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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: September 30, 2022

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.)

&nbsp;

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. 5,637,830 shares of common stock, outstanding at October 31, 2022.

INDEX

PART I. FINANCIAL INFORMATION

|  | PAGE(S)
Item 1. | Financial Statements | 4
| Consolidated Balance Sheets at September 30, 2022 (Unaudited) and December 31, 2021 (Audited) | 4
| Consolidated Statements of Earnings for the three and nine months ended September 30, 2022 and 2021 (Unaudited) | 5
| Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2022 and 2021 (Unaudited) | 6
| Consolidated Statements of Changes in Shareholders' Equity for the three and nine months ended September 30, 2022 and 2021 (Unaudited) | 7
| Consolidated Statements of Cash Flows for the nine months ended September 30, 2022 and 2021 (Unaudited) | 8
| Notes to Consolidated Financial Statements (Unaudited) | 10
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 27
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 39
Item 4. | Controls and Procedures | 39

PART II. OTHER INFORMATION

Item 1. | Legal Proceedings | 40
Item 1A. | Risk Factors | 40
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 41
Item 3. | Defaults upon Senior Securities | 41
Item 5. | Other Information | 41
Item 6. | Exhibits | 42
Signatures | 43
Certifications |

2
Table of Contents

FORWARD-LOOKING STATEMENTS

Statements made in this Quarterly Report on Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Quarterly Report on Form 10-Q was prepared. These statements can be identified by the use of words like “expect,” “anticipate,” “estimate,” and “believe,” variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ include, but are not limited to, (1) competition in the markets served by the registrant and its subsidiaries, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environments and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in other filings with the Securities and Exchange Commission, including but not limited to, those described in the registrant’s Annual Report on Form 10-K for the year ended December 31, 2021.

3
Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Balance Sheets
September 30, 2022 and December 31, 2021
(Dollars in thousands)
|  | September 30, |  |  | December 31, |
Assets |  | 2022 |  |  | 2021 |
|  | (Unaudited) |  |  | (Audited) |
Cash and due from banks, including reserve requirements of $0 at both 9/30/22 and 12/31/21 |  | $ | 55,063 |  |  |  | 44,711 |
Interest-bearing deposits |  |  | 100,398 |  |  |  | 232,788 |
Cash and cash equivalents |  |  | 155,461 |  |  |  | 277,499 |
Investment securities available for sale |  |  | 444,367 |  |  |  | 406,549 |
Other investments |  |  | 2,762 |  |  |  | 3,668 |
Total securities |  |  | 447,129 |  |  |  | 410,217 |
Mortgage loans held for sale |  |  | 975 |  |  |  | 3,637 |
Loans |  |  | 1,004,907 |  |  |  | 884,869 |
Less allowance for loan losses |  |  | (10,030 | ) |  |  | (9,355 | )
Net loans |  |  | 994,877 |  |  |  | 875,514 |
Premises and equipment, net |  |  | 18,508 |  |  |  | 16,104 |
Cash surrender value of life insurance |  |  | 17,601 |  |  |  | 17,365 |
Right of use lease asset |  |  | 5,770 |  |  |  | 4,612 |
Accrued interest receivable and other assets |  |  | 35,969 |  |  |  | 19,245 |
Total assets |  | $ | 1,676,290 |  |  |  | 1,624,193 |
Liabilities and Shareholders' Equity |  |  |  |  |  |  |  |
Deposits: |  |  |  |  |  |  |  |
Noninterest-bearing demand |  | $ | 563,142 |  |  |  | 514,319 |
Interest-bearing demand, MMDA & savings |  |  | 839,532 |  |  |  | 797,179 |
Time, $250,000 or more |  |  | 30,118 |  |  |  | 26,333 |
Other time |  |  | 68,299 |  |  |  | 74,917 |
Total deposits |  |  | 1,501,091 |  |  |  | 1,412,748 |
Securities sold under agreements to repurchase |  |  | 37,986 |  |  |  | 37,094 |
Junior subordinated debentures |  |  | 15,464 |  |  |  | 15,464 |
Lease liability |  |  | 5,847 |  |  |  | 4,677 |
Accrued interest payable and other liabilities |  |  | 11,978 |  |  |  | 11,841 |
Total liabilities |  |  | 1,572,366 |  |  |  | 1,481,824 |
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 5,641,030 shares at September 30, 2022 and 5,661,569 shares at December 31, 2021 |  |  | 52,752 |  |  |  | 53,305 |
Common stock held by deferred compensation trust, at cost; 167,889 shares at September 30, 2022 and 162,193 shares at December 31, 2021 |  |  | (2,150 | ) |  |  | (1,992 | )
Deferred compensation |  |  | 2,150 |  |  |  | 1,992 |
Retained earnings |  |  | 97,029 |  |  |  | 88,968 |
Accumulated other comprehensive income (loss) |  |  | (45,857 | ) |  |  | 96 |
Total shareholders' equity |  |  | 103,924 |  |  |  | 142,369 |
Total liabilities and shareholders' equity |  | $ | 1,676,290 |  |  |  | 1,624,193 |
See accompanying Notes to Consolidated Financial Statements. |  |  |  |  |  |  |  |

4
Table of Contents

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Earnings
Three and Nine Months Ended September 30, 2022 and 2021
(Dollars in thousands, except per share amounts)
|  | Three months ended |  |  | Nine months ended |
|  | September 30, |  |  | September 30, |
|  | 2022 |  |  | 2021 |  |  | 2022 |  |  | 2021 |
|  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |
Interest income: |  |  |  |  |  |  |  |  |  |  |  |
Interest and fees on loans |  | $ | 11,051 |  |  |  | 9,807 |  |  |  | 30,727 |  |  |  | 31,474 |
Interest on due from banks |  |  | 900 |  |  |  | 89 |  |  |  | 1,453 |  |  |  | 172 |
Interest on investment securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government sponsored enterprises |  |  | 1,580 |  |  |  | 679 |  |  |  | 2,676 |  |  |  | 1,899 |
State and political subdivisions |  |  | 1,056 |  |  |  | 825 |  |  |  | 3,009 |  |  |  | 2,222 |
Other |  |  | 24 |  |  |  | 21 |  |  |  | 67 |  |  |  | 93 |
Total interest income |  |  | 14,611 |  |  |  | 11,421 |  |  |  | 37,932 |  |  |  | 35,860 |
Interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW, MMDA & savings deposits |  |  | 494 |  |  |  | 577 |  |  |  | 1,263 |  |  |  | 1,617 |
Time deposits |  |  | 134 |  |  |  | 181 |  |  |  | 421 |  |  |  | 584 |
Junior subordinated debentures |  |  | 146 |  |  |  | 69 |  |  |  | 324 |  |  |  | 211 |
Other |  |  | 44 |  |  |  | 34 |  |  |  | 117 |  |  |  | 106 |
Total interest expense |  |  | 818 |  |  |  | 861 |  |  |  | 2,125 |  |  |  | 2,518 |
Net interest income |  |  | 13,793 |  |  |  | 10,560 |  |  |  | 35,807 |  |  |  | 33,342 |
Provision for (recovery of) loan losses |  |  | 408 |  |  |  | (182 | ) |  |  | 889 |  |  |  | (863 | )
Net interest income after provision for loan losses |  |  | 13,385 |  |  |  | 10,742 |  |  |  | 34,918 |  |  |  | 34,205 |
Non-interest income: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Service charges |  |  | 1,458 |  |  |  | 1,023 |  |  |  | 4,000 |  |  |  | 2,859 |
Other service charges and fees |  |  | 169 |  |  |  | 187 |  |  |  | 540 |  |  |  | 570 |
Mortgage banking income |  |  | 59 |  |  |  | 516 |  |  |  | 358 |  |  |  | 2,109 |
Insurance and brokerage commissions |  |  | 213 |  |  |  | 266 |  |  |  | 709 |  |  |  | 764 |
Appraisal management fee income |  |  | 2,711 |  |  |  | 1,954 |  |  |  | 9,656 |  |  |  | 5,775 |
Gain on sale of other assets |  |  | - |  |  |  | 104 |  |  |  | - |  |  |  | 104 |
Gain on sale of other real estate |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 21 |
Miscellaneous |  |  | 2,183 |  |  |  | 1,990 |  |  |  | 5,904 |  |  |  | 5,751 |
Total non-interest income |  |  | 6,793 |  |  |  | 6,040 |  |  |  | 21,167 |  |  |  | 17,953 |
Non-interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Salaries and employee benefits |  |  | 6,177 |  |  |  | 6,054 |  |  |  | 18,469 |  |  |  | 17,903 |
Occupancy |  |  | 2,038 |  |  |  | 1,999 |  |  |  | 5,886 |  |  |  | 5,891 |
Professional fees |  |  | 413 |  |  |  | 582 |  |  |  | 1,241 |  |  |  | 1,354 |
Advertising |  |  | 175 |  |  |  | 91 |  |  |  | 509 |  |  |  | 388 |
Debit card expense |  |  | 228 |  |  |  | 244 |  |  |  | 826 |  |  |  | 740 |
FDIC Insurance |  |  | 121 |  |  |  | 108 |  |  |  | 346 |  |  |  | 304 |
Appraisal management fee expense |  |  | 2,151 |  |  |  | 1,556 |  |  |  | 7,680 |  |  |  | 4,646 |
Miscellaneous |  |  | 2,152 |  |  |  | 1,934 |  |  |  | 6,082 |  |  |  | 5,742 |
Total non-interest expense |  |  | 13,455 |  |  |  | 12,568 |  |  |  | 41,039 |  |  |  | 36,968 |
Earnings before income taxes |  |  | 6,723 |  |  |  | 4,214 |  |  |  | 15,046 |  |  |  | 15,190 |
Income tax expense |  |  | 1,416 |  |  |  | 824 |  |  |  | 3,070 |  |  |  | 3,064 |
Net earnings |  | $ | 5,307 |  |  |  | 3,390 |  |  |  | 11,976 |  |  |  | 12,126 |
Basic net earnings per share |  | $ | 0.96 |  |  |  | 0.61 |  |  |  | 2.18 |  |  |  | 2.16 |
Diluted net earnings per share |  | $ | 0.93 |  |  |  | 0.59 |  |  |  | 2.11 |  |  |  | 2.10 |
Cash dividends declared per share |  | $ | 0.18 |  |  |  | 0.17 |  |  |  | 0.69 |  |  |  | 0.49 |
See accompanying Notes to Consolidated Financial Statements. |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Comprehensive Income (Loss)
Three and Nine Months Ended September 30, 2022 and 2021
(Dollars in thousands)
|  | Three months ended |  |  | Nine months ended |
|  | September 30, |  |  | September 30, |
|  | 2022 |  |  | 2021 |  |  | 2022 |  |  | 2021 |
|  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |
Net earnings |  | $ | 5,307 |  |  |  | 3,390 |  |  |  | 11,976 |  |  |  | 12,126 |
Other comprehensive loss: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding losses on securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
available for sale |  |  | (16,578 | ) |  |  | (844 | ) |  |  | (59,661 | ) |  |  | (2,714 | )
Income tax benefit related to other |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
comprehensive loss: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding losses on securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
available for sale |  |  | (3,808 | ) |  |  | (194 | ) |  |  | (13,708 | ) |  |  | (624 | )
Total other comprehensive loss, |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
net of tax |  |  | (12,770 | ) |  |  | (650 | ) |  |  | (45,953 | ) |  |  | (2,090 | )
Total comprehensive income (loss) |  | $ | (7,463 | ) |  |  | 2,740 |  |  |  | (33,977 | ) |  |  | 10,036 |
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 Nine Months Ended September 30, 2022 and 2021
(Dollars in thousands)
|  |  |  |  |  |  |  |  |  |  |  |  |  | Common Stock |  |  |  |  |  |  |
|  |  |  |  |  |  |  |  |  |  |  |  |  | Held By |  |  | Accumulated |  |  |  |
|  |  |  |  |  |  |  |  |  |  |  |  |  | Deferred |  |  | Other |  |  |  |
|  | Common Stock |  |  | Retained |  |  | Deferred |  |  | Compensation |  |  | Comprehensive |  |  |  |
|  | Shares |  |  | Amount |  |  | Earnings |  |  | Compensation |  |  | Trust |  |  | Income (Loss) |  |  | Total |
|  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |  |  | (Unaudited) |
Balance, December 31, 2021 |  |  | 5,661,569 |  |  | $ | 53,305 |  |  |  | 88,968 |  |  |  | 1,992 |  |  |  | (1,992 | ) |  |  | 96 |  |  |  | 142,369 |
Common stock repurchase |  |  | (7,000 | ) |  |  | (199 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (199 | )
Cash dividends declared on |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
common stock |  |  | - |  |  |  | - |  |  |  | (1,877 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (1,877 | )
Restricted stock units exercised |  |  | 1,461 |  |  |  | 41 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 41 |
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 50 |  |  |  | (50 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 3,452 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,452 |
Change in accumulated other |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
comprehensive loss, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (18,342 | ) |  |  | (18,342 | )
Balance, March 31, 2022 |  |  | 5,656,030 |  |  | $ | 53,147 |  |  |  | 90,543 |  |  |  | 2,042 |  |  |  | (2,042 | ) |  |  | (18,246 | ) |  |  | 125,444 |
Common stock repurchase |  |  | (15,000 | ) |  |  | (395 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (395 | )
Cash dividends declared on |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
common stock |  |  | - |  |  |  | - |  |  |  | (1,019 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (1,019 | )
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 57 |  |  |  | (57 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 3,217 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,217 |
Change in accumulated other |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
comprehensive loss, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (14,841 | ) |  |  | (14,841 | )
Balance, June 30, 2022 |  |  | 5,641,030 |  |  | $ | 52,752 |  |  |  | 92,741 |  |  |  | 2,099 |  |  |  | (2,099 | ) |  |  | (33,087 | ) |  |  | 112,406 |
Cash dividends declared on |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
common stock |  |  | - |  |  |  | - |  |  |  | (1,019 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (1,019 | )
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 51 |  |  |  | (51 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 5,307 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 5,307 |
Change in accumulated other |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
comprehensive loss, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (12,770 | ) |  |  | (12,770 | )
Balance, September 30, 2022 |  |  | 5,641,030 |  |  | $ | 52,752 |  |  |  | 97,029 |  |  |  | 2,150 |  |  |  | (2,150 | ) |  |  | (45,857 | ) |  |  | 103,924 |
Balance, 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 loss, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (3,100 | ) |  |  | (3,100 | )
Balance, 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, June 30, 2021 |  |  | 5,789,166 |  |  | $ | 56,910 |  |  |  | 84,504 |  |  |  | 1,901 |  |  |  | (1,901 | ) |  |  | 3,960 |  |  |  | 145,374 |
Common stock repurchase |  |  | (127,597 | ) |  |  | (3,605 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (3,605 | )
Cash dividends declared on |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
common stock |  |  | - |  |  |  | - |  |  |  | (967 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (967 | )
Equity incentive plan, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 45 |  |  |  | (45 | ) |  |  | - |  |  |  | - |
Net earnings |  |  | - |  |  |  | - |  |  |  | 3,390 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,390 |
Change in accumulated other |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
comprehensive loss, net of tax |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (650 | ) |  |  | (650 | )
Balance, September 30, 2021 |  |  | 5,661,569 |  |  | $ | 53,305 |  |  |  | 86,927 |  |  |  | 1,946 |  |  |  | (1,946 | ) |  |  | 3,310 |  |  |  | 143,542 |
See accompanying Notes to Consolidated Financial Statements. |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2022 and 2021
(Dollars in thousands)
|  | 2022 |  |  | 2021 |
|  | (Unaudited) |  |  | (Unaudited) |
Cash flows from operating activities: |  |  |  |  |  |
Net earnings |  | $ | 11,976 |  |  |  | 12,126 |
Adjustments to reconcile net earnings to |  |  |  |  |  |  |  |
net cash provided by operating activities: |  |  |  |  |  |  |  |
Depreciation, amortization and accretion |  |  | 4,914 |  |  |  | 3,991 |
Provision for (recovery of) loan losses |  |  | 889 |  |  |  | (863 | )
Deferred income taxes |  |  | (31 | ) |  |  | (27 | )
Gain on sale of other real estate |  |  | - |  |  |  | (21 | )
Gain on sale of other assets |  |  | - |  |  |  | (104 | )
Restricted stock expense |  |  | (95 | ) |  |  | (166 | )
Proceeds from sales of mortgage loans held for sale |  |  | 20,475 |  |  |  | 76,086 |
Origination of mortgage loans held for sale |  |  | (17,813 | ) |  |  | (76,033 | )
Change in: |  |  |  |  |  |  |  |
Cash surrender value of life insurance |  |  | (301 | ) |  |  | (297 | )
Right of use lease asset |  |  | 568 |  |  |  | 562 |
Other assets |  |  | (2,944 | ) |  |  | 455 |
Lease liability |  |  | (556 | ) |  |  | (549 | )
Other liabilities |  |  | 232 |  |  |  | 2,138 |
Net cash provided by operating activities |  |  | 17,314 |  |  |  | 17,298 |
Cash flows from investing activities: |  |  |  |  |  |  |  |
Purchases of investment securities available for sale |  |  | (139,657 | ) |  |  | (186,793 | )
Proceeds from sales, calls and maturities of investment securities |  |  |  |  |  |  |  |
available for sale |  |  | 7,870 |  |  |  | 6,010 |
Proceeds from paydowns of investment securities available for sale |  |  | 31,186 |  |  |  | 18,335 |
Proceeds from paydowns on other investments |  |  | 1,011 |  |  |  | 132 |
Redemptions (purchases) of FHLB stock |  |  | (105 | ) |  |  | 331 |
Net change in loans |  |  | (120,252 | ) |  |  | 57,552 |
Purchases of premises and equipment |  |  | (4,196 | ) |  |  | (379 | )
Proceeds from sale of other assets |  |  | - |  |  |  | 515 |
Proceeds from sale of other real estate |  |  | - |  |  |  | 149 |
Proceeds from bank owned life insurance |  |  | 65 |  |  |  | - |
Net cash used by investing activities |  |  | (224,078 | ) |  |  | (104,148 | )
Cash flows from financing activities: |  |  |  |  |  |  |  |
Net change in deposits |  |  | 88,343 |  |  |  | 188,879 |
Net change in securities sold under agreement to repurchase |  |  | 892 |  |  |  | 6,131 |
Common stock repurchased |  |  | (594 | ) |  |  | (3,605 | )
Cash dividends paid on common stock |  |  | (3,915 | ) |  |  | (2,827 | )
Net cash provided by financing activities |  |  | 84,726 |  |  |  | 188,578 |
Net change in cash and cash equivalents |  |  | (122,038 | ) |  |  | 101,728 |
Cash and cash equivalents at beginning of period |  |  | 277,499 |  |  |  | 161,580 |
Cash and cash equivalents at end of period |  | $ | 155,461 |  |  |  | 263,308 |

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PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Statements of Cash Flows, continued
Nine Months Ended September 30, 2022 and 2021
(Dollars in thousands)
|  | 2022 |  |  | 2021 |
|  | (Unaudited) |  |  | (Unaudited) |
Supplemental disclosures of cash flow information: |  |  |  |  |  |
Cash paid during the period for: |  |  |  |  |  |
Interest |  | $ | 2,112 |  |  |  | 1,658 |
Income taxes |  | $ | 3,069 |  |  |  | 3,221 |
Noncash investing and financing activities: |  |  |  |  |  |  |  |
Change in unrealized loss on investment securities |  |  |  |  |  |  |  |
available for sale, net |  | $ | (45,953 | ) |  |  | (2,090 | )
Issuance of accrued restricted stock units |  | $ | 41 |  |  |  | 39 |
Transfer of premises and equipment to other assets held for sale |  | $ | - |  |  |  | 408 |
Initial recognition of lease right-of-use asset and lease liability |  | $ | 1,726 |  |  |  | 952 |
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. (the “Company”) and its wholly owned subsidiary, Peoples Bank (the “Bank”), along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc. (“PIS”), Real Estate Advisory Services, Inc. (“REAS”), Community Bank Real Estate Solutions, LLC (“CBRES”) and PB Real Estate Holdings, LLC. All significant intercompany balances and transactions have been eliminated in consolidation.

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

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

The Consolidated Financial Statements in this report (other than the Consolidated Balance Sheet at December 31, 2021) are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these Consolidated Financial Statements in conformity with generally accepted accounting principles in the United States (“GAAP”). Actual results could differ from those estimates.

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 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders.

Recent Accounting Pronouncements

The following table provides a summary of Accounting Standards Updates (“ASUs”) issued by the Financial Accounting Standards Board (“FASB”) that the Company has not adopted as of September 30, 2022, which may impact the Company’s financial statements.

Recently Issued Accounting Guidance Not Yet Adopted

ASU | Description | Effective Date | Effect on Financial Statements or Other Significant Matters
ASU 2016-13: 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 has developed CECL model assumptions and is comparing results to current allowance for loan loss calculations. Parallel processing of the existing allowance for loan losses model with the CECL model will occur during the fourth quarter of 2022. The Company is currently evaluating the impact of this adoption on its financial statements and disclosures and currently expects to record a one-time adjustment to retained earnings to increase the allowance for loan losses. In addition to the Company’s allowance for loan losses, it will also review 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. Based on implementation progress to date, the Company believes the capital adequacy requirements to which it and the Bank are subject to, and its business strategies and practices, will not be materially impacted following the adoption on January 1, 2023.

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ASU | Description | Effective Date | Effect on Financial Statements or Other Significant Matters
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 and 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.
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 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.
ASU 2022-02: Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures | Eliminates the guidance on troubled debt restructurings (TDRs) for creditors in ASC 310-40 2 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination. | January 1, 2023 | The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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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.

(2) Investment Securities

Investment securities available for sale at September 30, 2022 and December 31, 2021 are as follows:

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | September 30, 2022 |
|  | Amortized Cost |  |  | Gross Unrealized Gains |  |  | Gross Unrealized Losses |  |  | Fair Value |
U.S. Treasuries |  | $ | 10,946 |  |  |  | - |  |  |  | 1,169 |  |  |  | 9,777 |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  |  | 12,827 |  |  |  | - |  |  |  | 685 |  |  |  | 12,142 |
Mortgage-backed securities |  |  | 296,204 |  |  |  | 271 |  |  |  | 24,576 |  |  |  | 271,899 |
State and political subdivisions |  |  | 183,924 |  |  |  | 14 |  |  |  | 33,389 |  |  |  | 150,549 |
Total |  | $ | 503,901 |  |  |  | 285 |  |  |  | 59,819 |  |  |  | 444,367 |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 2021 |
|  | Amortized Cost |  |  | Gross Unrealized Gains |  |  | Gross Unrealized Losses |  |  | Fair Value |
U.S Treasuries |  | $ | 7,964 |  |  |  | - |  |  |  | 75 |  |  |  | 7,889 |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  |  | 14,252 |  |  |  | 200 |  |  |  | 185 |  |  |  | 14,267 |
Mortgage-backed securities |  |  | 218,402 |  |  |  | 1,769 |  |  |  | 3,019 |  |  |  | 217,152 |
State and political subdivisions |  |  | 165,804 |  |  |  | 3,694 |  |  |  | 2,257 |  |  |  | 167,241 |
Total |  | $ | 406,422 |  |  |  | 5,663 |  |  |  | 5,536 |  |  |  | 406,549 |

The current fair value and associated unrealized losses on investments in securities with unrealized losses at September 30, 2022 and December 31, 2021 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | September 30, 2022 |
|  | Less than 12 Months |  |  | 12 Months or More |  |  | Total |
|  | Fair Value |  |  | Unrealized Losses |  |  | Fair Value |  |  | Unrealized Losses |  |  | Fair Value |  |  | Unrealized Losses |
U.S. Treasuries |  | $ | 2,868 |  |  |  | 109 |  |  |  | 6,909 |  |  |  | 1,060 |  |  |  | 9,777 |  |  |  | 1,169 |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  |  | 5,098 |  |  |  | 513 |  |  |  | 7,044 |  |  |  | 172 |  |  |  | 12,142 |  |  |  | 685 |
Mortgage-backed securities |  |  | 136,374 |  |  |  | 9,243 |  |  |  | 109,222 |  |  |  | 15,333 |  |  |  | 245,596 |  |  |  | 24,576 |
State and political subdivisions |  |  | 90,030 |  |  |  | 14,557 |  |  |  | 57,040 |  |  |  | 18,832 |  |  |  | 147,070 |  |  |  | 33,389 |
Total |  | $ | 234,370 |  |  |  | 24,422 |  |  |  | 180,215 |  |  |  | 35,397 |  |  |  | 414,585 |  |  |  | 59,819 |

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(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 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 |  | $ | 7,889 |  |  |  | 75 |  |  |  | - |  |  |  | - |  |  |  | 7,889 |  |  |  | 75 |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  |  | 5,232 |  |  |  | 15 |  |  |  | 3,263 |  |  |  | 170 |  |  |  | 8,495 |  |  |  | 185 |
Mortgage-backed securities |  |  | 131,483 |  |  |  | 2,477 |  |  |  | 19,632 |  |  |  | 542 |  |  |  | 151,115 |  |  |  | 3,019 |
State and political subdivisions |  |  | 80,076 |  |  |  | 1,981 |  |  |  | 5,922 |  |  |  | 276 |  |  |  | 85,998 |  |  |  | 2,257 |
Total |  | $ | 224,680 |  |  |  | 4,548 |  |  |  | 28,817 |  |  |  | 988 |  |  |  | 253,497 |  |  |  | 5,536 |

At September 30, 2022, unrealized losses in the investment securities portfolio relating to debt securities totaled $59.8 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the September 30, 2022 tables above, all three U.S. Treasury securities, 152 out of 166 securities issued by state and political subdivisions and 127 out of 139 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed. At December 31, 2021, unrealized losses in the investment securities portfolio relating to debt securities totaled $5.5 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the December 31, 2021 tables above, both of the U.S. Treasury securities, 70 of the 146 securities issued by state and political subdivisions contained unrealized losses and 54 of the 99 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The amortized cost and estimated fair value of investment securities available for sale at September 30, 2022, 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.

September 30, 2022 |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |
|  | Amortized Cost |  |  | Fair Value |
Due within one year |  | $ | 2,395 |  |  |  | 2,396 |
Due from one to five years |  |  | 9,173 |  |  |  | 8,962 |
Due from five to ten years |  |  | 59,376 |  |  |  | 51,386 |
Due after ten years |  |  | 136,753 |  |  |  | 109,724 |
Mortgage-backed securities |  |  | 296,204 |  |  |  | 271,899 |
Total |  | $ | 503,901 |  |  |  | 444,367 |

No securities available for sale were sold during the three and nine months ended September 30, 2022 and 2021.

Securities with a fair value of approximately $101.8 million and $98.6 million at September 30, 2022 and December 31, 2021, 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 September 30, 2022 and December 31, 2021 are summarized as follows:

(Dollars in thousands) |  |  |  |  |  |
|  | September 30, 2022 |  |  | December 31, 2021 |
Real estate loans: |  |  |  |  |  |
Construction and land development |  | $ | 112,854 |  |  |  | 95,760 |
Single-family residential |  |  | 312,208 |  |  |  | 266,111 |
Single-family residential - |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 20,469 |  |  |  | 23,147 |
Commercial |  |  | 399,015 |  |  |  | 337,841 |
Multifamily and farmland |  |  | 62,040 |  |  |  | 58,366 |
Total real estate loans |  |  | 906,586 |  |  |  | 781,225 |
Loans not secured by real estate: |  |  |  |  |  |  |  |
Commercial loans |  |  | 76,434 |  |  |  | 91,172 |
Farm loans |  |  | 961 |  |  |  | 796 |
Consumer loans |  |  | 6,438 |  |  |  | 6,436 |
All other loans |  |  | 14,488 |  |  |  | 5,240 |
Total loans |  |  | 1,004,907 |  |  |  | 884,869 |
Less allowance for loan losses |  |  | (10,030 | ) |  |  | (9,355 | )
Total net loans |  | $ | 994,877 |  |  |  | 875,514 |

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

| · | Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral.
| · | Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.
| · | Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over the loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.
| · | Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.
| · | Multifamily and farmland loans – Decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.

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

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The following tables present an age analysis of past due loans, by loan type, as of September 30, 2022 and December 31, 2021:

September 30, 2022 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Loans 30-89 Days Past Due |  |  | Loans 90 or More Days Past Due |  |  | Total Past Due Loans |  |  | Total Current Loans |  |  | Total Current Loans |  |  | Total Loans |  |  | Accruing Loans 90 or More Days Past Due |
Real estate loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Construction and land development |  | $ | 513 |  |  |  | - |  |  |  | 513 |  |  |  | 112,341 |  |  |  | - |  |  |  | 112,854 |  |  |  | - |
Single-family residential |  |  | 1,050 |  |  |  | 158 |  |  |  | 1,208 |  |  |  | 311,000 |  |  |  | - |  |  |  | 312,208 |  |  |  | - |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 602 |  |  |  | 191 |  |  |  | 793 |  |  |  | 19,676 |  |  |  | - |  |  |  | 20,469 |  |  |  | - |
Commercial |  |  | 123 |  |  |  | - |  |  |  | 123 |  |  |  | 398,892 |  |  |  | - |  |  |  | 399,015 |  |  |  | - |
Multifamily and farmland |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 62,040 |  |  |  | - |  |  |  | 62,040 |  |  |  | - |
Total real estate loans |  |  | 2,288 |  |  |  | 349 |  |  |  | 2,637 |  |  |  | 903,949 |  |  |  | - |  |  |  | 906,586 |  |  |  | - |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 1,237 |  |  |  | - |  |  |  | 1,237 |  |  |  | 75,197 |  |  |  | - |  |  |  | 76,434 |  |  |  | - |
Farm loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 961 |  |  |  | - |  |  |  | 961 |  |  |  | - |
Consumer loans |  |  | 41 |  |  |  | 3 |  |  |  | 44 |  |  |  | 6,394 |  |  |  | - |  |  |  | 6,438 |  |  |  | - |
All other loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 14,488 |  |  |  | - |  |  |  | 14,488 |  |  |  | - |
Total loans |  | $ | 3,566 |  |  |  | 352 |  |  |  | 3,918 |  |  |  | 1,000,989 |  |  |  | - |  |  |  | 1,004,907 |  |  |  | - |

December 31, 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 |  | $ | - |  |  |  | - |  |  |  | - |  |  |  | 95,760 |  |  |  | 95,760 |  |  |  | - |
Single-family residential |  |  | 2,323 |  |  |  | 634 |  |  |  | 2,957 |  |  |  | 263,154 |  |  |  | 266,111 |  |  |  | - |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 2,593 |  |  |  | 112 |  |  |  | 2,705 |  |  |  | 20,442 |  |  |  | 23,147 |  |  |  | - |
Commercial |  |  | 488 |  |  |  | - |  |  |  | 488 |  |  |  | 337,353 |  |  |  | 337,841 |  |  |  | - |
Multifamily and farmland |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 58,366 |  |  |  | 58,366 |  |  |  | - |
Total real estate loans |  |  | 5,404 |  |  |  | 746 |  |  |  | 6,150 |  |  |  | 775,075 |  |  |  | 781,225 |  |  |  | - |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 43 |  |  |  | - |  |  |  | 43 |  |  |  | 91,129 |  |  |  | 91,172 |  |  |  | - |
Farm loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 796 |  |  |  | 796 |  |  |  | - |
Consumer loans |  |  | 38 |  |  |  | - |  |  |  | 38 |  |  |  | 6,398 |  |  |  | 6,436 |  |  |  | - |
All other loans |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 5,240 |  |  |  | 5,240 |  |  |  | - |
Total loans |  | $ | 5,485 |  |  |  | 746 |  |  |  | 6,231 |  |  |  | 878,638 |  |  |  | 884,869 |  |  |  | - |

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The following table presents non-accrual loans as of September 30, 2022 and December 31, 2021:

(Dollars in thousands) |  |  |  |  |  |
|  | September 30, 2022 |  |  | December 31, 2021 |
Real estate loans: |  |  |  |  |  |
Construction and land development |  | $ | - |  |  |  | - |
Single-family residential |  |  | 1,999 |  |  |  | 1,642 |
Single-family residential - |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 1,462 |  |  |  | 1,232 |
Commercial |  |  | 133 |  |  |  | 200 |
Multifamily and farmland |  |  | 96 |  |  |  | 105 |
Total real estate loans |  |  | 3,690 |  |  |  | 3,179 |
Loans not secured by real estate: |  |  |  |  |  |  |  |
Commercial loans |  |  | - |  |  |  | 49 |
Consumer loans |  |  | 18 |  |  |  | 2 |
Total |  | $ | 3,708 |  |  |  | 3,230 |

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 less estimated selling costs. 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 Restructurings (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Impaired loans were $15.7 million and $18.3 million at September 30, 2022 and December 31, 2021, respectively. Interest income recognized on accruing impaired loans was $649,000 and $754,000 for the nine months ended September 30, 2022 and 2021, respectively. Interest income recognized on accruing impaired loans was $217,000 and $253,000 for the three months ended September 30, 2022 and the three months ended September 30, 2021, 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 September 30, 2022:

September 30, 2022 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Unpaid Contractual Principal Balance |  |  | Recorded Investment With No Allowance |  |  | Recorded Investment With Allowance |  |  | Recorded Investment in Impaired Loans |  |  | Related Allowance |
Real estate loans: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Construction and land development |  | $ | 59 |  |  |  | - |  |  |  | 59 |  |  |  | 59 |  |  |  | 1 |
Single-family residential |  |  | 3,929 |  |  |  | 240 |  |  |  | 3,381 |  |  |  | 3,621 |  |  |  | 62 |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 10,557 |  |  |  | - |  |  |  | 9,890 |  |  |  | 9,890 |  |  |  | 619 |
Commercial |  |  | 1,996 |  |  |  | 426 |  |  |  | 1,502 |  |  |  | 1,928 |  |  |  | 9 |
Multifamily and farmland |  |  | 107 |  |  |  | - |  |  |  | 96 |  |  |  | 96 |  |  |  | - |
Total impaired real estate loans |  |  | 16,648 |  |  |  | 666 |  |  |  | 14,928 |  |  |  | 15,594 |  |  |  | 691 |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 130 |  |  |  | - |  |  |  | 130 |  |  |  | 130 |  |  |  | 1 |
Consumer loans |  |  | 21 |  |  |  | - |  |  |  | 20 |  |  |  | 20 |  |  |  | - |
Total impaired loans |  | $ | 16,799 |  |  |  | 666 |  |  |  | 15,078 |  |  |  | 15,744 |  |  |  | 692 |

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The following table presents impaired loans as of and for the year ended December 31, 2021:

December 31, 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 |  | $ | 73 |  |  |  | - |  |  |  | 73 |  |  |  | 73 |  |  |  | 3 |
Single-family residential |  |  | 5,138 |  |  |  | 524 |  |  |  | 4,374 |  |  |  | 4,898 |  |  |  | 86 |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente non-traditional |  |  | 11,753 |  |  |  | - |  |  |  | 10,922 |  |  |  | 10,922 |  |  |  | 687 |
Commercial |  |  | 2,138 |  |  |  | 435 |  |  |  | 1,608 |  |  |  | 2,043 |  |  |  | 11 |
Multifamily and farmland |  |  | 113 |  |  |  | - |  |  |  | 105 |  |  |  | 105 |  |  |  | - |
Total impaired real estate loans |  |  | 19,215 |  |  |  | 959 |  |  |  | 17,082 |  |  |  | 18,041 |  |  |  | 787 |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 282 |  |  |  | 49 |  |  |  | 170 |  |  |  | 219 |  |  |  | 2 |
Consumer loans |  |  | 8 |  |  |  | - |  |  |  | 4 |  |  |  | 4 |  |  |  | - |
Total impaired loans |  | $ | 19,505 |  |  |  | 1,008 |  |  |  | 17,256 |  |  |  | 18,264 |  |  |  | 789 |

The following table presents the average impaired loan balance and the interest income recognized by loan class for the three and nine months ended September 30, 2022 and 2021.

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Three months ended |  |  | Nine months ended |
|  | September 30, 2022 |  |  | September 30, 2021 |  |  | September 30, 2022 |  |  | September 30, 2021 |
|  | 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 |  | $ | 60 |  |  |  | 1 |  |  |  | 76 |  |  |  | 1 |  |  |  | 65 |  |  |  | 4 |  |  |  | 91 |  |  |  | 5 |
Single-family residential |  |  | 1,393 |  |  |  | 51 |  |  |  | 5,875 |  |  |  | 49 |  |  |  | 1,131 |  |  |  | 150 |  |  |  | 5,683 |  |  |  | 166 |
Single-family residential - |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Banco de la Gente stated income |  |  | 12,487 |  |  |  | 134 |  |  |  | 10,349 |  |  |  | 140 |  |  |  | 13,454 |  |  |  | 407 |  |  |  | 11,090 |  |  |  | 477 |
Commercial |  |  | 1,939 |  |  |  | 25 |  |  |  | 2,280 |  |  |  | 20 |  |  |  | 1,985 |  |  |  | 75 |  |  |  | 2,617 |  |  |  | 85 |
Multifamily and farmland |  |  | 97 |  |  |  | 1 |  |  |  | 110 |  |  |  | 2 |  |  |  | 100 |  |  |  | 4 |  |  |  | 113 |  |  |  | 4 |
Total impaired real estate loans |  |  | 15,976 |  |  |  | 212 |  |  |  | 18,690 |  |  |  | 212 |  |  |  | 16,735 |  |  |  | 640 |  |  |  | 19,594 |  |  |  | 737 |
Loans not secured by real estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial loans |  |  | 138 |  |  |  | 3 |  |  |  | 248 |  |  |  | 5 |  |  |  | 163 |  |  |  | 7 |  |  |  | 330 |  |  |  | 16 |
Farm loans (non RE) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  |  |  |  |  | - |  |  |  | - |  |  |  | - |
Consumer loans |  |  | 21 |  |  |  | 1 |  |  |  | 9 |  |  |  | - |  |  |  | 14 |  |  |  | 2 |  |  |  | 19 |  |  |  | 1 |
Total impaired loans |  | $ | 16,135 |  |  |  | 216 |  |  |  | 18,947 |  |  |  | 217 |  |  |  | 16,912 |  |  |  | 649 |  |  |  | 19,943 |  |  |  | 754 |

Impaired loans collectively evaluated for impairment totaled $5.1 million at September 30, 2022 and December 31, 2021 and are included in the tables above. Allowance on impaired loans collectively evaluated for impairment totaled $44,000 and $52,000 at September 30, 2022 and December 31, 2021, respectively.

The following tables present changes in the allowance for loan losses for the three and nine months ended September 30, 2022 and 2021. Unallocated balances in the following tables include allowance for loan losses based on qualitative factors such as economic outlook, concentrations of credit, interest rate risk and loan volume trends. Paycheck Protection Program (“PPP”) loans are excluded from the allowance for loan losses as PPP loans are 100 percent guaranteed by the Small Business Administration (“SBA”).

17
Table of Contents

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

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Real Estate Loans |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Construction and Land Development |  |  | Single-Family Residential |  |  | Single-Family Residential - Banco de la Gente Non-traditional |  |  | Commercial |  |  | Multifamily and Farmland |  |  | Commercial |  |  | Farm |  |  | Consumer and All Other |  |  | Unallocated |  |  | Total |
Nine months ended September 30, 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 |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (293 | ) |  |  | - |  |  |  | (249 | ) |  |  | - |  |  |  | (542 | )
Recoveries |  |  | 121 |  |  |  | 165 |  |  |  | - |  |  |  | 50 |  |  |  | 3 |  |  |  | 7 |  |  |  | - |  |  |  | 114 |  |  |  | - |  |  |  | 460 |
Provision |  |  | (421 | ) |  |  | (306 | ) |  |  | (162 | ) |  |  | 46 |  |  |  | 22 |  |  |  | (153 | ) |  |  | - |  |  |  | 98 |  |  |  | 13 |  |  |  | (863 | )
Ending balance |  | $ | 896 |  |  |  | 1,702 |  |  |  | 890 |  |  |  | 2,308 |  |  |  | 147 |  |  |  | 906 |  |  |  | - |  |  |  | 91 |  |  |  | 2,023 |  |  |  | 8,963 |
Three months ended September 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Allowance for loan losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance |  | $ | 1,038 |  |  |  | 1,723 |  |  |  | 980 |  |  |  | 2,180 |  |  |  | 148 |  |  |  | 996 |  |  |  | - |  |  |  | 89 |  |  |  | 2,133 |  |  |  | 9,287 |
Charge-offs |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (215 | ) |  |  | - |  |  |  | (91 | ) |  |  | - |  |  |  | (306 | )
Recoveries |  |  | 31 |  |  |  | 86 |  |  |  | - |  |  |  | 2 |  |  |  | 4 |  |  |  | 1 |  |  |  | - |  |  |  | 40 |  |  |  | - |  |  |  | 164 |
Provision |  |  | (173 | ) |  |  | (107 | ) |  |  | (90 | ) |  |  | 126 |  |  |  | (5 | ) |  |  | 124 |  |  |  | - |  |  |  | 53 |  |  |  | (110 | ) |  |  | (182 | )
Ending balance |  | $ | 896 |  |  |  | 1,702 |  |  |  | 890 |  |  |  | 2,308 |  |  |  | 147 |  |  |  | 906 |  |  |  | - |  |  |  | 91 |  |  |  | 2,023 |  |  |  | 8,963 |
Allowance for loan losses at September 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance: individually |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 1 |  |  |  | 58 |  |  |  | 710 |  |  |  | 7 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 776 |
Ending balance: collectively |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  |  | 895 |  |  |  | 1,644 |  |  |  | 180 |  |  |  | 2,301 |  |  |  | 147 |  |  |  | 906 |  |  |  | - |  |  |  | 91 |  |  |  | 2,023 |  |  |  | 8,187 |
Ending balance |  | $ | 896 |  |  |  | 1,702 |  |  |  | 890 |  |  |  | 2,308 |  |  |  | 147 |  |  |  | 906 |  |  |  | - |  |  |  | 91 |  |  |  | 2,023 |  |  |  | 8,963 |
Loans at September 30, 2021: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending balance |  | $ | 80,009 |  |  |  | 258,403 |  |  |  | 24,043 |  |  |  | 363,174 |  |  |  | 58,856 |  |  |  | 94,376 |  |  |  | 633 |  |  |  | 11,511 |  |  |  | - |  |  |  | 891,005 |
Ending balance: individually |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 6 |  |  |  | 1,398 |  |  |  | 10,236 |  |  |  | 1,450 |  |  |  | - |  |  |  | 54 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 13,144 |
Ending balance: collectively |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
evaluated for impairment |  | $ | 80,003 |  |  |  | 257,005 |  |  |  | 13,807 |  |  |  | 361,724 |  |  |  | 58,856 |  |  |  | 94,322 |  |  |  | 633 |  |  |  | 11,511 |  |  |  | - |  |  |  | 877,861 |

18
Table of Contents

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

| · | Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.
| · | Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Bank’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 Bank’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). PPP loans are classified as risk grade 3.
| · | 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 Bank’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 Bank will sustain some loss if the deficiencies are not corrected.
| · | Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.
| · | Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of September 30, 2022 and December 31, 2021:

September 30, 2022 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Real Estate Loans |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Construction and Land Development |  |  | Single-Family Residential |  |  | Single-Family Residential - Banco de la Gente non-traditional |  |  | Commercial |  |  | Multifamily and Farmland |  |  | Commercial |  |  | Farm |  |  | Consumer |  |  | All Other |  |  | Total |
1- Excellent Quality |  | $ | - |  |  |  | 3,808 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1,381 |  |  |  | - |  |  |  | 523 |  |  |  | - |  |  |  | 5,712 |
2- High Quality |  |  | 18,162 |  |  |  | 129,784 |  |  |  | - |  |  |  | 30,197 |  |  |  | 17 |  |  |  | 16,163 |  |  |  | - |  |  |  | 2,064 |  |  |  | 1,427 |  |  |  | 197,814 |
3- Good Quality |  |  | 93,266 |  |  |  | 163,179 |  |  |  | 7,777 |  |  |  | 334,206 |  |  |  | 59,539 |  |  |  | 56,973 |  |  |  | 961 |  |  |  | 3,600 |  |  |  | 12,782 |  |  |  | 732,283 |
4- Management Attention |  |  | 1,307 |  |  |  | 11,046 |  |  |  | 9,130 |  |  |  | 31,732 |  |  |  | 1,869 |  |  |  | 1,127 |  |  |  | - |  |  |  | 225 |  |  |  | 133 |  |  |  | 56,569 |
5- Watch |  |  | 60 |  |  |  | 915 |  |  |  | 1,150 |  |  |  | 2,321 |  |  |  | 519 |  |  |  | 786 |  |  |  | - |  |  |  | - |  |  |  | 146 |  |  |  | 5,897 |
6- Substandard |  |  | 59 |  |  |  | 3,476 |  |  |  | 2,412 |  |  |  | 559 |  |  |  | 96 |  |  |  | 4 |  |  |  | - |  |  |  | 26 |  |  |  | - |  |  |  | 6,632 |
7- Doubtful |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
8- Loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Total |  | $ | 112,854 |  |  |  | 312,208 |  |  |  | 20,469 |  |  |  | 399,015 |  |  |  | 62,040 |  |  |  | 76,434 |  |  |  | 961 |  |  |  | 6,438 |  |  |  | 14,488 |  |  |  | 1,004,907 |

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December 31, 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 |  | $ | - |  |  |  | 5,923 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 371 |  |  |  | - |  |  |  | 581 |  |  |  | - |  |  |  | 6,875 |
2- High Quality |  |  | 11,752 |  |  |  | 109,337 |  |  |  | - |  |  |  | 28,546 |  |  |  | 19 |  |  |  | 16,177 |  |  |  | - |  |  |  | 2,039 |  |  |  | 1,309 |  |  |  | 169,179 |
3- Good Quality |  |  | 80,325 |  |  |  | 129,856 |  |  |  | 8,712 |  |  |  | 272,786 |  |  |  | 54,945 |  |  |  | 68,183 |  |  |  | 792 |  |  |  | 3,510 |  |  |  | 3,931 |  |  |  | 623,040 |
4- Management Attention |  |  | 3,534 |  |  |  | 14,964 |  |  |  | 10,478 |  |  |  | 30,937 |  |  |  | 2,754 |  |  |  | 5,214 |  |  |  | 4 |  |  |  | 284 |  |  |  | - |  |  |  | 68,169 |
5- Watch |  |  | 76 |  |  |  | 2,464 |  |  |  | 1,703 |  |  |  | 4,938 |  |  |  | 543 |  |  |  | 1,177 |  |  |  | - |  |  |  | 1 |  |  |  | - |  |  |  | 10,902 |
6- Substandard |  |  | 73 |  |  |  | 3,567 |  |  |  | 2,254 |  |  |  | 634 |  |  |  | 105 |  |  |  | 50 |  |  |  | - |  |  |  | 21 |  |  |  | - |  |  |  | 6,704 |
7- Doubtful |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
8- Loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Total |  | $ | 95,760 |  |  |  | 266,111 |  |  |  | 23,147 |  |  |  | 337,841 |  |  |  | 58,366 |  |  |  | 91,172 |  |  |  | 796 |  |  |  | 6,436 |  |  |  | 5,240 |  |  |  | 884,869 |

There were no new TDR modifications during the three and nine months ended September 30, 2022 and 2021.

There were no loans modified as TDR loans that defaulted during the nine months ended September 30, 2022 and 2021, which were within 12 months of their modification date.

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 were able to apply for loans from existing SBA lenders and other approved regulated lenders, subject to certain limitations and eligibility criteria. A second round of PPP funding provided a total of $320 billion additional funding for the PPP. The Bank participated as a lender in the PPP. Total PPP loans originated during the years ended December 31, 2020 and 2021 amounted to $128.1 million. The outstanding balance of PPP loans was $103,000 and $18.0 million at September 30, 2022 and December 31, 2021, respectively. These loans are classified as commercial loans in the tables above. The Bank recognized $54,000 and $489,000 of PPP loan fee income for the three months ended September 30, 2022 and the three months ended September 30, 2021, respectively. The Bank recognized $948,000 and $3.0 million of PPP loan fee income for the nine months ended September 30, 2022 and nine months ended September 30, 2021, respectively.

(4) Net Earnings Per Share

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

The reconciliation of the amounts used in the computation of both “basic earnings per share” and “diluted earnings per share” for the three and nine months ended September 30, 2022 and 2021 is as follows:

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

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

For the three months ended September 30, 2021 |  |  |  |  |  |  |  |  |
|  | Net Earnings (Dollars in thousands) |  |  | Weighted Average Number of Shares |  |  | Per Share Amount |
Basic earnings per share |  | $ | 3,390 |  |  |  | 5,544,596 |  |  | $ | 0.61 |
Effect of dilutive securities: |  |  |  |  |  |  |  |  |  |  |  |
Restricted stock units - unvested |  |  | - |  |  |  | 14,690 |  |  |  |  |
Shares held in deferred comp plan |  |  |  |  |  |  |  |  |  |  |  |
by deferred compensation trust |  |  |  |  |  |  | 159,797 |  |  |  |  |
Diluted earnings per share |  | $ | 3,390 |  |  |  | 5,719,083 |  |  | $ | 0.59 |

For the nine months ended September 30, 2021 |  |  |  |  |  |  |  |  |
|  | Net Earnings (Dollars in thousands) |  |  | Weighted Average Number of Shares |  |  | Per Share Amount |
Basic earnings per share |  | $ | 12,126 |  |  |  | 5,601,879 |  |  | $ | 2.16 |
Effect of dilutive securities: |  |  |  |  |  |  |  |  |  |  |  |
Restricted stock units - unvested |  |  | - |  |  |  | 13,190 |  |  |  |  |
Shares held in deferred comp plan |  |  |  |  |  |  |  |  |  |  |  |
by deferred compensation trust |  |  |  |  |  |  | 158,039 |  |  |  |  |
Diluted earnings per share |  | $ | 12,126 |  |  |  | 5,773,108 |  |  | $ | 2.10 |

(5) Fair Value

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

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

| · | Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.
| · | Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
| · | Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Cash and Cash Equivalents

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

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Investment Securities Available for Sale

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

Other Investments

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

Mortgage Loans Held for Sale

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

Loans

The fair value of 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 the balance sheet and reported in the Level 2 fair value category.

Deposits

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

Securities Sold Under Agreements to Repurchase

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

FHLB Borrowings

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

Junior Subordinated Debentures

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

Commitments to Extend Credit and Standby Letters of Credit

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

Limitations

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

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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 all financial instruments measured at fair value on a recurring basis by level within the fair value hierarchy, as of September 30, 2022 and December 31, 2021.

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | September 30, 2022 |
|  | Fair Value |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
U.S. Treasuries |  | $ | 9,777 |  |  |  | - |  |  |  | 9,777 |  |  |  | - |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  | $ | 12,142 |  |  |  | - |  |  |  | 12,142 |  |  |  | - |
Mortgage-backed securities |  | $ | 271,899 |  |  |  | - |  |  |  | 271,899 |  |  |  | - |
State and political subdivisions |  | $ | 150,549 |  |  |  | - |  |  |  | 150,549 |  |  |  | - |
Mutual funds held in deferred compensation trust |  | $ | 1,218 |  |  |  | - |  |  |  | 1,218 |  |  |  |  |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | December 31, 2021 |
|  | Fair Value |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
U.S. Treasuries |  | $ | 7,889 |  |  |  | - |  |  |  | 7,889 |  |  |  | - |
U.S. Government |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
sponsored enterprises |  | $ | 14,267 |  |  |  | - |  |  |  | 14,267 |  |  |  | - |
Mortgage-backed securities |  | $ | 217,152 |  |  |  | - |  |  |  | 217,152 |  |  |  | - |
State and political subdivisions |  | $ | 167,241 |  |  |  | - |  |  |  | 167,241 |  |  |  | - |
Mutual funds held in deferred compensation trust |  | $ | 1,510 |  |  |  | - |  |  |  | 1,510 |  |  |  | - |

The fair value measurements for mortgage loans held for sale and impaired loans on a non-recurring basis at September 30, 2022 and December 31, 2021 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 September 30, 2022 |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
Mortgage loans held for sale |  | $ | 975 |  |  |  | - |  |  |  | - |  |  |  | 975 |
Impaired loans |  | $ | 15,052 |  |  |  | - |  |  |  | - |  |  |  | 15,052 |
(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value Measurements December 31, 2021 |  |  | Level 1 Valuation |  |  | Level 2 Valuation |  |  | Level 3 Valuation |
Mortgage loans held for sale |  | $ | 3,637 |  |  |  | - |  |  |  | - |  |  |  | 3,637 |
Impaired loans |  | $ | 17,475 |  |  |  | - |  |  |  | - |  |  |  | 17,475 |

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |
|  | Fair Value September 30, 2022 |  |  | Fair Value December 31, 2021 |  |  | Valuation Technique |  | Significant Unobservable Inputs |  |  | General Range of Significant Unobservable Input Values |
Mortgage loans held for sale |  | $ | 975 |  |  |  | 3,637 |  |  | Rate lock commitment |  |  | N/A |  |  |  | N/A |
Impaired loans |  | $ | 15,052 |  |  |  | 17,475 |  |  | Appraised value and discounted cash flows |  | Discounts to reflect current market conditions and ultimate collectability |  |  | 0 - 25% |

The carrying amount and estimated fair value of financial instruments at September 30, 2022 and December 31, 2021 are as follows:

(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  |  |  |  | Fair Value Measurements at September 30, 2022 |
|  | Carrying Amount |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |  |  | Total |
Assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 155,461 |  |  |  | 155,461 |  |  |  | - |  |  |  | - |  |  |  | 155,461 |
Investment securities available for sale |  |  | 444,367 |  |  |  | - |  |  |  | 444,367 |  |  |  | - |  |  |  | 444,367 |
Other investments |  |  | 2,762 |  |  |  | - |  |  |  | - |  |  |  | 2,762 |  |  |  | 2,762 |
Mortgage loans held for sale |  |  | 975 |  |  |  | - |  |  |  | - |  |  |  | 975 |  |  |  | 975 |
Loans, net |  |  | 994,877 |  |  |  | - |  |  |  | - |  |  |  | 970,038 |  |  |  | 970,038 |
Mutual funds held in deferred |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
compensation trust |  |  | 1,288 |  |  |  | - |  |  |  | 1,288 |  |  |  | - |  |  |  | 1,288 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 1,501,091 |  |  |  | - |  |  |  | - |  |  |  | 1,500,613 |  |  |  | 1,500,613 |
Securities sold under agreements |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
to repurchase |  |  | 37,986 |  |  |  | - |  |  |  | 37,986 |  |  |  | - |  |  |  | 37,986 |
Junior subordinated debentures |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |

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(Dollars in thousands) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  |  |  |  | Fair Value Measurements at December 31, 2021 |
|  | Carrying Amount |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |  |  | Total |
Assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 277,499 |  |  |  | 277,499 |  |  |  | - |  |  |  | - |  |  |  | 277,499 |
Investment securities available for sale |  |  | 406,549 |  |  |  | - |  |  |  | 406,549 |  |  |  | - |  |  |  | 406,549 |
Other investments |  |  | 3,668 |  |  |  | - |  |  |  | - |  |  |  | 3,668 |  |  |  | 3,668 |
Mortgage loans held for sale |  |  | 3,637 |  |  |  | - |  |  |  | - |  |  |  | 3,637 |  |  |  | 3,637 |
Loans, net |  |  | 875,514 |  |  |  | - |  |  |  | - |  |  |  | 855,814 |  |  |  | 855,814 |
Mutual funds held in deferred |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
compensation trust |  |  | 1,510 |  |  |  | - |  |  |  | 1,510 |  |  |  | - |  |  |  | 1,510 |
Liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 1,412,748 |  |  |  | - |  |  |  | - |  |  |  | 1,401,833 |  |  |  | 1,401,833 |
Securities sold under agreements |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
to repurchase |  |  | 37,094 |  |  |  | - |  |  |  | 37,094 |  |  |  | - |  |  |  | 37,094 |
Junior subordinated debentures |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |  |  |  | - |  |  |  | 15,464 |

(6) Leases

As of September 30, 2022, the Bank had operating right of use assets of $5.8 million and operating lease liabilities of $5.8 million. The Bank maintains operating leases on land and buildings for some of the Bank’s branch facilities and loan production offices. Most leases include one option to renew, with renewal terms extending up to 15 years. The exercise of renewal options is based on the judgment of management as to whether or not the renewal option is reasonably certain to be exercised. Factors in determining whether an option is reasonably certain of exercise include, but are not limited to, the value of leasehold improvements, the value of renewal rates compared to market rates, and the presence of factors that would cause a significant economic penalty to the Bank if the option is not exercised. Leases with a term of 12 months or less are not recorded on the balance sheet and instead are recognized in lease expense on a straight-line basis over the lease term.

The following table presents lease cost and other lease information as of September 30, 2022 and 2021.

(Dollars in thousands) |  |  |  |  |  |
|  | September 30, 2022 |  |  | September 30, 2021 |
Operating lease cost |  | $ | 617 |  |  | $ | 538 |
Other information: |  |  |  |  |  |  |  |
Cash paid for amounts included in the measurement of lease liabilities |  |  | 605 |  |  |  | 520 |
Operating cash flows from operating leases |  |  | - |  |  |  | - |
Right-of-use assets obtained in exchange for new lease liabilities - operating leases |  |  | 1,726 |  |  |  | 952 |
Weighted-average remaining lease term - operating leases |  |  | 9.01 |  |  |  | 6.72 |
Weighted-average discount rate - operating leases |  |  | 2.30 | % |  |  | 2.71 | %

The following table presents lease maturities as of September 30, 2022 and December 31, 2021.

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(Dollars in thousands) |  |  |
Maturity Analysis of Operating Lease Liabilities: |  | September 30,2022 |
2022 |  | $ | 229 |
2023 |  |  | 922 |
2024 |  |  | 867 |
2025 |  |  | 812 |
2026 |  |  | 694 |
Thereafter |  |  | 2,975 |
Total |  |  | 6,499 |
Less: Imputed Interest |  |  | (652 | )
Operating Lease Liability |  | $ | 5,847 |

(7) Subsequent Events

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

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

The following is a discussion of the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company’s Annual Report of Form 10-K and the Company’s Consolidated Financial Statements and Notes thereto on pages A-28 through A-69 of the Company’s 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders.

Introduction

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

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 and lease losses (“ALLL”, “allowance for loan losses”, or “allowance”) 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. Subsequently, continuing supply-chain disruption and rising inflation has caused the FOMC to increase the target federal funds rate by 300 basis points in 2022 to a range of 3.00% to 3.25% at October 31, 2022.

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

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

Summary of Significant Accounting Policies

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. The following is a summary of some of the more subjective and complex accounting policies of the Company. A more complete description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders.

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

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

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

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

Results of Operations

Summary. Net earnings were $5.3 million or $0.96 per share and $0.93 per diluted share for the three months ended September 30, 2022, as compared to $3.4 million or $0.61 per share and $0.59 per diluted share for the prior year period. The increase in third quarter net earnings is primarily the result of an increase in net interest income and an increase in non-interest income, which were partially offset by an increase in the provision for loan losses and an increase in non-interest expense, compared to the prior year period, as discussed below.

The annualized return on average assets was 1.25% for the three months ended September 30, 2022, compared to 0.83% for the same period one year ago, and annualized return on average shareholders’ equity was 18.42% for the three months ended September 30, 2022, compared to 9.30% for the same period one year ago.

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Year-to-date net earnings as of September 30, 2022 were $12.0 million or $2.18 per share and $2.11 per diluted share for the nine months ended September 30, 2022, as compared to $12.1 million or $2.16 per share and $2.10 per diluted share for the prior year period. The decrease in year-to-date net earnings is primarily attributable to an increase in non-interest expense and an increase in the provision for loan losses, which were partially offset by an increase in net interest income and an increase in non-interest income compared to the prior year period, as discussed below.

The annualized return on average assets was 0.96% for the nine months ended September 30, 2022, compared to 1.05 % for the same period one year ago, and annualized return on average shareholders’ equity was 12.53% for the nine months ended September 30, 2022, compared to 11.04% for the same period one year ago.

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

Net interest income was $13.8 million for the three months ended September 30, 2022, compared to $10.6 million for the three months ended September 30, 2021. The increase in net interest income is due to a $3.2 million increase in interest income and a $43,000 decrease in interest expense. The increase in interest income is due to a $1.2 million increase in interest income and fees on loans, a $811,000 increase in interest income on balances due from banks and a $1.1 million increase in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a decrease in fee income on SBA PPP loans. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased during the second and third quarters of 2022. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities

Interest income was $14.6 million for the three months ended September 30, 2022, compared to $11.4 million for the three months ended September 30, 2021. The increase in interest income is due to a $1.2 million increase in interest income and fees on loans, a $811,000 increase in interest income on balances due from banks and a $1.1 million increase in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by the Federal Reserve, partially offset by a decrease in fee income on SBA PPP loans. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased during the second and third quarters of 2022. The Bank recognized $54,000 and $489,000 of PPP loan fee income for the three months ended September 30, 2022 and the three months ended September 30, 2021, respectively. During the three months ended September 30, 2022, average loans were $971.6 million, an increase of $82.1 million from average loans of $889.5 million for the three months ended September 30, 2021. During the three months ended September 30, 2022, average PPP loans were $739,000, a reduction of $29.9 million from average PPP loans of $30.7 million for the three months ended September 30, 2021. During the three months ended September 30, 2022, average investment securities available for sale were $490.6 million, an increase of $111.8 million from average investment securities available for sale of $378.8 million for the three months ended September 30, 2021. The average yield on loans for the three months ended September 30, 2022 and 2021 was 4.51% and 4.37%, respectively. The average yield on investment securities available for sale was 2.23% and 1.70% for the three months ended September 30, 2022 and 2021, respectively. The average yield on earning assets was 3.59% and 2.98% for the three months ended September 30, 2022 and 2021, respectively.

Interest expense was $818,000 for the three months ended September 30, 2022, compared to $861,000 for the three months ended September 30, 2021. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the three months ended September 30, 2022, average interest-bearing non-maturity deposits were $843.8 million, an increase of $55.8 million from average interest-bearing non-maturity deposits of $788.0 million for the three months ended September 30, 2021. During the three months ended September 30, 2022, average certificates of deposit were $99.9 million, a reduction of $3.9 million from average certificates of deposit of $103.8 million for the three months ended September 30, 2021. The average rate paid on interest-bearing checking and savings accounts was 0.23% and 0.29% for the three months ended September 30, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.53% for the three months ended September 30, 2022, compared to 0.69% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.33% for the three months ended September 30, 2022, compared to 0.36% for the same period one year ago.

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The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the three months ended September 30, 2022 and 2021. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields and interest income on tax-exempt investments for the three months ended September 30, 2022 and 2021 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below.

|  | Three months ended |  |  | Three months ended |
|  | September 30, 2022 |  |  | September 30, 2021 |
(Dollars in thousands) |  | Average Balance |  |  | Interest |  |  | Yield / Rate |  |  | Average Balance |  |  | Interest |  |  | Yield / Rate |
Interest-earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans receivable |  | $ | 971,592 |  |  | $ | 11,051 |  |  |  | 4.51 | % |  | $ | 889,455 |  |  | $ | 9,807 |  |  |  | 4.37 | %
Investments - taxable |  |  | 357,269 |  |  |  | 2,074 |  |  |  | 2.30 | % |  |  | 227,026 |  |  |  | 657 |  |  |  | 1.15 | %
Investments - nontaxable* |  |  | 136,587 |  |  |  | 687 |  |  |  | 2.00 | % |  |  | 155,986 |  |  |  | 972 |  |  |  | 2.47 | %
Other |  |  | 158,680 |  |  |  | 899 |  |  |  | 2.25 | % |  |  | 262,205 |  |  |  | 89 |  |  |  | 0.13 | %
Total interest-earning assets |  |  | 1,624,128 |  |  |  | 14,711 |  |  |  | 3.59 | % |  |  | 1,534,672 |  |  |  | 11,525 |  |  |  | 2.98 | %
Non-interest earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  |  | 37,514 |  |  |  |  |  |  |  |  |  |  |  | 29,644 |  |  |  |  |  |  |  |  |
Allowance for loan losses |  |  | (9,785 | ) |  |  |  |  |  |  |  |  |  |  | (9,313 | ) |  |  |  |  |  |  |  |
Other assets |  |  | 34,290 |  |  |  |  |  |  |  |  |  |  |  | 64,439 |  |  |  |  |  |  |  |  |
Total assets |  | $ | 1,686,147 |  |  |  |  |  |  |  |  |  |  | $ | 1,619,442 |  |  |  |  |  |  |  |  |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand, MMDA & savings deposits |  | $ | 843,798 |  |  | $ | 494 |  |  |  | 0.23 | % |  | $ | 787,985 |  |  | $ | 577 |  |  |  | 0.29 | %
Time deposits |  |  | 99,889 |  |  |  | 134 |  |  |  | 0.53 | % |  |  | 103,828 |  |  |  | 181 |  |  |  | 0.69 | %
Junior subordinated debentures |  |  | 15,464 |  |  |  | 146 |  |  |  | 3.75 | % |  |  | 15,464 |  |  |  | 69 |  |  |  | 1.77 | %
Other |  |  | 37,965 |  |  |  | 44 |  |  |  | 0.46 | % |  |  | 29,595 |  |  |  | 34 |  |  |  | 0.46 | %
Total interest-bearing liabilities |  |  | 997,116 |  |  |  | 818 |  |  |  | 0.33 | % |  |  | 936,872 |  |  |  | 861 |  |  |  | 0.36 | %
Non-interest bearing liabilities and shareholders' equity: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Demand deposits |  |  | 562,979 |  |  |  |  |  |  |  |  |  |  |  | 528,481 |  |  |  |  |  |  |  |  |
Other liabilities |  |  | 11,763 |  |  |  |  |  |  |  |  |  |  |  | 9,439 |  |  |  |  |  |  |  |  |
Shareholders' equity |  |  | 114,289 |  |  |  |  |  |  |  |  |  |  |  | 144,650 |  |  |  |  |  |  |  |  |
Total liabilities and shareholders' equity |  | $ | 1,686,147 |  |  |  |  |  |  |  |  |  |  | $ | 1,619,442 |  |  |  |  |  |  |  |  |
Net interest spread |  |  |  |  |  | $ | 13,893 |  |  |  | 3.26 | % |  |  |  |  |  | $ | 10,664 |  |  |  | 2.62 | %
Net yield on interest-earning assets |  |  |  |  |  |  |  |  |  |  | 3.39 | % |  |  |  |  |  |  |  |  |  |  | 2.76 | %
Taxable equivalent adjustment |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investment securities |  |  |  |  |  | $ | 100 |  |  |  |  |  |  |  |  |  |  | $ | 104 |  |  |  |  |
Net interest income |  |  |  |  |  | $ | 13,793 |  |  |  |  |  |  |  |  |  |  | $ | 10,560 |  |  |  |  |

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $13.0 million in 2022 and $14.9 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2022 and 2021.

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Year-to-date net interest income as of September 30, 2022 was $35.8 million for the nine months ended September 30, 2022, compared to $33.3 million for the nine months ended September 30, 2021. The increase in net interest income is due to a $2.1 million increase in interest income and a $393,000 decrease in interest expense. The increase in interest income is primarily due to a $1.5 million increase in interest income on investment securities and a $1.3 million increase in interest income on balances due from banks, which were partially offset by a $747,000 decrease in interest income and fees on loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased during the second and third quarters of 2022. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities.

Interest income was $37.9 million for the nine months ended September 30, 2022, compared to $35.9 million for the nine months ended September 30, 2021. The increase in net interest income is due to a $2.1 million increase in interest income and a $393,000 decrease in interest expense. The increase in interest income is primarily due to a $1.5 million increase in interest income on investment securities and a $1.3 million increase in interest income on balances due from banks, which were partially offset by a $747,000 decrease in interest income and fees on loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased during the second and third quarters of 2022. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans, which offset the increase in interest income resulting from rate increases by the Federal Reserve. The Bank recognized $948,000 and $3.0 million of PPP loan fee income for the nine months ended September 30, 2022 and the nine months ended September 30, 2021, respectively. During the nine months ended September 30, 2022, average loans were $925.2 million, an increase of $7.7 million from average loans of $917.5 million for the nine months ended September 30, 2021. During the nine months ended September 30, 2022, average PPP loans were $9.1 million, a decrease of $41.6 million from average PPP loans of $50.7 million for the nine months ended September 30, 2021. During the nine months ended September 30, 2022, average investment securities available for sale were $453.4 million, an increase of $123.4 million from average investment securities available for sale of $330.0 million for the nine months ended September 30, 2021. The average yield on loans for the nine months ended September 30, 2022 and 2021 was 4.44% and 4.59%, respectively. The average yield on investment securities available for sale was 1.75% and 1.81% for the nine months ended September 30, 2022 and 2021, respectively. The average yield on earning assets was 3.20% and 3.31% for the nine months ended September 30, 2022 and 2021, respectively.

Interest expense was $2.1 million for the nine months ended September 30, 2022, compared to $2.5 million for the nine months ended September 30, 2021. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the nine months ended September 30, 2022, average interest-bearing non-maturity deposits were $822.3 million, an increase of $90.3 million from average interest-bearing non-maturity deposits of $732.0 million for the nine months ended September 30, 2021. During the nine months ended September 30, 2022, average certificates of deposit were $100.6 million, a decrease of $5.5 million from average certificates of deposit of $106.1 million for the nine months ended September 30, 2021. The average rate paid on interest-bearing checking and savings accounts was 0.21% and 0.30% for the nine months ended September 30, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.56% for the nine months ended September 30, 2022, compared to 0.74% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.29% for the nine months ended September 30, 2022, compared to 0.38% for the same period one year ago.

The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the nine months ended September 30, 2022 and 2021. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields and interest income on tax-exempt investments for the nine months ended September 30, 2022 and 2021 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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|  | Nine months ended |  |  | Nine months ended |
|  | September 30, 2022 |  |  | September 30, 2021 |
(Dollars in thousands) |  | Average Balance |  |  | Interest |  |  | Yield / Rate |  |  | Average Balance |  |  | Interest |  |  | Yield / Rate |
Interest-earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans receivable |  | $ | 925,178 |  |  |  | 30,727 |  |  |  | 4.44 | % |  | $ | 917,473 |  |  |  | 31,474 |  |  |  | 4.59 | %
Investments - taxable |  |  | 324,664 |  |  |  | 4,140 |  |  |  | 1.70 | % |  |  | 199,395 |  |  |  | 1,847 |  |  |  | 1.24 | %
Investments - nontaxable* |  |  | 132,301 |  |  |  | 1,891 |  |  |  | 1.91 | % |  |  | 134,893 |  |  |  | 2,714 |  |  |  | 2.69 | %
Other |  |  | 213,342 |  |  |  | 1,453 |  |  |  | 0.91 | % |  |  | 210,855 |  |  |  | 172 |  |  |  | 0.11 | %
Total interest-earning assets |  |  | 1,595,485 |  |  |  | 38,211 |  |  |  | 3.20 | % |  |  | 1,462,616 |  |  |  | 36,207 |  |  |  | 3.31 | %
Non-interest earning assets: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  |  | 36,576 |  |  |  |  |  |  |  |  |  |  |  | 30,652 |  |  |  |  |  |  |  |  |
Allowance for loan losses |  |  | (9,535 | ) |  |  |  |  |  |  |  |  |  |  | (9,602 | ) |  |  |  |  |  |  |  |
Other assets |  |  | 43,074 |  |  |  |  |  |  |  |  |  |  |  | 63,739 |  |  |  |  |  |  |  |  |
Total assets |  | $ | 1,665,600 |  |  |  |  |  |  |  |  |  |  | $ | 1,547,405 |  |  |  |  |  |  |  |  |
Interest-bearing liabilities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Interest-bearing demand, MMDA & savings deposits |  | $ | 822,299 |  |  |  | 1,263 |  |  |  | 0.21 | % |  | $ | 732,045 |  |  |  | 1,617 |  |  |  | 0.30 | %
Time deposits |  |  | 100,630 |  |  |  | 421 |  |  |  | 0.56 | % |  |  | 106,158 |  |  |  | 584 |  |  |  | 0.74 | %
Trust preferred securities |  |  | 15,464 |  |  |  | 324 |  |  |  | 2.80 | % |  |  | 15,464 |  |  |  | 211 |  |  |  | 1.82 | %
Other |  |  | 37,964 |  |  |  | 117 |  |  |  | 0.41 | % |  |  | 29,095 |  |  |  | 106 |  |  |  | 0.49 | %
Total interest-bearing liabilities |  |  | 976,357 |  |  |  | 2,125 |  |  |  | 0.29 | % |  |  | 882,762 |  |  |  | 2,518 |  |  |  | 0.38 | %
Non-interest bearing liabilities and shareholders' equity: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Demand deposits |  |  | 554,335 |  |  |  |  |  |  |  |  |  |  |  | 515,433 |  |  |  |  |  |  |  |  |
Other liabilities |  |  | 7,073 |  |  |  |  |  |  |  |  |  |  |  | 2,298 |  |  |  |  |  |  |  |  |
Shareholders' equity |  |  | 127,835 |  |  |  |  |  |  |  |  |  |  |  | 146,912 |  |  |  |  |  |  |  |  |
Total liabilities and shareholders' equity |  | $ | 1,665,600 |  |  |  |  |  |  |  |  |  |  | $ | 1,547,405 |  |  |  |  |  |  |  |  |
Net interest spread |  |  |  |  |  | $ | 36,086 |  |  |  | 2.91 | % |  |  |  |  |  | $ | 33,689 |  |  |  | 2.93 | %
Net yield on interest-earning assets |  |  |  |  |  |  |  |  |  |  | 3.02 | % |  |  |  |  |  |  |  |  |  |  | 3.08 | %
Taxable equivalent adjustment |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Investment securities |  |  |  |  |  | $ | 279 |  |  |  |  |  |  |  |  |  |  | $ | 347 |  |  |  |  |
Net interest income |  |  |  |  |  | $ | 35,807 |  |  |  |  |  |  |  |  |  |  | $ | 33,342 |  |  |  |  |

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $13.5 million in 2022 and $12.1 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2022 and 2021.

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

|  | Three months ended September 30, 2022 compared to three months ended September 30, 2021 |  |  |  |  | Nine months ended September 30, 2022 compared to nine months ended September 30, 2021 |
(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 |  | $ | 920 |  |  |  | 324 |  |  |  | 1,244 |  |  |  |  |  | 260 |  |  |  | (1,007 | ) |  |  | (747 | )
Investments - taxable |  |  | 566 |  |  |  | 851 |  |  |  | 1,417 |  |  |  |  |  | 1,379 |  |  |  | 914 |  |  |  | 2,293 |
Investments - nontaxable |  |  | (109 | ) |  |  | (176 | ) |  |  | (285 | ) |  |  |  |  | (45 | ) |  |  | (778 | ) |  |  | (823 | )
Other |  |  | (311 | ) |  |  | 1,121 |  |  |  | 810 |  |  |  |  |  | 9 |  |  |  | 1,272 |  |  |  | 1,281 |
Total interest income |  |  | 1,066 |  |  |  | 2,120 |  |  |  | 3,186 |  |  |  |  |  | 1,603 |  |  |  | 401 |  |  |  | 2,004 |
Interest expense: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
NOW, MMDA & savings deposits |  |  | 37 |  |  |  | (120 | ) |  |  | (83 | ) |  |  |  |  | 169 |  |  |  | (523 | ) |  |  | (354 | )
Time deposits |  |  | (6 | ) |  |  | (41 | ) |  |  | (47 | ) |  |  |  |  | (27 | ) |  |  | (136 | ) |  |  | (163 | )
Trust preferred securities |  |  | - |  |  |  | 77 |  |  |  | 77 |  |  |  |  |  | - |  |  |  | 113 |  |  |  | 113 |
Other |  |  | 10 |  |  |  | - |  |  |  | 10 |  |  |  |  |  | 30 |  |  |  | (19 | ) |  |  | 11 |
Total interest expense |  |  | 41 |  |  |  | (84 | ) |  |  | (43 | ) |  |  |  |  | 172 |  |  |  | (565 | ) |  |  | (393 | )
Net interest income |  | $ | 1,025 |  |  |  | 2,204 |  |  |  | 3,229 |  |  |  |  |  | 1,431 |  |  |  | 966 |  |  |  | 2,397 |

Provision for Loan Losses. The provision for loan losses for the three months ended September 30, 2022 was $408,000, compared to a recovery of $182,000 for the three months ended September 30, 2021. The increase in the provision for loan losses is primarily attributable to an increase in reserves due to a net increase in the volume of loans in the general reserve pool. The recovery of provision for loan losses for the three months ended September 30, 2021 was 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 in the general reserve pool. There were no loans with modifications as a result of the COVID-19 pandemic at September 30, 2022 and December 31, 2021.

The provision for loan losses for the nine months ended September 30, 2022 was $889,000, compared to a recovery of $863,000 for the nine months ended September 30, 2021. The increase in the provision for loan losses is primarily attributable to an increase in reserves due to a net increase in the volume of loans in the general reserve pool. The recovery of provision for loan losses for the nine months ended September 30, 2021 was 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 in the general reserve pool.

Non-Interest Income. Total non-interest income was $6.8 million for the three months ended September 30, 2022, compared to $6.0 million for the three months ended September 30, 2021. The increase in non-interest income is primarily attributable to a $757,000 increase in appraisal management fee income due to an increase in appraisal volume and a $435,000 increase in service charge income, primarily due to service charge changes implemented in March 2022, which were partially offset by a $457,000 decrease in mortgage banking income due to a decrease in mortgage loan volume and additional mortgage loans being retained in the Bank’s portfolio.

Non-interest income was $21.2 million for the nine months ended September 30, 2022, compared to $18.0 million for the nine months ended September 30, 2021. The increase in non-interest income is primarily attributable to a $3.9 million increase in appraisal management fee income due to an increase in appraisal volume and a $1.1 million increase in service charge income, primarily due to service charge changes implemented in March 2022, which were partially offset by a $1.8 million decrease in mortgage banking income due to a decrease in mortgage loan volume and additional mortgage loans being retained in the Bank’s portfolio.

Non-Interest Expense. Total non-interest expense was $13.5 million for the three months ended September 30, 2022, compared to $12.6 million for the three months ended September 30, 2021. The increase in non-interest expense is primarily attributable to a $595,000 increase in appraisal management fee expense due to an increase in appraisal volume, a $123,000 increase in salaries and employee benefits expense primarily due to an increase in insurance costs and a $218,000 increase in other non-interest expenses.

Non-interest expense was $41.0 million for the nine months ended September 30, 2022, compared to $37.0 million for the nine months ended September 30, 2021. The increase in non-interest expense is primarily attributable to a $3.0 million increase in appraisal management fee expense due to an increase in appraisal volume and a $566,000 increase in salaries and employee benefits expense primarily due to an increase in insurance costs and a $340,000 increase in other non-interest expenses.

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Income Taxes. Income tax expense was $1.4 million for the three months ended September 30, 2022, compared to $824,000 for the three months ended September 30, 2021. The effective tax rate was 21.06% for the three months ended September 30, 2022, compared to 19.55% for the three months ended September 30, 2021. Income tax expense was $3.1 million for the nine months ended September 30, 2022 and 2021. The effective tax rate was 20.40% for the nine months ended September 30, 2022, compared to 20.17% for the nine months ended September 30, 2021.

Analysis of Financial Condition

Investment Securities. Available for sale securities were $444.4 million as of September 30, 2022, compared to $406.5 million as of December 31, 2021. Average investment securities available for sale for the nine months ended September 30, 2022 were $490.6 million, compared to $349.6 million for the year ended December 31, 2021.

Loans. Total loans were $1.0 billion as of September 30, 2022, compared to $884.9 million as of December 31, 2021. The increase in loans was achieved despite a $17.9 million reduction in PPP loans during the nine months ended September 30, 2022. The Bank had $103,000 and $18.0 million in PPP loans at September 30, 2022 and December 31, 2021, respectively. Average loans represented 58% and 61% of average earning assets for the nine months ended September 30, 2022 and the year ended December 31, 2021, respectively.

The Bank had $975,000 and $3.6 million in mortgage loans held for sale as of September 30, 2022 and December 31, 2021, respectively.

Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market. Real estate mortgage loans include both commercial and residential mortgage loans. At September 30, 2022, the Bank had $97.7 million in residential mortgage loans, $97.4 million in home equity loans and $596.4 million in commercial mortgage loans, which include $460.1 million secured by commercial property and $136.3 million secured by residential property. Residential mortgage loans at September 30, 2022 include $20.5 million in non-traditional mortgage loans from the former Banco division of the Bank. At December 31, 2021, the Bank had $101.5 million in residential mortgage loans, $85.6 million in home equity loans and $494.4 million in commercial mortgage loans, which include $381.0 million secured by commercial property and $113.4 million secured by residential property. Residential mortgage loans include $23.1 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.

Past due TDR loans and non-accrual TDR loans totaled $2.4 million and $2.2 million at September 30, 2022 and December 31, 2021, 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 September 30, 2022 and December 31, 2021.

There were no new TDR modifications during the three and nine months ended September 30, 2022 and 2021.

Allowance for Loan Losses (ALLL). 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 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 Board of Directors of the Bank (“Bank Board”) reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration.

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

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

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance. The provision for 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.

The allowance 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 September 30, 2022 and December 31, 2021, there were no loans with existing modifications as a result of the COVID-19 pandemic. At September 30, 2022, the Bank continues to maintain a pool of loans that were previously modified as a result of the COVID-19 pandemic. The loan balances associated with those loans that were previously modified as a result of the COVID-19 pandemic related modifications have been grouped into their own pool within the Bank’s ALLL model as management considers that they have a higher risk profile, and a higher reserve rate has been applied to this pool. Loans included in this pool totaled $74.0 million and $88.7 million at September 30, 2022 and December 31, 2021, respectively.

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 the three and nine months ended September 30, 2022 as compared to the three and nine months ended September 30, 2021. Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

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

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PPP loans are excluded from the allowance as PPP loans are 100 percent guaranteed by the SBA.

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

|  | Percentage of Loans |
|  | By Risk Grade |
Risk Grade |  | 9/30/2022 |  |  | 12/31/2021 |
Risk Grade 1 (Excellent Quality) |  |  | 0.57 | % |  |  | 0.78 | %
Risk Grade 2 (High Quality) |  |  | 19.68 | % |  |  | 19.12 | %
Risk Grade 3 (Good Quality) |  |  | 72.87 | % |  |  | 70.41 | %
Risk Grade 4 (Management Attention) |  |  | 5.63 | % |  |  | 7.70 | %
Risk Grade 5 (Watch) |  |  | 0.59 | % |  |  | 1.23 | %
Risk Grade 6 (Substandard) |  |  | 0.66 | % |  |  | 0.76 | %
Risk Grade 7 (Doubtful) |  |  | 0.00 | % |  |  | 0.00 | %
Risk Grade 8 (Loss) |  |  | 0.00 | % |  |  | 0.00 | %

At September 30, 2022, including non-accrual loans, there were no relationships exceeding $1.0 million in the Watch and Substandard risk grades.

Non-performing Assets. Non-performing assets totaled $3.7 million at September 30, 2022 or 0.22% of total assets, compared to $3.2 million or 0.20% of total assets at December 31, 2021. Non-accrual loans were $3.7 million at September 30, 2022 and $3.2 million at December 31, 2021. As a percentage of total loans outstanding, non-accrual loans were 0.37% at September 30, 2022 and December 31, 2021, respectively. Non-performing assets include $3.7 million in commercial and residential mortgage loans and $19,000 in other loans at September 30, 2022, compared to $3.2 million in commercial and residential mortgage loans, $51,000 in other loans at December 31, 2021. The Bank had no loans 90 days past due and still accruing at September 30, 2022 and December 31, 2021. The Bank had no other real estate owned at September 30, 2022 and December 31, 2021.

Deposits. Total deposits at September 30, 2022 were $1.5 billion compared to $1.4 billion at December 31, 2021. Core deposits, a non-GAAP measure, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $250,000, amounted to $1.5 billion and $1.4 billion at September 30, 2022 and December 31, 2021, respectively. Management believes it is useful to calculate and present core deposits because of the positive impact this low cost funding source provides to the Bank’s funding base.

Borrowed Funds. There were no FHLB borrowings outstanding at September 30, 2022 and December 31, 2021.

Securities sold under agreements to repurchase were $38.0 million at September 30, 2022 and December 31, 2021.

Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were $15.5 million at September 30, 2022 and December 31, 2021.

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. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes. The debentures represent the sole assets of PEBK Trust II. PEBK Trust II is not included in the Consolidated Financial Statements.

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The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities. The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities.

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

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 ceased to be published on December 31, 2021. The overnight, one-month, three-month, nine-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 done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income.

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

The Company’s rate sensitive assets are those earning interest at variable rates and those with contractual maturities within one year. Rate sensitive assets therefore include both loans and available for sale securities. Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds. Average rate sensitive assets for the nine months ended September 30, 2022 totaled $1.6 billion, exceeding average rate sensitive liabilities of $976.4 million by $619.1 million.

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company. The Company did not have any interest rate derivatives outstanding as of September 30, 2022.

Included in the rate sensitive assets are $183.3 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the FOMC. The Company utilizes interest rate floors on certain variable rate loans to protect against downward movements in the prime rate. At September 30, 2022, the Company had $110.8 million in loans with interest rate floors. The floors were in effect on $9,000 of these loans.

Liquidity. The objectives of the Company’s liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As of September 30, 2022, such unfunded commitments to extend credit were $373.9 million, while commitments in the form of standby letters of credit totaled $5.5 million. As of December 31, 2021, such unfunded commitments to extend credit were $304.3 million, while commitments in the form of standby letters of credit totaled $4.9 million.

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The Bank uses several sources to meet its liquidity requirements. The primary source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposit of denominations less than $250,000. The Bank considers these to be a stable portion of the Bank’s liability mix and the result of on-going consumer and commercial banking relationships. As of September 30, 2022, the Bank’s core deposits, a non-GAAP measure, totaled $1.5 billion, or 97.99% of total deposits. As of December 31, 2021, the Bank’s core deposits totaled $1.4 billion, or 98.14% of total deposits.

The other sources of funding for the Bank are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreements to repurchase and FHLB borrowings. The Bank is also able to borrow from the Federal Reserve Bank (“FRB”) on a short-term basis. The Bank’s policies include the ability to access wholesale funding of up to 40% of total assets. The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to the State of North Carolina. The Bank’s ratio of wholesale funding to total assets was 0.91% and 0.68% as of September 30, 2022 and December 31, 2021, 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 September 30, 2022 and December 31, 2021. At September 30, 2022, the carrying value of loans pledged as collateral to the FHLB totaled $143.4 million compared to $137.4 million at December 31, 2021. The remaining availability under the line of credit with the FHLB was $88.2 million at September 30, 2022 compared to $90.9 million at December 31, 2021. The Bank had no borrowings from the FRB at September 30, 2022 or December 31, 2021. FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At September 30, 2022, the carrying value of loans pledged as collateral to the FRB totaled $565.1 million compared to $475.2 million at December 31, 2021. Availability under the line of credit with the FRB was $427.2 million and $346.20 million at September 30, 2022 and December 31, 2021, 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 September 30, 2022.

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 34.62% at September 30, 2022 and 43.28% at December 31, 2021. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at September 30, 2022 and December 31, 2021.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations and other commitments as of September 30, 2022 and December 31, 2021 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) |  |  |  |  |  |
|  | September 30, 2022 |  |  | December 31, 2021 |
Contractual Cash Obligations |  |  |  |  |  |
Junior subordinated debentures |  | $ | 15,464 |  |  |  | 15,464 |
Operating lease obligations |  |  | 6,487 |  |  |  | 5,168 |
Total |  | $ | 21,951 |  |  |  | 20,632 |
Other Commitments |  |  |  |  |  |  |  |
Commitments to extend credit |  | $ | 373,939 |  |  |  | 304,258 |
Standby letters of credit and financial guarantees written |  |  | 5,511 |  |  |  | 4,892 |
SBIC Investments |  |  | 1,684 |  |  |  | 2,204 |
Income tax credits |  |  | 101 |  |  |  | 101 |
Total |  | $ | 381,235 |  |  |  | 311,455 |

Capital Resources. Shareholders’ equity was $103.9 million, or 6.78% of total assets, at September 30, 2022, compared to $142.4 million, or 8.77% of total assets, at December 31, 2021. The decrease in shareholders’ equity is primarily due to an increase in the unrealized loss on investment securities available for sale due to rate changes from December 31, 2021 to September 30, 2022.

Annualized return on average equity for the nine months ended September 30, 2022 was 12.53%, compared to 11.04% for the nine months ended September 30, 2021. Total cash dividends paid on common stock were $3.9 million and $2.8 million for the nine months ended September 30, 2022 and 2021, respectively.

In February of 2022, the Board of Directors authorized a stock repurchase program, whereby up to $2.0 million may be allocated to repurchase the Company’s common stock. Any purchases under the Company’s stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately-negotiated transactions. The timing and amount of any repurchase of shares will be determined by the Company’s management, based on its evaluation of market conditions and other factors. The stock repurchase program may be suspended at any time or from time-to-time without prior notice. The Company has repurchased approximately $594,000, or 22,000 shares of its common stock, under this stock repurchase program as of September 30, 2022.

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

Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. Tier 1 capital is generally defined as shareholders’ equity and trust preferred securities less all intangible assets and goodwill. Tier 1 capital includes $15.0 million in trust preferred securities at September 30, 2022 and December 31, 2021. The Company’s Tier 1 capital ratio was 13.39% and 15.43% at September 30, 2022 and December 31, 2021, 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 14.20% and 16.35% at September 30, 2022 and December 31, 2021, respectively. The Company’s common equity Tier 1 capital consists of common stock and retained earnings. The Company’s common equity Tier 1 capital ratio was 12.17% and 13.96% at September 30, 2022 and December 31, 2021, 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 9.58% and 9.64% at September 30, 2022 and December 31, 2021, respectively.

The Bank’s Tier 1 risk-based capital ratio was 13.27% and 15.27% at September 30, 2022 and December 31, 2021, respectively. The total risk-based capital ratio for the Bank was 14.08% and 16.19% at September 30, 2022 and December 31, 2021, respectively. The Bank’s common equity Tier 1 capital ratio was 13.27% and 15.27% at September 30, 2022 and December 31, 2021, respectively. The Bank’s Tier 1 leverage capital ratio was 9.43% and 9.50% at September 30, 2022 and December 31, 2021, respectively.

A bank is considered to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater. Based upon these guidelines, the Bank was considered to be “well capitalized” at September 30, 2022.

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 Item 7A of Part II of the Company’s Annual Report on Form 10-K, filed with the SEC on March 18, 2022.

Item 4. Controls and Procedures

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

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On October 19, 2018, the Bank received a draft audit report from the North Carolina Department of Revenue (“NCDOR”) setting forth certain proposed adjustments to the North Carolina income tax returns for the Bank for the tax years January 1, 2014 through December 31, 2016. The NCDOR sought to disallow certain tax credits taken by the Bank in tax years January 1, 2014 through December 31, 2016 from an investment made by the Bank. The total proposed adjustments sought by the NCDOR as of the date of the draft audit report (including additional tax, penalties and interest up to the date of the draft audit report) was approximately $1.4 million. The Bank disagreed with the NCDOR’s proposed adjustments and the disallowance of certain tax credits, and challenged the proposed adjustments and the disallowance of such tax credits. During the second quarter of 2019, the Bank paid the NCDOR $1.2 million in taxes and interest associated with the proposed adjustments noted above. This payment stopped the accrual of interest during the period while the proposed adjustments and disallowance are being contested, and the NCDOR waived associated penalties. The Bank purchased a Guaranty Agreement along with this tax credit investment that unconditionally guarantees the amount of its investment plus associated penalties and interest which management believes would limit the Bank’s exposure to approximately $125,000. The Tax Credit Guaranty Agreement by State Tax Credit Exchange, LLC dated September 10, 2014 was attached to the Company’s September 30, 2018 Quarterly Report on Form 10-Q as Exhibit 99.

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 18, 2022, which is accessible on the SEC’s website at www.sec.gov. There have been no material changes to the risk factors previously disclosed in the Form 10-K.

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

ISSUER PURCHASES OF EQUITY SECURITIES |  |  |  |  |  |  |
Period |  | Total Number of Shares Purchased (1) |  |  | Average Price Paid per Share |  |  | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) |  |  | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (3) |
July 1 - 31, 2022 |  |  | 1,297 |  |  | $ | 27.10 |  |  |  | - |  |  | $ | 1,405,790 |
August 1 - 31, 2022 |  |  | 320 |  |  | $ | 26.20 |  |  |  | - |  |  | $ | 1,405,790 |
September 1 - 30, 2022 |  |  | 288 |  |  | $ | 25.91 |  |  |  | - |  |  | $ | 1,405,790 |
Total |  |  | 1,905 |  |  | $ | 26.81 |  |  |  | - |  |  |  |  |
(1) The Company purchased 1,905 shares on the open market in the three months ended September 30, 2022 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.
(2) Reflects shares purchased under the Company's publicly announced stock repurchase program.
(3) Reflects dollar value of balance available for repurchase at end of period under the Company's stock repurchase program, which was authorized in February 2022 and expires in February 2023.

Item 3. Defaults Upon Senior Securities

Not applicable

Item 5. Other Information

Not applicable

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Item 6. Exhibits

Exhibit (3)(i)(a) |  | Articles of Incorporation of the Registrant, incorporated by reference to Exhibit (3)(i) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999
Exhibit (3)(i)(b) |  | Articles of Amendment dated December 19, 2008, regarding the Series A Preferred Stock, incorporated by reference to Exhibit (3)(1) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008
Exhibit (3)(i)(c) |  | Articles of Amendment dated February 26, 2010, incorporated by reference to Exhibit (3)(2) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2010
Exhibit (3)(i)(d) |  | Articles of Amendment dated May 6, 2021, incorporated by reference to Exhibit (3)(i)(d) to the Form 10-K filed with the Securities and Exchange Commission on March 18, 2022
Exhibit (3)(ii) |  | Second Amended and Restated Bylaws of the Registrant, incorporated by reference to Exhibit (3)(ii) to the Form 8-K filed with the Securities and Exchange Commission on June 24, 2015
Exhibit (4)(i) |  | Specimen Stock Certificate, incorporated by reference to Exhibit (4) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999
Exhibit (31)(a) |  | Certification of principal executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit (31)(b) |  | Certification of principal financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Exhibit (32) |  | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit (101) |  | The following materials from the Company’s 10-Q Report for the quarterly period ended September 30, 2022, formatted in eXtensible Business Reporting Language (“XBRL”): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Earnings, (iii) the Condensed Consolidated Statements of Comprehensive Income (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to the Condensed Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

| Peoples Bancorp of North Carolina, Inc.

November 4, 2022 |  | /s/ Lance A. Sellers |
Date |  | Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer) |

November 4, 2022 |  | /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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