UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2023

OR

☐     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

000-27205

(Commission File No.)

PEOPLES BANCORP OF NORTH CAROLINA, INC.

(Exact name of registrant as specified in its charter)

North Carolina	56-2132396
(State or other jurisdiction of incorporation or organization)	(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:

Title of each class Trading Symbol(s) Name on each exchange on which registered

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 such files). Yes ☒     No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 Exchange Act Rule 12b-2 of the Exchange Act). Yes ☐     No ☒

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 5,542,299 shares of common stock, outstanding at October 31, 2023.

INDEX

		PAGE(S)
Item 1.	Financial Statements
	Consolidated Balance Sheets at September 30, 2023 (Unaudited) and December 31, 2022 (Audited)	4
	Consolidated Statements of Earnings for the three and nine months ended September 30, 2023 and 2022 (Unaudited)	5
	Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2023 and 2022 (Unaudited)	6
	Consolidated Statements of Changes in Shareholders' Equity for the three and nine months ended September 30, 2023 and 2022 (Unaudited)	7
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2023 and 2022 (Unaudited)	8-9
	Notes to Consolidated Financial Statements (Unaudited)	10-28
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29-40
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	41

Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3.	Defaults upon Senior Securities	43
Item 5.	Other Information	43
Item 6.	Exhibits	44
Signatures		45
Certifications

2

FORWARD-LOOKING STATEMENTS

Statements made in this Quarterly Report on Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Quarterly Report on Form 10-Q was 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 include, but are not limited to, (1) competition in the markets served by the registrant and its subsidiaries, (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 environments 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 other filings with the Securities and Exchange Commission, including but not limited to, those described in the registrant’s Annual Report on Form 10-K for the year ended December 31, 2022.

3

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Balance Sheets
September 30, 2023 and December 31, 2022
(Dollars in thousands)
	September 30,			December 31,
Assets	2023			2022
	(Unaudited)			(Audited)
Cash and due from banks, including reserve requirements of $0 at both 9/30/23 and 12/31/22	$	35,762			50,061
Interest-bearing deposits		40,857			21,535
Cash and cash equivalents		76,619			71,596
Investment securities available for sale		378,794			445,394
Other investments		2,900			2,656
Total securities		381,694			448,050
Mortgage loans held for sale		1,848			211
Loans		1,078,173			1,032,608
Less allowance for credit losses		(10,285	)		(10,494	)
Net loans		1,067,888			1,022,114
Premises and equipment, net		16,782			18,205
Cash surrender value of life insurance		18,021			17,703
Right of use lease asset		4,908			5,116
Accrued interest receivable and other assets		39,504			37,932
Total assets	$	1,607,264			1,620,927
Liabilities and Shareholders' Equity
Deposits:
Noninterest-bearing demand	$	444,627			523,088
Interest-bearing demand, MMDA & savings		633,003			814,128
Time, over $250,000		137,715			31,001
Other time		165,423			66,998
Total deposits		1,380,768			1,435,215
Securities sold under agreements to repurchase		83,024			47,688
Junior subordinated debentures		15,464			15,464
Lease liability		5,002			5,185
Accrued interest payable and other liabilities		15,654			12,180
Total liabilities		1,499,912			1,515,732
Commitments
Shareholders' equity:
Preferred stock, no par value; authorized 5,000,000 shares; no shares issued and outstanding		-			-
Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 5,549,799 shares at September 30, 2023 and 5,636,830 shares at December 31, 2022		50,969			52,636
Common stock held by deferred compensation trust, at cost; 167,193 shares at September 30, 2023 and 169,094 shares at December 31, 2022		(2,011	)		(2,181	)
Deferred compensation		2,011			2,181
Retained earnings		107,372			100,156
Accumulated other comprehensive loss		(50,989	)		(47,597	)
Total shareholders' equity		107,352			105,195
Total liabilities and shareholders' equity	$	1,607,264			1,620,927
See accompanying Notes to Consolidated Financial Statements.

4

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Earnings
Three and Nine Months Ended September 30, 2023 and 2022
(Dollars in thousands, except per share amounts)
	Three months ended				Nine months ended
	September 30,				September 30,
	2023		2022		2023			2022
	(Unaudited)		(Unaudited)		(Unaudited)			(Unaudited)
Interest income:
Interest and fees on loans	$	14,145		11,051		40,695			30,727
Interest on due from banks		606		900		1,506			1,453
Interest on investment securities:
U.S. Government sponsored enterprises		2,358		1,288		6,868			2,280
State and political subdivisions		696		1,056		2,254			3,009
Other		501		316		1,383			463
Total interest income		18,306		14,611		52,706			37,932
Interest expense:
NOW, MMDA & savings deposits		1,752		494		4,888			1,263
Time deposits		2,512		134		4,666			421
Junior subordinated debentures		284		146		791			324
Other		418		44		912			117
Total interest expense		4,966		818		11,257			2,125
Net interest income		13,340		13,793		41,449			35,807
Provision for credit losses		562		408		1,161			889
Net interest income after provision for loan losses		12,778		13,385		40,288			34,918
Non-interest income:
Service charges		1,412		1,458		4,081			4,000
Other service charges and fees		165		169		510			540
Loss on sale of securities, net		-		-		(2,488	)		-
Mortgage banking income		72		59		204			358
Insurance and brokerage commissions		291		213		725			709
Appraisal management fee income		2,785		2,711		7,469			9,656
Miscellaneous		2,049		2,183		6,286			5,904
Total non-interest income		6,774		6,793		16,787			21,167
Non-interest expense:
Salaries and employee benefits		6,722		6,177		19,508			18,469
Occupancy		1,988		2,038		5,983			5,886
Professional fees		406		413		1,255			1,241
Advertising		217		175		562			509
Debit card expense		392		228		947			826
FDIC Insurance		186		121		556			346
Appraisal management fee expense		2,182		2,151		5,881			7,680
Miscellaneous		2,162		2,152		6,884			6,082
Total non-interest expense		14,255		13,455		41,576			41,039
Earnings before income taxes		5,297		6,723		15,499			15,046
Income tax expense		1,170		1,416		3,393			3,070
Net earnings	$	4,127		5,307		12,106			11,976
Basic net earnings per share	$	0.76		0.96		2.22			2.18
Diluted net earnings per share	$	0.74		0.93		2.15			2.11
Cash dividends declared per share	$	0.19		0.18		0.72			0.69
See accompanying Notes to Consolidated Financial Statements.

5

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Comprehensive Income (Loss)
Three and Nine Months Ended September 30, 2023 and 2022
(Dollars in thousands)
	Three months ended						Nine months ended
	September 30,						September 30,
	2023			2022			2023			2022
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net earnings	$	4,127			5,307			12,106			11,976
Other comprehensive loss:
Unrealized holding losses on securities available for sale		(9,408	)		(16,578	)		(6,892	)		(59,661	)
Reclassification adjustment for losses on securities available for sale included in net earnings		-			-			2,488			-
Total other comprehensive loss, before income taxes		(9,408	)		(16,578	)		(4,404	)		(59,661	)
Income tax benefit related to other comprehensive income:
Unrealized holding losses on securities available for sale		(2,162	)		(3,808	)		(1,584	)		(13,708	)
Reclassification adjustment for losses on securities available for sale included in net earnings		-			-			572			-
Total income tax benefit related to other comprehensive income		(2,162	)		(3,808	)		(1,012	)		(13,708	)
Total other comprehensive loss, net of tax		(7,246	)		(12,770	)		(3,392	)		(45,953	)
Total comprehensive income (loss)	$	(3,119	)		(7,463	)		8,714			(33,977	)
See accompanying Notes to Consolidated Financial Statements.

6

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Changes in Shareholders' Equity
Three and Nine Months Ended September 30, 2023 and 2022
(Dollars in thousands)
													Common Stock
													Held By			Accumulated
													Deferred			Other
	Common Stock						Retained			Deferred			Compensation			Comprehensive
	Shares			Amount			Earnings			Compensation			Trust			Loss			Total
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Balance, December 31, 2022		5,636,830		$	52,636			100,156			2,181			(2,181	)		(47,597	)		105,195
Adoption of new accounting standard, net of tax		-			-			(838	)		-			-			-			(838	)
Cash dividends declared on common stock ($0.34 per share)		-			-			(1,925	)		-			-			-			(1,925	)
Restricted stock units exercised		191			6			-			-			-			-			6
Equity incentive plan, net		-			-			-			(344	)		344			-			-
Net earnings		-			-			3,171			-			-			-			3,171
Change in accumulated other comprehensive loss, net of tax		-			-			-			-			-			9,173			9,173
Balance, March 31, 2023		5,637,021		$	52,642			100,564			1,837			(1,837	)		(38,424	)		114,782
Common stock repurchase		(46,222	)		(833	)		-			-			-			-			(833	)
Cash dividends declared on common stock ($0.19 per share)		-			-			(1,069	)		-			-			-			(1,069	)
Equity incentive plan, net		-			-			-			130			(130	)		-			-
Net earnings		-			-			4,808			-			-			-			4,808
Change in accumulated other comprehensive loss, net of tax		-			-			-			-			-			(5,319	)		(5,319	)
Balance, June 30, 2023		5,590,799		$	51,809			104,303			1,967			(1,967	)		(43,743	)		112,369
Common stock repurchase		(41,000	)		(840	)		-			-			-			-			(840	)
Cash dividends declared on common stock ($0.19 per share)		-			-			(1,058	)		-			-			-			(1,058	)
Equity incentive plan, net		-			-			-			44			(44	)		-			-
Net earnings		-			-			4,127			-			-			-			4,127
Change in accumulated other comprehensive loss, net of tax		-			-			-			-			-			(7,246	)		(7,246	)
Balance, September 30, 2023		5,549,799		$	50,969			107,372			2,011			(2,011	)		(50,989	)		107,352
Balance, December 31, 2021		5,661,569		$	53,305			88,968			1,992			(1,992	)		96			142,369
Common stock repurchase		(7,000	)		(199	)		-			-			-			-			(199	)
Cash dividends declared on common stock ($0.33 per share)		-			-			(1,877	)		-			-			-			(1,877	)
Restricted stock units exercised		1,461			41			-			-			-			-			41
Equity incentive plan, net		-			-			-			50			(50	)		-			-
Net earnings		-			-			3,452			-			-			-			3,452
Change in accumulated other comprehensive loss, net of tax		-			-			-			-			-			(18,342	)		(18,342	)
Balance, March 31, 2022		5,656,030		$	53,147			90,543			2,042			(2,042	)		(18,246	)		125,444
Common stock repurchase		(15,000	)		(395	)		-			-			-			-			(395	)
Cash dividends declared on common stock ($0.18 per share)		-			-			(1,019	)		-			-			-			(1,019	)
Equity incentive plan, net		-			-			-			57			(57	)		-			-
Net earnings		-			-			3,217			-			-			-			3,217
Change in accumulated other comprehensive loss, net of tax		-			-			-			-			-			(14,841	)		(14,841	)
Balance, June 30, 2022		5,641,030		$	52,752			92,741			2,099			(2,099	)		(33,087	)		112,406
Cash dividends declared on common stock ($0.18 per share)		-			-			(1,019	)		-			-			-			(1,019	)
Equity incentive plan, net		-			-			-			51			(51	)		-			-
Net earnings		-			-			5,307			-			-			-			5,307
Change in accumulated other comprehensive loss, net of tax		-			-			-			-			-			(12,770	)		(12,770	)
Balance, September 30, 2022		5,641,030		$	52,752			97,029			2,150			(2,150	)		(45,857	)		103,924
See accompanying Notes to Consolidated Financial Statements.

7

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2023 and 2022
(Dollars in thousands)
	2023			2022
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net earnings	$	12,106			11,976
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation, amortization and accretion		2,416			4,914
Provision for credit losses		1,161			889
Deferred income taxes		(248	)		(31	)
Loss on sale of investment securities, net		2,488			-
Gain on sale of premises and equipment		(185	)		-
Restricted stock expense		(7	)		(95	)
Proceeds from sales of mortgage loans held for sale		11,031			20,475
Origination of mortgage loans held for sale		(12,668	)		(17,813	)
Change in:
Cash surrender value of life insurance		(318	)		(301	)
Right of use lease asset		578			568
Other assets		(93	)		(2,944	)
Lease liability		(553	)		(556	)
Other liabilities		1,357			232
Net cash provided by operating activities		17,066			17,314
Cash flows from investing activities:
Purchases of investment securities available for sale		(6,992	)		(139,657	)
Proceeds from sales, calls and maturities of investment securities available for sale		52,023			7,870
Proceeds from paydowns of investment securities available for sale		13,898			31,186
Proceeds from paydowns on other investments		112			1,011
Purchases of FHLB stock		(323	)		(105	)
Net change in loans		(45,862	)		(120,252	)
Purchases of premises and equipment		(1,522	)		(4,196	)
Proceeds from sale of premises and equipment		1,460			-
Proceeds from bank owned life insurance		-			65
Net cash provided (used) by investing activities		12,793			(224,078	)
Cash flows from financing activities:
Net change in deposits		(54,447	)		88,343
Net change in securities sold under agreement to repurchase		35,336			892
Common stock repurchased		(1,673	)		(594	)
Cash dividends paid on common stock		(4,052	)		(3,915	)
Net cash provided (used) by financing activities		(24,836	)		84,726
Net change in cash and cash equivalents		5,023			(122,038	)
Cash and cash equivalents at beginning of period		71,596			277,499
Cash and cash equivalents at end of period	$	76,619			155,461

8

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows, continued
Nine Months Ended September 30, 2023 and 2022
(Dollars in thousands)
	2023			2022
	(Unaudited)			(Unaudited)
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	10,766			2,112
Income taxes	$	3,462			3,069
Noncash investing and financing activities:
Change in unrealized loss on investment securities available for sale, net	$	(3,392	)		(45,953	)
Issuance of accrued restricted stock units	$	6			41
Initial recognition of lease right-of-use asset and lease liability	$	370			1,726
Allowance for credit losses record upon adoption of ASU 326, net of tax	$	(838	)		-
See accompanying Notes to Consolidated Financial Statements.

9

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Notes to Consolidated Financial Statements (Unaudited)

(1) Summary of Significant Accounting Policies

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

In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), to facilitate the issuance of $20.6 million of trust preferred securities. PEBK Trust II is not included in the Consolidated Financial Statements.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a separate division of the Bank under the name Banco de la Gente (“Banco”). These offices, which offer the same banking services as our other branches offer, now operate under the same name as our other offices; however, we continue to separately categorize mortgage loans originated from these offices.

The Consolidated Financial Statements in this report (other than the Consolidated Balance Sheet at December 31, 2022) are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these Consolidated Financial Statements in conformity with generally accepted accounting principles in the United States (“GAAP”). Actual results could differ from those estimates.

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by management in deciding how to allocate resources and in assessing performance. Management has determined that the Company has two significant operating segment: Banking Operations and CBRES, as discussed more fully in Note 7. In determining the appropriateness of segment definition, the Company considers the criteria of Accounting Standards Codification (“ASC”) 280, Segment Reporting.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of the specific accounting guidance. A description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2022 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2023 Annual Meeting of Shareholders. There have been no significant changes to the application of significant accounting policies since December 31, 2022, except for the adoption of ASC 326 noted below.

10

Recent Accounting Pronouncements

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

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2019-10: Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates	Guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (CECL), leases and hedging.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position but did impact disclosure requirements.
ASU 2019-11: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the ASC.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position but did impact disclosure requirements.
ASU 2020-03: Codification Improvements to Financial Instruments	Guidance to clarify that the contractual term of a net investment in a lease, determined in accordance with the leases standard, should be the contractual term used to measure expected credit losses under ASC 326.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2022-02: Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures	Eliminates the guidance on troubled debt restructurings (TDRs) for creditors in ASC 310-40 2 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position but did impact disclosure requirements.

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.

On January 1, 2023, the Company adopted ASC 326, which replaced the incurred loss impairment framework in prior GAAP with a current expected credit loss (“CECL”) framework, which requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan receivables and some off-balance sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost are presented at the net amount expected to be collected by using an allowance for credit losses (“ACL”).

In addition, the adoption of CECL resulted in changes to the Company’s accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management does not intend to sell and does not believe that it is more likely than not, they will be required to sell.

The Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. Adoption of ASC 326 resulted in an initial reduction to retained earnings of $838,000, net of tax, due to a $1.1 million increase in the allowance for credit losses, comprised of a $2.3 million increase in the allowance for credit losses on unfunded commitments and a $1.2 million decrease in the allowance for credit losses on loans. There was no impact to the available-for-sale securities portfolio or other financial instruments. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP (referred to as the “Incurred Loss” methodology).

The Company adopted ASC 326 using the prospective transition approach for debt securities for which other-than-temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have any other than-temporarily impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined that an allowance for credit losses on available for sale securities was not deemed material.

The Company elected not to measure an allowance for credit losses for accrued interest receivable and instead elected to reverse interest income on loans or securities that are placed on nonaccrual status, which is generally when the instrument is 90 days past due, or earlier if the Company believes the collection of interest is doubtful. The Company has concluded that this policy results in the timely reversal of uncollectible interest.

11

The allowance for credit losses on loans is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Accrued interest receivable is excluded from the estimate of credit losses. The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of September 30, 2023. The allowance for credit losses is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The Company measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. No loans were individually evaluated as of September 30, 2023. The Company has identified the following portfolio segments and calculates the allowance for credit losses for each using a Weighted Average Remaining Maturity (“WARM”) methodology:

- 1-4 family residential construction loans

- Other construction loans and all land development and other land loans

- Secured by farmland (including farm residential and other improvements)

- Home equity loans

- 1-4 family residential loans secured by first liens

- 1-4 family residential loans secured by junior liens

- Secured by multifamily residential properties

- Loans secured by owner-occupied, nonfarm nonresidential properties

- Loans secured by other nonfarm nonresidential properties

- Loans to finance agricultural production and other loans to farmers

- Commercial and industrial loans

- Other revolving credit plans

- Other consumer loans

- Obligations (other than securities and leases) of states and political subdivisions in the US

- Other loans

Under the WARM methodology, lifetime losses are calculated by determining the remaining life of the loan pool and then applying a loss rate which includes a forecast component over this remaining life of the loan pool. The methodology considers historical loss experience and a loss forecast expectation to estimate credit losses for the remaining balance of the loan pool. The calculated loss rate is applied to the contractual term (adjusted for prepayments) to determine the loan pool’s current expected credit losses. The Company’s forecast component projects the next four quarters to have similar loss rates to the period between November 1, 2015 and September 30, 2019, and then with a reversion back to the long-term average over four quarters. This period is intended to reflect the environment that began when the Federal Reserve started its last series of rate hikes beginning in November of 2015, and reflects the overall loan loss rates of the Company during this time of no higher than 0.4%. This period has been extended from the prior quarter by three months, and had minor impacts on the loss rates. The Company expects to adjust these time frames for affecting the forecast periods as the rate environment changes to reflect either increasing or decreasing loan loss rates that will adjust the historical loss rates.

Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may increase or reduce reserve levels and include adjustments for: local, state and national economic outlook; levels and trends of delinquencies; trends in volume, mix and size of loans; seasoning of the loan portfolio; experience of staff; concentrations of credit; and interest rate risk.

Loans that do not share risk characteristics are evaluated on an individual basis. When management determines that foreclosure is probable and the borrower is experiencing financial difficulty, the expected credit losses are based on the fair value of collateral at the reporting date unadjusted for selling costs as appropriate. The Company did not have any loans evaluated on an individual basis at September 30, 2023.

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.

Reclassification

Certain amounts in the 2022 consolidated financial statements have been reclassified to conform to the 2023 presentation. These reclassifications did not have any impact on shareholders’ equity or net earnings.

12

(2) Investment Securities

Investment securities available for sale at September 30, 2023 and December 31, 2022 are as follows:

(Dollars in thousands)
	September 30, 2023
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S Treasuries	$	10,968		-		1,130		9,838
U.S. Government sponsored enterprises		11,510		-		765		10,745
Mortgage-backed securities		292,512		70		32,715		259,867
State and political subdivisions		130,000		-		31,656		98,344
Total	$	444,990		70		66,266		378,794

(Dollars in thousands)
	December 31, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S Treasuries	$	10,951		-		1,137		9,814
U.S. Government sponsored enterprises		12,245		-		706		11,539
Mortgage-backed securities		299,222		445		25,829		273,838
State and political subdivisions		184,768		91		34,656		150,203
Total	$	507,186		536		62,328		445,394

The current fair value and associated unrealized losses on investments in securities with unrealized losses at September 30, 2023 and December 31, 2022 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)
	September 30, 2023
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasuries	$	-		-		9,838		1,130		9,838		1,130
U.S. Government sponsored enterprises		-		-		10,745		765		10,745		765
Mortgage-backed securities		33,158		1,336		221,918		31,379		255,076		32,715
State and political subdivisions		-		-		98,344		31,656		98,344		31,656
Total	$	33,158		1,336		340,845		64,930		374,003		66,266

(Dollars in thousands)
	December 31, 2022
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasuries	$	2,878		104		6,936		1,033		9,814		1,137
U.S. Government sponsored enterprises		2,904		87		8,635		619		11,539		706
Mortgage-backed securities		128,241		8,740		120,464		17,089		248,705		25,829
State and political subdivisions		65,880		7,766		76,291		26,890		142,171		34,656
Total	$	199,903		16,697		212,326		45,631		412,229		62,328

13

At September 30, 2023, unrealized losses in the investment securities portfolio relating to debt securities totaled $66.3 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the September 30, 2023 tables above, all three of the U.S. Treasury securities, all 108 of the securities issued by state and political subdivisions, all seven of the securities issued by U.S. Government sponsored enterprises and 129 of the 134 mortgage-backed securities contained unrealized losses. These unrealized losses are not related to credit impairment because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities. The Company does not have an allowance for credit losses on available for sale securities at September 30, 2023. At December 31, 2022, unrealized losses in the investment securities portfolio relating to debt securities totaled $62.3 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the December 31, 2022 tables above, all three of the U.S. Treasury securities, 149 of the 158 securities issued by state and political subdivisions, all seven of the securities issued by U.S. Government sponsored enterprises and 123 of the 133 mortgage-backed securities contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities.

The amortized cost and estimated fair value of investment securities available for sale at September 30, 2023, presented by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.

September 30, 2023
(Dollars in thousands)
	Amortized Cost		Fair Value
Due within one year	$	2,994		2,956
Due from one to five years		16,454		14,707
Due from five to ten years		53,180		43,382
Due after ten years		79,850		57,882
Mortgage-backed securities		292,512		259,867
Total	$	444,990		378,794

No securities available for sale were sold during the three months ended September 30, 2023. During the nine months ended September 30, 2023, proceeds from sales of securities available for sale were $51.0 million and resulted in gross losses of $2.7 million and gross gains of $177,000. No securities available for sale were sold during the nine months ended September 30, 2022.

Securities with a fair value of approximately $129.8 million and $96.0 million at September 30, 2023 and December 31, 2022, respectively, were pledged to secure public deposits and for other purposes as required by law.

14

(3) Loans

Major classifications of loans at September 30, 2023 and December 31, 2022 are summarized as follows:

(Dollars in thousands)
	September 30, 2023			December 31, 2022
Real estate loans:
Construction and land development	$	127,706			114,446
Single-family residential		344,415			322,262
Single-family residential -
Banco de la Gente non-traditional		18,388			20,019
Commercial		430,270			406,750
Multifamily and farmland		64,313			65,562
Total real estate loans		985,092			929,039
Loans not secured by real estate:
Commercial loans		68,738			81,307
Farm loans		574			938
Consumer loans		7,680			6,834
All other loans		16,089			14,490
Total loans		1,078,173			1,032,608
Less allowance for credit losses		(10,285	)		(10,494	)
Total net loans	$	1,067,888			1,022,114

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

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

· Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.

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

· Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.

· Multifamily and farmland loans – Decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.

Loans are considered past due if the required principal and interest payments have not been received within 30 days of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Generally, a loan is placed on non-accrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

15

The following tables present an age analysis of past due loans, by loan type, as of September 30, 2023 and December 31, 2022:

September 30, 2023
(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	$	39		-		39		127,667		127,706		-
Single-family residential		938		217		1,155		343,260		344,415		-
Single-family residential -
Banco de la Gente non-traditional		840		89		929		17,459		18,388		-
Commercial		481		-		481		429,789		430,270		-
Multifamily and farmland		-		-		-		64,313		64,313		-
Total real estate loans		2,298		306		2,604		982,488		985,092		-
Loans not secured by real estate:
Commercial loans		375		99		474		68,264		68,738		99
Farm loans		-		-		-		574		574		-
Consumer loans		37		-		37		7,643		7,680		-
All other loans		-		-		-		16,089		16,089		-
Total loans	$	2,710		405		3,115		1,075,058		1,078,173		99

December 31, 2022
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	363		-		363		114,083		114,446		-
Single-family residential		4,318		256		4,574		317,688		322,262		-
Single-family residential -
Banco de la Gente non-traditional		2,977		264		3,241		16,778		20,019		-
Commercial		306		-		306		406,444		406,750		-
Multifamily and farmland		-		-		-		65,562		65,562		-
Total real estate loans		7,964		520		8,484		920,555		929,039		-
Loans not secured by real estate:
Commercial loans		3		-		3		81,304		81,307		-
Farm loans		-		-		-		938		938		-
Consumer loans		71		-		71		6,763		6,834		-
All other loans		-		-		-		14,490		14,490		-
Total loans	$	8,038		520		8,558		1,024,050		1,032,608		-

16

The following table presents non-accrual loans as of September 30, 2023 and December 31, 2022:

	CECL Methodology						Incurred Loss Methodology
	September 30, 2023						December 31, 2022
	Nonaccrual Loans		Nonaccrual Loans		Total		Total
	With No		With		Nonaccrual		Nonaccrual
(Dollars in thousands)	Allowance		Allowance		Loans		Loans
Real estate loans:
Construction and land development	$	46		-		46		53
Single-family residential		1,878		-		1,878		1,914
Single-family residential -
Banco de la Gente non-traditional		1,575		-		1,575		1,532
Commercial		-		-		-		129
Multifamily and farmland		80		-		80		91
Total real estate loans		3,579		-		3,579		3,719
Loans not secured by real estate:
Commercial loans		33		-		33		-
Consumer loans		2		-		2		9
Total	$	3,614		-		3,614		3,728

Interest income is not recognized on non-accrual loans.

The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification.

Because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Bank modifies loans by providing principal forgiveness on certain loans. When principal forgiveness is provided, the amortized cost basis of the asset is written off against the allowance for credit losses. The amount of the principal forgiveness is deemed to be uncollectible; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses.

In some cases, the Bank may modify a certain loan by providing multiple types of concessions. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted.

The following table shows the amortized cost basis at September 30, 2023 of the loans to borrowers experiencing financial difficulty that were modified during the nine months ended September 30, 2023, disaggregated by loan class and type of concession granted. There were no loans to borrowers experiencing financial difficulty that were modified during the three months ended September 30, 2023.

(Dollars in thousands)
	Term Extension
	Amortized Cost Basis at September 30, 2023		% of Loan Class
Loan class:
Single-family residential		154		0.04	%
Commercial real estate		673		0.16	%
Total	$	827

17

The following table describes the financial effect of the modifications made to borrowers experiencing financial difficulty.

Term Extension
Loan Class	Financial Effect
Single-family residential	Forbearance agreement on matured home equity line of credit (HELOC) that was modified to 180 month term.
Commercial real estate	Extended existing amortization from 148 months to 173 months to keep existing payment the same with the current market rate.

Upon the Bank’s determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount.

No loans modified in the nine months ended September 30, 2023 that were made to borrowers experiencing financial difficulty had been written off at September 30, 2023.

The Bank closely monitors the performance of those loans that are modified because borrowers are experiencing financial difficulty so as to understand the effectiveness of its modification efforts. The following table shows the performance of loans that have been modified in the nine months ended September 30, 2023.

(Dollars in thousands)
	Payment Status (Amortized Cost Basis)
	Current		30 - 89 Days Past Due		90 + Days Past Due
Loan type:
Single-family residential		154		-		-
Commercial real estate		673		-		-
Total	$	827		-		-

The following table presents impaired loans as of and for the year ended December 31, 2022:

December 31, 2022
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance
Real estate loans:
Construction and land development	$	110		-		110		110		2
Single-family residential		3,912		236		3,300		3,536		60
Single-family residential -
Banco de la Gente non-traditional		10,441		-		9,748		9,748		611
Commercial		1,785		421		1,346		1,767		9
Multifamily and farmland		104		-		91		91		-
Total impaired real estate loans		16,352		657		14,595		15,252		682
Loans not secured by real estate:
Commercial loans		116		-		116		116		1
Consumer loans		11		-		9		9		-
Total impaired loans	$	16,479		657		14,720		15,377		683

18

The following table presents the average impaired loan balance and the interest income recognized by loan class for the three and nine months ended September 30, 2022 and the twelve months ended December 31, 2022.

(Dollars in thousands)
	Three months ended				Nine months ended				Twelve months ended
	September 30, 2022				September 30, 2022				December 31, 2022
	Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized
Real estate loans:
Construction and land development	$	60		1		65		4		75		8
Single-family residential		1,393		51		1,131		150		5,194		194
Single-family residential -
Banco de la Gente stated income		12,487		134		13,454		407		8,757		552
Commercial		1,939		25		1,985		75		1,916		93
Multifamily and farmland		97		1		100		4		96		5
Total impaired real estate loans		15,976		212		16,735		640		16,038		852
Loans not secured by real estate:
Commercial loans		138		3		163		7		137		8
Consumer loans		21		1		14		2		15		2
Total impaired loans	$	16,135		216		16,912		649		16,190		862

Impaired loans collectively evaluated for impairment totaled $5.1 million $4.9 million at September 30, 2022 and December 31, 2022, respectively and are included in the tables above. Allowance on impaired loans collectively evaluated for impairment totaled $44,000 and $44,000 at September 30, 2022 and December 31, 2022, respectively.

The following tables present changes in the allowance for credit losses for the three and nine months ended September 30, 2023 and 2022. The September 30, 2023 table reflects the CECL methodology and the September 30, 2022 table reflects the Incurred Loss methodology. Paycheck Protection Program (“PPP”) loans are excluded from the allowance for credit losses because PPP loans are guaranteed by the Small Business Administration (“SBA”). No loans were individually evaluated as of September 30, 2023.

(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
Three months ended September 30, 2023
Allowance for credit losses:
Beginning balance	$	5,394			3,207			183			2,365			288			367			2		242			-			12,048
Charge-offs		-			-			-			-			-			(94	)		-		(141	)		-			(235	)
Recoveries		-			8			-			1			-			8			-		24			-			41
Provision (recovery) for
unfunded commitments		(95	)		(31	)		-			-			-			3			-		(4	)		-			(127	)
Provision (recovery) for
loan losses		390			111			(5	)		(12	)		(15	)		87			-		133			-			689
Ending balance	$	5,689			3,295			178			2,354			273			371			2		254			-			12,416
Nine months ended September 30, 2023
Allowance for credit losses:
Beginning balance	$	1,415			2,322			763			3,207			164			657			-		214			1,752			10,494
Adjustment for CECL implementation		3,781			715			(576	)		(986	)		115			(295	)		2		54			(1,752	)		1,058
Charge-offs		-			-			-			-			-			(129	)		-		(450	)		-			(579	)
Recoveries		-			131			-			5			-			40			-		106			-			282
Provision (recovery) for unfunded commitments		(125	)		(18	)		-			-			-			3			-		(6	)		-			(146	)
Provision (recovery) for loan losses		618			145			(9	)		128			(6	)		95			-		336			-			1,307
Ending balance	$	5,689			3,295			178			2,354			273			371			2		254			-			12,416
Allowance for credit loss-loans	$	3,618			3,237			178			2,354			273			371			2		252			-			10,285
Allowance for credit losses unfunded loan commitments		2,071			58			-			-			-			-			-		2			-			2,131
Total allowance for credit losses	$	5,689			3,295			178			2,354			273			371			2		254			-			12,416

19

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential			Single-Family Residential - Banco de la Gente Non-traditional			Commercial			Multifamily and Farmland			Commercial			Farm		Consumer and All Other			Unallocated			Total
Nine months ended September 30, 2022:
Allowance for loan losses:
Beginning balance	$	1,193		2,013			864			2,234			150			711			-		110			2,080			9,355
Charge-offs		-		(120	)		-			-			-			(20	)		-		(450	)		-			(590	)
Recoveries		-		219			-			6			-			64			-		87			-			376
Provision		180		78			(101	)		885			5			(14	)		-		467			(611	)		889
Ending balance	$	1,373		2,190			763			3,125			155			741			-		214			1,469			10,030
Three months ended September 30, 2022:
Allowance for loan losses:
Beginning balance	$	1,272		2,171			813			3,156			157			633			-		216			1,371			9,789
Charge-offs		-		(89	)		-			-			-			(13	)		-		(204	)		-			(306	)
Recoveries		-		92			-			2			-			8			-		37			-			139
Provision		101		16			(50	)		(33	)		(2	)		113			-		165			98			408
Ending balance	$	1,373		2,190			763			3,125			155			741			-		214			1,469			10,030
Allowance for loan losses at September 30, 2022:
Ending balance: individually
evaluated for impairment	$	-		37			605			6			-			-			-		-			-			648
Ending balance: collectively
evaluated for impairment		1,373		2,153			158			3,119			155			741			-		214			1,469			9,382
Ending balance	$	1,373		2,190			763			3,125			155			741			-		214			1,469			10,030
Loans at September 30, 2022:
Ending balance	$	112,854		312,208			20,469			399,015			62,040			76,434			961		20,926			-			1,004,907
Ending balance: individually
evaluated for impairment	$	-		547			8,703			1,401			-			-			-		-			-			10,651
Ending balance: collectively
evaluated for impairment	$	112,854		311,661			11,766			397,614			62,040			76,434			961		20,926			-			994,256

The Bank utilizes several credit quality indicators to manage credit risk in an ongoing manner. The Bank uses an internal risk grade system that categorizes loans into pass, watch or substandard categories.

The Bank uses the following credit quality indicators:

· Pass – Includes loans ranging from excellent quality with a minimal amount of credit risk to loans with higher risk and servicing needs but still are considered to be acceptable. The higher risk loans in this category are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

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

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

20

The following table presents by credit quality indicator, loan class and year of origination, the amortized cost of the Bank’s loans as of September 30, 2023.

	Term Loans by Origination Year														Revolving
															Loans
(dollars in thousands)													Revolving		Converted to		Total
	2023		2022		2021		2020		2019		Prior		Loans		Term Loans		Loans
September 30, 2023
Real Estate Loans
Construction and land
development
Pass	$	28,242		72,097		12,409		6,798		2,019		4,409		1,638		-		127,612
Watch		-		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		94		-		-		94
Total Construction and
land development	$	28,242		72,097		12,409		6,798		2,019		4,503		1,638		-		127,706
Single family
Pass	$	27,917		71,607		47,350		25,406		13,323		52,180		102,493		-		340,276
Watch		-		-		-		-		90		372		630		-		1,092
Substandard		-		-		-		-		-		2,664		383		-		3,047
Total single family	$	27,917		71,607		47,350		25,406		13,413		55,216		103,506		-		344,415
Single family-Banco de la
Gente non-traditional
Pass	$	-		-		-		-		-		15,894		-		-		15,894
Watch		-		-		-		-		-		381		-		-		381
Substandard		-		-		-		-		-		2,113		-		-		2,113
Total Banco de la Gente
non-traditional	$	-		-		-		-		-		18,388		-		-		18,388
Commercial
Pass	$	34,136		110,380		81,144		69,611		30,713		96,897		1,610		-		424,491
Watch		235		-		-		117		-		5,015		-		-		5,367
Substandard		-		-		-		412		-		-		-		-		412
Total commercial	$	34,371		110,380		81,144		70,140		30,713		101,912		1,610		-		430,270
Multifamily and farmland
Pass	$	7,921		13,464		22,026		6,789		3,245		10,056		620		-		64,121
Watch		-		-		-		-		-		112		-		-		112
Substandard		-		-		-		-		-		80		-		-		80
Total multifamily and
farmland	$	7,921		13,464		22,026		6,789		3,245		10,248		620		-		64,313
Total real estate loans	$	98,451		267,548		162,929		109,133		49,390		190,267		107,374		-		985,092
Loans not secured by real estate
Commercial
Pass	$	7,370		15,184		4,335		3,193		2,630		12,973		21,663		-		67,348
Watch		-		85		-		-		81		110		1,081		-		1,357
Substandard		33		-		-		-		-		-		-		-		33
Total Commercial	$	7,403		15,269		4,335		3,193		2,711		13,083		22,744		-		68,738
Farm
Pass	$	202		46		91		-		11		53		171		-		574
Watch		-		-		-		-		-		-		-		-		-
Substandard		-		-		-		-		-		-		-		-		-
Total farm	$	202		46		91		-		11		53		171		-		574
Consumer
Pass	$	2,603		1,558		484		253		84		67		2,624		-		7,673
Watch		-		-		-		-		-		-		-		-		-
Substandard		-		-		3		-		-		-		4		-		7
Total consumer	$	2,603		1,558		487		253		84		67		2,628		-		7,680
All other
Pass	$	1,074		6,455		498		433		648		4,030		2,812		-		15,950
Watch		-		-		-		-		-		75		64		-		139
Substandard		-		-		-		-		-		-		-		-		-
Total all other	$	1,074		6,455		498		433		648		4,105		2,876		-		16,089
Total loans not secured
by real estate	$	11,282		23,328		5,411		3,879		3,454		17,308		28,419		-		93,081
Total loans	$	109,733		290,876		168,340		113,012		52,844		207,575		135,793		-		1,078,173
Current period gross charge-offs	$	-		87		104		21		1		366		-		-		579

21

The following table presents the credit risk profile of each loan type based on credit quality indicators as of December 31, 2022:

December 31, 2022
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total
Pass	$	114,282		317,850		16,410		402,236		65,348		80,596		938		6,818		14,345		1,018,823
Watch		54		922		1,136		3,963		123		711		-		1		145		7,055
Substandard		110		3,490		2,473		551		91		-		-		15		-		6,730
Total	$	114,446		322,262		20,019		406,750		65,562		81,307		938		6,834		14,490		1,032,608

(4) Net Earnings Per Share

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

The reconciliation of the amounts used in the computation of both “basic earnings per share” and “diluted earnings per share” for the three and nine months ended September 30, 2023 and 2022 is as follows:

For the three months ended September 30, 2023
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	4,127		5,402,048	$	0.76
Effect of dilutive securities:
Restricted stock units - unvested				19,070
Shares held in deferred comp plan by deferred compensation trust				166,168
Diluted earnings per share	$	4,127		5,587,286	$	0.74

For the nine months ended September 30, 2023
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	12,106		5,442,788	$	2.22
Effect of dilutive securities:
Restricted stock units - unvested				18,899
Shares held in deferred comp plan by deferred compensation trust				168,099
Diluted earnings per share	$	12,106		5,629,786	$	2.15

For the three months ended September 30, 2022
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	5,307		5,473,443	$	0.96
Effect of dilutive securities:
Restricted stock units - unvested				17,188
Shares held in deferred comp plan by deferred compensation trust				166,937
Diluted earnings per share	$	5,307		5,657,568	$	0.93

22

For the nine months ended September 30, 2022
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	11,976		5,484,063	$	2.18
Effect of dilutive securities:
Restricted stock units - unvested				15,090
Shares held in deferred comp plan by deferred compensation trust				165,041
Diluted earnings per share	$	11,976		5,664,194	$	2.11

(5) Fair Value

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

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

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

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

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

Cash and Cash Equivalents

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

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.

23

Loans

The fair value of loans, excluding previously presented individually evaluated loans measured at fair value on a non-recurring basis, is estimated using discounted cash flow analyses. The discount rates used to determine fair value use interest rate spreads that reflect factors such as liquidity, credit, and nonperformance risk of the loans. Loans are reported in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

Mutual Funds

For mutual funds held in the deferred compensation trust, the carrying value is a reasonable estimate of fair value. Mutual funds held in the deferred compensation trust are included in other assets on the balance sheet and reported in the Level 2 fair value category.

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Deposits are reported in the Level 3 fair value category.

Securities Sold Under Agreements to Repurchase

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

FHLB Borrowings

The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 3 fair value category.

Junior Subordinated Debentures

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

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally short-term in duration and made 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.

24

The tables below present all financial instruments measured at fair value on a recurring basis by level within the fair value hierarchy, as of September 30, 2023 and December 31, 2022.

(Dollars in thousands)
	September 30, 2023
	Fair Value		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
U.S. Treasuries	$	9,838		-		9,838		-
U.S. Government sponsored enterprises		10,745		-		10,745		-
Mortgage-backed securities		259,867		-		259,867		-
State and political subdivisions		98,344		-		98,344		-
Mutual funds held in deferred compensation trust		1,850		-		1,850

(Dollars in thousands)
	December 31, 2022
	Fair Value		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
U.S. Treasuries	$	9,814		-		9,814		-
U.S. Government sponsored enterprises		11,539		-		11,539		-
Mortgage-backed securities		273,838		-		273,838		-
State and political subdivisions		150,203		-		150,203		-
Mutual funds held in deferred compensation trust		1,327		-		1,327

The fair value measurements for mortgage loans held for sale and individually evaluated loans on a non-recurring basis at September 30, 2023 and December 31, 2022 are presented below. The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of, and judgment about, current market conditions, specific issues relating to the collateral and other matters. As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements September 30, 2023		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	1,848		-		-		1,848
Individually evaluated loans		-		-		-		-

(Dollars in thousands)
	Fair Value Measurements December 31, 2022		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	211		-		-		211
Impaired loans		14,694		-		-		14,694

(Dollars in thousands)
	Fair Value September 30, 2023		Fair Value December 31, 2022		Valuation Technique	Significant Unobservable Inputs		General Range of Significant Unobservable Input Values
Mortgage loans held for sale	$	1,848		211	Rate lock commitment		N/A		N/A
Individually evaluated loans		-		14,694	Appraised value and discounted cash flows	Discounts to reflect current market conditions and ultimate collectability		0 - 25%

25

The carrying amount and estimated fair value of financial instruments at September 30, 2023 and December 31, 2022 are as follows:

(Dollars in thousands)
			Fair Value Measurements at September 30, 2023
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	76,619		76,619		-		-		76,619
Investment securities available for sale		378,794		-		378,794		-		378,794
Other investments		2,900		-		-		2,900		2,900
Mortgage loans held for sale		1,848		-		-		1,848		1,848
Loans, net		1,067,888		-		-		1,053,008		1,053,008
Mutual funds held in deferred compensation trust		1,850		-		1,850		-		1,850
Liabilities:
Deposits	$	1,380,768		-		-		1,384,977		1,384,977
Securities sold under agreements to repurchase		83,024		-		83,024		-		83,024
Junior subordinated debentures		15,464		-		15,464		-		15,464

(Dollars in thousands)
			Fair Value Measurements at December 31, 2022
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	71,596		71,596		-		-		71,596
Investment securities available for sale		445,394		-		445,394		-		445,394
Other investments		2,656		-		-		2,656		2,656
Mortgage loans held for sale		211		-		-		211		211
Loans, net		1,022,114		-		-		998,587		998,587
Mutual funds held in deferred compensation trust		1,327		-		1,327		-		1,327
Liabilities:
Deposits	$	1,435,215		-		-		1,434,871		1,434,871
Securities sold under agreements to repurchase		47,688		-		47,688		-		47,688
Junior subordinated debentures		15,464		-		15,464		-		15,464

(6) Leases

As of September 30, 2023, the Bank had operating right of use assets of $4.9 million and operating lease liabilities of $5.0 million. The Bank maintains operating leases on land and buildings for some of the Bank’s branch facilities and loan production offices. Most leases include one option to renew, with renewal terms extending up to 15 years. The exercise of renewal options is based on the judgment of management as to whether or not the renewal option is reasonably certain to be exercised. Factors in determining whether an option is reasonably certain of exercise include, but are not limited to, the value of leasehold improvements, the value of renewal rates compared to market rates, and the presence of factors that would cause a significant economic penalty to the Bank if the option is not exercised. Leases with a term of 12 months or less are not recorded on the balance sheet and instead are recognized in lease expense on a straight-line basis over the lease term.

26

The following table presents lease cost and other lease information as of September 30, 2023 and 2022.

(Dollars in thousands)
	September 30, 2023			September 30, 2022
Operating lease cost	$	605		$	617
Other information:
Cash paid for amounts included in the measurement of lease liabilities		583			605
Operating cash flows from operating leases		-			-
Right-of-use assets obtained in exchange for new lease liabilities - operating leases		370			1,726
Weighted-average remaining lease term - operating leases		8.61			9.01
Weighted-average discount rate - operating leases		2.71	%		2.30	%

The following table presents lease maturities as of September 30, 2023.

(Dollars in thousands)
Maturity Analysis of Operating Lease Liabilities:	September 30, 2023
2023	$	203
2024		819
2025		773
2026		650
2027		612
Thereafter		2,625
Total		5,682
Less: Imputed Interest		(680	)
Operating Lease Liability	$	5,002

(7) Reportable Segments

The Company has two reportable segments, as described below.

Banking Operations – This segment reflects the consolidated Bank, excluding CBRES. The primary source of revenue for this segment is net interest income.

CBRES – A Bank subsidiary that provides appraisal management services to community banks. The primary source of revenue for this segment is appraisal management fee income.

27

The following table presents financial information for the reportable segments. The information provided under the caption “Other” represents financial information for the Company, which is not considered to be a reportable segment, and is included to reconcile the results of the reportable segments to the Consolidated Financial Statements prepared in conformity with GAAP.

(Dollars in thousands)
	Banking
	Operations		CBRES		Other			Consolidated
As of and for the three months ended September 30, 2023
Interest income	$	18,297	$	-	$	9		$	18,306
Interest expense		4,681		-		285			4,966
Net interest income		13,616		-		(276	)		13,340
Provision for credit losses		562		-		-			562
Noninterest income		3,989		-		-			3,989
Appraisal management fee income		-		2,785		-			2,785
Noninterest expense		11,515		401		157			12,073
Appraisal management fee expense		-		2,182		-			2,182
Income tax expense (benefit)		1,215		46		(91	)		1,170
Net income (loss)	$	4,313	$	156	$	(342	)	$	4,127
Total assets	$	1,601,541	$	3,713	$	2,010		$	1,607,264
As of and for the three months ended September 30, 2022
Interest income	$	14,606	$	-	$	5		$	14,611
Interest expense		671		-		147			818
Net interest income		13,935		-		(142	)		13,793
Provision for loan losses		408		-		-			408
Noninterest income		4,080		2		-			4,082
Appraisal management fee income		-		2,711		-			2,711
Noninterest expense		10,607		538		159			11,304
Appraisal management fee expense		-		2,151		-			2,151
Income tax expense (benefit)		1,473		6		(63	)		1,416
Net income (loss)	$	5,527	$	18	$	(238	)	$	5,307
Total assets	$	1,670,896	$	3,298	$	2,096		$	1,676,290
As of and for the nine months ended September 30, 2023
Interest income	$	52,680	$	-	$	26		$	52,706
Interest expense		10,466		-		791			11,257
Net interest income		42,214		-		(765	)		41,449
Provision for credit losses		1,161		-		-			1,161
Noninterest income		9,318		-		-			9,318
Appraisal management fee income		-		7,469		-			7,469
Noninterest expense		34,118		1,094		483			35,695
Appraisal management fee expense		-		5,881		-			5,881
Income tax expense (benefit)		3,541		114		(262	)		3,393
Net income (loss)	$	12,712	$	380	$	(986	)	$	12,106
Total assets	$	1,601,541	$	3,713	$	2,010		$	1,607,264
As of and for the nine months ended September 30, 2022
Interest income	$	37,921	$	-	$	11		$	37,932
Interest expense		1,801		-		324			2,125
Net interest income		36,120		-		(313	)		35,807
Provision for loan losses		889		-		-			889
Noninterest income		11,497		14		-			11,511
Appraisal management fee income		-		9,656		-			9,656
Noninterest expense		31,518		1,360		481			33,359
Appraisal management fee expense		-		7,680		-			7,680
Income tax expense (benefit)		3,091		146		(167	)		3,070
Net income (loss)	$	12,119	$	484	$	(627	)	$	11,976
Total assets	$	1,670,896	$	3,298	$	2,096		$	1,676,290

(8) Subsequent Events

The Company has reviewed and evaluated subsequent events and transactions for material subsequent events through the date the financial statements are issued. Management has concluded that there were no material subsequent events.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company’s Annual Report of Form 10-K and the Company’s Consolidated Financial Statements and Notes thereto on pages A-19 through A-59 of the Company’s 2022 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2023 Annual Meeting of Shareholders.

Introduction

Management’s discussion and analysis of earnings and related data are presented to assist in understanding the consolidated financial condition and results of operations of the Company. The Company is the parent company of the Bank and a registered bank holding company operating under the supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is a North Carolina-chartered bank, with offices in Catawba, Lincoln, Alexander, Mecklenburg, Iredell, Wake, Rowan and Forsyth counties, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”).

Overview

Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses.

Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve, inflation, interest rates, market and monetary fluctuations. Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered. Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating the allowance for credit losses (“ACL”, “allowance for credit losses”, or “allowance”) and changes in these economic factors could result in increases or decreases to the provision for loan losses.

Prior to the COVID-19 pandemic, economic conditions, while not as robust as the period from 2004 to 2007, had stabilized such that businesses in our market area were growing and investing again. The uncertainty expressed in the local, national and international markets through the primary economic indicators of activity were previously sufficiently stable to allow for reasonable economic growth in our markets. Subsequently, continuing supply-chain disruption and rising inflation has caused the Federal Reserve Federal Open Market Committee (“FOMC”) to increase the target federal funds rate 500 basis points since March 1, 2022 to a range of 5.25% to 5.50% at September 30, 2023.

Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends. Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plants and inventories. During periods of high inflation there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits. Also, general increases in the price of goods and services can be expected to result in increased operating expenses.

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Our business emphasis has been and continues to be to operate as a well-capitalized, profitable and independent community-oriented financial institution dedicated to providing quality customer service. We are committed to meeting the financial needs of the communities in which we operate. We expect growth to be achieved in our local markets and through expansion opportunities in contiguous or nearby markets. While we would be willing to consider growth by acquisition in certain circumstances, we do not consider the acquisition of another company to be necessary for our continued ability to provide a reasonable return to our shareholders. We believe that we can be more effective in serving our customers than many of our non-local competitors because of our ability to quickly and effectively provide senior management responses to customer needs and inquiries. Our ability to provide these services is enhanced by the stability and experience of our Bank officers and managers.

Summary of Significant Accounting Policies

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. 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 2022 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2023 Annual Meeting of Shareholders. There have been no significant changes to the application of significant accounting policies since December 31, 2022, except for the adoption of ASC 326 noted in Note 1 above.

The allowance for credit losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance credit losses that management believes will be adequate in light of anticipated risks and loan losses.

Many of the Company’s assets and liabilities are recorded using various techniques that require significant judgment as to recoverability. The collectability of loans is reflected through the Company’s estimate of the allowance for credit losses. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability. In addition, certain assets and liabilities are reflected at their estimated fair value in the Consolidated Financial Statements. Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques. The Company’s internal models generally involve present value of cash flow techniques. The various techniques are discussed in greater detail elsewhere in this management’s discussion and analysis and the Notes to the Consolidated Financial Statements. Fair value of the Company’s financial instruments is discussed in Note 5 of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report.

There are other complex accounting standards that require the Company to employ significant judgment in interpreting and applying certain of the principles prescribed by those standards. These judgments include, but are not limited to, the determination of whether a financial instrument or other contract meets the definition of a derivative in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”).

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

Results of Operations

Summary. Net earnings were $4.1 million or $0.76 per share and $0.74 per diluted share for the three months ended September 30, 2023, as compared to $5.3 million or $0.96 per share and $0.93 per diluted share for the prior year period. The decrease in third quarter net earnings is primarily the result of a decrease in net interest income, an increase in the provision for credit losses and an increase in non-interest expense, compared to the prior year period, as discussed below.

Net earnings were $12.1 million or $2.22 per share and $2.15 per diluted share for the nine months ended September 30, 2023, as compared to $12.0 million or $2.18 per share and $2.11 per diluted share for the prior year period. The increase in year-to-date net earnings is primarily attributable to an increase in net interest income, which was partially offset by a decrease in non-interest income, an increase in non-interest expense and an increase in the provision for credit losses, compared to the prior year period, as discussed below.

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

Net Interest Income. Net interest income, the major component of the Company’s net income, is the amount by which interest and fees generated by interest-earning assets exceed the total cost of funds used to carry them. Net interest income is affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned and rates paid. Net interest margin is calculated by dividing tax-equivalent net interest income by average interest-earning assets, and represents the Company’s net yield on its interest-earning assets.

Net interest income was $13.3 million for the three months ended September 30, 2023, compared to $13.8 million for the three months ended September 30, 2022. The decrease in net interest income is due to a $4.1 million increase in interest expense, partially offset by a $3.7 million increase in interest income. The increase in interest expense is primarily due to an increase in time deposits and an increase in rates paid on interest-bearing liabilities. The increase in interest income is due to a $3.1 million increase in interest income and fees on loans and a $895,000 increase in interest income on investment securities, which were partially offset by a $294,000 decrease in interest income on balances due from banks. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a $54,000 decrease in fee income on SBA PPP loans. The increase in interest income on investment securities is primarily due to higher yields on securities purchased during the third and fourth quarter of 2022. The decrease in interest income on balances due from banks is primarily due to a reduction in balances outstanding.

Interest income was $18.3 million for the three months ended September 30, 2023, compared to $14.6 million for the three months ended September 30, 2022. The increase in interest income is due to a $3.1 million increase in interest income and fees on loans and a $895,000 increase in interest income on investment securities, which were partially offset by a $294,000 decrease in interest income on balances due from banks. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a $54,000 decrease in fee income on SBA PPP loans. The increase in interest income on investment securities is primarily due to higher yields on securities purchased during the third and fourth quarter of 2022. The decrease in interest income on balances due from banks is primarily due to a reduction in balances outstanding. The Bank recognized zero and $54,000 of PPP loan fee income for the three months ended September 30, 2023 and the three months ended September 30, 2022, respectively. During the three months ended September 30, 2023, average loans were $1.1 billion, an increase of $92.5 million from average loans of $971.6 million for the three months ended September 30, 2022. During the three months ended September 30, 2023, average PPP loans were zero, compared to average PPP loans of $739,000 for the three months ended September 30, 2022. During the three months ended September 30, 2023, average investment securities available for sale were $448.0 million, a decrease of $42.6 million from average investment securities available for sale of $490.6 million for the three months ended September 30, 2022. The average yield on loans for the three months ended September 30, 2023 and 2022 was 5.27% and 4.51%, respectively. The average yield on investment securities available for sale was 3.15% and 2.23% for the three months ended September 30, 2023 and 2022, respectively. The average yield on earning assets was 4.65% and 3.59% for the three months ended September 30, 2023 and 2022, respectively.

Interest expense was $5.0 million for the three months ended September 30, 2023, compared to $818,000 for the three months ended September 30, 2022. The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities and an increase in time deposits. During the three months ended September 30, 2023, average interest-bearing non-maturity deposits were $652.7 million, a decrease of $191.1 million from average interest-bearing non-maturity deposits of $843.8 million for the three months ended September 30, 2022. During the three months ended September 30, 2023, average certificates of deposit were $268.7 million, an increase of $168.8 million from average certificates of deposit of $99.9 million for the three months ended September 30, 2022. The average rate paid on interest-bearing checking and savings accounts was 1.06% and 0.23% for the three months ended September 30, 2023 and 2022, respectively. The average rate paid on certificates of deposit was 3.71% for the three months ended September 30, 2023, compared to 0.53% for the same period one year ago. The average rate paid on interest-bearing liabilities was 1.92% for the three months ended September 30, 2023, compared to 0.33% for the same period one year ago.

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The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the three months ended September 30, 2023 and 2022. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields and interest income on tax-exempt investments for the three months ended September 30, 2023 and 2022 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

	Three months ended								Three months ended
	September 30, 2023								September 30, 2022
(Dollars in thousands)	Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate
Interest-earning assets:
Loans receivable	$	1,064,135		$	14,145		5.27	%	$	971,592		$	11,051		4.51	%
Investments - taxable		305,405			2,767		3.59	%		357,269			2,074		2.30	%
Investments - nontaxable*		145,820			794		2.16	%		136,587			687		2.00	%
Due from banks		45,938			606		5.23	%		158,680			899		2.25	%
Total interest-earning assets		1,561,298			18,312		4.65	%		1,624,128			14,711		3.59	%
Non-interest earning assets:
Cash and due from banks		34,105								37,514
Allowance for credit losses		(9,731	)							(9,785	)
Other assets		17,127								34,290
Total assets	$	1,602,799							$	1,686,147
Interest-bearing liabilities:
Interest-bearing demand, MMDA & savings deposits	$	652,739		$	1,752		1.06	%	$	843,798		$	494		0.23	%
Time deposits		268,670			2,512		3.71	%		99,889			134		0.53	%
Junior subordinated debentures		15,464			284		7.29	%		15,464			146		3.75	%
Other		87,117			418		1.90	%		37,965			44		0.46	%
Total interest-bearing liabilities		1,023,990			4,966		1.92	%		997,116			818		0.33	%
Non-interest bearing liabilities and shareholders' equity:
Demand deposits		451,842								562,979
Other liabilities		15,440								11,763
Shareholders' equity		111,527								114,289
Total liabilities and shareholders' equity	$	1,602,799							$	1,686,147
Net interest spread				$	13,346		2.73	%				$	13,893		3.26	%
Net yield on interest-earning assets							3.39	%							3.39	%
Taxable equivalent adjustment Investment securities				$	6							$	100
Net interest income				$	13,340							$	13,793
*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $11.6 million in 2023 and $13.0 million in 2022.  A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities.

Year-to-date net interest income was $41.4 million for the nine months ended September 30, 2023, compared to $35.8 million for the nine months ended September 30, 2022. The increase in net interest income is due to a $14.8 million increase in interest income, partially offset by a $9.1 million increase in interest expense. The increase in interest income is due to a $10.0 million increase in interest income and fees on loans, a $53,000 increase in interest income on balances due from banks and a $4.8 million increase in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a $893,000 decrease in fee income on SBA PPP loans. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The increase in interest income on investment securities is primarily due to higher yields on securities purchased after June 30, 2022. The increase in interest expense is primarily due to an increase in time deposits and an increase in rates paid on interest-bearing liabilities.

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Interest income was $52.7 million for the nine months ended September 30, 2023, compared to $37.9 million for the nine months ended September 30, 2022. The increase in interest income is due to a $10.0 million increase in interest income and fees on loans, a $53,000 increase in interest income on balances due from banks and a $4.8 million increase in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a $893,000 decrease in fee income on SBA PPP loans. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The increase in interest income on investment securities is primarily due to higher yields on securities purchased after June 30, 2022. The Bank recognized zero and $893,000 of PPP loan fee income for the nine months ended September 30, 2023 and the nine months ended September 30, 2022, respectively. During the nine months ended September 30, 2023, average loans were $1.1 billion, an increase of $127.4 million from average loans of $925.2 million for the nine months ended September 30, 2022. During the nine months ended September 30, 2023, average PPP loans were zero, compared to average PPP loans of $9.1 million for the nine months ended September 30, 2022. During the nine months ended September 30, 2023, average investment securities available for sale were $458.2 million, an increase of $4.8 million from average investment securities available for sale of $453.4 million for the nine months ended September 30, 2022. The average yield on loans for the nine months ended September 30, 2023 and 2022 was 5.17% and 4.44%, respectively. The average yield on investment securities available for sale was 3.05% and 1.75% for the nine months ended September 30, 2023 and 2022, respectively. The average yield on earning assets was 4.54% and 3.20% for the nine months ended September 30, 2023 and 2022, respectively.

Interest expense was $11.3 million for the nine months ended September 30, 2023, compared to $2.1 million for the nine months ended September 30, 2022. The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities and an increase in certificates of deposit. During the nine months ended September 30, 2023, average interest-bearing non-maturity deposits were $710.0 million, a decrease of $112.3 million from average interest-bearing non-maturity deposits of $822.3 million for the nine months ended September 30, 2022. During the nine months ended September 30, 2023, average certificates of deposit were $198.3 million, an increase of $97.7 million from average certificates of deposit of $100.6 million for the nine months ended September 30, 2022. The average rate paid on interest-bearing checking and savings accounts was 0.92% and 0.21% for the nine months ended September 30, 2023 and 2022, respectively. The average rate paid on certificates of deposit was 3.15% for the nine months ended September 30, 2023, compared to 0.56% for the same period one year ago. The average rate paid on interest-bearing liabilities was 1.53% for the nine months ended September 30, 2023, compared to 0.29% for the same period one year ago.

The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the nine months ended September 30, 2023 and 2022. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields and interest income on tax-exempt investments for the nine months ended September 30, 2023 and 2022 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

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	Three months ended								Three months ended
	September 30, 2023								September 30, 2022
(Dollars in thousands)	Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate
Interest-earning assets:
Loans receivable	$	1,064,135		$	14,145		5.27	%	$	971,592		$	11,051		4.51	%
Investments - taxable		305,405			2,767		3.59	%		357,269			2,074		2.30	%
Investments - nontaxable*		145,820			794		2.16	%		136,587			687		2.00	%
Due from banks		45,938			606		5.23	%		158,680			899		2.25	%
Total interest-earning assets		1,561,298			18,312		4.65	%		1,624,128			14,711		3.59	%
Non-interest earning assets:
Cash and due from banks		34,105								37,514
Allowance for credit losses		(9,731	)							(9,785	)
Other assets		17,127								34,290
Total assets	$	1,602,799							$	1,686,147
Interest-bearing liabilities:
Interest-bearing demand, MMDA & savings deposits	$	652,739		$	1,752		1.06	%	$	843,798		$	494		0.23	%
Time deposits		268,670			2,512		3.71	%		99,889			134		0.53	%
Junior subordinated debentures		15,464			284		7.29	%		15,464			146		3.75	%
Other		87,117			418		1.90	%		37,965			44		0.46	%
Total interest-bearing liabilities		1,023,990			4,966		1.92	%		997,116			818		0.33	%
Non-interest bearing liabilities and shareholders' equity:
Demand deposits		451,842								562,979
Other liabilities		15,440								11,763
Shareholders' equity		111,527								114,289
Total liabilities and shareholders' equity	$	1,602,799							$	1,686,147
Net interest spread				$	13,346		2.73	%				$	13,893		3.26	%
Net yield on interest-earning assets							3.39	%							3.39	%
Taxable equivalent adjustment Investment securities				$	6							$	100
Net interest income				$	13,340							$	13,793
*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $11.6 million in 2023 and $13.0 million in 2022. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities.

Changes in interest income and interest expense can result from variances in both volume and rates. The following table describes the impact on the Company’s tax equivalent net interest income resulting from changes in average balances and average rates for the periods indicated. The changes in net interest income due to both volume and rate changes have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each.

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	Three months ended September 30, 2023 compared to three months  ended September 30, 2022								Nine months ended September 30, 2023 compared to nine months  ended September 30, 2022
(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	$	1,141			1,953		3,094			4,577			5,391		9,968
Investments - taxable		(385	)		1,078		693			(27	)		4,114		4,087
Investments - nontaxable		48			59		107			91			362		453
Due from banks		(1,063	)		770		(293	)		(3,873	)		3,926		53
Total interest income		(259	)		3,860		3,601			768			13,793		14,561
Interest expense:
Interest-bearing demand, MMDA & savings deposits		(312	)		1,570		1,258			(473	)		4,098		3,625
Time deposits		902			1,476		2,378			1,353			2,892		4,245
Junior subordinated debentures		-			138		138			-			467		467
Other		146			228		374			215			580		795
Total interest expense		736			3,412		4,148			1,095			8,037		9,132
Net interest income	$	(995	)		448		(547	)		(327	)		5,756		5,429

Provision for Credit Losses. The provision for credit losses for the three months ended September 30, 2023 was $562,000, compared to $408,000 for the three months ended September 30, 2022. The increase in the provision for credit losses is primarily attributable to an increase in loan balances and in qualitative adjustments for economic conditions and other factors at September 30, 2023, compared to September 30, 2022. The provision for credit losses for the three months ended September 30, 2023 includes a $127,000 credit to the provision on unfunded commitments.

The provision for credit losses for the nine months ended September 30, 2023 was $1.2 million, compared to $889,000 for the nine months ended September 30, 2022. The increase in the provision for credit losses is primarily attributable to an increase in loan balances and in qualitative adjustments for economic conditions and other factors at September 30, 2023, compared to September 30, 2022. The provision for credit losses for the nine months ended September 30, 2023 includes a $146,000 credit to the provision on unfunded commitments.

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

Non-interest income was $16.8 million for the nine months ended September 30, 2023, compared to $21.2 million for the nine months ended September 30, 2022. The decrease in non-interest income is primarily attributable to a $2.5 million net loss on the sale of securities and a $2.2 million decrease in appraisal management fee income due to a decrease in appraisal volume related to national trends in real estate purchases, which were partially offset by a $382,000 increase in miscellaneous non-interest income primarily due to an increase in deferred compensation income due to an increase in valuations for the assets in the deferred compensation plan. The securities sales referenced above were executed in January and February 2023 to reduce risk in the investment portfolio, at a time when favorable sale conditions had developed for municipal securities. These sales also provided the Bank with more flexibility to support loan growth and reduce the need for other borrowings.

Non-Interest Expense. Total non-interest expense was $14.3 million for the three months ended September 30, 2023, compared to $13.5 million for the three months ended September 30, 2022. The increase in non-interest expense is primarily attributable to a $545,000 increase in salaries and employee benefits expense primarily due to a reduction in the amortization of loan origination costs, which was partially offset by a $164,000 increase in debit card expense and a $65,000 increase in FDIC insurance expense.

Non-interest expense was $41.6 million for the nine months ended September 30, 2023, compared to $41.0 million for the nine months ended September 30, 2022. The increase in non-interest expense is primarily attributable to a $1.0 million increase in salaries and employee benefits expense primarily due to a reduction in the amortization of loan origination costs and an increase in supplemental retirement plan expense, and a $802,000 increase in other non-interest expenses primarily due to an increase in deferred compensation expense due to an increase in valuations for the assets in the deferred compensation plan, which were partially offset by a $1.8 million decrease in appraisal management fee expense due to a decrease in appraisal volume related to national trends in real estate purchases.

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Income Taxes. Income tax expense was $1.2 million for the three months ended September 30, 2023, compared to $1.4 million for the three months ended September 30, 2022. The effective tax rate was 22.09% for the three months ended September 30, 2023, compared to 21.06% for the three months ended September 30, 2022. Income tax expense was $3.4 million for the nine months ended September 30, 2023, compared to $3.1 million for the nine months ended September 30, 2022. The effective tax rate was 21.89% for the nine months ended September 30, 2023, compared to 20.40% for the nine months ended September 30, 2022. The increase in the effective tax rate is primarily due to a reduction in non-taxable investments.

Analysis of Financial Condition

Investment Securities. Available for sale securities were $378.8 million as of September 30, 2023, compared to $445.4 million as of December 31, 2022. Average investment securities available for sale for the nine months ended September 30, 2023 were $458.2 million, compared to $467.5 million for the year ended December 31, 2022.

Loans. Total loans were $1.1 billion as of September 30, 2023, compared to $1.0 billion as of December 31, 2022. Average loans represented 68% and 59% of average earning assets for the nine months ended September 30, 2023 and the year ended December 31, 2022, respectively.

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

Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market. Real estate mortgage loans include both commercial and residential mortgage loans. At September 30, 2023, the Bank had $107.1 million in residential mortgage loans, $103.1 million in home equity loans and $644.6 million in commercial mortgage loans, which include $493.6 million secured by commercial property and $151.0 million secured by residential property. Residential mortgage loans at September 30, 2023 include $18.4 million in non-traditional mortgage loans from the former Banco division of the Bank. At December 31, 2022, the Bank had $101.5 million in residential mortgage loans, $101.1 million in home equity loans and $610.0 million in commercial mortgage loans, which include $472.3 million secured by commercial property and $137.7 million secured by residential property. Residential mortgage loans include $20.0 million in non-traditional mortgage loans from the former Banco division of the Bank. All residential mortgage loans are originated as fully amortizing loans, with no negative amortization

Allowance for Credit Losses (ACL). The allowance for credit losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance that management believes will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, size, quality and risk of loans in the portfolio are reviewed.

The allowance for credit losses on loans is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Accrued interest receivable is excluded from the estimate of credit losses. The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of September 30, 2023. The allowance for credit losses is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The Company measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. The Company calculates the allowance for credit losses using a WARM methodology.

Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may increase or reduce reserve levels and include adjustments for: local, state and national economic outlook; levels and trends of delinquencies; trends in volume, mix and size of loans; seasoning of the loan portfolio; experience of staff; concentrations of credit; and interest rate risk.

Loans that do not share risk characteristics are evaluated on an individual basis. When management determines that foreclosure is probable and the borrower is experiencing financial difficulty, the expected credit losses are based on the fair value of collateral at the reporting dated unadjusted for selling costs as appropriate. The Company did not have any loans evaluated on an individual basis at September 30, 2023.

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

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The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.

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 Board reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration.

As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third party reviews and evaluates loan relationships greater than or equal to $1.5 million as well as a periodic sample of commercial relationships with exposures below $1.5 million, excluding loans in default, and loans in process of litigation or liquidation. The third party’s evaluation and report is shared with management and the board of directors of the Bank (“Bank Board”).

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

Since the adoption of CECL on January 1, 2023, the allowance for credit losses represents management’s estimate of credit losses for the remaining estimated life of the Bank’s financial assets, including loan receivables and some off-balance sheet credit exposures. Estimating the amount of the allowance for credit losses requires significant judgment and the use of estimates related to historical experience, current conditions, reasonable and supportable forecasts, and the value of collateral on collateral-dependent loans. The loan portfolio also represents the largest asset type on our consolidated balance sheet. Loan losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

There are many factors affecting the allowance for credit losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and is susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for credit losses could be required that could adversely affect our earnings or financial position in future periods.

Beginning December 31, 2012, certain mortgage loans from the former Banco division of the Bank were, prior to the adoption of CECL, analyzed separately from other single-family residential loans in the Bank’s loan portfolio. These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg, North Carolina and surrounding counties. These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers. These loans are included in the single-family residential loan pool in the Company's CECL model. The Company did not have any loans evaluated on an individual basis at 38 September 30, 2023.

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Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations. Management believes it has established the allowance for credit losses pursuant to CECL, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date of the financial statements. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company.

Non-performing Assets. Non-performing assets were $3.7 million or 0.23% of total assets at September 30, 2023 and December 31, 2022. Non-accrual loans were $3.6 million at September 30, 2023 and $3.7 million at December 31, 2022. As a percentage of total loans outstanding, non-accrual loans were 0.34% and 0.36% at September 30, 2023 and December 31, 2022, respectively. Non-performing assets include $3.6 million in commercial and residential mortgage loans and $134,000 in other loans at September 30, 2023, compared to $3.7 million in commercial and residential mortgage loans and $9,000 in other loans at December 31, 2022. The Bank had $99,000 in loans 90 days past due and still accruing at September 30, 2023, compared to zero at December 31, 2022. The Bank had no other real estate owned at September 30, 2023 and December 31, 2022.

Deposits. Total deposits were $1.4 billion at September 30, 2023 and December 31, 2022. Core deposits, a non-GAAP measure, which include noninterest-bearing demand deposits, NOW, MMDA, savings and non-brokered certificates of deposit of denominations of $250,000 or less, were $1.2 billion at September 30, 2023, compared to $1.4 billion at December 31, 2022. Management believes it is useful to calculate and present core deposits because of the positive impact this low cost funding source provides to the Bank’s overall cost of funds and profitability. Certificates of deposit in amounts of more than $250,000 totaled $137.7 million at September 30, 2023, compared to $31.0 million at December 31, 2022. Other time deposits totaled $165.4 million at September 30, 2023, compared to $67.0 million at December 31, 2022. The increases in certificates of deposit in amounts of more than $250,000 and other time deposits are primarily due to promotional rates offered on select certificate of deposit products during the nine months ended September 30, 2023.

Estimated uninsured deposits totaled $376.6 million, or 27.27% of total deposits, at September 30, 2023, compared to $439.8 million, or 30.64% of total deposits, at December 31, 2022. Uninsured amounts are estimated based on the portion of account balances in excess of FDIC insurance limits. The Bank did not have any significant deposit concentrations at September 30, 2023.

Borrowed Funds. There were no FHLB borrowings outstanding at September 30, 2023 and December 31, 2022. Securities sold under agreements to repurchase were $83.0 million at September 30, 2023, compared to $47.7 million at December 31, 2022. The increase in securities sold under agreements to repurchase is primarily due to customers that transferred funds from deposits to securities sold under agreements to repurchase during the nine months ended September 30, 2023.

Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were $15.5 million at September 30, 2023 and December 31, 2022.

In June 2006, the Company formed a second wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes. The debentures represent the sole assets of PEBK Trust II. PEBK Trust II is not included in the consolidated financial statements. The Company redeemed $5.0 million of outstanding trust preferred securities in 2019.

The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month United States Secured Overnight Financing Rate (SOFR) plus 189 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities. The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

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Prior to September 15, 2023, the trust preferred securities accrued and paid interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The one-week and two-month U.S. dollar-denominated (USD) LIBOR rates ceased to be published after December 31, 2021. The overnight, one-month, three-month, nine-month, and 12-month USD LIBOR rates ceased to be published after June 30, 2023. Effective September 15, 2023, the trust preferred securities accrue and pay interest quarterly at a floating rate of three-month SOFR plus 189 basis points, including a 26 basis point credit spread adjustment.

Asset Liability and Interest Rate Risk Management. The objective of the Company’s Asset Liability and Interest Rate Risk strategies is to identify and manage the sensitivity of net interest income to changing interest rates and to minimize the interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities. This is done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income.

The Company manages its exposure to fluctuations in interest rates through policies established by the Asset/Liability Committee (“ALCO”) of the Bank. The ALCO meets quarterly and has the responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company. ALCO seeks to minimize interest rate risk between interest-earning assets and interest-bearing liabilities by attempting to minimize wide fluctuations in net interest income due to interest rate movements. The ability to control these fluctuations has a direct impact on the profitability of the Company. Management monitors this activity on a regular basis through analysis of its portfolios to determine the difference between rate sensitive assets and rate sensitive liabilities.

The Company’s rate sensitive assets are those earning interest at variable rates and those with contractual maturities within one year. Rate sensitive assets therefore include both loans and available for sale securities. Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds. Average rate sensitive assets for the nine months ended September 30, 2023 totaled $1.6 billion, exceeding average rate sensitive liabilities of $985.9 million by $567.8 million.

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. By 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 minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company. The Company did not have any interest rate derivatives outstanding as of September 30, 2023.

Included in the rate sensitive assets are $178.2 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the FOMC. The Company utilizes interest rate floors on certain variable rate loans to protect against downward movements in the prime rate. At September 30, 2023, the Company had $114.8 million in loans with interest rate floors. No floors were in effect on these loans at September 30, 2023.

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 September 30, 2023, such unfunded commitments to extend credit were $397.3 million, while commitments in the form of standby letters of credit totaled $4.3 million. As of December 31, 2022, such unfunded commitments to extend credit were $382.7 million, while commitments in the form of standby letters of credit totaled $4.4 million.

The Bank uses several sources to meet its liquidity requirements. The primary source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposit of denominations less than $250,000. The Bank considers these to be a stable portion of the Bank’s liability mix and the result of on-going consumer and commercial banking relationships. As of September 30, 2023, the Bank’s core deposits, a non-GAAP measure, totaled $1.2 billion, or 90.03% of total deposits. As of December 31, 2022, the Bank’s core deposits totaled $1.4 billion, or 97.84% of total deposits.

The other sources of funding for the Bank are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreements to repurchase and FHLB borrowings. The Bank is also able to borrow from the Federal Reserve Bank (“FRB”) on a short-term basis. The Bank’s policies include the ability to access wholesale funding of up to 40% of total assets. The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to the State of North Carolina. The Bank’s ratio of wholesale funding to total assets was 1.86% and 0.92% as of September 30, 2023 and December 31, 2022, respectively.

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The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets. There were no FHLB borrowings outstanding at September 30, 2023 and December 31, 2022. At September 30, 2023, the carrying value of loans pledged as collateral to the FHLB totaled $196.4 million compared to $149.4 million at December 31, 2022. The remaining availability under the line of credit with the FHLB was $121.0 million at September 30, 2023 compared to $86.5 million at December 31, 2022. The Bank had no borrowings from the FRB at September 30, 2023 or December 31, 2022. FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At September 30, 2023, the carrying value of loans pledged as collateral to the FRB totaled $598.9 million compared to $585.0 million at December 31, 2022. Availability under the line of credit with the FRB was $437.9 million and $445.1 million at September 30, 2023 and December 31, 2022, respectively. The Bank has completed the necessary steps in order to access the FRB’s Bank Term Funding Program (“BTFP”), should it wish to do so at any time in the future. The Bank has not pledged any collateral to the BTFP as of September 30, 2023.

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

The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 24.38% at September 30, 2023 and 30.32% at December 31, 2022. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at September 30, 2023 and December 31, 2022.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit.

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

Annualized return on average equity for the nine months ended September 30, 2023 was 13.97%, compared to 12.53% for the nine months ended September 30, 2022. Total cash dividends paid on common stock were $4.1 million and $3.9 million for the nine months ended September 30, 2023 and 2022, respectively.

In March of 2023, the Board of Directors authorized a stock repurchase program, whereby up to $2.0 million may be allocated to repurchase the Company’s common stock. Any purchases under the Company’s stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately-negotiated transactions. The timing and amount of any repurchase of shares will be determined by the Company’s management, based on its evaluation of market conditions and other factors. The stock repurchase program may be suspended at any time or from time-to-time without prior notice. The Company has repurchased approximately $1.7 million, or 87,222 shares of its common stock, under this stock repurchase program as of September 30, 2023.

In 2013, the FRB approved its final rule on the Basel III capital standards, which implement changes to the regulatory capital framework for banking organizations. The Basel III capital standards, which became effective January 1, 2015, include new risk-based capital and leverage ratios, which were phased in from 2015 to 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are as follows: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total risk based capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% (unchanged from previous rules). An additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes beginning on January 1, 2016 and was phased in through 2019 (increasing by 0.625% on January 1, 2016 and each subsequent January 1, until it reached 2.5% on January 1, 2019). This resulted in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained earnings that could be utilized for such actions.

Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. Tier 1 capital is generally defined as shareholders’ equity and trust preferred securities less all intangible assets and goodwill. Tier 1 capital includes $15.0 million in trust preferred securities at September 30, 2023 and December 31, 2022. The Company’s Tier 1 capital ratio was 13.66% and 13.21% at September 30, 2023 and December 31, 2022, respectively. Total risk-based capital is defined as Tier 1 capital plus supplementary capital. Supplementary capital, or Tier 2 capital, consists of the Company’s allowance for credit losses, not exceeding 1.25% of the Company’s risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets. The Company’s total risk-based capital ratio was 14.64% and 14.04% at September 30, 2023 and December 31, 2022, respectively. The Company’s common equity Tier 1 capital consists of common stock and retained earnings. The Company’s common equity Tier 1 capital ratio was 12.48% and 12.03% at September 30, 2023 and December 31, 2022, respectively. Financial institutions are also required to maintain a leverage ratio of Tier 1 capital to total average assets of 4.0% or greater. The Company’s Tier 1 leverage capital ratio was 10.52% and 9.82% at September 30, 2023 and December 31, 2022, respectively.

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The Bank’s Tier 1 risk-based capital ratio was 13.55% and 13.10% at September 30, 2023 and December 31, 2022, respectively. The total risk-based capital ratio for the Bank was 14.53% and 13.93% at September 30, 2023 and December 31, 2022, respectively. The Bank’s common equity Tier 1 capital ratio was 13.55% and 13.10% at September 30, 2023 and December 31, 2022, respectively. The Bank’s Tier 1 leverage capital ratio was 10.36% and 9.68% at September 30, 2023 and December 31, 2022, respectively.

A bank is considered to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater. Based upon these guidelines, the Bank was considered to be “well capitalized” at September 30, 2023.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, which are our controls and other procedures that are designed to ensure that information required to be disclosed in our periodic reports with the SEC is recorded, processed, summarized and reported within the required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed is communicated to our management to allow timely decisions regarding required disclosure. Based on the evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in allowing timely decisions regarding disclosure to be made about material information required to be included in our periodic reports with the SEC. In addition, no change in our internal control over financial reporting has occurred during, or subsequent to, the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. 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 sought 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) was approximately $1.4 million. The Bank disagreed with the NCDOR’s proposed adjustments and the disallowance of certain tax credits, and challenged the proposed adjustments and the disallowance of such tax credits. During the second quarter of 2019, the Bank paid the NCDOR $1.2 million in taxes and interest associated with the proposed adjustments noted above. This payment stopped the accrual of interest during the period while the proposed adjustments and disallowance are being contested, and the NCDOR waived associated penalties. 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 management believes would limit the Bank’s exposure to approximately $125,000. The Tax Credit Guaranty Agreement by State Tax Credit Exchange, LLC dated September 10, 2014 was attached to the Company’s September 30, 2018 Quarterly Report on Form 10-Q as Exhibit 99. On April 3, 2023, the NC Business Court issued decisions in two related cases involving North Carolina tax credits concluding that the position taken by the NCDOR in those cases was legally incorrect and the tax credits should not have been disallowed. The rationale advanced in those cases was the same as that used to disallow the Bank’s tax credits. The Bank understands an appeal of those decisions by the NCDOR is likely. If upheld, the Company believes the NCDOR will apply the ruling to the Bank’s tax credits.

Item 1A. Risk Factors

For information regarding the risk factors that could affect the Company’s business, results of operations, financial condition and liquidity, see the information under Part I, Item 1A. “Risk Factors” in the Form 10-K filed with the SEC on March 17, 2023, which is accessible on the SEC’s website at www.sec.gov. There have been no material changes to the risk factors previously disclosed in the Form 10-K.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES
Period	Total Number of Shares Purchased (1)		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (3)
July 1 - 31, 2023		1,701	$	21.45		-	$	1,167,354
August 1 - 31, 2023		25,000	$	20.21		25,000	$	662,198
September 1 - 30, 2023		16,850	$	20.97		16,000	$	327,222
Total		43,551	$	20.55		41,000

(1)	The Company purchased 2,551 shares on the open market in the three months ended September 30, 2023 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.
(2)	Reflects shares purchased under the Company's publicly announced stock repurchase program.
(3)	Reflects dollar value of balance available for repurchase at end of period under the Company's stock repurchase program, which was authorized in March 2023 and expires in March 2024.

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

The below event occurred within four business days of the filing date of this report and as such, the Company is disclosing the occurrence of the event under this Item 5. Other Information, instead of a separate Current Report on Form 8-K:

Item 1.01 – Entry into a Material Definitive Agreement

Item 5.02 – Departure of Directors or Certain Officers, Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers

On October 19, 2023, the Compensation Committee of the Board of Directors of the Company adopted, and the Board ratified, the Excess Incentive-Based Compensation Recovery Policy (the “Clawback Policy”) in compliance with the final clawback rules adopted by the Securities and Exchange Commission under Section 10D and Rule 10D-1 of the Securities Exchange Act of 1934, as amended (“Rule 10D-1”), and the listing standards, as set forth in The Nasdaq Stock Market, LLC Listing Rule 5608 (the “Final Clawback Rules”). The Clawback Policy provides for the mandatory recovery of erroneously awarded incentive-based compensation from current and former executive officers as defined in Rule 10D-1 (“Covered Officers”) of the Company in the event that the Company is required to prepare an accounting restatement to correct a material error, in accordance with the Final Clawback Rules. The recovery of such compensation applies regardless of whether a Covered Officer engaged in misconduct or otherwise caused or contributed to the requirement of an accounting restatement. Under the Clawback Policy, the Company may recoup from the Covered Officers erroneously awarded compensation received within a lookback period of the three completed fiscal years preceding the date on which the Company is required to prepare an accounting restatement to correct a material error. On November 1, 2023, the Company entered into a First Amendment to Employment Agreement with each of its named executive officers: Lance A. Sellers, President and Chief Executive Officer; Jeffrey N. Hooper, Executive Vice President and Chief Financial Officer; and William D. Cable, Sr., Executive Vice President and Chief Operating Officer for the purposes of implementing compliance by each of the executives with the Clawback Policy. A copy of the form of First Amendment to Employment Agreement is attached hereto as Exhibit (10)(i) and incorporated herein by reference.

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Item 6. Exhibits

Exhibit (3)(i)(a)	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)(i)(b)	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)(i)(c)	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)(i)(d)	Articles of Amendment dated May 6, 2021, incorporated by reference to Exhibit (3)(i)(d) to the Form 10-K filed with the Securities and Exchange Commission on March 18, 2022
Exhibit (3)(ii)	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)(i)		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)		First Amendment to Employment Agreement with each of the Company’s named executive officers: Lance A. Sellers, President and Chief Executive Officer; Jeffrey N. Hooper, Executive Vice President and Chief Financial Officer; and William D. Cable, Sr., Executive Vice President and Chief Operating Officer
Exhibit (31)(a)		Certification of principal executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit (31)(b)		Certification of principal financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
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-Q Report for the quarterly period ended September 30, 2023, formatted in eXtensible Business Reporting Language (“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.

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SIGNATURES

Pursuant to the requirements 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.

November 7, 2023	/s/ Lance A. Sellers
Date	Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer)

November 7, 2023	/s/ Jeffrey N. Hooper
Date	Jeffrey N. Hooper Executive Vice President and Chief Financial Officer (Principal Financial and Principal Accounting Officer)

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