Peoples Bancorp of North Carolina(PEBK) - 2023 Q3 - Quarterly Report

FORM 10-Q Filing Information Registrant Information This section provides the basic identification details for Peoples Bancorp of North Carolina, Inc., including its filing status and common stock shares outstanding - Registrant is Peoples Bancorp of North Carolina, Inc., a non-accelerated filer and smaller reporting company[2][3][4] Consolidated Balance Sheet Highlights (Dollars in thousands) | Metric | Value | | :--- | :--- | | Quarterly Period Ended | September 30, 2023 | | Commission File No. | 000-27205 | | State of Incorporation | North Carolina | | IRS Employer Identification No. | 56-2132396 | | Common Stock Outstanding (Oct 31, 2023) | 5,542,299 shares | Table of Contents Part I. Financial Information Item 1. Financial Statements This section presents the unaudited consolidated financial statements for Peoples Bancorp of North Carolina, Inc. for the quarter and nine months ended September 30, 2023, alongside comparative data Consolidated Balance Sheets Consolidated Balance Sheet Highlights (Dollars in thousands) | Metric | Sep 30, 2023 (Unaudited) | Dec 31, 2022 (Audited) | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Assets | $1,607,264 | $1,620,927 | $(13,663) | -0.84% | | Total Liabilities | $1,499,912 | $1,515,732 | $(15,820) | -1.04% | | Total Shareholders' Equity | $107,352 | $105,195 | $2,157 | 2.05% | | Loans, Net | $1,067,888 | $1,022,114 | $45,774 | 4.48% | | Total Deposits | $1,380,768 | $1,435,215 | $(54,447) | -3.79% | | Investment Securities Available for Sale | $378,794 | $445,394 | $(66,600) | -14.95% | Consolidated Statements of Earnings Consolidated Statements of Earnings Highlights (Dollars in thousands, except per share amounts) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Interest Income | $18,306 | $14,611 | $3,695 | 25.29% | | Total Interest Expense | $4,966 | $818 | $4,148 | 507.09% | | Net Interest Income | $13,340 | $13,793 | $(453) | -3.28% | | Provision for Credit Losses | $562 | $408 | $154 | 37.75% | | Total Non-Interest Income | $6,774 | $6,793 | $(19) | -0.28% | | Total Non-Interest Expense | $14,255 | $13,455 | $800 | 5.95% | | Net Earnings | $4,127 | $5,307 | $(1,180) | -22.23% | | Basic Net Earnings Per Share | $0.76 | $0.96 | $(0.20) | -20.83% | | Diluted Net Earnings Per Share | $0.74 | $0.93 | $(0.19) | -20.43% | | Cash Dividends Declared Per Share | $0.19 | $0.18 | $0.01 | 5.56% | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Interest Income | $52,706 | $37,932 | $14,774 | 38.95% | | Total Interest Expense | $11,257 | $2,125 | $9,132 | 429.74% | | Net Interest Income | $41,449 | $35,807 | $5,642 | 15.76% | | Provision for Credit Losses | $1,161 | $889 | $272 | 30.59% | | Total Non-Interest Income | $16,787 | $21,167 | $(4,380) | -20.69% | | Total Non-Interest Expense | $41,576 | $41,039 | $537 | 1.31% | | Net Earnings | $12,106 | $11,976 | $130 | 1.09% | | Basic Net Earnings Per Share | $2.22 | $2.18 | $0.04 | 1.83% | | Diluted Net Earnings Per Share | $2.15 | $2.11 | $0.04 | 1.90% | | Cash Dividends Declared Per Share | $0.72 | $0.69 | $0.03 | 4.35% | Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Comprehensive Income (Loss) Highlights (Dollars in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Earnings | $4,127 | $5,307 | $(1,180) | -22.23% | | Total Other Comprehensive Loss, Net of Tax | $(7,246) | $(12,770) | $5,524 | -43.26% | | Total Comprehensive Income (Loss) | $(3,119) | $(7,463) | $4,344 | -58.21% | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Earnings | $12,106 | $11,976 | $130 | 1.09% | | Total Other Comprehensive Loss, Net of Tax | $(3,392) | $(45,953) | $42,561 | -92.62% | | Total Comprehensive Income (Loss) | $8,714 | $(33,977) | $42,691 | -125.65% | Consolidated Statements of Changes in Shareholders' Equity Shareholders' Equity Changes (Dollars in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Shareholders' Equity (End of Period) | $107,352 | $105,195 | $2,157 | 2.05% | | Retained Earnings (End of Period) | $107,372 | $100,156 | $7,216 | 7.20% | | Accumulated Other Comprehensive Loss (End of Period) | $(50,989) | $(47,597) | $(3,392) | 7.13% | | Common Stock Shares Outstanding (End of Period) | 5,549,799 | 5,636,830 | (87,031) | -1.54% | Key Changes for Nine Months Ended September 30, 2023 (Dollars in thousands) | Item | Amount | | :--- | :--- | | Net Earnings | $12,106 | | Cash Dividends Declared | $(4,052) | | Common Stock Repurchase | $(1,673) | | Change in Accumulated Other Comprehensive Loss, Net of Tax | $(3,392) | | Adjustment for CECL Implementation (Net of Tax) | $(838) | Consolidated Statements of Cash Flows Consolidated Statements of Cash Flows Highlights (Nine Months Ended September 30, Dollars in thousands) | Cash Flow Activity | 2023 (Unaudited) | 2022 (Unaudited) | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Cash Provided by Operating Activities | $17,066 | $17,314 | $(248) | -1.43% | | Net Cash Provided (Used) by Investing Activities | $12,793 | $(224,078) | $236,871 | -105.71% | | Net Cash Provided (Used) by Financing Activities | $(24,836) | $84,726 | $(109,562) | -129.31% | | Net Change in Cash and Cash Equivalents | $5,023 | $(122,038) | $127,061 | -104.11% | | Cash and Cash Equivalents at End of Period | $76,619 | $155,461 | $(78,842) | -50.72% | Notes to Consolidated Financial Statements (Unaudited) This section provides detailed explanations and disclosures for the consolidated financial statements, covering significant accounting policies, investment securities, loans, and fair value measurements (1) Summary of Significant Accounting Policies This note outlines the Company's consolidation principles, the treatment of PEBK Capital Trust II, and the operational structure of its banking offices - The Company's consolidated financial statements include Peoples Bancorp of North Carolina, Inc. and its wholly-owned subsidiary, Peoples Bank, along with the Bank's subsidiaries[25] - The Bank operates three banking offices focused on the Latino population, now operating under the same name as other offices but categorizing mortgage loans originated from these offices separately[27] - The Company has two significant operating segments: Banking Operations and CBRES (appraisal management services)[29] - The only significant change in accounting policies since December 31, 2022, is the adoption of ASC 326 (CECL)[30] Recent Accounting Pronouncements The Company adopted several Accounting Standards Updates (ASUs) effective January 1, 2023, primarily ASC 326 (CECL), which replaced the incurred loss impairment framework - Adopted ASC 326 (CECL) effective January 1, 2023, replacing the incurred loss impairment framework with a current expected credit loss framework[35] - Adoption of ASC 326 resulted in an initial reduction to retained earnings of $838,000, net of tax[37] - The $838,000 reduction was due to a $1.1 million increase in the allowance for credit losses, comprising a $2.3 million increase for unfunded commitments and a $1.2 million decrease for loans[37] Allowance for Credit Losses on Loans The allowance for credit losses (ACL) on loans is a valuation account reflecting management's estimate of lifetime credit losses, determined using historical experience, current conditions, and reasonable forecasts - ACL on loans is a valuation account for lifetime expected credit losses, estimated using historical data, current conditions, and forecasts[39][40] - The Weighted Average Remaining Maturity (WARM) methodology is used for pooled loans, considering historical loss experience and a forecast component[40][41] - Qualitative adjustments are made for factors such as economic outlook, delinquencies, loan volume/mix, staff experience, credit concentrations, and interest rate risk[42] - Allowance for credit losses on off-balance sheet credit exposures is recorded using the same methodologies as portfolio loans, considering funding likelihood and third-party guarantees[45] Reclassification Certain amounts in the 2022 consolidated financial statements were reclassified to align with the 2023 presentation, with no impact on shareholders' equity or net earnings - Reclassifications in 2022 financial statements to conform to 2023 presentation had no impact on shareholders' equity or net earnings[46] (2) Investment Securities Investment securities available for sale decreased by $66.6 million from December 31, 2022, to September 30, 2023, primarily due to sales and maturities Investment Securities Available for Sale (Dollars in thousands) | Category | Sep 30, 2023 Fair Value | Dec 31, 2022 Fair Value | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | U.S Treasuries | $9,838 | $9,814 | $24 | 0.24% | | U.S. Government sponsored enterprises | $10,745 | $11,539 | $(794) | -6.88% | | Mortgage-backed securities | $259,867 | $273,838 | $(13,971) | -5.10% | | State and political subdivisions | $98,344 | $150,203 | $(51,859) | -34.53% | | Total Securities | $378,794 | $445,394 | $(66,600) | -14.95% | Unrealized Losses on Investment Securities (Dollars in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Gross Unrealized Losses | $66,266 | $62,328 | $3,938 | 6.32% | | Unrealized Losses (12 Months or More) | $64,930 | $45,631 | $19,299 | 42.29% | - Unrealized losses of $66.3 million at September 30, 2023, are considered temporary and not credit impaired, primarily due to changing interest rates[51] - Proceeds from sales of securities available for sale were $51.0 million during the nine months ended September 30, 2023, resulting in $2.7 million gross losses and $177,000 gross gains[52] (3) Loans Total loans increased to $1.078 billion at September 30, 2023, from $1.033 billion at December 31, 2022, with the portfolio heavily collateralized by real estate Major Classifications of Loans (Dollars in thousands) | Loan Type | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Real Estate Loans | $985,092 | $929,039 | $56,053 | 6.03% | | Construction and land development | $127,706 | $114,446 | $13,260 | 11.59% | | Single-family residential | $344,415 | $322,262 | $22,153 | 6.87% | | Commercial | $430,270 | $406,750 | $23,520 | 5.78% | | Total Loans | $1,078,173 | $1,032,608 | $45,565 | 4.41% | | Less allowance for credit losses | $(10,285) | $(10,494) | $209 | -1.99% | | Total Net Loans | $1,067,888 | $1,022,114 | $45,774 | 4.48% | - The Bank's loan portfolio is primarily within the Catawba Valley region of North Carolina and is substantially collateralized by real estate[54] Major Classifications of Loans This section details the composition of the loan portfolio, showing an increase in total loans, particularly in real estate categories like construction and commercial loans Loan Portfolio Composition (Dollars in thousands) | Loan Type | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Construction and land development | $127,706 | $114,446 | $13,260 | 11.59% | | Single-family residential | $344,415 | $322,262 | $22,153 | 6.87% | | Commercial real estate | $430,270 | $406,750 | $23,520 | 5.78% | | Total Real Estate Loans | $985,092 | $929,039 | $56,053 | 6.03% | | Total Loans | $1,078,173 | $1,032,608 | $45,565 | 4.41% | Age Analysis of Past Due Loans The total past due loans (30-89 days and 90+ days) significantly decreased from $8.558 million at December 31, 2022, to $3.115 million at September 30, 2023 Past Due Loans (Dollars in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Loans 30-89 Days Past Due | $2,710 | $8,038 | $(5,328) | -66.29% | | Loans 90 or More Days Past Due | $405 | $520 | $(115) | -22.12% | | Total Past Due Loans | $3,115 | $8,558 | $(5,443) | -63.60% | Non-accrual Loans Total non-accrual loans slightly decreased from $3.728 million at December 31, 2022, to $3.614 million at September 30, 2023 Non-accrual Loans (Dollars in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Real Estate Loans | $3,579 | $3,719 | $(140) | -3.77% | | Single-family residential | $1,878 | $1,914 | $(36) | -1.88% | | Single-family residential - Banco de la Gente non-traditional | $1,575 | $1,532 | $43 | 2.81% | | Total Nonaccrual Loans | $3,614 | $3,728 | $(114) | -3.06% | Modified Loans to Borrowers Experiencing Financial Difficulty During the nine months ended September 30, 2023, the Bank modified $827,000 in loans to borrowers experiencing financial difficulty, primarily through term extensions Modified Loans to Borrowers Experiencing Financial Difficulty (Nine Months Ended Sep 30, 2023, Dollars in thousands) | Loan Class | Amortized Cost Basis at Sep 30, 2023 | % of Loan Class | | :--- | :--- | :--- | | Single-family residential | $154 | 0.04% | | Commercial real estate | $673 | 0.16% | | Total | $827 | N/A | - No loans modified in the nine months ended September 30, 2023, due to financial difficulty had been written off at September 30, 2023[66] Changes in the Allowance for Credit Losses The allowance for credit losses (ACL) increased to $12.416 million at September 30, 2023, from $10.494 million at December 31, 2022, primarily due to a CECL implementation adjustment Allowance for Credit Losses (ACL) Changes (Dollars in thousands) | Metric | Sep 30, 2023 (CECL) | Dec 31, 2022 (Incurred Loss) | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | ACL Beginning Balance (Nine Months) | $10,494 | $9,355 | $1,139 | 12.18% | | Adjustment for CECL Implementation | $1,058 | N/A | N/A | N/A | | Charge-offs (Nine Months) | $(579) | $(590) | $11 | -1.86% | | Recoveries (Nine Months) | $282 | $376 | $(94) | -25.00% | | Provision for Loan Losses (Nine Months) | $1,307 | $889 | $418 | 47.02% | | ACL Ending Balance (Sep 30, 2023) | $12,416 | $10,030 (Sep 30, 2022) | $2,386 | 23.79% | | ACL - Loans (Sep 30, 2023) | $10,285 | N/A | N/A | N/A | | ACL - Unfunded Loan Commitments (Sep 30, 2023) | $2,131 | N/A | N/A | N/A | Credit Quality Indicators The Bank categorizes loans into 'Pass,' 'Watch,' or 'Substandard' based on credit risk, with the vast majority in the 'Pass' category as of September 30, 2023 - Loans are categorized into Pass, Watch, or Substandard based on credit quality indicators[73][78] Loan Credit Quality (Dollars in thousands) | Category | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Pass Loans | $1,075,058 (Total Loans Current) | $1,018,823 | $56,235 | 5.52% | | Watch Loans | $7,055 | $7,055 | $0 | 0.00% | | Substandard Loans | $6,730 | $6,730 | $0 | 0.00% | | Total Loans | $1,078,173 | $1,032,608 | $45,565 | 4.41% | (4) Net Earnings Per Share Basic net earnings per share for the three months ended September 30, 2023, was $0.76, and diluted EPS was $0.74 Net Earnings Per Share (EPS) (Dollars in thousands, except per share amounts) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :--- | :--- | :--- | :--- | :--- | | Net Earnings | $4,127 | $5,307 | $12,106 | $11,976 | | Basic EPS | $0.76 | $0.96 | $2.22 | $2.18 | | Diluted EPS | $0.74 | $0.93 | $2.15 | $2.11 | | Weighted Average Shares (Basic) | 5,402,048 | 5,473,443 | 5,442,788 | 5,484,063 | | Weighted Average Shares (Diluted) | 5,587,286 | 5,657,568 | 5,629,786 | 5,664,194 | (5) Fair Value The Company discloses fair value information for financial instruments, categorizing them into Level 1, 2, or 3 based on input observability - Fair value measurements are categorized into Level 1 (quoted prices in active markets), Level 2 (observable inputs other than quoted prices), and Level 3 (unobservable inputs)[87][94] - Investment securities available for sale are primarily Level 2, while loans and deposits are generally Level 3 due to subjective pricing and unobservable inputs[88][91][95] Fair Value of Financial Instruments (Dollars in thousands) | Asset/Liability | Sep 30, 2023 Carrying Amount | Sep 30, 2023 Total Fair Value | Dec 31, 2022 Carrying Amount | Dec 31, 2022 Total Fair Value | | :--- | :--- | :--- | :--- | :--- | | Cash and cash equivalents | $76,619 | $76,619 | $71,596 | $71,596 | | Investment securities available for sale | $378,794 | $378,794 | $445,394 | $445,394 | | Loans, net | $1,067,888 | $1,053,008 | $1,022,114 | $998,587 | | Deposits | $1,380,768 | $1,384,977 | $1,435,215 | $1,434,871 | | Securities sold under agreements to repurchase | $83,024 | $83,024 | $47,688 | $47,688 | Fair Value Hierarchy The Company categorizes financial instruments into a three-level hierarchy for fair value measurement, based on the observability of inputs used - Level 1: Valuation based on quoted prices for identical instruments in active markets (e.g., Cash and Cash Equivalents)[87][94] - Level 2: Valuation based on quoted prices for similar instruments or model-based techniques with observable inputs (e.g., Investment Securities Available for Sale, Securities Sold Under Agreements to Repurchase, Junior Subordinated Debentures)[88][94][96][98] - Level 3: Valuation generated from model-based techniques using at least one significant unobservable assumption (e.g., Other Investments, Mortgage Loans Held for Sale, Loans, Deposits, FHLB Borrowings)[89][90][91][95][97] Financial Instruments Measured at Fair Value on a Recurring Basis As of September 30, 2023, all recurring fair value measurements for investment securities and mutual funds were categorized as Level 2 Recurring Fair Value Measurements (Dollars in thousands) | Instrument | Sep 30, 2023 Fair Value | Level 1 | Level 2 | Level 3 | | :--- | :--- | :--- | :--- | :--- | | 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 | - | Fair Value Measurements for Mortgage Loans Held for Sale and Individually Evaluated Loans Mortgage loans held for sale significantly increased to $1.848 million at September 30, 2023, with all fair value measurements considered Level 3 Non-Recurring Fair Value Measurements (Dollars in thousands) | Instrument | Sep 30, 2023 Fair Value | Dec 31, 2022 Fair Value | Level 3 Valuation | | :--- | :--- | :--- | :--- | | Mortgage loans held for sale | $1,848 | $211 | $1,848 (Sep 30, 2023) / $211 (Dec 31, 2022) | | Individually evaluated loans | - | $14,694 | - (Sep 30, 2023) / $14,694 (Dec 31, 2022) | - All fair value measurements for mortgage loans held for sale and individually evaluated loans are considered Level 3, relying on certified appraisals, market-based information, and management's judgment on unobservable inputs[103][104] Carrying Amount and Estimated Fair Value of Financial Instruments This section provides a comprehensive comparison of the carrying amounts and estimated fair values for all financial instruments Carrying Amount vs. Fair Value (Dollars in thousands) | Asset/Liability | Sep 30, 2023 Carrying Amount | Sep 30, 2023 Total Fair Value | Dec 31, 2022 Carrying Amount | Dec 31, 2022 Total Fair Value | | :--- | :--- | :--- | :--- | :--- | | Cash and cash equivalents | $76,619 | $76,619 | $71,596 | $71,596 | | Investment securities available for sale | $378,794 | $378,794 | $445,394 | $445,394 | | Other investments | $2,900 | $2,900 | $2,656 | $2,656 | | Mortgage loans held for sale | $1,848 | $1,848 | $211 | $211 | | Loans, net | $1,067,888 | $1,053,008 | $1,022,114 | $998,587 | | Mutual funds held in deferred compensation trust | $1,850 | $1,850 | $1,327 | $1,327 | | Deposits | $1,380,768 | $1,384,977 | $1,435,215 | $1,434,871 | | Securities sold under agreements to repurchase | $83,024 | $83,024 | $47,688 | $47,688 | | Junior subordinated debentures | $15,464 | $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, primarily for branch facilities Lease Information (Dollars in thousands) | Metric | Sep 30, 2023 | Sep 30, 2022 | | :--- | :--- | :--- | | Operating Right-of-Use Assets | $4,908 | N/A | | Operating Lease Liabilities | $5,002 | N/A | | Operating Lease Cost (9 months) | $605 | $617 | | Weighted-Average Remaining Lease Term | 8.61 years | 9.01 years | | Weighted-Average Discount Rate | 2.71% | 2.30% | Operating Lease Liabilities Maturity Analysis (Dollars in thousands, Sep 30, 2023) | Year | Amount | | :--- | :--- | | 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 operates two reportable segments: Banking Operations and CBRES (appraisal management services), with Banking Operations generating the majority of net income - The Company has two reportable segments: Banking Operations (primary revenue from net interest income) and CBRES (appraisal management services, primary revenue from appraisal management fee income)[109] Segment Net Income (Loss) (Dollars in thousands) | Segment | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :--- | :--- | :--- | :--- | :--- | | Banking Operations | $4,313 | $5,527 | $12,712 | $12,119 | | CBRES | $156 | $18 | $380 | $484 | | Other | $(342) | $(238) | $(986) | $(627) | | Consolidated Net Income | $4,127 | $5,307 | $12,106 | $11,976 | CBRES Appraisal Management Fee Income (Dollars in thousands) | Period | 2023 | 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | 3 Months Ended Sep 30 | $2,785 | $2,711 | $74 | 2.73% | | 9 Months Ended Sep 30 | $7,469 | $9,656 | $(2,187) | -22.65% | (8) Subsequent Events Management has reviewed subsequent events through the financial statement issuance date and concluded that there were no material subsequent events requiring disclosure - No material subsequent events were identified through the financial statement issuance date[112] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the Company's financial performance and condition, detailing the impact of rising interest rates, CECL adoption, and changes in income and expenses Introduction This section introduces the Management's Discussion and Analysis, emphasizing its role in understanding the consolidated financial condition and results of operations of Peoples Bancorp of North Carolina, Inc - The Company is Peoples Bancorp of North Carolina, Inc., a registered bank holding company and parent of Peoples Bank, operating under Federal Reserve supervision[115] Overview The Company's profitability is primarily driven by net interest income, influenced by interest rates, loan demand, and local economic conditions, with a focus on community-oriented financial services - Profitability depends primarily on net interest income, affected by loan and investment yields versus cost of funds[116] - Federal Reserve increased target federal funds rate by 500 basis points since March 1, 2022, to 5.25%-5.50% at September 30, 2023[118] - The Company's strategy is to operate as a well-capitalized, profitable, and independent community-oriented financial institution, focusing on local market growth and expansion[120] Summary of Significant Accounting Policies This section reiterates the importance of the Company's accounting policies, particularly those requiring significant judgment in asset and liability valuation, such as the allowance for credit losses (ACL) - The allowance for credit losses reflects management's assessment of credit risks and loan portfolio quality[122] - Many assets and liabilities are recorded using techniques requiring significant judgment, including fair value estimates based on quoted market prices, dealer quotes, or internal modeling[124] - The adoption of ASC 326 (CECL) is the only significant change to accounting policies since December 31, 2022[121] Results of Operations Net earnings for the three months ended September 30, 2023, decreased by 22.23% to $4.1 million, while year-to-date net earnings slightly increased by 1.09% to $12.1 million Summary Net earnings for Q3 2023 decreased to $4.1 million ($0.76 basic EPS) from $5.3 million ($0.96 basic EPS) in Q3 2022, mainly due to lower net interest income, higher credit loss provision, and increased non-interest expense Net Earnings Summary (Dollars in thousands, except per share amounts) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Earnings | $4,127 | $5,307 | $(1,180) | -22.23% | | Basic EPS | $0.76 | $0.96 | $(0.20) | -20.83% | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Earnings | $12,106 | $11,976 | $130 | 1.09% | | Basic EPS | $2.22 | $2.18 | $0.04 | 1.83% | Annualized Returns (Nine Months Ended Sep 30) | Metric | 2023 | 2022 | Change (Absolute) | | :--- | :--- | :--- | :--- | | Return on Average Assets | 1.01% | 0.96% | 0.05% | | Return on Average Shareholders' Equity | 13.97% | 12.53% | 1.44% | Net Interest Income Net interest income decreased by 3.28% to $13.3 million for Q3 2023, primarily due to a significant increase in interest expense outpacing the rise in interest income Net Interest Income (Dollars in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Interest Income | $13,340 | $13,793 | $(453) | -3.28% | | Total Interest Income | $18,306 | $14,611 | $3,695 | 25.29% | | Total Interest Expense | $4,966 | $818 | $4,148 | 507.09% | | Net Interest Spread | 2.73% | 3.26% | -0.53% | N/A | | Net Yield on Interest-Earning Assets | 3.39% | 3.39% | 0.00% | N/A | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Interest Income | $41,449 | $35,807 | $5,642 | 15.76% | | Total Interest Income | $52,706 | $37,932 | $14,774 | 38.95% | | Total Interest Expense | $11,257 | $2,125 | $9,132 | 429.74% | | Net Interest Spread | 2.99% | 3.00% | -0.01% | N/A | | Net Yield on Interest-Earning Assets | 3.39% | 3.39% | 0.00% | N/A | - Increase in interest income for Q3 2023 was driven by a $3.1 million increase in interest and fees on loans and an $895,000 increase in investment securities interest, partially offset by a $294,000 decrease in interest on due from banks[131][132] - Increase in interest expense for Q3 2023 was primarily due to increased time deposits and higher rates paid on interest-bearing liabilities[131][134] Provision for Credit Losses The provision for credit losses increased to $562,000 for Q3 2023 and to $1.2 million for the nine months ended September 30, 2023, mainly due to higher loan balances and qualitative adjustments Provision for Credit Losses (Dollars in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Provision for Credit Losses | $562 | $408 | $154 | 37.75% | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Provision for Credit Losses | $1,161 | $889 | $272 | 30.59% | - The increase is primarily due to higher loan balances and qualitative adjustments for economic conditions, including a $127,000 credit to the provision on unfunded commitments for Q3 2023 and a $146,000 credit for the nine months ended September 30, 2023[146][147] Non-Interest Income Total non-interest income remained stable at $6.8 million for Q3 2023, but decreased by 20.69% to $16.8 million for the nine months ended September 30, 2023 Total Non-Interest Income (Dollars in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Non-Interest Income | $6,774 | $6,793 | $(19) | -0.28% | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Non-Interest Income | $16,787 | $21,167 | $(4,380) | -20.69% | - The year-to-date decrease was primarily due to a $2.5 million net loss on securities sales (executed in Q1 2023 to reduce risk and support loan growth) and a $2.2 million decrease in appraisal management fee income due to national real estate trends[149] Non-Interest Expense Total non-interest expense increased by 5.95% to $14.3 million for Q3 2023, mainly due to a $545,000 rise in salaries and employee benefits Total Non-Interest Expense (Dollars in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Non-Interest Expense | $14,255 | $13,455 | $800 | 5.95% | | Salaries and employee benefits | $6,722 | $6,177 | $545 | 8.82% | | Metric | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Non-Interest Expense | $41,576 | $41,039 | $537 | 1.31% | | Salaries and employee benefits | $19,508 | $18,469 | $1,039 | 5.62% | | Appraisal management fee expense | $5,881 | $7,680 | $(1,799) | -23.42% | - The increase in salaries and employee benefits was primarily due to a reduction in the amortization of loan origination costs and an increase in supplemental retirement plan expense[150][151] Income Taxes Income tax expense for Q3 2023 was $1.2 million (effective tax rate of 22.09%), down from $1.4 million (21.06%) in Q3 2022 Income Tax Expense and Effective Tax Rate (Dollars in thousands) | Metric | 3 Months Ended Sep 30, 2023 | 3 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2023 | 9 Months Ended Sep 30, 2022 | | :--- | :--- | :--- | :--- | :--- | | Income Tax Expense | $1,170 | $1,416 | $3,393 | $3,070 | | Effective Tax Rate | 22.09% | 21.06% | 21.89% | 20.40% | - The increase in the effective tax rate for the nine months ended September 30, 2023, was primarily due to a reduction in non-taxable investments[152] Analysis of Financial Condition This section analyzes the Company's financial position, highlighting changes in investment securities, deposits, and loans, alongside credit loss management and capital resources Investment Securities Available for sale securities decreased by 14.95% to $378.8 million at September 30, 2023, from $445.4 million at December 31, 2022 Investment Securities Available for Sale (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Available for Sale Securities | $378.8 | $445.4 | $(66.6) | -14.95% | | Average Investment Securities (9 months) | $458.2 | $467.5 (Year Ended Dec 31, 2022) | $(9.3) | -1.99% | Loans Total loans increased by 4.41% to $1.1 billion at September 30, 2023, from $1.0 billion at December 31, 2022, representing 68% of average earning assets Loan Portfolio Overview (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Loans | $1,100 | $1,000 | $100 | 10.00% | | Mortgage Loans Held for Sale | $1.8 | $0.211 | $1.629 | 771.09% | | Residential Mortgage Loans | $107.1 | $101.5 | $5.6 | 5.52% | | Home Equity Loans | $103.1 | $101.1 | $2.0 | 1.98% | | Commercial Mortgage Loans | $644.6 | $610.0 | $34.6 | 5.67% | - Loans represented 68% of average earning assets for the nine months ended September 30, 2023, up from 59% for the year ended December 31, 2022[154] Allowance for Credit Losses (ACL) The ACL reflects management's estimate of lifetime expected credit losses, calculated using the WARM methodology and qualitative adjustments, with continuous monitoring of loan performance - ACL is management's estimate of lifetime expected credit losses, using WARM methodology and qualitative adjustments for economic outlook, delinquencies, and other risk factors[158][159] - The Bank uses an internal loan grading system (Pass, Watch, Substandard) and engages an independent third party for credit review to monitor asset quality[163][164] - Management believes the allowance is adequate to cover estimated losses inherent in the loan portfolio, but future additions may be necessary due to changing conditions[170] Non-performing Assets Non-performing assets remained stable at $3.7 million (0.23% of total assets) at September 30, 2023, compared to December 31, 2022 Non-performing Assets (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Non-performing Assets | $3.7 | $3.7 | $0 | 0.00% | | Non-performing Assets as % of Total Assets | 0.23% | 0.23% | 0.00% | 0.00% | | Non-accrual Loans | $3.6 | $3.7 | $(0.1) | -2.70% | | Non-accrual Loans as % of Total Loans | 0.34% | 0.36% | -0.02% | -5.56% | | Loans 90 Days Past Due and Still Accruing | $0.099 | $0 | $0.099 | N/A | | Other Real Estate Owned | $0 | $0 | $0 | 0.00% | Deposits Total deposits remained stable at $1.4 billion at September 30, 2023, while core deposits decreased to $1.2 billion (90.03% of total deposits) Deposits Overview (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Total Deposits | $1,400 | $1,400 | $0 | 0.00% | | Core Deposits (Non-GAAP) | $1,200 | $1,400 | $(200) | -14.29% | | Core Deposits as % of Total Deposits | 90.03% | 97.84% | -7.81% | N/A | | Certificates of Deposit > $250,000 | $137.7 | $31.0 | $106.7 | 344.19% | | Other Time Deposits | $165.4 | $67.0 | $98.4 | 146.87% | | Estimated Uninsured Deposits | $376.6 | $439.8 | $(63.2) | -14.00% | | Estimated Uninsured Deposits as % of Total Deposits | 27.27% | 30.64% | -3.37% | N/A | - Increases in large certificates of deposit and other time deposits are primarily due to promotional rates offered[172] Borrowed Funds There were no FHLB borrowings outstanding at September 30, 2023, while securities sold under agreements to repurchase increased to $83.0 million from $47.7 million Borrowed Funds (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | FHLB Borrowings Outstanding | $0 | $0 | $0 | 0.00% | | Securities Sold Under Agreements to Repurchase | $83.0 | $47.7 | $35.3 | 74.00% | - The increase in securities sold under agreements to repurchase is primarily due to customers transferring funds from deposits[174] Junior Subordinated Debentures (related to Trust Preferred Securities) Junior subordinated debentures remained stable at $15.5 million, with the interest rate transitioning from LIBOR to SOFR effective September 15, 2023 Junior Subordinated Debentures (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Junior Subordinated Debentures | $15.5 | $15.5 | $0 | 0.00% | - Effective September 15, 2023, interest on trust preferred securities transitioned from three-month LIBOR plus 163 basis points to three-month SOFR plus 189 basis points (including a 26 basis point credit spread adjustment)[178] Asset Liability and Interest Rate Risk Management The Company's ALCO manages interest rate risk to minimize fluctuations in net interest income, with rate-sensitive assets exceeding rate-sensitive liabilities by $567.8 million - ALCO manages interest rate risk to minimize fluctuations in net interest income by balancing rate-sensitive assets and liabilities[179][180] - Average rate sensitive assets ($1.6 billion) exceeded average rate sensitive liabilities ($985.9 million) by $567.8 million for the nine months ended September 30, 2023[181] - The Company uses interest rate floors on $114.8 million in variable rate loans to protect against downward prime rate movements, though no floors were in effect at September 30, 2023[183] Liquidity The Company maintains liquidity to meet loan demand, deposit withdrawals, and regulatory requirements, with core deposits decreasing and significant borrowing capacity available Liquidity Metrics (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Unfunded Commitments to Extend Credit | $397.3 | $382.7 | $14.6 | 3.81% | | Core Deposits | $1,200 | $1,400 | $(200) | -14.29% | | Core Deposits as % of Total Deposits | 90.03% | 97.84% | -7.81% | N/A | | Wholesale Funding as % of Total Assets | 1.86% | 0.92% | 0.94% | 102.17% | | FHLB Availability | $121.0 | $86.5 | $34.5 | 39.88% | | FRB Availability | $437.9 | $445.1 | $(7.2) | -1.62% | | Liquidity Ratio | 24.38% | 30.32% | -5.94% | -19.59% | - The Bank has completed necessary steps to access the FRB's Bank Term Funding Program (BTFP)[188] Contractual Obligations and Off-Balance Sheet Arrangements The Company's contractual obligations include junior subordinated debentures and lease agreements, while off-balance sheet arrangements primarily consist of commitments to extend credit and standby letters of credit - Contractual obligations include junior subordinated debentures and lease agreements[191] Off-Balance Sheet Arrangements (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Unfunded Commitments to Extend Credit | $397.3 | $382.7 | $14.6 | 3.81% | | Standby Letters of Credit | $4.3 | $4.4 | $(0.1) | -2.27% | Capital Resources Shareholders' equity increased to $107.4 million (6.68% of total assets) at September 30, 2023, with the Company maintaining strong capital ratios exceeding 'well capitalized' thresholds Capital Resources (Dollars in millions) | Metric | Sep 30, 2023 | Dec 31, 2022 | Change (Absolute) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Shareholders' Equity | $107.4 | $105.2 | $2.2 | 2.09% | | Shareholders' Equity as % of Total Assets | 6.68% | 6.49% | 0.19% | N/A | | Annualized Return on Average Equity (9 months) | 13.97% | 12.53% | 1.44% | N/A | | Common Stock Repurchased (9 months) | $1.7 | N/A | N/A | N/A | Regulatory Capital Ratios (Company) | Ratio | Sep 30, 2023 | Dec 31, 2022 | Well Capitalized Threshold | | :--- | :--- | :--- | :--- | | Common Equity Tier 1 Capital Ratio | 12.48% | 12.03% | 6.5% | | Tier 1 Capital Ratio | 13.66% | 13.21% | 8.0% | | Total Risk-Based Capital Ratio | 14.64% | 14.04% | 10.0% | | Tier 1 Leverage Capital Ratio | 10.52% | 9.82% | 5.0% | - The Company's Board authorized a $2.0 million stock repurchase program in March 2023, under which $1.7 million (87,222 shares) of common stock had been repurchased as of September 30, 2023[193] Item 3. Quantitative and Qualitative Disclosures About Market Risk This item is marked as 'Not applicable' in the report, indicating no specific quantitative or qualitative disclosures about market risk are provided - This item is marked as 'Not applicable'[198] Item 4. Controls and Procedures Management, including the CEO and CFO, evaluated the effectiveness of disclosure controls and procedures as of September 30, 2023, concluding they are effective for timely and accurate reporting - CEO and CFO concluded that disclosure controls and procedures were effective as of September 30, 2023[198] - No material changes to internal control over financial reporting occurred during or subsequent to the period[198] Part II. Other Information Item 1. Legal Proceedings The Bank is contesting a $1.4 million proposed adjustment from the NCDOR for disallowed tax credits from 2014-2016, with recent court decisions supporting the Bank's position - The Bank is contesting a $1.4 million proposed adjustment from the NCDOR for disallowed tax credits (2014-2016)[199] - The Bank paid $1.2 million in Q2 2019 to stop interest accrual, and a Guaranty Agreement limits exposure to approximately $125,000[199] - Recent NC Business Court decisions in related cases, if upheld on appeal, support the Bank's position against the NCDOR's disallowance of tax credits[199] Item 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the Company's Annual Report on Form 10-K filed on March 17, 2023 - No material changes to risk factors previously disclosed in the Form 10-K filed March 17, 2023[200] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds During the three months ended September 30, 2023, the Company repurchased 43,551 shares of its common stock at an average price of $20.55 per share Issuer Purchases of Equity Securities (Three Months Ended Sep 30, 2023) | Period | Total Shares Purchased | Average Price Paid per Share | Shares Purchased as Part of Publicly Announced Programs | Maximum Dollar Value of Shares that May Yet Be Purchased Under Programs | | :--- | :--- | :--- | :--- | :--- | | 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 | N/A | - 2,551 shares were purchased on the open market for the deferred compensation plan, funded by participant contributions[202] Item 3. Defaults Upon Senior Securities This item is marked as 'Not applicable' in the report, indicating no defaults upon senior securities occurred during the period - This item is marked as 'Not applicable'[203] Item 4. Mine Safety Disclosures This item is marked as 'Not applicable' in the report, indicating no mine safety disclosures are required for the Company - This item is marked as 'Not applicable'[203] Item 5. Other Information On October 19, 2023, the Company adopted an Excess Incentive-Based Compensation Recovery Policy (Clawback Policy) in compliance with SEC and Nasdaq rules - On October 19, 2023, the Company adopted an Excess Incentive-Based Compensation Recovery Policy (Clawback Policy) in compliance with SEC and Nasdaq rules[203] - The Clawback Policy mandates recovery of erroneously awarded incentive-based compensation from current and former executive officers if an accounting restatement is required, regardless of misconduct[203] - Employment agreements for named executive officers (Lance A. Sellers, Jeffrey N. Hooper, William D. Cable, Sr.) were amended on November 1, 2023, to implement the Clawback Policy[203] Item 6. Exhibits This section lists all exhibits filed with the Form 10-Q, including articles of incorporation, bylaws, specimen stock certificate, and various certifications - Exhibits include organizational documents (Articles of Incorporation, Bylaws), a specimen stock certificate, and the First Amendment to Employment Agreement for named executive officers[203][205] - Certifications pursuant to the Sarbanes-Oxley Act (Sections 302 and 906) and XBRL formatted financial statements are also filed as exhibits[205] Signatures Signatures The report is duly signed on November 7, 2023, by Lance A. Sellers, President and Chief Executive Officer, and Jeffrey N. Hooper, Executive Vice President and Chief Financial Officer - The report was signed on November 7, 2023, by Lance A. Sellers (President and CEO) and Jeffrey N. Hooper (EVP and CFO)[209]