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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: June 30, 2021

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. 5,789,166 shares of common stock, outstanding at July 31, 2021.

INDEX

|  |  | PAGE(S) |
PART I. FINANCIAL INFORMATION |  |  |
Item 1. | Financial Statements |  | 3 |
| Consolidated Balance Sheets at June 30, 2021 (Unaudited) and December 31, 2020 (Audited) |  | 3 |
| Consolidated Statements of Earnings for the three and six months ended June 30, 2021 and 2020 (Unaudited) |  | 4 |
| Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2021 and 2020 (Unaudited) |  | 5 |
| Consolidated Statements of Changes in Shareholders’ Equity for the three and six months ended June 30, 2021 and 2020 (Unaudited) |  | 6 |
| Consolidated Statements of Cash Flows for the three and six months ended June 30, 2021 and 2020 (Unaudited) |  | 7-8 |
| Notes to Consolidated Financial Statements (Unaudited) |  | 9-29 |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |  | 30-45 |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |  | 46 |
Item 4. | Controls and Procedures |  | 46 |

PART II. OTHER INFORMATION

Item 1. | Legal Proceedings |  | 46 |
Item 1A. | Risk Factors |  | 46 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |  | 47 |
Item 3. | Defaults upon Senior Securities |  | 47 |
Item 5. | Other Information |  | 47 |
Item 6. | Exhibits |  | 47-50 |
Signatures |  | 51 |
Certifications |  |  |

Statements made in this 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 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, 2020.

2
Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Balance Sheets
June 30, 2021 and December 31, 2020
(Dollars in thousands)
|  | June 30, |  |  | December 31, |
|  | 2021 |  |  | 2020 |
|  | (Unaudited) |  |  | (Audited) |
Assets |  |  |  |  |  |
Cash and due from banks, including reserve requirements of $0 at both June 30, 2021 and December 31, 2020 |  | $ | 47,151 |  |  |  | 42,737 |
Interest-bearing deposits |  |  | 240,158 |  |  |  | 118,843 |
Cash and cash equivalents |  |  | 287,309 |  |  |  | 161,580 |
Investment securities available for sale |  |  | 367,529 |  |  |  | 245,249 |
Other investments |  |  | 3,758 |  |  |  | 4,155 |
Total securities |  |  | 371,287 |  |  |  | 249,404 |
Mortgage loans held for sale |  |  | 5,501 |  |  |  | 9,139 |
Loans |  |  | 888,360 |  |  |  | 948,639 |
Less allowance for loan losses |  |  | (9,287 | ) |  |  | (9,908 | )
Net loans |  |  | 879,073 |  |  |  | 938,731 |
Premises and equipment, net |  |  | 17,217 |  |  |  | 18,600 |
Cash surrender value of life insurance |  |  | 17,164 |  |  |  | 16,968 |
Other real estate |  |  | - |  |  |  | 128 |
Right of use lease asset |  |  | 3,017 |  |  |  | 3,423 |
Accrued interest receivable and other assets |  |  | 19,005 |  |  |  | 18,202 |
Total assets |  | $ | 1,599,573 |  |  |  | 1,416,175 |
Liabilities and Shareholders' Equity |  |  |  |  |  |  |  |
Deposits: |  |  |  |  |  |  |  |
Noninterest-bearing demand |  | $ | 512,577 |  |  |  | 456,980 |
Interest-bearing demand, MMDA & savings |  |  | 775,009 |  |  |  | 657,834 |
Time, $250,000 or more |  |  | 26,631 |  |  |  | 25,771 |
Other time |  |  | 77,837 |  |  |  | 80,501 |
Total deposits |  |  | 1,392,054 |  |  |  | 1,221,086 |
Securities sold under agreements to repurchase |  |  | 31,249 |  |  |  | 26,201 |
Junior subordinated debentures |  |  | 15,464 |  |  |  | 15,464 |
Lease liability |  |  | 3,073 |  |  |  | 3,471 |
Accrued interest payable and other liabilities |  |  | 12,359 |  |  |  | 10,054 |
Total liabilities |  |  | 1,454,199 |  |  |  | 1,276,276 |
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 5,789,166 shares at June 30, 2021 and 5,787,504 shares at December 31, 2020 |  |  | 56,910 |  |  |  | 56,871 |
Common stock held by deferred compensation trust, at cost; 158,985 shares at June 30, 2021 and 155,469 shares at December 31, 2020 |  |  | (1,901 | ) |  |  | (1,796 | )
Deferred compensation |  |  | 1,901 |  |  |  | 1,796 |
Retained earnings |  |  | 84,504 |  |  |  | 77,628 |
Accumulated other comprehensive income |  |  | 3,960 |  |  |  | 5,400 |
Total shareholders' equity |  |  | 145,374 |  |  |  | 139,899 |
Total liabilities and shareholders' equity |  | $ | 1,599,573 |  |  |  | 1,416,175 |

See accompanying Notes to Consolidated Financial Statements.

3
Table of Contents

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Earnings
Three and Six Months Ended June 30, 2021 and 2020
(Dollars in thousands, except per share amounts)
|  | Three months ended |  |  | Six months ended |
|  | June 30, |  |  | June 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
|  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |
Interest income: |  |  |  |  |  |  |  |  |  |  |  |
Interest and fees on loans |  | $ | 11,003 |  |  |  | 10,180 |  |  |  | 21,667 |  |  |  | 20,860 |
Interest on due from banks |  |  | 48 |  |  |  | 41 |  |  |  | 83 |  |  |  | 84 |
Interest on fededal funds sold |  |  | - |  |  |  | 22 |  |  |  | - |  |  |  | 145 |
Interest on investment securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government sponsored enterprises |  |  | 682 |  |  |  | 651 |  |  |  | 1,220 |  |  |  | 1,336 |
State and political subdivisions |  |  | 758 |  |  |  | 684 |  |  |  | 1,397 |  |  |  | 1,325 |
Other |  |  | 26 |  |  |  | 60 |  |  |  | 72 |  |  |  | 138 |
Total interest income |  |  | 12,517 |  |  |  | 11,638 |  |  |  | 24,439 |  |  |  | 23,888 |
Interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW, MMDA & savings deposits |  |  | 543 |  |  |  | 448 |  |  |  | 1,040 |  |  |  | 973 |
Time deposits |  |  | 191 |  |  |  | 224 |  |  |  | 403 |  |  |  | 501 |
FHLB borrowings |  |  | - |  |  |  | 102 |  |  |  | - |  |  |  | 166 |
Junior subordinated debentures |  |  | 71 |  |  |  | 90 |  |  |  | 142 |  |  |  | 220 |
Other |  |  | 37 |  |  |  | 48 |  |  |  | 72 |  |  |  | 93 |
Total interest expense |  |  | 842 |  |  |  | 912 |  |  |  | 1,657 |  |  |  | 1,953 |
Net interest income |  |  | 11,675 |  |  |  | 10,726 |  |  |  | 22,782 |  |  |  | 21,935 |
Provision for (recovery of) loan losses |  |  | (226 | ) |  |  | 1,417 |  |  |  | (681 | ) |  |  | 2,938 |
Net interest income after provision for loan losses |  |  | 11,901 |  |  |  | 9,309 |  |  |  | 23,463 |  |  |  | 18,997 |
Non-interest income: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Service charges |  |  | 910 |  |  |  | 718 |  |  |  | 1,836 |  |  |  | 1,826 |
Other service charges and fees |  |  | 171 |  |  |  | 162 |  |  |  | 383 |  |  |  | 355 |
Gain on sale of investment securities |  |  | - |  |  |  | 457 |  |  |  | - |  |  |  | 457 |
Mortgage banking income |  |  | 723 |  |  |  | 563 |  |  |  | 1,593 |  |  |  | 885 |
Insurance and brokerage commissions |  |  | 238 |  |  |  | 205 |  |  |  | 498 |  |  |  | 447 |
Appraisal management fee income |  |  | 2,005 |  |  |  | 1,734 |  |  |  | 3,821 |  |  |  | 3,084 |
Gain on sale of other real estate |  |  | 21 |  |  |  | - |  |  |  | 21 |  |  |  | - |
Miscellaneous |  |  | 1,972 |  |  |  | 1,400 |  |  |  | 3,761 |  |  |  | 2,780 |
Total non-interest income |  |  | 6,040 |  |  |  | 5,239 |  |  |  | 11,913 |  |  |  | 9,834 |
Non-interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Salaries and employee benefits |  |  | 5,666 |  |  |  | 5,535 |  |  |  | 11,849 |  |  |  | 11,259 |
Occupancy |  |  | 1,939 |  |  |  | 1,861 |  |  |  | 3,892 |  |  |  | 3,782 |
Professional fees |  |  | 435 |  |  |  | 414 |  |  |  | 772 |  |  |  | 747 |
Advertising |  |  | 154 |  |  |  | 196 |  |  |  | 297 |  |  |  | 414 |
Debit card expense |  |  | 264 |  |  |  | 258 |  |  |  | 496 |  |  |  | 488 |
FDIC Insurance |  |  | 164 |  |  |  | 48 |  |  |  | 196 |  |  |  | 88 |
Appraisal management fee expense |  |  | 1,634 |  |  |  | 1,333 |  |  |  | 3,090 |  |  |  | 2,367 |
Other |  |  | 1,876 |  |  |  | 1,807 |  |  |  | 3,808 |  |  |  | 3,756 |
Total non-interest expense |  |  | 12,132 |  |  |  | 11,452 |  |  |  | 24,400 |  |  |  | 22,901 |
Earnings before income taxes |  |  | 5,809 |  |  |  | 3,096 |  |  |  | 10,976 |  |  |  | 5,930 |
Income tax expense |  |  | 1,194 |  |  |  | 535 |  |  |  | 2,240 |  |  |  | 1,002 |
Net earnings |  | $ | 4,615 |  |  |  | 2,561 |  |  |  | 8,736 |  |  |  | 4,928 |
Basic net earnings per share |  | $ | 0.82 |  |  |  | 0.46 |  |  |  | 1.55 |  |  |  | 0.87 |
Diluted net earnings per share |  | $ | 0.80 |  |  |  | 0.44 |  |  |  | 1.51 |  |  |  | 0.84 |
Cash dividends declared per share |  | $ | 0.16 |  |  |  | 0.15 |  |  |  | 0.32 |  |  |  | 0.45 |

See accompanying Notes to Consolidated Financial Statements.

4
Table of Contents

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Comprehensive Income
Three and Six Months Ended June 30, 2021 and 2020
(Dollars in thousands)
|  | Three months ended |  |  | Six months ended |
|  | June 30, |  |  | June 30, |
|  | 2021 |  |  | 2020 |  |  | 2021 |  |  | 2020 |
|  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |
Net earnings |  | $ | 4,615 |  |  |  | 2,561 |  |  |  | 8,736 |  |  |  | 4,928 |
Other comprehensive income: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding gains (losses) on securities available for sale |  |  | 2,155 |  |  |  | 2,396 |  |  |  | (1,870 | ) |  |  | 5,110 |
Reclassification adjustment for gains on securities available for sale included in net earnings |  |  | - |  |  |  | (457 | ) |  |  | - |  |  |  | (457 | )
Total other comprehensive income (loss), before income taxes |  |  | 2,155 |  |  |  | 1,939 |  |  |  | (1,870 | ) |  |  | 4,653 |
Income tax expense (benefit) related to other comprehensive income: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding gains (losses) on securities available for sale |  |  | 495 |  |  |  | 550 |  |  |  | (430 | ) |  |  | 1,174 |
Reclassification adjustment for gains on securities available for sale included in net earnings |  |  | - |  |  |  | (105 | ) |  |  | - |  |  |  | (105 | )
Total income tax expense (benefit) related to other comprehensive income |  |  | 495 |  |  |  | 445 |  |  |  | (430 | ) |  |  | 1,069 |
Total other comprehensive income (loss), net of tax |  |  | 1,660 |  |  |  | 1,494 |  |  |  | (1,440 | ) |  |  | 3,584 |
Total comprehensive income |  | $ | 6,275 |  |  |  | 4,055 |  |  |  | 7,296 |  |  |  | 8,512 |

See accompanying Notes to Consolidated Financial Statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Changes in Shareholders' Equity
Three and Six Months Ended June 30, 2021 and 2020
(Dollars in thousands)
|  | Common Stock |  |  | Retained |  |  | Deferred |  |  | Common Stock Held By Deferred Compensation |  |  | Accumulated Other Comprehensive |  |  |  |
|  | Shares |  |  | Amount |  |  | Earnings |  |  | Compensation |  |  | Trust |  |  | Income |  |  | Total |
|  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |
Balance, As At December 31, 2020 |  |  | 5,787,504 |  |  | $ | 56,871 |  |  |  | 77,628 |  |  |  | 1,796 |  |  |  | (1,796 | ) |  |  | 5,400 |  |  |  | 139,899 |
Cash dividends declared on common stock |  |  | - |  |  |  | - |  |  |  | (930 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (930 | )
Restricted stock units exercised |  |  | 1,662 |  |  |  | 39 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 39 |
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 53 |  |  |  | (53 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 4,121 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 4,121 |
Change in accumulated other comprehensive income, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (3,100 | ) |  |  | (3,100 | )
Balance, As At March 31, 2021 |  |  | 5,789,166 |  |  |  | 56,910 |  |  |  | 80,819 |  |  |  | 1,849 |  |  |  | (1,849 | ) |  |  | 2,300 |  |  |  | 140,029 |
Cash dividends declared on common stock |  |  | - |  |  |  | - |  |  |  | (930 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (930 | )
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 52 |  |  |  | (52 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 4,615 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 4,615 |
Change in accumulated other comprehensive income, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1,660 |  |  |  | 1,660 |
Balance, As At June 30, 2021 |  |  | 5,789,166 |  |  | $ | 56,910 |  |  |  | 84,504 |  |  |  | 1,901 |  |  |  | (1,901 | ) |  |  | 3,960 |  |  |  | 145,374 |
Balance, As At December 31, 2019 |  |  | 5,912,300 |  |  | $ | 59,813 |  |  |  | 70,663 |  |  |  | 1,588 |  |  |  | (1,588 | ) |  |  | 3,644 |  |  |  | 134,120 |
Common stock repurchase |  |  | (126,800 | ) |  |  | (2,999 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (2,999 | )
Cash dividends declared on common stock |  |  | - |  |  |  | - |  |  |  | (1,779 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (1,779 | )
Restricted stock units exercised |  |  | 2,004 |  |  |  | 57 |  |  |  | - |  |  |  |  |  |  |  |  |  |  |  | - |  |  |  | 57 |
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 64 |  |  |  | (64 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 2,367 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 2,367 |
Change in accumulated other comprehensive income, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 2,090 |  |  |  | 2,090 |
Balance, As At March 31, 2020 |  |  | 5,787,504 |  |  |  | 56,871 |  |  |  | 71,251 |  |  |  | 1,652 |  |  |  | (1,652 | ) |  |  | 5,734 |  |  |  | 133,856 |
Cash dividends declared on common stock |  |  | - |  |  |  | - |  |  |  | (870 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (870 | )
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 48 |  |  |  | (48 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 2,561 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 2,561 |
Change in accumulated other comprehensive income, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1,494 |  |  |  | 1,494 |
Balance, As At June 30, 2020 |  |  | 5,787,504 |  |  | $ | 56,871 |  |  |  | 72,942 |  |  |  | 1,700 |  |  |  | (1,700 | ) |  |  | 7,228 |  |  |  | 137,041 |

See accompanying Notes to Consolidated Financial Statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2021 and 2020
(Dollars in thousands)
|  | 2021 |  |  | 2020 |
|  | (Unaudited) |  |  | (Unaudited) |
Cash flows from operating activities: |  |  |  |  |  |
Net earnings |  | $ | 8,736 |  |  |  | 4,928 |
Adjustments to reconcile net earnings to net cash provided by operating activities: |  |  |  |  |  |  |  |
Depreciation, amortization and accretion |  |  | 2,549 |  |  |  | 2,017 |
Provision for (recovery of) loan losses |  |  | (681 | ) |  |  | 2,938 |
Deferred income taxes |  |  | (18 | ) |  |  | (16 | )
Gain on sale of investment securities |  |  | - |  |  |  | (457 | )
Gain on sale of other real estate |  |  | (21 | ) |  |  | - |
Restricted stock expense |  |  | (100 | ) |  |  | (75 | )
Proceeds from sales of mortgage loans held for sale |  |  | 54,006 |  |  |  | 43,832 |
Origination of mortgage loans held for sale |  |  | (50,368 | ) |  |  | (50,009 | )
Change in: |  |  |  |  |  |  |  |
Cash surrender value of life insurance |  |  | (196 | ) |  |  | (188 | )
Right of use lease asset |  |  | 406 |  |  |  | 255 |
Other assets |  |  | 53 |  |  |  | (212 | )
Lease liability |  |  | (398 | ) |  |  | (244 | )
Other liabilities |  |  | 2,405 |  |  |  | 3,214 |
Net cash provided by operating activities |  |  | 16,373 |  |  |  | 5,983 |
Cash flows from investing activities: |  |  |  |  |  |  |  |
Purchases of investment securities available for sale |  |  | (141,780 | ) |  |  | (37,340 | )
Proceeds from sales, calls and maturities of investment securities available for sale |  |  | 5,300 |  |  |  | 20,592 |
Proceeds from paydowns of investment securities available for sale |  |  | 11,073 |  |  |  | 9,305 |
Proceeds from paydowns on other investments |  |  | 88 |  |  |  | 88 |
Redemptions (purchases) of FHLB stock |  |  | 331 |  |  |  | (3,031 | )
Net change in loans |  |  | 60,339 |  |  |  | (116,854 | )
Purchases of premises and equipment |  |  | (339 | ) |  |  | (1,085 | )
Proceeds from sale of other real estate and repossessions |  |  | 149 |  |  |  | - |
Net cash used by investing activities |  |  | (64,839 | ) |  |  | (128,325 | )
Cash flows from financing activities: |  |  |  |  |  |  |  |
Net change in deposits |  |  | 170,968 |  |  |  | 187,812 |
Net change in securities sold under agreement to repurchase |  |  | 5,048 |  |  |  | 7,526 |
Proceeds from FHLB borrowings |  |  | - |  |  |  | 70,000 |
Repayments of FHLB borrowings |  |  | - |  |  |  | - |
Repayment of Junior Subordinated Debt |  |  | - |  |  |  | (155 | )
Proceeds from Fed Funds purchased |  |  | - |  |  |  | (6,935 | )
Repayments of Fed Funds purchased |  |  | - |  |  |  | 6,935 |
Restricted stock units exercised |  |  | 39 |  |  |  | 57 |
Common stock repurchased |  |  | - |  |  |  | (2,999 | )
Cash dividends paid on common stock |  |  | (1,860 | ) |  |  | (2,647 | )
Net cash provided by financing activities |  |  | 174,195 |  |  |  | 259,594 |
Net change in cash and cash equivalents |  |  | 125,729 |  |  |  | 137,252 |
Cash and cash equivalents at beginning of period |  |  | 161,580 |  |  |  | 52,387 |
Cash and cash equivalents at end of period |  | $ | 287,309 |  |  |  | 189,639 |

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows, continued

Six Months Ended June 30, 2021 and 2020

(Dollars in thousands)

Supplemental disclosures of cash flow information: |  |  |  |  |  |
Cash paid during the period for: |  |  |  |  |  |
Interest |  | $ | 1,653 |  |  |  | 1,909 |
Income taxes |  | $ | 2,000 |  |  |  | 796 |
Noncash investing and financing activities: |  |  |  |  |  |  |  |
Change in unrealized gain on investment securities available for sale, net |  | $ | (1,440 | ) |  |  | 3,584 |
Issuance of accrued restricted stock units |  | $ | 39 |  |  |  | 57 |
Transfer of premises and equipment to other assets held for sale |  | $ | 408 |  |  |  | - |

See accompanying Notes to Consolidated Financial Statements.

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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. 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 (collectively called the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

The Bank formerly operated three banking offices focused on the Latino population that were operated as a division of the Bank under the name Banco de la Gente (“Banco”). Two of these offices remain open as Bank branches that offer the same banking services offered in the Bank’s other branches such as the taking of deposits and the making of loans.

The consolidated financial statements in this report (other than the Consolidated Balance Sheet at December 31, 2020) are unaudited. In the opinion of management, all adjustments (none of which were other than normal accruals) 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.

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 2020 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 6, 2021 Annual Meeting of Shareholders.

Correction of an Error

Subsequent to issuance of the Company’s December 31, 2020 Form 10-K, it was identified that the Company’s non-qualified deferred compensation plan had not been properly recorded on the Consolidated Balance Sheets. The deferred compensation plan requires all deferral amounts and contributions to be held in a rabbi trust, and the assets held by the trust should be recorded on the Company’s financial statements along with a corresponding liability.

For balances related to mutual fund investments held in the rabbi trust, the accrued interest receivable and other assets, accrued interest payable and other liabilities, total assets, and total liabilities line items on the Consolidated Balance Sheets were adjusted as of December 31, 2020 to reflect the asset and corresponding liability associated with the portion of the rabbi trust held in mutual fund investments. This resulted in an increase to these line items of $1.3 million. Additionally, an adjustment to the presentation of the Company’s shareholders’ equity on the Consolidated Balance Sheets has been made to disclose the number of shares of Company stock held by the rabbi trust and the cost basis for those shares, as well as a corresponding liability for the deferred compensation as of December 31, 2020.

On the Consolidated Statements of Earnings, basic earnings per share has been adjusted from $0.44 to $0.46 for the three months ended June 30, 2020 and from $0.84 to $0.87 for the six months ended June 30, 2020. The impact of the changes in the fair value of the mutual funds held in the rabbi trust and the changes in the deferred compensation liability that were not previously recorded were not considered material to the financial statements. These changes to basic earnings per share are also reflected within Note 4 to the financial statements.

In addition to the adjustments to the presentation of the Company’s shareholders’ equity on the Consolidated Balance Sheets, the Company adjusted the presentation of the Consolidated Statements of Changes in Shareholders’ Equity for all periods presented to reflect the Company shares held within the rabbi trust, as well as the corresponding deferred compensation associated with these shares.

The Company’s Consolidated Statements of Cash Flows were adjusted for the six months ended June 30, 2020 in order to reflect the changes to other assets and other liabilities made on the Consolidated Balance Sheets.

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These unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results of the periods presented. All adjustments were not considered material to the financial statements.

Revenue Recognition

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

Revenue and Method of Adoption

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

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

The following disclosures involve the Company’s material income streams derived from contracts with customers which are within the scope of ASU 2014-09. Through the Company’s wholly-owned subsidiary, PIS, the Company contracts with a registered investment advisor to perform investment advisory services on behalf of the Company’s customers. The Company receives commissions from this third party investment advisor based on the volume of business that the Company’s customers do with such investment advisor. Total revenue recognized from these contracts was $260,000 and $241,000 for the three months ended June 30, 2021 and 2020, respectively. Total revenue recognized from these contracts was $498,000 and $446,000 for the six months ended June 30, 2021 and 2020, respectively. The Company utilizes third parties to contract with the Company’s customers to perform debit and credit card clearing services. These third parties pay the Company commissions based on the volume of transactions that they process on behalf of the Company’s customers. Total revenue recognized from these contracts with these third parties was $1.2 million and $972,000 for the three months ended June 30, 2021 and 2020, respectively. Total revenue recognized from these contracts with these third parties was $2.5 million and $2.0 million for the six months ended June 30, 2021 and 2020, respectively. This revenue is reflected in the “Miscellaneous” line under “Non-interest income” on the Company’s June 30, 2021 consolidated statements of earnings. Through the Company’s wholly-owned subsidiary, REAS, the Company provides property appraisal services for negotiated fee amounts on a per appraisal basis. Total revenue recognized from these contracts with customers was $180,000 and $181,000 for the three months ended June 30, 2021 and 2020, respectively. Total revenue recognized from these contracts with customers was $388,000 for the six months ended June 30, 2021 and 2020. This revenue is reflected in the “Miscellaneous” line under “Non-interest income” on the Company’s June 30, 2021 consolidated statements of earnings. Through the Company’s wholly-owned subsidiary, CBRES, the Company provides appraisal management services. Total revenue recognized from these contracts with customers was $1.8 million and $1.4 million for the three months ended June 30, 2021 and 2020, respectively. Total revenue recognized from these contracts with customers was $3.8 million and $3.1 million for the six months ended June 30, 2021 and 2020, respectively. Due to the nature of the Company’s relationship with the customers that the Company provides services, the Company does not incur costs to obtain contracts and there are no material incremental costs to fulfill these contracts that should be capitalized.

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Disaggregation of Revenue. The Company’s portfolio of services provided to the Company’s customers consists of over 50,000 active contracts. The Company has disaggregated revenue according to timing of the transfer of service. Total revenue for the six months ended June 30, 2021 derived from contracts in which services are transferred at a point in time was approximately $4.7 million. None of the Company’s revenue is derived from contracts in which services are transferred over time. Revenue is recognized as the services are provided to the customers. Economic factors, such as the financial stress impacting businesses and individuals as a result of the novel coronavirus (“COVID-19”) pandemic, could affect the nature, amount, and timing of these cash flows, as unfavorable economic conditions could impair a customers’ ability to provide payment for services. For the Company’s deposit contracts, this risk is mitigated as the Company generally deducts payments from customers’ accounts as services are rendered. For the Company’s appraisal services, the risk is mitigated in that the appraisal is not released until payment is received.

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

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

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

Recent Accounting Pronouncements

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

Recently Adopted Accounting Guidance

ASU | Description | Effective Date | Effect on Financial Statements or Other Significant Matters
ASU 2019-07: Codification Updates to SEC Sections | Guidance updated for various Topics of the ASC to align the guidance in various SEC sections of the ASC with the requirements of certain SEC final rules. | Effective upon issuance | The adoption of this guidance did not have a material impact on the Company s results of operations, financial position or disclosures.
ASU 2018-13: Disclosure Framework Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820) | Updates the disclosure requirements on fair value measurements in ASC 820, Fair Value Measurement. | January 1, 2020 | The adoption of this guidance did not have a material impact on the Company s results of operations, financial position or disclosures.
ASU 2018-18: Clarifying the Interaction between Topic 808 and Topic 606 | Clarifies the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard. | January 1, 2020 Early adoption permitted | The adoption of this guidance did not have a material impact on the Company s results of operations, financial position or disclosures.
ASU 2018-19: Leases (Topic 842): Codification Improvements | Provides guidance to address concerns companies had raised about an accounting exception they would lose when assessing the fair value of underlying assets under the leases standard and clarify that lessees and lessors are exempt from a certain interim disclosure requirement associated with adopting the new standard. | January 1, 2020 | The adoption of this guidance did not have a material impact on the Company s results of operations, financial position or disclosures.

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The following table provides a summary of ASU’s issued by the FASB that the Company has not adopted as of June 30, 2021, which may impact the Company’s financial statements.

ASU | Description | Effective Date | Effect on Financial Statements or Other Significant Matters
ASU 2016-13: Measurement of Credit Losses on Financial Instruments | Provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. | See ASU 2019-10 below. | The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company is currently developing CECL model assumptions and comparing results to current allowance for loan loss calculations. The Company plans to run parallel calculations leading up to the effective date of this guidance to ensure it is prepared for implementation by the effective date. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.
ASU 2018-14: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans | Updates disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. | January 1, 2021 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses | Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic. | See ASU 2019-10 below. | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above.
ASU 2019-04: Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments | Addresses unintended issues accountants flagged when implementing ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, ASU 2016-13, Measurement of Credit Losses on Financial Instruments, and ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. | See ASU 2019-10 below. | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above.
ASU 2019-05: Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief | Guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. | See ASU 2019-10 below. | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above.
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, hedging. | January 1, 2023 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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ASU | Description | Effective Date | Effect on Financial Statements or Other Significant Matters
ASU 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 is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2019-12: Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes | Guidance to simplify accounting for income taxes by removing specific technical exceptions that often produce information investors have a hard time understanding. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. | January 1, 2021 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2020-01: Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the FASB Emerging Issues Task Force) | Guidance to clarify the interaction of the accounting for equity securities under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the accounting for certain forward contracts and purchased options accounted for under Topic 815. | January 1, 2021 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2020-02: Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842)—Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842) (SEC Update) | Guidance to add and amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119 related to the new credit losses standard and comments by the SEC staff related to the revised effective date of the new leases standard. | Effective upon issuance | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 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 is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2020-04: Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting | Guidance that provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The ASU is intended to help stakeholders during the global market-wide reference rate transition period. Therefore, it will be in effect for a limited time through December 31, 2022. | March 12, 2020 through December 31, 2022 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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ASU | Description | Effective Date | Effect on Financial Statements or Other Significant Matters
ASU 2020-06: Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity | Guidance to improve financial reporting associated with accounting for convertible instruments and contracts in an entity’s own equity. | January 1, 2022 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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

Reclassification

Certain amounts in the 2020 consolidated financial statements have been reclassified to conform to the 2021 presentation. These reclassifications did not have any impact on shareholders’ equity or net earnings.

(2) Investment Securities

Investment securities available for sale at June 30, 2021 and December 31, 2020 are as follows:

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | June 30, 2021 |
|  | Amortized Cost |  |  | Gross Unrealized Gains |  |  | Gross Unrealized Losses |  |  | Estimated Fair Value |
U.S Treasuries |  | $ | 7,961 |  |  |  | 30 |  |  |  | 31 |  |  |  | 7,960 |
U.S. Government sponsored enterprises |  |  | 15,098 |  |  |  | 291 |  |  |  | 195 |  |  |  | 15,194 |
Mortgage-backed securities |  |  | 207,289 |  |  |  | 2,483 |  |  |  | 654 |  |  |  | 209,118 |
State and political subdivisions |  |  | 132,038 |  |  |  | 4,185 |  |  |  | 966 |  |  |  | 135,257 |
Total |  | $ | 362,386 |  |  |  | 6,989 |  |  |  | 1,846 |  |  |  | 367,529 |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 2020 |
|  | Amortized Cost |  |  | Gross Unrealized Gains |  |  | Gross Unrealized Losses |  |  | Estimated Fair Value |
U.S. Government sponsored enterprises |  | $ | 7,384 |  |  |  | 331 |  |  |  | 208 |  |  |  | 7,507 |
Mortgage-backed securities |  |  | 143,095 |  |  |  | 2,812 |  |  |  | 593 |  |  |  | 145,314 |
State and political subdivisions |  |  | 87,757 |  |  |  | 4,758 |  |  |  | 87 |  |  |  | 92,428 |
Total |  | $ | 238,236 |  |  |  | 7,901 |  |  |  | 888 |  |  |  | 245,249 |

The current fair value and associated unrealized losses on investments in securities with unrealized losses at June 30, 2021 and December 31, 2020 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

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(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | June 30, 2021 |
|  | Less than 12 Months |  |  | 12 Months or More |  |  | Total |
|  | Fair Value |  |  | Unrealized Losses |  |  | Fair Value |  |  | Unrealized Losses |  |  | Fair Value |  |  | Unrealized Losses |
U.S. Treasuries |  | $ | 4,975 |  |  |  | 31 |  |  |  | - |  |  |  | - |  |  |  | 4,975 |  |  |  | 31 |
U.S. Government sponsored enterprises |  |  | 5,515 |  |  |  | 4 |  |  |  | 3,841 |  |  |  | 191 |  |  |  | 9,356 |  |  |  | 195 |
Mortgage-backed securities |  |  | 41,819 |  |  |  | 635 |  |  |  | 1,980 |  |  |  | 19 |  |  |  | 43,799 |  |  |  | 654 |
State and political subdivisions |  |  | 34,460 |  |  |  | 966 |  |  |  | - |  |  |  | - |  |  |  | 34,460 |  |  |  | 966 |
Total |  | $ | 86,769 |  |  |  | 1,636 |  |  |  | 5,821 |  |  |  | 210 |  |  |  | 92,590 |  |  |  | 1,846 |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 2020 |
|  | Less than 12 Months |  |  | 12 Months or More |  |  | Total |
|  | Fair Value |  |  | Unrealized Losses |  |  | Fair Value |  |  | Unrealized Losses |  |  | Fair Value |  |  | Unrealized Losses |
U.S. Government sponsored enterprises |  | $ | - |  |  |  | - |  |  |  | 4,193 |  |  |  | 208 |  |  |  | 4,193 |  |  |  | 208 |
Mortgage-backed securities |  |  | 80,827 |  |  |  | 565 |  |  |  | 4,762 |  |  |  | 28 |  |  |  | 85,589 |  |  |  | 593 |
State and political subdivisions |  |  | 7,126 |  |  |  | 87 |  |  |  | - |  |  |  | - |  |  |  | 7,126 |  |  |  | 87 |
Total |  | $ | 87,953 |  |  |  | 652 |  |  |  | 8,955 |  |  |  | 236 |  |  |  | 96,908 |  |  |  | 888 |

At June 30, 2021, unrealized losses in the investment securities portfolio relating to debt securities totaled $1.8 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the June 30, 2021 tables above, one out of two U.S. Treasury securities, 29 out of 129 securities issued by state and political subdivisions and 21 out of 92 securities issued by U.S. Government sponsored enterprises contained unrealized losses. These unrealized losses are considered temporary because of acceptable financial condition and results of operations of entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The amortized cost and estimated fair value of investment securities available for sale at June 30, 2021, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

June 30, 2021 |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |
|  | Amortized Cost |  |  | Estimated Fair Value |
Due within one year |  | $ | 12,347 |  |  |  | 12,511 |
Due from one to five years |  |  | 10,160 |  |  |  | 10,812 |
Due from five to ten years |  |  | 102,044 |  |  |  | 104,879 |
Due after ten years |  |  | 30,546 |  |  |  | 30,209 |
Mortgage-backed securities |  |  | 207,289 |  |  |  | 209,118 |
Total |  | $ | 362,386 |  |  |  | 367,529 |

No securities available for sale were sold during the three and six months ended June 30, 2021. Proceeds from sales of securities available for sale during the three and six months ended June 30, 2020 were $17.0 million and resulted in net gains of $457,000.

Securities with a fair value of approximately $79.3 million and $77.3 million at June 30, 2021 and December 31, 2020, respectively, were pledged to secure public deposits and for other purposes as required by law.

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(3) Loans

Major classifications of loans at June 30, 2021 and December 31, 2020 are summarized as follows:

(Dollars in thousands) |  |  |  |  |  |
|  | June 30, 2021 |  |  | December 31, 2020 |
Real estate loans: |  |  |  |  |  |
Construction and land development |  | $ | 90,579 |  |  |  | 94,124 |
Single-family residential |  |  | 257,901 |  |  |  | 272,325 |
Single-family residential - Banco de la Gente non-traditional |  |  | 25,198 |  |  |  | 26,883 |
Commercial |  |  | 340,216 |  |  |  | 332,971 |
Multifamily and farmland |  |  | 59,142 |  |  |  | 48,880 |
Total real estate loans |  |  | 773,036 |  |  |  | 775,183 |
Loans not secured by real estate: |  |  |  |  |  |  |  |
Commercial loans |  |  | 104,506 |  |  |  | 161,740 |
Farm loans |  |  | 742 |  |  |  | 855 |
Consumer loans |  |  | 6,519 |  |  |  | 7,113 |
All other loans |  |  | 3,557 |  |  |  | 3,748 |
Total loans |  |  | 888,360 |  |  |  | 948,639 |
Less allowance for loan losses |  |  | (9,287 | ) |  |  | (9,908 | )
Total net loans |  | $ | 879,073 |  |  |  | 938,731 |

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

| · | Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of June 30, 2021, construction and land development loans comprised approximately 10% of the Bank’s total loan portfolio.
| · | Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of June 30, 2021, single-family residential loans comprised approximately 32% of the Bank’s total loan portfolio, and include Banco’s non-traditional single-family residential loans, which were approximately 3% of the Bank’s total loan portfolio.
| · | Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of June 30, 2021, commercial real estate loans comprised approximately 38% of the Bank’s total loan portfolio.
| · | Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid or fluctuate in value based on the success of the business. As of June 30, 2021, commercial loans comprised approximately 12% of the Bank’s total loan portfolio, including $35.7 million in Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans. The Company had $75.8 million in PPP loans at December 31, 2020.

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

The following tables present an age analysis of past due loans, by loan type, as of June 30, 2021 and December 31, 2020:

June 30, 2021 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(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 |  | $ | 49 |  |  |  | - |  |  |  | 49 |  |  |  | 90,530 |  |  |  | 90,579 |  |  |  | - |
Single-family residential |  |  | 1,114 |  |  |  | 44 |  |  |  | 1,158 |  |  |  | 256,743 |  |  |  | 257,901 |  |  |  | - |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 306 |  |  |  | 41 |  |  |  | 347 |  |  |  | 24,851 |  |  |  | 25,198 |  |  |  | - |
Commercial |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 340,216 |  |  |  | 340,216 |  |  |  | - |
Multifamily and farmland |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 59,142 |  |  |  | 59,142 |  |  |  | - |
Total real estate loans |  |  | 1,469 |  |  |  | 85 |  |  |  | 1,554 |  |  |  | 771,482 |  |  |  | 773,036 |  |  |  | - |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 110 |  |  |  | - |  |  |  | 110 |  |  |  | 104,396 |  |  |  | 104,506 |  |  |  | - |
Farm loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 742 |  |  |  | 742 |  |  |  | - |
Consumer loans |  |  | 61 |  |  |  | 1 |  |  |  | 62 |  |  |  | 6,457 |  |  |  | 6,519 |  |  |  | - |
All other loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,557 |  |  |  | 3,557 |  |  |  | - |
Total loans |  | $ | 1,640 |  |  |  | 86 |  |  |  | 1,726 |  |  |  | 886,634 |  |  |  | 888,360 |  |  |  | - |

December 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(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 |  | $ | 298 |  |  |  | - |  |  |  | 298 |  |  |  | 93,826 |  |  |  | 94,124 |  |  |  | - |
Single-family residential |  |  | 3,660 |  |  |  | 270 |  |  |  | 3,930 |  |  |  | 268,395 |  |  |  | 272,325 |  |  |  | - |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 3,566 |  |  |  | 105 |  |  |  | 3,671 |  |  |  | 23,212 |  |  |  | 26,883 |  |  |  | - |
Commercial |  |  | 36 |  |  |  | - |  |  |  | 36 |  |  |  | 332,935 |  |  |  | 332,971 |  |  |  | - |
Multifamily and farmland |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 48,880 |  |  |  | 48,880 |  |  |  | - |
Total real estate loans |  |  | 7,560 |  |  |  | 375 |  |  |  | 7,935 |  |  |  | 767,248 |  |  |  | 775,183 |  |  |  | - |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 161,740 |  |  |  | 161,740 |  |  |  | - |
Farm loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 855 |  |  |  | 855 |  |  |  | - |
Consumer loans |  |  | 45 |  |  |  | 2 |  |  |  | 47 |  |  |  | 7,066 |  |  |  | 7,113 |  |  |  | - |
All other loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,748 |  |  |  | 3,748 |  |  |  | - |
Total loans |  | $ | 7,605 |  |  |  | 377 |  |  |  | 7,982 |  |  |  | 940,657 |  |  |  | 948,639 |  |  |  | - |

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The following table presents non-accrual loans as of June 30, 2021 and December 31, 2020:

(Dollars in thousands) |  |  |  |  |  |
|  | June 30, 2021 |  |  | December 31, 2020 |
Real estate loans: |  |  |  |  |  |
Single-family residential |  |  | 1,273 |  |  |  | 1,266 |
Single-family residential - |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 1,516 |  |  |  | 1,709 |
Commercial |  |  | 412 |  |  |  | 440 |
Multifamily and farmland |  |  | 111 |  |  |  | 117 |
Total real estate loans |  |  | 3,312 |  |  |  | 3,532 |
Loans not secured by real estate: |  |  |  |  |  |  |  |
Commercial loans |  |  | 59 |  |  |  | 212 |
Consumer loans |  |  | 7 |  |  |  | 14 |
Total |  | $ | 3,378 |  |  |  | 3,758 |

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $250,000 are not individually evaluated for impairment with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Accruing impaired loans were $19.7 million, $21.3 million and $22.5 million at June 30, 2021, December 31, 2020 and June 30, 2020, respectively. Interest income recognized on accruing impaired loans was $536,000, $1.2 million, and $635,000 for the six months ended June 30, 2021, the year ended December 31, 2020 and the six months ended June 30, 2020, respectively. Interest income recognized on accruing impaired loans was $253,000 and $306,000 for the three months ended June 30, 2021 and 2020, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following table presents impaired loans as of June 30, 2021:

June 30, 2021 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(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 |  | $ | 78 |  |  |  | - |  |  |  | 78 |  |  |  | 78 |  |  |  | 3 |
Single-family residential |  |  | 4,886 |  |  |  | 277 |  |  |  | 4,417 |  |  |  | 4,694 |  |  |  | 31 |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 12,692 |  |  |  | - |  |  |  | 12,075 |  |  |  | 12,075 |  |  |  | 806 |
Commercial |  |  | 2,466 |  |  |  | 441 |  |  |  | 1,987 |  |  |  | 2,428 |  |  |  | 15 |
Multifamily and farmland |  |  | 116 |  |  |  | - |  |  |  | 111 |  |  |  | 111 |  |  |  | - |
Total impaired real estate loans |  |  | 20,238 |  |  |  | 718 |  |  |  | 18,668 |  |  |  | 19,386 |  |  |  | 855 |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 319 |  |  |  | 59 |  |  |  | 199 |  |  |  | 258 |  |  |  | 3 |
Consumer loans |  |  | 15 |  |  |  | - |  |  |  | 11 |  |  |  | 11 |  |  |  | - |
Total impaired loans |  | $ | 20,572 |  |  |  | 777 |  |  |  | 18,878 |  |  |  | 19,655 |  |  |  | 858 |

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The following table presents the average impaired loan balance and the interest income recognized by loan class for the three and six months ended June 30, 2021 and 2020.

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Three months ended |  |  | Six months ended |
|  | June 30, 2021 |  |  | June 30, 2020 |  |  | June 30, 2021 |  |  | June 30, 2020 |
|  | Average Balance |  |  | Interest Income Recognized |  |  | Average Balance |  |  | Interest Income Recognized |  |  | Average Balance |  |  | Interest Income Recognized |  |  | Average Balance |  |  | Interest Income Recognized |
Real estate loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Construction and land development |  | $ | 91 |  |  |  | 1 |  |  |  | 157 |  |  |  | 4 |  |  |  | 97 |  |  |  | 3 |  |  |  | 166 |  |  |  | 7 |
Single-family residential |  |  | 6,100 |  |  |  | 57 |  |  |  | 4,778 |  |  |  | 59 |  |  |  | 5,731 |  |  |  | 118 |  |  |  | 4,734 |  |  |  | 118 |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente stated income |  |  | 10,835 |  |  |  | 160 |  |  |  | 13,856 |  |  |  | 193 |  |  |  | 11,407 |  |  |  | 337 |  |  |  | 14,028 |  |  |  | 421 |
Commercial |  |  | 2,682 |  |  |  | 29 |  |  |  | 3,115 |  |  |  | 43 |  |  |  | 2,779 |  |  |  | 64 |  |  |  | 2,700 |  |  |  | 72 |
Multifamily and farmland |  |  | 113 |  |  |  | 1 |  |  |  | - |  |  |  | - |  |  |  | 114 |  |  |  | 2 |  |  |  | - |  |  |  | - |
Total impaired real estate loans |  |  | 19,821 |  |  |  | 248 |  |  |  | 21,906 |  |  |  | 299 |  |  |  | 20,128 |  |  |  | 524 |  |  |  | 21,628 |  |  |  | 618 |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 315 |  |  |  | 5 |  |  |  | 643 |  |  |  | 6 |  |  |  | 362 |  |  |  | 11 |  |  |  | 487 |  |  |  | 15 |
Farm loans (non RE) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  |  |  |  |  | - |  |  |  | - |  |  |  | - |
Consumer loans |  |  | 15 |  |  |  | - |  |  |  | 77 |  |  |  | 1 |  |  |  | 22 |  |  |  | 1 |  |  |  | 83 |  |  |  | 2 |
Total impaired loans |  | $ | 20,151 |  |  |  | 253 |  |  |  | 22,626 |  |  |  | 306 |  |  |  | 20,512 |  |  |  | 536 |  |  |  | 22,198 |  |  |  | 635 |

The following table presents impaired loans as of and for the year ended December 31, 2020:

December 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Unpaid Contractual Principal Balance |  |  | Recorded Investment With No Allowance |  |  | Recorded Investment With Allowance |  |  | Recorded Investment in Impaired Loans |  |  | Related Allowance |  |  | Average Outstanding Impaired Loans |  |  | Interest Income Recognized |
Real estate loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Construction and land development |  | $ | 108 |  |  |  | - |  |  |  | 108 |  |  |  | 108 |  |  |  | 4 |  |  |  | 134 |  |  |  | 8 |
Single-family residential |  |  | 5,302 |  |  |  | 379 |  |  |  | 4,466 |  |  |  | 4,845 |  |  |  | 33 |  |  |  | 4,741 |  |  |  | 262 |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 13,417 |  |  |  | - |  |  |  | 12,753 |  |  |  | 12,753 |  |  |  | 862 |  |  |  | 13,380 |  |  |  | 798 |
Commercial |  |  | 2,999 |  |  |  | 1,082 |  |  |  | 1,891 |  |  |  | 2,973 |  |  |  | 14 |  |  |  | 2,940 |  |  |  | 139 |
Multifamily and farmland |  |  | 119 |  |  |  | - |  |  |  | 117 |  |  |  | 117 |  |  |  | - |  |  |  | 29 |  |  |  | 6 |
Total impaired real estate loans |  |  | 21,945 |  |  |  | 1,461 |  |  |  | 19,335 |  |  |  | 20,796 |  |  |  | 913 |  |  |  | 21,224 |  |  |  | 1,213 |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 515 |  |  |  | 211 |  |  |  | 244 |  |  |  | 455 |  |  |  | 5 |  |  |  | 564 |  |  |  | 32 |
Consumer loans |  |  | 41 |  |  |  | - |  |  |  | 37 |  |  |  | 37 |  |  |  | 1 |  |  |  | 60 |  |  |  | 5 |
Total impaired loans |  | $ | 22,501 |  |  |  | 1,672 |  |  |  | 19,616 |  |  |  | 21,288 |  |  |  | 919 |  |  |  | 21,848 |  |  |  | 1,250 |

Impaired loans collectively evaluated for impairment totaled $5.7 million and $6.2 million at June 30, 2021 and 2020, respectively and are included in the tables above.

The following tables present changes in the allowance for loan losses for the three and six months ended June 30, 2021 and 2020. PPP loans are excluded from the allowance for loan losses as PPP loans are 100 percent guaranteed by the SBA. PPP loans are classified as risk grade 3.

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(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 |
Six months ended June 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Allowance for loan losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance |  | $ | 1,196 |  |  |  | 1,843 |  |  |  | 1,052 |  |  |  | 2,212 |  |  |  | 122 |  |  |  | 1,345 |  |  |  | - |  |  |  | 128 |  |  |  | 2,010 |  |  |  | 9,908 |
Charge-offs |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (78 | ) |  |  | - |  |  |  | (158 | ) |  |  | - |  |  |  | (236 | )
Recoveries |  |  | 90 |  |  |  | 78 |  |  |  | - |  |  |  | 48 |  |  |  | - |  |  |  | 6 |  |  |  | - |  |  |  | 74 |  |  |  | - |  |  |  | 296 |
Provision |  |  | (248 | ) |  |  | (198 | ) |  |  | (72 | ) |  |  | (80 | ) |  |  | 26 |  |  |  | (277 | ) |  |  | - |  |  |  | 45 |  |  |  | 123 |  |  |  | (681 | )
Ending balance |  | $ | 1,038 |  |  |  | 1,723 |  |  |  | 980 |  |  |  | 2,180 |  |  |  | 148 |  |  |  | 996 |  |  |  | - |  |  |  | 89 |  |  |  | 2,133 |  |  |  | 9,287 |
Three months ended June 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Allowance for loan losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance |  | $ | 1,061 |  |  |  | 1,850 |  |  |  | 1,033 |  |  |  | 2,252 |  |  |  | 145 |  |  |  | 1,244 |  |  |  | - |  |  |  | 91 |  |  |  | 1,856 |  |  |  | 9,532 |
Charge-offs |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (78 | ) |  |  | - |  |  |  | (73 | ) |  |  | - |  |  |  | (151 | )
Recoveries |  |  | 40 |  |  |  | 18 |  |  |  | - |  |  |  | 36 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 38 |  |  |  | - |  |  |  | 132 |
Provision |  |  | (63 | ) |  |  | (145 | ) |  |  | (53 | ) |  |  | (108 | ) |  |  | 3 |  |  |  | (170 | ) |  |  | - |  |  |  | 33 |  |  |  | 277 |  |  |  | (226 | )
Ending balance |  | $ | 1,038 |  |  |  | 1,723 |  |  |  | 980 |  |  |  | 2,180 |  |  |  | 148 |  |  |  | 996 |  |  |  | - |  |  |  | 89 |  |  |  | 2,133 |  |  |  | 9,287 |
Allowance for loan losses at June 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance: individually |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 1 |  |  |  | 5 |  |  |  | 790 |  |  |  | 10 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 806 |
Ending balance: collectively |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  |  | 1,037 |  |  |  | 1,718 |  |  |  | 190 |  |  |  | 2,170 |  |  |  | 148 |  |  |  | 996 |  |  |  | - |  |  |  | 89 |  |  |  | 2,133 |  |  |  | 8,481 |
Ending balance |  | $ | 1,038 |  |  |  | 1,723 |  |  |  | 980 |  |  |  | 2,180 |  |  |  | 148 |  |  |  | 996 |  |  |  | - |  |  |  | 89 |  |  |  | 2,133 |  |  |  | 9,287 |
Loans at June 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance |  | $ | 90,579 |  |  |  | 257,901 |  |  |  | 25,198 |  |  |  | 340,216 |  |  |  | 59,142 |  |  |  | 104,506 |  |  |  | 742 |  |  |  | 10,076 |  |  |  | - |  |  |  | 888,360 |
Ending balance: individually evaluated for impairment |  | $ | 6 |  |  |  | 1,426 |  |  |  | 10,722 |  |  |  | 1,741 |  |  |  | - |  |  |  | 59 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 13,954 |
Ending balance: collectively evaluated for impairment |  | $ | 90,573 |  |  |  | 256,475 |  |  |  | 14,476 |  |  |  | 338,475 |  |  |  | 59,142 |  |  |  | 104,447 |  |  |  | 742 |  |  |  | 10,076 |  |  |  | - |  |  |  | 874,406 |

(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 |
Six months ended June 30, 2020: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Allowance for loan losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance |  | $ | 694 |  |  |  | 1,274 |  |  |  | 1,073 |  |  |  | 1,305 |  |  |  | 120 |  |  |  | 688 |  |  |  | - |  |  |  | 138 |  |  |  | 1,388 |  |  |  | 6,680 |
Charge-offs |  |  | (5 | ) |  |  | - |  |  |  | - |  |  |  | (7 | ) |  |  | - |  |  |  | (109 | ) |  |  | - |  |  |  | (257 | ) |  |  | - |  |  |  | (378 | )
Recoveries |  |  | 2 |  |  |  | 25 |  |  |  | - |  |  |  | 34 |  |  |  | - |  |  |  | 26 |  |  |  | - |  |  |  | 106 |  |  |  | - |  |  |  | 193 |
Provision |  |  | 840 |  |  |  | 514 |  |  |  | 41 |  |  |  | 719 |  |  |  | (5 | ) |  |  | 375 |  |  |  | - |  |  |  | 175 |  |  |  | 279 |  |  |  | 2,938 |
Ending balance |  | $ | 1,531 |  |  |  | 1,813 |  |  |  | 1,114 |  |  |  | 2,051 |  |  |  | 115 |  |  |  | 980 |  |  |  | - |  |  |  | 162 |  |  |  | 1,667 |  |  |  | 9,433 |
Three months ended June 30, 2020: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Allowance for loan losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance |  | $ | 1,293 |  |  |  | 1,713 |  |  |  | 1,084 |  |  |  | 1,799 |  |  |  | 118 |  |  |  | 1,017 |  |  |  | - |  |  |  | 180 |  |  |  | 908 |  |  |  | 8,112 |
Charge-offs |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (78 | ) |  |  | - |  |  |  | (90 | ) |  |  | - |  |  |  | (168 | )
Recoveries |  |  | - |  |  |  | 9 |  |  |  | - |  |  |  | 11 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 52 |  |  |  | - |  |  |  | 72 |
Provision |  |  | 238 |  |  |  | 91 |  |  |  | 30 |  |  |  | 241 |  |  |  | (3 | ) |  |  | 41 |  |  |  | - |  |  |  | 20 |  |  |  | 759 |  |  |  | 1,417 |
Ending balance |  | $ | 1,531 |  |  |  | 1,813 |  |  |  | 1,114 |  |  |  | 2,051 |  |  |  | 115 |  |  |  | 980 |  |  |  | - |  |  |  | 162 |  |  |  | 1,667 |  |  |  | 9,433 |
Allowance for loan losses at June 30, 2020: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance: individually |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 2 |  |  |  | 5 |  |  |  | 894 |  |  |  | 11 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 912 |
Ending balance: collectively |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  |  | 1,529 |  |  |  | 1,808 |  |  |  | 220 |  |  |  | 2,040 |  |  |  | 115 |  |  |  | 980 |  |  |  | - |  |  |  | 162 |  |  |  | 1,667 |  |  |  | 8,521 |
Ending balance |  | $ | 1,531 |  |  |  | 1,813 |  |  |  | 1,114 |  |  |  | 2,051 |  |  |  | 115 |  |  |  | 980 |  |  |  | - |  |  |  | 162 |  |  |  | 1,667 |  |  |  | 9,433 |
Loans at June 30, 2020: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance |  | $ | 110,077 |  |  |  | 268,174 |  |  |  | 29,325 |  |  |  | 303,828 |  |  |  | 49,465 |  |  |  | 188,398 |  |  |  | 887 |  |  |  | 16,389 |  |  |  | - |  |  |  | 966,543 |
Ending balance: individually |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 8 |  |  |  | 1,657 |  |  |  | 12,297 |  |  |  | 2,084 |  |  |  | - |  |  |  | 275 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 16,321 |
Ending balance: collectively |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 110,069 |  |  |  | 266,517 |  |  |  | 17,028 |  |  |  | 301,744 |  |  |  | 49,465 |  |  |  | 188,123 |  |  |  | 887 |  |  |  | 16,389 |  |  |  | - |  |  |  | 950,222 |

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The provision for loan losses for the three months ended June 30, 2021 was a recovery of $226,000, compared to a provision of $1.4 million for the three months ended June 30, 2020. The decrease in the provision for loan losses is primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves due to a net decrease in the volume of loans in the general reserve pool. At June 30, 2021, the balance of loans with existing modifications as a result of the COVID-19 pandemic was $283,000. At December 31, 2020, the balance of loans with existing modifications as a result of the COVID-19 pandemic was $18.3 million. The Company continues to track all loans that are currently modified or have been modified as a result of the COVID-19 pandemic. The loan balances associated with COVID-19 pandemic related modifications have been grouped into their own pool within the Company’s Allowance for Loan and Lease Losses (“ALLL”) model as they have a higher likelihood of risk, and a higher reserve rate has been applied to that pool. Of all loans modified as a result of the COVID-19 pandemic, $108.2 million have returned to their original terms; however, the effects of stimulus in the current environment are still unknown, and additional losses may be present in loans that are currently modified and/or loans that were once modified. At December 31, 2020, the balance for all loans that were then currently modified or previously modified but returned to their original terms was $119.6 million. The $11.4 million decrease from December 31, 2020 to June 30, 2021 in the balance of currently or previously modified loans that had returned to their original terms is primarily due to loans paid off during the six months ended June 30, 2021. Loan payment modifications associated with the COVID-19 pandemic are not classified as TDR due to Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), which provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP.

The provision for loan losses for the six months ended June 30, 2021 was a recovery of $681,000, compared to a provision of $2.9 million for the six months ended June 30, 2020. The decrease in the provision for loan losses is primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves due to a net decrease in the volume of loans in the general reserve pool.

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

| · | Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. Certificates of deposit or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.
| · | Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability. The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.
| · | Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).
| · | Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.
| · | Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.
| · | Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any). There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
| · | Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified as Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.
| · | Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

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The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of June 30, 2021 and December 31, 2020:

June 30, 2021 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Real Estate Loans |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Construction and Land Development |  |  | Single-Family Residential |  |  | Single-Family Residential - Banco de la Gente non-traditional |  |  | Commercial |  |  | Multifamily and Farmland |  |  | Commercial |  |  | Farm |  |  | Consumer |  |  | All Other |  |  | Total |
1- Excellent Quality |  | $ | - |  |  |  | 4,463 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 427 |  |  |  | - |  |  |  | 724 |  |  |  | - |  |  |  | 5,614 |
2- High Quality |  |  | 8,186 |  |  |  | 105,826 |  |  |  | - |  |  |  | 36,894 |  |  |  | 20 |  |  |  | 15,825 |  |  |  | - |  |  |  | 2,034 |  |  |  | 1,430 |  |  |  | 170,215 |
3- Good Quality |  |  | 78,058 |  |  |  | 124,184 |  |  |  | 9,350 |  |  |  | 257,930 |  |  |  | 55,338 |  |  |  | 80,494 |  |  |  | 728 |  |  |  | 3,450 |  |  |  | 1,442 |  |  |  | 610,974 |
4- Management Attention |  |  | 4,218 |  |  |  | 17,083 |  |  |  | 11,515 |  |  |  | 34,508 |  |  |  | 3,110 |  |  |  | 5,711 |  |  |  | 14 |  |  |  | 278 |  |  |  | 685 |  |  |  | 77,122 |
5- Watch |  |  | 39 |  |  |  | 2,999 |  |  |  | 1,862 |  |  |  | 10,031 |  |  |  | 563 |  |  |  | 1,985 |  |  |  | - |  |  |  | 5 |  |  |  | - |  |  |  | 17,484 |
6- Substandard |  |  | 78 |  |  |  | 3,346 |  |  |  | 2,471 |  |  |  | 853 |  |  |  | 111 |  |  |  | 64 |  |  |  | - |  |  |  | 28 |  |  |  | - |  |  |  | 6,951 |
7- Doubtful |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
8- Loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Total |  | $ | 90,579 |  |  |  | 257,901 |  |  |  | 25,198 |  |  |  | 340,216 |  |  |  | 59,142 |  |  |  | 104,506 |  |  |  | 742 |  |  |  | 6,519 |  |  |  | 3,557 |  |  |  | 888,360 |

December 31, 2020 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Real Estate Loans |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Construction and Land Development |  |  | Single-Family Residential |  |  | Single-Family Residential - Banco de la Gente non-traditional |  |  | Commercial |  |  | Multifamily and Farmland |  |  | Commercial |  |  | Farm |  |  | Consumer |  |  | All Other |  |  | Total |
1- Excellent Quality |  | $ | 228 |  |  |  | 9,867 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 406 |  |  |  | - |  |  |  | 678 |  |  |  | - |  |  |  | 11,179 |
2- High Quality |  |  | 9,092 |  |  |  | 121,331 |  |  |  | - |  |  |  | 40,569 |  |  |  | 22 |  |  |  | 19,187 |  |  |  | - |  |  |  | 2,237 |  |  |  | 1,563 |  |  |  | 194,001 |
3- Good Quality |  |  | 76,897 |  |  |  | 115,109 |  |  |  | 10,170 |  |  |  | 241,273 |  |  |  | 44,890 |  |  |  | 128,727 |  |  |  | 832 |  |  |  | 3,826 |  |  |  | 1,477 |  |  |  | 623,201 |
4- Management Attention |  |  | 4,917 |  |  |  | 20,012 |  |  |  | 12,312 |  |  |  | 39,370 |  |  |  | 3,274 |  |  |  | 11,571 |  |  |  | 23 |  |  |  | 336 |  |  |  | 708 |  |  |  | 92,523 |
5- Watch |  |  | 2,906 |  |  |  | 2,947 |  |  |  | 1,901 |  |  |  | 10,871 |  |  |  | 694 |  |  |  | 1,583 |  |  |  | - |  |  |  | 6 |  |  |  | - |  |  |  | 20,908 |
6- Substandard |  |  | 84 |  |  |  | 3,059 |  |  |  | 2,500 |  |  |  | 888 |  |  |  | - |  |  |  | 266 |  |  |  | - |  |  |  | 30 |  |  |  | - |  |  |  | 6,827 |
7- Doubtful |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
8- Loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Total |  | $ | 94,124 |  |  |  | 272,325 |  |  |  | 26,883 |  |  |  | 332,971 |  |  |  | 48,880 |  |  |  | 161,740 |  |  |  | 855 |  |  |  | 7,113 |  |  |  | 3,748 |  |  |  | 948,639 |

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $2.2 million and $3.8 million at June 30, 2021 and December 31, 2020, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were no performing loans classified as TDR loans at June 30, 2021 and December 31, 2020.

There were no new TDR modifications during the three and six months ended June 30, 2021 and 2020.

There were no loans modified as TDR that defaulted during the six months ended June 30, 2021 and 2020, which were within 12 months of their modification date. Generally, a TDR loan is considered to be in default once it becomes 90 days or more past due following a modification.

On March 27, 2020, President Trump signed the CARES Act, which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the PPP. Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. A second round of PPP funding, signed into law by President Trump on April 24, 2020, provided $320 billion additional funding for the PPP. The Bank is participating as a lender in the PPP. Total PPP loans originated as of June 30, 2021 amounted to $128.1 million. The outstanding balance of PPP loans was $35.7 million and $75.8 million at June 30, 2021 and December 31, 2020, respectively. The Bank has received $5.7 million and $4.0 million in fees from the SBA for PPP loans originated as of June 30, 2021. The Bank recognized $2.5 million and $1.4 million PPP loan fee income for the six months ended June 30, 2021 and the year ended December 31, 2020 respectively. PPP loan fee income recognized for the three months ended June 30, 2021 was $1.5 million. No PPP loan fee income was recognized for the three and six months ended June 30, 2020.

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(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 six months ended June 30, 2021 and 2020 is as follows:

For the three months ended June 30, 2021 |  |  |  |  |  |  |  |  |
|  | Net Earnings (Dollars in thousands) |  |  | Weighted Average Number of Shares |  |  | Per Share Amount |
Basic earnings per share |  | $ | 4,615 |  |  |  | 5,630,580 |  |  | $ | 0.82 |
Effect of dilutive securities: |  |  |  |  |  |  |  |  |  |  |  |
Restricted stock units |  |  | - |  |  |  | 12,683 |  |  |  |  |
Shares held in deferred comp plan |  |  |  |  |  |  | 157,897 |  |  |  |  |
Diluted earnings per share |  | $ | 4,615 |  |  |  | 5,801,160 |  |  | $ | 0.80 |

For the six months ended June 30, 2021 |  |  |  |  |  |  |  |  |
|  | Net Earnings (Dollars in thousands) |  |  | Weighted Average Number of Shares |  |  | Per Share Amount |
Basic earnings per share |  | $ | 8,736 |  |  |  | 5,630,995 |  |  | $ | 1.55 |
Effect of dilutive securities: |  |  |  |  |  |  |  |  |  |  |  |
Restricted stock units |  |  | - |  |  |  | 12,427 |  |  |  |  |
Shares held in deferred comp plan |  |  |  |  |  |  | 157,227 |  |  |  |  |
Diluted earnings per share |  | $ | 8,736 |  |  |  | 5,800,649 |  |  | $ | 1.51 |

For the three months ended June 30, 2020 |  |  |  |  |  |  |  |  |
|  | Net Earnings (Dollars in thousands) |  |  | Weighted Average Number of Shares |  |  | Per Share Amount |
Basic earnings per share |  | $ | 2,561 |  |  |  | 5,637,711 |  |  | $ | 0.46 |
Effect of dilutive securities: |  |  |  |  |  |  |  |  |  |  |  |
Restricted stock units |  |  | - |  |  |  | 13,127 |  |  |  |  |
Shares held in deferred comp plan |  |  | - |  |  |  | 149,013 |  |  |  |  |
Diluted earnings per share |  | $ | 2,561 |  |  |  | 5,799,851 |  |  | $ | 0.44 |

For the six months ended June 30, 2020 |  |  |  |  |  |  |  |  |
|  | Net Earnings (Dollars in thousands) |  |  | Weighted Average Number of Shares |  |  | Per Share Amount |
Basic earnings per share |  | $ | 4,928 |  |  |  | 5,680,625 |  |  | $ | 0.87 |
Effect of dilutive securities: |  |  |  |  |  |  |  |  |  |  |  |
Restricted stock units |  |  | - |  |  |  | 13,284 |  |  |  |  |
Shares held in deferred comp plan |  |  | - |  |  |  | 147,814 |  |  |  |  |
Diluted earnings per share |  | $ | 4,928 |  |  |  | 5,841,723 |  |  | $ | 0.84 |

(5) Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. The 2009 Plan expired on May 7, 2019 but still governs the rights and obligations of the parties for grants made thereunder. As of June 30, 2021, there were no outstanding shares reserved for possible issuance under the 2009 Plan.

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The Company granted 16,583 restricted stock units under the 2009 Plan at a grant date fair value of $16.34 per share during the first quarter of 2015. The Company granted 5,544 restricted stock units under the 2009 Plan at a grant date fair value of $16.91 per share during the first quarter of 2016. The Company granted 4,114 restricted stock units under the 2009 Plan at a grant date fair value of $25.00 per share during the first quarter of 2017. The Company granted 3,725 restricted stock units under the 2009 Plan at a grant date fair value of $31.43 per share during the first quarter of 2018. The Company granted 5,290 restricted stock units under the 2009 Plan at a grant date fair value of $28.43 per share during the first quarter of 2019. The number of restricted stock units granted and grant date fair values for the restricted stock units granted in 2015 through 2017 have been restated to reflect the 10% stock dividend that was paid in the fourth quarter of 2017. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (four years from the grant date for the 2015, 2016, 2017, 2018 and 2019 grants). The amount of expense recorded each period reflects the changes in the Company’s stock price during such period. As of June 30, 2021, the total unrecognized compensation expense related to the restricted stock unit grants under the 2009 Plan was $66,000.

The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2020 (the “2020 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. A total of 300,000 shares were reserved for possible issuance under the 2020 Plan when it was adopted. As of June 30, 2021, a total of 285,075 shares out of the initial 300,000 shares reserved remain available for future issuance under the 2020 Plan. All stock-based rights under the 2020 Plan must be granted or awarded by May 7, 2030 (or ten years from the 2020 Plan effective date).

The Company granted 7,635 restricted stock units under the 2020 Plan at a grant date fair value of $17.08 per share during the second quarter of 2020. The Company granted 7,290 restricted stock units under the 2020 Plan at a grant date fair value of $22.04 per share during the first quarter of 2021. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (four years from the grant date for 2020 and 2021 grants). As of June 30, 2021, the total unrecognized compensation expense related to the restricted stock unit grants under the 2020 Plan was $308,000.

The Company recognized compensation expense for restricted stock unit awards granted under the 2009 Plan and 2020 Plan of $99,000 for the six months ended June 30, 2021. The Company recognized a $75,000 credit to compensation expense for restricted stock unit awards granted under the 2009 Plan and 2020 Plan for the six months ended June 30, 2020 due to a reduction in the Company’s stock price from $32.85 per share at December 31, 2019, compared to $17.67 per share at June 30, 2020.

(6) 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 methods of determining the fair value of assets and liabilities presented in this note are consistent with methodologies disclosed in Note 16 of the Company’s 2020 Form 10-K, except for the valuation of loans which was impacted by the adoption of ASU No. 2016-01.

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.

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

Loans

In accordance with ASU No. 2016-01, the fair value of loans, excluding previously presented impaired 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 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 and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

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Limitations

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

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

The tables below present the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy, as of June 30, 2021 and December 31, 2020.

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | June 30, 2021 |
|  | Fair Value Measurements |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
U. S Treasuries |  | $ | 7,960 |  |  |  | - |  |  | $ | 7,960 |  |  |  | - |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  |  | 15,194 |  |  |  | - |  |  |  | 15,194 |  |  |  | - |
Mortgage-backed securities |  |  | 209,118 |  |  |  | - |  |  |  | 209,118 |  |  |  | - |
State and political subdivisions |  |  | 135,257 |  |  |  | - |  |  |  | 135,257 |  |  |  | - |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 2020 |
|  | Fair Value Measurements |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  | $ | 7,507 |  |  |  | - |  |  |  | 7,507 |  |  |  | - |
Mortgage-backed securities |  |  | 145,314 |  |  |  | - |  |  |  | 145,314 |  |  |  | - |
State and political subdivisions |  |  | 92,428 |  |  |  | - |  |  |  | 92,428 |  |  |  | - |

The tables below present the balance of mutual funds held in the deferred compensation trust, which are measured at fair value on a recurring basis by level within the fair value hierarchy, as of June 30, 2021 and December 31, 2020.

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | June 30, 2021 |
|  | Fair Value Measurements |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
Mutual funds held in deferred compensation trust |  | $ | 1,421 |  |  |  | - |  |  |  | 1,421 |  |  |  | - |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 2020 |
|  | Fair Value Measurements |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
Mutual funds held in deferred compensation trust |  | $ | 1,320 |  |  |  | - |  |  |  | 1,320 |  |  |  | - |

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at June 30, 2021 and December 31, 2020 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.

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(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value Measurements June 30, 2021 |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
Mortgage loans held for sale |  | $ | 5,501 |  |  |  | - |  |  |  | - |  |  |  | 5,501 |
Impaired loans |  |  | 18,797 |  |  |  | - |  |  |  | - |  |  |  | 18,797 |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value Measurements December 31, 2020 |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
Mortgage loans held for sale |  | $ | 9,139 |  |  |  | - |  |  |  | - |  |  |  | 9,139 |
Impaired loans |  |  | 20,369 |  |  |  | - |  |  |  | - |  |  |  | 20,369 |
Other real estate |  |  | 128 |  |  |  | - |  |  |  | - |  |  |  | 128 |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value June 30, 2021 |  |  | Fair Value December 31, 2020 |  |  | Valuation Technique |  | Significant Unobservable Inputs |  |  | General Range of Significant Unobservable Input Values |
Mortgage loans held for sale |  | $ | 5,501 |  |  |  | 9,139 |  |  | Rate lock commitment |  |  | N/A |  |  |  | N/A |
Impaired loans |  |  | 18,797 |  |  |  | 20,369 |  |  | Appraised value and discounted cash flows |  | Discounts to reflect current market conditions and ultimate collectability |  |  | 0 - 25 | %
Other real estate |  |  | - |  |  |  | 128 |  |  | Appraised value |  | Discounts to reflect current market conditions and estimated costs to sell |  |  | 0 - 25 | %

The carrying amount and estimated fair value of financial instruments at June 30, 2021 and December 31, 2020 are as follows:

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  |  |  |  | Fair Value Measurements at June 30, 2021 |
|  | Carrying Amount |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |  |  | Total |
Assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 287,309 |  |  |  | 287,309 |  |  |  | - |  |  |  | - |  |  |  | 287,309 |
Investment securities available for sale |  |  | 367,529 |  |  |  | - |  |  |  | 367,529 |  |  |  | - |  |  |  | 367,529 |
Other investments |  |  | 3,758 |  |  |  | - |  |  |  | - |  |  |  | 3,758 |  |  |  | 3,758 |
Mortgage loans held for sale |  |  | 5,501 |  |  |  | - |  |  |  | - |  |  |  | 5,501 |  |  |  | 5,501 |
Loans, net |  |  | 879,073 |  |  |  | - |  |  |  | - |  |  |  | 861,686 |  |  |  | 861,686 |
Mutual funds held in deferred |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
compensation trust |  |  | 1,421 |  |  |  | - |  |  |  | 1,421 |  |  |  | - |  |  |  | 1,421 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 1,392,054 |  |  |  | - |  |  |  | - |  |  |  | 1,389,964 |  |  |  | 1,389,964 |
Securities sold under agreements |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
to repurchase |  |  | 31,249 |  |  |  | - |  |  |  | 31,249 |  |  |  | - |  |  |  | 31,249 |
Junior subordinated debentures |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |

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(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  |  |  |  | Fair Value Measurements at December 31, 2020 |
|  | Carrying Amount |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |  |  | Total |
Assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 161,580 |  |  |  | 161,580 |  |  |  | - |  |  |  | - |  |  |  | 161,580 |
Investment securities available for sale |  |  | 245,249 |  |  |  | - |  |  |  | 245,249 |  |  |  | - |  |  |  | 245,249 |
Other investments |  |  | 4,155 |  |  |  | - |  |  |  | - |  |  |  | 4,155 |  |  |  | 4,155 |
Mortgage loans held for sale |  |  | 9,139 |  |  |  | - |  |  |  | - |  |  |  | 9,139 |  |  |  | 9,139 |
Loans, net |  |  | 938,731 |  |  |  | - |  |  |  | - |  |  |  | 924,845 |  |  |  | 924,845 |
Mutual funds held in deferred |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
compensation trust |  |  | 1,320 |  |  |  | - |  |  |  | 1,320 |  |  |  | - |  |  |  | 1,320 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 1,221,086 |  |  |  | - |  |  |  | - |  |  |  | 1,216,503 |  |  |  | 1,216,503 |
Securities sold under agreements |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
to repurchase |  |  | 26,201 |  |  |  | - |  |  |  | 26,201 |  |  |  | - |  |  |  | 26,201 |
Junior subordinated debentures |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |

(7) Leases

As of June 30, 2021, the Company had operating ROU assets of $3.0 million and operating lease liabilities of $3.1 million. The Company 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 Company if the option is not exercised. As allowed by ASU 2016-02, 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.

The following table presents lease cost and other lease information as of June 30, 2021 and 2020.

(Dollars in thousands) |  |  |  |  |  |
|  | June 30, 2021 |  |  | June 30, 2020 |
Operating lease cost |  | $ | 418 |  |  | $ | 443 |
Other information: |  |  |  |  |  |  |  |
Cash paid for amounts included in the measurement of lease liabilities |  |  | 404 |  |  |  | 432 |
Operating cash flows from operating leases |  |  | - |  |  |  | - |
Right-of-use assets obtained in exchange for new lease liabilities - operating leases |  |  | 942 |  |  |  | 132 |
Weighted-average remaining lease term - operating leases |  |  | 6.84 |  |  |  | 7.03 |
Weighted-average discount rate - operating leases |  |  | 2.71 | % |  |  | 3.13 | %

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The following table presents lease maturities as of June 30, 2021 and December 31, 2020.

(Dollars in thousands) |  |  |  |  |  |
Maturity Analysis of Operating Lease Liabilities: |  | June 30, 2021 |  |  | December 31, 2020 |
2021 |  | $ | 357 |  |  | $ | 754 |
2022 |  |  | 550 |  |  |  | 588 |
2023 |  |  | 544 |  |  |  | 567 |
2024 |  |  | 489 |  |  |  | 489 |
2025 |  |  | 433 |  |  |  | 433 |
Thereafter |  |  | 1,041 |  |  |  | 1,041 |
Total |  |  | 3,414 |  |  |  | 3,872 |
Less: Imputed Interest |  |  | (341 | ) |  |  | (401 | )
Operating Lease Liability |  | $ | 3,073 |  |  | $ | 3,471 |

(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.

The SBA has continued to forgive the Bank’s PPP loans. The outstanding balance of PPP loans was $33.1 million at July 31, 2021, as compared to $35.7 million at June 30, 2021. The decrease from June 30, 2021 to July 31, 2021 was primarily due to PPP loans being forgiven by the SBA.

The Bank closed its West Lincoln branch location on June 11, 2021. The West Lincoln branch property was sold on July 1, 2021 for a net gain of $107,000 that will be recognized in the third quarter of 2021. The $408,000 net book value of the West Lincoln branch property at June 30, 2021 was classified as held for sale at June 30, 2021 and is reflected in “Accrued interest receivable and other assets” on the Company’s June 30, 2021 consolidated balance sheets.

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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 and the Company’s Consolidated Financial Statements and Notes thereto on pages A-26 through A-71 of the Company’s 2020 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 6, 2021 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 and Wake counties, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation.

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 loan losses and changes in these economic factors could result in increases or decreases to the provision for loan losses.

COVID-19 has adversely affected, and may continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak in December 2019 and January 2020, market interest rates declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. Such events generally had an adverse effect on business and consumer confidence and the Company and its customers. On March 3, 2020, the Federal Reserve Federal Open Market Committee (“FOMC”) reduced the target federal funds rate by 50 basis points to a range of 1.00% to 1.25%. Subsequently on March 16, 2020, the FOMC further reduced the target federal funds rate by an additional 100 basis points to a range of 0.00% to 0.25%. These reductions in interest rates and other effects of the COVID-19 pandemic had an adverse effect on the Company’s financial condition and results of operations. Prior to the occurrence of the COVID-19 pandemic, economic conditions, while not as robust as the economic conditions during 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. See COVID-19 Impact below for additional information regarding the impact of the COVID-19 pandemic on the Company’s business.

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.

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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.

COVID 19 Impact

Overview. The COVID-19 pandemic has caused unprecedented disruption that has affected daily living and negatively impacted the global economy, the banking industry and the Company. While we are unable to estimate the magnitude, the COVID-19 pandemic and the related global economic crisis may adversely affect our future operating results. As such, the impact of the COVID-19 pandemic on future fiscal periods is subject to a high degree of uncertainty. The emergence of COVID-19 and new variants of the virus around the world, and particularly in the United States and Canada, continues to present significant risks to the Company, not all of which the Company is able to fully evaluate or even to foresee at the current time. The pandemic has affected the Company’s financial results and business operations, and economic and health conditions in the United States and across most of the globe have continued to change since the beginning of the pandemic. Management cannot predict the full impact of the pandemic on the Company’s management and employees, its customers nor to economic conditions generally, and such effects could exist for an extended period of time.

Effects on Our Market Areas. Our commercial and consumer banking products and services are offered primarily in North Carolina where individual and governmental responses to the COVID-19 pandemic led to a broad curtailment of economic activity beginning in March 2020. In North Carolina, schools closed for the remainder of the 2019-2020 academic year, businesses were ordered to temporarily close or reduce their business operations to accommodate social distancing and shelter in place requirements, non-critical healthcare services were significantly curtailed and unemployment levels rose. Since the initial shut down in March 2020, phased reopening plans began in mid-May of 2020 and continued through mid-May of 2021 subject to public health guidelines, restrictions and limitations on capacity. In mid-May 2021, as the number of COVID-19 cases decreased and COVID-19 vaccinations increased and new guidance was issued by the Center for Disease Control for fully vaccinated individuals, the COVID-19 restrictions were primarily lifted in North Carolina allowing businesses to operate in a manner in which they operated prior to the COVID-19 pandemic. In mid-July 2021, despite vaccinations being readily available to all individuals living in North Carolina over the age of 12, COVID-19 vaccinations have slowed and the number of COVID-19 cases have started to rise. We are unable to predict if COVID-19 cases will continue to rise and the impact that such rise will have on businesses and whether additional public health guidelines, restrictions and limitations will be implemented.

Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

| · | The Federal Reserve decreased the range for the federal funds target rate by 0.5 percent on March 3, 2020, and by another 1.0 percent on March 16, 2020, reaching a current range of 0.0 - 0.25 percent.
| · | On March 27, 2020, President Trump signed the CARES Act, which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the Small Business Administration (“SBA”), referred to as the Paycheck Protection Program (“PPP”). Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals could apply for loans from existing SBA lenders and other approved regulated lenders that enrolled in the program, subject to numerous limitations and eligibility criteria. After the initial $349 billion in funds for the PPP was exhausted, an additional $310 billion in funding for PPP loans was authorized. On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (the “Economic Aid Act”) became law. The Economic Aid Act reopened and expanded the PPP loan program. The changes to the PPP program allowed new borrowers to apply for a loan under the original PPP loan program and the creation of an additional PPP loan for eligible borrowers. The Economic Aid Act also revised certain PPP requirements, including aspects of loan forgiveness on existing PPP loans. Under the Economic Aid Act, the PPP loan program was set to expire on March 31, 2021; however, the PPP Extension Act which was signed into law on March 30, 2021 extended the PPP loan program until May 31, 2021. The Bank participated as a lender in the PPP. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to troubled debt restructured (“TDR”) loans for a limited period of time to account for the effects of COVID-19. See Note 3 of the financial statements for additional disclosure of loan modifications as of June 30, 2021.

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| · | On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs. See Note 3 of the financial statements for additional disclosure of loan modifications as of June 30, 2021.
| · | On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and mid-sized businesses, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which established two new loan facilities intended to facilitate lending to small and mid-sized businesses: (1) the Main Street New Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or MSELF. MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program is up to $600 billion. The program is designed for businesses with up to 10,000 employees or $2.5 billion in 2019 revenues. In addition, the Federal Reserve created a Municipal Liquidity Facility to support state and local governments with up to $500 billion in lending, with the Treasury Department backing $35 billion for the facility using funds appropriated by the CARES Act. The facility makes short-term financing available to cities with a population of more than one million or counties with a population of greater than two million. The Federal Reserve expanded both the size and scope of its Primary and Secondary Market Corporate Credit Facilities to support up to $750 billion in credit to corporate debt issuers. This will allow companies that were investment grade before the onset of COVID-19 but then subsequently downgraded after March 22, 2020 to gain access to the facility. Finally, the Federal Reserve announced that its Term Asset-Backed Securities Loan Facility will be scaled up in scope to include the triple A-rated tranche of commercial mortgage-backed securities and newly issued collateralized loan obligations. The size of the facility is $100 billion. The Bank did not participate in the MSELF or MSNLF.
| · | In addition to the policy responses described above, the federal bank regulatory agencies, along with their state counterparts, issued a stream of guidance in response to the COVID-19 pandemic and taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act (“CRA”) for certain pandemic related loans, investments and public service. Moreover, because of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of their regular institutions, including making greater use of off-site reviews. The Federal Reserve also issued guidance encouraging banking institutions to utilize its discount window for loans and intraday credit extended by its Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities. The FDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and the Federal Reserve’s PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.

Effects on Our Business. The COVID-19 pandemic and the specific developments referred to above have had and will likely continue to have an impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the hotel, restaurant and retail industries will continue to endure economic distress, which has caused, and may continue to cause, them to draw on their existing lines of credit and adversely affect their ability to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, including labor shortages, may also impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, and the value of certain collateral securing our loans. As a result, our financial condition, capital levels and results of operations may be adversely affected, as described in further detail below.

Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:

| · | On March 13, 2020 we enacted our Pandemic Plan. We used available physical resources to achieve appropriate social distancing protocols in all facilities; in addition, we established mandatory remote work to isolate certain personnel essential to critical business continuity operations. We also expanded and tested remote access for the core banking system, funds transfer and loan operations.

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| · | We are actively working with loan customers to evaluate prudent loan modification terms.
| · | We continue to promote our digital banking options through our website. Customers are encouraged to utilize online and mobile banking tools, and our customer service and retail departments are fully staffed and available to assist customers remotely.
| · | We were a participating lender in the PPP. We believed it was our responsibility as a community bank to assist the SBA in the distribution of funds authorized under the CARES Act to our customers and communities.
| · | On March 19, 2020, we restricted branch customer activity to drive-up and appointment only services. Branch lobbies were reopened on May 20, 2020. One small branch located in an assisted living facility was permanently closed effective December 31, 2020 due to limited lobby space and COVID-19 restrictions. All business functions continue to be operational. We continue to pay all employees according to their normal work schedule, even if their work has been reduced. No employees have been furloughed. While the majority of employees are now working on-site, some employees whose job responsibilities can be effectively carried out remotely continue to work from home. Employees working on-site are observing current public health guidelines.

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. 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 2020 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 6, 2021 Annual Meeting of Shareholders.

Many of the Company’s assets and liabilities are recorded using various techniques that require significant judgment as to recoverability. The collectibility of loans is reflected through the Company’s estimate of the allowance for loan losses. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectibility. 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 (6) of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report.

Results of Operations

Summary. Net earnings were $4.6 million or $0.82 basic net earnings per share and $0.80 diluted net earnings per share for the three months ended June 30, 2021, as compared to $2.6 million or $0.46 basic net earnings per share and $0.44 diluted net earnings per share for the same period one year ago. The increase in second quarter net earnings is primarily due to an increase in net interest income, a decrease in the provision for loan losses and an increase in non-interest income, which were partially offset by an increase in non-interest expense during the three months ended June 30, 2021, compared to the three months ended June 30, 2020, as discussed below.

The annualized return on average assets was 1.18% for the three months ended June 30, 2021, compared to 0.76% for the same period one year ago, and annualized return on average shareholders’ equity was 13.11% for the three months ended June 30, 2021, compared to 7.64% for the same period one year ago.

Net Interest Income. Net interest income, the major component of the Company’s net earnings, was $11.7 million for the three months ended June 30, 2021, compared to $10.7 million for the three months ended June 30, 2020. The increase in net interest income was due to a $879,000 increase in interest income and a $70,000 decrease in interest expense. The increase in interest income was primarily due to a $823,000 increase in interest income and fees on loans, which was primarily due to a $1.5 million increase in fee income on SBA PPP loans. The decrease in interest expense was primarily due to a decrease in Federal Home Loan Bank (“FHLB”) borrowings.

Interest income was $12.5 million for the three months ended June 30, 2021, compared to $11.6 million for the three months ended June 30, 2020. The increase in interest income was primarily due to a $823,000 increase in interest income and fees on loans, which was primarily due to a $1.5 million increase in fee income on SBA PPP loans. During the three months ended June 30, 2021, average loans decreased $30.9 million to $916.4 million from $947.3 million for the three months ended June 30, 2020. During the three months ended June 30, 2021, average investment securities available for sale increased $151.8 million to $346.9 million from $195.1 million for the three months ended June 30, 2020. The average yield on loans for the three months ended June 30, 2021 and 2020 was 4.82% and 4.32%, respectively. The average yield on investment securities available for sale was 1.80% and 3.09% for the three months ended June 30, 2021 and 2020, respectively. The average yield on earning assets was 3.43% and 3.77% for the three months ended June 30, 2021 and 2020, respectively.

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Interest expense was $842,000 for the three months ended June 30, 2021, compared to $912,000 for the three months ended June 30, 2020. The decrease in interest expense was primarily due to a decrease in FHLB borrowings. During the three months ended June 30, 2021, average interest-bearing non-maturity deposits increased $164.8 million to $735.0 million from $570.2 million for the three months ended June 30, 2020. During the three months ended June 30, 2021, average certificates of deposit increased $6.6 million to $106.7 million from $100.1 million for the three months ended June 30, 2020. Average FHLB borrowings decreased $70.0 million to zero for the three months ended June 30, 2021 from $70.0 million for the three months ended June 30, 2020. The average rate paid on interest-bearing checking and savings accounts was 0.30% and 0.32% for the three months ended June 30, 2021 and 2020, respectively. The average rate paid on certificates of deposit was 0.72% for the three months ended June 30, 2021, compared to 0.90% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.38% for the three months ended June 30, 2021, compared to 0.47% for the same period one year ago.

The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the three months ended June 30, 2021 and 2020. 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 June 30, 2021 and 2020 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 |
|  | June 30, 2021 |  |  | June 30, 2020 |
(Dollars in thousands) |  | Average Balance |  |  | Interest |  |  | Yield / Rate |  |  | Average Balance |  |  | Interest |  |  | Yield / Rate |
Interest-earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans receivable |  | $ | 916,393 |  |  |  | 11,003 |  |  |  | 4.82 | % |  | $ | 947,344 |  |  |  | 10,180 |  |  |  | 4.32 | %
Investments - taxable |  |  | 211,422 |  |  |  | 649 |  |  |  | 1.23 | % |  |  | 85,505 |  |  |  | 554 |  |  |  | 2.61 | %
Investments - nontaxable* |  |  | 139,704 |  |  |  | 936 |  |  |  | 2.69 | % |  |  | 117,271 |  |  |  | 1,004 |  |  |  | 3.44 | %
Federal funds sold |  |  | - |  |  |  | - |  |  |  | 0.00 | % |  |  | 75,393 |  |  |  | 22 |  |  |  | 0.12 | %
Other |  |  | 209,737 |  |  |  | 49 |  |  |  | 0.09 | % |  |  | 33,070 |  |  |  | 41 |  |  |  | 0.50 | %
Total interest-earning assets |  |  | 1,477,256 |  |  |  | 12,637 |  |  |  | 3.43 | % |  |  | 1,258,583 |  |  |  | 11,801 |  |  |  | 3.77 | %
Non-interest earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  |  | 32,350 |  |  |  |  |  |  |  |  |  |  |  | 37,250 |  |  |  |  |  |  |  |  |
Allowance for loan losses |  |  | (9,572 | ) |  |  |  |  |  |  |  |  |  |  | (8,084 | ) |  |  |  |  |  |  |  |
Other assets |  |  | 63,536 |  |  |  |  |  |  |  |  |  |  |  | 72,659 |  |  |  |  |  |  |  |  |
Total assets |  | $ | 1,563,570 |  |  |  |  |  |  |  |  |  |  | $ | 1,360,408 |  |  |  |  |  |  |  |  |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand, MMDA & savings deposits |  | $ | 734,988 |  |  |  | 543 |  |  |  | 0.30 | % |  | $ | 570,220 |  |  |  | 448 |  |  |  | 0.32 | %
Time deposits |  |  | 106,669 |  |  |  | 191 |  |  |  | 0.72 | % |  |  | 100,064 |  |  |  | 224 |  |  |  | 0.90 | %
FHLB borrowings |  |  | - |  |  |  | - |  |  |  | 0.00 | % |  |  | 70,000 |  |  |  | 102 |  |  |  | 0.59 | %
Trust preferred securities |  |  | 15,464 |  |  |  | 71 |  |  |  | 1.84 | % |  |  | 15,464 |  |  |  | 90 |  |  |  | 2.34 | %
Other |  |  | 30,295 |  |  |  | 37 |  |  |  | 0.49 | % |  |  | 28,804 |  |  |  | 48 |  |  |  | 0.67 | %
Total interest-bearing liabilities |  |  | 887,416 |  |  |  | 842 |  |  |  | 0.38 | % |  |  | 784,552 |  |  |  | 912 |  |  |  | 0.47 | %
Non-interest bearing liabilities and shareholders' equity: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Demand deposits |  |  | 528,502 |  |  |  |  |  |  |  |  |  |  |  | 434,109 |  |  |  |  |  |  |  |  |
Other liabilities |  |  | 6,485 |  |  |  |  |  |  |  |  |  |  |  | 6,944 |  |  |  |  |  |  |  |  |
Shareholders' equity |  |  | 141,167 |  |  |  |  |  |  |  |  |  |  |  | 134,803 |  |  |  |  |  |  |  |  |
Total liabilities and shareholders' equity |  | $ | 1,563,570 |  |  |  |  |  |  |  |  |  |  | $ | 1,360,408 |  |  |  |  |  |  |  |  |
Net interest spread |  |  |  |  |  | $ | 11,795 |  |  |  | 3.05 | % |  |  |  |  |  | $ | 10,889 |  |  |  | 3.30 | %
Net yield on interest-earning assets |  |  |  |  |  |  |  |  |  |  | 3.20 | % |  |  |  |  |  |  |  |  |  |  | 3.48 | %
Taxable equivalent adjustment |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investment securities |  |  |  |  |  | $ | 120 |  |  |  |  |  |  |  |  |  |  | $ | 163 |  |  |  |  |
Net interest income |  |  |  |  |  | $ | 11,675 |  |  |  |  |  |  |  |  |  |  | $ | 10,726 |  |  |  |  |

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $13.9 million in 2021 and $24.7 million in 2020. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2021 and 2020.

Year-to-date net interest income as of June 30, 2021 was $22.8 million, compared to $21.9 million for the same period one year ago. The increase in net interest income was due to a $551,000 increase in interest income and a $296,000 decrease in interest expense. The increase in interest income was primarily due to a $807,000 increase in interest income and fees on loans, which was primarily due to a $2.5 million increase in fee income on SBA PPP loans. The decrease in interest expense was primarily due to a decrease in rates paid on interest-bearing liabilities and a decrease in FHLB borrowings.

Interest income was $24.4 million for the six months ended June 30, 2021, compared to $23.9 million for the six months ended June 30, 2020. The increase in interest income was primarily due to a $807,000 increase in interest income and fees on loans, which was primarily due to a $2.5 million increase in fee income on SBA PPP loans. During the six months ended June 30, 2021, average loans increased $27.2 million to $931.7 million from $904.5 million for the six months ended June 30, 2020. During the six months ended June 30, 2021, average investment securities available for sale increased $113.1 million to $305.1 million from $192.0 million for the six months ended June 30, 2020. The average yield on loans for the six months ended June 30, 2021 and 2020 was 4.69% and 4.64%, respectively. The average yield on investment securities available for sale was 1.87% and 3.12% for the six months ended June 30, 2021 and 2020, respectively. The average yield on earning assets was 3.49% and 4.12% for the six months ended June 30, 2021 and 2020, respectively.

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Interest expense was $1.7 million for the six months ended June 30, 2021, compared to $2.0 million for the six months ended June 30, 2020. The decrease in interest expense was primarily due to a decrease in rates paid on interest-bearing liabilities and a decrease in FHLB borrowings. During the six months ended June 30, 2021, average interest-bearing non-maturity deposits increased $157.9 million to $703.6 million from $545.7 million for the six months ended June 30, 2020. During the six months ended June 30, 2021, average certificates of deposit increased $4.2 million to $107.3 million from $103.1 million for the six months ended June 30, 2020. Average FHLB borrowings decreased $56.9 million to zero for the six months ended June 30, 2021 from $56.9 million for the six months ended June 30, 2020. The average rate paid on interest-bearing checking and savings accounts was 0.30% and 0.36% for the six months ended June 30, 2021 and 2020, respectively. The average rate paid on certificates of deposit was 0.76% for the six months ended June 30, 2021, compared to 0.98% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.39% for the six months ended June 30, 2021, compared to 0.43% for the same period one year ago.

The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the six months ended June 30, 2021 and 2020. 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 six months ended June 30, 2021 and 2020 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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|  | Six months ended |  |  | Six months ended |
|  | June 30, 2021 |  |  | June 30, 2020 |
(Dollars in thousands) |  | Average Balance |  |  | Interest |  |  | Yield / Rate |  |  | Average Balance |  |  | Interest |  |  | Yield / Rate |
Interest-earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans receivable |  | $ | 931,714 |  |  |  | 21,667 |  |  |  | 4.69 | % |  | $ | 904,489 |  |  |  | 20,860 |  |  |  | 4.64 | %
Investments - taxable |  |  | 185,350 |  |  |  | 1,190 |  |  |  | 1.29 | % |  |  | 84,402 |  |  |  | 1,180 |  |  |  | 2.81 | %
Investments - nontaxable* |  |  | 124,171 |  |  |  | 1,741 |  |  |  | 2.83 | % |  |  | 114,694 |  |  |  | 1,944 |  |  |  | 3.41 | %
Federal funds sold |  |  | - |  |  |  | - |  |  |  | 0.00 | % |  |  | 52,491 |  |  |  | 145 |  |  |  | 0.56 | %
Other |  |  | 184,755 |  |  |  | 84 |  |  |  | 0.09 | % |  |  | 25,161 |  |  |  | 84 |  |  |  | 0.67 | %
Total interest-earning assets |  |  | 1,425,990 |  |  |  | 24,682 |  |  |  | 3.49 | % |  |  | 1,181,237 |  |  |  | 24,213 |  |  |  | 4.12 | %
Non-interest earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  |  | 31,164 |  |  |  |  |  |  |  |  |  |  |  | 37,113 |  |  |  |  |  |  |  |  |
Allowance for loan losses |  |  | (9,749 | ) |  |  |  |  |  |  |  |  |  |  | (7,382 | ) |  |  |  |  |  |  |  |
Other assets |  |  | 63,384 |  |  |  |  |  |  |  |  |  |  |  | 67,705 |  |  |  |  |  |  |  |  |
Total assets |  | $ | 1,510,789 |  |  |  |  |  |  |  |  |  |  | $ | 1,278,673 |  |  |  |  |  |  |  |  |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW, MMDA & savings deposits |  | $ | 703,610 |  |  |  | 1,040 |  |  |  | 0.30 | % |  | $ | 545,742 |  |  |  | 973 |  |  |  | 0.36 | %
Time deposits |  |  | 107,343 |  |  |  | 403 |  |  |  | 0.76 | % |  |  | 103,121 |  |  |  | 501 |  |  |  | 0.98 | %
FHLB borrowings |  |  | - |  |  |  | - |  |  |  | 0.00 | % |  |  | 56,923 |  |  |  | 166 |  |  |  | 0.59 | %
Trust preferred securities |  |  | 15,464 |  |  |  | 142 |  |  |  | 1.85 | % |  |  | 15,520 |  |  |  | 220 |  |  |  | 2.85 | %
Other |  |  | 28,841 |  |  |  | 72 |  |  |  | 0.50 | % |  |  | 25,885 |  |  |  | 93 |  |  |  | 0.72 | %
Total interest-bearing liabilities |  |  | 855,258 |  |  |  | 1,657 |  |  |  | 0.39 | % |  |  | 747,191 |  |  |  | 1,953 |  |  |  | 0.53 | %
Non-interest bearing liabilities and shareholders' equity: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Demand deposits |  |  | 508,801 |  |  |  |  |  |  |  |  |  |  |  | 389,975 |  |  |  |  |  |  |  |  |
Other liabilities |  |  | 4,164 |  |  |  |  |  |  |  |  |  |  |  | 5,732 |  |  |  |  |  |  |  |  |
Shareholders' equity |  |  | 142,566 |  |  |  |  |  |  |  |  |  |  |  | 135,775 |  |  |  |  |  |  |  |  |
Total liabilities and shareholders' equity |  | $ | 1,510,789 |  |  |  |  |  |  |  |  |  |  | $ | 1,278,673 |  |  |  |  |  |  |  |  |
Net interest spread |  |  |  |  |  | $ | 23,025 |  |  |  | 3.10 | % |  |  |  |  |  | $ | 22,260 |  |  |  | 3.60 | %
Net yield on interest-earning assets |  |  |  |  |  |  |  |  |  |  | 3.26 | % |  |  |  |  |  |  |  |  |  |  | 3.79 | %
Taxable equivalent adjustment |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investment securities |  |  |  |  |  | $ | 243 |  |  |  |  |  |  |  |  |  |  | $ | 325 |  |  |  |  |
Net interest income |  |  |  |  |  | $ | 22,782 |  |  |  |  |  |  |  |  |  |  | $ | 21,935 |  |  |  |  |

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $10.7 million in 2021 and $26.1 million in 2020. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2021 and 2020.

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

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|  | Three months ended June 30, 2021 compared to three months ended June 30, 2020 |  |  | Six months ended June 30, 2021 compared to six months ended June 30, 2020 |
(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 |  | $ | (352 | ) |  |  | 1,175 |  |  |  | 823 |  |  |  | 631 |  |  |  | 176 |  |  |  | 807 |
Investments - taxable |  |  | 601 |  |  |  | (506 | ) |  |  | 95 |  |  |  | 1,030 |  |  |  | (1,020 | ) |  |  | 10 |
Investments - nontaxable |  |  | 171 |  |  |  | (239 | ) |  |  | (68 | ) |  |  | 147 |  |  |  | (350 | ) |  |  | (203 | )
Federal funds sold |  |  | (11 | ) |  |  | (11 | ) |  |  | (22 | ) |  |  | (73 | ) |  |  | (72 | ) |  |  | (145 | )
Other |  |  | 130 |  |  |  | (122 | ) |  |  | 8 |  |  |  | 303 |  |  |  | (303 | ) |  |  | - |
Total interest income |  |  | 539 |  |  |  | 297 |  |  |  | 836 |  |  |  | 2,038 |  |  |  | (1,569 | ) |  |  | 469 |
Interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW, MMDA & savings deposits |  |  | 126 |  |  |  | (31 | ) |  |  | 95 |  |  |  | 257 |  |  |  | (190 | ) |  |  | 67 |
Time deposits |  |  | 13 |  |  |  | (46 | ) |  |  | (33 | ) |  |  | 18 |  |  |  | (116 | ) |  |  | (98 | )
FHLB borrowings |  |  | (51 | ) |  |  | (51 | ) |  |  | (102 | ) |  |  | (83 | ) |  |  | (83 | ) |  |  | (166 | )
Trust preferred securities |  |  | - |  |  |  | (19 | ) |  |  | (19 | ) |  |  | (1 | ) |  |  | (77 | ) |  |  | (78 | )
Other |  |  | 2 |  |  |  | (13 | ) |  |  | (11 | ) |  |  | 9 |  |  |  | (30 | ) |  |  | (21 | )
Total interest expense |  |  | 90 |  |  |  | (160 | ) |  |  | (70 | ) |  |  | 200 |  |  |  | (496 | ) |  |  | (296 | )
Net interest income |  | $ | 449 |  |  |  | 457 |  |  |  | 906 |  |  |  | 1,838 |  |  |  | (1,073 | ) |  |  | 765 |

Provision for Loan Losses. The provision for loan losses for the three months ended June 30, 2021 was a recovery of $226,000, compared to a provision of $1.4 million for the three months ended June 30, 2020. The decrease in the provision for loan losses is primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves due to a net decrease in the volume of loans in the general reserve pool. At June 30, 2021, the balance of loans with existing modifications as a result of the COVID-19 pandemic was $283,000. At December 31, 2020, the balance of loans with existing modifications as a result of the COVID-19 pandemic was $18.3 million. The Company continues to track all loans that are currently modified or have been modified as a result of the COVID-19 pandemic. The loan balances associated with COVID-19 pandemic related modifications have been grouped into their own pool within the Company’s ALLL model as they have a higher likelihood of risk, and a higher reserve rate has been applied to that pool. Of all loans modified as a result of the COVID-19 pandemic, $108.2 million have returned to their original terms; however, the effects of stimulus in the current environment are still unknown, and additional losses may be present in loans that are currently modified and/or loans that were once modified. At December 31, 2020, the balance for all loans that were then currently modified or previously modified but returned to their original terms was $119.6 million. The $11.4 million decrease from December 31, 2020 to June 30, 2021 in the balance of currently or previously modified loans that had returned to their original terms is primarily due to loans paid off during the six months ended June 30, 2021. Loan payment modifications associated with the COVID-19 pandemic are not classified as TDR due to Section 4013 of the CARES Act, which provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP.

The provision for loan losses for the six months ended June 30, 2021 was a recovery of $681,000, compared to a provision of $2.9 million for the six months ended June 30, 2020. The decrease in the provision for loan losses is primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves due to a net decrease in the volume of loans in the general reserve pool.

Non-Interest Income. Total non-interest income was $6.0 million for the three months ended June 30, 2021, compared to $5.2 million for the three months ended June 30, 2020. The increase in non-interest income is primarily attributable to a $572,000 increase in miscellaneous non-interest income primarily due to an increase in debit card income resulting from increased debit card activity and an increase in income on Small Business Investment Company (“SBIC”) investments, and a $271,000 increase in appraisal management fee income due to an increase in the volume of appraisals.

Non-interest income was $11.9 million for the six months ended June 30, 2021, compared to $9.8 million for the six months ended June 30, 2020. The increase in non-interest income is primarily attributable to a $708,000 increase in mortgage banking income due to an increased in mortgage loan volume, a $737,000 increase in appraisal management fee income due to an increase in the volume of appraisals and a $1.0 million increase in miscellaneous non-interest income primarily due to an increase in debit card income resulting from increased debit card activity and an increase in income on SBIC investments.

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Non-Interest Expense. Total non-interest expense was $12.1 million for the three months ended June 30, 2021, compared to $11.5 million for the three months ended June 30, 2020. The increase in non-interest expense was primarily attributable to a $301,000 increase in appraisal management fee expense due to an increase in the volume of appraisals and a $116,000 increase in FDIC insurance expense.

Non-interest expense was $24.4 million for the six months ended June 30, 2021, compared to $22.9 million for the six months ended June 30, 2020. The increase in non-interest expense was primarily attributable to a $723,000 increase in appraisal management fee expense due to an increase in the volume of appraisals and a $590,000 increase in salaries and employee benefits expense primarily due to increases in insurance costs and incentive compensation.

Income Taxes. Income tax expense was $1.2 million for the three months ended June 30, 2021, compared to $535,000 for the three months ended June 30, 2020. The effective tax rate was 20.55% for the three months ended June 30, 2021, compared to 17.28% for the three months ended June 30, 2020. Income tax expense was $2.2 million for the six months ended June 30, 2021, compared to $1.0 million for the six months ended June 30, 2020. The effective tax rate was 20.41% for the six months ended June 30, 2021, compared to 16.90% for the six months ended June 30, 2020. The increase in the effective tax rate is primarily due to a reduction in non-taxable investments combined with an increase in earnings before income taxes.

Analysis of Financial Condition

Investment Securities. Available for sale securities were $367.5 million at June 30, 2021, compared to $245.2 million at December 31, 2020. The increase in available for sale securities is primarily due to additional securities purchases due to an increase in excess cash. Average investment securities available for sale for the six months ended June 30, 2021 were $305.1 million, compared to $200.8 million for the year ended December 31, 2020.

Loans. At June 30, 2021, loans were $888.4 million, compared to $948.6 million at December 31, 2020. The decrease in loans is primarily due to a $38.3 million decrease in PPP loans primarily due to PPP loans being forgiven by the SBA during the six months ended June 30, 2021 and a $33.7 decrease in commercial loans due to loan payoffs during the six months ended June 30, 2021. The Company had $37.5 million and $75.8 million in PPP loans at June 30, 2021 and December 31, 2020, respectively. Average loans represented 65% and 74% of average earning assets for the six months ended June 30, 2021 and the year ended December 31, 2020, respectively.

The Company had $5.5 million and $9.1 million in mortgage loans held for sale as of June 30, 2021 and December 31, 2020, respectively.

Although the Company has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market. Real estate mortgage loans include both commercial and residential mortgage loans. At June 30, 2021, the Company had $93.3 million in residential mortgage loans, $88.3 million in home equity loans and $498.7 million in commercial mortgage loans, which include $391.4 million secured by commercial property and $107.3 million secured by residential property. Residential mortgage loans at June 30, 2021 include $25.2 million in non-traditional mortgage loans from the former Banco division of the Bank. At December 31, 2020, the Company had $104.2 million in residential mortgage loans, $96.6 million in home equity loans and $476.7 million in commercial mortgage loans, which include $375.0 million secured by commercial property and $101.7 million secured by residential property. Residential mortgage loans at December 31, 2020 include $26.9 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.

The Company had $90.6 million and $94.1 million in construction and land development loans at June 30, 2021 and December 31, 2020, respectively. The following tables present a breakout of these loans.

June 30, 2021 |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |
|  | Number of Loans |  |  | Balance Outstanding |  |  | Non-accrual Balance |
Land acquisition and development - commercial purposes |  |  | 35 |  |  | $ | 7,211 |  |  | $ | - |
Land acquisition and development - residential purposes |  |  | 146 |  |  |  | 19,811 |  |  |  | - |
1 to 4 family residential construction |  |  | 105 |  |  |  | 17,155 |  |  |  | - |
Commercial construction |  |  | 40 |  |  |  | 46,402 |  |  |  | - |
Total construction and land development |  |  | 326 |  |  | $ | 90,579 |  |  | $ | - |

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December 31, 2020 |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |
|  | Number of Loans |  |  | Balance Outstanding |  |  | Non-accrual Balance |
Land acquisition and development - commercial purposes |  |  | 36 |  |  | $ | 7,509 |  |  | $ | - |
Land acquisition and development - residential purposes |  |  | 161 |  |  |  | 20,444 |  |  |  | - |
1 to 4 family residential construction |  |  | 93 |  |  |  | 18,897 |  |  |  | - |
Commercial construction |  |  | 32 |  |  |  | 47,274 |  |  |  | - |
Total construction and land development |  |  | 322 |  |  | $ | 94,124 |  |  | $ | - |

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $2.2 million and $3.8 million at June 30, 2021 and December 31, 2020, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were no performing loans classified as TDR loans at June 30, 2021 and December 31, 2020.

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

| · | the Bank’s loan loss experience;
| · | the amount of past due and non-performing loans;
| · | specific known risks;
| · | the status and amount of other past due and non-performing assets;
| · | underlying estimated values of collateral securing loans;
| · | current and anticipated economic conditions (including those arising out of the COVID-19 pandemic); and
| · | other factors which management believes affect the allowance for potential credit losses.

Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectability becomes doubtful. Upon loan origination, the Bank’s originating loan officer evaluates the quality of the loan and assigns one of eight risk grades. The loan officer monitors the loan’s performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank’s Credit Administration. Before making any changes in these risk grades, management considers assessments as determined by the third-party credit review firm (as described below), regulatory examiners and the Bank’s Credit Administration. Any issues regarding the risk assessments are addressed by the Bank’s senior credit administrators and factored into management’s decision to originate or renew the loan. The Bank’s Board of Directors reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration.

As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third-party reviews and evaluates loan relationships greater than $1.0 million as well as a sample of commercial relationships with exposures below $1.0 million, excluding loans in default, and loans in process of litigation or liquidation. The third party’s evaluation and report is shared with management and the Bank’s Board of Directors.

Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

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

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

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four, or five years’ loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves. Qualitative factors applied in the Bank’s ALLL model include the impact to the economy from the COVID-19 pandemic and reserves on loans with payment modifications as a result of the COVID-19 pandemic. At June 30, 2021, the balance of loans with existing modifications as a result of the COVID-19 pandemic was $283,000. At December 31, 2020, the balance of loans with existing modifications as a result of COVID-19 was $18.3 million. The Company continues to track all loans that are currently modified or have been modified under COVID-19. At June 30, 2021, the balance for all loans that are currently modified or previously modified but have returned to their original terms was $108.2 million. The loan balances associated with COVID-19 related modifications have been grouped into their own pool within the Company’s ALLL model as they have a higher likelihood of risk, and a higher reserve rate has been applied to that pool. Of all loans modified as a result of COVID-19, $108.2 million have returned to their original terms; however, the effects of stimulus in the current environment are still unknown, and additional losses may be present in loans that are currently modified and/or loans that were once modified.

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

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the six months ended June 30, 2021, as compared to the six months ended June 30, 2020. Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, certain mortgage loans from the former Banco division of the Bank were analyzed separately from other single-family residential loans in the Bank’s loan portfolio. These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg County, North Carolina and surrounding counties. These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations. Management believes it has established the allowance for credit losses pursuant to GAAP, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date

|  | Percentage of Loans |
|  | By Risk Grade |
Risk Grade |  | 06/30/2021 |  |  | 12/31/2020 |
Risk Grade 1 (Excellent Quality) |  |  | 0.63 | % |  |  | 1.18 | %
Risk Grade 2 (High Quality) |  |  | 19.16 | % |  |  | 20.45 | %
Risk Grade 3 (Good Quality) |  |  | 68.78 | % |  |  | 65.70 | %
Risk Grade 4 (Management Attention) |  |  | 8.68 | % |  |  | 9.75 | %
Risk Grade 5 (Watch) |  |  | 1.97 | % |  |  | 2.20 | %
Risk Grade 6 (Substandard) |  |  | 0.78 | % |  |  | 0.72 | %
Risk Grade 7 (Doubtful) |  |  | 0.00 | % |  |  | 0.00 | %
Risk Grade 8 (Loss) |  |  | 0.00 | % |  |  | 0.00 | %

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At June 30, 2021, including non-accrual loans, there were three relationships exceeding $1.0 million in the Watch risk grade (which totaled $8.3 million). At December 31, 2020, including non-accrual loans, there were three relationships exceeding $1.0 million in the Watch risk grade (which totaled $7.9 million). There were no relationships exceeding $1.0 million in the Substandard risk grade at June 30, 2021 and December 31, 2020.

Non-performing Assets. Non-performing assets totaled $3.4 million at June 30, 2021 or 0.21% of total assets, compared to $3.8 million or 0.27% of total assets at December 31, 2020. Non-accrual loans were $3.4 million at June 30, 2021 and $3.9 million at December 31, 2020. As a percentage of total loans outstanding, non-accrual loans were 0.38% at June 30, 2021, compared to 0.40% at December 31, 2020. Non-performing assets include $3.3 million in commercial and residential mortgage loans and $67,000 in other loans at June 30, 2021, compared to $3.5 million in commercial and residential mortgage loans, $226,000 in other loans and $128,000 in other real estate owned at December 31, 2020. The Bank had no loans 90 days past due and still accruing at June 30, 2021 and December 31, 2020. The Bank had no other real estate owned at June 30, 2021.

Deposits. Total deposits at June 30, 2021 were $1.4 billion compared to $1.2 billion at December 31, 2020. Core deposits, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $250,000, amounted to $1.4 billion at June 30, 2021, compared to $1.2 billion at December 31, 2020.

Borrowed Funds. There were no FHLB borrowings outstanding at June 30, 2021 and December 31, 2020.

Securities sold under agreements to repurchase were $31.2 million at June 30, 2021, compared to $26.2 million at December 31, 2020.

Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were $15.5 million at June 30, 2021 and December 31, 2020.

In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company, which pay a floating rate equal to three-month LIBOR plus 163 basis points. The proceeds received by the Company from the sale of the junior subordinated debentures were used 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 asset of PEBK Trust II. PEBK Trust II is not included in the Consolidated Financial Statements.

The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. The net combined effect of the trust preferred securities transaction is that the Company is obligated to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

The Company has no financial instruments tied to LIBOR other than the trust preferred securities issued by PEBK Trust II, which are tied to three-month LIBOR. The one-week and two-month U.S. dollar-denominated (USD) LIBOR rates will retire on December 31, 2021. The overnight, one-month, three-month, six-month, and 12-month USD LIBOR rates will continue to be published through June 30, 2023.

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 to be done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income.

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

The Company’s rate sensitive assets are those earning interest at variable rates and those with contractual maturities within one year. Rate sensitive assets therefore include both loans and available for sale securities. Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds. Average rate sensitive assets for the six months ended June 30, 2021 totaled $1.4 billion, exceeding average rate sensitive liabilities of $855.3 million by $655.5 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 June 30, 2021.

Included in the rate sensitive assets are $206.7 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 further downward movements in the prime rate. At June 30, 2021, the Company had $134.5 million in loans with interest rate floors. The floors were in effect on $107.5 million of these loans pursuant to the terms of the promissory notes on these loans. The weighted average rate on these loans is 0.81% higher than the indexed rate on the promissory notes without interest rate floors.

Liquidity. The objectives of the Company’s liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As of June 30, 2021, such unfunded commitments to extend credit were $312.1 million, while commitments in the form of standby letters of credit totaled $5.1 million. As of December 31, 2020, such unfunded commitments to extend credit were $299.0 million, while commitments in the form of standby letters of credit totaled $4.7 million.

The Company 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 Company considers these to be a stable portion of the Company’s liability mix and the result of on-going consumer and commercial banking relationships. As of June 30, 2021, the Company’s core deposits totaled $1.4 billion, or 98.09% of total deposits. As of December 31, 2020, the Company’s core deposits totaled $1.2 billion, or 97.89% of total deposits.

The other sources of funding for the Company are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under 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 Company’s policies include the ability to access wholesale funding of up to 40% of total assets. The Company’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 Company’s ratio of wholesale funding to total assets was 0.69% and 0.88% as of June 30, 2021 and December 31, 2020, respectively.

The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets. There were no FHLB borrowings outstanding at June 30, 2021 and December 31, 2020. At June 30, 2021, the carrying value of loans pledged as collateral to the FHLB totaled $144.6 million compared to $165.1 million at December 31, 2020. The remaining availability under the line of credit with the FHLB was $95.1 million at June 30, 2021 compared to $111.4 million at December 31, 2020. The Bank had no borrowings from the FRB at June 30, 2021 or December 31, 2020. FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At June 30, 2021, the carrying value of loans pledged as collateral to the FRB totaled $468.2 million compared to $469.5 million at December 31, 2020. Availability under the line of credit with the FRB was $337.1 million and $340.0 million at June 30, 2021 and December 31, 2020, respectively.

The Bank also had the ability to borrow up to $110.5 million for the purchase of overnight federal funds from five correspondent financial institutions as of June 30, 2021.

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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 42.71% at June 30, 2021 and 28.12% at December 31, 2020. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at June 30, 2021 and December 31, 2020.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations and other commitments as of June 30, 2021 and December 31, 2020 are summarized in the table below. The Company’s contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit. Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below.

(Dollars in thousands) |  |  |  |  |  |
|  | June 30, 2021 |  |  | December 31, 2020 |
Contractual Cash Obligations |  |  |  |  |  |
Junior subordinated debentures |  | $ | 15,464 |  |  |  | 15,464 |
Operating lease obligations |  |  | 2,781 |  |  |  | 3,083 |
Total |  | $ | 18,245 |  |  |  | 18,547 |
Other Commitments |  |  |  |  |  |  |  |
Commitments to extend credit |  | $ | 312,094 |  |  |  | 299,039 |
Standby letters of credit and financial guarantees written |  |  | 5,095 |  |  |  | 4,745 |
Income tax credits |  |  | 101 |  |  |  | 184 |
Total |  | $ | 317,290 |  |  |  | 303,968 |

The Company enters into derivative contracts from time to time to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Further discussions of derivative instruments are included above in the section entitled “Asset Liability and Interest Rate Risk Management”.

Capital Resources. Shareholders’ equity was $145.4 million, or 9.09% of total assets, at June 30, 2021, compared to $139.9 million, or 9.88% of total assets, at December 31, 2020.

Annualized return on average equity for the six months ended June 30, 2021 was 12.36%, compared to 7.30% for the six months ended June 30, 2020. Total cash dividends paid on common stock were $1.9 million and $2.6 million for the six months ended June 30, 2021 and 2020, respectively.

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

In February of 2021, the Company’s Board of Directors authorized a stock repurchase program, whereby up to $4.0 million will 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 not repurchased any shares of its common stock under this stock repurchase program as of June 30, 2021.

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.

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Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. Tier 1 capital is generally defined as shareholders’ equity and trust preferred securities less all intangible assets and goodwill. Tier 1 capital includes $15.0 million in trust preferred securities at June 30, 2021 and December 31, 2020. The Company’s Tier 1 capital ratio was 15.63% and 15.07% at June 30, 2021 and December 31, 2020, respectively. Total risk-based capital is defined as Tier 1 capital plus supplementary capital. Supplementary capital, or Tier 2 capital, consists of the Company’s allowance for loan losses, not exceeding 1.25% of the Company’s risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets. The Company’s total risk-based capital ratio was 16.56% and 16.07% at June 30, 2021 and December 31, 2020, 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 14.13% and 13.56% at June 30, 2021 and December 31, 2020, 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 10.01% and 10.24% at June 30, 2021 and December 31, 2020, respectively.

The Bank’s Tier 1 risk-based capital ratio was 15.24% and 14.85% at June 30, 2021 and December 31, 2020, respectively. The total risk-based capital ratio for the Bank was 16.17% and 15.85% at June 30, 2021 and December 31, 2020, respectively. The Bank’s common equity Tier 1 capital ratio was 15.24% and 14.85% at June 30, 2021 and December 31, 2020, respectively. The Bank’s Tier 1 leverage capital ratio was 9.72% and 10.04% at June 30, 2021 and December 31, 2020, respectively.

A bank is considered to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater. Based upon these guidelines, the Bank was considered to be “well capitalized” at June 30, 2021.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the Quantitative and Qualitative Disclosures About Market Risk from those previously disclosed in Part 7A. of Part II of the Company’s Form 10-K, filed with the SEC on March 19, 2021, which is accessible on the SEC’s website at www.sec.gov.

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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 is seeking to disallow certain tax credits taken by the Bank in tax years January 1, 2014 through December 31, 2016 from an investment made by the Bank. The total proposed adjustments sought by the NCDOR as of the date of the draft audit report (including additional tax, penalties and interest up to the date of the draft audit report) was approximately $1.4 million. The Bank disagrees with the NCDOR’s proposed adjustments and the disallowance of certain tax credits, and is challenging 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 from State Tax Credit Exchange, LLC dated September 10, 2014 was attached to the Company’s September 30, 2018 Form 10-Q as Exhibit 99.
Item 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 19, 2021, 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 |  |  | 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) |
April 1 - 30, 2021 |  |  | 1,426 |  |  | $ | 23.35 |  |  |  | - |  |  | $ | 4,000,000 |
May 1 - 31, 2021 |  |  | 307 |  |  |  | 25.96 |  |  |  | - |  |  | $ | 4,000,000 |
June 1 - 30, 2021 |  |  | 444 |  |  |  | 25.38 |  |  |  | - |  |  | $ | 4,000,000 |
Total |  |  | 2,177 | (1) |  | $ | 24.25 |  |  |  | - |  |  |  |  |

| (1) The Company purchased 2,177 shares on the open market in the three months ended June 30, 2021 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.
| (2) Reflects shares purchased under the Company's stock repurchase program.
| (3) Reflects dollar value of shares that may yet be purchased under the Company's stock repurchase program, which was funded in February 2021.
Item 3. | Defaults Upon Senior Securities
| Not applicable
Item 5. | Other Information
| Not applicable

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 8-K filed with the Securities and Exchange Commission on May 10, 2021
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

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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 (4)(ii) |  | Description of Registrant’s Securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, incorporated by reference to Exhibit 4(ii) to the Form 10-K/A filed with the Securities and Exchange Commission on March 16, 2020
Exhibit (10)(i) |  | Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Tony W. Wolfe dated December 18, 2008, incorporated by reference to Exhibit (10)(a)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (10)(ii) |  | Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Joseph F. Beaman, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(b)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (10)(iii) |  | Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and William D. Cable, Sr. dated December 18, 2008, incorporated by reference to Exhibit (10)(c)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (10)(iv) |  | Employment Agreement dated January 22, 2015 between the Registrant and William D. Cable, Sr., incorporated by reference to Exhibit (10)(c) to the Form 8-K filed with the Securities and Exchange Commission on February 9, 2015
Exhibit (10)(v) |  | Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Lance A. Sellers dated December 18, 2008, incorporated by reference to Exhibit (10)(d)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (10)(vi) |  | Employment Agreement dated January 22, 2015 between the Registrant and Lance A. Sellers, incorporated by reference to Exhibit (10)(a) to the Form 8-K filed with the Securities and Exchange Commission on February 9, 2015
Exhibit (10)(vii) |  | Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(f)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (10)(viii) |  | Employment Agreement dated January 22, 2015 between the Registrant and A. Joseph Lampron, Jr., incorporated by reference to Exhibit (10)(b) to the Form 8-K filed with the Securities and Exchange Commission on February 9, 2015

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Exhibit (10)(ix) |  | Peoples Bank Directors’ and Officers’ Deferral Plan, incorporated by reference to Exhibit 10(h) to the Form 10-K filed with the Securities and Exchange Commission on March 28, 2002
Exhibit (10)(x) |  | Rabbi Trust for the Peoples Bank Directors’ and Officers’ Deferral Plan, incorporated by reference to Exhibit 10(i) to the Form 10-K filed with the Securities and Exchange Commission on March 28, 2002
Exhibit (10)(xi) |  | Description of Service Recognition Program maintained by Peoples Bank, incorporated by reference to Exhibit 10(i) to the Form 10-K filed with the Securities and Exchange Commission on March 27, 2003
Exhibit (10)(xii) |  | Capital Securities Purchase Agreement dated as of June 26, 2006, by and among the Registrant, PEBK Capital Trust II and Bear, Sterns Securities Corp., incorporated by reference to Exhibit 10(j) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006
Exhibit (10)(xiii) |  | Amended and Restated Trust Agreement of PEBK Capital Trust II, dated as of June 28, 2006, incorporated by reference to Exhibit 10(k) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006
Exhibit (10)(xiv) |  | Guarantee Agreement of the Registrant dated as of June 28, 2006, incorporated by reference to Exhibit 10(l) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006
Exhibit (10)(xv) |  | Indenture, dated as of June 28, 2006, by and between the Registrant and LaSalle Bank National Association, as Trustee, relating to Junior Subordinated Debt Securities Due September 15, 2036, incorporated by reference to Exhibit 10(m) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006
Exhibit (10)(xvi) |  | Form of Amended and Restated Director Supplemental Retirement Agreement between Peoples Bank and Directors Robert C. Abernethy, James S. Abernethy, Douglas S. Howard, John W. Lineberger, Jr., Gary E. Matthews, Dr. Billy L. Price, Jr., Larry E Robinson, W. Gregory Terry, Dan Ray Timmerman, Sr., and Benjamin I. Zachary, incorporated by reference to Exhibit (10)(n) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (10)(xvii) |  | 2009 Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(o) to the Form 10-K filed with the Securities and Exchange Commission on March 20, 2009
Exhibit (10)(xviii) |  | First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Lance A. Sellers dated February 16, 2018, incorporated by reference to Exhibit (10)(xx) to the Form 10-Q filed with the Securities and Exchange Commission on March 18, 2018

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Exhibit (10)(xix) |  | First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated February 16, 2018, incorporated by reference to Exhibit (10)(xxi) to the Form 10-Q filed with the Securities and Exchange Commission on March 18, 2018
Exhibit (10)(xx) |  | First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and William D. Cable, Sr. dated February 16, 2018, incorporated by reference to Exhibit (10)(xxii) to the Form 10-Q filed with the Securities and Exchange Commission on March 18, 2018
Exhibit (10)(xxi) |  | 2020 Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(xii) to the Form 10-K filed with the Securities and Exchange Commission on March 19, 2021
Exhibit (14) |  | Code of Business Conduct and Ethics of Peoples Bancorp of North Carolina, Inc., incorporated by reference to Exhibit (14) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2005
Exhibit (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 June 30, 2021, 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, tagged as blocks of text.*

*Furnished, not filed.

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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. |
August 4, 2021 |  | /s/ Lance A. Sellers |
Date |  | Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer) |

August 4, 2021 |  | /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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