLB Act”) dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited. In doing so, it increased competition in the financial services industry, presenting greater opportunities for our larger competitors, which were more able to expand their service and products than smaller, community-oriented financial institutions, such as the Bank.

USA Patriot Act of 2001. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act (the “Patriot Act”) was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Patriot Act was intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Patriot Act on financial institutions of all kinds has been significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Interstate Banking and Branching. The BHCA was amended by the Interstate Banking Act. The Interstate Banking Act provides that adequately capitalized and managed financial and bank holding companies are permitted to acquire banks in any state. State law prohibiting interstate banking or discriminating against out-of-state banks is preempted. States are not permitted to enact laws opting out of this provision; however, states are allowed to adopt a minimum age restriction requiring that target banks located within the state be in existence for a period of years, up to a maximum of five years, before a bank may be subject to the Interstate Banking Act. The Interstate Banking Act, as amended by the Dodd-Frank Act, establishes deposit caps which prohibit acquisitions that result in the acquiring company controlling 30% or more of the deposits of insured banks and thrift institutions held in the state in which the target maintains a breach or 10% or more of the deposits nationwide. States have the authority to waive the 30% deposit cap. State-level deposit caps are not preempted as long as they do not discriminate against out-of-state companies, and the federal deposit caps apply only to initial entry acquisitions.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 mandates for public companies a variety of reforms intended to address corporate and accounting fraud and provides for the establishment of the Public Company Accounting Oversight Board (the “PCAOB”) which enforces auditing, quality control and independence standards for firms that audit SEC-reporting companies. The Sarbanes-Oxley Act imposes higher standards for auditor independence and restricts the provision of consulting services by auditing firms to companies they audit and requires that certain audit partners be rotated periodically. It also requires chief executive officers and chief financial officers, or their equivalents, to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement, and increases the oversight and authority of audit committees of publicly traded companies.

Limits on Rates Paid on Deposits and Brokered Deposits.  FDIC regulations limit the ability of insured depository institutions to accept, renew or roll-over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in such depository institution’s normal market area. Under these regulations, “well capitalized” depository institutions may accept, renew or roll-over such deposits without restriction, “adequately capitalized” depository institutions may accept, renew or roll-over such deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates) and “undercapitalized” depository institutions may not accept, renew, or roll-over such deposits. Definitions of “well capitalized,” “adequately capitalized” and “undercapitalized” are the same as the definitions adopted by federal banking agencies to implement the prompt corrective action provisions discussed above.

Other. Additional regulations require annual examinations of all insured depository institutions by the appropriate federal banking agency and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards.

The Bank is subject to examination by the FDIC and the Commissioner. In addition, the Bank is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit, equal credit and fair credit reporting laws and laws relating to branch banking. The Bank, as an insured North Carolina commercial bank, is prohibited from engaging as a principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.

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Future Requirements. Statutes and regulations, which contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions, are introduced regularly. Neither the Company nor the Bank can predict whether or what form any proposed statute or regulation will be adopted or the extent to which the business of the Company or the Bank may be affected by such statute or regulation.

Consent Order

On August 31, 2015, the FDIC and the Commissioner issued a Consent Order (the “Order”) in connection with compliance by the Bank with the Bank Secrecy Act and its implementing regulations (collectively, the “BSA”). The Order was issued pursuant to the consent of the Bank. In consenting to the issuance of the Order, the Bank did not admit or deny any unsafe or unsound banking practices or violations of law or regulation.

The Order required the Bank to take certain affirmative actions to comply with its obligations under the BSA, including, without limitation, strengthening its Board of Directors’ oversight of BSA activities; reviewing, enhancing, adopting and implementing a revised BSA compliance program; completing a BSA risk assessment; developing a revised system of internal controls designed to ensure full compliance with the BSA; reviewing and revising customer due diligence and risk assessment processes, policies and procedures; developing, adopting and implementing effective BSA training programs; assessing BSA staffing needs and resources and appointing a qualified BSA officer; establishing an independent BSA testing program; ensuring that all reports required by the BSA are accurately and properly filed and engaging an independent firm to review past account activity to determine whether suspicious activity was properly identified and reported.

During the third quarter of 2017 the Bank received notice that the Order was terminated effective August 30, 2017.

Available Information

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports available free of charge on its internet website www.peoplesbanknc.com as soon as reasonably practicable after the reports are electronically filed with the SEC. The Company’s Annual Report on Form 10-K and Quarterly Reports on Form 10-Q are also available on its internet website in interactive data format using the eXtensible Business Reporting Language (XBRL), which allows financial statement information to be downloaded directly into spreadsheets, analyzed in a variety of ways using commercial off-the-shelf software and used within investment models in other software formats. The SEC maintains an Internet site that contains reports, proxy information, statements and other information filed by the Company with the SEC electronically. These filings are also accessible on the SEC’s website at https://www.sec.gov.

The Company maintains a website at https://peoplesbanknc.com. The Company’s corporate governance policies, including the charters of the Audit and Enterprise Risk, Compensation, and Governance Committees, and the Code of Business Conduct and Ethics may be found on the Company’s website. A written copy of the foregoing corporate governance policies is available upon written request to the Company.

ITEM 1A.

RISK FACTORS

The following are potential risks that management considers material and that could affect the future operating results and financial condition of the Bank and the Company. The risks are not listed in any particular order of importance, and there is the potential that there are other risks that have either not been identified or that management believed to be immaterial but which could in fact adversely affect the operating results and financial condition of the Bank and the Company.

If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly, and you could lose all or part of your investment.

Our business could be adversely affected by current conditions in the financial markets and economic conditions generally.

Our business is subject to periodic fluctuations based on national, regional and local economic conditions. These fluctuations are not predictable, cannot be controlled, and may have a material adverse impact on our operations and financial condition. Sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business: 

● 

a decrease in the demand for loans or other products and services offered by us;

● 

a decrease in the value of our loans or other assets secured by consumer or commercial real estate;

● 

a decrease in deposit balances due to overall reductions in the accounts of customers;

● 

an impairment of certain intangible assets or investment securities;

● 

a decreased ability to raise additional capital on terms acceptable to us or at all; or

● 

an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and provision for credit losses, which would reduce our earnings.

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Financial reform legislation enacted by Congress and resulting regulations have increased, and are expected to continue to increase our costs of operations.

Congress enacted the Dodd-Frank Act in 2010. This law has significantly changed the structure of the bank regulatory system and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations. Although some of these regulations have been promulgated, additional regulations could be issued in 2019.

It is difficult to quantify what specific impact the Dodd-Frank Act and related regulations have had on the Company to date and what impact yet to be written regulations will have on us in the future. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

Notwithstanding the foregoing, on February 3, 2017, the President of the United States issued an executive order identifying “core principles” for the administration’s financial services regulatory policy and directing the Secretary of the Treasury, in consultation with the heads of other financial regulatory agencies, to evaluate how the current regulatory framework promotes or inhibits the principles and what actions have been, and are being, taken to promote the principles. In response to the executive order, on June 12, 2017, October 6, 2017 and October 26, 2017, respectively, the U.S. Department of the Treasury issued the first three of four reports recommending a number of comprehensive changes in the current regulatory system for U.S. depository institutions, the U.S. capital markets and the U.S. asset management and insurance industries that may serve to reduce the impact of existing and future regulations on our operations. There can be no assurance that such regulations will be implemented or that they will reduce the impact of existing and future regulations on our operations.

Increases in FDIC insurance premiums may adversely affect the Company’s net income and profitability.

The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are bank or financial institution failures that exceed the FDIC’s expectations, the Bank may be required to pay higher FDIC premiums than those currently in force. Any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.

Market developments may adversely affect our industry, business and results of operations.

Significant declines in the housing market, with falling home prices and increasing foreclosures and unemployment, resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. As a consequence, the Company experienced significant challenges, its credit quality deteriorated and its net income and results of operations were adversely impacted. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers including other financial institutions. Although to date the Company and the Bank remain “well capitalized,” we are part of the financial system and a systemic lack of available credit, a lack of confidence in the financial sector, increased volatility in the financial markets and/or reduced business activity could materially adversely affect our business, financial condition and results of operations.

Loss of key personnel could adversely impact results.

The success of the Bank has been and will continue to be greatly influenced by the ability to retain the services of existing senior management. The Bank has benefited from consistency within its senior management team, with its top three executives averaging 20 years of service with the Bank. The Company has entered into employment contracts with each of these top management officials. Nevertheless, the unexpected loss of the services of any of the key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse impact on the business and financial results of the Bank.

A significant amount of the Bank’s business is concentrated in lending which is secured by property located in the Catawba Valley and surrounding areas.

In addition to the financial strength and cash flow characteristics of the borrower in each case, the Bank often secures its loans with real estate collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If the Bank is required to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, the Bank’s earnings and capital could be adversely affected.

Additionally, with most of the Bank’s loans concentrated in the Catawba Valley and surrounding areas, a decline in local economic conditions could adversely affect the values of the Bank’s real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on the Bank’s earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

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A significant amount of the Bank’s business is concentrated in lending which is secured by property located in the Catawba Valley and surrounding areas.

In addition to the financial strength and cash flow characteristics of the borrower in each case, the Bank often secures its loans with real estate collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If the Bank is required to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, the Bank’s earnings and capital could be adversely affected.

Additionally, with most of the Bank’s loans concentrated in the Catawba Valley and surrounding areas, a decline in local economic conditions could adversely affect the values of the Bank’s real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on the Bank’s earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

 

Our allowance for loan losses may be insufficient and could therefore reduce earnings.

The risk of credit losses on loans varies with, among other things, general economic conditions, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Management believes it has established the allowance in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) and in consideration of the current economic environment. 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. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require the Bank to increase the allowance for loan losses as a part of their examination process, the Bank’s earnings and capital could be significantly and adversely affected. For further discussion related to our process for determining the appropriate level of the allowance for loan losses, see “Allowance for Loan Losses” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results and Operation” of the Annual Report, which is included in this Form 10-K as Exhibit (13).

Changes in interest rates affect profitability and assets.

Changes in prevailing interest rates may hurt the Bank’s business. The Bank derives its income primarily from the difference or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the larger the spread, the more the Bank earns. When market rates of interest change, the interest the Bank receives on its assets and the interest the Bank pays on its liabilities will fluctuate. This can cause decreases in the “spread” and can adversely affect the Bank’s income. Changes in market interest rates could reduce the value of the Bank’s financial assets. Fixed-rate investments, mortgage-backed and related securities and mortgage loans generally decrease in value as interest rates rise. In addition, interest rates affect how much money the Bank lends. For example, when interest rates rise, the cost of borrowing increases and the loan originations tend to decrease. If the Bank is unsuccessful in managing the effects of changes in interest rates, the financial condition and results of operations could suffer.

We measure interest rate risk under various rate scenarios using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations, is presented within “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” of the Annual Report which is included in this Form 10-K as Exhibit (13).

The Bank faces strong competition from other banks and financial institutions which can hurt its business.

The financial services industry is highly competitive. The Bank competes against commercial banks, savings banks, savings and loan associations, credit unions, mortgage banks, brokerage firms, investment advisory firms, insurance companies and other financial institutions. Many of these entities are larger organizations with significantly greater financial, management and other resources than the Bank has. Moreover, one national money center commercial bank is headquartered in Charlotte, North Carolina, only 40 miles from the Bank’s primary market area.

While management believes it can and does successfully compete with other financial institutions in our market, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification.

13

Changes in technology may impact the Bank’s business.

The Bank uses various technologies in its business and the banking industry is undergoing rapid technological changes. The effective use of technology increases efficiency and enables financial institutions to reduce costs. The Bank’s future success will depend in part on its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience as well as create additional efficiencies in the Bank’s operations. The Bank’s competitors may have substantially greater resources to invest in technological improvements.

We may be subject to examinations by taxing authorities which could adversely affect our results of operations.

In the normal course of business, we may be subject to examinations from federal and state taxing authorities regarding the amount of taxes due in connection with investments we have made and the businesses in which we are engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. The challenges made by taxing authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in our favor, they could have an adverse effect on our financial condition and results of operations.

As discussed in Item 3. Legal Proceedings, the NCDOR (as defined on page 21) is seeking to disallow certain tax credits taken by the Bank in prior tax years from an investment made by the Bank. While the Bank purchased a Guaranty Agreement along with the investment, which we believe limits our exposure, there can be no assurance that the guarantor will perform under the Guaranty Agreement or that we will recover under the Guaranty Agreement. For additional information concerning the disallowance of the tax credits, see Item 3. Legal Proceedings on page 21.

 

Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.

Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

From time to time the Financial Accounting Standards Board (“FASB”) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.

Our internal controls may be ineffective.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, and financial condition.

Impairment of investment securities or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.

In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issues, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery of fair value in the near term. In assessing the future ability of the Company to realize the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.

14

We rely on other companies to provide key components of our business infrastructure.

Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of these possible events, there can be no assurance that any such failure, interruption or security breach will not occur or, if any does occur, that it can be sufficiently remediated.

There have been increasing efforts on the part of third parties, including through cyber-attacks, to breach data security at financial institutions or with respect to financial transactions. There have been several recent instances involving financial services and consumer-based companies reporting the unauthorized disclosure of client or customer information or the destruction or theft of corporate data. In addition, because the techniques used to cause such security breaches change frequently, often are not recognized until launched against a target and may originate from less regulated and remote areas around the world, we may be unable to proactively address these techniques or to implement adequate preventative measures. The ability of our customers to bank remotely, including online and through mobile devices, requires secure transmission of confidential information and increases the risk of data security breaches.

The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition, results of operations and business.

 

Liquidity is essential to our businesses.

Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

Negative publicity could damage our reputation

Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.

Financial services companies depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, financial advisors and consultants, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

15

If our non-performing assets increase, our earnings will suffer.

Our non-performing assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or real estate owned. We must reserve for probable losses, which is established through a current period charge to the provision for loan losses as well as from time to time, as appropriate, the write down of the value of properties in our other real estate owned portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our other real estate owned. Further, the resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity. Finally, if our estimate for the recorded allowance for loan losses proves to be incorrect and our allowance is inadequate, we will have to increase the allowance accordingly.

Our loan portfolio includes loans with a higher risk of loss.

We originate commercial real estate loans, commercial loans, construction and land development loans, and residential mortgage loans primarily within our market area. Commercial real estate, commercial, and construction and land development loans tend to involve larger loan balances to a single borrower or groups of related borrowers and are most susceptible to a risk of loss during a downturn in the business cycle. These loans also have historically had greater credit risk than other loans for the following reasons:

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Commercial Real Estate Loans. Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of December 31, 2018, commercial real estate loans comprised approximately 34% of the Bank’s total loan portfolio.

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Commercial Loans. Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. As of December 31, 2018, commercial loans comprised approximately 12% of the Bank’s total loan portfolio.

●

Construction and land development loans. The risk of loss is largely dependent on our initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If our estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of December 31, 2018, construction and land development loans comprised approximately 12% of the Bank’s total loan portfolio.

●

Single-family residential loans. Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of December 31, 2018, single-family residential loans comprised approximately 36% of the Bank’s total loan portfolio, including Banco single-family residential non-traditional loans which were approximately 4% of the Bank’s total loan portfolio.

 

Because we engage in lending secured by real estate and may be forced to foreclose on the collateral property and own the underlying real estate, we may be subject to the increased costs associated with the ownership of real property, which could result in reduced net income.

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to:

●

general or local economic conditions;

●

environmental cleanup liability;

●

neighborhood values;

●

interest rates;

●

real estate tax rates;

●

operating expenses of the mortgaged properties;

●

supply of and demand for rental units or properties;

●

ability to obtain and maintain adequate occupancy of the properties;

●

zoning laws;

●

governmental rules, regulations and fiscal policies; and

●

acts of God.

16

Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating real property may exceed the rental income earned from such property, and we may have to advance funds in order to protect our investment or we may be required to dispose of the real property at a loss.

We are subject to extensive regulation and oversight, and depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory action.

We are subject to extensive regulation and supervision, including examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on us if they determine, upon conclusion of their examination or otherwise, violations of laws with which we must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, consent orders, civil money penalties and termination of deposit insurance and bank closure. Enforcement actions may be taken regardless of the capital levels of the institution, and regardless of prior examination findings. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective actions. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions, paying dividends or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. The imposition of regulatory sanctions, including monetary penalties, may have a material impact on our financial condition and results of operations and/or damage our reputation. In addition, compliance with any such action could distract management’s attention from normal operations, cause us to incur significant expenses, restrict us from engaging in potentially profitable activities and limit our ability to raise capital.

We will become subject to more stringent capital requirements, which may adversely impact our return on equity, require us to raise additional capital, or constrain us from paying dividends or repurchasing shares.

In July 2013, the Federal Reserve and the FDIC approved new rules that substantially amended the regulatory risk-based capital rules applicable to the Bank. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.

The final rule includes new minimum risk-based capital and leverage ratios, which became effective for the Bank and the Company on January 1, 2015, and revises the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital requirements are: (i) a new common equity tier 1 capital ratio of 4.5%; (ii) a tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a tier 1 leverage ratio of 4%. These rules also establish a “capital conservation buffer” of 2.5%, and will result in the following minimum ratios: (i) a common equity tier 1 capital ratio of 7.0%, (ii) a tier 1 to risk-based assets capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and increases each year until fully implemented in January 2019. An institution is 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 established a maximum percentage of eligible retained income that can be utilized for such actions.

The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions constraining us from paying dividends or repurchasing shares if we were to be unable to comply with such requirements.

 

The trading volume in our common stock is less than that of larger public companies which can cause price volatility.

The trading history of our common stock has been characterized by relatively low trading volume. The value of a shareholder’s investment may be subject to sudden decreases due to the volatility of the price of our common stock, which trades on the NASDAQ Global Market.

The market price of our common stock may be volatile and subject to fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:

●

actual or anticipated fluctuation in our operating results;

●

changes in interest rates;

●

changes in the legal or regulatory environment in which we operate;

●

press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;

●

changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors;

●

future sales of our common stock;

●

changes in economic conditions in our market, general conditions in the U.S. economy, financial markets or the banking industry; and

●

other developments affecting our competitors or us.

17

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent a shareholder from selling common stock at or above the current market price. These factors may also adversely affect the Company’s ability to raise capital in the open market if needed. In addition, the Company cannot say with any certainty that a more active and liquid trading market for its common stock will develop.

Our stock price can be volatile.

Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

●

actual or anticipated variations in quarterly results of operations;

●

recommendations by securities analysts;

●

operating results and stock price performance of other companies that investors deem comparable to us;

●

news reports relating to trends, concerns, and other issues in the financial services industry;

●

perceptions in the marketplace regarding us and/or our competitors;

●

new technology used or services offered by competitors;

●

significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors; and

●

changes in government regulations.

Our common stock is not FDIC insured.

 The Company’s common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, holders of our common stock may lose some or all of their investment.

 

We may reduce or eliminate dividends on our common stock.

Although we have historically paid a quarterly cash dividend to the holders of our common stock, holders of our common stock are not entitled to receive dividends. Downturns in the domestic and global economies could cause our Board of Directors to consider, among other things, reducing or eliminating dividends paid on our common stock. This could adversely affect the market price of our common stock. Furthermore, as a bank holding company, our ability to pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends before declaring or paying any dividends. Dividends also may be limited as a result of safety and soundness considerations.

We may need additional access to capital, which we may be unable to obtain on attractive terms or at all.

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments, for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to it, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired and our stock price negatively affected.

 18

Our articles of incorporation, as amended, amended and restated bylaws, and certain banking laws may have an anti-takeover effect.

Provisions of our articles of incorporation, as amended, amended and restated bylaws, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may prohibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

Our use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral.

In considering whether to make a loan secured by real property, we typically require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property.

Natural disasters and geopolitical events beyond our control could adversely affect us.

Natural disasters such as extreme weather conditions, hurricanes, floods, and other acts of nature and geopolitical events involving civil unrest, changes in government regimes, terrorism, or military conflict could adversely affect our business operations and those of our customers and cause substantial damage and loss to real and personal property. These natural disasters and geopolitical events could impair our borrowers' ability to service their loans, decrease the level and duration of deposits by customers, erode the value of loan collateral, and result in an increase in the amount of our non-performing loans and a higher level of non-performing assets (including real estate owned), net charge-offs, and provision for loan losses, which could materially and adversely affect our business, financial condition, results of operations and the value of our common stock.

We depend on the accuracy and completeness of information about customers.

In deciding whether to extend credit, open a bank account or enter into other transactions with customers, we may rely on information furnished to us by or on behalf of customers, including financial statements and other financial information. We also may rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. We may further rely on invoices, contracts, and other supporting documentation provided by our customers, as well as our customers' representations that their financial statements conform to GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on customer representations and certifications, or other audit or accountants' reports, with respect to the business and financial condition of our clients. Our financial condition, results of operations, financial reporting or reputation could be negatively affected if we rely on materially misleading, false, inaccurate or fraudulent information.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

Not applicable.

19

ITEM 2.

PROPERTIES

At December 31, 2018, the Company and the Bank conducted their business from the headquarters office in Newton, North Carolina, its Banco administrative office and its 20 other branch offices in Lincolnton, Hickory, Newton, Catawba, Conover, Claremont, Maiden, Denver, Triangle, Hiddenite, Charlotte, Cornelius, Mooresville, Raleigh and Cary, North Carolina. The Bank also operates loan production offices in Denver and Durham North Carolina. The following table sets forth certain information regarding the Bank’s properties at December 31, 2018.

Owned Corporate Office 518 West C Street Newton, North Carolina 28658 420 West A Street Newton, North Carolina 28658 2619 North Main Avenue Newton, North Carolina 28658 213 1st Street, West Conover, North Carolina 28613 3261 East Main Street Claremont, North Carolina 28610 6125 Highway 16 South Denver, North Carolina 28037 5153 N.C. Highway 90E Hiddenite, North Carolina 28636 200 Island Ford Road Maiden, North Carolina 28650 3310 Springs Road NE Hickory, North Carolina 28601 142 South Highway 16 Denver, North Carolina 28037 106 North Main Street Catawba, North Carolina 28609 2050 Catawba Valley Boulevard Hickory, North Carolina 28601 1074 River Highway Mooresville, North Carolina 28117 Leased 1333 2nd Street NE Hickory, North Carolina 28601 1910 East Main Street Lincolnton, North Carolina 28092 760 Highway 27 West Lincolnton, North Carolina 28092 102 Leonard Avenue Newton, North Carolina 28658 6350 South Boulevard Charlotte, North Carolina 28217 4451 Central Avenue Suite A Charlotte, North Carolina 28205 3752/3754 Highway 16 North Denver, North Carolina 28037 9624-I Bailey Road Cornelius, North Carolina 28031 3023-10 Capital Boulevard Raleigh, North Carolina 27604 2530 Meridian Parkway Durham, North Carolina 27713 1117 Parkside Main Street Cary, NC, 27519 800 E. Arrowood Road Charlotte, North Carolina 28217

20

ITEM 3.       LEGAL PROCEEDINGS

On October 19, 2018, the Bank received a draft audit report from the North Carolina Department of Revenue (“NCDOR”) setting forth certain proposed adjustments to the North Carolina income tax returns for the Bank for the tax years January 1, 2014 through December 31, 2016. The NCDOR is seeking to disallow certain tax credits taken by the Bank in tax years January 1, 2014 through December 31, 2016 from an investment made by the Bank. The total proposed adjustments sought by the NCDOR as of the date of the draft audit report (including additional tax, penalties and interest up to the date of the draft audit report) is approximately $1.4 million. The Bank disagrees with the NCDOR’s proposed adjustments and the disallowance of certain tax credits, and intends to challenge the proposed adjustments and the disallowance of such tax credits. The Bank purchased a Guaranty Agreement along with this tax credit investment that unconditionally guarantees the amount of its investment plus associated penalties and interest which we believe would limit the Bank’s exposure to approximately $150,000. The Tax Credit Guaranty Agreement from State Tax Credit Exchange, LLC dated September 10, 2014 was attached to the Company’s September 30, 2018 Form 10-Q as Exhibit 99.

ITEM 4.       MINE SAFETY DISCLOSURES

Not applicable.

 

PART II

ITEM 5.

MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock is listed on the NASDAQ Global Market, under the symbol “PEBK.” Market makers for the Company’s shares include Raymond James Financial, Inc. and Hovde Group, LLC.

Although the payment of dividends by the Company is subject to certain requirements and limitations of North Carolina corporate law, neither the Commissioner nor the FDIC have promulgated any regulations specifically limiting the right of the Company to pay dividends and repurchase shares. However, the ability of the Company to pay dividends and repurchase shares may be dependent upon, among other things, the Company’s receipt of dividends from the Bank. The Bank’s ability to pay dividends is limited. North Carolina commercial banks, such as the Bank, are subject to legal limitations on the amount of dividends they are permitted to pay. Dividends may be paid by the Bank from undivided profits, which are determined by deducting and charging certain items against actual profits, including any contributions to surplus required by North Carolina law. Also, an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations). Based on its current financial condition, the Bank does not expect that this provision will have any impact on the Bank’s ability to pay dividends. See Supervision and Regulation under Item 1 Business.

As of March 8, 2019, the Company had 658 shareholders of record, not including the number of persons or entitieswhose stock is held in nominee or street name through various brokerage firms or banks. The closing market price for the Company’s common stock was $27.30 on March 8, 2019.

21

STOCK PERFORMANCE GRAPH

The following graph compares the Company’s cumulative shareholder return on its common stock with a NASDAQ index and with a southeastern bank index. The graph was prepared by S&P Global Market Intelligence, using data as of December 31, 2018.

COMPARISON OF SIX-YEAR CUMULATIVE TOTAL RETURNS

Performance Report for

Peoples Bancorp of North Carolina, Inc.

		Period Ending
Index	12/31/13	12/31/14	12/31/15	12/31/16	12/31/17	12/31/18
Peoples Bancorp of North Carolina, Inc.	100.00	128.22	139.91	184.77	252.86	205.07
NASDAQ Composite Index	100.00	114.75	122.74	133.62	173.22	168.30
SNL Southeast Bank Index	100.00	112.63	110.87	147.18	182.06	150.42
Source: S&P Global Market Intelligence
© 2019

22

The information required by Item 201(d) concerning securities authorized for issuance under equity compensation plans is set forth in Item 12 hereof.

ISSUER PURCHASES OF EQUITY SECURITIES
Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (2)
January 1 - 31, 2018	632	$31.99	-	$16,180
February 1 - 28, 2018	199	28.87	-	$16,180
March 1 - 31, 2018	162	27.77	-	$16,180
April 1 - 30, 2018	731	31.40	-	$16,180
May 1 - 31, 2018	132	31.50	-	$16,180
June 1 - 30, 2018	168	32.00	-	$16,180
July 1 - 31, 2018	658	32.60	-	$16,180
August 1 - 31, 2018	115	30.79	-	$16,180
September 1 - 30, 2018	147	30.50	-	$16,180
October 1 - 31, 2018	739	28.77	-	$16,180
November 1 - 30, 2018	129	28.50	-	$16,180
December 1 - 31, 2018	149	29.47	-	$16,180
Total	3,961(1)	$30.74	-

(1) The Company purchased 3,961 shares on the open market in the year ended December 31, 2018 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.

(2) Reflects dollar value of shares that may yet be purchased under the Stock Repurchase Plan authorized by the Company's Board of Directors in 2016.

 

ITEM 6.

SELECTED FINANCIAL DATA

The information required by this Item is set forth in the section captioned "Selected Financial Data" on page A-3 of the Annual Report, which Annual Report is included in this Form 10-K as Exhibit (13). The section captioned "Selected Financial Data" on page A-3 of the Annual Report is incorporated herein by reference.

ITEM 7. 

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information required by this Item is set forth in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-23 of the Annual Report, which section is included in this Form 10-K as Exhibit (13), and which section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is incorporated herein by reference.

23

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this Item is set forth in the section captioned “Quantitative and Qualitative Disclosures About Market Risk” on page A-22 of the Annual Report, which Annual Report is included in this Form 10-K as Exhibit (13), and which section captioned “Quantitative and Qualitative Disclosures About Market Risk” is incorporated herein by reference.

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of the Company and supplementary data are set forth on pages A-24 through A-68 of the Annual Report, which Annual Report is included in this Form 10-K as Exhibit (13). The consolidated financial statements of the Company and supplementary data set forth on pages A-24 through A-68 of the Annual Report are incorporated herein by reference.

ITEM 9. 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer of the Company, has concluded, based on their evaluation as of the end of the period covered by this Report, that the Company’s disclosure controls and procedures (as defined in Rule 13A-15(e) promulgated under the Exchange Act) are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management including the Chief Executive Officer and the Chief Financial Officer of the Company as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

There have been no changes in internal control over financial reporting during the quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

Management’s Annual Report on Internal Controls over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

24

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018. In making this assessment, management used the criteria established in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2018.

 Elliott Davis, PLLC, an independent, registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2018, and audited the Company’s effectiveness of internal control over financial reporting as of December 31, 2018, as stated in their report, which is included in Item 8 hereof.

ITEM 9B.

OTHER INFORMATION

None

 

PART III

ITEM 10. 

DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item is set forth under the sections captioned “Director Nominees”, “Executive Officers of the Company “, “Security Ownership Of Certain Beneficial Owners and Management, “Section 16(a) Beneficial Ownership Reporting Compliance”, “Code of Business Conduct and Ethics”, “Board Committees – Governance Committee” and “Board Committees – Audit and Enterprise Risk Committee” contained in the Proxy Statement, which sections are incorporated herein by reference.

ITEM 11. 

EXECUTIVE COMPENSATION

The information required by this Item is set forth under the section captioned “Compensation Discussion and Analysis”, “Summary Compensation Table”, “Grants of Plan-Based Awards”, “Outstanding Equity Awards at Fiscal Year End”, “Option Exercises and Stock Vested”, “Pension Benefits”, “Nonqualified Deferred Compensation”, “Employment Agreements”, “Potential Payments upon Termination or Change in Control”, “Omnibus Stock Option and Long Term Incentive Plan”, “Director Compensation”, “Compensation Committee – Compensation Committee Interlocks and Insider Participation” and “Compensation Committee – Compensation Committee Report” contained in the Proxy Statement, which sections are incorporated herein by reference.

 25

ITEM 12. 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

For the information required by the Item see the section captioned “Security Ownership of Certain Beneficial Owners and Management” contained in the Proxy Statement, which section is incorporated herein by reference.

The following table presents the number of shares of Company common stock to be issued upon the exercise of outstanding options, warrants and rights; the weighted-average price of the outstanding options, warrants and rights and the number of options, warrants and rights remaining that may be issued under the Company’s Omnibus Plan described under the section captioned “Omnibus Stock Option and Long Term Incentive Plan” contained in the Proxy Statement.

Plan Category	Number of securities to be issued upon exercise of outstanding option, warrants and rights (1), (2), (3), (4)	Weighted-average exercise price of outstanding options, warrants and rights (5)	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (6), (7)
	(a)	(b)	(c)
Equity compensation plans approved by security holders	29,526	$24.46	280,933
Equity compensation plans not approved by security holders	-	-	-
Total	29,526	$24.46	280,933

(1)

Includes 16,583 restricted stock units granted on February 19, 2015 (adjusted for the 10% stock dividend paid on December 15, 2017) under the Omnibus Plan. These restricted stock grants vested on February 19, 2019.

(2)

Includes 5,104 restricted stock units granted on February 18, 2016 (adjusted for the 10% stock dividend paid on December 15, 2017) under the Omnibus Plan. These restricted stock grants vest on February 20, 2020.

(3)

Includes 4,144 restricted stock units granted on March 1, 2017 (adjusted for the 10% stock dividend paid on December 15, 2017) under the Omnibus Plan. These restricted stock grants vest on March 1, 2021.

(4)

Includes 3,725 restricted stock units granted on January 24, 2018 under the Omnibus Plan. These restricted stock grants vest on January 24, 2022.

(5)

The exercise price used for the grants of restricted stock units under the Omnibus Plan is $24.46, the closing price for the Company’s stock on December 31, 2018.

(6)

Reflects shares currently reserved for possible issuance under the Omnibus Plan.

(7)

Adjusted for the 10% stock dividend paid on December 15, 2017.

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

See the sections captioned “Indebtedness of and Transactions with Management and Directors” and “Board Leadership Structure and Risk Oversight” contained in the Proxy Statement, which sections are incorporated herein by reference.

ITEM 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

See the section captioned “Proposal 4 - Ratification of Selection of Independent Registered Public Accounting Firm” contained in the Proxy Statement, which section is incorporated herein by reference.

26

PART IV

ITEM 15. 

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

15(a)1. 

Consolidated Financial Statements (contained in the Annual Report attached hereto as Exhibit (13) and incorporated herein by reference)

(a) 

Reports of Independent Registered Public Accounting Firm

(b) 

Consolidated Balance Sheets as of December 31, 2018 and 2017

(c) 

Consolidated Statements of Earnings for the Years Ended December 31, 2018, 2017 and 2016

(d) 

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2018, 2017 and 2016

(e) 

Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016

(f) 

Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016

(g) 

Notes to Consolidated Financial Statements

15(a)2. 

Consolidated Financial Statement Schedules

All schedules have been omitted, as the required information is either inapplicable or included in the Notes to Consolidated Financial Statements.

15(a)3. 

Exhibits

Exhibit (3)(i) 

Articles of Amendment dated December 19, 2008, regarding the Series A Preferred Stock, incorporated by reference to Exhibit (3)(1) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (3)(ii)

Articles of Amendment dated February 26, 2010 incorporated by reference to Exhibit (3)(2) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2010

Exhibit (3)(iii)

Articles of Incorporation of the Registrant, incorporated by reference to Exhibit (3)(i) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999

Exhibit (3)(iv)

Second Amended and Restated Bylaws of the Registrant, incorporated by reference to Exhibit (3)(ii) to the Form 8-K filed with the Securities and Exchange Commission on June 24, 2015

Exhibit (4)

Specimen Stock Certificate, incorporated by reference to Exhibit (4) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999

Exhibit (10)(i)

Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Tony W. Wolfe dated December 18, 2008, incorporated by reference to Exhibit (10)(a)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

27

Exhibit (10)(ii)

Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Joseph F. Beaman, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(b)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (10)(iii)

Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and William D. Cable, Sr. dated December 18, 2008, incorporated by reference to Exhibit (10)(c)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (10)(iv)

Employment Agreement dated January 22, 2015 between the Registrant and William D. Cable, Sr., incorporated by reference to Exhibit (10)(c) to the Form 8-K filed with the Securities and Exchange Commission on February 9, 2015

Exhibit (10)(v)

Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Lance A. Sellers dated December 18, 2008, incorporated by reference to Exhibit (10)(d)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (10)(vi)

Employment Agreement dated January 22, 2015 between the Registrant and Lance A. Sellers, incorporated by reference to Exhibit (10)(a) to the Form 8-K filed with the Securities and Exchange Commission on February 9, 2015

Exhibit (10)(vii)

Peoples Bancorp of North Carolina, Inc. Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(f) to the Form 10-K filed with the Securities and Exchange Commission on March 30, 2000

Exhibit (10)(viii)

Amendment No. 1 to the Peoples Bancorp of North Carolina, Inc. Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(e)(i) to the Form 10-K filed with the Securities and Exchange Commission on March 15, 2007

Exhibit (10)(ix)

Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(f)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (10)(x)

Employment Agreement dated January 22, 2015 between the Registrant and A. Joseph Lampron, Jr., incorporated by reference to Exhibit (10)(b) to the Form 8-K filed with the Securities and Exchange Commission on February 9, 2015

Exhibit (10)(xi)

Peoples Bank Directors’ and Officers’ Deferral Plan, incorporated by reference to Exhibit (10)(h) to the Form 10-K filed with the Securities and Exchange Commission on March 28, 2002

Exhibit (10)(xii)

Rabbi Trust for the Peoples Bank Directors’ and Officers’ Deferral Plan, incorporated by reference to Exhibit (10)(i) to the Form 10-K filed with the Securities and Exchange Commission on March 28, 2002

Exhibit (10)(xiii)

Description of Service Recognition Program maintained by Peoples Bank, incorporated by reference to Exhibit (10)(i) to the Form 10-K filed with the Securities and Exchange Commission on March 27, 2003

Exhibit (10)(xiv)

Capital Securities Purchase Agreement dated as of June 26, 2006, by and among the Registrant, PEBK Capital Trust II and Bear, Sterns Securities Corp., incorporated by reference to Exhibit (10)(j) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

28

Exhibit (10)(xv)

Amended and Restated Trust Agreement of PEBK Capital Trust II, dated as of June 28, 2006, incorporated by reference to Exhibit (10)(k) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

Exhibit (10)(xvi)

Guarantee Agreement of the Registrant dated as of June 28, 2006, incorporated by reference to Exhibit (10)(l) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

Exhibit (10)(xvii)

Indenture, dated as of June 28, 2006, by and between the Registrant and LaSalle Bank National Association, as Trustee, relating to Junior Subordinated Debt Securities Due September 15, 2036, incorporated by reference to Exhibit (10)(m) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

Exhibit (10)(xviii)

Form of Amended and Restated Director Supplemental Retirement Agreement between Peoples Bank and Directors Robert C. Abernethy, James S. Abernethy, Douglas S. Howard, John W. Lineberger, Jr., Gary E. Matthews, Dr. Billy L Price, Jr., Larry E Robinson, W. Gregory Terry, Dan Ray Timmerman, Sr., and Benjamin I. Zachary, incorporated by reference to Exhibit (10)(n) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (10)(xix)

2009 Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(o) to the Form 10-K filed with the Securities and Exchange Commission on March 20, 2009

Exhibit (10)(xx)

First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Lance A. Sellers dated February 16, 2018

Exhibit (10)(xxi) 

First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated February 16, 2018

Exhibit (10)(xxii)

First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and William D. Cable, Jr. dated February 16, 2018

Exhibit (13)

2017 Annual Report of Peoples Bancorp of North Carolina, Inc.

Exhibit (14)

Code of Business Conduct and Ethics of Peoples Bancorp of North Carolina, Inc., incorporated by reference to Exhibit (14) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2005

Exhibit (21)

Subsidiaries of the Registrant

Exhibit (23)

Consent of Elliott Davis, PLLC

Exhibit (31)(i)

Certification of principal executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit (31)(ii)

Certification of principal financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

  29

Exhibit (32)

Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit (101) 

The following materials from the Company’s 10-K Report for the annual period ended December 31, 2017, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Earnings, (iii) the Condensed Consolidated Statements of Comprehensive Income, (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text.*

30

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	PEOPLES BANCORP OF NORTH CAROLINA, INC. (Registrant)
Date: March 14, 2019	By:	/s/ Lance A. Sellers
		Lance A. Sellers
		President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature	Title	Date
/s/ Lance A. Sellers	President and Chief Executive Officer	March 14, 2019
Lance A. Sellers	(Principal Executive Officer)
/s/ James S. Abernethy	Director	March 14, 2019
James S. Abernethy
/s/ Robert C. Abernethy	Chairman of the Board and Director	March 14, 2019
Robert C. Abernethy
/s/ Douglas S. Howard	Director	March 14, 2019
Douglas S. Howard
/s/ A. Joseph Lampron, Jr.	Executive Vice President and Chief	March 14, 2019
A. Joseph Lampron, Jr.	Financial Officer (Principal Financial
	and Principal Accounting Officer)
/s/ John W. Lineberger, Jr.	Director	March 14, 2019
John W. Lineberger, Jr.
/s/ Gary E. Matthews	Director	March 14, 2019
Gary E. Matthews
/s/ Billy L. Price, Jr., M.D.	Director	March 14, 2019
Billy L. Price, Jr., M.D.
/s/ Larry E. Robinson	Director	March 14, 2019
Larry E. Robinson
/s/ William Gregory Terry	Director	March 14, 2019
William Gregory Terry
/s/ Dan Ray Timmerman, Sr.	Director	March 14, 2019
Dan Ray Timmerman, Sr.
/s/ Benjamin I. Zachary	Director	March 14, 2019
Benjamin I. Zachary

  31

EX-13

EXHIBIT (13)

The Annual Report to Security Holders is Appendix A to the Proxy Statement for the 2019 Annual Meeting of Shareholders and is incorporated herein by reference.

APPENDIX A

ANNUAL REPORT

OF

PEOPLES BANCORP OF NORTH CAROLINA, INC.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

General Description of Business

Peoples Bancorp of North Carolina, Inc. (“Bancorp”), was formed in 1999 to serve as the holding company for Peoples Bank (the “Bank”). Bancorp is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). Bancorp’s principal source of income is dividends declared and paid by the Bank on its capital stock, if any. Bancorp has no operations and conducts no business of its own other than owning the Bank. Accordingly, the discussion of the business which follows concerns the business conducted by the Bank, unless otherwise indicated. Bancorp and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries are collectively called the “Company”.

The Bank, founded in 1912, is a state-chartered commercial bank serving the citizens and business interests of the Catawba Valley and surrounding communities through 20 banking offices, as of December 31, 2018, located in Lincolnton, Newton, Denver, Catawba, Conover, Maiden, Claremont, Hiddenite, Hickory, Charlotte, Cornelius, Mooresville, Raleigh, and Cary North Carolina. The Bank also operates loan production offices in Denver and Durham, North Carolina. At December 31, 2018, the Company had total assets of $1.1 billion, net loans of $797.6 million, deposits of $877.2 million, total securities of $198.9 million, and shareholders’ equity of $123.6 million.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a division of the Bank under the name Banco de la Gente (“Banco”). These offices are now branded as Bank branches and considered a separate market territory of the Bank as they offer normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans.

The Bank has a diversified loan portfolio, with no foreign loans and few agricultural loans. Real estate loans are predominately variable rate and fixed rate commercial property loans, which include residential development loans to commercial customers. Commercial loans are spread throughout a variety of industries with no one particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio. The majority of the Bank’s deposit and loan customers are individuals and small to medium-sized businesses located in the Bank’s market area. The Bank’s loan portfolio also includes Individual Taxpayer Identification Number (ITIN) mortgage loans generated thorough the Bank’s Banco offices. Additional discussion of the Bank’s loan portfolio and sources of funds for loans can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-23 of the Annual Report, which is included in this Form 10-K as Exhibit (13).

The operations of the Bank and depository institutions in general are significantly influenced by general economic conditions and by related monetary and fiscal policies of depository institution regulatory agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Commissioner of Banks (the “Commissioner”).

The Company’s fiscal year ends December 31. This Form 10-K is also being used as the Bank’s Annual Disclosure Statement under FDIC Regulations. This Form 10-K has not been reviewed, or confirmed for accuracy or relevance by the FDIC.

At December 31, 2018, the Company employed 310 full-time employees and 35 part-time employees, which equated to 334 full-time equivalent employees.

Subsidiaries

The Bank is a subsidiary of the Company. At December 31, 2018, the Bank had four subsidiaries, Peoples Investment Services, Inc., Real Estate Advisory Services, Inc., Community Bank Real Estate Solutions, LLC (“CBRES”) and PB Real Estate Holdings, LLC. Through a relationship with Raymond James Financial Services, Inc., Peoples Investment Services, Inc. provides the Bank’s customers access to investment counseling and non-deposit investment products such as stocks, bonds, mutual funds, tax deferred annuities, and related brokerage services. Real Estate Advisory Services, Inc. provides real estate appraisal and real estate brokerage services. CBRES serves as a “clearing-house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property to be appraised is located. This type of service ensures that the appraisal process remains independent from the financing process within the Bank. PB Real Estate Holdings, LLC acquires, manages and disposes of real property, other collateral and other assets obtained in the ordinary course of collecting debts previously contracted.

A-1

In June 2006, the Company formed a 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, which pay a floating rate equal to three-month LIBOR plus 163 basis points. The proceeds received by the Company from the sale of the junior subordinated debentures were used in December 2006 to repay 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 asset of PEBK Trust II. PEBK Trust II is not included in the consolidated financial statements.

The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. The net combined effect of the trust preferred securities transaction is that the Company is obligated 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, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

This report contains certain forward-looking statements with respect to the financial condition, results of operations and business of the Company. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on the information available to management at the time that these disclosures were prepared. These statements can be identified by the use of words like “expect,” “anticipate,” “estimate” and “believe,” variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the markets served by the Bank, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environment and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in the Company’s other filings with the Securities and Exchange Commission. The Company undertakes no obligation to update any forward-looking statements.

A-2

SELECTED FINANCIAL DATA

Dollars in Thousands Except Per Share Amounts

	2018	2017	2016	2015	2014
Summary of Operations
Interest income	$45,350	41,949	39,809	38,666	38,420
Interest expense	2,146	2,377	3,271	3,484	4,287
Net interest income	43,204	39,572	36,538	35,182	34,133
Provision for loan losses	790	(507)	(1,206)	(17)	(699)
Net interest income after provision
for loan losses	42,414	40,079	37,744	35,199	34,832
Non-interest income (1)	16,166	15,364	16,236	15,256	13,824
Non-interest expense (1)	42,574	41,228	42,242	37,722	37,331
Earnings before income taxes	16,006	14,215	11,738	12,733	11,325
Income tax expense	2,624	3,947	2,561	3,100	1,937
Net earnings	$13,382	10,268	9,177	9,633	9,388
Selected Year-End Balances
Assets	$1,093,251	1,092,166	1,087,991	1,038,481	1,040,494
Investment securities available for sale	194,578	229,321	249,946	268,530	281,099
Net loans	797,578	753,398	716,261	679,502	640,809
Mortgage loans held for sale	680	857	5,709	4,149	1,375
Interest-earning assets	1,007,078	996,509	999,201	977,079	956,900
Deposits	877,213	906,952	892,918	832,175	814,700
Interest-bearing liabilities	657,110	679,922	698,120	679,937	722,991
Shareholders' equity	$123,617	115,975	107,428	104,864	98,665
Shares outstanding	5,995,256	5,995,256	5,417,800	5,510,538	5,612,588
Selected Average Balances
Assets	$1,094,707	1,098,992	1,076,604	1,038,594	1,036,486
Investment securities available for sale	209,742	234,278	252,725	266,830	287,371
Net loans	777,098	741,655	703,484	669,628	631,025
Interest-earning assets	1,007,484	998,821	985,236	952,251	949,537
Deposits	903,120	895,129	856,313	816,628	808,399
Interest-bearing liabilities	665,165	700,559	705,291	707,611	731,786
Shareholders' equity	$123,797	116,883	113,196	106,644	96,877
Shares outstanding (2)	5,995,256	5,988,183	6,024,970	6,115,159	6,177,233
Profitability Ratios
Return on average total assets	1.22%	0.93%	0.85%	0.93%	0.91%
Return on average shareholders' equity	10.81%	8.78%	8.11%	9.03%	9.69%
Dividend payout ratio	23.41%	25.67%	22.95%	16.34%	10.89%
Liquidity and Capital Ratios (averages)
Loan to deposit	86.05%	82.85%	82.15%	82.00%	78.06%
Shareholders' equity to total assets	11.31%	10.64%	10.51%	10.27%	9.35%
Per share of Common Stock (2)
Basic net earnings	$2.23	1.71	1.53	1.57	1.52
Diluted net earnings	$2.22	1.69	1.50	1.56	1.51
Cash dividends	$0.52	0.44	0.35	0.25	0.16
Book value	$20.62	19.34	18.03	17.30	15.98

(1)

Appraisal management fee income and expense from the Bank’s subsidiary, CBRES, was reported as a net amount prior to March 31, 2018, which was included in miscellaneous non-interest income. This income and expense is now reported on separate line items under non-interest income and non-interest expense. Prior periods have been restated to reflect this change.

(2)

Average shares outstanding and per share computations have been restated to reflect a 10% stock dividend paid during the fourth quarter of 2017.

A-3

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following is a discussion of our financial position and results of operations and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company’s annual report on Form 10-K and the Company’s consolidated financial statements and notes thereto on pages A-24 through A-68.

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 Peoples Bancorp of North Carolina, Inc. (“Bancorp”), for the years ended December 31, 2018, 2017 and 2016. Bancorp is a registered bank holding company operating under the supervision of the Federal Reserve Board (the “FRB”) and the parent company of Peoples Bank (the “Bank”). The Bank is a North Carolina-chartered bank, with offices in Catawba, Lincoln, Alexander, Mecklenburg, Iredell, Wake and Durham 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 Board of Governors of the Federal Reserve System (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 loan losses and changes in these economic factors could result in increases or decreases to the provision for loan losses.

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.

The Federal Reserve maintained the Federal Funds rate at 0.25% from December 2008 to December 2015 before increasing the Fed Funds rate nine times since December 2015 to the Fed Funds rate of 2.50% at December 31, 2018. These increases have had a positive impact on earnings in recent periods and should continue to have a positive impact on the Bank’s net interest income in future periods.

The Company plans to open a Loan Production Office in the Ballantyne area of Charlotte, North Carolina during 2019. The Company does not have specific plans for additional offices in 2019 but will continue to look for growth opportunities in nearby markets and may expand if considered a worthwhile opportunity.

A-4

On August 31, 2015, the FDIC and the North Carolina Office of the Commissioner of Banks (“Commissioner”) issued a Consent Order (the “Order”) in connection with compliance by the Bank with the Bank Secrecy Act and its implementing regulations (collectively, the “BSA”). The Order was issued pursuant to the consent of the Bank. In consenting to the issuance of the Order, the Bank did not admit or deny any unsafe or unsound banking practices or violations of law or regulation.

The Order required the Bank to take certain affirmative actions to comply with its obligations under the BSA, including, without limitation, strengthening its Board of Directors’ oversight of BSA activities; reviewing, enhancing, adopting and implementing a revised BSA compliance program; completing a BSA risk assessment; developing a revised system of internal controls designed to ensure full compliance with the BSA;reviewing and revising customer due diligence and risk assessment processes, policies and procedures; developing, adopting and implementing effective BSA training programs; assessing BSA staffing needs and resources and appointing a qualified BSA officer;establishing an independent BSA testing program; ensuring that all reports required by the BSA are accurately and properly filed and engaging an independent firm to review past account activity to determine whether suspicious activity was properly identified and reported.

During the third quarter of 2017 the Bank received notice that the Order was terminated effective August 30, 2017.

Summary of Significant and Critical Accounting Policies

The consolidated financial statements include the financial statements of Bancorp and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc., Real Estate Advisory Services, Inc. (“REAS”), Community Bank Real Estate Solutions, LLC (“CBRES”) andPB Real Estate Holdings, LLC (collectively called the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

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. The following is a summary of some of the more subjective and complex accounting policies of the Company. 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 2018 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 2, 2019 Annual Meeting of Shareholders.

The allowance for loan 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 for loan 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 loan 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 Consolidated Financial Statements.

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”).

The disclosure requirements for derivatives and hedging activities are intended to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of, and gains and losses, on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

A-5

The Company has an overall interest rate risk management strategy that has, in prior years, incorporated the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. When using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative. The Company minimized the credit risk in derivative instruments by entering into transactions with high-quality counterparties that were reviewed periodically by the Company. The Company did not have any interest rate derivatives outstanding as of December 31, 2018 or 2017.

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.

Results of Operations

Summary. The Company reported earnings of $13.4 million or $2.23 basic net earnings per share and $2.22 diluted net earnings per share for the year ended December 31, 2018, as compared to $10.3 million or $1.71 basic net earnings per share and $1.69 diluted net earnings per share for the same period one year ago. The increase in year-to-date net earnings is primarily attributable to an increase in net interest income, an increase in non-interest income and a decrease in income tax expense, which were partially offset by an increase in the provision for loan losses and an increase in non-interest expense, as discussed below.

The Company reported earnings of $10.3 million or $1.71 basic net earnings per share and $1.69 diluted net earnings per share for the year ended December 31, 2017, as compared to $9.2 million or $1.53 basic net earnings per share and $1.50 diluted net earnings per share for the year ended December 31, 2016. The increase in year-to-date net earnings from 2016 to 2017 is primarily attributable to an increase in net interest income and a decrease in non-interest expense, which were partially offset by a decrease in non-interest income and a decrease in the credit to the provision for loan losses, as discussed below. Earnings for the year ended December 31, 2017 were reduced by a charge to income tax expense of $588,000 due to the revaluation of deferred taxes as required due to the passing of the Tax Cuts and Jobs Act (“TCJA”) in December, 2017. Without this charge to earnings, the Company would have had net earnings totaling $10.9 million for the year ended December 31, 2017.

The return on average assets in 2018 was 1.22%, compared to 0.93% in 2017 and 0.85% in 2016. The return on average shareholders’ equity was 10.81% in 2018 compared to 8.78% in 2017 and 8.11% in 2016.

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 for 2018 was $43.2 million compared to $39.6 million in 2017. The increase in net interest income was primarily due to a $3.4 million increase in interest income, which was primarily attributable to an increase in the average outstanding balance of loans and a 1.00% increase in the prime rate since December 31, 2017, combined with a $231,000 decrease in interest expense, which was primarily attributable to a decrease in the average outstanding balances of Federal Home Loan Bank (“FHLB”) borrowings during the year ended December 31, 2018, as compared to the same period one year ago due to the payoff of remaining FHLB borrowings in October 2017. Net interest income increased to $39.6 million in 2017 from $36.5 million in 2016.

Table 1 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 incurredfor the years ended December 31, 2018, 2017 and 2016. 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 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.

A-6

Table 1- Average Balance Table
	December 31, 2018			December 31, 2017			December 31, 2016
(Dollars in thousands)	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate
Interest-earning assets:
Loans	$777,098	38,654	4.97%	$741,655	34,888	4.70%	703,484	32,452	4.61%
Investments - taxable	71,093	1,936	2.72%	64,341	1,693	2.63%	78,575	1,925	2.45%
Investments - nontaxable*	142,832	5,508	3.86%	173,069	7,314	4.23%	178,379	7,577	4.25%
Other	16,461	304	1.85%	19,756	219	1.11%	24,798	123	0.50%
Total interest-earning assets	1,007,484	46,402	4.61%	998,821	44,114	4.42%	985,236	42,077	4.27%
Cash and due from banks	41,840			53,805			44,732
Other assets	51,704			53,557			59,537
Allowance for loan losses	(6,321)			(7,191)			(8,884)
Total assets	$1,094,707			1,098,992			1,080,621
Interest-bearing liabilities:
NOW, MMDA & savings deposits	$484,180	769	0.16%	$481,455	598	0.12%	447,582	495	0.11%
Time deposits	112,398	472	0.42%	132,626	466	0.35%	150,641	586	0.39%
FHLB borrowings	-	-	-	16,329	662	4.05%	42,903	1,661	3.87%
Trust preferred securities	20,619	790	3.83%	20,619	590	2.86%	20,619	485	2.35%
Other	47,968	115	0.24%	49,530	61	0.12%	43,546	44	0.10%
Total interest-bearing liabilities	665,165	2,146	0.32%	700,559	2,377	0.34%	705,291	3,271	0.46%
Demand deposits	306,544			281,048			258,091
Other liabilities	(799)			502			4,043
Shareholders' equity	123,797			116,883			113,196
Total liabilities and shareholder's equity	$1,094,707			1,098,992			1,080,621
Net interest spread		$44,256	4.29%		$41,737	4.08%		$38,806	3.81%
Net yield on interest-earning assets			4.39%			4.18%			3.94%
Taxable equivalent adjustment
Investment securities		$1,052			$2,165			$2,268
Net interest income		$43,204			$39,572			$36,538

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $38.0 million in 2018, $40.3 million in 2017 and $38.7 million in 2016. The tax rates of 2.50%, 3.00% and 4.00% were used to calculate the tax equivalent yields on these securities in 2018, 2017 and 2016, respectively.

Changes in interest income and interest expense can result from variances in both volume and rates. Table 2 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 interest due to both volume and rate have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each.

A-7

Table 2 - Rate/Volume Variance Analysis-Tax Equivalent Basis
	December 31, 2018			December 31, 2017
(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	$1,715	2,051	3,766	1,778	658	2,436
Investments - taxable	181	62	243	(362)	130	(232)
Investments - nontaxable	(1,222)	(584)	(1,806)	(225)	(38)	(263)
Other	(49)	134	85	(40)	136	96
Total interest income	625	1,663	2,288	1,151	886	2,037
Interest expense:
NOW, MMDA & savings deposits	4	167	171	40	63	103
Time deposits	(78)	84	6	(66)	(54)	(120)
FHLB / FRB Borrowings	(331)	(331)	(662)	(1,053)	54	(999)
Trust Preferred Securities	-	200	200	-	105	105
Other	(3)	57	54	7	10	17
Total interest expense	(408)	177	(231)	(1,072)	178	(894)
Net interest income	$1,033	1,486	2,519	2,223	708	2,931

Net interest income on a tax equivalent basis totaled $44.3 million in 2018 as compared to $41.7 million in 2017. The net interest rate spread, which represents the rate earned on interest-earning assets less the rate paid on interest-bearing liabilities, was 4.29% in 2018, as compared to a net interest rate spread of 4.08% in 2017. The net yield on interest-earning assets was 4.39% in 2018 and 4.18% in 2017.

Tax equivalent interest income increased $2.3 million in 2018 primarily due toan increase in interest income resulting from an increase in the average outstanding principal balance of loans, which was partially offset bya decrease in the average outstanding balance of investment securities. The average outstanding principal balance of loans increased $35.4 million to $777.1 million in 2018 compared to $741.7 million in 2017. The average outstanding balance of investment securities decreased $23.5 million to $213.9 million in 2018 compared to $237.4 million in 2017. The yield on interest-earning assets was 4.61% in 2018 compared to 4.42% in 2017.

Interest expense decreased $231,000 in 2018 compared to 2017. The decrease in interest expense is primarily due to a decrease in the average outstanding balance of FHLB borrowings. Average interest-bearing liabilities decreased by $35.4 million to $665.2 million in 2018 compared to $700.6 million in 2017. The cost of funds decreased to 0.32% in 2018 from 0.34% in 2017.

In 2017 net interest income on a tax equivalent basis was $41.7 million compared to $38.8 million in 2016. The net interest spread was 4.08% in 2017 compared to 3.81% in 2016. The net yield on interest-earning assets was 4.18% in 2017 compared to 3.94% in 2016.

Provision for Loan Losses. Provisions for loan losses are charged to income in order to bring the total allowance for loan losses to a level deemed appropriate by management of the Company based on factors such as management’s judgment as to losses within the Bank’s loan portfolio, including the valuation of impaired loans, loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies and management’s assessment of the quality of the loan portfolio and general economic climate.

The provision for loan losses for the year ended December 31, 2018 was an expense of $790,000, as compared to a credit of $507,000 for the year ended December 31, 2017. The increase in the provision for loan losses is primarily attributable to a $44.2 million increase in loans from December 31, 2017 to December 31, 2018. The credits to provision for loan losses for the years ended December 31, 2017 and 2016 resulted from, and were considered appropriate as part of, management’s assessment and estimate of the risks in the total loan portfolio and determination of the total allowance for loan losses. The primary factors contributing to the continued decrease in the allowance for loan losses as a percent of total loans outstanding were the continuing positive trends in indicators of potential losses on loans, primarily non-accrual loans and the reduction in the level of net charge-offs since 2014, as shown in Table 3 below: 

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Table 3 - Net Charge-off Analysis
	Net charge-offs/(recoveries)					Net charge-offs/(recoveries) as a percent of average loans outstanding
	Years ended December 31,					Years ended December 31,
(Dollars in thousands)	2018	2017	2016	2015	2014	2018	2017	2016	2015	2014
Real estate loans
Construction and land development	$43	(14)	(3)	153	456	0.05%	(0.02%)	(0.01%)	0.25%	0.78%
Single-family residential	10	164	220	584	237	0.00%	0.07%	0.09%	0.27%	0.12%
Single-family residential -
Banco de la Gente non-traditional	-	-	-	95	174	0.00%	0.00%	0.00%	0.21%	0.36%
Commercial	348	(21)	299	308	119	0.13%	(0.01%)	0.12%	0.13%	0.05%
Multifamily and farmland	4	66	-	-	-	0.01%	0.23%	0.00%	0.00%	0.00%
Total real estate loans	405	195	516	1,140	986	0.06%	0.03%	0.09%	0.20%	0.18%
Loans not secured by real estate
Commercial loans	22	163	(25)	(64)	376	0.02%	(0.03%)	(0.03%)	(0.07%)	0.53%
Farm loans	-	-	-	-	-	0.00%	0.00%	0.00%	0.00%	0.00%
Consumer loans (1)	284	319	342	400	358	3.11%	3.10%	3.38%	4.00%	3.63%
All other loans	-	-	-	-	-	0.00%	0.00%	0.00%	0.00%	0.00%
Total loans	$711	677	833	1,476	1,720	0.09%	0.09%	0.12%	0.22%	0.27%
Provision for (reduction of) loan losses
for the period	$790	(507)	(1,206)	(17)	(699)
Allowance for loan losses at end of period	$6,445	6,366	7,550	9,589	11,082
Total loans at end of period	$804,023	759,764	723,811	689,091	651,891
Non-accrual loans at end of period	$3,314	3,711	3,825	8,432	10,728
Allowance for loan losses as a percent of
total loans outstanding at end of period	0.80%	0.84%	1.04%	1.39%	1.70%
Non-accrual loans as a percent of
total loans outstanding at end of period	0.41%	0.49%	0.53%	1.22%	1.65%

(1) The loss ratio for consumer loans is elevated because overdraft charge-offs related to DDA and NOW accounts are reported in consumer loan charge-offs and recoveries. The net overdraft charge-offs are not considered material and are therefore not shown separately.

Please see the section below entitled “Allowance for Loan Losses” for a more complete discussion of the Bank’s policy for addressing potential loan losses.

Non-Interest Income. Non-interest income was $16.2 million for the year ended December 31, 2018, compared to $15.4 million for the year ended December 31, 2017. The increase in non-interest income is primarily attributable to a $893,000 increase in miscellaneous non-interest income, which was partially offset by a $339,000 decrease in mortgage banking income during the year ended December 31, 2018, as compared to the year ended December 31, 2017. The increase in miscellaneous non-interest income is primarily due to a $576,000 increase in net gains associated with the disposal of premises and equipment, as compared to the year ended December 31, 2017. The decrease in mortgage banking income is primarily due to a decrease in mortgage loan volume resulting from an increase in mortgage loan rates.

Non-interest income was $15.4 million for the year ended December 31, 2017, compared to $16.2 million for the year ended December 31, 2016. The decrease in non-interest income is primarily attributable to a $729,000 decrease in gains on the sale of securities, a $341,000 decrease in service charges and fees and a $238,000 decrease in mortgage banking income during the year ended December 31, 2017, as compared to the year ended December 31, 2016.

 The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary.   No investment impairments were deemed other-than-temporary in 2018, 2017 or 2016.

 

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Table 4 presents a summary of non-interest income for the years ended December 31, 2018, 2017 and 2016.

Table 4 - Non-Interest Income
(Dollars in thousands)	2018	2017	2016
Service charges	$4,355	4,453	4,497
Other service charges and fees	705	593	890
Gain on sale of securities	15	-	729
Mortgage banking income	851	1,190	1,428
Insurance and brokerage commissions	824	761	632
Gain/(loss) on sale and write-down of other real estate	17	(239)	64
Visa debit card income	3,911	3,757	3,589
Appraisal management fee income	3,206	3,306	3,146
Miscellaneous	2,282	1,543	1,261
Total non-interest income	$16,166	15,364	16,236

Non-Interest Expense. Non-interest expense was $42.6 million for the year ended December 31, 2018, as compared to $41.2 million for the year ended December 31, 2017. The increase in non-interest expense was primarily due to a $1.5 million increase in salaries and benefits expense and a $469,000 increase in occupancy expense, which were partially offset by decreases in adverting expense, debit card expense and other non-interest expense, during the year ended December 31, 2018, as compared to the year ended December 31, 2017. The increase in salaries and benefits expense is primarily due to an increase in the number of full-time equivalent employees and annual salary increases. The increase in occupancy expense is primarily due to an increase in depreciation expense during the year ended December 31, 2018, as compared to the year ended December 31, 2017.

Non-interest expense was $41.2 million for the year ended December 31, 2017, as compared to $42.2 million for the year ended December 31, 2016. The decrease in non-interest expense was primarily due to a $1.2 million decrease in professional fees and a $878,000 decrease in other non-interest expense, which were partially offset by a $794,000 increase in salaries and benefits expense during the year ended December 31, 2017, as compared to the year ended December 31, 2016. The decrease in professional fees is primarily due to a $1.5 million decrease in consulting fees resulting from the termination of the Order. The decrease in other non-interest expense is primarily due to a $752,000 decrease in FHLB prepayment penalties and the increase in salaries and benefits expense is primarily due to an increase in the number of full-time equivalent employees, annual salary increases and an increase in expenses associated with restricted stock units due to an increase in the Company’s stock price.

Table 5 presents a summary of non-interest expense for the years ended December 31, 2018, 2017 and 2016.

Table 5 - Non-Interest Expense
(Dollars in thousands)	2018	2017	2016
Salaries and employee benefits	$21,530	20,058	19,264
Occupancy expense	7,170	6,701	6,765
Office supplies	503	517	465
FDIC deposit insurance	328	347	494
Visa debit card expense	994	1,248	1,141
Professional services	513	451	182
Postage	249	258	224
Telephone	678	855	754
Director fees and expense	312	317	326
Advertising	922	1,195	1,136
Consulting fees	1,012	785	2,257
Taxes and licenses	288	263	272
Foreclosure/OREO expense	58	46	120
Internet banking expense	603	720	710
FHLB advance prepayment penalty	-	508	1,260
Appraisal management fee expense	2,460	2,526	2,260
Other operating expense	4,954	4,433	4,612
Total non-interest expense	$42,574	41,228	42,242

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Income Taxes. The Company reported income tax expense of $2.6 million, $3.9 million and $2.6 million for the years ended December 31, 2018, 2017 and 2016, respectively. The Company’s effective tax rates were 16.39%, 28.03% and 21.82% in 2018, 2017 and 2016, respectively. Income tax expense for the year ended December 31, 2017 includes $588,000 additional tax expense due to the revaluation of the Company’s deferred tax asset as a result of the TCJA, which reduced the Company’s federal corporate tax rate from 34% to 21% effective January 1, 2018.

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 December 31, 2018, such unfunded commitments to extend credit were $268.7 million, while commitments in the form of standby letters of credit totaled $3.7 million.

The Company uses several funding sources to meet its liquidity requirements. The primary funding source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $250,000. The Company considers these to be a stable portion of the Company’s liability mix and the result of on-going consumer and commercial banking relationships. As of December 31, 2018, the Company’s core deposits totaled $859.2 million, or 98% 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 FRB on a short-term basis. The Bank’s policies include the ability to access wholesale fundingup to 40% of total assets. The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits and internet certificates of deposit. The Company’s ratio of wholesale funding to total assets was 0.31% as of December 31, 2018.

The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets, with no balances outstanding at December 31, 2018. At December 31, 2018, the carrying value of loans pledged as collateral totaled approximately $140.0 million. The remaining availability under the line of credit with the FHLB was $84.9 million at December 31, 2018. The Bank had no borrowings from the FRB at December 31, 2018. The FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At December 31, 2018, the carrying value of loans pledged as collateral to the FRB totaled approximately $442.6 million.

The Bank also had the ability to borrow up to $82.5 million for the purchase of overnight federal funds from six correspondent financial institutions as of December 31, 2018.

The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits with banks, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 16.09%, 20.62% and 24.78% at December 31, 2018, 2017 and 2016, respectively. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy for on balance sheet liquidity was 10% at December 31, 2018, 2017 and 2016.

As disclosed in the Company’s Consolidated Statements of Cash Flows included elsewhere herein, net cash provided by operating activities was approximately $17.2 million during 2018. Net cash used in investing activities was $18.6 million during 2018 and net cash used by financing activities was $12.5 million during 2018.

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. Table 6 presents an interest rate sensitivity analysis for the interest-earning assets and interest-bearing liabilities for the year ended December 31, 2018.

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Table 6 - Interest Sensitivity Analysis
(Dollars in thousands)	Immediate	1-3 months	4-12 months	Total Within One Year	Over One Year & Non-sensitive	Total
Interest-earning assets:
Loans	$284,260	12,993	16,371	313,624	490,399	804,023
Mortgage loans held for sale	680	-	-	680	-	680
Investment securities available for sale	-	5,261	22,383	27,644	166,934	194,578
Interest-bearing deposit accounts	2,817	-	-	2,817	-	2,817
Other interest-earning assets	-	-	-	-	4,980	4,980
Total interest-earning assets	287,757	18,254	38,754	344,765	662,313	1,007,078
Interest-bearing liabilities:
NOW, savings, and money market deposits	475,223	-	-	475,223	-	475,223
Time deposits	11,574	13,990	36,365	61,929	41,244	103,173
FHLB borrowings	-	-	-	-	-	-
Securities sold under
agreement to repurchase	58,095	-	-	58,095	-	58,095
Trust preferred securities	-	20,619	-	20,619	-	20,619
Total interest-bearing liabilities	544,892	34,609	36,365	615,866	41,244	657,110
Interest-sensitive gap	$(257,135)	(16,355)	2,389	(271,101)	621,069	349,968
Cumulative interest-sensitive gap	$(257,135)	273,490)	(271,101)	(271,101)	349,968
Interest-earning assets as a percentage of interest-bearing liabilities	52.81%	52.74%	106.57%	55.98%	1605.84%

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 tries 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 (“AFS”) securities. Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds. At December 31, 2018, rate sensitive assets and rate sensitive liabilities totaled $1.0 billion and $657.1 million, respectively.

Included in the rate sensitive assets are $279.1 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the Federal Open Market Committee (“FOMC”). The Bank utilizes interest rate floors on certain variable rate loans to protect against further downward movements in the prime rate. At December 31, 2018, the Bank had $161.4 million in loans with interest rate floors. The floors were in effect on $2.5 million of these loans pursuant to the terms of the promissory notes on these loans. The weighted average rate on these loans is 0.47% higher than the indexed rate on the promissory notes without interest rate floors.

An analysis of the Company’s financial condition and growth can be made by examining the changes and trends in interest-earning assets and interest-bearing liabilities. A discussion of these changes and trends follows.

Analysis of Financial Condition

Investment Securities. The composition of the investment securities portfolio reflects the Company’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits.

All of the Company’s investment securities are held in the AFS category. At December 31, 2018, the market value of AFS securities totaled $194.6 million, compared to $229.3 million and $249.9 million at December 31, 2017 and 2016, respectively. Table 7 presents the fair value of the AFS securities held at December 31, 2018, 2017 and 2016.

 

A-12

Table 7 - Summary of Investment Portfolio
(Dollars in thousands)	2018	2017	2016
U. S. Government sponsored enterprises	$34,634	40,380	38,222
State and political subdivisions	107,591	133,570	141,856
Mortgage-backed securities	52,103	53,609	67,585
Corporate bonds	-	1,512	1,533
Trust preferred securities	250	250	750
Total securities	$194,578	229,321	249,946

The Company’s investment portfolio consists of U.S. Government sponsored enterprise securities, municipal securities, U.S. Government sponsored enterprise mortgage-backed securities, corporate bonds, trust preferred securities and equity securities. AFS securities averaged $209.7 million in 2018, $234.3 million in 2017 and $252.7 million in 2016. Table 8 presents the book value of AFS securities held by the Company by maturity category at December 31, 2018. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields are calculated on a tax equivalent basis. Yields and interest income on tax-exempt investments 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.

Table 8 - Maturity Distribution and Weighted Average Yield on Investments
			After One Year		After 5 Years
	One Year or Less		Through 5 Years		Through 10 Years		After 10 Years		Totals
(Dollars in thousands)	Amount	Yield	Amount	Yield	Amount	Yield	Amount	Yield	Amount	Yield
Book value:
U.S. Government
sponsored enterprises	$2,356	-0.86%	13,956	2.01%	16,307	2.94%	2,737	4.34%	35,356	1.35%
State and political subdivisions	19,023	3.80%	66,976	3.17%	15,965	3.28%	3,581	3.95%	105,545	3.52%
Mortgage-backed securities	6,215	3.29%	20,056	3.29%	12,534	3.34%	13,340	3.33%	52,145	3.30%
Trust preferred securities	-	-	-	-	-	-	250	8.11%	250	8.11%
Total securities	$27,594	2.99%	100,988	3.05%	44,806	3.10%	19,908	3.91%	193,296	3.14%

Loans. The loan portfolio is the largest category of the Company’s earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Wake and Durham counties in North Carolina.

Although the Company 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 December 31, 2018, the Company had $102.1 million in residential mortgage loans, $106.9 million in home equity loans and $376.6 million in commercial mortgage loans, which include $300.3 million secured by commercial property and $76.3 million secured by residential property. Residential mortgage loans include $34.3 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.

At December 31, 2018, the Bank had $94.1 million in construction and land development loans. Table 9 presents a breakout of these loans.

Table 9 - Construction and Land Development Loans
(Dollars in thousands)	Number of Loans	Balance Outstanding	Non-accrual Balance
Land acquisition and development - commercial purposes	44	$9,777	-
Land acquisition and development - residential purposes	196	19,097	1
1 to 4 family residential construction	137	26,933	-
Commercial construction	25	38,371	-
Total acquisition, development and construction	402	$94,178	1

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The mortgage loans originated in the traditional banking offices are generally 15 to 30 year fixed rate loans with attributes that prevent the loans from being sellable in the secondary market. These factors may include higher loan-to-value ratio, limited documentation on income, non-conforming appraisal or non-conforming property type. These loans are generally made to existing Bank customers and have been originated throughout the Bank’s seven county service area, with no geographic concentration.

 

The composition of the Bank’s loan portfolio at December 31 is presented in Table 10.

Table 10 - Loan Portfolio
	2018		2017		2016		2015		2014
(Dollars in thousands)	Amount	% of Loans	Amount	% of Loans	Amount	% of Loans	Amount	% of Loans	Amount	% of Loans
Real estate loans
Construction and land development	$94,178	11.71%	84,987	11.19%	61,749	8.53%	65,791	9.55%	57,617	8.84%
Single-family residential	252,983	31.47%	246,703	32.47%	240,700	33.25%	220,690	32.03%	206,417	31.66%
Single-family residential- Banco de la
Gente non-traditional	34,261	4.26%	37,249	4.90%	40,189	5.55%	43,733	6.35%	47,015	7.21%
Commercial	270,055	33.59%	248,637	32.73%	247,521	34.20%	228,526	33.16%	228,558	35.06%
Multifamily and farmland	33,163	4.12%	28,937	3.81%	21,047	2.91%	18,080	2.62%	12,400	1.90%
Total real estate loans	684,640	85.15%	646,513	85.10%	611,206	84.44%	576,820	83.71%	552,007	84.68%
Loans not secured by real estate
Commercial loans	97,465	12.12%	89,022	11.71%	87,596	12.11%	91,010	13.22%	76,262	11.71%
Farm loans	926	0.12%	1,204	0.16%	-	0.00%	3	0.00%	7	0.00%
Consumer loans	9,165	1.14%	9,888	1.30%	9,832	1.36%	10,027	1.46%	10,060	1.54%
All other loans	11,827	1.47%	13,137	1.73%	15,177	2.10%	11,231	1.63%	13,555	2.08%
Total loans	804,023	100.00%	759,764	100.00%	723,811	100.00%	689,091	100.00%	651,891	100.00%
Less: Allowance for loan losses	6,445		6,366		7,550		9,589		11,082
Net loans	$797,578		753,398		716,261		679,502		640,809

As of December 31, 2018, gross loans outstanding were $804.0 million, compared to $759.8 million at December 31, 2017. Average loans represented 71% and 74% of total earning assets for the years ended December 31, 2018 and 2017, respectively. The Bank had $680,000 and $857,000 in mortgage loans held for sale as of December 31, 2018 and 2017, respectively.

Troubled debt restructured (“TDR”) modified in 2018, past due TDR loans and non-accrual TDR loans totaled $4.7 million and $4.5 million at December 31, 2018 and December 31, 2017, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were $92,000 and $21,000 in performing loans classified as TDR loans at December 31, 2018 and December 31, 2017, respectively.

Table 11 identifies the maturities of all loans as of December 31, 2018 and addresses the sensitivity of these loans to changes in interest rates. 

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Table 11 - Maturity and Repricing Data for Loans
(Dollars in thousands)	Within one year or less	After one year through five years	After five years	Total loans
Real estate loans
Construction and land development	$44,536	17,357	32,285	94,178
Single-family residential	118,229	88,338	46,416	252,983
Single-family residential- Banco de la Gente
stated income	15,061	-	19,200	34,261
Commercial	82,210	141,347	46,498	270,055
Multifamily and farmland	4,560	14,761	13,842	33,163
Total real estate loans	264,596	261,803	158,241	684,640
Loans not secured by real estate
Commercial loans	56,679	23,910	16,876	97,465
Farm loans	691	235	-	926
Consumer loans	5,127	3,777	261	9,165
All other loans	6,130	3,042	2,655	11,827
Total loans	$333,223	292,767	178,033	804,023
Total fixed rate loans	$19,599	245,838	178,033	443,470
Total floating rate loans	313,624	46,929	-	360,553
Total loans	$333,223	292,767	178,033	804,023

In the normal course of business, there are various commitments outstanding to extend credit that are not reflected in the financial statements. At December 31, 2018, outstanding loan commitments totaled $272.4 million. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Additional information regarding commitments is provided below in the section entitled “Contractual Obligations and Off-Balance Sheet Arrangements” and in Note 10 to the Consolidated Financial Statements.

Allowance for Loan Losses. The allowance for loan 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 for loan losses 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. Other factors considered are:

●

the Bank’s loan loss experience;

●

the amount of past due and non-performing loans;

●

specific known risks;

●

the status and amount of other past due and non-performing assets;

●

underlying estimated values of collateral securing loans;

●

current and anticipated economic conditions; and

●

other factors which management believes affect the allowance for potential credit losses.

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 Bank’s Board of Directors 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.

 

A-15

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 $1.0 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’s Board of Directors.

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. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance for loan losses. The provision for loan losses charged or credited to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management’s assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance for loan losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four or five years’ loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2018 as compared to the year ended December 31, 2017. Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, certain mortgage loans from the former Banco division of the Bank were 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.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. 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 GAAP, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance for loan losses 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.

A-16

Net charge-offs for 2018, 2017 and 2016 were $711,000, $677,000 and $833,000, respectively. The ratio of net charge-offs to average total loans was 0.09%in 2018, 0.09% in 2017 and 0.12% in 2016. The Bank strives to proactively work with its customers to identify potential problems. If found, the Bank works to quickly recognize identifiable losses and to establish a plan, with the borrower, if possible, to have the loans paid off. This process of early identification increased the levels of charge-offs and provision for loan losses in 2009 through 2013 as compared to historical periods prior to 2009. The years ended December 31, 2016, 2017 and 2018 saw net charge-offs at historically low levels.. The current level of past due and non-accrual loans currently indicate that net charge-offs may remain near these historical lows. The allowance for loan losses was $6.4 million or 0.80% of total loans outstanding at December 31, 2018. For December 31, 2017 and 2016, the allowance for loan losses amounted to $6.4 million or 0.84% of total loans outstanding and $7.6 million, or 1.04% of total loans outstanding, respectively.

Table 12 presents the percentage of loans assigned to each risk grade at December 31, 2018 and 2017.

Table 12 - Loan Risk Grade Analysis
	Percentage of Loans
	By Risk Grade
Risk Grade	2018	2017
Risk Grade 1 (Excellent Quality)	0.94%	1.31%
Risk Grade 2 (High Quality)	25.47%	26.23%
Risk Grade 3 (Good Quality)	60.85%	60.67%
Risk Grade 4 (Management Attention)	10.19%	8.19%
Risk Grade 5 (Watch)	1.72%	2.54%
Risk Grade 6 (Substandard)	0.84%	1.04%
Risk Grade 7 (Doubtful)	0.00%	0.00%
Risk Grade 8 (Loss)	0.00%	0.00%

Table 13 presents an analysis of the allowance for loan losses, including charge-off activity.

Table 13 - Analysis of Allowance for Loan Losses
(Dollars in thousands)	2018	2017	2016	2015	2014
Allowance for loan losses at beginning	$6,366	7,550	9,589	11,082	13,501
Loans charged off:
Commercial	54	194	146	38	430
Real estate - mortgage	574	315	593	1,064	789
Real estate - construction	53	-	7	197	884
Consumer	452	473	492	545	534
Total loans charged off	1,133	982	1,238	1,844	2,637
Recoveries of losses previously charged off:
Commercial	32	31	170	101	54
Real estate - mortgage	212	106	74	77	259
Real estate - construction	10	14	10	45	428
Consumer	168	154	151	145	176
Total recoveries	422	305	405	368	917
Net loans charged off	711	677	833	1,476	1,720
Provision for loan losses	790	(507)	(1,206)	(17)	(699)
Allowance for loan losses at end of year	$6,445	6,366	7,550	9,589	11,082
Loans charged off net of recoveries, as
a percent of average loans outstanding	0.09%	0.09%	0.12%	0.22%	0.27%
Allowance for loan losses as a percent
of total loans outstanding at end of year	0.80%	0.84%	1.04%	1.39%	1.70%

A-17

Non-performing Assets. Non-performing assets were $3.3 million or 0.31% of total assets at December 31, 2018, compared to $3.8 million or 0.35% of total assets at December 31, 2017. Non-performing loans include $3.2 million in commercial and residential mortgage loans, $1,000 in construction and land development loans and $99,000 in other loans at December 31, 2018, as compared to $3.6 million in commercial and residential mortgage loans, $14,000 in construction and land development loans and $112,000 in other loans at December 31, 2017. Other real estate owned totaled $27,000 and $118,000 as of December 31, 2018 and 2017, respectively. The Bank had no repossessed assets as of December 31, 2018 and 2017.

At December 31, 2018, the Bank had non-performing loans, defined as non-accrual and accruing loans past due more than 90 days, of $3.3 million or 0.41% of total loans. Non-performing loans at December 31, 2017 were $3.7 million or 0.49% of total loans.

Management continually monitors the loan portfolio to ensure that all loans potentially having a material adverse impact on future operating results, liquidity or capital resources have been classified as non-performing. Should economic conditions deteriorate, the inability of distressed customers to service their existing debt could cause higher levels of non-performing loans. Management expects the level of non-accrual loans to continue to be in-line with the level of non-accrual loans at December 31, 2018 and 2017.

It is the general policy of the Bank to stop accruing interest income when a loan is placed on non-accrual status and any interest previously accrued but not collected is reversed against current income. Generally a loan is placed on non-accrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected.

A summary of non-performing assets at December 31 for each of the years presented is shown in Table 14.

Table 14 - Non-performing Assets
(Dollars in thousands)	2018	2017	2016	2015	2014
Non-accrual loans	$3,314	3,711	3,825	8,432	10,728
Loans 90 days or more past due and still accruing	-	-	-	17	-
Total non-performing loans	3,314	3,711	3,825	8,449	10,728
All other real estate owned	27	118	283	739	2,016
Repossessed assets	-	-	-	-	-
Total non-performing assets	$3,341	3,829	4,108	9,188	12,744
TDR loans not included in above,
(not 90 days past due or on nonaccrual)	3,173	2,543	3,337	5,102	7,217
As a percent of total loans at year end
Non-accrual loans	0.41%	0.49%	0.53%	1.22%	1.65%
Loans 90 days or more past due and still accruing	0.00%	0.00%	0.00%	0.00%	0.00%
Total non-performing assets
as a percent of total assets at year end	0.31%	0.35%	0.38%	0.88%	1.22%
Total non-performing loans
as a percent of total loans at year-end	0.41%	0.49%	0.53%	1.23%	1.65%

Deposits. The Company primarily uses deposits to fund its loan and investment portfolios. The Company offers a variety of deposit accounts to individuals and businesses. Deposit accounts include checking, savings, money market and time deposits. As of December 31, 2018, total deposits were $877.2 million, compared to $907.0 million at December 31, 2017. Core deposits, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $250,000, amounted to $859.2 million at December 31, 2018, compared to $887.4 million at December 31, 2017.

Time deposits in amounts of $250,000 or more totaled $16.2 million and $18.8 million at December 31, 2018 and 2017, respectively. At December 31, 2018, brokered deposits amounted to $3.4 million as compared to $5.2 million at December 31, 2017. Certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) included in brokered deposits amounted to $3.4 million and $5.2 million as of December 31, 2018 and 2017, respectively. Brokered deposits are generally considered to be more susceptible to withdrawal as a result of interest rate changes and to be a less stable source of funds, as compared to deposits from the local market. Brokered deposits outstanding as of December 31, 2018 have a weighted average rate of 0.07% with a weighted average original term of 41 months.

A-18

Table 15 is a summary of the maturity distribution of time deposits in amounts of $250,000 or more as of December 31, 2018.

Table 15 - Maturities of Time Deposits of $250,000 or greater
(Dollars in thousands)	2018
Three months or less	$4,199
Over three months through six months	1,347
Over six months through twelve months	2,176
Over twelve months	8,517
Total	$16,239

Borrowed Funds. The Company has access to various short-term borrowings, including the purchase of federal funds and borrowing arrangements from the FHLB and other financial institutions. There were no FHLB borrowings outstanding at December 31, 2018 and 2017. Average FHLB borrowings for 2018 and 2017 were zero and $16.3 million, respectively. The maximum amount of outstanding FHLB borrowings was $20.0 million in 2017.Additional information regarding FHLB borrowings is provided in Note 6 to the Consolidated Financial Statements.

The Bank had no borrowings from the FRB at December 31, 2018 and 2017. FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At December 31, 2018, the carrying value of loans pledged as collateral totaled approximately $442.6 million.

Securities sold under agreements to repurchase were $58.1 million at December 31, 2018, as compared to $37.8 million at December 31, 2017.

Junior subordinated debentures were $20.6 million as of December 31, 2018 and 2017.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations and other commitments as of December 31, 2018 are summarized in Table 16 below. 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. Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below.

Table 16 - Contractual Obligations and Other Commitments
(Dollars in thousands)	Within One Year	One to Three Years	Three to Five Years	Five Years or More	Total
Contractual Cash Obligations
Junior subordinated debentures	$-	-	-	20,619	20,619
Operating lease obligations	734	1,416	703	1,465	4,318
Total	$734	1,416	703	22,084	24,937
Other Commitments
Commitments to extend credit	$104,152	27,335	24,902	112,319	268,708
Standby letters of credit
and financial guarantees written	3,651	-	-	-	3,651
Income tax credits	535	101	63	56	755
Total	$108,338	27,436	24,965	112,375	273,114

               The Company enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Therefore, the derivative amounts recorded on the balance sheet do not represent the amounts that may ultimately be paid under these contracts. Further discussions of derivative instruments are included above in the section entitled “Asset Liability and Interest Rate Risk Management” beginning on page A-11 and in Notes 1, 10 and 15 to the Consolidated Financial Statements. There were no derivatives at December 31, 2018 or 2017.

A-19

Capital Resources. Shareholders’ equity was $123.6 million, or 11.31% of total assets, as of December 31, 2018, compared to $116.0 million, or 10.62% of total assets, as of December 31, 2017. The increase in shareholders’ equity is primarily due to an increase in retained earnings due to net income.

Average shareholders’ equity as a percentage of total average assets is one measure used to determine capital strength. Average shareholders’ equity as a percentage of total average assets was 11.31%, 10.64% and 10.51% for 2018, 2017 and 2016, respectively. The return on average shareholders’ equity was 10.81% at December 31, 2018 as compared to 8.78% and 8.11% at December 31, 2017 and December 31, 2016, respectively. Total cash dividends paid on common stock were $3.1 million, $2.6 million and $2.1 million during 2018, 2017 and 2016 respectively. The Company did not pay any dividends on preferred stock during 2018 and 2017.

The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares. The Board is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights.

In 2016, the Company’s Board of Directors authorized a stock repurchase program, pursuant to which up to $2.0 million was allocated to repurchase the Company’s common stock. Any purchases under the Company’s stock repurchase program were 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 were determined by the Company’s management, based on its evaluation of market conditions and other factors. The Company has repurchased approximately $2.0 million, or 92,738 shares of its common stock, under this program as of December 31, 2017.

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 are being 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 at 0.625% and is being phased in through 2019 (increasing by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019). This will result 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 at December 31, 2018 and December 31, 2017 includes $20.0 million in trust preferred securities. The Company’s Tier 1 capital ratio was 15.46% and 15.32% at December 31, 2018 and December 31, 2017, 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 loan 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 16.15% and 16.06% at December 31, 2018 and December 31, 2017, 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 13.29% and 13.00% at December 31, 2018 and December 31, 2017, 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 13.05% and 11.94% at December 31, 2018 and December 31, 2017, respectively.

The Bank’s Tier 1 risk-based capital ratio was 15.21% and 15.09% at December 31, 2018 and December 31, 2017, respectively. The total risk-based capital ratio for the Bank was 15.91% and 15.83% at December 31, 2018 and December 31, 2017, respectively. The Bank’s common equity Tier 1 capital ratio was 15.21% and 15.09% at December 31, 2018 and December 31, 2017, respectively. The Bank’s Tier 1 leverage capital ratio was 12.76% and 11.69% at December 31, 2018 and December 31, 2017, respectively.

 

A-20

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 December 31, 2018.

The Company’s key equity ratios as of December 31, 2018, 2017 and 2016 are presented in Table 17.

Table 17 - Equity Ratios
	2018	2017	2016
Return on average assets	1.22%	0.93%	0.85%
Return on average equity	10.81%	8.78%	8.11%
Dividend payout ratio	23.41%	25.67%	22.95%
Average equity to average assets	11.31%	10.64%	10.51%

 Quarterly Financial Data. The Company’s consolidated quarterly operating results for the years ended December 31, 2018 and 2017 are presented in Table 18.

Table 18 - Quarterly Financial Data

	2018				2017
(Dollars in thousands, except per share amounts)	First	Second	Third	Fourth	First	Second	Third	Fourth
Total interest income	$10,759	11,059	11,608	11,924	$10,064	10,461	10,698	10,726
Total interest expense	467	513	557	609	598	622	650	507
Net interest income	10,292	10,546	11,051	11,315	9,466	9,839	10,048	10,219
(Reduction of) provision for loan losses	31	231	110	418	(236)	49	(218)	(102)
Other income	3,736	4,016	3,915	4,499	3,442	3,929	4,159	3,834
Other expense	10,042	10,560	10,702	11,270	10,361	9,983	10,006	10,878
Income before income taxes	3,955	3,771	4,154	4,126	2,783	3,736	4,419	3,277
Income taxes (benefit)	652	595	687	690	578	925	1,177	1,267
Net earnings	3,303	3,176	3,467	3,436	2,205	2,811	3,242	2,010
Basic net earnings per share	$0.55	0.53	0.58	0.57	$0.36	0.47	0.54	0.34
Diluted net earnings per share	$0.55	0.53	0.57	0.57	$0.36	0.46	0.53	0.34

A-21

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates. This risk of loss can be reflected in either diminished current market values or reduced potential net interest income in future periods.

The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. The structure of the Company’s loan and deposit portfolios is such that a significant decline (increase) in interest rates may adversely (positively)impact net market values and interest income. Management seeks to manage the risk through the utilization of its investment securities and off-balance sheet derivative instruments. During the years ended December 31, 2018, 2017 and 2016, the Company used interest rate contracts to manage market risk as discussed above in the section entitled “Asset Liability and Interest Rate Risk Management.”

Table 19 presents in tabular form the contractual balances and the estimated fair value of the Company’s on-balance sheet financial instruments at their expected maturity dates for the period ended December 31, 2018. The expected maturity categories take into consideration historical prepayment experience as well as management’s expectations based on the interest rate environment at December 31, 2018. For core deposits without contractual maturity (i.e. interest-bearing checking, savings, and money market accounts), the table presents principal cash flows based on management’s judgment concerning their most likely runoff or repricing behaviors.

Table 19 - Market Risk Table
(Dollars in thousands)
Loans Receivable	2019	2020	2021	2022	2023	Thereafter	Total	Fair Value
Fixed rate	$34,451	33,452	54,215	66,253	91,918	180,479	460,768	411,427
Average interest rate	4.90%	4.95%	4.78%	4.88%	5.24%	5.03%
Variable rate	$65,371	31,409	22,619	22,166	33,255	169,115	343,935	344,615
Average interest rate	6.10%	5.90%	6.11%	6.12%	5.87%	5.51%
Total							804,703	756,042
Investment Securities
Interest bearing cash	$2,817	-	-	-	-	-	2,817	2,817
Average interest rate	2.35%	-	-	-	-	-
Securities available for sale	$21,207	18,467	16,674	22,980	22,387	92,863	194,578	194,578
Average interest rate	4.36%	4.03%	4.56%	4.44%	4.46%	4.27%
Nonmarketable equity securities	$-	-	-	-	-	4,361	4,361	4,361
Average interest rate	-	-	-	-	-	2.87%
Debt Obligations
Deposits	$58,782	21,661	14,093	2,655	3,145	776,877	877,213	857,999
Average interest rate	0.24%	0.42%	0.62%	0.65%	0.98%	0.05%
Securities sold under agreement
to repurchase	$58,095	-	-	-	-	-	58,095	58,095
Average interest rate	0.44%	-	-	-	-	-
Junior subordinated debentures	$-	-	-	-	-	20,619	20,619	20,619
Average interest rate	-	-	-	-	-	4.42%

A-22

Table 20 presents the simulated impact to net interest income under varying interest rate scenarios and the theoretical impact of rate changes over a twelve-month period referred to as “rate ramps.” The table shows the estimated theoretical impact on the Company’s tax equivalent net interest income from hypothetical rate changes of plus and minus 1%, 2% and 3% as compared to the estimated theoretical impact of rates remaining unchanged. The table also shows the simulated impact to market value of equity under varying interest rate scenarios and the theoretical impact of immediate and sustained rate changes referred to as “rate shocks” of plus and minus 1%, 2% and 3% as compared to the theoretical impact of rates remaining unchanged. The prospective effects of the hypothetical interest rate changes are based upon various assumptions, including relative and estimated levels of key interest rates. This type of modeling has limited usefulness because it does not allow for the strategies management would utilize in response to sudden and sustained rate changes. Also, management does not believe that rate changes of the magnitude presented are likely in the forecast period presented.

Table 20 - Interest Rate Risk
(Dollars in thousands)
	Estimated Resulting Theoretical Net Interest Income
Hypothetical rate change (ramp over 12 months)	Amount	% Change
+3%	$50,196	3.32%
+2%	$50,008	2.94%
+1%	$49,363	1.61%
0%	$48,582	0.00%
-1%	$47,315	-2.61%
-2%	$46,160	-4.99%
-3%	$45,727	-5.88%
	Estimated Resulting Theoretical Market Value of Equity
Hypothetical rate change (immediate shock)	Amount	% Change
+3%	$183,598	8.06%
+2%	$188,528	10.96%
+1%	$184,838	8.79%
0%	$169,908	0.00%
-1%	$145,669	-14.27%
-2%	$114,949	-32.35%
-3%	$91,103	-46.38%

A-23

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Financial Statements

December 31, 2018, 2017 and 2016

INDEX

	PAGE(S)
Reports of Independent Registered Public Accounting Firm on the Consolidated Financial Statements	A-25 - A-27
Financial Statements
Consolidated Balance Sheets at December 31, 2018 and 2017	A-28
Consolidated Statements of Earnings for the years ended December 31, 2018, 2017 and 2016	A-29
Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 2017 and 2016	A-30
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2018, 2017 and 2016	A-31
Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017 and 2016	A-32 - A-33
Notes to Consolidated Financial Statements	A-34 - A-68

A-24

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of Peoples Bancorp of North Carolina, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Peoples Bancorp of North Carolina, Inc. and its subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 14, 2019 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Elliott Davis, PLLC

We have served as the Company's auditor since 2015.

Charlotte, North Carolina

March 14, 2019

  elliottdavis.com

A-25

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of Peoples Bancorp of North Carolina, Inc.:

Opinion on the Internal Control Over Financial Reporting

We have audited Peoples Bancorp of North Carolina, Inc.'s (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of earnings, comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes to the consolidated financial statements and our report dated March 14, 2019 expressed an unqualified opinion.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Annual Report on Internal Controls over Financial Reporting Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

elliottdavis.com

A-26

Definition and Limitations of Internal Control Over Financial Reporting

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Elliott Davis, PLLC

Charlotte, North Carolina

March 14, 2019

A-27

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Balance Sheets

December 31, 2018 and December 31, 2017

(Dollars in thousands)

	December 31,	December 31,
Assets	2018	2017
Cash and due from banks, including reserve requirements	$40,553	53,186
of $8,918 at 12/31/18 and $7,472 at 12/31/17
Interest-bearing deposits	2,817	4,118
Cash and cash equivalents	43,370	57,304
Investment securities available for sale	194,578	229,321
Other investments	4,361	1,830
Total securities	198,939	231,151
Mortgage loans held for sale	680	857
Loans	804,023	759,764
Less allowance for loan losses	(6,445)	(6,366)
Net loans	797,578	753,398
Premises and equipment, net	18,450	19,911
Cash surrender value of life insurance	15,936	15,552
Other real estate	27	118
Accrued interest receivable and other assets	18,271	13,875
Total assets	$1,093,251	1,092,166
Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing demand	$298,817	285,406
NOW, MMDA & savings	475,223	498,445
Time, $250,000 or more	16,239	18,756
Other time	86,934	104,345
Total deposits	877,213	906,952
Securities sold under agreements to repurchase	58,095	37,757
Junior subordinated debentures	20,619	20,619
Accrued interest payable and other liabilities	13,707	10,863
Total liabilities	969,634	976,191
Commitments (Note 10)
Shareholders' equity:
Series A preferred stock, $1,000 stated value; authorized
5,000,000 shares; no shares issued and outstanding	-	-
Common stock, no par value; authorized
20,000,000 shares; issued and outstanding 5,995,256 shares
at December 31, 2018 and December 31, 2017	62,096	62,096
Retained earnings	60,535	50,286
Accumulated other comprehensive income	986	3,593
Total shareholders' equity	123,617	115,975
Total liabilities and shareholders' equity	$1,093,251	1,092,166

See accompanying Notes to Consolidated Financial Statements.

A-28

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Earnings

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands, except per share amounts)

	2018	2017	2016
Interest income:
Interest and fees on loans	$38,654	34,888	32,452
Interest on due from banks	304	219	123
Interest on investment securities:
U.S. Government sponsored enterprises	2,333	2,404	2,531
States and political subdivisions	3,877	4,236	4,454
Other	182	202	249
Total interest income	45,350	41,949	39,809
Interest expense:
NOW, MMDA & savings deposits	769	598	495
Time deposits	472	466	586
FHLB borrowings	-	662	1,661
Junior subordinated debentures	790	590	485
Other	115	61	44
Total interest expense	2,146	2,377	3,271
Net interest income	43,204	39,572	36,538
Provision for (reduction of) loan losses	790	(507)	(1,206)
Net interest income after provision for loan losses	42,414	40,079	37,744
Non-interest income:
Service charges	4,355	4,453	4,497
Other service charges and fees	705	593	890
Gain on sale of securities	15	-	729
Mortgage banking income	851	1,190	1,428
Insurance and brokerage commissions	824	761	632
Appraisal management fee income	3,206	3,306	3,146
Gain (loss) on sales and write-downs of
other real estate	17	(239)	64
Miscellaneous	6,193	5,300	4,850
Total non-interest income	16,166	15,364	16,236
Non-interest expense:
Salaries and employee benefits	21,530	20,058	19,264
Occupancy	7,170	6,701	6,765
Professional fees	1,525	1,236	2,439
Advertising	922	1,195	1,136
Debit card expense	994	1,248	1,141
FDIC insurance	328	347	494
Appraisal management fee expense	2,460	2,526	2,260
Other	7,645	7,917	8,743
Total non-interest expense	42,574	41,228	42,242
Earnings before income taxes	16,006	14,215	11,738
Income tax expense	2,624	3,947	2,561
Net earnings	$13,382	10,268	9,177
Basic net earnings per share	$2.23	1.71	1.53
Diluted net earnings per share	$2.22	1.69	1.50
Cash dividends declared per share	$0.52	0.44	0.35

See accompanying Notes to Consolidated Financial Statements.

A-29

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Comprehensive Income

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

	2018	2017	2016
Net earnings	$13,382	10,268	9,177
Other comprehensive income (loss):
Unrealized holding losses on securities
available for sale	(3,370)	(355)	(3,274)
Reclassification adjustment for gains on
securities available for sale
included in net earnings	(15)	-	(729)
Total other comprehensive loss,
before income taxes	(3,385)	(355)	(4,003)
Income tax benefit related to other
comprehensive loss:
Unrealized holding losses on securities
available for sale	(774)	(354)	(1,196)
Reclassification adjustment for gains on
securities available for sale
included in net earnings	(4)	-	(284)
Total income tax benefit related to
other comprehensive loss	(778)	(354)	(1,480)
Total other comprehensive loss,
net of tax	(2,607)	(1)	(2,523)
Total comprehensive income	$10,775	10,267	6,654

See accompanying Notes to Consolidated Financial Statements.

A-30

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Changes in Shareholders' Equity

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

				Accumulated
	Common	Common		Other
	Stock	Stock	Retained	Comprehensive
	Shares	Amount	Earnings	Income	Total
Balance, December 31, 2015	5,510,538	$46,171	53,183	5,510	104,864
Common stock
repurchase	(92,738)	(1,984)	-	-	(1,984)
Cash dividends declared on
common stock	-	-	(2,106)	-	(2,106)
Net earnings	-	-	9,177	-	9,177
Change in accumulated other
comprehensive income,
net of tax	-	-	-	(2,523)	(2,523)
Balance, December 31, 2016	5,417,800	$44,187	60,254	2,987	107,428
Cash dividends declared on
common stock	-	-	(2,629)	-	(2,629)
10% stock dividend	544,844	16,994	(17,000)	-	(6)
Restricted stock units exercised	32,612	915	-	-	915
Net earnings	-	-	10,268	-	10,268
Change in accumulated other
comprehensive income due to
Tax Cuts and Jobs Act	-	-	(607)	607	-
Change in accumulated other
comprehensive income,
net of tax	-	-	-	(1)	(1)
Balance, December 31, 2017	5,995,256	$62,096	50,286	3,593	115,975
Cash dividends declared on
common stock	-	-	(3,133)	-	(3,133)
Net earnings	-	-	13,382	-	13,382
Change in accumulated other
comprehensive income,
net of tax	-	-	-	(2,607)	(2,607)
Balance, December 31, 2018	5,995,256	$62,096	60,535	986	123,617

See accompanying Notes to Consolidated Financial Statements.

A-31

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

	2018	2017	2016
Cash flows from operating activities:
Net earnings	$13,382	10,268	9,177
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation, amortization and accretion	4,571	5,018	5,423
Provision for (reduction of) loan losses	790	(507)	(1,206)
Deferred income taxes	78	2,120	1,097
Gain on sale of investment securities	(15)	-	(729)
Gain on sale of other real estate	(17)	-	(81)
Write-down of other real estate	-	239	17
Gain on sale of premises and equipment	(544)	-	-
Restricted stock expense	85	592	932
Proceeds from sales of loans held for sale	35,922	59,193	67,764
Origination of loans held for sale	(35,745)	(54,341)	(69,324)
Change in:
Cash surrender value of life insurance	(384)	(600)	(406)
Other assets	(3,695)	(3,982)	(636)
Other liabilities	2,759	594	211
Net cash provided by operating activities	17,187	18,594	12,239
Cash flows from investing activities:
Purchases of investment securities available for sale	(34,692)	(10,014)	(12,707)
Proceeds from sales, calls and maturities of investment securities
available for sale	48,241	10,162	4,053
Proceeds from paydowns of investment securities available for sale	15,556	17,202	20,675
Purchases of other investments	(2,611)	(45)	(255)
Proceeds from paydowns of other investment securities	117	-	-
Net change in FHLB stock	(4)	850	1,256
Net change in loans	(45,094)	(36,748)	(36,116)
Purchases of premises and equipment	(1,742)	(5,557)	(1,610)
Proceeds from sale of premises and equipment	1,410	-	-
Proceeds from sale of other real estate and repossessions	232	44	1,083
Net cash used by investing activities	(18,587)	(24,106)	(23,621)
Cash flows from financing activities:
Net change in deposits	(29,739)	14,034	60,743
Net change in securities sold under agreement to repurchase	20,338	1,323	8,560
Proceeds from FHLB borrowings	-	1	6,000
Repayments of FHLB borrowings	-	(20,001)	(29,500)
Proceeds from FRB borrowings	1	1	1
Repayments of FRB borrowings	(1)	(1)	(1)
Proceeds from Fed Funds Purchased	4,277	187	9,112
Repayments of Fed Funds Purchased	(4,277)	(187)	(9,112)
Common stock repurchased	-	-	(1,984)
Cash dividends paid in lieu of fractional shares	-	(6)	-
Cash dividends paid on common stock	(3,133)	(2,629)	(2,106)
Net cash (used) provided by financing activities	(12,534)	(7,278)	41,713
Net change in cash and cash equivalents	(13,934)	(12,790)	30,331
Cash and cash equivalents at beginning of period	57,304	70,094	39,763
Cash and cash equivalents at end of period	$43,370	57,304	70,094

A-32

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows, continued

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

	2018	2017	2016
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$2,128	2,526	3,415
Income taxes	$1,163	2,408	2,028
Noncash investing and financing activities:
Change in unrealized (loss) gain on investment securities
available for sale, net	$(2,607)	(1)	(2,523)
Transfer of loans to other real estate and repossessions	$124	118	563
Issuance of accrued restricted stock units	$-	(915)	-

See accompanying Notes to Consolidated Financial Statements.

A-33

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Notes to Consolidated Financial Statements

(1) 

Summary of Significant Accounting Policies

Organization

Peoples Bancorp of North Carolina, Inc. (“Bancorp”) received regulatory approval to operate as a bank holding company on July 22, 1999, and became effective August 31, 1999. Bancorp is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for Peoples Bank (the “Bank”).

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is primarily regulated by the Commissioner and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell, Wake and Durham counties in North Carolina.

Peoples Investment Services, Inc. is a wholly owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC (“CBRES”) is a wholly owned subsidiary of the Bank and began operations in 2009 as a “clearing house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property is located.

PB Real Estate Holdings, LLC (“PBREH”) is a wholly owned subsidiary of the Bank and began operation in 2015. PBREH acquires, manages and disposes of real property, other collateral and other assets obtained in the ordinary course of collecting debts previously contracted.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a division of the Bank under the name Banco de la Gente (“Banco”). These offices are now branded as Bank branches and considered a separate market territory of the Bank as they offer normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans.

Principles of Consolidation

The consolidated financial statements include the financial statements of Bancorp and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc., REAS, CBRES and PBREH (collectively called the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Cash and Cash Equivalents

Cash, due from banks and interest-bearing deposits are considered cash and cash equivalents for cash flow reporting purposes.

  A-34

Investment Securities

There are three classifications the Company is able to classify its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2018 and 2017, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on an annual basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield. Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

The allowance for loan 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 for loan losses 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. Other factors considered are:

●

the Bank’s loan loss experience;

●

the amount of past due and non-performing loans;

●

specific known risks;

●

the status and amount of other past due and non-performing assets;

●

underlying estimated values of collateral securing loans;

●

current and anticipated economic conditions; and

●

other factors which management believes affect the allowance for potential credit losses.

A-35

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 Bank’s Board of Directors 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 $1.0 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’s Board of Directors.

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. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance for loan losses. The provision for loan losses charged or credited to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management’s assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance for loan losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four or five years’ loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2018 as compared to the year ended December 31, 2017. Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

A-36

Effective December 31, 2012, certain mortgage loans from the former Banco division of the Bank were 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.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. 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 GAAP, and has taken into account the views of its regulators and the current economic environment.Management considers the allowance for loan losses 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.

Mortgage Banking Activities

Mortgage banking income represents net gains from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $866,000, $1.0 million and $1.4 million at December 31, 2018, 2017 and 2016, respectively.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale. The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts. The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for that period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

Buildings and improvements	10 - 50 years
Furniture and equipment	3 - 10 years

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan. Foreclosed assets are reported at fair value less estimated selling costs. Any write-downs at the time of foreclosure are charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value less estimated selling costs declines below carrying value. Costs relating to the development and improvement of the property are capitalized. Revenues and expenses from operations are included in other expenses. Changes in the valuation allowance are included in loss on sale and write-down of other real estate.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of 

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the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning  strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Derivative Financial Instruments and Hedging Activities

In the normal course of business, the Company enters into derivative contracts to manage interest rate risk by modifying the characteristics of the related balance sheet instruments in order to reduce the adverse effect of changes in interest rates. All material derivative financial instruments are recorded at fair value in the financial statements. The fair value of derivative contracts related to the origination of fixed rate mortgage loans and the commitments to sell these loans to a third party is immaterial and has no effect on the recorded amounts in the financial statements.

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of, and gains and losses on, derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

On the date a derivative contract is entered into, the Company designates the derivative as a fair value hedge, a cash flow hedge, or a trading instrument. Changes in the fair value of instruments used as fair value hedges are accounted for in the earnings of the period simultaneous with accounting for the fair value change of the item being hedged. Changes in the fair value of the effective portion of cash flow hedges are accounted for in other comprehensive income rather than earnings. Changes in fair value of instruments that are not intended as a hedge are accounted for in the earnings of the period of the change.

If a derivative instrument designated as a fair value hedge is terminated or the hedge designation removed, the difference between a hedged item’s then carrying amount and its face amount is recognized into income over the original hedge period. Likewise, if a derivative instrument designated as a cash flow hedge is terminated or the hedge designation removed, related amounts accumulated in other accumulated comprehensive income are reclassified into earnings over the original hedge period during which the hedged item affects income.

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company formally documents all hedging relationships, including an assessment that the derivative instruments are expected to be highly effective in offsetting the changes in fair values or cash flows of the hedged items.

Advertising Costs

Advertising costs are expensed as incurred.

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Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. A total of 280,933 shares are currently reserved for possible issuance under the Plan. All stock-based rights under the Plan must be granted or awarded by May 7, 2019 (i.e., ten years from the Plan effective date).

The Company granted 32,465 restricted stock units under the Plan at a grant date fair value of $7.18 per share during the first quarter of 2012, of which 5,891 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury in conjunction with the Company’s participation in the Capital Purchase Program under the Troubled Asset Relief Program. In July 2012, the Company granted 5,891 restricted stock units at a grant date fair value of $7.50 per share. The Company granted 29,475 restricted stock units under the Plan at a grant date fair value of $10.82 per share during the second quarter of 2013. The Company granted 23,162 restricted stock units under the Plan at a grant date fair value of $14.27 per share during the first quarter of 2014. The Company granted 16,583 restricted stock units under the Plan at a grant date fair value of $16.34 per share during the first quarter of 2015. The Company granted 5,544 restricted stock units under the Plan at a grant date fair value of $16.91 per share during the first quarter of 2016. The Company granted 4,114 restricted stock units under the Plan at a grant date fair value of $25.00 per share during the first quarter of 2017. The Company granted 3,725 restricted stock units under the Plan at a grant date fair value of $31.43 per share during the first quarter of 2018. The number of restricted stock units granted and grant date fair values have been restated to reflect the 10% stock dividend during the fourth quarter of 2017. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the 2012 grants, four years from the grant date for the 2013, 2015, 2016, 2017 and 2018 grants and three years from the grant date for the 2014 grants). The amount of expense recorded each period reflects the changes in the Company’s stock price during such period. As of December 31, 2018, the total unrecognized compensation expense related to the restricted stock unit grants under the Plan was $165,000.

The Company recognized compensation expense for restricted stock units granted under the Plan of $85,000, $592,000 and $932,000 for the years ended December 31, 2018, 2017 and 2016, respectively.

Net Earnings Per Share

Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share. The average market price during the year is used to compute equivalent shares.

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2018, 2017 and 2016 are as follows:

For the year ended December 31, 2018

	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$13,382	5,995,256	$2.23
Effect of dilutive securities:
Restricted stock units	-	20,240
Diluted earnings per share	$13,382	6,015,496	$2.22

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For the year ended December 31, 2017

	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$10,268	5,988,183	$1.71
Effect of dilutive securities:
Restricted stock units	-	74,667
Diluted earnings per share	$10,268	6,062,850	$1.69

For the year ended December 31, 2016

	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$9,177	6,024,970	$1.53
Effect of dilutive securities:
Restricted stock units	-	77,807
Diluted earnings per share	$9,177	6,102,777	$1.50

In November 2017, the Board of Directors of the Company declared a 10% stock dividend. As a result of the stock dividend, each shareholder received one new share of stock for every ten shares of stock they held as of the record date of December 4, 2017. The payable date for the stock dividend was December 15, 2017. All previously reported per share amounts have been restated to reflect this stock dividend.

Recent Accounting Pronouncements

The following tables provide a summary of Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”)that the Company has recently adopted.

Recently Adopted Accounting Guidance

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2014-09: Revenue from Contracts with Customers	Provides guidance on the recognition of revenue from contracts with customers. The core principle of this guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive.	January 1, 2018	See section titled "ASU 2014-09" below for a despription of the effect on the Company’s results of operations, financial position and disclosures.
ASU 2016-01: Recognition and Measurement of Financial Assets and Financial Liabilities	Addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-01: Clarifying the Definition of a Business	Adds guidance to assist companies and other reporting organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-05: Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets	Clarifies the scope of established guidance on nonfinancial asset derecognition (issued as part of the new revenue standard, ASU 2014-09, Revenue from Contracts with Customers), as well as the accounting for partial sales of nonfinancial assets.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

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ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2017-07: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs	Amended the requirements related to the income statement presentation of the components of net periodic benefit cost for an entity’s sponsored defined benefit pension and other postretirement plans.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-09: Scope of Modification Accounting	Amended the requirements related to changes to the terms or conditions of a share-based payment award.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-13: Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)	Updated the Revenue from Contracts with Customers and the Leases Topics of the Accounting Standards Codification (“ASC”). The amendments incorporate into the ASC recent Securities Exchange Commission (“SEC”) guidance about certain public business entities (“PBEs”) electing to use the non-PBE effective dates solely to adopt the FASB’s new standards on revenue and leases.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-14: Income Statement—Reporting Comprehensive, Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)	Incorporates into the ASC recent SEC guidance related to revenue recognition.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-02: Income Statement (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income	Requires companies to reclassify the stranded effects in other comprehensive income to retained earnings as a result of the change in the tax rates under the Tax Cuts and Jobs Act (“TCJA”).	Effective upon issuance	The Company opted to early adopt this pronouncement by retrospective application to each period in which the effect of the change in the tax rate under the TCJA is recognized. The impact of the reclassification from other comprehensive income to retained earnings at December 31, 2017 was $607,000.
ASU 2018-03: Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities	Clarifies certain aspects of the guidance issued in ASU 2016-01.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-04: Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update)	Incorporates recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulation.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-05: Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)	Incorporates recent SEC guidance related to the income tax accounting implications of the TCJA.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-06: Codification Improvements to Topic 942: Financial Services—Depository and Lending	Eliminates a reference to the Office of the Comptroller of the Currency’s Banking Circular 202, Accounting for Net Deferred Tax Charges, from the ASC. The Office of the Comptroller of the Currency published the guidance in 1985 but has since rescinded it.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

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ASU 2014-09

The Company has applied ASU 2014-09 using a modified retrospective approach. The Company’s revenue is comprised of net interest income and noninterest income. The scope of ASU 2014-09 explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. Accordingly, the majority of the Company’s revenues are not affected. Appraisal management fee income and expense from the Bank’s subsidiary, CBRES, was reported as a net amount prior to March 31, 2018, which was included in miscellaneous non-interest income. This income and expense is now reported on separate line items under non-interest income and non-interest expense.See below for additional information related to revenue generated from contracts with customers.

Revenue and Method of Adoption

The majority of the Company’s revenue is derived primarily from interest income from receivables (loans) and securities. Other revenues are derived from fees received in connection with deposit accounts, investment advisory, and appraisal services. On January 1, 2018, the Company adopted the requirements of ASU 2014-09. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

The Company adopted ASU 2014-09 using the modified retrospective transition approach which does not require restatement of prior periods. The method was selected as there were no material changes in the timing of revenue recognition resulting in no comparability issues with prior periods. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard. When applying the modified retrospective approach under ASU 2014-09, the Company has elected, as a practical expedient, to apply this approach only to contracts that were not completed as of January 1, 2018. A completed contract is considered to be a contract for which all (or substantially all) of the revenue was recognized in accordance with revenue guidance that was in effect before January 1, 2018. There were no uncompleted contracts as of January 1, 2018 for which application of the new standard required an adjustment to retained earnings.

The following disclosures involve the Company’s material income streams derived from contracts with customers which are within the scope of ASU 2014-09. Through the Company’s wholly-owned subsidiary, PIS, the Company contracts with a registered investment advisor to perform investment advisory services on behalf of the Company’s customers. The Company receives commissions from this third party investment advisor based on the volume of business that the Company’s customers do with such investment advisor. Total revenue recognized from these contracts for the year ended December 31, 2018 was $823,000. The Company utilizes third parties to contract with the Company’s customers to perform debit and credit card clearing services. These third parties pay the Company commissions based on the volume of transactions that they process on behalf of the Company’s customers. Total revenue recognized for the year ended December 31, 2018 from the contract with these third partieswas $3.9 million. Through the Company’s wholly-owned subsidiary, REAS, the Company provides property appraisal services for negotiated fee amounts on a per appraisal basis. Total revenue recognized for the year ended December 31, 2018 from these contracts with customers was $597,000. Through the Company’s wholly-owned subsidiary, CBRES, the Company provides appraisal management services. Total revenue recognized for the year ended December 31, 2018 from these contracts with customers was $3.2 million. Due to the nature of the Company’s relationship with the customers that the Company provides services, the Company does not incur costs to obtain contracts and there are no material incremental costs to fulfill these contracts that should be capitalized.

Disaggregation of Revenue. The Company’s portfolio of services provided to the Company’s customers consists of over 50,000 active contracts. The Company has disaggregated revenue according to timing of the transfer of service. Total revenue for the year ended December 31, 2018 derived from contracts in which services are transferred at a point in time was approximately $8.5 million. None of the Company’s revenue is derived from contracts in which services are transferred over time. Revenue is recognized as the services are provided to the customers. Economic factors impacting the customers could affect the nature, amount, and timing of these cash flows, as unfavorable economic conditions could impair the customers’ ability to provide payment for services. For the Company’s deposit contracts, this risk is mitigated as the Company generally deducts payments from customers’ accounts as services are rendered. For the Company’s appraisal services, the risk is mitigated in that the appraisal is not released until payment is received.

              Contract Balances. The timing of revenue recognition, billings, and cash collections results in billed accounts receivable on the balance sheet. Most contracts call for payment by a charge or deduction to the respective customer account but there are some that require a receipt of payment from the customer.

              For fee per transaction contracts, the customers are billed as the transactions are processed. The Company has no contracts in which 

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customers are billed in advance for services to be performed. These types of contracts would create contract liabilities or deferred revenue, as the customers pay in advance for services. There are no contract liabilities or accounts receivables balances that are material to the Company’s balance sheet.

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASU 2014-09. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Performance obligations are satisfied as the service is provided to the customer at a point in time. There are no significant financing components in the Company’s contracts. Excluding deposit and appraisal service revenues which are primarily billed at a point in time as a fee for services incurred, all other contracts within the scope of ASU 2014-09 contain variable consideration in that fees earned are derived from market values of accounts which determine the amount of consideration to which the Company is entitled. The variability is resolved when the services are provided. The contracts do not include obligations for returns, refunds, or warranties. The contracts are specific to the amounts owed to the Company for services performed during a period should the contracts be terminated.

Significant Judgements. All of the Company’s contracts create performance obligations that are satisfied at a point in time excluding some immaterial deposit revenues. Revenue is recognized as services are billed to the customers. Variable consideration does exist for contracts related to the Company’s contract with its registered investment advisor as some revenues earned pursuant to that contract are based on market values of accounts at the end of the period.

The following tables provide a summary of ASU’s issued by the FASB that the Company has not adopted as of December 31, 2018, which may impact the Company’s financial statements.

Recently Issued Accounting Guidance Not Yet Adopted

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2016-02: Leases	Increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.	January 1, 2019	The Company expects to adopt this guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow the Company to largely account for its existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. The Company epects to record an increase in assets and liabilities of approximatley $4.4 million as a result of recording lease contracts where the Company is lessee and expects to adopt the new guidance prospectively as of January 1, 2019 and to not restate comparative periods.
ASU 2016-13: Measurement of Credit Losses on Financial Instruments	Provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities.	January 1, 2020 Early adoption permitted	The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company is currently developing CECL model assumptions and comparing results to current allowance for loan loss calculations. The Company plans to run parallel calculations leading up to the effective date of this guidance to ensure it is prepared for implementation by the effective date. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.
ASU 2017-04: Simplifying the Test for Goodwill Impairment	Provides guidance to simplify the accounting related to goodwill impairment.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-08: Premium Amortization on Purchased Callable Debt Securities	Amended the requirements related to the amortization period for certain purchased callable debt securities held at a premium.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2018-11: Leases (Topic 842): Targeted Improvements	Intended to reduce costs and ease implementation of ASU 2016-02.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-13: Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820)	Updates the disclosure requirements on fair value measurements in ASC 820, Fair Value Measurement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-14: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans (Subtopic 715-20)	Updates disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.	January 1, 2021	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-15: Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40)	Reduces complexity of the accounting for costs of implementing a cloud computing service arrangement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-16: Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes	Expand the list of U.S. benchmark interest rates permitted in the application of hedge accounting.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-17: Targeted Improvements to Related Party Guidance for Variable Interest Entities	Amended the Consolidation topic of the ASC for determining whether a decision-making fee is a variable interest. The amendments require organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-18: Clarifying the Interaction between Topic 808 and Topic 606	Clarifies the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic.	January 1, 2020 Early adoption permitted	See comments for ASU 2016-13 above.
ASU 2018-20: Narrow- Scope Improvements for Lessors	Provides narrow-scope improvements for lessors, that provide relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components.	January 1, 2019	See comments for ASU 2016-02 above.

               Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results ofoperations, financial position or disclosures.

Reclassification

Certain amounts in the 2017 and 2016 consolidated financial statements have been reclassified to conform to the 2018 presentation.

 

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(2) 

Investment Securities

Investment securities available for sale at December 31, 2018 and 2017 are as follows:

(Dollars in thousands)

	December 31, 2018
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Mortgage-backed securities	$52,145	516	558	52,103
U.S. Government
sponsored enterprises	35,356	71	793	34,634
State and political subdivisions	105,545	2,089	43	107,591
Trust preferred securities	250	-	-	250
Total	$193,296	2,676	1,394	194,578

(Dollars in thousands)

	December 31, 2017
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Mortgage-backed securities	$53,124	814	329	53,609
U.S. Government
sponsored enterprises	40,504	140	264	40,380
State and political subdivisions	129,276	4,310	16	133,570
Corporate bonds	1,500	12	-	1,512
Trust preferred securities	250	-	-	250
Total	$224,654	5,276	609	229,321

The current fair value and associated unrealized losses on investments in debt securities with unrealized losses at December 31, 2018 and 2017 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)
	December 31, 2018
	Less than 12 Months		12 Months or More		Total
	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses
Mortgage-backed securities	$6,932	56	17,670	502	24,602	558
U.S. Government
sponsored enterprises	1,784	69	25,172	724	26,956	793
State and political subdivisions	4,815	26	1,578	17	6,393	43
Total	$13,531	151	44,420	1,243	57,951	1,394

(Dollars in thousands)
	December 31, 2017
	Less than 12 Months		12 Months or More		Total
	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses
Mortgage-backed securities	$8,701	75	11,259	254	19,960	329
U.S. Government
sponsored enterprises	12,661	98	10,067	166	22,728	264
State and political subdivisions	798	2	1,501	14	2,299	16
Total	$22,160	175	22,827	434	44,987	609

At December 31, 2018, unrealized losses in the investment securities portfolio relating to debt securities totaled $1.4 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered

 

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               to be temporary. From the December 31, 2018 tables above, 11 out of 130 securities issued by state and political subdivisions contained unrealized losses and 31 out of 46 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These                unrealized losses are considered temporary because of acceptable financial condition and results of operations on each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary.   No investment impairments were deemed other-than-temporary in 2018, 2017 or 2016.

The amortized cost and estimated fair value of investment securities available for sale at December 31, 2018, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

 

December 31, 2018
(Dollars in thousands)
	Amortized Cost	Estimated Fair Value
Due within one year	$21,379	21,426
Due from one to five years	80,932	82,325
Due from five to ten years	32,271	32,174
Due after ten years	6,569	6,550
Mortgage-backed securities	52,145	52,103
Total	$193,296	194,578

During 2018, proceeds from sales of securities available for sale were $36.0 million and resulted in gross gains of $15,000. No securities available for sale were sold during the year ended December 31, 2017. During 2016, proceeds from sales of securities available for sale were $1.5 million and resulted in gross gains of $729,000.

Securities with a fair value of approximately $93.0 million and $105.6 million at December 31, 2018 and 2017, respectively, were pledged to secure public deposits, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings and for other purposes as required by law.

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2018 and 2017.

(Dollars in thousands)
	December 31, 2018
	Fair Value Measurements	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation
Mortgage-backed securities	$52,103	-	52,103	-
U.S. Government
sponsored enterprises	$34,634	-	34,634	-
State and political subdivisions	$107,591	-	107,591	-
Trust preferred securities	$250	-	-	250

(Dollars in thousands)
	December 31, 2017
	Fair Value Measurements	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation
Mortgage-backed securities	$53,609	-	53,609	-
U.S. Government
sponsored enterprises	$40,380	-	40,380	-
State and political subdivisions	$133,570	-	133,570	-
Corporate bonds	$1,512	-	1,512	-
Trust preferred securities	$250	-	-	250

A-46

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the year ended December 31, 2018.

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$250
Change in book value	-
Change in gain/(loss) realized and unrealized	-
Purchases/(sales and calls)	-
Transfers in and/or (out) of Level 3	-
Balance, end of period	$250
Change in unrealized gain/(loss) for assets still held in Level 3	$-

 (3) 

Loans

Major classifications of loans at December 31, 2018 and 2017 are summarized as follows:

(Dollars in thousands)
	December 31, 2018	December 31, 2017
Real estate loans:
Construction and land development	$94,178	84,987
Single-family residential	252,983	246,703
Single-family residential -
Banco de la Gente non-traditional	34,261	37,249
Commercial	270,055	248,637
Multifamily and farmland	33,163	28,937
Total real estate loans	684,640	646,513
Loans not secured by real estate:
Commercial loans	97,465	89,022
Farm loans	926	1,204
Consumer loans	9,165	9,888
All other loans	11,827	13,137
Total loans	804,023	759,764
Less allowance for loan losses	6,445	6,366
Net loans	$797,578	753,398

The above table includes deferred costs, net of deferred fees, totaling $1.6 million at December 31, 2018 and 2017.

The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Wake and Durham counties of North Carolina. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market. Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

 

A-47

●

Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of December 31, 2018, construction and land development loans comprised approximately 12% of the Bank’s total loan portfolio.

●

Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of December 31, 2018, single-family residential loans comprised approximately 36% of the Bank’s total loan portfolio, including Banco single-family residential non-traditional loans which were approximately 4% of the Bank’s total loan portfolio.

●

Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of December 31, 2018, commercial real estate loans comprised approximately 34% of the Bank’s total loan portfolio.

●

Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. As of December 31, 2018, commercial loans comprised approximately 12% of the Bank’s total loan portfolio.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present an age analysis of past due loans, by loan type, as of December 31, 2018 and 2017:

December 31, 2018
(Dollars in thousands)
	Loans 30-89 Days Past Due	Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$3	-	3	94,175	94,178	-
Single-family residential	4,162	570	4,732	248,251	252,983	-
Single-family residential -
Banco de la Gente non-traditional	4,627	580	5,207	29,054	34,261	-
Commercial	228	-	228	269,827	270,055	-
Multifamily and farmland	-	-	-	33,163	33,163	-
Total real estate loans	9,020	1,150	10,170	674,470	684,640	-
Loans not secured by real estate:
Commercial loans	445	90	535	96,930	97,465	-
Farm loans	-	-	-	926	926	-
Consumer loans	99	4	103	9,062	9,165	-
All other loans	-	-	-	11,827	11,827	-
Total loans	$9,564	1,244	10,808	793,215	804,023	-

A-48

December 31, 2017
(Dollars in thousands)
	Loans 30-89 Days Past Due	Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$277	-	277	84,710	84,987	-
Single-family residential	3,241	193	3,434	243,269	246,703	-
Single-family residential -
Banco de la Gente non-traditional	4,078	465	4,543	32,706	37,249	-
Commercial	588	-	588	248,049	248,637	-
Multifamily and farmland	-	12	12	28,925	28,937	-
Total real estate loans	8,184	670	8,854	637,659	646,513	-
Loans not secured by real estate:
Commercial loans	53	100	153	88,869	89,022	-
Farm loans	-	-	-	1,204	1,204	-
Consumer loans	113	5	118	9,770	9,888	-
All other loans	-	-	-	13,137	13,137	-
Total loans	$8,350	775	9,125	750,639	759,764	-

The following table presents the Bank’s non-accrual loans as of December 31, 2018 and 2017:

(Dollars in thousands)
	December 31, 2018	December 31, 2017
Real estate loans:
Construction and land development	$1	14
Single-family residential	1,530	1,634
Single-family residential -
Banco de la Gente non-traditional	1,440	1,543
Commercial	244	396
Multifamily and farmland	-	12
Total real estate loans	3,215	3,599
Loans not secured by real estate:
Commercial loans	89	100
Consumer loans	10	12
Total	$3,314	3,711

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $250,000 are not individually evaluated for impairment with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Impaired loans collectively evaluated for impairment totaled $4.8 million and $4.9 million at December 31, 2018 and 2017, respectively. Accruing impaired loans were $22.8 million and $24.6 million at December 31, 2018 and December 31, 2017, respectively. Interest income recognized on accruing impaired loans was $1.3 million and $1.4 million for the years ended December 31, 2018 and 2017, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

A-49

The following tables present the Bank’s impaired loans as of December 31, 2018, 2017 and 2016:

December 31, 2018
(Dollars in thousands)
	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans	YTD Interest Income Recognized
Real estate loans:
Construction and land development	$281	-	279	279	5	327	19
Single-family residential	5,059	422	4,188	4,610	32	6,271	261
Single-family residential -
Banco de la Gente non-traditional	16,424	-	15,776	15,776	1,042	14,619	944
Commercial	1,995	-	1,925	1,925	17	2,171	111
Total impaired real estate loans	23,759	422	22,168	22,590	1,096	23,388	1,335
Loans not secured by real estate:
Commercial loans	251	89	1	90	-	96	-
Consumer loans	116	-	113	113	2	137	7
Total impaired loans	$24,126	511	22,282	22,793	1,098	23,621	1,342

December 31, 2017
(Dollars in thousands)
	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans	YTD Interest Income Recognized
Real estate loans:
Construction and land development	$282	-	277	277	6	253	17
Single-family residential	5,226	1,135	3,686	4,821	41	5,113	265
Single-family residential -
Banco de la Gente non-traditional	17,360	-	16,805	16,805	1,149	16,867	920
Commercial	2,761	807	1,661	2,468	1	3,411	148
Multifamily and farmland	78	-	12	12	-	28	-
Total impaired real estate loans	25,707	1,942	22,441	24,383	1,197	25,672	1,350
Loans not secured by real estate:
Commercial loans	264	100	4	104	-	149	3
Consumer loans	158	-	154	154	2	194	9
Total impaired loans	$26,129	2,042	22,599	24,641	1,199	26,015	1,362

December 31, 2016
(Dollars in thousands)
	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans	YTD Interest Income Recognized
Real estate loans:
Construction and land development	$282	-	278	278	11	330	13
Single-family residential	5,354	703	4,323	5,026	47	7,247	164
Single-family residential -
Banco de la Gente non-traditional	18,611	-	18,074	18,074	1,182	17,673	861
Commercial	3,750	1,299	2,197	3,496	166	4,657	152
Multifamily and farmland	78	-	78	78	-	78	-
Total impaired real estate loans	28,075	2,002	24,950	26,952	1,406	29,985	1,190
Loans not secured by real estate:
Commercial loans	27	-	27	27	-	95	-
Consumer loans	211	-	202	202	3	222	8
Total impaired loans	$28,313	2,002	25,179	27,181	1,409	30,302	1,198

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at December 31, 2018 and 2017 are presented below. The Company’s valuation methodology is discussed in Note 15.

A-50

(Dollars in thousands)
	Fair Value Measurements December 31, 2018	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation
Mortgage loans held for sale	$680	-	-	680
Impaired loans	$21,695	-	-	21,695
Other real estate	$27	-	-	27

(Dollars in thousands)
	Fair Value Measurements December 31, 2017	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation
Mortgage loans held for sale	$857	-	-	857
Impaired loans	$23,442	-	-	23,442
Other real estate	$118	-	-	118

Changes in the allowance for loan losses for the year ended December 31, 2018 were as follows:

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non-traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer and All Other	Unallocated	Total
Allowance for loan losses:
Beginning balance	$804	1,812	1,280	1,193	72	574	-	155	476	6,366
Charge-offs	(53)	(116)	-	(453)	(5)	(54)	-	(452)	-	(1,133)
Recoveries	10	106	-	105	1	32	-	168	-	422
Provision	52	(477)	(103)	433	15	74	-	290	506	790
Ending balance	$813	1,325	1,177	1,278	83	626	-	161	982	6,445
Ending balance: individually
evaluated for impairment	$-	-	1,023	15	-	-	-	-	-	1,038
Ending balance: collectively
evaluated for impairment	813	1,325	154	1,263	83	626	-	161	982	5,407
Ending balance	$813	1,325	1,177	1,278	83	626	-	161	982	6,445
Loans:
Ending balance	$94,178	252,983	34,261	270,055	33,163	97,465	926	20,992	-	804,023
Ending balance: individually
evaluated for impairment	$96	1,779	14,310	1,673	-	89	-	-	-	17,947
Ending balance: collectively
evaluated for impairment	$94,082	251,204	19,951	268,382	33,163	97,376	926	20,992	-	786,076

A-51

Changes in the allowance for loan losses for the year ended December 31, 2017 were as follows:

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non-traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer and All Other	Unallocated	Total
Allowance for loan losses:
Beginning balance	$1,152	2,126	1,377	1,593	52	675	-	204	371	7,550
Charge-offs	-	(249)	-	-	(66)	(194)	-	(473)	-	(982)
Recoveries	14	85	-	21	-	31	-	154	-	305
Provision	(362)	(150)	(97)	(421)	86	62	-	270	105	(507)
Ending balance	$804	1,812	1,280	1,193	72	574	-	155	476	6,366
Ending balance: individually
evaluated for impairment	$-	-	1,093	37	-	-	-	-	-	1,130
Ending balance: collectively
evaluated for impairment	804	1,812	187	1,156	72	574	-	155	476	5,236
Ending balance	$804	1,812	1,280	1,193	72	574	-	155	476	6,366
Loans:
Ending balance	$84,987	246,703	37,249	248,637	28,937	89,022	1,204	23,025	-	759,764
Ending balance: individually
evaluated for impairment	$98	1,855	15,460	2,251	-	100	-	-	-	19,764
Ending balance: collectively
evaluated for impairment	$84,889	244,848	21,789	246,386	28,937	88,922	1,204	23,025	-	740,000

Changes in the allowance for loan losses for the year ended December 31, 2016 were as follows:

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non-traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer and All Other	Unallocated	Total
Allowance for loan losses:
Beginning balance	$2,185	2,534	1,460	1,917	-	842	-	172	479	9,589
Charge-offs	(7)	(275)	-	(318)	-	(146)	-	(492)	-	(1,238)
Recoveries	10	55	-	19	-	170	-	151	-	405
Provision	(1,036)	(188)	(83)	(25)	52	(191)	-	373	(108)	(1,206)
Ending balance	$1,152	2,126	1,377	1,593	52	675	-	204	371	7,550
Ending balance: individually
evaluated for impairment	$-	-	1,160	159	-	-	-	-	-	1,319
Ending balance: collectively
evaluated for impairment	1,152	2,126	217	1,434	52	675	-	204	371	6,231
Ending balance	$1,152	2,126	1,377	1,593	52	675	-	204	371	7,550
Loans:
Ending balance	$61,749	240,700	40,189	247,521	21,047	87,596	-	25,009	-	723,811
Ending balance: individually
evaluated for impairment	$-	935	16,718	3,648	-	-	-	-	-	21,301
Ending balance: collectively
evaluated for impairment	$61,749	239,765	23,471	243,873	21,047	87,596	-	25,009	-	702,510

The Bank utilizes an internal risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 8. These risk grades are evaluated on an ongoing basis. A description of the general characteristics of the eight risk grades is as follows:

●

Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.

●

Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability. The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.

A-52

●

Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).

●

Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

●

Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.

●

Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any). There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

●

Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.

●

Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of December 31, 2018 and 2017.

December 31, 2018
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non-traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$504	5,795	-	-	-	605	-	673	-	7,577
2- High Quality	24,594	128,588	-	25,321	395	20,520	-	3,229	2,145	204,792
3- Good Quality	59,549	92,435	13,776	211,541	27,774	69,651	785	4,699	8,932	489,142
4- Management Attention	5,707	19,200	15,012	30,333	3,906	6,325	141	529	750	81,903
5- Watch	3,669	3,761	2,408	2,616	1,088	264	-	18	-	13,824
6- Substandard	155	3,204	3,065	244	-	100	-	17	-	6,785
7- Doubtful	-	-	-	-	-	-	-	-	-	-
8- Loss	-	-	-	-	-	-	-	-	-	-
Total	$94,178	252,983	34,261	270,055	33,163	97,465	926	9,165	11,827	804,023

December 31, 2017
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non-traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$152	8,590	-	-	-	446	-	791	-	9,979
2- High Quality	20,593	120,331	-	34,360	561	17,559	-	3,475	2,410	199,289
3- Good Quality	53,586	89,120	14,955	196,439	25,306	65,626	1,085	5,012	9,925	461,054
4- Management Attention	4,313	20,648	15,113	13,727	1,912	5,051	119	562	802	62,247
5- Watch	6,060	4,796	3,357	3,671	1,146	223	-	23	-	19,276
6- Substandard	283	3,218	3,824	440	12	117	-	25	-	7,919
7- Doubtful	-	-	-	-	-	-	-	-	-	-
8- Loss	-	-	-	-	-	-	-	-	-	-
Total	$84,987	246,703	37,249	248,637	28,937	89,022	1,204	9,888	13,137	759,764

A-53

TDR loans modified in 2018, past due TDR loans and non-accrual TDR loans totaled $4.7 million and $4.5 million at December 31, 2018 and December 31, 2017, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were $92,000 and $21,000 in performing loans classified as TDR loans at December 31, 2018 and December 31, 2017, respectively.

The following table presents an analysis of loan modifications during the year ended December 31, 2018:

Year ended December 31, 2018
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential	2	$94	94
Total TDR loans	2	$94	94

During the year ended December 31, 2018, two loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.

The following table presents an analysis of loan modifications during the year ended December 31, 2017:

Year ended December 31, 2017
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential	2	$22	22
Total TDR loans	2	$22	22

During the year ended December 31, 2017, two loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.

There were no TDR loans with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the years ended December 31, 2018 and 2017. TDR loans are deemed to be in default if they become past due by 90 days or more.

(4) 

Premises and Equipment

Major classifications of premises and equipment at December 31, 2018 and 2017 are summarized as follows:

(Dollars in thousands)
	2018	2017
Land	$3,456	3,700
Buildings and improvements	19,357	19,312
Furniture and equipment	22,315	21,115
Construction in process	381	847
Total premises and equipment	45,509	44,974
Less accumulated depreciation	27,059	25,063
Total net premises and equipment	$18,450	19,911

A-54

The Company recognized approximately $2.3 million in depreciation expense for the year ended December 31, 2018. Depreciation expense was approximately $2.1 million and $2.1 million for the years ended December 31, 2017 and 2016, respectively.

The Company had $544,000 net gains on the sale of premises and equipment for the year ended December 31, 2018, which was primarily due to the sale of a Bank building that housed primarily administrative staff. Staff working at this location have been relocated to other Bank locations.

(5) 

Time Deposits

At December 31, 2018, the scheduled maturities of time deposits are as follows:

(Dollars in thousands)
2019	$61,723
2020	21,566
2021	14,121
2022	2,618
2023 and thereafter	3,145
Total	$103,173

At December 31, 2018 and 2017, the Bank had approximately $3.4 million and $5.2 million, respectively, in time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers. CDARS balances totaled $3.4 million and $5.2 million as of December 31, 2018 and 2017, respectively. The weighted average rate of brokered deposits as of December 31, 2018 and 2017 was 0.07% and 0.07%, respectively.

(6) 

Federal Home Loan Bank and Federal Reserve Bank Borrowings

The Bank had no borrowings from the FHLB at December 31, 2018 and 2017. FHLB borrowings are collateralized by a blanket assignment on all residential first mortgage loans, home equity lines of credit and loans secured by multi-family real estate that the Bank owns. At December 31, 2018, the carrying value of loans pledged as collateral totaled approximately $140.0 million. The remaining availability under the line of credit with the FHLB was $84.9 million at December 31, 2018.

The Bank is required to purchase and hold certain amounts of FHLB stock in order to obtain FHLB borrowings. No ready market exists for the FHLB stock, and it has no quoted market value. The stock is redeemable at $100 per share subject to certain limitations set by the FHLB. The Bank owned $982,000 and $978,000 of FHLB stock, included in other investments, at December 31, 2018 and 2017, respectively.

The Bank prepaid FHLB borrowings totaling $20.0 million in 2017 with prepayment penalties totaling $508,000.

As of December 31, 2018 and 2017, the Bank had no borrowings from the Federal Reserve Bank (“FRB”). FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At December 31, 2018, the carrying value of loans pledged as collateral totaled approximately $442.6 million. Availability under the line of credit with the FRB was $335.8 million at December 31, 2018.

(7) 

Junior Subordinated Debentures

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.

A-55

The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. 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, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

(8) 

Income Taxes

On December 22, 2017, the President of the United States signed into law the TCJA. The TCJA includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 34 percent to 21 percent for tax years beginning after December 31, 2017.

The Company recognized the income tax effects of the TCJA in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the TCJA was signed into law. As such, the Company’s financial results reflect the income tax effects of the TCJA for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the TCJA for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined. The Company did not identify items for which the income tax effects of the TCJA have not been completed and a reasonable estimate could not be determined as of December 31, 2017.

The provision for income taxes is summarized as follows:

(Dollars in thousands)
	2018	2017	2016
Current expense	$2,546	1,827	1,464
Deferred income tax expense	78	2,120	1,097
Total income tax	$2,624	3,947	2,561

The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to earnings before income taxes are as follows:

(Dollars in thousands)
	2018	2017	2016
Tax expense at statutory rate (21% in 2018)	$3,361	4,833	3,991
State income tax, net of federal income tax effect	358	307	339
Tax-exempt interest income	(990)	(1,594)	(1,681)
Increase in cash surrender value of life insurance	(81)	(136)	(138)
Nondeductible interest and other expense	23	46	78
Impact of TCJA	-	588	-
Other	(47)	(97)	(28)
Total	$2,624	3,947	2,561

The following summarizes the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities. The net deferred tax asset is included as a component of other assets at December 31, 2018 and 2017.

A-56

(Dollars in thousands)
	2018	2017
Deferred tax assets:
Allowance for loan losses	$1,481	1,463
Accrued retirement expense	1,119	1,073
Federal credit carryforward	-	88
Restricted stock	262	243
Accrued bonuses	211	171
Interest income on nonaccrual loans	1	5
Other than temporary impairment	-	9
Total gross deferred tax assets	3,074	3,052
Deferred tax liabilities:
Deferred loan fees	379	365
Accumulated depreciation	610	498
Prepaid expenses	10	14
Other	5	28
Unrealized gain on available for sale securities	294	1,072
Total gross deferred tax liabilities	1,298	1,977
Net deferred tax asset	$1,776	1,075

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 34 percent to 21 percent, resulting in a $588,000 increase in income tax expense for the year ended December 31, 2017 and a corresponding $588,000 decrease in net deferred tax assets as of December 31, 2017.

The Company has analyzed the tax positions taken or expected to be taken in its tax returns and has concluded that it has no liability related to uncertain tax positions.

The Company’s Federal income tax filings for years 2015 through 2018 were at year end 2018 open to audit under statutes of limitations by the Internal Revenue Service. The Company's North Carolina income tax returns are currently under audit for tax years 2014-2016, tax years 2017 and 2018 are open to audit under the statutes of limitations by the North Carolina Department of Revenue.

(9)            

Related Party Transactions

The Company conducts transactions with its directors and executive officers, including companies in which they have beneficial interests, in the normal course of business. It is the policy of the Company that loan transactions with directors and officers are made on substantially the same terms as those prevailing at the time made for comparable loans to other persons. The following is a summary of activity for related party loans for 2018 and 2017:

(Dollars in thousands)
	2018	2017
Beginning balance	$3,679	4,503
New loans	8,030	5,879
Repayments	(8,517)	(6,703)
Ending balance	$3,192	3,679

At December 31, 2018 and 2017, the Company had deposit relationships with related parties of approximately $31.6 million and $26.6 million, respectively.

A director of the Company is an officer and partial owner of the construction company that renovated the Bank’s Corporate Center located at 518 West C Street, Newton, North Carolina during 2017. During 2017 theCompany paid a total of approximately $2.6 million to this construction company for such renovation work. The Company did not make any payments to this construction company during 2018.

A-57

 

(10) 

Commitments and Contingencies

The Company leases various office spaces for banking and operational facilities and equipment under operating lease arrangements. Future minimum lease payments required for all operating leases having a remaining term in excess of one year at December 31, 2018 are as follows:

(Dollars in thousands)
Year ending December 31,
2019	$820
2020	809
2021	793
2022	501
2023	393
Thereafter	1,624
Total minimum obligation	$4,940

Total rent expense was approximately $785,000, $756,000 and $752,000 for the years ended December 31, 2018, 2017 and 2016, respectively.

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

In most cases, the Bank requires collateral or other security to support financial instruments with credit risk.

(Dollars in thousands)
	Contractual Amount
	2018	2017
Financial instruments whose contract amount represent credit risk:
Commitments to extend credit	$268,708	233,972
Standby letters of credit and financial guarantees written	$3,651	3,325

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and because they may expire without being drawn upon, the total commitment amount of $272.4 million does not necessarily represent future cash requirements.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to businesses in the Bank’s delineated market area. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds real estate, equipment, automobiles and customer deposits as collateral supporting those commitments for which collateral is deemed necessary.

In the normal course of business, the Company is a party (both as plaintiff and defendant) to a number of lawsuits. In the opinion of management and counsel, none of these cases should have a material adverse effect on the financial position of the Company.

 A-58

Bancorp and the Bank have employment agreements with certain key employees. The agreements, among other things, include salary, bonus, incentive compensation, and change in control provisions.

At December 31, 2017, the Bank committed to invest $3.0 million in an income tax credit partnership owning and developing two multifamily housing developments in Charlotte, North Carolina, with $1.5 million allocated to each property. The Bank has funded $2.4 million of this commitment at December 31, 2018.

(11) 

Employee and Director Benefit Programs

The Company has a profit sharing and 401(k) plan for the benefit of substantially all employees subject to certain minimum age and service requirements. Under the 401(k) plan, the Company matched employee contributions to a maximum of 4.00% of annual compensation in 2016, 2017 and 2018. The Company’s contribution pursuant to this formula was approximately $670,000, $622,000 and $565,000 for the years 2018, 2017 and 2016, respectively. Investments of the 401(k) plan are determined by a committee comprised of senior management. No investments in Company stock have been made by the 401(k) plan. Contributions to the 401(k) plan are vested immediately.

In December 2001, the Company initiated a postretirement benefit plan to provide retirement benefits to key officers and its Board of Directors and to provide death benefits for their designated beneficiaries. Under the postretirement benefit plan, the Company purchased life insurance contracts on the lives of the key officers and each director. The increase in cash surrender value of the contracts constitutes the Company’s contribution to the postretirement benefit plan each year. Postretirement benefit plan participants are to be paid annual benefits for a specified number of years commencing upon retirement. Expenses incurred for benefits relating to the postretirement benefit plan were approximately $423,000, $411,000 and $428,000 for the years 2018, 2017 and 2016, respectively.

The Company is currently paying medical benefits for certain retired employees. The Company did not incur any postretirement medical benefits expense in 2018, 2017 and 2016 due to an excess accrual balance.

The following table sets forth the change in the accumulated benefit obligation for the Company’s two postretirement benefit plans described above:

(Dollars in thousands)
	2018	2017
Benefit obligation at beginning of period	$4,361	4,174
Service cost	362	348
Interest cost	70	68
Benefits paid	(227)	(229)
Benefit obligation at end of period	$4,566	4,361

The amounts recognized in the Company’s Consolidated Balance Sheet as of December 31, 2018 and 2017 are shown in the following two tables:

(Dollars in thousands)
	2018	2017
Benefit obligation	$4,566	4,361
Fair value of plan assets	-	-

 A-59

(Dollars in thousands)
	2018	2017
Funded status	$(4,566)	(4,361)
Unrecognized prior service cost/benefit	-	-
Unrecognized net actuarial loss	-	-
Net amount recognized	$(4,566)	(4,361)
Unfunded accrued liability	$(4,566)	(4,361)
Intangible assets	-	-
Net amount recognized	$(4,566)	(4,361)

Net periodic benefit cost of the Company’s postretirement benefit plans for the years ended December 31, 2018, 2017 and 2016 consisted of the following:

(Dollars in thousands)
	2018	2017	2016
Service cost	$362	348	346
Interest cost	70	68	67
Net periodic cost	$432	416	413
Weighted average discount rate assumption
used to determine benefit obligation	5.49%	5.49%	5.47%

The Company paid benefits under the two postretirement plans totaling $227,000 and $229,000 during the years ended December 31, 2018 and 2017, respectively. Information about the expected benefit payments for the Company’s two postretirement benefit plans is as follows:

(Dollars in thousands)
Year ending December 31,
2019	$235
2020	$353
2021	$353
2022	$342
2023	$342
Thereafter	$8,709

(12) 

Regulatory Matters

The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of capital in relation to both on- and off-balance sheet items at various risk weights. Total capital consists of two tiers of capital. Tier 1 capital includes common shareholders’ equity and trust preferred securities less adjustments for intangible assets. Tier 2 capital consists of the allowance for loan losses, up to 1.25% of risk-weighted assets and other adjustments. Management believes, as of December 31, 2018, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

A-60

  

As of December 31, 2018, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

In 2013, the Federal Reserve Board 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 are being 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 at 0.625% and is being phased in through 2019 (increasing by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019). This will result 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.

The Company’s and the Bank’s actual capital amounts and ratios are presented below:

(Dollars in thousands)
	Actual		For Capital Adequacy Purposes		To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount	Ratio	Amount	Ratio	Amount	Ratio
As of December 31, 2018:
Total Capital (to Risk-Weighted Assets)
Consolidated	$149,076	16.15%	91,133	9.88%	N/A	N/A
Bank	$146,640	15.91%	90,995	9.88%	92,147	10.00%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$142,631	15.46%	72,676	7.88%	N/A	N/A
Bank	$140,195	15.21%	72,566	7.88%	73,717	8.00%
Tier 1 Capital (to Average Assets)
Consolidated	$142,631	13.05%	43,723	4.00%	N/A	N/A
Bank	$140,195	12.76%	43,950	4.00%	54,937	5.00%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$122,631	13.29%	58,833	6.38%	N/A	N/A
Bank	$140,195	15.21%	58,744	6.38%	59,895	6.50%

A-61

(Dollars in thousands)
	Actual		For Capital Adequacy Purposes		To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount	Ratio	Amount	Ratio	Amount	Ratio
As of December 31, 2017:
Total Capital (to Risk-Weighted Assets)
Consolidated	$138,492	16.06%	79,758	9.25%	N/A	N/A
Bank	$136,299	15.83%	79,627	9.25%	86,084	10.00%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$132,126	15.32%	62,513	7.25%	N/A	N/A
Bank	$129,933	15.09%	62,411	7.25%	68,867	8.00%
Tier 1 Capital (to Average Assets)
Consolidated	$132,126	11.94%	44,255	4.00%	N/A	N/A
Bank	$129,933	11.69%	44,475	4.00%	55,594	5.00%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$112,126	13.00%	49,579	5.75%	N/A	N/A
Bank	$129,933	15.09%	49,498	5.75%	55,954	6.50%

 (13) 

Shareholders’ Equity

Shareholders’ equity was $123.6 million, or 11.31% of total assets, as of December 31, 2018, compared to $116.0 million, or 10.62% of total assets, as of December 31, 2017. The increase in shareholders’ equity is primarily due to an increase in retained earnings due to net income.

Annualized return on average equity for the year ended December 31, 2018 was 10.81% compared to 8.78% for the year ended December 31, 2017. Total cash dividends paid on common stock were $3.1 million and $2.6 million for the years ended December 31, 2018 and 2017, respectively.

The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares. The Board is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights. The Board of Directors does not currently anticipate issuing shares of preferred stock.

In 2016, the Company’s Board of Directors authorized a stock repurchase program, pursuant to which up to $2 million was allocated to repurchase the Company’s common stock. Any purchases under the Company’s stock repurchase program were 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 were determined by the Company’s management, based on its evaluation of market conditions and other factors. The Company repurchased approximately $2.0 million, or 92,738 shares of its common stock, under this program as of December 31, 2017.

(14) 

Other Operating Income and Expense

Miscellaneous non-interest income for the years ended December 31, 2018, 2017 and 2016 included the following items:

(Dollars in thousands)
	2018	2017	2016
Visa debit card income	$3,911	3,757	3,589
Bank owned life insurance income	384	400	407
Gain (loss) on sale of capital assets	544	(32)	-
Other	1,354	1,175	854
	$6,193	5,300	4,850

A-62

Other non-interest expense for the years ended December 31, 2018, 2017 and 2016 included the following items:

(Dollars in thousands)
	2018	2017	2016
ATM expense	$542	673	658
Consulting	1,012	785	2,257
Data processing	466	426	418
Deposit program expense	586	539	371
Dues and subscriptions	421	354	451
FHLB advance prepayment penalty	-	508	1,260
Internet banking expense	603	720	710
Office supplies	503	517	465
Telephone	678	855	754
Other	2,834	2,540	1,399
	$7,645	7,917	8,743

(15) 

Fair Value of Financial Instruments

The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance.

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

●

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

●

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

●

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Cash and Cash Equivalents

For cash, due from banks and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value. Cash and cash equivalents are reported in the Level 1 fair value category.

Investment Securities Available for Sale

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category. Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category. All other fair value measurements are reported in the Level 3 fair value category.

Other Investments

For other investments, the carrying value is a reasonable estimate of fair value. Other investments are reported in the Level 3 fair value category.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value. Mortgage loans held for sale are reported in the Level 3 fair value category.

A-63

Loans

The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value. Loans are reported in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

Cash Surrender Value of Life Insurance

For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value. Cash surrender value of life insurance is reported in the Level 2 fair value category.

Other Real Estate

The fair value of other real estate is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Other real estate is reported in the Level 3 fair value category.

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Deposits are reported in the Level 2 fair value category.

Securities Sold Under Agreements to Repurchase

For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value. Securities sold under agreements to repurchase are reported in the Level 2 fair value category.

FHLB Borrowings

The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 2 fair value category.

Junior Subordinated Debentures

Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value. Junior subordinated debentures are reported in the Level 2 fair value category.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The fair value presentation for recurring assets is presented in Note 2. There were no recurring liabilities at December 31, 2018 and 2017. The fair value presentation for non-recurring assets is presented in Note 3. There were no non-recurring liabilities at December 31, 2018 and 2017. The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2018 and 2017 are as follows:

A-64

(Dollars in thousands)
		Fair Value Measurements at December 31, 2018
	Carrying Amount	Level 1	Level 2	Level 3	Total
Assets:
Cash and cash equivalents	$43,370	43,370	-	-	43,370
Investment securities available for sale	$194,578	-	194,328	250	194,578
Other investments	$4,361	-	-	4,361	4,361
Mortgage loans held for sale	$680	-	-	680	680
Loans, net	$797,578	-	-	748,917	748,917
Cash surrender value of life insurance	$15,936	-	15,936	-	15,936
Liabilities:
Deposits	$877,213	-	-	857,999	857,999
Securities sold under agreements
to repurchase	$58,095	-	58,095	-	58,095
Junior subordinated debentures	$20,619	-	20,619	-	20,619

(Dollars in thousands)
		Fair Value Measurements at December 31, 2017
	Carrying Amount	Level 1	Level 2	Level 3	Total
Assets:
Cash and cash equivalents	$57,304	57,304	-	-	57,304
Investment securities available for sale	$229,321	-	229,071	250	229,321
Other investments	$1,830	-	-	1,830	1,830
Mortgage loans held for sale	$857	-	-	857	857
Loans, net	$753,398	-	-	735,837	735,837
Cash surrender value of life insurance	$15,552	-	15,552	-	15,552
Liabilities:
Deposits	$906,952	-	-	894,932	894,932
Securities sold under agreements
to repurchase	$37,757	-	37,757	-	37,757
Junior subordinated debentures	$20,619	-	20,619	-	20,619

  A-65

(16) 

Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements

Balance Sheets

December 31, 2018 and 2017

(Dollars in thousands)

Assets	2018	2017
Cash	$689	428
Interest-bearing time deposit	1,000	1,000
Investment in subsidiaries	141,181	133,781
Investment in PEBK Capital Trust II	619	619
Investment securities available for sale	250	250
Other assets	533	546
Total assets	$144,272	136,624
Liabilities and Shareholders' Equity
Junior subordinated debentures	$20,619	20,619
Liabilities	36	30
Shareholders' equity	123,617	115,975
Total liabilities and shareholders' equity	$144,272	136,624

Statements of Earnings

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

Revenues:	2018	2017	2016
Interest and dividend income	$4,544	1,839	4,569
Gain on sale of securities	-	-	405
Total revenues	4,544	1,839	4,974
Expenses:
Interest	790	590	485
Other operating expenses	678	725	513
Total expenses	1,468	1,315	998
Income before income tax benefit and equity in
undistributed earnings of subsidiaries	3,076	524	3,976
Income tax benefit	299	434	178
Income before equity in undistributed
earnings of subsidiaries	3,375	958	4,154
Equity in undistributed earnings of subsidiaries	10,007	9,310	5,023
Net earnings	$13,382	10,268	9,177

A-66

Statements of Cash Flows

For the Years Ended December 31, 20178, 2017 and 2016

(Dollars in thousands)

	2018	2017	2016
Cash flows from operating activities:
Net earnings	$13,382	10,268	9,177
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Equity in undistributed earnings of subsidiaries	(10,007)	(9,310)	(5,023)
Gain on sale of investment securities	-	-	(405)
Change in:
Other assets	13	(272)	61
Other liabilities	6	5	5
Net cash provided by operating activities	3,394	691	3,815
Cash flows from investing activities:
Proceeds from calls and maturities of investment securities
available for sale	-	500	669
In kind transfer from parent to Bank	-	-	10
Net cash provided by investing activities	-	500	679
Cash flows from financing activities:
Cash dividends paid on common stock	(3,133)	(2,629)	(2,106)
Cash in lieu stock dividend	-	(6)	-
Stock repurchase	-	-	(1,984)
Proceeds from exercise of restricted stock units	-	915	-
Net cash used by financing activities	(3,133)	(1,720)	(4,090)
Net change in cash	261	(529)	404
Cash at beginning of year	428	957	553
Cash at end of year	$689	428	957
Noncash investing and financing activities:
Change in unrealized gain on investment securities
available for sale, net	$(2,607)	(1)	(2,523)

A-67

(17) 

Quarterly Data

(Dollars in thousands, except per share amounts)	First	Second	Third	Fourth	First	Second	Third	Fourth
Total interest income	$10,759	11,059	11,608	11,924	$10,064	10,461	10,698	10,726
Total interest expense	467	513	557	609	598	622	650	507
Net interest income	10,292	10,546	11,051	11,315	9,466	9,839	10,048	10,219
(Reduction of) provision for loan losses	31	231	110	418	(236)	49	(218)	(102)
Other income	3,736	4,016	3,915	4,499	3,442	3,929	4,159	3,834
Other expense	10,042	10,560	10,702	11,270	10,361	9,983	10,006	10,878
Income before income taxes	3,955	3,771	4,154	4,126	2,783	3,736	4,419	3,277
Income taxes (benefit)	652	595	687	690	578	925	1,177	1,267
Net earnings	3,303	3,176	3,467	3,436	2,205	2,811	3,242	2,010
Basic net earnings per share	$0.55	0.53	0.58	0.57	$0.36	0.47	0.54	0.34
Diluted net earnings per share	$0.55	0.53	0.57	0.57	$0.36	0.46	0.53	0.34

A-68

DIRECTORS AND OFFICERS OF THE COMPANY

DIRECTORS

Robert C. Abernethy – Chairman

Chairman of the Board, Peoples Bancorp of North Carolina, Inc. and Peoples Bank;

President, Secretary and Treasurer, Carolina Glove Company, Inc. (glove manufacturer)

Secretary and Assistant Treasurer, Midstate Contractors, Inc. (paving company)

James S. Abernethy

Vice President, Carolina Glove Company, Inc. (glove manufacturer)

President and Assistant Secretary, Midstate Contractors, Inc. (paving company)

Vice President, Secretary and Chairman of the Board of Directors, Alexander Railroad Company

Douglas S. Howard

Vice President and Treasurer, Denver Equipment Company of Charlotte, Inc.

John W. Lineberger, Jr.

President, Lincoln Bonded Warehouse Company (commercial warehousing facility)

Gary E. Matthews

President and Director, Matthews Construction Company, Inc. (general contractor)

Billy L. Price, Jr. MD

Practitioner of Internal Medicine, BL Price Jr. Medical Consultants, PLLC

Larry E. Robinson

Shareholder, Director, Chairman of the Board and Chief Executive Officer, The Blue Ridge Distributing Co., Inc. (beer and wine distributor)

Director and member of the Board of Directors, United Beverages of North Carolina, LLC (beer distributor)

William Gregory (Greg) Terry

President, DFH Holdings

Operator/General Manager, Drum & Willis-Reynolds Funeral Homes and Crematory

Dan Ray Timmerman, Sr.

Chairman of the Board and Chief Executive Officer, Timmerman Manufacturing, Inc. (wrought iron furniture, railings and gates manufacturer)

Benjamin I. Zachary

President, Treasurer, General Manager and Director, Alexander Railroad Company

OFFICERS

Lance A. Sellers

President and Chief Executive Officer

A. Joseph Lampron, Jr.

Executive Vice President, Chief Financial Officer, Corporate Treasurer and Assistant Corporate Secretary

William D. Cable, Sr.

Executive Vice President, Corporate Secretary and Assistant Corporate Treasurer

 

  A-69

EX-21

EXHIBIT (21)

SUBSIDIARIES OF THE REGISTRANT

A list of subsidiaries is contained in Part I, Item 1 Business under the section titled “Subsidiaries” and is incorporated herein by reference.

EX-23

EXHIBIT (23)

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements (No. 333-43426 on Form S-3, effective August 10, 2000 and No. 333-46860 on Form S-8, effective September 28, 2000) of Peoples Bancorp of North Carolina, Inc. of our reports dated March 14, 2019, relating to the consolidated financial statements and the effectiveness of internal control over financial reporting of Peoples Bancorp of North Carolina, Inc., appearing in this Annual Report on Form 10-K of Peoples Bancorp of North Carolina, Inc. for the year ended December 31, 2018.

/s/ Elliott Davis, PLLC

Charlotte, North Carolina

March 14, 2019

EX-31.1

EXHIBIT (31)(i)

CERTIFICATIONS

I, Lance A. Sellers, certify that:

1.

I have reviewed this annual report on Form 10-K of Peoples Bancorp of North Carolina, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

March 14, 2019	/s/ Lance A. Sellers
Date	Lance A. Sellers
	President and Chief Executive Officer
	(Principal Executive Officer)

EX-31.2

EXHIBIT (31)(ii)

CERTIFICATIONS

I, A. Joseph Lampron, Jr., certify that:

1.

I have reviewed this annual report on Form 10-K of Peoples Bancorp of North Carolina, Inc.;

2.

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)

designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)

designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)

evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation ; and

d)

disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting; and

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)

all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

March 14, 2019	/s/ A. Joseph Lampron, Jr.
Date	A. Joseph Lampron, Jr.
	Executive Vice President and Chief Financial Officer
	(Principal Financial and Principal Accounting Officer)

EX-32

EXHIBIT (32)

CERTIFICATION PURSUANT TO

18 U.S.C. § 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Peoples Bancorp of North Carolina, Inc. (the “Company”) on Form 10-K for the period ended December 31, 2018, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best knowledge of the undersigned:

(1)

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

March 14, 2019	/s/ Lance A. Sellers
Date	Lance A. Sellers
	Chief Executive Officer

March 14, 2019	/s/ A. Joseph Lampron, Jr.
Date	A. Joseph Lampron, Jr.
	Chief Financial Officer

XML

Document and Entity Information - USD ($)	12 Months Ended
	Dec. 31, 2018	Feb. 28, 2019	Jun. 30, 2018
Document And Entity Information
Entity Registrant Name	PEOPLES BANCORP OF NORTH CAROLINA INC
Entity Central Index Key	0001093672
Document Type	10-K
Document Period End Date	Dec. 31, 2018
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Accelerated Filer
Entity Emerging Growth Company	false
Entity Small Business	true
Entity Shell Company	false
Entity Public Float			$ 147,933,656
Entity Common Stock, Shares Outstanding		5,997,136
Document Fiscal Period Focus	FY
Document Fiscal Year Focus	2018

XML

Consolidated Balance Sheets - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Assets
Cash and due from banks, including reserve requirements of $8,918 at 12/31/18 and $7,472 at 12/31/17	$ 40,553	$ 53,186
Interest-bearing deposits	2,817	4,118
Cash and cash equivalents	43,370	57,304
Investment securities available for sale	194,578	229,321
Other investments	4,361	1,830
Total securities	198,939	231,151
Mortgage loans held for sale	680	857
Loans	804,023	759,764
Less allowance for loan losses	(6,445)	(6,366)
Net loans	797,578	753,398
Premises and equipment, net	18,450	19,911
Cash surrender value of life insurance	15,936	15,552
Other real estate	27	118
Accrued interest receivable and other assets	18,271	13,875
Total assets	1,093,251	1,092,166
Deposits:
Non-interest bearing demand	298,817	285,406
NOW, MMDA & savings	475,223	498,445
Time, $250,000 or more	16,239	18,756
Other time	86,934	104,345
Total deposits	877,213	906,952
Securities sold under agreements to repurchase	58,095	37,757
Junior subordinated debentures	20,619	20,619
Accrued interest payable and other liabilities	13,707	10,863
Total liabilities	969,634	976,191
Commitments (Note 10)
Shareholders' equity:
Series A preferred stock, $1,000 stated value; authorized 5,000,000 shares; no shares issued and outstanding	0	0
Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 5,995,256 shares at December 31, 2018 and December 31, 2017	62,096	62,096
Retained earnings	60,535	50,286
Accumulated other comprehensive income	986	3,593
Total shareholders' equity	123,617	115,975
Total liabilities and shareholders' equity	$ 1,093,251	$ 1,092,166

XML

Consolidated Balance Sheets (Parenthetical) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Assets
Cash and due from banks, reserve requirements	$ 8,918	$ 7,472
Shareholders' equity:
Series A preferred stock, stated value (in dollars per share)	$ 1,000	$ 1,000
Series A preferred stock, shares authorized (in shares)	5,000,000	5,000,000
Series A preferred stock, shares issued (in shares)	0	0
Series A preferred stock, shares outstanding (in shares)	0	0
Common stock, par value (in dollars per share)	$ 0.00	$ 0.00
Common stock, shares authorized (in shares)	20,000,000	20,000,000
Common stock, shares issued (in shares)	5,995,256	5,995,256
Common stock, shares outstanding (in shares)	5,995,256	5,995,256

XML

Consolidated Statements of Earnings - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Interest income:
Interest and fees on loans	$ 38,654	$ 34,888	$ 32,452
Interest on due from banks	304	219	123
Interest on investment securities:
U.S. Government sponsored enterprises	2,333	2,404	2,531
States and political subdivisions	3,877	4,236	4,454
Other	182	202	249
Total interest income	45,350	41,949	39,809
Interest expense:
NOW, MMDA & savings deposits	769	598	495
Time deposits	472	466	586
FHLB borrowings	0	662	1,661
Junior subordinated debentures	790	590	485
Other	115	61	44
Total interest expense	2,146	2,377	3,271
Net interest income	43,204	39,572	36,538
Provision for (reduction of) loan losses	790	(507)	(1,206)
Net interest income after provision for loan losses	42,414	40,079	37,744
Non-interest income:
Service charges	4,355	4,453	4,497
Other service charges and fees	705	593	890
Gain on sale of securities	15	0	729
Mortgage banking income	851	1,190	1,428
Insurance and brokerage commissions	824	761	632
Appraisal management fee income	3,206	3,306	3,146
Gain (loss) on sales and write-downs of other real estate	17	(239)	64
Miscellaneous	6,193	5,300	4,850
Total non-interest income	16,166	15,364	16,236
Non-interest expense:
Salaries and employee benefits	21,530	20,058	19,264
Occupancy	7,170	6,701	6,765
Professional fees	1,525	1,236	2,439
Advertising	922	1,195	1,136
Debit card expense	994	1,248	1,141
FDIC insurance	328	347	494
Appraisal management fee expense	2,460	2,526	2,260
Other	7,645	7,917	8,743
Total non-interest expense	42,574	41,228	42,242
Earnings before income taxes	16,006	14,215	11,738
Income tax expense	2,624	3,947	2,561
Net earnings	$ 13,382	$ 10,268	$ 9,177
Basic net earnings per share	$ 2.23	$ 1.71	$ 1.53
Diluted net earnings per share	2.22	1.69	1.5
Cash dividends declared per share	$ 0.52	$ 0.44	$ 0.35

XML

Consolidated Statements of Comprehensive Income - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Consolidated Statements Of Comprehensive Income
Net earnings	$ 13,382	$ 10,268	$ 9,177
Other comprehensive income (loss):
Unrealized holding losses on securities available for sale	(3,370)	(355)	(3,274)
Reclassification adjustment for gains on securities available for sale included in net earnings	(15)	0	(729)
Total other comprehensive loss, before income taxes	(3,385)	(355)	(4,003)
Income tax benefit related to other comprehensive loss:
Unrealized holding losses on securities available for sale	(774)	(354)	(1,196)
Reclassification adjustment for gains on securities available for sale included in net earnings	(4)	0	(284)
Total income tax benefit related to other comprehensive loss	(778)	(354)	(1,480)
Total other comprehensive loss, net of tax	(2,607)	(1)	(2,523)
Total comprehensive income	$ 10,775	$ 10,267	$ 6,654

XML

Consolidated Statements of Changes in Shareholders' Equity - USD ($) $ in Thousands	Common Stock	Retained Earnings	Accumulated Other Comprehensive Income (Loss)	Total
Beginning Balance, Shares at Dec. 31, 2015	5,510,538
Beginning Balance, Amount at Dec. 31, 2015	$ 46,171	$ 53,183	$ 5,510	$ 104,864
Common stock repurchase, Shares	(92,738)
Common stock repurchase, Amount	$ (1,984)			(1,984)
Cash dividends declared on common stock		(2,106)		(2,106)
10% stock dividend, Amount				0
Restricted stock units exercised, Amount				0
Net earnings		9,177		9,177
Change in accumulated other comprehensive income, net of tax			(2,523)	(2,523)
Ending Balance, Shares at Dec. 31, 2016	5,417,800
Ending Balance, Amount at Dec. 31, 2016	$ 44,187	60,254	2,987	107,428
Cash dividends declared on common stock		(2,629)		(2,629)
10% stock dividend, Shares	544,844
10% stock dividend, Amount	$ 16,994	(17,000)		(6)
Restricted stock units exercised, Shares	32,612
Restricted stock units exercised, Amount	$ 915			915
Net earnings		10,268		10,268
Change in accumulated other comprehensive income due to Tax Cuts and Jobs Act		(607)	607
Change in accumulated other comprehensive income, net of tax			(1)	(1)
Ending Balance, Shares at Dec. 31, 2017	5,995,256
Ending Balance, Amount at Dec. 31, 2017	$ 62,096	50,286	3,593	115,975
Common stock repurchase, Amount		(3,133)		(3,133)
10% stock dividend, Amount				0
Restricted stock units exercised, Amount				0
Net earnings		13,382		13,382
Change in accumulated other comprehensive income, net of tax			(2,607)	(2,607)
Ending Balance, Shares at Dec. 31, 2018	5,995,256
Ending Balance, Amount at Dec. 31, 2018	$ 62,096	$ 60,535	$ 986	$ 123,617

XML

Consolidated Statements of Cash Flows - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Cash flows from operating activities:
Net earnings	$ 13,382	$ 10,268	$ 9,177
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation, amortization and accretion	4,571	5,018	5,423
Provision for (reduction of) loan losses	790	(507)	(1,206)
Deferred income taxes	78	2,120	1,097
Gain on sale of investment securities	(15)	0	(729)
Gain on sale of other real estate	(17)	0	(81)
Write-down of other real estate	0	239	17
Gain on sale of premises and equipment	(544)	0	0
Restricted stock expense	85	592	932
Proceeds from sales of loans held for sale	35,922	59,193	67,764
Origination of loans held for sale	(35,745)	(54,341)	(69,324)
Change in:
Cash surrender value of life insurance	(384)	(600)	(406)
Other assets	(3,695)	(3,982)	(636)
Other liabilities	2,759	594	211
Net cash provided by operating activities	17,187	18,594	12,239
Cash flows from investing activities:
Purchases of investment securities available for sale	(34,692)	(10,014)	(12,707)
Proceeds from sales, calls and maturities of investment securities available for sale	48,241	10,162	4,053
Proceeds from paydowns of investment securities available for sale	15,556	17,202	20,675
Purchases of other investments	(2,611)	(45)	(255)
Proceeds from paydowns of other investment securities	117	0	0
Net change in FHLB stock	(4)	850	1,256
Net change in loans	(45,094)	(36,748)	(36,116)
Purchases of premises and equipment	(1,742)	(5,557)	(1,610)
Proceeds from sale of premises and equipment	1,410	0	0
Proceeds from sale of other real estate and repossessions	232	44	1,083
Net cash used by investing activities	(18,587)	(24,106)	(23,621)
Cash flows from financing activities:
Net change in deposits	(29,739)	14,034	60,743
Net change in securities sold under agreement to repurchase	20,338	1,323	8,560
Proceeds from FHLB borrowings	0	1	6,000
Repayments of FHLB borrowings	0	(20,001)	(29,500)
Proceeds from FRB borrowings	1	1	1
Repayments of FRB borrowings	(1)	(1)	(1)
Proceeds from Fed Funds Purchased	4,277	187	9,112
Repayments of Fed Funds Purchased	(4,277)	(187)	(9,112)
Common stock repurchased	0	0	(1,984)
Cash dividends paid in lieu of fractional shares	0	(6)	0
Cash dividends paid on common stock	(3,133)	(2,629)	(2,106)
Net cash (used) provided by financing activities	(12,534)	(7,278)	41,713
Net change in cash and cash equivalents	(13,934)	(12,790)	30,331
Cash and cash equivalents at beginning of period	57,304	70,094	39,763
Cash and cash equivalents at end of period	43,370	57,304	70,094
Cash paid during the year for:
Interest	2,128	2,526	3,415
Income taxes	1,163	2,408	2,028
Noncash investing and financing activities:
Change in unrealized gain (loss) on investment securities available for sale, net	(2,607)	(1)	(2,523)
Transfer of loans to other real estate and repossessions	124	118	563
Issuance of accrued restricted stock units	$ 0	$ (915)	$ 0

XML

1. Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2018

Accounting Policies [Abstract]

1. Summary of Significant Accounting Policies

Organization  

Peoples Bancorp of North Carolina, Inc. (“Bancorp”) received regulatory approval to operate as a bank holding company on July 22, 1999, and became effective August 31, 1999. Bancorp is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for Peoples Bank (the “Bank”).

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is primarily regulated by the Commissioner and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell, Wake and Durham counties in North Carolina.

Peoples Investment Services, Inc. is a wholly owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC (“CBRES”) is a wholly owned subsidiary of the Bank and began operations in 2009 as a “clearing house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property is located.

PB Real Estate Holdings, LLC (“PBREH”) is a wholly owned subsidiary of the Bank and began operation in 2015. PBREH acquires, manages and disposes of real property, other collateral and other assets obtained in the ordinary course of collecting debts previously contracted.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a division of the Bank under the name Banco de la Gente (“Banco”). These offices are now branded as Bank branches and considered a separate market territory of the Bank as they offer normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans.

Principles of Consolidation

The consolidated financial statements include the financial statements of Bancorp and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc., REAS, CBRES and PBREH (collectively called the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation. 

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Cash and Cash Equivalents

Cash, due from banks and interest-bearing deposits are considered cash and cash equivalents for cash flow reporting purposes.

Investment Securities

There are three classifications the Company is able to classify its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2018 and 2017, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on an annual basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield. Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

The allowance for loan 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 for loan losses 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. Other factors considered are:

● the Bank’s loan loss experience;

● the amount of past due and non-performing loans;

● specific known risks;

● the status and amount of other past due and non-performing assets;

● underlying estimated values of collateral securing loans;

● current and anticipated economic conditions; and

● other factors which management believes affect the allowance for potential credit losses.

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 Bank’s Board of Directors 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 $1.0 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’s Board of Directors.

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. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance for loan losses. The provision for loan losses charged or credited to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management’s assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance for loan losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four or five years’ loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2018 as compared to the year ended December 31, 2017. Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, certain mortgage loans from the former Banco division of the Bank were 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.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. 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 GAAP, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance for loan losses 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.

Mortgage Banking Activities

Mortgage banking income represents net gains from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $866,000, $1.0 million and $1.4 million at December 31, 2018, 2017 and 2016, respectively.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale. The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts. The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for that period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

Buildings and improvements	10 - 50 years
Furniture and equipment	3 - 10 years

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan. Foreclosed assets are reported at fair value less estimated selling costs. Any write-downs at the time of foreclosure are charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value less estimated selling costs declines below carrying value. Costs relating to the development and improvement of the property are capitalized. Revenues and expenses from operations are included in other expenses. Changes in the valuation allowance are included in loss on sale and write-down of other real estate.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Derivative Financial Instruments and Hedging Activities

In the normal course of business, the Company enters into derivative contracts to manage interest rate risk by modifying the characteristics of the related balance sheet instruments in order to reduce the adverse effect of changes in interest rates. All material derivative financial instruments are recorded at fair value in the financial statements. The fair value of derivative contracts related to the origination of fixed rate mortgage loans and the commitments to sell these loans to a third party is immaterial and has no effect on the recorded amounts in the financial statements.

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of, and gains and losses on, derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

On the date a derivative contract is entered into, the Company designates the derivative as a fair value hedge, a cash flow hedge, or a trading instrument. Changes in the fair value of instruments used as fair value hedges are accounted for in the earnings of the period simultaneous with accounting for the fair value change of the item being hedged. Changes in the fair value of the effective portion of cash flow hedges are accounted for in other comprehensive income rather than earnings. Changes in fair value of instruments that are not intended as a hedge are accounted for in the earnings of the period of the change.

If a derivative instrument designated as a fair value hedge is terminated or the hedge designation removed, the difference between a hedged item’s then carrying amount and its face amount is recognized into income over the original hedge period. Likewise, if a derivative instrument designated as a cash flow hedge is terminated or the hedge designation removed, related amounts accumulated in other accumulated comprehensive income are reclassified into earnings over the original hedge period during which the hedged item affects income.

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company formally documents all hedging relationships, including an assessment that the derivative instruments are expected to be highly effective in offsetting the changes in fair values or cash flows of the hedged items.

Advertising Costs

Advertising costs are expensed as incurred.

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. A total of 280,933 shares are currently reserved for possible issuance under the Plan. All stock-based rights under the Plan must be granted or awarded by May 7, 2019 (i.e., ten years from the Plan effective date).

The Company granted 32,465 restricted stock units under the Plan at a grant date fair value of $7.18 per share during the first quarter of 2012, of which 5,891 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury in conjunction with the Company’s participation in the Capital Purchase Program under the Troubled Asset Relief Program. In July 2012, the Company granted 5,891 restricted stock units at a grant date fair value of $7.50 per share. The Company granted 29,475 restricted stock units under the Plan at a grant date fair value of $10.82 per share during the second quarter of 2013. The Company granted 23,162 restricted stock units under the Plan at a grant date fair value of $14.27 per share during the first quarter of 2014. The Company granted 16,583 restricted stock units under the Plan at a grant date fair value of $16.34 per share during the first quarter of 2015. The Company granted 5,544 restricted stock units under the Plan at a grant date fair value of $16.91 per share during the first quarter of 2016. The Company granted 4,114 restricted stock units under the Plan at a grant date fair value of $25.00 per share during the first quarter of 2017. The Company granted 3,725 restricted stock units under the Plan at a grant date fair value of $31.43 per share during the first quarter of 2018. The number of restricted stock units granted and grant date fair values have been restated to reflect the 10% stock dividend during the fourth quarter of 2017. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the 2012 grants, four years from the grant date for the 2013, 2015, 2016, 2017 and 2018 grants and three years from the grant date for the 2014 grants). The amount of expense recorded each period reflects the changes in the Company’s stock price during such period. As of December 31, 2018, the total unrecognized compensation expense related to the restricted stock unit grants under the Plan was $165,000.

The Company recognized compensation expense for restricted stock units granted under the Plan of $85,000, $592,000 and $932,000 for the years ended December 31, 2018, 2017 and 2016, respectively.

Net Earnings Per Share

Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share. The average market price during the year is used to compute equivalent shares.

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2018, 2017 and 2016 are as follows:

For the year ended December 31, 2018

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	13,382		5,995,256	$	2.23
Effect of dilutive securities:
Restricted stock units		—		20,240
Diluted earnings per share	$	13,382		6,015,496	$	2.22

For the year ended December 31, 2017

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	10,268		5,988,183	$	1.71
Effect of dilutive securities:
Restricted stock units		—		74,667
Diluted earnings per share	$	10,268		6,062,850	$	1.69

For the year ended December 31, 2016

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	9,177		6,024,970	$	1.53
Effect of dilutive securities:
Restricted stock units		—		77,807
Diluted earnings per share	$	9,177		6,102,777	$	1.50

In November 2017, the Board of Directors of the Company declared a 10% stock dividend. As a result of the stock dividend, each shareholder received one new share of stock for every ten shares of stock they held as of the record date of December 4, 2017. The payable date for the stock dividend was December 15, 2017. All previously reported per share amounts have been restated to reflect this stock dividend.

Recent Accounting Pronouncements

The following tables provide a summary of Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”)that the Company has recently adopted.

Recently Adopted Accounting Guidance

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2014-09: Revenue from Contracts with Customers	Provides guidance on the recognition of revenue from contracts with customers. The core principle of this guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive.	January 1, 2018	See section titled ASU 2014-09 below for a description of the effect on the Company’s results of operations, financial position and disclosures.
ASU 2016-01: Recognition and Measurement of Financial Assets and Financial Liabilities	Addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-01: Clarifying the Definition of a Business	Adds guidance to assist companies and other reporting organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-05: Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets	Clarifies the scope of established guidance on nonfinancial asset derecognition (issued as part of the new revenue standard, ASU 2014-09, Revenue from Contracts with Customers), as well as the accounting for partial sales of nonfinancial assets.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2017-07: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs	Amended the requirements related to the income statement presentation of the components of net periodic benefit cost for an entity’s sponsored defined benefit pension and other postretirement plans.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-09: Scope of Modification Accounting	Amended the requirements related to changes to the terms or conditions of a share-based payment award.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-13: Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)	Updated the Revenue from Contracts with Customers and the Leases Topics of the Accounting Standards Codification (“ASC”). The amendments incorporate into the ASC recent Securities Exchange Commission (“SEC”) guidance about certain public business entities (“PBEs”) electing to use the non-PBE effective dates solely to adopt the FASB’s new standards on revenue and leases.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-14: Income Statement—Reporting Comprehensive, Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)	Incorporates into the ASC recent SEC guidance related to revenue recognition.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-02: Income Statement (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income	Requires companies to reclassify the stranded effects in other comprehensive income to retained earnings as a result of the change in the tax rates under the Tax Cuts and Jobs Act (“TCJA”).	Effective upon issuance	The Company opted to early adopt this pronouncement by retrospective application to each period in which the effect of the change in the tax rate under the TCJA is recognized. The impact of the reclassification from other comprehensive income to retained earnings at December 31, 2017 was $607,000.
ASU 2018-03: Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities	Clarifies certain aspects of the guidance issued in ASU 2016-01.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-04: Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update)	Incorporates recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulation.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-05: Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)	Incorporates recent SEC guidance related to the income tax accounting implications of the TCJA.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-06: Codification Improvements to Topic 942: Financial Services—Depository and Lending	Eliminates a reference to the Office of the Comptroller of the Currency’s Banking Circular 202, Accounting for Net Deferred Tax Charges, from the ASC. The Office of the Comptroller of the Currency published the guidance in 1985 but has since rescinded it.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU 2014-09

The Company has applied ASU 2014-09 using a modified retrospective approach. The Company’s revenue is comprised of net interest income and noninterest income. The scope of ASU 2014-09 explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, ecurities, and derivatives. Accordingly, the majority of the

Company’s revenues are not affected. Appraisal management fee income and expense from the Bank’s subsidiary, CBRES, was reported as a net amount prior to March 31, 2018, which was included in miscellaneous non-interest income. This income and expense is now reported on separate line items under non-interest income and non-interest expense. See below for additional information related to revenue generated from contracts with customers.

Revenue and Method of Adoption

The majority of the Company’s revenue is derived primarily from interest income from receivables (loans) and securities. Other revenues are derived from fees received in connection with deposit accounts, investment advisory, and appraisal services. On January 1, 2018, the Company adopted the requirements of ASU 2014-09. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

The Company adopted ASU 2014-09 using the modified retrospective transition approach which does not require restatement of prior periods. The method was selected as there were no material changes in the timing of revenue recognition resulting in no comparability issues with prior periods. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard. When applying the modified retrospective approach under ASU 2014-09, the Company has elected, as a practical expedient, to apply this approach only to contracts that were not completed as of January 1, 2018. A completed contract is considered to be a contract for which all (or substantially all) of the revenue was recognized in accordance with revenue guidance that was in effect before January 1, 2018. There were no uncompleted contracts as of January 1, 2018 for which application of the new standard required an adjustment to retained earnings.

The following disclosures involve the Company’s material income streams derived from contracts with customers which are within the scope of ASU 2014-09. Through the Company’s wholly-owned subsidiary, PIS, the Company contracts with a registered investment advisor to perform investment advisory services on behalf of the Company’s customers. The Company receives commissions from this third party investment advisor based on the volume of business that the Company’s customers do with such investment advisor. Total revenue recognized from these contracts for the year ended December 31, 2018 was $823,000. The Company utilizes third parties to contract with the Company’s customers to perform debit and credit card clearing services. These third parties pay the Company commissions based on the volume of transactions that they process on behalf of the Company’s customers. Total revenue recognized for the year ended December 31, 2018 from the contract with these third parties was $3.9 million. Through the Company’s wholly-owned subsidiary, REAS, the Company provides property appraisal services for negotiated fee amounts on a per appraisal basis. Total revenue recognized for the year ended December 31, 2018 from these contracts with customers was $597,000. Through the Company’s wholly-owned subsidiary, CBRES, the Company provides appraisal management services. Total revenue recognized for the year ended December 31, 2018 from these contracts with customers was $3.2 million. Due to the nature of the Company’s relationship with the customers that the Company provides services, the Company does not incur costs to obtain contracts and there are no material incremental costs to fulfill these contracts that should be capitalized.

Disaggregation of Revenue. The Company’s portfolio of services provided to the Company’s customers consists of over 50,000 active contracts. The Company has disaggregated revenue according to timing of the transfer of service. Total revenue for the year ended December 31, 2018 derived from contracts in which services are transferred at a point in time was approximately $8.5 million. None of the Company’s revenue is derived from contracts in which services are transferred over time. Revenue is recognized as the services are provided to the customers. Economic factors impacting the customers could affect the nature, amount, and timing of these cash flows, as unfavorable economic conditions could impair the customers’ ability to provide payment for services. For the Company’s deposit contracts, this risk is mitigated as the Company generally deducts payments from customers’ accounts as services are rendered. For the Company’s appraisal services, the risk is mitigated in that the appraisal is not released until payment is received.

Contract Balances. The timing of revenue recognition, billings, and cash collections results in billed accounts receivable on the balance sheet. Most contracts call for payment by a charge or deduction to the respective customer account but there are some that require a receipt of payment from the customer. For fee per transaction contracts, the customers are billed as the transactions are processed. The Company has no contracts in which customers are billed in advance for services to be performed. These types of contracts would create contract liabilities or deferred revenue, as the customers pay in advance for services. There are no contract liabilities or accounts receivables balances that are material to the Company’s balance sheet.

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASU 2014-09. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Performance obligations are satisfied as the service is provided to the customer at a point in time. There are no significant financing components in the Company’s contracts. Excluding deposit and appraisal service revenues which are primarily billed at a point in time as a fee for services incurred, all other contracts within the scope of ASU 2014-09 contain variable consideration in that fees earned are derived from market values of accounts which determine the amount of consideration to which the Company is entitled. The variability is resolved when the services are provided. The contracts do not include obligations for returns, refunds, or warranties. The contracts are specific to the amounts owed to the Company for services performed during a period should the contracts be terminated.

Significant Judgements. All of the Company’s contracts create performance obligations that are satisfied at a point in time excluding some immaterial deposit revenues. Revenue is recognized as services are billed to the customers. Variable consideration does exist for contracts related to the Company’s contract with its registered investment advisor as some revenues earned pursuant to that contract are based on market values of accounts at the end of the period.

The following tables provide a summary of ASU’s issued by the FASB that the Company has not adopted as of December 31, 2018, which may impact the Company’s financial statements.

Recently Issued Accounting Guidance Not Yet Adopted

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2016-02: Leases	Increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.	January 1, 2019	The Company expects to adopt this guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow the Company to largely account for its existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. The Company epects to record an increase in assets and liabilities of approximatley $4.4 million as a result of recording lease contracts where the Company is lessee and expects to adopt the new guidance prospectively as of January 1, 2019 and to not restate comparative periods.
ASU 2016-13: Measurement of Credit Losses on Financial Instruments	Provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities.	January 1, 2020 Early adoption permitted	The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company is currently developing CECL model assumptions and comparing results to current allowance for loan loss calculations. The Company plans to run parallel calculations leading up to the effective date of this guidance to ensure it is prepared for implementation by the effective date. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.
ASU 2017-04: Simplifying the Test for Goodwill Impairment	Provides guidance to simplify the accounting related to goodwill impairment.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-08: Premium Amortization on Purchased Callable Debt Securities	Amended the requirements related to the amortization period for certain purchased callable debt securities held at a premium.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2018-11: Leases (Topic 842): Targeted Improvements	Intended to reduce costs and ease implementation of ASU 2016-02.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-13: Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820)	Updates the disclosure requirements on fair value measurements in ASC 820, Fair Value Measurement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-14: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans (Subtopic 715-20)	Updates disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.	January 1, 2021	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-15: Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40)	Reduces complexity of the accounting for costs of implementing a cloud computing service arrangement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-16: Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes	Expand the list of U.S. benchmark interest rates permitted in the application of hedge accounting.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-17: Targeted Improvements to Related Party Guidance for Variable Interest Entities	Amended the Consolidation topic of the ASC for determining whether a decision-making fee is a variable interest. The amendments require organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-18: Clarifying the Interaction between Topic 808 and Topic 606	Clarifies the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic.	January 1, 2020 Early adoption permitted	See comments for ASU 2016-13 above.
ASU 2018-20: Narrow- Scope Improvements for Lessors	Provides narrow-scope improvements for lessors, that provide relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components.	January 1, 2019	See comments for ASU 2016-02 above.

Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

Reclassification

Certain amounts in the 2017 and 2016 consolidated financial statements have been reclassified to conform to the 2018 presentation.

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2. Investment Securities

12 Months Ended

Dec. 31, 2018

Investments, Debt and Equity Securities [Abstract]

Investment Securities

Investment securities available for sale at December 31, 2018 and 2017 are as follows:

(Dollars in thousands)

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	52,145		516		558		52,103
U.S. Government
sponsored enterprises		35,356		71		793		34,634
State and political subdivisions		105,545		2,089		43		107,591
Trust preferred securities		250		—		—		250
Total	$	193,296		2,676		1,394		194,578

(Dollars in thousands)

	December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	53,124		814		329		53,609
U.S. Government
sponsored enterprises		40,504		140		264		40,380
State and political subdivisions		129,276		4,310		16		133,570
Corporate bonds		1,500		12		—		1,512
Trust preferred securities		250		—		—		250
Total	$	224,654		5,276		609		229,321

The current fair value and associated unrealized losses on investments in debt securities with unrealized losses at December 31, 2018 and 2017 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)                                    

	December 31, 2018
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	6,932		56		17,670		502		24,602		558
U.S. Government
sponsored enterprises		1,784		69		25,172		724		26,956		793
State and political subdivisions		4,815		26		1,578		17		6,393		43
Total	$	13,531		151		44,420		1,243		57,951		1,394

(Dollars in thousands)                                    

	December 31, 2017
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	8,701		75		11,259		254		19,960		329
U.S. Government
sponsored enterprises		12,661		98		10,067		166		22,728		264
State and political subdivisions		798		2		1,501		14		2,299		16
Total	$	22,160		175		22,827		434		44,987		609

At December 31, 2018, unrealized losses in the investment securities portfolio relating to debt securities totaled $1.4 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the December 31, 2018 tables above, 11 out of 130 securities issued by state and political subdivisions contained unrealized losses and 31 out of 46 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of acceptable financial condition and results of operations on each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary.   No investment impairments were deemed other-than-temporary in 2018, 2017 or 2016.

The amortized cost and estimated fair value of investment securities available for sale at December 31, 2018, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

December 31, 2018
(Dollars in thousands)
	Amortized Cost		Estimated Fair Value
Due within one year	$	21,379		21,426
Due from one to five years		80,932		82,325
Due from five to ten years		32,271		32,174
Due after ten years		6,569		6,550
Mortgage-backed securities		52,145		52,103
Total	$	193,296		194,578

During 2018, proceeds from sales of securities available for sale were $36.0 million and resulted in gross gains of $15,000. No securities available for sale were sold during the year ended December 31, 2017. During 2016, proceeds from sales of securities available for sale were $1.5 million and resulted in gross gains of $729,000.

Securities with a fair value of approximately $93.0 million and $105.6 million at December 31, 2018 and 2017, respectively, were pledged to secure public deposits, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings and for other purposes as required by law.

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2018 and 2017.

(Dollars in thousands)
	December 31, 2018
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	52,103		—		52,103		—
U.S. Government
sponsored enterprises	$	34,634		—		34,634		—
State and political subdivisions	$	107,591		—		107,591		—
Trust preferred securities	$	250		—		—		250

(Dollars in thousands)
	December 31, 2017
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	53,609		—		53,609		—
U.S. Government
sponsored enterprises	$	40,380		—		40,380		—
State and political subdivisions	$	133,570		—		133,570		—
Corporate bonds	$	1,512		—		1,512		—
Trust preferred securities	$	250		—		—		250

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the year ended December 31, 2018.

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$	250
Change in book value		—
Change in gain/(loss) realized and unrealized		—
Purchases/(sales and calls)		—
Transfers in and/or (out) of Level 3		—
Balance, end of period	$	250
Change in unrealized gain/(loss) for assets still held in Level 3	$	—

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3. Loans

12 Months Ended

Dec. 31, 2018

Receivables [Abstract]

Loans

Major classifications of loans at December 31, 2018 and 2017 are summarized as follows:

(Dollars in thousands)
	December 31, 2018		December 31, 2017
Real estate loans:
Construction and land development	$	94,178		84,987
Single-family residential		252,983		246,703
Single-family residential -
Banco de la Gente non-traditional		34,261		37,249
Commercial		270,055		248,637
Multifamily and farmland		33,163		28,937
Total real estate loans		684,640		646,513
Loans not secured by real estate:
Commercial loans		97,465		89,022
Farm loans		926		1,204
Consumer loans		9,165		9,888
All other loans		11,827		13,137
Total loans		804,023		759,764
Less allowance for loan losses		6,445		6,366
Net loans	$	797,578		753,398

The above table includes deferred costs, net of deferred fees, totaling $1.6 million at December 31, 2018 and 2017.

The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Wake and Durham counties of North Carolina. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market. Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

● Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of December 31, 2018, construction and land development loans comprised approximately 12% of the Bank’s total loan portfolio.

● Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of December 31, 2018, single-family residential loans comprised approximately 36% of the Bank’s total loan portfolio, including Banco single-family residential non-traditional loans which were approximately 4% of the Bank’s total loan portfolio.

● Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of December 31, 2018, commercial real estate loans comprised approximately 34% of the Bank’s total loan portfolio.

● Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. As of December 31, 2018, commercial loans comprised approximately 12% of the Bank’s total loan portfolio.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present an age analysis of past due loans, by loan type, as of December 31, 2018 and 2017:

December 31, 2018
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	3		—		3		94,175		94,178		—
Single-family residential		4,162		570		4,732		248,251		252,983		—
Single-family residential -
Banco de la Gente non-traditional		4,627		580		5,207		29,054		34,261		—
Commercial		228		—		228		269,827		270,055		—
Multifamily and farmland		—		—		—		33,163		33,163		—
Total real estate loans		9,020		1,150		10,170		674,470		684,640		—
Loans not secured by real estate:
Commercial loans		445		90		535		96,930		97,465		—
Farm loans		—		—		—		926		926		—
Consumer loans		99		4		103		9,062		9,165		—
All other loans		—		—		—		11,827		11,827		—
Total loans	$	9,564		1,244		10,808		793,215		804,023		—

December 31, 2017
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	277		—		277		84,710		84,987		—
Single-family residential		3,241		193		3,434		243,269		246,703		—
Single-family residential -
Banco de la Gente non-traditional		4,078		465		4,543		32,706		37,249		—
Commercial		588		—		588		248,049		248,637		—
Multifamily and farmland		—		12		12		28,925		28,937		—
Total real estate loans		8,184		670		8,854		637,659		646,513		—
Loans not secured by real estate:
Commercial loans		53		100		153		88,869		89,022		—
Farm loans		—		—		—		1,204		1,204		—
Consumer loans		113		5		118		9,770		9,888		—
All other loans		—		—		—		13,137		13,137		—
Total loans	$	8,350		775		9,125		750,639		759,764		—

The following table presents the Bank’s non-accrual loans as of December 31, 2018 and 2017:

(Dollars in thousands)
	December 31, 2018		December 31, 2017
Real estate loans:
Construction and land development	$	1		14
Single-family residential		1,530		1,634
Single-family residential -
Banco de la Gente non-traditional		1,440		1,543
Commercial		244		396
Multifamily and farmland		—		12
Total real estate loans		3,215		3,599
Loans not secured by real estate:
Commercial loans		89		100
Consumer loans		10		12
Total	$	3,314		3,711

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $250,000 are not individually evaluated for impairment with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Impaired loans collectively evaluated for impairment totaled $4.8 million and $4.9 million at December 31, 2018 and 2017, respectively. Accruing impaired loans were $22.8 million and $24.6 million at December 31, 2018 and December 31, 2017, respectively. Interest income recognized on accruing impaired loans was $1.3 million and $1.4 million for the years ended December 31, 2018 and 2017, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual. 

The following tables present the Bank’s impaired loans as of December 31, 2018, 2017 and 2016:

December 31, 2018
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	281		—		279		279		5		327		19
Single-family residential		5,059		422		4,188		4,610		32		6,271		261
Single-family residential -
Banco de la Gente non-traditional		16,424		—		15,776		15,776		1,042		14,619		944
Commercial		1,995		—		1,925		1,925		17		2,171		111
Total impaired real estate loans		23,759		422		22,168		22,590		1,096		23,388		1,335
Loans not secured by real estate:
Commercial loans		251		89		1		90		—		96		—
Consumer loans		116		—		113		113		2		137		7
Total impaired loans	$	24,126		511		22,282		22,793		1,098		23,621		1,342

December 31, 2017
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	282		—		277		277		6		253		17
Single-family residential		5,226		1,135		3,686		4,821		41		5,113		265
Single-family residential -
Banco de la Gente non-traditional		17,360		—		16,805		16,805		1,149		16,867		920
Commercial		2,761		807		1,661		2,468		1		3,411		148
Multifamily and farmland		78		—		12		12		—		28		—
Total impaired real estate loans		25,707		1,942		22,441		24,383		1,197		25,672		1,350
Loans not secured by real estate:
Commercial loans		264		100		4		104		—		149		3
Consumer loans		158		—		154		154		2		194		9
Total impaired loans	$	26,129		2,042		22,599		24,641		1,199		26,015		1,362

December 31, 2016
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	282		—		278		278		11		330		13
Single-family residential		5,354		703		4,323		5,026		47		7,247		164
Single-family residential -
Banco de la Gente non-traditional		18,611		—		18,074		18,074		1,182		17,673		861
Commercial		3,750		1,299		2,197		3,496		166		4,657		152
Multifamily and farmland		78		—		78		78		—		78		—
Total impaired real estate loans		28,075		2,002		24,950		26,952		1,406		29,985		1,190
Loans not secured by real estate:
Commercial loans		27		—		27		27		—		95		—
Consumer loans		211		—		202		202		3		222		8
Total impaired loans	$	28,313		2,002		25,179		27,181		1,409		30,302		1,198

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at December 31, 2018 and 2017 are presented below. The Company’s valuation methodology is discussed in Note 15.

(Dollars in thousands)
	Fair Value Measurements December 31, 2018		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	680		—		—		680
Impaired loans	$	21,695		—		—		21,695
Other real estate	$	27		—		—		27

(Dollars in thousands)
	Fair Value Measurements December 31, 2017		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	857		—		—		857
Impaired loans	$	23,442		—		—		23,442
Other real estate	$	118		—		—		118

Changes in the allowance for loan losses for the year ended December 31, 2018 were as follows:

(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm	Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Charge-offs		(53	)	(116	)	—		(453	)	(5	)	(54	)	—	(452	)	—	(1,133	)
Recoveries		10		106		—		105		1		32		—	168		—	422
Provision		52		(477	)	(103	)	433		15		74		—	290		506	790
Ending balance	$	813		1,325		1,177		1,278		83		626		—	161		982	6,445
Ending balance: individually
evaluated for impairment	$	—		—		1,023		15		—		—		—	—		—	1,038
Ending balance: collectively
evaluated for impairment		813		1,325		154		1,263		83		626		—	161		982	5,407
Ending balance	$	813		1,325		1,177		1,278		83		626		—	161		982	6,445
Loans:
Ending balance	$	94,178		252,983		34,261		270,055		33,163		97,465		926	20,992		—	804,023
Ending balance: individually
evaluated for impairment	$	96		1,779		14,310		1,673		—		89		—	—		—	17,947
Ending balance: collectively
evaluated for impairment	$	94,082		251,204		19,951		268,382		33,163		97,376		926	20,992		—	786,076

Changes in the allowance for loan losses for the year ended December 31, 2017 were as follows:

(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm	Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	1,152		2,126		1,377		1,593		52		675		—	204		371	7,550
Charge-offs		—		(249	)	—		—		(66	)	(194	)	—	(473	)	—	(982	)
Recoveries		14		85		—		21		—		31		—	154		—	305
Provision		(362	)	(150	)	(97	)	(421	)	86		62		—	270		105	(507	)
Ending balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Ending balance: individually
evaluated for impairment	$	—		—		1,093		37		—		—		—	—		—	1,130
Ending balance: collectively
evaluated for impairment		804		1,812		187		1,156		72		574		—	155		476	5,236
Ending balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Loans:
Ending balance	$	84,987		246,703		37,249		248,637		28,937		89,022		1,204	23,025		—	759,764
Ending balance: individually
evaluated for impairment	$	98		1,855		15,460		2,251		—		100		—	—		—	19,764
Ending balance: collectively
evaluated for impairment	$	84,889		244,848		21,789		246,386		28,937		88,922		1,204	23,025		—	740,000

Changes in the allowance for loan losses for the year ended December 31, 2016 were as follows:

(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Non-traditional		Commercial		Multifamily and Farmland	Commercial		Farm	Consumer and All Other		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	2,185		2,534		1,460		1,917		—	842		—	172		479		9,589
Charge-offs		(7	)	(275	)	—		(318	)	—	(146	)	—	(492	)	—		(1,238	)
Recoveries		10		55		—		19		—	170		—	151		—		405
Provision		(1,036	)	(188	)	(83	)	(25	)	52	(191	)	—	373		(108	)	(1,206	)
Ending balance	$	1,152		2,126		1,377		1,593		52	675		—	204		371		7,550
Ending balance: individually
evaluated for impairment	$	—		—		1,160		159		—	—		—	—		—		1,319
Ending balance: collectively
evaluated for impairment		1,152		2,126		217		1,434		52	675		—	204		371		6,231
Ending balance	$	1,152		2,126		1,377		1,593		52	675		—	204		371		7,550
Loans:
Ending balance	$	61,749		240,700		40,189		247,521		21,047	87,596		—	25,009		—		723,811
Ending balance: individually
evaluated for impairment	$	—		935		16,718		3,648		—	—		—	—		—		21,301
Ending balance: collectively
evaluated for impairment	$	61,749		239,765		23,471		243,873		21,047	87,596		—	25,009		—		702,510

The Bank utilizes an internal risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 8. These risk grades are evaluated on an ongoing basis. A description of the general characteristics of the eight risk grades is as follows:

● Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.

● Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability. The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.

● Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).

● Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

● Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.

● Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any). There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

● Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.

● Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of December 31, 2018 and 2017.

December 31, 2018
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development	Single-Family Residential	Single- Family Residential - Banco de la Gente Non- traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$	504	5,795	—	—	—	605	—	673	—	7,577
2- High Quality		24,594	128,588	—	25,321	395	20,520	—	3,229	2,145	204,792
3- Good Quality		59,549	92,435	13,776	211,541	27,774	69,651	785	4,699	8,932	489,142
4- Management Attention		5,707	19,200	15,012	30,333	3,906	6,325	141	529	750	81,903
5- Watch		3,669	3,761	2,408	2,616	1,088	264	—	18	—	13,824
6- Substandard		155	3,204	3,065	244	—	100	—	17	—	6,785
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	94,178	252,983	34,261	270,055	33,163	97,465	926	9,165	11,827	804,023

December 31, 2017
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non- traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$	152	8,590	—	—	—	446	—	791	—	9,979
2- High Quality		20,593	120,331	—	34,360	561	17,559	—	3,475	2,410	199,289
3- Good Quality		53,586	89,120	14,955	196,439	25,306	65,626	1,085	5,012	9,925	461,054
4- Management Attention		4,313	20,648	15,113	13,727	1,912	5,051	119	562	802	62,247
5- Watch		6,060	4,796	3,357	3,671	1,146	223	—	23	—	19,276
6- Substandard		283	3,218	3,824	440	12	117	—	25	—	7,919
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	84,987	246,703	37,249	248,637	28,937	89,022	1,204	9,888	13,137	759,764

TDR loans modified in 2018, past due TDR loans and non-accrual TDR loans totaled $4.7 million and $4.5 million at December 31, 2018 and December 31, 2017, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were $92,000 and $21,000 in performing loans classified as TDR loans at December 31, 2018 and December 31, 2017, respectively.

The following table presents an analysis of loan modifications during the year ended December 31, 2018:

Year ended December 31, 2018
(Dollars in thousands)
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential		2	$	94		94
Total TDR loans		2	$	94		94

During the year ended December 31, 2018, two loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.

The following table presents an analysis of loan modifications during the year ended December 31, 2017:

Year ended December 31, 2017
(Dollars in thousands)
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential		2	$	22		22
Total TDR loans		2	$	22		22

During the year ended December 31, 2017, two loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.

There were no TDR loans with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the years ended December 31, 2018 and 2017. TDR loans are deemed to be in default if they become past due by 90 days or more.

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4. Premises and Equipment

12 Months Ended

Dec. 31, 2018

Property, Plant and Equipment [Abstract]

Premises and Equipment

Major classifications of premises and equipment at December 31, 2018 and 2017 are summarized as follows:

(Dollars in thousands)
	2018		2017
Land	$	3,456		3,700
Buildings and improvements		19,357		19,312
Furniture and equipment		22,315		21,115
Construction in process		381		847
Total premises and equipment		45,509		44,974
Less accumulated depreciation		27,059		25,063
Total net premises and equipment	$	18,450		19,911

The Company recognized approximately $2.3 million in depreciation expense for the year ended December 31, 2018. Depreciation expense was approximately $2.1 million and $2.1 million for the years ended December 31, 2017 and 2016, respectively.

The Company had $544,000 net gains on the sale of premises and equipment for the year ended December 31, 2018, which was primarily due to the sale of a Bank building that housed primarily administrative staff. Staff working at this location have been relocated to other Bank locations.

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5. Time Deposits

12 Months Ended

Dec. 31, 2018

Banking and Thrift [Abstract]

Time Deposits

At December 31, 2018, the scheduled maturities of time deposits are as follows:

(Dollars in thousands)
	2019	$	61,723
	2020		21,566
	2021		14,121
	2022		2,618
	2023 and thereafter		3,145
	Total	$	103,173

At December 31, 2018 and 2017, the Bank had approximately $3.4 million and $5.2 million, respectively, in time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers. CDARS balances totaled $3.4 million and $5.2 million as of December 31, 2018 and 2017, respectively. The weighted average rate of brokered deposits as of December 31, 2018 and 2017 was 0.07% and 0.07%, respectively.

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6. Federal Home Loan Bank and Federal Reserve Bank Borrowings

12 Months Ended

Dec. 31, 2018

Banking and Thrift [Abstract]

Federal Home Loan Bank and Federal Reserve Bank Borrowings

The Bank had no borrowings from the FHLB at December 31, 2018 and 2017. FHLB borrowings are collateralized by a blanket assignment on all residential first mortgage loans, home equity lines of credit and loans secured by multi-family real estate that the Bank owns. At December 31, 2018, the carrying value of loans pledged as collateral totaled approximately $140.0 million. The remaining availability under the line of credit with the FHLB was $84.9 million at December 31, 2018.

The Bank is required to purchase and hold certain amounts of FHLB stock in order to obtain FHLB borrowings. No ready market exists for the FHLB stock, and it has no quoted market value. The stock is redeemable at $100 per share subject to certain limitations set by the FHLB. The Bank owned $982,000 and $978,000 of FHLB stock, included in other investments, at December 31, 2018 and 2017, respectively.

The Bank prepaid FHLB borrowings totaling $20.0 million in 2017 with prepayment penalties totaling $508,000.

As of December 31, 2018 and 2017, the Bank had no borrowings from the Federal Reserve Bank (“FRB”). FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At December 31, 2018, the carrying value of loans pledged as collateral totaled approximately $442.6 million. Availability under the line of credit with the FRB was $335.8 million at December 31, 2018.

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7. Junior Subordinated Debentures

12 Months Ended

Dec. 31, 2018

Brokers and Dealers [Abstract]

Junior Subordinated Debentures

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 trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. 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, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

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8. Income Taxes

12 Months Ended

Dec. 31, 2018

Income Tax Disclosure [Abstract]

Income Taxes

On December 22, 2017, the President of the United States signed into law the TCJA. The TCJA includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 34 percent to 21 percent for tax years beginning after December 31, 2017.

The Company recognized the income tax effects of the TCJA in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the TCJA was signed into law. As such, the Company’s financial results reflect the income tax effects of the TCJA for which the accounting under ASC Topic 740 is complete and provisional amounts for those specific income tax effects of the TCJA for which the accounting under ASC Topic 740 is incomplete but a reasonable estimate could be determined. The Company did not identify items for which the income tax effects of the TCJA have not been completed and a reasonable estimate could not be determined as of December 31, 2017.

The provision for income taxes is summarized as follows:

(Dollars in thousands)
	2018		2017		2016
Current expense	$	2,546		1,827		1,464
Deferred income tax expense		78		2,120		1,097
Total income tax	$	2,624		3,947		2,561

The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to earnings before income taxes are as follows:

(Dollars in thousands)
	2018			2017			2016
Tax expense at statutory rate (21% in 2018)	$	3,361			4,833			3,991
State income tax, net of federal income tax effect		358			307			339
Tax-exempt interest income		(990	)		(1,594	)		(1,681	)
Increase in cash surrender value of life insurance		(81	)		(136	)		(138	)
Nondeductible interest and other expense		23			46			78
Impact of TCJA		—			588			—
Other		(47	)		(97	)		(28	)
Total	$	2,624			3,947			2,561

The following summarizes the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities. The net deferred tax asset is included as a component of other assets at December 31, 2018 and 2017.

(Dollars in thousands)
	2018		2017
Deferred tax assets:
Allowance for loan losses	$	1,481		1,463
Accrued retirement expense		1,119		1,073
Federal credit carryforward		—		88
Restricted stock		262		243
Accrued bonuses		211		171
Interest income on nonaccrual loans		1		5
Other than temporary impairment		—		9
Total gross deferred tax assets		3,074		3,052
Deferred tax liabilities:
Deferred loan fees		379		365
Accumulated depreciation		610		498
Prepaid expenses		10		14
Other		5		28
Unrealized gain on available for sale securities		294		1,072
Total gross deferred tax liabilities		1,298		1,977
Net deferred tax asset	$	1,776		1,075

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 34 percent to 21 percent, resulting in a $588,000 increase in income tax expense for the year ended December 31, 2017 and a corresponding $588,000 decrease in net deferred tax assets as of December 31, 2017.

The Company has analyzed the tax positions taken or expected to be taken in its tax returns and has concluded that it has no liability related to uncertain tax positions.

The Company’s Federal income tax filings for years 2015 through 2018 were at year end 2018 open to audit under statutes of limitations by the Internal Revenue Service. The Company’s North Carolina income tax returns are currently under audit for tax years 2014-2016, tax years 2017 and 2018 are open to audit under the statutes of limitations by the North Carolina Department of Revenue.

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9. Related Party Transactions

12 Months Ended

Dec. 31, 2018

Related Party Transactions [Abstract]

Related Party Transactions

The Company conducts transactions with its directors and executive officers, including companies in which they have beneficial interests, in the normal course of business. It is the policy of the Company that loan transactions with directors and officers are made on substantially the same terms as those prevailing at the time made for comparable loans to other persons. The following is a summary of activity for related party loans for 2018 and 2017:

(Dollars in thousands)
	2018			2017
Beginning balance	$	3,679			4,503
New loans		8,030			5,879
Repayments		(8,517	)		(6,703	)
Ending balance	$	3,192			3,679

At December 31, 2018 and 2017, the Company had deposit relationships with related parties of approximately $31.6 million and $26.6 million, respectively.

A director of the Company is an officer and partial owner of the construction company that renovated the Bank’s Corporate Center located at 518 West C Street, Newton, North Carolina during 2017. During 2017 the Company paid a total of approximately $2.6 million to this construction company for such renovation work. The Company did not make any payments to this construction company during 2018.

A director of the Company has a membership interest in a company that leases two branch facilities to the Bank. The Bank’s lease payments for these facilities totaled $230,000 and $215,000 during 2018 and 2017, respectively.

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10. Commitments and Contingencies

12 Months Ended

Dec. 31, 2018

Commitments and Contingencies Disclosure [Abstract]

Commitments and Contingencies

The Company leases various office spaces for banking and operational facilities and equipment under operating lease arrangements. Future minimum lease payments required for all operating leases having a remaining term in excess of one year at December 31, 2018 are as follows:

(Dollars in thousands)
Year ending December 31,
	2019	$	820
	2020		809
	2021		793
	2022		501
	2023		393
	Thereafter		1,624
	Total minimum obligation	$	4,940

Total rent expense was approximately $785,000, $756,000 and $752,000 for the years ended December 31, 2018, 2017 and 2016, respectively.

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

In most cases, the Bank requires collateral or other security to support financial instruments with credit risk.

(Dollars in thousands)
		Contractual Amount
		2018	2017
Financial instruments whose contract amount represent credit risk:
Commitments to extend credit	$	268,708	233,972
Standby letters of credit and financial guarantees written	$	3,651	3,325

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates and because they may expire without being drawn upon, the total commitment amount of $272.4 million does not necessarily represent future cash requirements.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to businesses in the Bank’s delineated market area. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds real estate, equipment, automobiles and customer deposits as collateral supporting those commitments for which collateral is deemed necessary.

In the normal course of business, the Company is a party (both as plaintiff and defendant) to a number of lawsuits. In the opinion of management and counsel, none of these cases should have a material adverse effect on the financial position of the Company.

Bancorp and the Bank have employment agreements with certain key employees. The agreements, among other things, include salary, bonus, incentive compensation, and change in control provisions.

The Company has $82.5 million available for the purchase of overnight federal funds from six correspondent financial institutions as of December 31, 2018.

At December 31, 2017, the Bank committed to invest $3.0 million in an income tax credit partnership owning and developing two multifamily housing developments in Charlotte, North Carolina, with $1.5 million allocated to each property. The Bank has funded $2.4 million of this commitment at December 31, 2018.

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11. Employee and Director Benefit Programs

12 Months Ended

Dec. 31, 2018

Retirement Benefits [Abstract]

Employee and Director Benefit Programs

The Company has a profit sharing and 401(k) plan for the benefit of substantially all employees subject to certain minimum age and service requirements. Under the 401(k) plan, the Company matched employee contributions to a maximum of 4.00% of annual compensation in 2016, 2017 and 2018. The Company’s contribution pursuant to this formula was approximately $670,000, $622,000 and $565,000 for the years 2018, 2017 and 2016, respectively. Investments of the 401(k) plan are determined by a committee comprised of senior management. No investments in Company stock have been made by the 401(k) plan. Contributions to the 401(k) plan are vested immediately.

In December 2001, the Company initiated a postretirement benefit plan to provide retirement benefits to key officers and its Board of Directors and to provide death benefits for their designated beneficiaries. Under the postretirement benefit plan, the Company purchased life insurance contracts on the lives of the key officers and each director. The increase in cash surrender value of the contracts constitutes the Company’s contribution to the postretirement benefit plan each year. Postretirement benefit plan participants are to be paid annual benefits for a specified number of years commencing upon retirement. Expenses incurred for benefits relating to the postretirement benefit plan were approximately $423,000, $411,000 and $428,000 for the years 2018, 2017 and 2016, respectively.

The Company is currently paying medical benefits for certain retired employees. The Company did not incur any postretirement medical benefits expense in 2018, 2017 and 2016 due to an excess accrual balance.

The following table sets forth the change in the accumulated benefit obligation for the Company’s two postretirement benefit plans described above:

(Dollars in thousands)
	2018			2017
Benefit obligation at beginning of period	$	4,361			4,174
Service cost		362			348
Interest cost		70			68
Benefits paid		(227	)		(229	)
Benefit obligation at end of period	$	4,566			4,361

The amounts recognized in the Company’s Consolidated Balance Sheet as of December 31, 2018 and 2017 are shown in the following two tables:

(Dollars in thousands)
	2018		2017
Benefit obligation	$	4,566		4,361
Fair value of plan assets		—		—

(Dollars in thousands)
	2018			2017
Funded status	$	(4,566	)		(4,361	)
Unrecognized prior service cost/benefit		—			—
Unrecognized net actuarial loss		—			—
Net amount recognized	$	(4,566	)		(4,361	)
Unfunded accrued liability	$	(4,566	)		(4,361	)
Intangible assets		—			—
Net amount recognized	$	(4,566	)		(4,361	)

Net periodic benefit cost of the Company’s postretirement benefit plans for the years ended December 31, 2018, 2017 and 2016 consisted of the following:

(Dollars in thousands)
	2018			2017			2016
Service cost	$	362			348			346
Interest cost		70			68			67
Net periodic cost	$	432			416			413
Weighted average discount rate assumption
used to determine benefit obligation		5.49	%		5.49	%		5.47	%

The Company paid benefits under the two postretirement plans totaling $227,000 and $229,000 during the years ended December 31, 2018 and 2017, respectively. Information about the expected benefit payments for the Company’s two postretirement benefit plans is as follows:

(Dollars in thousands)
Year ending December 31,
	2019	$	235
	2020	$	353
	2021	$	353
	2022	$	342
	2023	$	342
	Thereafter	$	8,709

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12. Regulatory Matters

12 Months Ended

Dec. 31, 2018

Banking and Thrift [Abstract]

Regulatory Matters

The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of capital in relation to both on- and off-balance sheet items at various risk weights. Total capital consists of two tiers of capital. Tier 1 capital includes common shareholders’ equity and trust preferred securities less adjustments for intangible assets. Tier 2 capital consists of the allowance for loan losses, up to 1.25% of risk-weighted assets and other adjustments. Management believes, as of December 31, 2018, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2018, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

In 2013, the Federal Reserve Board 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 are being 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 at 0.625% and is being phased in through 2019 (increasing by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019). This will result 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.

The Company’s and the Bank’s actual capital amounts and ratios are presented below:

(Dollars in thousands)
	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2018:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	149,076		16.15	%		91,133		9.88	%		N/A		N/A
Bank	$	146,640		15.91	%		90,995		9.88	%		92,147		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	142,631		15.46	%		72,676		7.88	%		N/A		N/A
Bank	$	140,195		15.21	%		72,566		7.88	%		73,717		8.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	142,631		13.05	%		43,723		4.00	%		N/A		N/A
Bank	$	140,195		12.76	%		43,950		4.00	%		54,937		5.00	%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	122,631		13.29	%		58,833		6.38	%		N/A		N/A
Bank	$	140,195		15.21	%		58,744		6.38	%		59,895		6.50	%

(Dollars in thousands)
	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2017:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	138,492		16.06	%		79,758		9.25	%		N/A		N/A
Bank	$	136,299		15.83	%		79,627		9.25	%		86,084		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	132,126		15.32	%		62,513		7.25	%		N/A		N/A
Bank	$	129,933		15.09	%		62,411		7.25	%		68,867		8.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	132,126		11.94	%		44,255		4.00	%		N/A		N/A
Bank	$	129,933		11.69	%		44,475		4.00	%		55,594		5.00	%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	112,126		13.00	%		49,579		5.75	%		N/A		N/A
Bank	$	129,933		15.09	%		49,498		5.75	%		55,954		6.50	%

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13. Shareholders' Equity

12 Months Ended

Dec. 31, 2018

Equity [Abstract]

Shareholders' Equity

Shareholders’ equity was $123.6 million, or 11.31% of total assets, as of December 31, 2018, compared to $116.0 million, or 10.62% of total assets, as of December 31, 2017. The increase in shareholders’ equity is primarily due to an increase in retained earnings due to net income.

Annualized return on average equity for the year ended December 31, 2018 was 10.81% compared to 8.78% for the year ended December 31, 2017. Total cash dividends paid on common stock were $3.1 million and $2.6 million for the years ended December 31, 2018 and 2017, respectively.

The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares. The Board is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights. The Board of Directors does not currently anticipate issuing shares of preferred stock.

In 2016, the Company’s Board of Directors authorized a stock repurchase program, pursuant to which up to $2 million was allocated to repurchase the Company’s common stock. Any purchases under the Company’s stock repurchase program were 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 were determined by the Company’s management, based on its evaluation of market conditions and other factors. The Company repurchased approximately $2.0 million, or 92,738 shares of its common stock, under this program as of December 31, 2017.

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14. Other Operating Income and Expense

12 Months Ended

Dec. 31, 2018

Other Income and Expenses [Abstract]

Other Operating Income and Expense

Miscellaneous non-interest income for the years ended December 31, 2018, 2017 and 2016 included the following items:

(Dollars in thousands)
	2018		2017			2016
Visa debit card income	$	3,911		3,757			3,589
Bank owned life insurance income		384		400			407
Gain (loss) on sale of capital assets		544		(32	)		—
Other		1,354		1,175			854
	$	6,193		5,300			4,850

Other non-interest expense for the years ended December 31, 2018, 2017 and 2016 included the following items:

(Dollars in thousands)
	2018		2017		2016
ATM expense	$	542		673		658
Consulting		1,012		785		2,257
Data processing		466		426		418
Deposit program expense		586		539		371
Dues and subscriptions		421		354		451
FHLB advance prepayment penalty		—		508		1,260
Internet banking expense		603		720		710
Office supplies		503		517		465
Telephone		678		855		754
Other		2,834		2,540		1,399
	$	7,645		7,917		8,743

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15. Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2018

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments

The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance.

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

● Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

● Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

● Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Cash and Cash Equivalents

For cash, due from banks and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value. Cash and cash equivalents are reported in the Level 1 fair value category.

Investment Securities Available for Sale

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category. Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category. All other fair value measurements are reported in the Level 3 fair value category.

Other Investments

For other investments, the carrying value is a reasonable estimate of fair value. Other investments are reported in the Level 3 fair value category.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value. Mortgage loans held for sale are reported in the Level 3 fair value category.

Loans

The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value. Loans are reported in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

Cash Surrender Value of Life Insurance

For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value. Cash surrender value of life insurance is reported in the Level 2 fair value category.

Other Real Estate

The fair value of other real estate is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Other real estate is reported in the Level 3 fair value category.

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Deposits are reported in the Level 2 fair value category.

Securities Sold Under Agreements to Repurchase

For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value. Securities sold under agreements to repurchase are reported in the Level 2 fair value category.

FHLB Borrowings

The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 2 fair value category.

Junior Subordinated Debentures

Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value. Junior subordinated debentures are reported in the Level 2 fair value category.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The fair value presentation for recurring assets is presented in Note 2. There were no recurring liabilities at December 31, 2018 and 2017. The fair value presentation for non-recurring assets is presented in Note 3. There were no non-recurring liabilities at December 31, 2018 and 2017. The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2018 and 2017 are as follows:

(Dollars in thousands)
			Fair Value Measurements at December 31, 2018
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	43,370		43,370		—		—		43,370
Investment securities available for sale	$	194,578		—		194,328		250		194,578
Other investments	$	4,361		—		—		4,361		4,361
Mortgage loans held for sale	$	680		—		—		680		680
Loans, net	$	797,578		—		—		748,917		748,917
Cash surrender value of life insurance	$	15,936		—		15,936		—		15,936
Liabilities:
Deposits	$	877,213		—		—		857,999		857,999
Securities sold under agreements
to repurchase	$	58,095		—		58,095		—		58,095
Junior subordinated debentures	$	20,619		—		20,619		—		20,619

(Dollars in thousands)
			Fair Value Measurements at December 31, 2017
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	57,304		57,304		—		—		57,304
Investment securities available for sale	$	229,321		—		229,071		250		229,321
Other investments	$	1,830		—		—		1,830		1,830
Mortgage loans held for sale	$	857		—		—		857		857
Loans, net	$	753,398		—		—		735,837		735,837
Cash surrender value of life insurance	$	15,552		—		15,552		—		15,552
Liabilities:
Deposits	$	906,952		—		—		894,932		894,932
Securities sold under agreements
to repurchase	$	37,757		—		37,757		—		37,757
Junior subordinated debentures	$	20,619		—		20,619		—		20,619

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16. Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements

12 Months Ended

Dec. 31, 2018

Condensed Financial Information Disclosure [Abstract]

Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements

Balance Sheets

December 31, 2018 and 2017

(Dollars in thousands)

Assets	2018		2017
Cash	$	689		428
Interest-bearing time deposit		1,000		1,000
Investment in subsidiaries		141,181		133,781
Investment in PEBK Capital Trust II		619		619
Investment securities available for sale		250		250
Other assets		533		546
Total assets	$	144,272		136,624
Liabilities and Shareholders' Equity
Junior subordinated debentures	$	20,619		20,619
Liabilities		36		30
Shareholders' equity		123,617		115,975
Total liabilities and shareholders' equity	$	144,272		136,624

Statements of Earnings

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

Revenues:	2018		2017		2016
Interest and dividend income	$	4,544		1,839		4,569
Gain on sale of securities		—		—		405
Total revenues		4,544		1,839		4,974
Expenses:
Interest		790		590		485
Other operating expenses		678		725		513
Total expenses		1,468		1,315		998
Income before income tax benefit and equity in
undistributed earnings of subsidiaries		3,076		524		3,976
Income tax benefit		299		434		178
Income before equity in undistributed
earnings of subsidiaries		3,375		958		4,154
Equity in undistributed earnings of subsidiaries		10,007		9,310		5,023
Net earnings	$	13,382		10,268		9,177

Statements of Cash Flows

For the Years Ended December 31, 20178, 2017 and 2016

(Dollars in thousands)

	2018			2017			2016
Cash flows from operating activities:
Net earnings	$	13,382			10,268			9,177
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Equity in undistributed earnings of subsidiaries		(10,007	)		(9,310	)		(5,023	)
Gain on sale of investment securities		—			—			(405	)
Change in:
Other assets		13			(272	)		61
Other liabilities		6			5			5
Net cash provided by operating activities		3,394			691			3,815
Cash flows from investing activities:
Proceeds from calls and maturities of investment securities
available for sale		—			500			669
In kind transfer from parent to Bank		—			—			10
Net cash provided by investing activities		—			500			679
Cash flows from financing activities:
Cash dividends paid on common stock		(3,133	)		(2,629	)		(2,106	)
Cash in lieu stock dividend		—			(6	)		—
Stock repurchase		—			—			(1,984	)
Proceeds from exercise of restricted stock units		—			915			—
Net cash used by financing activities		(3,133	)		(1,720	)		(4,090	)
Net change in cash		261			(529	)		404
Cash at beginning of year		428			957			553
Cash at end of year	$	689			428			957
Noncash investing and financing activities:
Change in unrealized gain on investment securities
available for sale, net	$	(2,607	)		(1	)		(2,523	)

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17. Quarterly Data

12 Months Ended

Dec. 31, 2018

Quarterly Financial Information Disclosure [Abstract]

Quarterly Data

	2018								2017
(Dollars in thousands, except per share amounts)	First		Second		Third		Fourth		First			Second		Third			Fourth
Total interest income	$	10,759		11,059		11,608		11,924	$	10,064			10,461		10,698			10,726
Total interest expense		467		513		557		609		598			622		650			507
Net interest income		10,292		10,546		11,051		11,315		9,466			9,839		10,048			10,219
(Reduction of) provision for loan losses		31		231		110		418		(236	)		49		(218	)		(102	)
Other income		3,736		4,016		3,915		4,499		3,442			3,929		4,159			3,834
Other expense		10,042		10,560		10,702		11,270		10,361			9,983		10,006			10,878
Income before income taxes		3,955		3,771		4,154		4,126		2,783			3,736		4,419			3,277
Income taxes (benefit)		652		595		687		690		578			925		1,177			1,267
Net earnings		3,303		3,176		3,467		3,436		2,205			2,811		3,242			2,010
Basic net earnings per share	$	0.55		0.53		0.58		0.57	$	0.36			0.47		0.54			0.34
Diluted net earnings per share	$	0.55		0.53		0.57		0.57	$	0.36			0.46		0.53			0.34

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1. Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2018

Accounting Policies [Abstract]

Organization

Peoples Bancorp of North Carolina, Inc. (“Bancorp”) received regulatory approval to operate as a bank holding company on July 22, 1999, and became effective August 31, 1999. Bancorp is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for Peoples Bank (the “Bank”).

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is primarily regulated by the Commissioner and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell, Wake and Durham counties in North Carolina.

Peoples Investment Services, Inc. is a wholly owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC (“CBRES”) is a wholly owned subsidiary of the Bank and began operations in 2009 as a “clearing house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property is located.

PB Real Estate Holdings, LLC (“PBREH”) is a wholly owned subsidiary of the Bank and began operation in 2015. PBREH acquires, manages and disposes of real property, other collateral and other assets obtained in the ordinary course of collecting debts previously contracted.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a division of the Bank under the name Banco de la Gente (“Banco”). These offices are now branded as Bank branches and considered a separate market territory of the Bank as they offer normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans.

Principles of Consolidation

The consolidated financial statements include the financial statements of Bancorp and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc., REAS, CBRES and PBREH (collectively called the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation. 

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Cash and Cash Equivalents

Cash, due from banks and interest-bearing deposits are considered cash and cash equivalents for cash flow reporting purposes.

Investment Securities

There are three classifications the Company is able to classify its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2018 and 2017, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on an annual basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield. Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

The allowance for loan 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 for loan losses 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. Other factors considered are:

● the Bank’s loan loss experience;

● the amount of past due and non-performing loans;

● specific known risks;

● the status and amount of other past due and non-performing assets;

● underlying estimated values of collateral securing loans;

● current and anticipated economic conditions; and

● other factors which management believes affect the allowance for potential credit losses.

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 Bank’s Board of Directors 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 $1.0 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’s Board of Directors.

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. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance for loan losses. The provision for loan losses charged or credited to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management’s assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance for loan losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four or five years’ loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2018 as compared to the year ended December 31, 2017. Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, certain mortgage loans from the former Banco division of the Bank were 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.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. 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 GAAP, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance for loan losses 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.

Mortgage Banking Activities

Mortgage banking income represents net gains from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $866,000, $1.0 million and $1.4 million at December 31, 2018, 2017 and 2016, respectively.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale. The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts. The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for that period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

Buildings and improvements	10 - 50 years
Furniture and equipment	3 - 10 years

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan. Foreclosed assets are reported at fair value less estimated selling costs. Any write-downs at the time of foreclosure are charged to the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value less estimated selling costs declines below carrying value. Costs relating to the development and improvement of the property are capitalized. Revenues and expenses from operations are included in other expenses. Changes in the valuation allowance are included in loss on sale and write-down of other real estate.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Derivative Financial Instruments and Hedging Activities

In the normal course of business, the Company enters into derivative contracts to manage interest rate risk by modifying the characteristics of the related balance sheet instruments in order to reduce the adverse effect of changes in interest rates. All material derivative financial instruments are recorded at fair value in the financial statements. The fair value of derivative contracts related to the origination of fixed rate mortgage loans and the commitments to sell these loans to a third party is immaterial and has no effect on the recorded amounts in the financial statements.

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of, and gains and losses on, derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

On the date a derivative contract is entered into, the Company designates the derivative as a fair value hedge, a cash flow hedge, or a trading instrument. Changes in the fair value of instruments used as fair value hedges are accounted for in the earnings of the period simultaneous with accounting for the fair value change of the item being hedged. Changes in the fair value of the effective portion of cash flow hedges are accounted for in other comprehensive income rather than earnings. Changes in fair value of instruments that are not intended as a hedge are accounted for in the earnings of the period of the change.

If a derivative instrument designated as a fair value hedge is terminated or the hedge designation removed, the difference between a hedged item’s then carrying amount and its face amount is recognized into income over the original hedge period. Likewise, if a derivative instrument designated as a cash flow hedge is terminated or the hedge designation removed, related amounts accumulated in other accumulated comprehensive income are reclassified into earnings over the original hedge period during which the hedged item affects income.

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company formally documents all hedging relationships, including an assessment that the derivative instruments are expected to be highly effective in offsetting the changes in fair values or cash flows of the hedged items.

Advertising Costs

Advertising costs are expensed as incurred.

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. A total of 280,933 shares are currently reserved for possible issuance under the Plan. All stock-based rights under the Plan must be granted or awarded by May 7, 2019 (i.e., ten years from the Plan effective date).

The Company granted 32,465 restricted stock units under the Plan at a grant date fair value of $7.18 per share during the first quarter of 2012, of which 5,891 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury in conjunction with the Company’s participation in the Capital Purchase Program under the Troubled Asset Relief Program. In July 2012, the Company granted 5,891 restricted stock units at a grant date fair value of $7.50 per share. The Company granted 29,475 restricted stock units under the Plan at a grant date fair value of $10.82 per share during the second quarter of 2013. The Company granted 23,162 restricted stock units under the Plan at a grant date fair value of $14.27 per share during the first quarter of 2014. The Company granted 16,583 restricted stock units under the Plan at a grant date fair value of $16.34 per share during the first quarter of 2015. The Company granted 5,544 restricted stock units under the Plan at a grant date fair value of $16.91 per share during the first quarter of 2016. The Company granted 4,114 restricted stock units under the Plan at a grant date fair value of $25.00 per share during the first quarter of 2017. The Company granted 3,725 restricted stock units under the Plan at a grant date fair value of $31.43 per share during the first quarter of 2018. The number of restricted stock units granted and grant date fair values have been restated to reflect the 10% stock dividend during the fourth quarter of 2017. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the 2012 grants, four years from the grant date for the 2013, 2015, 2016, 2017 and 2018 grants and three years from the grant date for the 2014 grants). The amount of expense recorded each period reflects the changes in the Company’s stock price during such period. As of December 31, 2018, the total unrecognized compensation expense related to the restricted stock unit grants under the Plan was $165,000.

The Company recognized compensation expense for restricted stock units granted under the Plan of $85,000, $592,000 and $932,000 for the years ended December 31, 2018, 2017 and 2016, respectively.

Net Earnings Per Share

Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share. The average market price during the year is used to compute equivalent shares.

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2018, 2017 and 2016 are as follows:

For the year ended December 31, 2018

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	13,382		5,995,256	$	2.23
Effect of dilutive securities:
Restricted stock units		—		20,240
Diluted earnings per share	$	13,382		6,015,496	$	2.22

For the year ended December 31, 2017

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	10,268		5,988,183	$	1.71
Effect of dilutive securities:
Restricted stock units		—		74,667
Diluted earnings per share	$	10,268		6,062,850	$	1.69

For the year ended December 31, 2016

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	9,177		6,024,970	$	1.53
Effect of dilutive securities:
Restricted stock units		—		77,807
Diluted earnings per share	$	9,177		6,102,777	$	1.50

In November 2017, the Board of Directors of the Company declared a 10% stock dividend. As a result of the stock dividend, each shareholder received one new share of stock for every ten shares of stock they held as of the record date of December 4, 2017. The payable date for the stock dividend was December 15, 2017. All previously reported per share amounts have been restated to reflect this stock dividend.

Recent Accounting Pronouncements

The following tables provide a summary of Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”)that the Company has recently adopted.

Recently Adopted Accounting Guidance

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2014-09: Revenue from Contracts with Customers	Provides guidance on the recognition of revenue from contracts with customers. The core principle of this guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive.	January 1, 2018	See section titled ASU 2014-09 below for a description of the effect on the Company’s results of operations, financial position and disclosures.
ASU 2016-01: Recognition and Measurement of Financial Assets and Financial Liabilities	Addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-01: Clarifying the Definition of a Business	Adds guidance to assist companies and other reporting organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-05: Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets	Clarifies the scope of established guidance on nonfinancial asset derecognition (issued as part of the new revenue standard, ASU 2014-09, Revenue from Contracts with Customers), as well as the accounting for partial sales of nonfinancial assets.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2017-07: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs	Amended the requirements related to the income statement presentation of the components of net periodic benefit cost for an entity’s sponsored defined benefit pension and other postretirement plans.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-09: Scope of Modification Accounting	Amended the requirements related to changes to the terms or conditions of a share-based payment award.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-13: Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842)	Updated the Revenue from Contracts with Customers and the Leases Topics of the Accounting Standards Codification (“ASC”). The amendments incorporate into the ASC recent Securities Exchange Commission (“SEC”) guidance about certain public business entities (“PBEs”) electing to use the non-PBE effective dates solely to adopt the FASB’s new standards on revenue and leases.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-14: Income Statement—Reporting Comprehensive, Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)	Incorporates into the ASC recent SEC guidance related to revenue recognition.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-02: Income Statement (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income	Requires companies to reclassify the stranded effects in other comprehensive income to retained earnings as a result of the change in the tax rates under the Tax Cuts and Jobs Act (“TCJA”).	Effective upon issuance	The Company opted to early adopt this pronouncement by retrospective application to each period in which the effect of the change in the tax rate under the TCJA is recognized. The impact of the reclassification from other comprehensive income to retained earnings at December 31, 2017 was $607,000.
ASU 2018-03: Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities	Clarifies certain aspects of the guidance issued in ASU 2016-01.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-04: Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update)	Incorporates recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulation.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-05: Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)	Incorporates recent SEC guidance related to the income tax accounting implications of the TCJA.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-06: Codification Improvements to Topic 942: Financial Services—Depository and Lending	Eliminates a reference to the Office of the Comptroller of the Currency’s Banking Circular 202, Accounting for Net Deferred Tax Charges, from the ASC. The Office of the Comptroller of the Currency published the guidance in 1985 but has since rescinded it.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU 2014-09

The Company has applied ASU 2014-09 using a modified retrospective approach. The Company’s revenue is comprised of net interest income and noninterest income. The scope of ASU 2014-09 explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, ecurities, and derivatives. Accordingly, the majority of the

Company’s revenues are not affected. Appraisal management fee income and expense from the Bank’s subsidiary, CBRES, was reported as a net amount prior to March 31, 2018, which was included in miscellaneous non-interest income. This income and expense is now reported on separate line items under non-interest income and non-interest expense. See below for additional information related to revenue generated from contracts with customers.

Revenue and Method of Adoption

The majority of the Company’s revenue is derived primarily from interest income from receivables (loans) and securities. Other revenues are derived from fees received in connection with deposit accounts, investment advisory, and appraisal services. On January 1, 2018, the Company adopted the requirements of ASU 2014-09. The core principle of the new standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

The Company adopted ASU 2014-09 using the modified retrospective transition approach which does not require restatement of prior periods. The method was selected as there were no material changes in the timing of revenue recognition resulting in no comparability issues with prior periods. This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard. When applying the modified retrospective approach under ASU 2014-09, the Company has elected, as a practical expedient, to apply this approach only to contracts that were not completed as of January 1, 2018. A completed contract is considered to be a contract for which all (or substantially all) of the revenue was recognized in accordance with revenue guidance that was in effect before January 1, 2018. There were no uncompleted contracts as of January 1, 2018 for which application of the new standard required an adjustment to retained earnings.

The following disclosures involve the Company’s material income streams derived from contracts with customers which are within the scope of ASU 2014-09. Through the Company’s wholly-owned subsidiary, PIS, the Company contracts with a registered investment advisor to perform investment advisory services on behalf of the Company’s customers. The Company receives commissions from this third party investment advisor based on the volume of business that the Company’s customers do with such investment advisor. Total revenue recognized from these contracts for the year ended December 31, 2018 was $823,000. The Company utilizes third parties to contract with the Company’s customers to perform debit and credit card clearing services. These third parties pay the Company commissions based on the volume of transactions that they process on behalf of the Company’s customers. Total revenue recognized for the year ended December 31, 2018 from the contract with these third parties was $3.9 million. Through the Company’s wholly-owned subsidiary, REAS, the Company provides property appraisal services for negotiated fee amounts on a per appraisal basis. Total revenue recognized for the year ended December 31, 2018 from these contracts with customers was $597,000. Through the Company’s wholly-owned subsidiary, CBRES, the Company provides appraisal management services. Total revenue recognized for the year ended December 31, 2018 from these contracts with customers was $3.2 million. Due to the nature of the Company’s relationship with the customers that the Company provides services, the Company does not incur costs to obtain contracts and there are no material incremental costs to fulfill these contracts that should be capitalized.

Disaggregation of Revenue. The Company’s portfolio of services provided to the Company’s customers consists of over 50,000 active contracts. The Company has disaggregated revenue according to timing of the transfer of service. Total revenue for the year ended December 31, 2018 derived from contracts in which services are transferred at a point in time was approximately $8.5 million. None of the Company’s revenue is derived from contracts in which services are transferred over time. Revenue is recognized as the services are provided to the customers. Economic factors impacting the customers could affect the nature, amount, and timing of these cash flows, as unfavorable economic conditions could impair the customers’ ability to provide payment for services. For the Company’s deposit contracts, this risk is mitigated as the Company generally deducts payments from customers’ accounts as services are rendered. For the Company’s appraisal services, the risk is mitigated in that the appraisal is not released until payment is received.

Contract Balances. The timing of revenue recognition, billings, and cash collections results in billed accounts receivable on the balance sheet. Most contracts call for payment by a charge or deduction to the respective customer account but there are some that require a receipt of payment from the customer. For fee per transaction contracts, the customers are billed as the transactions are processed. The Company has no contracts in which customers are billed in advance for services to be performed. These types of contracts would create contract liabilities or deferred revenue, as the customers pay in advance for services. There are no contract liabilities or accounts receivables balances that are material to the Company’s balance sheet.

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASU 2014-09. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. Performance obligations are satisfied as the service is provided to the customer at a point in time. There are no significant financing components in the Company’s contracts. Excluding deposit and appraisal service revenues which are primarily billed at a point in time as a fee for services incurred, all other contracts within the scope of ASU 2014-09 contain variable consideration in that fees earned are derived from market values of accounts which determine the amount of consideration to which the Company is entitled. The variability is resolved when the services are provided. The contracts do not include obligations for returns, refunds, or warranties. The contracts are specific to the amounts owed to the Company for services performed during a period should the contracts be terminated.

Significant Judgements. All of the Company’s contracts create performance obligations that are satisfied at a point in time excluding some immaterial deposit revenues. Revenue is recognized as services are billed to the customers. Variable consideration does exist for contracts related to the Company’s contract with its registered investment advisor as some revenues earned pursuant to that contract are based on market values of accounts at the end of the period.

The following tables provide a summary of ASU’s issued by the FASB that the Company has not adopted as of December 31, 2018, which may impact the Company’s financial statements.

Recently Issued Accounting Guidance Not Yet Adopted

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2016-02: Leases	Increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.	January 1, 2019	The Company expects to adopt this guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow the Company to largely account for its existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. The Company epects to record an increase in assets and liabilities of approximatley $4.4 million as a result of recording lease contracts where the Company is lessee and expects to adopt the new guidance prospectively as of January 1, 2019 and to not restate comparative periods.
ASU 2016-13: Measurement of Credit Losses on Financial Instruments	Provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities.	January 1, 2020 Early adoption permitted	The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company is currently developing CECL model assumptions and comparing results to current allowance for loan loss calculations. The Company plans to run parallel calculations leading up to the effective date of this guidance to ensure it is prepared for implementation by the effective date. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.
ASU 2017-04: Simplifying the Test for Goodwill Impairment	Provides guidance to simplify the accounting related to goodwill impairment.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-08: Premium Amortization on Purchased Callable Debt Securities	Amended the requirements related to the amortization period for certain purchased callable debt securities held at a premium.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2018-11: Leases (Topic 842): Targeted Improvements	Intended to reduce costs and ease implementation of ASU 2016-02.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-13: Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820)	Updates the disclosure requirements on fair value measurements in ASC 820, Fair Value Measurement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-14: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans (Subtopic 715-20)	Updates disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.	January 1, 2021	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-15: Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40)	Reduces complexity of the accounting for costs of implementing a cloud computing service arrangement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-16: Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes	Expand the list of U.S. benchmark interest rates permitted in the application of hedge accounting.	January 1, 2019	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-17: Targeted Improvements to Related Party Guidance for Variable Interest Entities	Amended the Consolidation topic of the ASC for determining whether a decision-making fee is a variable interest. The amendments require organizations to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-18: Clarifying the Interaction between Topic 808 and Topic 606	Clarifies the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic.	January 1, 2020 Early adoption permitted	See comments for ASU 2016-13 above.
ASU 2018-20: Narrow- Scope Improvements for Lessors	Provides narrow-scope improvements for lessors, that provide relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components.	January 1, 2019	See comments for ASU 2016-02 above.

Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

Reclassification

Certain amounts in the 2017 and 2016 consolidated financial statements have been reclassified to conform to the 2018 presentation.

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1. Summary of Significant Accounting Policies (Tables)

12 Months Ended

Dec. 31, 2018

Summary Of Significant Accounting Policies

Reconciliations of the amounts used in the computation of both basic earnings per common share and diluted earnings per common share

For the year ended December 31, 2018

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	13,382		5,995,256	$	2.23
Effect of dilutive securities:
Restricted stock units		—		20,240
Diluted earnings per share	$	13,382		6,015,496	$	2.22

For the year ended December 31, 2017

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	10,268		5,988,183	$	1.71
Effect of dilutive securities:
Restricted stock units		—		74,667
Diluted earnings per share	$	10,268		6,062,850	$	1.69

For the year ended December 31, 2016

	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	9,177		6,024,970	$	1.53
Effect of dilutive securities:
Restricted stock units		—		77,807
Diluted earnings per share	$	9,177		6,102,777	$	1.50

XML

2. Investment Securities (Tables)

12 Months Ended

Dec. 31, 2018

Investment Securities Tables Abstract

Investment securities available for sale

(Dollars in thousands)

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	52,145		516		558		52,103
U.S. Government
sponsored enterprises		35,356		71		793		34,634
State and political subdivisions		105,545		2,089		43		107,591
Trust preferred securities		250		—		—		250
Total	$	193,296		2,676		1,394		194,578

(Dollars in thousands)

	December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	53,124		814		329		53,609
U.S. Government
sponsored enterprises		40,504		140		264		40,380
State and political subdivisions		129,276		4,310		16		133,570
Corporate bonds		1,500		12		—		1,512
Trust preferred securities		250		—		—		250
Total	$	224,654		5,276		609		229,321

Current fair value and associated unrealized losses on investments in debt securities with unrealized losses

(Dollars in thousands)                                    

	December 31, 2018
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	6,932		56		17,670		502		24,602		558
U.S. Government
sponsored enterprises		1,784		69		25,172		724		26,956		793
State and political subdivisions		4,815		26		1,578		17		6,393		43
Total	$	13,531		151		44,420		1,243		57,951		1,394

(Dollars in thousands)                                    

	December 31, 2017
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	8,701		75		11,259		254		19,960		329
U.S. Government
sponsored enterprises		12,661		98		10,067		166		22,728		264
State and political subdivisions		798		2		1,501		14		2,299		16
Total	$	22,160		175		22,827		434		44,987		609

Amortized cost and estimated fair value of investment securities available for sale by contractual maturity

December 31, 2018
(Dollars in thousands)
	Amortized Cost		Estimated Fair Value
Due within one year	$	21,379		21,426
Due from one to five years		80,932		82,325
Due from five to ten years		32,271		32,174
Due after ten years		6,569		6,550
Mortgage-backed securities		52,145		52,103
Total	$	193,296		194,578

Available for sale securities measured at fair value on a recurring basis

(Dollars in thousands)
	December 31, 2018
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	52,103		—		52,103		—
U.S. Government
sponsored enterprises	$	34,634		—		34,634		—
State and political subdivisions	$	107,591		—		107,591		—
Trust preferred securities	$	250		—		—		250

(Dollars in thousands)
	December 31, 2017
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	53,609		—		53,609		—
U.S. Government
sponsored enterprises	$	40,380		—		40,380		—
State and political subdivisions	$	133,570		—		133,570		—
Corporate bonds	$	1,512		—		1,512		—
Trust preferred securities	$	250		—		—		250

Fair value measurements of investment securities available for sale using Level 3 significant unobservable inputs

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$	250
Change in book value		—
Change in gain/(loss) realized and unrealized		—
Purchases/(sales and calls)		—
Transfers in and/or (out) of Level 3		—
Balance, end of period	$	250
Change in unrealized gain/(loss) for assets still held in Level 3	$	—

XML

3. Loans (Tables)

12 Months Ended

Dec. 31, 2018

Loans Tables Abstract

Major classifications of loans

(Dollars in thousands)
	December 31, 2018		December 31, 2017
Real estate loans:
Construction and land development	$	94,178		84,987
Single-family residential		252,983		246,703
Single-family residential -
Banco de la Gente non-traditional		34,261		37,249
Commercial		270,055		248,637
Multifamily and farmland		33,163		28,937
Total real estate loans		684,640		646,513
Loans not secured by real estate:
Commercial loans		97,465		89,022
Farm loans		926		1,204
Consumer loans		9,165		9,888
All other loans		11,827		13,137
Total loans		804,023		759,764
Less allowance for loan losses		6,445		6,366
Net loans	$	797,578		753,398

Age analysis of past due loans, by loan type

December 31, 2018
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	3		—		3		94,175		94,178		—
Single-family residential		4,162		570		4,732		248,251		252,983		—
Single-family residential -
Banco de la Gente non-traditional		4,627		580		5,207		29,054		34,261		—
Commercial		228		—		228		269,827		270,055		—
Multifamily and farmland		—		—		—		33,163		33,163		—
Total real estate loans		9,020		1,150		10,170		674,470		684,640		—
Loans not secured by real estate:
Commercial loans		445		90		535		96,930		97,465		—
Farm loans		—		—		—		926		926		—
Consumer loans		99		4		103		9,062		9,165		—
All other loans		—		—		—		11,827		11,827		—
Total loans	$	9,564		1,244		10,808		793,215		804,023		—

December 31, 2017
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	277		—		277		84,710		84,987		—
Single-family residential		3,241		193		3,434		243,269		246,703		—
Single-family residential -
Banco de la Gente non-traditional		4,078		465		4,543		32,706		37,249		—
Commercial		588		—		588		248,049		248,637		—
Multifamily and farmland		—		12		12		28,925		28,937		—
Total real estate loans		8,184		670		8,854		637,659		646,513		—
Loans not secured by real estate:
Commercial loans		53		100		153		88,869		89,022		—
Farm loans		—		—		—		1,204		1,204		—
Consumer loans		113		5		118		9,770		9,888		—
All other loans		—		—		—		13,137		13,137		—
Total loans	$	8,350		775		9,125		750,639		759,764		—

Non-accrual loans

(Dollars in thousands)
	December 31, 2018		December 31, 2017
Real estate loans:
Construction and land development	$	1		14
Single-family residential		1,530		1,634
Single-family residential -
Banco de la Gente non-traditional		1,440		1,543
Commercial		244		396
Multifamily and farmland		—		12
Total real estate loans		3,215		3,599
Loans not secured by real estate:
Commercial loans		89		100
Consumer loans		10		12
Total	$	3,314		3,711

Impaired loans

December 31, 2018
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	281		—		279		279		5		327		19
Single-family residential		5,059		422		4,188		4,610		32		6,271		261
Single-family residential -
Banco de la Gente non-traditional		16,424		—		15,776		15,776		1,042		14,619		944
Commercial		1,995		—		1,925		1,925		17		2,171		111
Total impaired real estate loans		23,759		422		22,168		22,590		1,096		23,388		1,335
Loans not secured by real estate:
Commercial loans		251		89		1		90		—		96		—
Consumer loans		116		—		113		113		2		137		7
Total impaired loans	$	24,126		511		22,282		22,793		1,098		23,621		1,342

December 31, 2017
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	282		—		277		277		6		253		17
Single-family residential		5,226		1,135		3,686		4,821		41		5,113		265
Single-family residential -
Banco de la Gente non-traditional		17,360		—		16,805		16,805		1,149		16,867		920
Commercial		2,761		807		1,661		2,468		1		3,411		148
Multifamily and farmland		78		—		12		12		—		28		—
Total impaired real estate loans		25,707		1,942		22,441		24,383		1,197		25,672		1,350
Loans not secured by real estate:
Commercial loans		264		100		4		104		—		149		3
Consumer loans		158		—		154		154		2		194		9
Total impaired loans	$	26,129		2,042		22,599		24,641		1,199		26,015		1,362

December 31, 2016
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	282		—		278		278		11		330		13
Single-family residential		5,354		703		4,323		5,026		47		7,247		164
Single-family residential -
Banco de la Gente non-traditional		18,611		—		18,074		18,074		1,182		17,673		861
Commercial		3,750		1,299		2,197		3,496		166		4,657		152
Multifamily and farmland		78		—		78		78		—		78		—
Total impaired real estate loans		28,075		2,002		24,950		26,952		1,406		29,985		1,190
Loans not secured by real estate:
Commercial loans		27		—		27		27		—		95		—
Consumer loans		211		—		202		202		3		222		8
Total impaired loans	$	28,313		2,002		25,179		27,181		1,409		30,302		1,198

Fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis

(Dollars in thousands)
	Fair Value Measurements December 31, 2018		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	680		—		—		680
Impaired loans	$	21,695		—		—		21,695
Other real estate	$	27		—		—		27

(Dollars in thousands)
	Fair Value Measurements December 31, 2017		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	857		—		—		857
Impaired loans	$	23,442		—		—		23,442
Other real estate	$	118		—		—		118

Changes in the allowance for loan losses

Changes in the allowance for loan losses for the year ended December 31, 2018 were as follows:

(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm	Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Charge-offs		(53	)	(116	)	—		(453	)	(5	)	(54	)	—	(452	)	—	(1,133	)
Recoveries		10		106		—		105		1		32		—	168		—	422
Provision		52		(477	)	(103	)	433		15		74		—	290		506	790
Ending balance	$	813		1,325		1,177		1,278		83		626		—	161		982	6,445
Ending balance: individually
evaluated for impairment	$	—		—		1,023		15		—		—		—	—		—	1,038
Ending balance: collectively
evaluated for impairment		813		1,325		154		1,263		83		626		—	161		982	5,407
Ending balance	$	813		1,325		1,177		1,278		83		626		—	161		982	6,445
Loans:
Ending balance	$	94,178		252,983		34,261		270,055		33,163		97,465		926	20,992		—	804,023
Ending balance: individually
evaluated for impairment	$	96		1,779		14,310		1,673		—		89		—	—		—	17,947
Ending balance: collectively
evaluated for impairment	$	94,082		251,204		19,951		268,382		33,163		97,376		926	20,992		—	786,076

Changes in the allowance for loan losses for the year ended December 31, 2017 were as follows:

(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm	Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	1,152		2,126		1,377		1,593		52		675		—	204		371	7,550
Charge-offs		—		(249	)	—		—		(66	)	(194	)	—	(473	)	—	(982	)
Recoveries		14		85		—		21		—		31		—	154		—	305
Provision		(362	)	(150	)	(97	)	(421	)	86		62		—	270		105	(507	)
Ending balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Ending balance: individually
evaluated for impairment	$	—		—		1,093		37		—		—		—	—		—	1,130
Ending balance: collectively
evaluated for impairment		804		1,812		187		1,156		72		574		—	155		476	5,236
Ending balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Loans:
Ending balance	$	84,987		246,703		37,249		248,637		28,937		89,022		1,204	23,025		—	759,764
Ending balance: individually
evaluated for impairment	$	98		1,855		15,460		2,251		—		100		—	—		—	19,764
Ending balance: collectively
evaluated for impairment	$	84,889		244,848		21,789		246,386		28,937		88,922		1,204	23,025		—	740,000

Changes in the allowance for loan losses for the year ended December 31, 2016 were as follows:

(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Non-traditional		Commercial		Multifamily and Farmland	Commercial		Farm	Consumer and All Other		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	2,185		2,534		1,460		1,917		—	842		—	172		479		9,589
Charge-offs		(7	)	(275	)	—		(318	)	—	(146	)	—	(492	)	—		(1,238	)
Recoveries		10		55		—		19		—	170		—	151		—		405
Provision		(1,036	)	(188	)	(83	)	(25	)	52	(191	)	—	373		(108	)	(1,206	)
Ending balance	$	1,152		2,126		1,377		1,593		52	675		—	204		371		7,550
Ending balance: individually
evaluated for impairment	$	—		—		1,160		159		—	—		—	—		—		1,319
Ending balance: collectively
evaluated for impairment		1,152		2,126		217		1,434		52	675		—	204		371		6,231
Ending balance	$	1,152		2,126		1,377		1,593		52	675		—	204		371		7,550
Loans:
Ending balance	$	61,749		240,700		40,189		247,521		21,047	87,596		—	25,009		—		723,811
Ending balance: individually
evaluated for impairment	$	—		935		16,718		3,648		—	—		—	—		—		21,301
Ending balance: collectively
evaluated for impairment	$	61,749		239,765		23,471		243,873		21,047	87,596		—	25,009		—		702,510

Credit risk profile of each loan type based on internally assigned risk grade

December 31, 2018
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development	Single-Family Residential	Single- Family Residential - Banco de la Gente Non- traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$	504	5,795	—	—	—	605	—	673	—	7,577
2- High Quality		24,594	128,588	—	25,321	395	20,520	—	3,229	2,145	204,792
3- Good Quality		59,549	92,435	13,776	211,541	27,774	69,651	785	4,699	8,932	489,142
4- Management Attention		5,707	19,200	15,012	30,333	3,906	6,325	141	529	750	81,903
5- Watch		3,669	3,761	2,408	2,616	1,088	264	—	18	—	13,824
6- Substandard		155	3,204	3,065	244	—	100	—	17	—	6,785
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	94,178	252,983	34,261	270,055	33,163	97,465	926	9,165	11,827	804,023

December 31, 2017
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente Non- traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$	152	8,590	—	—	—	446	—	791	—	9,979
2- High Quality		20,593	120,331	—	34,360	561	17,559	—	3,475	2,410	199,289
3- Good Quality		53,586	89,120	14,955	196,439	25,306	65,626	1,085	5,012	9,925	461,054
4- Management Attention		4,313	20,648	15,113	13,727	1,912	5,051	119	562	802	62,247
5- Watch		6,060	4,796	3,357	3,671	1,146	223	—	23	—	19,276
6- Substandard		283	3,218	3,824	440	12	117	—	25	—	7,919
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	84,987	246,703	37,249	248,637	28,937	89,022	1,204	9,888	13,137	759,764

Analysis of TDR loans by loan type

Year ended December 31, 2018
(Dollars in thousands)
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential		2	$	94		94
Total TDR loans		2	$	94		94

Year ended December 31, 2017
(Dollars in thousands)
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential		2	$	22		22
Total TDR loans		2	$	22		22

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4. Premises and Equipment (Tables)

12 Months Ended

Dec. 31, 2018

Property, Plant and Equipment [Abstract]

Summary of premises and equipment

(Dollars in thousands)
	2018		2017
Land	$	3,456		3,700
Buildings and improvements		19,357		19,312
Furniture and equipment		22,315		21,115
Construction in process		381		847
Total premises and equipment		45,509		44,974
Less accumulated depreciation		27,059		25,063
Total net premises and equipment	$	18,450		19,911

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5. Time Deposits (Tables)

12 Months Ended

Dec. 31, 2018

Banking and Thrift [Abstract]

Scheduled maturities of time deposits

(Dollars in thousands)
	2019	$	61,723
	2020		21,566
	2021		14,121
	2022		2,618
	2023 and thereafter		3,145
	Total	$	103,173

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8. Income Taxes (Tables)

12 Months Ended

Dec. 31, 2018

Income Tax Disclosure [Abstract]

Components of income tax expense (benefit)

(Dollars in thousands)
	2018		2017		2016
Current expense	$	2,546		1,827		1,464
Deferred income tax expense		78		2,120		1,097
Total income tax	$	2,624		3,947		2,561

Schedule of effective income Tax rate reconciliation

(Dollars in thousands)
	2018			2017			2016
Tax expense at statutory rate (21% in 2018)	$	3,361			4,833			3,991
State income tax, net of federal income tax effect		358			307			339
Tax-exempt interest income		(990	)		(1,594	)		(1,681	)
Increase in cash surrender value of life insurance		(81	)		(136	)		(138	)
Nondeductible interest and other expense		23			46			78
Impact of TCJA		—			588			—
Other		(47	)		(97	)		(28	)
Total	$	2,624			3,947			2,561

Schedule of deferred tax assets and liabilities

(Dollars in thousands)
	2018		2017
Deferred tax assets:
Allowance for loan losses	$	1,481		1,463
Accrued retirement expense		1,119		1,073
Federal credit carryforward		—		88
Restricted stock		262		243
Accrued bonuses		211		171
Interest income on nonaccrual loans		1		5
Other than temporary impairment		—		9
Total gross deferred tax assets		3,074		3,052
Deferred tax liabilities:
Deferred loan fees		379		365
Accumulated depreciation		610		498
Prepaid expenses		10		14
Other		5		28
Unrealized gain on available for sale securities		294		1,072
Total gross deferred tax liabilities		1,298		1,977
Net deferred tax asset	$	1,776		1,075

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9. Related Party Transactions (Tables)

12 Months Ended

Dec. 31, 2018

Related Party Transactions [Abstract]

Summary of activity for related party loans

(Dollars in thousands)
	2018			2017
Beginning balance	$	3,679			4,503
New loans		8,030			5,879
Repayments		(8,517	)		(6,703	)
Ending balance	$	3,192			3,679

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10. Commitments and Contingencies (Tables)

12 Months Ended

Dec. 31, 2018

Commitments and Contingencies Disclosure [Abstract]

Future minimum rental payments for operating leases

(Dollars in thousands)
Year ending December 31,
	2019	$	820
	2020		809
	2021		793
	2022		501
	2023		393
	Thereafter		1,624
	Total minimum obligation	$	4,940

Financial instruments with credit risk

(Dollars in thousands)
		Contractual Amount
		2018	2017
Financial instruments whose contract amount represent credit risk:
Commitments to extend credit	$	268,708	233,972
Standby letters of credit and financial guarantees written	$	3,651	3,325

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11. Employee and Director Benefit Programs (Tables)

12 Months Ended

Dec. 31, 2018

Retirement Benefits [Abstract]

Change in accumulated benefit obligation

(Dollars in thousands)
	2018			2017
Benefit obligation at beginning of period	$	4,361			4,174
Service cost		362			348
Interest cost		70			68
Benefits paid		(227	)		(229	)
Benefit obligation at end of period	$	4,566			4,361

Amounts recognized in the Consolidated Balance Sheet

(Dollars in thousands)
	2018		2017
Benefit obligation	$	4,566		4,361
Fair value of plan assets		—		—

(Dollars in thousands)
	2018			2017
Funded status	$	(4,566	)		(4,361	)
Unrecognized prior service cost/benefit		—			—
Unrecognized net actuarial loss		—			—
Net amount recognized	$	(4,566	)		(4,361	)
Unfunded accrued liability	$	(4,566	)		(4,361	)
Intangible assets		—			—
Net amount recognized	$	(4,566	)		(4,361	)

Schedule of net benefit costs

(Dollars in thousands)
	2018			2017			2016
Service cost	$	362			348			346
Interest cost		70			68			67
Net periodic cost	$	432			416			413
Weighted average discount rate assumption
used to determine benefit obligation		5.49	%		5.49	%		5.47	%

Schedule of expected benefit payments

(Dollars in thousands)
Year ending December 31,
	2019	$	235
	2020	$	353
	2021	$	353
	2022	$	342
	2023	$	342
	Thereafter	$	8,709

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12. Regulatory Matters (Tables)

12 Months Ended

Dec. 31, 2018

Banking and Thrift [Abstract]

Bank's actual capital amounts and ratios

(Dollars in thousands)
	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2018:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	149,076		16.15	%		91,133		9.88	%		N/A		N/A
Bank	$	146,640		15.91	%		90,995		9.88	%		92,147		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	142,631		15.46	%		72,676		7.88	%		N/A		N/A
Bank	$	140,195		15.21	%		72,566		7.88	%		73,717		8.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	142,631		13.05	%		43,723		4.00	%		N/A		N/A
Bank	$	140,195		12.76	%		43,950		4.00	%		54,937		5.00	%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	122,631		13.29	%		58,833		6.38	%		N/A		N/A
Bank	$	140,195		15.21	%		58,744		6.38	%		59,895		6.50	%

(Dollars in thousands)
	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2017:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	138,492		16.06	%		79,758		9.25	%		N/A		N/A
Bank	$	136,299		15.83	%		79,627		9.25	%		86,084		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	132,126		15.32	%		62,513		7.25	%		N/A		N/A
Bank	$	129,933		15.09	%		62,411		7.25	%		68,867		8.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	132,126		11.94	%		44,255		4.00	%		N/A		N/A
Bank	$	129,933		11.69	%		44,475		4.00	%		55,594		5.00	%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	112,126		13.00	%		49,579		5.75	%		N/A		N/A
Bank	$	129,933		15.09	%		49,498		5.75	%		55,954		6.50	%

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14. Other Operating Income and Expense (Tables)

12 Months Ended

Dec. 31, 2018

Other Income and Expenses [Abstract]

Other operating income and expense

(Dollars in thousands)
	2018		2017			2016
Visa debit card income	$	3,911		3,757			3,589
Bank owned life insurance income		384		400			407
Gain (loss) on sale of capital assets		544		(32	)		—
Other		1,354		1,175			854
	$	6,193		5,300			4,850

(Dollars in thousands)
	2018		2017		2016
ATM expense	$	542		673		658
Consulting		1,012		785		2,257
Data processing		466		426		418
Deposit program expense		586		539		371
Dues and subscriptions		421		354		451
FHLB advance prepayment penalty		—		508		1,260
Internet banking expense		603		720		710
Office supplies		503		517		465
Telephone		678		855		754
Other		2,834		2,540		1,399
	$	7,645		7,917		8,743

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15. Fair Value of Financial Instruments (Tables)

12 Months Ended

Dec. 31, 2018

Fair Value Disclosures [Abstract]

Carrying amount and estimated fair value of the Company's financial instruments

(Dollars in thousands)
			Fair Value Measurements at December 31, 2018
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	43,370		43,370		—		—		43,370
Investment securities available for sale	$	194,578		—		194,328		250		194,578
Other investments	$	4,361		—		—		4,361		4,361
Mortgage loans held for sale	$	680		—		—		680		680
Loans, net	$	797,578		—		—		748,917		748,917
Cash surrender value of life insurance	$	15,936		—		15,936		—		15,936
Liabilities:
Deposits	$	877,213		—		—		857,999		857,999
Securities sold under agreements
to repurchase	$	58,095		—		58,095		—		58,095
Junior subordinated debentures	$	20,619		—		20,619		—		20,619

(Dollars in thousands)
			Fair Value Measurements at December 31, 2017
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	57,304		57,304		—		—		57,304
Investment securities available for sale	$	229,321		—		229,071		250		229,321
Other investments	$	1,830		—		—		1,830		1,830
Mortgage loans held for sale	$	857		—		—		857		857
Loans, net	$	753,398		—		—		735,837		735,837
Cash surrender value of life insurance	$	15,552		—		15,552		—		15,552
Liabilities:
Deposits	$	906,952		—		—		894,932		894,932
Securities sold under agreements
to repurchase	$	37,757		—		37,757		—		37,757
Junior subordinated debentures	$	20,619		—		20,619		—		20,619

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16. Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements (Tables)

12 Months Ended

Dec. 31, 2018

Condensed Financial Information Disclosure [Abstract]

Balance Sheets

Balance Sheets

December 31, 2018 and 2017

(Dollars in thousands)

Assets	2018		2017
Cash	$	689		428
Interest-bearing time deposit		1,000		1,000
Investment in subsidiaries		141,181		133,781
Investment in PEBK Capital Trust II		619		619
Investment securities available for sale		250		250
Other assets		533		546
Total assets	$	144,272		136,624
Liabilities and Shareholders' Equity
Junior subordinated debentures	$	20,619		20,619
Liabilities		36		30
Shareholders' equity		123,617		115,975
Total liabilities and shareholders' equity	$	144,272		136,624

Statements of Earnings

Statements of Earnings

For the Years Ended December 31, 2018, 2017 and 2016

(Dollars in thousands)

Revenues:	2018		2017		2016
Interest and dividend income	$	4,544		1,839		4,569
Gain on sale of securities		—		—		405
Total revenues		4,544		1,839		4,974
Expenses:
Interest		790		590		485
Other operating expenses		678		725		513
Total expenses		1,468		1,315		998
Income before income tax benefit and equity in
undistributed earnings of subsidiaries		3,076		524		3,976
Income tax benefit		299		434		178
Income before equity in undistributed
earnings of subsidiaries		3,375		958		4,154
Equity in undistributed earnings of subsidiaries		10,007		9,310		5,023
Net earnings	$	13,382		10,268		9,177

Statements of Cash Flows

Statements of Cash Flows

For the Years Ended December 31, 20178, 2017 and 2016

(Dollars in thousands)

	2018			2017			2016
Cash flows from operating activities:
Net earnings	$	13,382			10,268			9,177
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Equity in undistributed earnings of subsidiaries		(10,007	)		(9,310	)		(5,023	)
Gain on sale of investment securities		—			—			(405	)
Change in:
Other assets		13			(272	)		61
Other liabilities		6			5			5
Net cash provided by operating activities		3,394			691			3,815
Cash flows from investing activities:
Proceeds from calls and maturities of investment securities
available for sale		—			500			669
In kind transfer from parent to Bank		—			—			10
Net cash provided by investing activities		—			500			679
Cash flows from financing activities:
Cash dividends paid on common stock		(3,133	)		(2,629	)		(2,106	)
Cash in lieu stock dividend		—			(6	)		—
Stock repurchase		—			—			(1,984	)
Proceeds from exercise of restricted stock units		—			915			—
Net cash used by financing activities		(3,133	)		(1,720	)		(4,090	)
Net change in cash		261			(529	)		404
Cash at beginning of year		428			957			553
Cash at end of year	$	689			428			957
Noncash investing and financing activities:
Change in unrealized gain on investment securities
available for sale, net	$	(2,607	)		(1	)		(2,523	)

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17. Quarterly Data (Tables)

12 Months Ended

Dec. 31, 2018

Quarterly Financial Information Disclosure [Abstract]

Schedule of quarterly financial information

	2018								2017
(Dollars in thousands, except per share amounts)	First		Second		Third		Fourth		First			Second		Third			Fourth
Total interest income	$	10,759		11,059		11,608		11,924	$	10,064			10,461		10,698			10,726
Total interest expense		467		513		557		609		598			622		650			507
Net interest income		10,292		10,546		11,051		11,315		9,466			9,839		10,048			10,219
(Reduction of) provision for loan losses		31		231		110		418		(236	)		49		(218	)		(102	)
Other income		3,736		4,016		3,915		4,499		3,442			3,929		4,159			3,834
Other expense		10,042		10,560		10,702		11,270		10,361			9,983		10,006			10,878
Income before income taxes		3,955		3,771		4,154		4,126		2,783			3,736		4,419			3,277
Income taxes (benefit)		652		595		687		690		578			925		1,177			1,267
Net earnings		3,303		3,176		3,467		3,436		2,205			2,811		3,242			2,010
Basic net earnings per share	$	0.55		0.53		0.58		0.57	$	0.36			0.47		0.54			0.34
Diluted net earnings per share	$	0.55		0.53		0.57		0.57	$	0.36			0.46		0.53			0.34

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1. Summary of Significant Accounting Policies (Details) - USD ($) $ / shares in Units, $ in Thousands	3 Months Ended								12 Months Ended
	Dec. 31, 2018	Sep. 30, 2018	Jun. 30, 2018	Mar. 31, 2018	Dec. 31, 2017	Sep. 30, 2017	Jun. 30, 2017	Mar. 31, 2017	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Net Earnings Available to Common Shareholders
Basic earnings per common share									$ 13,382	$ 10,268	$ 9,177
Effect of dilutive securities: Restricted stock units									0	0	0
Diluted earnings per common share									$ 13,382	$ 10,268	$ 9,177
Common Shares
Basic earnings per common share (in shares)									5,995,256	5,988,183	6,024,970
Effect of dilutive securities: Restricted stock units (in shares)									20,240	74,667	77,807
Diluted earnings per common share (in shares)									6,015,496	6,062,850	6,102,777
Per Share Amount
Basic earnings per common share (in dollars per share)	$ 0.57	$ 0.58	$ 0.53	$ 0.55	$ 0.34	$ 0.54	$ 0.47	$ 0.36	$ 2.23	$ 1.71	$ 1.53
Diluted earnings per common share (in dollars per share)	$ 0.57	$ 0.57	$ 0.53	$ 0.55	$ 0.34	$ 0.53	$ 0.46	$ 0.36	$ 2.22	$ 1.69	$ 1.5

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1. Summary of Significant Accounting Policies (Details Narrative) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Summary Of Significant Accounting Policies Details Narrative Abstract
Unpaid principal balances of mortgage loans serviced for others	$ 866	$ 1,000	$ 1,400
Compensation expense for restricted stock units	$ 85	$ 592	$ 932

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2. Investment Securities (Details) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017
Investment securities available for sale
Amortized Cost	$ 193,296
Estimated Fair Value	194,578	$ 229,321
Mortgage-backed securities
Investment securities available for sale
Amortized Cost	52,145	53,124
Gross Unrealized Gains	516	814
Gross Unrealized Losses	558	329
Estimated Fair Value	52,103	53,609
U.S. Government sponsored enterprises
Investment securities available for sale
Amortized Cost	35,356	40,504
Gross Unrealized Gains	71	140
Gross Unrealized Losses	793	264
Estimated Fair Value	34,634	40,380
State and political subdivisions
Investment securities available for sale
Amortized Cost	105,545	129,276
Gross Unrealized Gains	2,089	4,310
Gross Unrealized Losses	43	16
Estimated Fair Value	107,591	133,570
Corporate bonds
Investment securities available for sale
Amortized Cost		1,500
Gross Unrealized Gains		12
Gross Unrealized Losses		0
Estimated Fair Value		1,512
Trust preferred securities
Investment securities available for sale
Amortized Cost	250	250
Gross Unrealized Gains	0	0
Gross Unrealized Losses	0	0
Estimated Fair Value	250	250
Total
Investment securities available for sale
Amortized Cost	193,296	224,654
Gross Unrealized Gains	2,676	5,276
Gross Unrealized Losses	1,394	609
Estimated Fair Value	$ 194,578	$ 229,321

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2. Investment securities, Continuous Unrealized Loss Position (Details) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	$ 13,531	$ 22,160
Less than 12 Months, Unrealized Losses	151	175
12 Months or More, Fair Value	44,420	22,827
12 Months or More, Unrealized Losses	1,243	434
Total, Fair Value	57,951	44,987
Total, Unrealized Losses	1,394	609
Mortgage-backed securities
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	6,932	8,701
Less than 12 Months, Unrealized Losses	56	75
12 Months or More, Fair Value	17,670	11,259
12 Months or More, Unrealized Losses	502	254
Total, Fair Value	24,602	19,960
Total, Unrealized Losses	558	329
U.S. Government sponsored enterprises
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	1,784	12,661
Less than 12 Months, Unrealized Losses	69	98
12 Months or More, Fair Value	25,172	10,067
12 Months or More, Unrealized Losses	724	166
Total, Fair Value	26,956	22,728
Total, Unrealized Losses	793	264
State and political subdivisions
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	4,815	798
Less than 12 Months, Unrealized Losses	26	2
12 Months or More, Fair Value	1,578	1,501
12 Months or More, Unrealized Losses	17	14
Total, Fair Value	6,393	2,299
Total, Unrealized Losses	$ 43	$ 16

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2. Investment securities, Contractual Maturity (Details) $ in Thousands	Dec. 31, 2018 USD ($)
Amortized Cost
Due within one year	$ 21,379
Due from one to five years	80,932
Due from five to ten years	32,271
Due after ten years	6,569
Mortgage-backed securities	52,145
Total	193,296
Estimated Fair Value
Due within one year	21,426
Due from one to five years	82,325
Due from five to ten years	32,174
Due after ten years	6,550
Mortgage-backed securities	52,103
Total	$ 194,578

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2. Investment securities, Fair Value Measurements (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Estimated Fair Value	$ 194,578	$ 229,321
Mortgage-backed securities
Estimated Fair Value	52,103	53,609
Level 1 valuation	0	0
Level 2 valuation	52,103	53,609
Level 3 valuation	0	0
U.S. Government sponsored enterprises
Estimated Fair Value	34,634	40,380
Level 1 valuation	0	0
Level 2 valuation	34,634	40,380
Level 3 valuation	0	0
State and political subdivisions
Estimated Fair Value	107,591	133,570
Level 1 valuation	0	0
Level 2 valuation	107,591	133,570
Level 3 valuation	0	0
Corporate bonds
Estimated Fair Value		1,512
Level 1 valuation		0
Level 2 valuation		1,512
Level 3 valuation		0
Trust preferred securities
Estimated Fair Value	250	250
Level 1 valuation	0	0
Level 2 valuation	0	0
Level 3 valuation	$ 250	$ 250

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2. Investment securities, Fair Value Level 3 Valuation (Details) $ in Thousands	12 Months Ended
	Dec. 31, 2018 USD ($)
Investment Securities Available for Sale Level 3 Valuation
Balance, beginning of period	$ 250
Change in book value	0
Change in gain/(loss) realized and unrealized	0
Purchases/(sales and calls)	0
Transfers in and/or (out) of Level 3	0
Balance, end of period	250
Change in unrealized gain/(loss) for assets still held in Level 3	$ 0

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2. Investment Securities (Details Narrative) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2017	Dec. 31, 2016	Dec. 31, 2018
Investment Securities Details Narrative Abstract
Unrealized losses in the investment securites portfolio relating to debt securities	$ 609		$ 1,400
Proceeds from sales of investment securities available for sale	36,000	$ 1,500
Gains on sales of available for sale securities	15	$ 729
Securities pledged to secure public deposits	$ 105,600		$ 93,000

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3. Loans (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016	Dec. 31, 2015
Major classifications
Total Loans	$ 804,023	$ 759,764	$ 723,811
Less allowance for loan losses	6,445	6,366	7,550	$ 9,589
Net loans	797,578	753,398
Construction and land development
Major classifications
Total Loans	94,178	84,987	61,749
Less allowance for loan losses	813	804	1,152	2,185
Single-family residential
Major classifications
Total Loans	252,983	246,703	240,700
Less allowance for loan losses	1,325	1,812	2,126	2,534
Single-family residential - Banco de la Gente Non-traditional
Major classifications
Total Loans	34,261	37,249	40,189
Less allowance for loan losses	1,177	1,280	1,377	1,460
Commercial
Major classifications
Total Loans	270,055	248,637	247,521
Less allowance for loan losses	1,278	1,193	1,593	1,917
Multifamily and Farmland
Major classifications
Total Loans	33,163	28,937	21,047
Less allowance for loan losses	83	72	52	0
Total real estate loans
Major classifications
Total Loans	684,640	646,513
Commercial loans (not secured by real estate)
Major classifications
Total Loans	97,465	89,022	87,596
Less allowance for loan losses	626	574	675	842
Farm loans (not secured by real estate)
Major classifications
Total Loans	926	1,204	0
Less allowance for loan losses	0	0	$ 0	$ 0
Consumer loans (not secured by real estate)
Major classifications
Total Loans	9,165	9,888
All other loans (not secured by real estate)
Major classifications
Total Loans	$ 11,827	$ 13,137

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3. Loans, Past Due (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Past due loans
Loans 30-89 Days Past Due	$ 9,564	$ 8,350
Loans 90 or More Days Past Due	1,244	775
Total Past Due Loans	10,808	9,125
Total Current Loans	793,215	750,639
Total loans	804,023	759,764	$ 723,811
Accruing Loans 90 or More Days Past Due	0	0
Construction and land development
Past due loans
Loans 30-89 Days Past Due	3	277
Loans 90 or More Days Past Due	0	0
Total Past Due Loans	3	277
Total Current Loans	94,175	84,710
Total loans	94,178	84,987
Accruing Loans 90 or More Days Past Due	0	0
Single-family residential
Past due loans
Loans 30-89 Days Past Due	4,162	3,241
Loans 90 or More Days Past Due	570	193
Total Past Due Loans	4,732	3,434
Total Current Loans	248,251	243,269
Total loans	252,983	246,703
Accruing Loans 90 or More Days Past Due	0	0
Single-family residential - Banco de la Gente Non-traditional
Past due loans
Loans 30-89 Days Past Due	4,627	4,078
Loans 90 or More Days Past Due	580	465
Total Past Due Loans	5,207	4,543
Total Current Loans	29,054	32,706
Total loans	34,261	37,249
Accruing Loans 90 or More Days Past Due	0	0
Commercial
Past due loans
Loans 30-89 Days Past Due	228	588
Loans 90 or More Days Past Due	0	0
Total Past Due Loans	228	588
Total Current Loans	269,827	248,049
Total loans	270,055	248,637
Accruing Loans 90 or More Days Past Due	0	0
Multifamily and Farmland
Past due loans
Loans 30-89 Days Past Due	0	0
Loans 90 or More Days Past Due	0	12
Total Past Due Loans	0	12
Total Current Loans	33,163	28,925
Total loans	33,163	28,937
Accruing Loans 90 or More Days Past Due	0	0
Total real estate loans
Past due loans
Loans 30-89 Days Past Due	9,020	8,184
Loans 90 or More Days Past Due	1,150	670
Total Past Due Loans	10,170	8,854
Total Current Loans	674,470	637,659
Total loans	684,640	646,513
Accruing Loans 90 or More Days Past Due	0	0
Commercial loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	445	53
Loans 90 or More Days Past Due	90	100
Total Past Due Loans	535	153
Total Current Loans	96,930	88,869
Total loans	97,465	89,022
Accruing Loans 90 or More Days Past Due	0	0
Farm loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	0	0
Loans 90 or More Days Past Due	0	0
Total Past Due Loans	0	0
Total Current Loans	926	1,204
Total loans	926	1,204
Accruing Loans 90 or More Days Past Due	0	0
Consumer loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	99	113
Loans 90 or More Days Past Due	4	5
Total Past Due Loans	103	118
Total Current Loans	9,062	9,770
Total loans	9,165	9,888
Accruing Loans 90 or More Days Past Due	0	0
All other loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	0	0
Loans 90 or More Days Past Due	0	0
Total Past Due Loans	0	0
Total Current Loans	11,827	13,137
Total loans	11,827	13,137
Accruing Loans 90 or More Days Past Due	$ 0	$ 0

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3. Loans, Nonaccrual (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Non-accrual loans
Non-accrual loans	$ 3,314	$ 3,711
Construction and land development
Non-accrual loans
Non-accrual loans	1	14
Single-family residential
Non-accrual loans
Non-accrual loans	1,530	1,634
Single-family residential - Banco de la Gente Non-traditional
Non-accrual loans
Non-accrual loans	1,440	1,543
Commercial
Non-accrual loans
Non-accrual loans	244	396
Multifamily and Farmland
Non-accrual loans
Non-accrual loans	0	12
Total real estate loans
Non-accrual loans
Non-accrual loans	3,215	3,599
Commercial loans (not secured by real estate)
Non-accrual loans
Non-accrual loans	89	100
Consumer loans (not secured by real estate)
Non-accrual loans
Non-accrual loans	$ 10	$ 12

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3. Loans, Impaired (Details) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Impaired loans
Unpaid Contractual Principal Balance	$ 24,126	$ 26,129	$ 28,313
Recorded Investment With No Allowance	511	2,042	2,002
Recorded Investment With Allowance	22,282	22,599	25,179
Recorded Investment in Impaired Loans	22,793	24,641	27,181
Related Allowance	1,098	1,199	1,409
Average Outstanding Impaired Loans	23,621	26,015	30,302
Year-To-Date Interest Income Recognized	1,342	1,362	1,198
Construction and land development
Impaired loans
Unpaid Contractual Principal Balance	281	282	282
Recorded Investment With No Allowance	0	0	0
Recorded Investment With Allowance	279	277	278
Recorded Investment in Impaired Loans	279	277	278
Related Allowance	5	6	11
Average Outstanding Impaired Loans	327	253	330
Year-To-Date Interest Income Recognized	19	17	13
Single-family residential
Impaired loans
Unpaid Contractual Principal Balance	5,059	5,226	5,354
Recorded Investment With No Allowance	422	1,135	703
Recorded Investment With Allowance	4,188	3,686	4,323
Recorded Investment in Impaired Loans	4,610	4,821	5,026
Related Allowance	32	41	47
Average Outstanding Impaired Loans	6,271	5,113	7,247
Year-To-Date Interest Income Recognized	261	265	164
Single-family residential - Banco de la Gente Non-traditional
Impaired loans
Unpaid Contractual Principal Balance	16,424	17,360	18,611
Recorded Investment With No Allowance	0	0	0
Recorded Investment With Allowance	15,776	16,805	18,074
Recorded Investment in Impaired Loans	15,776	16,805	18,074
Related Allowance	1,042	1,149	1,182
Average Outstanding Impaired Loans	14,619	16,867	17,673
Year-To-Date Interest Income Recognized	944	920	861
Commercial
Impaired loans
Unpaid Contractual Principal Balance	1,995	2,761	3,750
Recorded Investment With No Allowance	0	807	1,299
Recorded Investment With Allowance	1,925	1,661	2,197
Recorded Investment in Impaired Loans	1,925	2,468	3,496
Related Allowance	17	1	166
Average Outstanding Impaired Loans	2,171	3,411	4,657
Year-To-Date Interest Income Recognized	111	148	152
Multifamily and Farmland
Impaired loans
Unpaid Contractual Principal Balance		78	78
Recorded Investment With No Allowance		0	0
Recorded Investment With Allowance		12	78
Recorded Investment in Impaired Loans		12	78
Related Allowance		0	0
Average Outstanding Impaired Loans		28	78
Year-To-Date Interest Income Recognized		0	0
Total real estate loans
Impaired loans
Unpaid Contractual Principal Balance	23,759	25,707	28,075
Recorded Investment With No Allowance	422	1,942	2,002
Recorded Investment With Allowance	22,168	22,441	24,950
Recorded Investment in Impaired Loans	22,590	24,383	26,952
Related Allowance	1,096	1,197	1,406
Average Outstanding Impaired Loans	23,388	25,672	29,985
Year-To-Date Interest Income Recognized	1,335	1,350	1,190
Commercial loans (not secured by real estate)
Impaired loans
Unpaid Contractual Principal Balance	251	264	27
Recorded Investment With No Allowance	89	100	0
Recorded Investment With Allowance	1	4	27
Recorded Investment in Impaired Loans	90	104	27
Related Allowance	0	0	0
Average Outstanding Impaired Loans	96	149	95
Year-To-Date Interest Income Recognized	0	3	0
Consumer loans (not secured by real estate)
Impaired loans
Unpaid Contractual Principal Balance	116	158	211
Recorded Investment With No Allowance	0	0	0
Recorded Investment With Allowance	113	154	202
Recorded Investment in Impaired Loans	113	154	202
Related Allowance	2	2	3
Average Outstanding Impaired Loans	137	194	222
Year-To-Date Interest Income Recognized	$ 7	$ 9	$ 8

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3. Loans Impaired, Fair Value Measurements (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Mortgage loans held for sale	$ 680	$ 857
Impaired loans	21,695	23,442
Other real estate	27	118
Level 1
Mortgage loans held for sale	0	0
Impaired loans	0	0
Other real estate	0	0
Level 2
Mortgage loans held for sale	0	0
Impaired loans	0	0
Other real estate	0	0
Level 3
Mortgage loans held for sale	680	857
Impaired loans	21,695	23,442
Other real estate	$ 27	$ 118

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3. Loans, Allowance for Loan Losses (Details) (USD $) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Allowance for loan losses
Beginning balance	$ 6,366	$ 7,550	$ 9,589
Charge-offs	(1,133)	(982)	(1,238)
Recoveries	422	305	405
Provision	790	(507)	(1,206)
Ending balance	6,445	6,366	7,550
Ending balance: individually evaluated for impairments	1,038	1,130	1,319
Ending balance: collectively evaluated for impairments	5,407	5,236	6,231
Ending balance	6,445	6,366	7,550
Loans
Ending balance	804,023	759,764	723,811
Ending balance: individually evaluated for impairment	17,947	19,764	21,301
Ending balance: collectively evaluated for impairment	786,076	740,000	702,510
Construction and land development
Allowance for loan losses
Beginning balance	804	1,152	2,185
Charge-offs	(53)	0	(7)
Recoveries	10	14	10
Provision	52	(362)	(1,036)
Ending balance	813	804	1,152
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	813	804	1,152
Ending balance	813	804	1,152
Loans
Ending balance	94,178	84,987	61,749
Ending balance: individually evaluated for impairment	96	98	0
Ending balance: collectively evaluated for impairment	94,082	84,889	61,749
Single-family residential
Allowance for loan losses
Beginning balance	1,812	2,126	2,534
Charge-offs	(116)	(249)	(275)
Recoveries	106	85	55
Provision	(477)	(150)	(188)
Ending balance	1,325	1,812	2,126
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	1,325	1,812	2,126
Ending balance	1,325	1,812	2,126
Loans
Ending balance	252,983	246,703	240,700
Ending balance: individually evaluated for impairment	1,779	1,855	935
Ending balance: collectively evaluated for impairment	251,204	244,848	239,765
Single-family residential - Banco de la Gente Non-traditional
Allowance for loan losses
Beginning balance	1,280	1,377	1,460
Charge-offs	0	0	0
Recoveries	0	0	0
Provision	(103)	(97)	(83)
Ending balance	1,177	1,280	1,377
Ending balance: individually evaluated for impairments	1,023	1,093	1,160
Ending balance: collectively evaluated for impairments	154	187	217
Ending balance	1,177	1,280	1,377
Loans
Ending balance	34,261	37,249	40,189
Ending balance: individually evaluated for impairment	14,310	15,460	16,718
Ending balance: collectively evaluated for impairment	19,951	21,789	23,471
Commercial
Allowance for loan losses
Beginning balance	1,193	1,593	1,917
Charge-offs	(453)	0	(318)
Recoveries	105	21	19
Provision	433	(421)	(25)
Ending balance	1,278	1,193	1,593
Ending balance: individually evaluated for impairments	15	37	159
Ending balance: collectively evaluated for impairments	1,263	1,156	1,434
Ending balance	1,278	1,193	1,593
Loans
Ending balance	270,055	248,637	247,521
Ending balance: individually evaluated for impairment	1,673	2,251	3,648
Ending balance: collectively evaluated for impairment	268,382	246,386	243,873
Multifamily and Farmland
Allowance for loan losses
Beginning balance	72	52	0
Charge-offs	(5)	(66)	0
Recoveries	1	0	0
Provision	15	86	52
Ending balance	83	72	52
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	83	72	52
Ending balance	83	72	52
Loans
Ending balance	33,163	28,937	21,047
Ending balance: individually evaluated for impairment	0	0	0
Ending balance: collectively evaluated for impairment	33,163	28,937	21,047
Commercial loans (not secured by real estate)
Allowance for loan losses
Beginning balance	574	675	842
Charge-offs	(54)	(194)	(146)
Recoveries	32	31	170
Provision	74	62	(191)
Ending balance	626	574	675
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	626	574	675
Ending balance	626	574	675
Loans
Ending balance	97,465	89,022	87,596
Ending balance: individually evaluated for impairment	89	100	0
Ending balance: collectively evaluated for impairment	97,376	88,922	87,596
Farm loans (not secured by real estate)
Allowance for loan losses
Beginning balance	0	0	0
Charge-offs	0	0	0
Recoveries	0	0	0
Provision	0	0	0
Ending balance	0	0	0
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	0	0	0
Ending balance	0	0	0
Loans
Ending balance	926	1,204	0
Ending balance: individually evaluated for impairment	0	0	0
Ending balance: collectively evaluated for impairment	926	1,204	0
Consumer And All Other Loans
Allowance for loan losses
Beginning balance	155	204	172
Charge-offs	(452)	(473)	(492)
Recoveries	168	154	151
Provision	290	270	373
Ending balance	161	155	204
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	161	155	204
Ending balance	161	155	204
Loans
Ending balance	20,992	23,025	25,009
Ending balance: individually evaluated for impairment	0	0	0
Ending balance: collectively evaluated for impairment	20,992	23,025	25,009
Unallocated
Allowance for loan losses
Beginning balance	476	371	479
Charge-offs	0	0	0
Recoveries	0	0	0
Provision	506	105	(108)
Ending balance	982	476	371
Ending balance: individually evaluated for impairments	0	0	0
Ending balance: collectively evaluated for impairments	982	476	371
Ending balance	982	476	371
Loans
Ending balance	0	0	0
Ending balance: individually evaluated for impairment	0	0	0
Ending balance: collectively evaluated for impairment	$ 0	$ 0	$ 0

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3. Loans, Credit Risk (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Credit risk profile
Total Loans	$ 804,023	$ 759,764	$ 723,811
Excellent Quality
Credit risk profile
Total Loans	7,577	9,979
High Quality
Credit risk profile
Total Loans	204,792	199,289
Good Quality
Credit risk profile
Total Loans	489,142	461,054
Management Attention
Credit risk profile
Total Loans	81,903	62,247
Watch
Credit risk profile
Total Loans	13,824	19,276
Substandard
Credit risk profile
Total Loans	6,785	7,919
Doubtful
Credit risk profile
Total Loans	0	0
Loss
Credit risk profile
Total Loans	0	0
Construction and land development
Credit risk profile
Total Loans	94,178	84,987
Single-family residential
Credit risk profile
Total Loans	252,983	246,703
Single-family residential - Banco de la Gente Non-traditional
Credit risk profile
Total Loans	34,261	37,249
Commercial
Credit risk profile
Total Loans	270,055	248,637
Multifamily and Farmland
Credit risk profile
Total Loans	33,163	28,937
Commercial loans (not secured by real estate)
Credit risk profile
Total Loans	97,465	89,022
Farm loans (not secured by real estate)
Credit risk profile
Total Loans	926	1,204
Consumer loans (not secured by real estate)
Credit risk profile
Total Loans	9,165	9,888
All other loans (not secured by real estate)
Credit risk profile
Total Loans	11,827	13,137
Construction and land development
Credit risk profile
Total Loans	94,178	84,987	61,749
Construction and land development | Excellent Quality
Credit risk profile
Total Loans	504	152
Construction and land development | High Quality
Credit risk profile
Total Loans	24,594	20,593
Construction and land development | Good Quality
Credit risk profile
Total Loans	59,549	53,586
Construction and land development | Management Attention
Credit risk profile
Total Loans	5,707	4,313
Construction and land development | Watch
Credit risk profile
Total Loans	3,669	6,060
Construction and land development | Substandard
Credit risk profile
Total Loans	155	283
Construction and land development | Doubtful
Credit risk profile
Total Loans	0	0
Construction and land development | Loss
Credit risk profile
Total Loans	0	0
Single-family residential
Credit risk profile
Total Loans	252,983	246,703	240,700
Single-family residential | Excellent Quality
Credit risk profile
Total Loans	5,795	8,590
Single-family residential | High Quality
Credit risk profile
Total Loans	128,588	120,331
Single-family residential | Good Quality
Credit risk profile
Total Loans	92,435	89,120
Single-family residential | Management Attention
Credit risk profile
Total Loans	19,200	20,648
Single-family residential | Watch
Credit risk profile
Total Loans	3,761	4,796
Single-family residential | Substandard
Credit risk profile
Total Loans	3,204	3,218
Single-family residential | Doubtful
Credit risk profile
Total Loans	0	0
Single-family residential | Loss
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente Non-traditional
Credit risk profile
Total Loans	34,261	37,249	40,189
Single-family residential - Banco de la Gente Non-traditional | Excellent Quality
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente Non-traditional | High Quality
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente Non-traditional | Good Quality
Credit risk profile
Total Loans	13,776	14,955
Single-family residential - Banco de la Gente Non-traditional | Management Attention
Credit risk profile
Total Loans	15,012	15,113
Single-family residential - Banco de la Gente Non-traditional | Watch
Credit risk profile
Total Loans	2,408	3,357
Single-family residential - Banco de la Gente Non-traditional | Substandard
Credit risk profile
Total Loans	3,065	3,824
Single-family residential - Banco de la Gente Non-traditional | Doubtful
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente Non-traditional | Loss
Credit risk profile
Total Loans	0	0
Commercial
Credit risk profile
Total Loans	270,055	248,637	247,521
Commercial | Excellent Quality
Credit risk profile
Total Loans	0	0
Commercial | High Quality
Credit risk profile
Total Loans	25,321	34,360
Commercial | Good Quality
Credit risk profile
Total Loans	211,541	196,439
Commercial | Management Attention
Credit risk profile
Total Loans	30,333	13,727
Commercial | Watch
Credit risk profile
Total Loans	2,616	3,671
Commercial | Substandard
Credit risk profile
Total Loans	244	440
Commercial | Doubtful
Credit risk profile
Total Loans	0	0
Commercial | Loss
Credit risk profile
Total Loans	0	0
Multifamily and Farmland
Credit risk profile
Total Loans	33,163	28,937	21,047
Multifamily and Farmland | Excellent Quality
Credit risk profile
Total Loans	0	0
Multifamily and Farmland | High Quality
Credit risk profile
Total Loans	395	561
Multifamily and Farmland | Good Quality
Credit risk profile
Total Loans	27,774	25,306
Multifamily and Farmland | Management Attention
Credit risk profile
Total Loans	3,906	1,912
Multifamily and Farmland | Watch
Credit risk profile
Total Loans	1,088	1,146
Multifamily and Farmland | Substandard
Credit risk profile
Total Loans	0	12
Multifamily and Farmland | Doubtful
Credit risk profile
Total Loans	0	0
Multifamily and Farmland | Loss
Credit risk profile
Total Loans	0	0
Commercial loans (not secured by real estate)
Credit risk profile
Total Loans	97,465	89,022	87,596
Commercial loans (not secured by real estate) | Excellent Quality
Credit risk profile
Total Loans	605	446
Commercial loans (not secured by real estate) | High Quality
Credit risk profile
Total Loans	20,520	17,559
Commercial loans (not secured by real estate) | Good Quality
Credit risk profile
Total Loans	69,651	65,626
Commercial loans (not secured by real estate) | Management Attention
Credit risk profile
Total Loans	6,325	5,051
Commercial loans (not secured by real estate) | Watch
Credit risk profile
Total Loans	264	223
Commercial loans (not secured by real estate) | Substandard
Credit risk profile
Total Loans	100	117
Commercial loans (not secured by real estate) | Doubtful
Credit risk profile
Total Loans	0	0
Commercial loans (not secured by real estate) | Loss
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate)
Credit risk profile
Total Loans	926	1,204	$ 0
Farm loans (not secured by real estate) | Excellent Quality
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate) | High Quality
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate) | Good Quality
Credit risk profile
Total Loans	785	1,085
Farm loans (not secured by real estate) | Management Attention
Credit risk profile
Total Loans	141	119
Farm loans (not secured by real estate) | Watch
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate) | Substandard
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate) | Doubtful
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate) | Loss
Credit risk profile
Total Loans	0	0
Consumer loans (not secured by real estate)
Credit risk profile
Total Loans	9,165	9,888
Consumer loans (not secured by real estate) | Excellent Quality
Credit risk profile
Total Loans	673	791
Consumer loans (not secured by real estate) | High Quality
Credit risk profile
Total Loans	3,229	3,475
Consumer loans (not secured by real estate) | Good Quality
Credit risk profile
Total Loans	4,699	5,012
Consumer loans (not secured by real estate) | Management Attention
Credit risk profile
Total Loans	529	562
Consumer loans (not secured by real estate) | Watch
Credit risk profile
Total Loans	18	23
Consumer loans (not secured by real estate) | Substandard
Credit risk profile
Total Loans	17	25
Consumer loans (not secured by real estate) | Doubtful
Credit risk profile
Total Loans	0	0
Consumer loans (not secured by real estate) | Loss
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate)
Credit risk profile
Total Loans	11,827	13,137
All other loans (not secured by real estate) | Excellent Quality
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | High Quality
Credit risk profile
Total Loans	2,145	2,410
All other loans (not secured by real estate) | Good Quality
Credit risk profile
Total Loans	8,932	9,925
All other loans (not secured by real estate) | Management Attention
Credit risk profile
Total Loans	750	802
All other loans (not secured by real estate) | Watch
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | Substandard
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | Doubtful
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | Loss
Credit risk profile
Total Loans	$ 0	$ 0

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3. Loans, TDR Loan Modifications (Details) $ in Thousands	12 Months Ended
	Dec. 31, 2018 USD ($) Integer	Dec. 31, 2017 USD ($) Integer
TDR Loans
Post-Modification Outstanding Recorded Investment	$ 4,800	$ 4,900
Single-family residential
TDR Loans
Number of Contracts | Integer	2	2
Pre-Modification Outstanding Recorded Investment	$ 94	$ 22
Post-Modification Outstanding Recorded Investment	$ 94	$ 22
Total TDR Loans
TDR Loans
Number of Contracts | Integer	2	2
Pre-Modification Outstanding Recorded Investment	$ 94	$ 22
Post-Modification Outstanding Recorded Investment	$ 94	$ 22

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3. Loans (Details Narrative) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017
Loans Details Narrative Abstract
Percentage of construction and land development loans in Bank's loan portfolio	12.00%	11.00%
Percentage of single-family residential loans in Bank's loan portfolio	36.00%	37.00%
Percentage of Single-family residential - Banco de la Gente Non-traditional loans in the Bank's loan portfolio	4.00%	5.00%
Percentage of commercial real estate loans in Bank's loan portfolio	34.00%	33.00%
Percentage of commercial loans in Bank's loan portfolio	12.00%	12.00%
Accruing impaired loans	$ 22,800	$ 24,600
Interest income recognized on accruing impaired loans	1,300	1,400
TDR loan amounts	4,800	4,900
Amount of performing TDR loans included	$ 92	$ 21

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4. Premises and Equipment (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Premises And Equipment
Land	$ 3,456	$ 3,700
Buildings and improvements	19,357	19,312
Furniture and equipment	22,315	21,115
Construction in process	381	847
Total premises and equipment	45,509	44,974
Less accumulated depreciation	27,059	25,063
Total net premises and equipment	$ 18,450	$ 19,911

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4. Premises and Equipment (Details Narrative) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Premises And Equipment Details Narrative Abstract
Depreciation expense	$ 2,300	$ 2,100	$ 2,100

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5. Time Deposits (Details) $ in Thousands	Dec. 31, 2018 USD ($)
Time Deposits Details Abstract
2019	$ 61,723
2020	21,566
2021	14,121
2022	2,618
2023 and thereafter	3,145
Total	$ 103,173

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5. Time Deposits (Details Narrative) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Time Deposits Details Narrative Abstract
Time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service ("CDARS") on behalf of local customers	$ 3,400	$ 5,200
CDARS balances	$ 3,400	$ 5,200
Weighted average rate of brokered deposits	0.07%	0.07%

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6. Federal Home Loan Bank and Federal Reserve Bank Borrowings (Details Narrative) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Federal Home Loan Bank And Federal Reserve Bank Borrowings
Loans pledged as collateral to the FHLB	$ 140,000	$ 137,500
FHLB stock owned	982	978
Carrying value of loans pledged as collateral to the FHLB	442,600	408,500
Availability under the line of credit with the FRB	$ 335,800	$ 315,200

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8. Income Taxes (Details) - USD ($) $ in Thousands	3 Months Ended								12 Months Ended
	Dec. 31, 2018	Sep. 30, 2018	Jun. 30, 2018	Mar. 31, 2018	Dec. 31, 2017	Sep. 30, 2017	Jun. 30, 2017	Mar. 31, 2017	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Income Taxes Details Abstract
Current expense									$ 2,546	$ 1,827	$ 1,464
Deferred income tax expense									78	2,120	1,097
Total income tax	$ 690	$ 687	$ 595	$ 652	$ 1,267	$ 1,177	$ 925	$ 578	$ 2,624	$ 3,947	$ 2,561

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8. Income Taxes (Details 1) - USD ($) $ in Thousands	3 Months Ended								12 Months Ended
	Dec. 31, 2018	Sep. 30, 2018	Jun. 30, 2018	Mar. 31, 2018	Dec. 31, 2017	Sep. 30, 2017	Jun. 30, 2017	Mar. 31, 2017	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Income Taxes Details 1Abstract
Tax expense at statutory rate (21% in 2018)									$ 3,361	$ 4,833	$ 3,991
Differences:
State income tax, net of federal income tax effect									358	307	339
Tax exempt interest income									(990)	(1,594)	(1,681)
Increase in cash surrender value of life insurance									(81)	(136)	(138)
Nondeductible interest and other expense									23	46	78
Impact of Tax Cuts and Jobs Act									0	588	0
Other									(47)	(97)	(28)
Total income tax	$ 690	$ 687	$ 595	$ 652	$ 1,267	$ 1,177	$ 925	$ 578	$ 2,624	$ 3,947	$ 2,561

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8. Income Taxes (Details 2) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Deferred tax assets:
Allowance for loan losses	$ 1,481	$ 1,463
Accrued retirement expense	1,119	1,073
Federal credit carryforward	0	88
Restricted stock	262	243
Accrued bonuses	211	171
Interest income on nonaccrual loans	1	5
Other than temporary impairment	0	9
Total gross deferred tax assets	3,074	3,052
Deferred tax liabilities:
Deferred loan fees	379	365
Accumulated depreciation	610	498
Prepaid expenses	10	14
Other	5	28
Unrealized gain on available for sale securities	294	1,072
Total gross deferred tax liabilities	1,298	1,977
Net deferred tax asset	$ 1,776	$ 1,075

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9. Related Party Transactions (Details) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017
Related Party Transactions Details Abstract
Beginning balance	$ 3,679	$ 4,503
New loans	8,030	5,879
Repayments	(8,517)	(6,703)
Ending balance	$ 3,192	$ 3,679

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9. Related Party Transactions (Details Narrative) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Related Party Transactions Details Narrative Abstract
Related party deposits	$ 31,600	$ 26,600

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10. Commitments and Contingencies (Details) $ in Thousands	Dec. 31, 2018 USD ($)
Commitments And Contingencies
2019	$ 820
2020	809
2021	793
2022	501
2023	393
Thereafter	1,624
Total minimum obligation	$ 4,940

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10. Commitments and Contingencies (Details 1) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Commitments and contingencies
Commitments to extend credit
Commitments and contingencies	268,708	233,972
Standby letters of credit and financial guarantees written
Commitments and contingencies	$ 3,651	$ 3,325

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10. Commitments and Contingencies (Details Narrative) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Commitments And Contingencies Details Narrative Abstract
Rent expense	$ 785	$ 756	$ 752
Overnight federal funds	$ 82,500

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11. Employee and Director Benefit Programs (Details) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Employee And Director Benefit Programs
Benefit obligation at beginning of period	$ 4,361	$ 4,174
Service cost	362	348	$ 346
Interest cost	70	68	67
Benefits paid	(227)	(229)
Benefit obligation at end of period	$ 4,566	$ 4,361	$ 4,174

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11. Employee and Director Benefit Programs (Details 1) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Employee And Director Benefit Programs Details 1Abstract
Benefit obligation	$ 4,566	$ 4,361	$ 4,174
Fair value of plan assets	0	0
Funded status	(4,566)	(4,361)
Unrecognized prior service cost/benefit	0	0
Unrecognized net actuarial loss	0	0
Net amount recognized	(4,566)	(4,361)
Unfunded accrued liability	(4,566)	(4,361)
Intangible assets	0	0
Net amounts recognized	$ (4,566)	$ (4,361)

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11. Employee and Director Benefit Programs (Details 2) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Employee And Director Benefit Programs Details 2Abstract
Service cost	$ 362	$ 348	$ 346
Interest cost	70	68	67
Net periodic cost	$ 432	$ 416	$ 413
Weighted average discount rate assumption used to determine benefit obligation	5.49%	5.49%	5.47%

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11. Employee and Director Benefit Programs (Details 3) $ in Thousands	Dec. 31, 2018 USD ($)
Employee And Director Benefit Programs Details 3Abstract
2019	$ 235
2020	353
2021	353
2022	342
2023	342
Thereafter	$ 8,709

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11. Employee and Director Benefit Programs (Details Narrative) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Employee And Director Benefit Programs Details Narrative Abstract
Matching of employee contributions, percentage	4.00%	4.00%	4.00%
Defined Benefit Plan, Contributions by Employer	$ 670	$ 622	$ 565
Expenses incurred for benefits relating to the postretirement benefit plan	423	411	$ 428
Postretirement Benefits paid	$ 227	$ 229

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12. Regulatory Matters (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Total capital (to Risk-Weighted Assets) | Consolidated
Actual, amount	$ 149,076	$ 138,492
Actual, ratio	16.15%	16.06%
For Capital Adequacy Purposes, amount	$ 91,133	$ 79,758
For Capital Adequacy Purposes, ratio	9.88%	9.25%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 0	$ 0
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	0.00%	0.00%
Total capital (to Risk-Weighted Assets) | Bank
Actual, amount	$ 146,640	$ 136,299
Actual, ratio	15.91%	15.83%
For Capital Adequacy Purposes, amount	$ 90,995	$ 79,627
For Capital Adequacy Purposes, ratio	9.88%	9.25%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 92,147	$ 86,084
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	10.00%	10.00%
Tier 1 Capital (to Risk- Weighted Assets) | Consolidated
Actual, amount	$ 142,631	$ 132,126
Actual, ratio	15.46%	15.32%
For Capital Adequacy Purposes, amount	$ 72,676	$ 62,513
For Capital Adequacy Purposes, ratio	7.88%	7.25%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 0	$ 0
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	0.00%	0.00%
Tier 1 Capital (to Risk- Weighted Assets) | Bank
Actual, amount	$ 140,195	$ 129,933
Actual, ratio	15.21%	15.09%
For Capital Adequacy Purposes, amount	$ 72,566	$ 62,411
For Capital Adequacy Purposes, ratio	7.88%	7.25%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 73,717	$ 68,867
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	8.00%	8.00%
Tier 1 Capital (Average Assets) | Consolidated
Actual, amount	$ 142,631	$ 132,126
Actual, ratio	13.05%	11.94%
For Capital Adequacy Purposes, amount	$ 43,723	$ 44,255
For Capital Adequacy Purposes, ratio	4.00%	4.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 0	$ 0
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	0.00%	0.00%
Tier 1 Capital (Average Assets) | Bank
Actual, amount	$ 140,195	$ 129,933
Actual, ratio	12.76%	11.69%
For Capital Adequacy Purposes, amount	$ 43,950	$ 44,475
For Capital Adequacy Purposes, ratio	4.00%	4.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 54,937	$ 55,594
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	5.00%	5.00%
Common Equity Tier 1 (to Risk-Weighted Assets) | Consolidated
Actual, amount	$ 122,631	$ 112,126
Actual, ratio	13.29%	13.00%
For Capital Adequacy Purposes, amount	$ 58,833	$ 49,579
For Capital Adequacy Purposes, ratio	6.38%	5.75%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 0	$ 0
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	0.00%	0.00%
Common Equity Tier 1 (to Risk-Weighted Assets) | Bank
Actual, amount	$ 140,195	$ 129,933
Actual, ratio	15.21%	15.09%
For Capital Adequacy Purposes, amount	$ 58,744	$ 49,498
For Capital Adequacy Purposes, ratio	6.38%	5.75%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 59,895	$ 55,954
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	6.50%	6.50%

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14. Other Operating Income and Expense (Details) - USD ($) $ in Thousands	12 Months Ended
	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Other Operating Income And Expense
Visa debit card income	$ 3,911	$ 3,757	$ 3,589
Bank owned life insurance income	384	400	407
Gain (loss) on sale of capital assets	544	(32)	0
Other	1,354	1,175	854
Miscellaneous non-interest income	6,193	5,300	4,850
ATM expense	542	673	658
Consulting	1,012	785	2,257
Data processing	466	426	418
Deposit program expense	586	539	371
Dues and subscriptions	421	354	451
FHLB advance prepayment penalty	0	508	1,260
Internet banking expense	603	720	710
Office supplies	503	517	465
Telephone	678	855	754
Other	2,834	2,540	1,399
Other non-interest expense	$ 7,645	$ 7,917	$ 8,743

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15. Fair Value of Financial Instruments (Details) - USD ($) $ in Thousands	Dec. 31, 2018	Dec. 31, 2017
Assets:
Investment securities available for sale	$ 194,578	$ 229,321
Mortgage loans held for sale	680	857
Carrying Amount
Assets:
Cash and cash equivalents	43,370	57,304
Investment securities available for sale	194,578	229,321
Other investments	4,361	1,830
Mortgage loans held for sale	680	857
Loans, net	797,578	753,398
Cash surrender value of life insurance	15,936	15,552
Liabilities:
Deposits	877,213	906,952
Securities sold under agreements to repurchase	58,095	37,757
Junior subordinated debentures	20,619	20,619
Level 1
Assets:
Cash and cash equivalents	43,370	57,304
Investment securities available for sale	0	0
Other investments	0	0
Mortgage loans held for sale	0	0
Loans, net	0	0
Cash surrender value of life insurance	0	0
Liabilities:
Deposits	0	0
Securities sold under agreements to repurchase	0	0
Junior subordinated debentures	0	0
Level 2
Assets:
Cash and cash equivalents	0	0
Investment securities available for sale	194,328	229,071
Other investments	0	0
Mortgage loans held for sale	0	0
Loans, net	0	0
Cash surrender value of life insurance	15,936	15,552
Liabilities:
Deposits	0	0
Securities sold under agreements to repurchase	58,095	37,757
Junior subordinated debentures	20,619	20,619
Level 3
Assets:
Cash and cash equivalents	0	0
Investment securities available for sale	250	250
Other investments	4,361	1,830
Mortgage loans held for sale	680	857
Loans, net	748,917	735,837
Cash surrender value of life insurance	0	0
Liabilities:
Deposits	857,999	894,932
Securities sold under agreements to repurchase	0	0
Junior subordinated debentures	0	0
Estimated Fair Value
Assets:
Cash and cash equivalents	43,370	57,304
Investment securities available for sale	194,578	229,321
Other investments	4,361	1,830
Mortgage loans held for sale	680	857
Loans, net	748,917	735,837
Cash surrender value of life insurance	15,936	15,552
Liabilities:
Deposits	857,999	894,932
Securities sold under agreements to repurchase	58,095	37,757
Junior subordinated debentures	$ 20,619	$ 20,619

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16. Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements (Details) - USD ($) $ in Thousands	3 Months Ended								12 Months Ended
	Dec. 31, 2018	Sep. 30, 2018	Jun. 30, 2018	Mar. 31, 2018	Dec. 31, 2017	Sep. 30, 2017	Jun. 30, 2017	Mar. 31, 2017	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016	Dec. 31, 2018	Dec. 31, 2017
Assets
Interest-bearing time deposit												$ 2,817	$ 4,118
Investment securities available for sale												194,578	229,321
Total assets												1,093,251	1,092,166
Liabilities and Shareholders' Equity
Junior subordinated debentures												20,619	20,619
Liabilities												969,634	976,191
Shareholders' equity												123,617	115,975
Total liabilities and shareholders' equity												1,093,251	1,092,166
Revenues:
Interest and dividend income	$ 11,924	$ 11,608	$ 11,059	$ 10,759	$ 10,726	$ 10,698	$ 10,461	$ 10,064	$ 45,350	$ 41,949	$ 39,809
Gain on sale of securities									15	0	729
Expenses:
Interest	609	557	513	467	507	650	622	598	2,146	2,377	3,271
Income before income tax benefit and equity in undistributed earnings of subsidiaries	4,126	4,154	3,771	3,955	3,277	4,419	3,736	2,783	16,006	14,215	11,738
Income tax benefit	690	687	595	652	1,267	1,177	925	578	2,624	3,947	2,561
Net earnings	3,436	3,467	3,176	3,303	2,010	3,242	2,811	2,205	13,382	10,268	9,177
Cash flows from operating activities:
Net earnings	3,436	$ 3,467	$ 3,176	3,303	2,010	$ 3,242	$ 2,811	2,205	13,382	10,268	9,177
Adjustments to reconcile net earnings to net cash provided by operating activities:
Gain on sale of investment securities									(15)	0	(729)
Change in:
Other assets									(3,695)	(3,982)	(636)
Net cash provided by operating activities									17,187	18,594	12,239
Cash flows from investing activities:
Purchases of investment securities available for sale									(34,692)	(10,014)	(12,707)
Proceeds from calls and maturities of investment securities available for sale									48,241	10,162	4,053
Net cash provided by investing activities									(18,587)	(24,106)	(23,621)
Cash flows from financing activities:
Cash in lieu stock dividend									0	(6)	0
Net cash used by financing activities									(12,534)	(7,278)	41,713
Net change in cash									(13,934)	(12,790)	30,331
Noncash investing and financing activities:
Change in unrealized gain on investment securities available for sale, net									(2,607)	(1)	(2,523)
Parent Company
Assets
Cash	689			428	428			957	428	428	957	689	428
Interest-bearing time deposit												1,000	1,000
Investment in subsidiaries												141,181	133,781
Investment in PEBK Capital Trust II												619	619
Investment securities available for sale												250	250
Other assets												533	546
Total assets												144,272	136,624
Liabilities and Shareholders' Equity
Junior subordinated debentures												20,619	20,619
Liabilities												36	30
Shareholders' equity												123,617	115,975
Total liabilities and shareholders' equity												$ 144,272	$ 136,624
Revenues:
Interest and dividend income									4,544	1,839	4,569
Gain on sale of securities									0	0	405
Total revenues									4,544	1,839	4,974
Expenses:
Interest									790	590	485
Other operating expenses									678	725	513
Total expenses									1,468	1,315	998
Income before income tax benefit and equity in undistributed earnings of subsidiaries									3,076	524	3,976
Income tax benefit									299	434	178
Income before equity in undistributed earnings of subsidiaries									3,375	958	4,154
Equity in undistributed earnings of subsidiaries									10,007	9,310	5,023
Net earnings									13,382	10,268	9,177
Cash flows from operating activities:
Net earnings									13,382	10,268	9,177
Adjustments to reconcile net earnings to net cash provided by operating activities:
Equity in undistributed earnings of subsidiaries									(10,007)	(9,310)	(5,023)
Gain on sale of investment securities									0	0	(405)
Change in:
Other assets									13	(272)	61
Other liabilities									6	5	5
Net cash provided by operating activities									3,394	691	3,815
Cash flows from investing activities:
Proceeds from calls and maturities of investment securities available for sale									0	500	669
In kind transfer from parent to Bank									0	0	10
Net cash provided by investing activities									0	500	679
Cash flows from financing activities:
Cash dividends paid on common stock									(3,133)	(2,629)	(2,106)
Cash in lieu stock dividend									0	(6)	0
Stock repurchase									0	0	(1,984)
Proceeds from exercise of restricted stock units									0	915	0
Net cash used by financing activities									(3,133)	(1,720)	(4,090)
Net change in cash									261	(529)	404
Cash at beginning of year				$ 428				$ 957	428	957	553
Cash at end of year	$ 689				$ 428				689	428	957
Noncash investing and financing activities:
Change in unrealized gain on investment securities available for sale, net									$ (2,607)	$ (1)	$ (2,523)

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17. Quarterly Data (Details) - USD ($) $ / shares in Units, $ in Thousands	3 Months Ended								12 Months Ended
	Dec. 31, 2018	Sep. 30, 2018	Jun. 30, 2018	Mar. 31, 2018	Dec. 31, 2017	Sep. 30, 2017	Jun. 30, 2017	Mar. 31, 2017	Dec. 31, 2018	Dec. 31, 2017	Dec. 31, 2016
Quarterly Financial Information Disclosure [Abstract]
Total interest income	$ 11,924	$ 11,608	$ 11,059	$ 10,759	$ 10,726	$ 10,698	$ 10,461	$ 10,064	$ 45,350	$ 41,949	$ 39,809
Total interest expense	609	557	513	467	507	650	622	598	2,146	2,377	3,271
Net interest income	11,315	11,051	10,546	10,292	10,219	10,048	9,839	9,466	43,204	39,572	36,538
(Reduction of) provision for loan losses	418	110	231	31	(102)	(218)	49	(236)	790	(507)	(1,206)
Other income	4,499	3,915	4,016	3,736	3,834	4,159	3,929	3,442	16,166	15,364	16,236
Other expense	11,270	10,702	10,560	10,042	10,878	10,006	9,983	10,361	42,574	41,228	42,242
Income before income taxes	4,126	4,154	3,771	3,955	3,277	4,419	3,736	2,783	16,006	14,215	11,738
Income tax expense	690	687	595	652	1,267	1,177	925	578	2,624	3,947	2,561
Net earnings	$ 3,436	$ 3,467	$ 3,176	$ 3,303	$ 2,010	$ 3,242	$ 2,811	$ 2,205	$ 13,382	$ 10,268	$ 9,177
Basic net earnings per share	$ 0.57	$ 0.58	$ 0.53	$ 0.55	$ 0.34	$ 0.54	$ 0.47	$ 0.36	$ 2.23	$ 1.71	$ 1.53
Diluted net earnings per share	$ 0.57	$ 0.57	$ 0.53	$ 0.55	$ 0.34	$ 0.53	$ 0.46	$ 0.36	$ 2.22	$ 1.69	$ 1.5