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, ~~2017~~2019

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

PEOPLES BANCORP OF NORTH CAROLINA, INC.

(Exact name of registrant as specified in its charter)

North Carolina

(State or other jurisdiction of incorporation or organization)

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

518 West C Street, Newton, North Carolina		28658
(Address of principal executive offices)		(Zip Code)

(828) 464-5620

(Registrant’s telephone number, including area code)

~~Indicate by check mark whether the registrant (1) has filed all reports required~~Securities registered pursuant to ~~be filed by~~ Section ~~13 or 15(d)~~12(b) 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 ☐Act:

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

Indicate by check mark whether the registrant has submitted electronically ~~and posted on its corporate Web site, if any,~~ every Interactive Data File required to be submitted ~~and posted~~ pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit ~~and post~~ such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated ~~filer.~~filer, smaller reporting company, or an emerging growth company. See ~~definition~~the definitions of “large accelerated filer”, “accelerated ~~filer~~filer”, “smaller reporting company”, and ~~large accelerated filer~~“emerging growth company” in Rule 12b-2 of the Exchange Act. ~~(Check one):~~ ~~Yes ☒ No ☐~~

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~~Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable ~~date.~~ date~~5,450,412 shares~~.5,912,300 shares of common stock, outstanding at October 31, ~~2017.~~2019.

INDEX

PART I. FINANCIAL INFORMATION

		PAGE(S)
Item 1.		Financial Statements

	Consolidated Balance Sheets at September 30, ~~2017~~2019 (Unaudited) and December 31, ~~2016~~2018 (Audited)	3

	Consolidated Statements of Earnings for the three and nine months ended September 30, ~~2017~~2019 and ~~2016~~2018 (Unaudited)	4

	Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, ~~2017~~2019 and ~~2016~~2018 (Unaudited)	5

	Consolidated Statements of Changes in Shareholders' Equity for the three and nine months ended September 30, ~~2017~~2019 and ~~2016~~2018 (Unaudited)	6

	Consolidated Statements of Cash Flows for the nine months ended September 30, ~~2017~~2019 and ~~2016~~2018 (Unaudited)	7-8

	Notes to Consolidated Financial Statements (Unaudited)	~~9-26~~ 9-30

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	~~27-40~~ 31-43

Item 3.		Quantitative and Qualitative Disclosures About Market Risk	41 44

Item 4.		Controls and Procedures	42
		44

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	43 44
~~Item 1A.~~	~~Risk Factors~~	43
Item 1A. Risk Factors	44

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43 45

Item 3.	Defaults upon Senior Securities	43 45
~~Item 5.~~	~~Other Information~~	43
Item 6.5. Other Information	~~Exhibits~~	~~43-45~~ 45
~~Signatures~~
46 Item 6. Exhibits	45-47
~~Certifications~~
~~47-49~~ Signatures	48

Certifications	49-51

Statements made in this Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Form 10-Q was prepared. These statements can be identified by the use of words like “expect,” “anticipate,” “estimate,” and “believe,” variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ include, but are not limited to, (1) competition in the markets served by the registrant and its subsidiaries, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environments and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in other filings with the Securities and Exchange Commission, including but not limited to, those described in the registrant’s Annual Report on Form 10-K for the year ended December 31, ~~2016.~~2018.

PART I. FINANCIAL INFORMATION

~~Item~~ Item 1. Financial Statements

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Balance Sheets

September 30, 2017 and December 31, 2016

(Dollars in thousands)

September 30,

December 31,

Assets

2017

2016

(Unaudited)

(Audited)

Cash and due from banks, including reserve requirements
$55,718
  53,613
of $9,337 at 9/30/17 and $6,075 at 12/31/16


Interest-bearing deposits
  37,538
  16,481
Cash and cash equivalents
  93,256
  70,094



Investment securities available for sale
  235,736
  249,946
Other investments
  2,680
  2,635
Total securities
  238,416
  252,581



Mortgage loans held for sale
  2,623
  5,709



Loans
  747,437
  723,811
Less allowance for loan losses
  (6,844)
  (7,550)
Net loans
  740,593
  716,261



Premises and equipment, net
  19,697
  16,452
Cash surrender value of life insurance
  15,452
  14,952
Other real estate
  -
  283
Accrued interest receivable and other assets
  11,516
  11,659
Total assets
$1,121,553
  1,087,991



Liabilities and Shareholders' Equity





Deposits:


Noninterest-bearing demand
$287,794
  271,851
NOW, MMDA & savings
  486,051
  477,054
Time, $250,000 or more
  21,318
  26,771
Other time
  106,476
  117,242
Total deposits
  901,639
  892,918



Securities sold under agreements to repurchase
  53,307
  36,434
Short-term Federal Reserve Bank borrowings
  -
  -
FHLB borrowings
  20,000
  20,000
Junior subordinated debentures
  20,619
  20,619
Accrued interest payable and other liabilities
  9,835
  10,592
Total liabilities
  1,005,400
  980,563



Commitments





Shareholders' equity:


Series A preferred stock, $1,000 stated value; authorized


5,000,000 shares; no shares issued and outstanding
  -
  -
Common stock, no par value; authorized


20,000,000 shares; issued and outstanding 5,450,412 shares


at September 30, 2017 and 5,417,800 shares at December 31, 2016
  45,102
  44,187
Retained earnings
  66,539
  60,254
Accumulated other comprehensive income
  4,512
  2,987
Total shareholders' equity
  116,153
  107,428
Total liabilities and shareholders' equity
$1,121,553
  1,087,991



See accompanying Notes to Consolidated Financial Statements.


PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Balance Sheets

September 30, 2019 and December 31, 2018

(Dollars in thousands)

	September 30,	December 31,
Assets	2019	2018
	(Unaudited)	(Audited)

Cash and due from banks, including reserve requirements of $12,254 at 09/30/19 and $8,918 at 12/31/18	$48,605	40,553
Interest-bearing deposits	80,948	2,817
Cash and cash equivalents	129,553	43,370

Investment securities available for sale	186,263	194,578
Other investments	7,239	4,361
Total securities	193,502	198,939

Mortgage loans held for sale	4,263	680

Loans	845,599	804,023
Less allowance for loan losses	(6,578)	(6,445)
Net loans	839,021	797,578

Premises and equipment, net	18,730	18,450
Cash surrender value of life insurance	16,222	15,936
Other real estate	26	27
Right of use lease asset	3,816	-
Accrued interest receivable and other assets	18,066	18,271
Total assets	$1,223,199	1,093,251

Liabilities and Shareholders' Equity

Deposits:
Noninterest-bearing demand	$339,081	298,817
NOW, MMDA & savings	509,611	475,223
Time, $250,000 or more	33,082	16,239
Other time	79,794	86,934
Total deposits	961,568	877,213

Securities sold under agreements to repurchase	21,927	58,095
FHLB borrowings	70,000	-
Junior subordinated debentures	20,619	20,619
Lease liability	3,835	-
Accrued interest payable and other liabilities	12,567	13,707
Total liabilities	1,090,516	969,634

Commitments

Shareholders' equity:

Series A preferred stock, $1,000 stated value; authorized 5,000,000 shares; no shares issued and outstanding	-	-
Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 5,912,300 shares at September 30, 2019 and 5,995,256 shares December 31, 2018	59,813	62,096
Retained earnings	68,528	60,535
Accumulated other comprehensive income	4,342	986
Total shareholders' equity	132,683	123,617
Total liabilities and shareholders' equity	$1,223,199	1,093,251

See accompanying Notes to Consolidated Financial Statements.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Earnings

Three and Nine Months Ended September 30, 2019 and 2018

(Dollars in thousands, except per share amounts)

	Three months ended		Nine months ended
	September 30,		September 30,
	2019	2018	2019	2018
	(Unaudited)	(Unaudited)	(Unaudited)	(Unaudited)

Interest income:
Interest and fees on loans	$11,004	9,907	32,517	28,362
Interest on due from banks	87	86	136	255
Interest on investment securities:
U.S. Government sponsored enterprises	628	591	1,942	1,721
State and political subdivisions	671	974	2,265	2,950
Other	40	50	128	138
Total interest income	12,430	11,608	36,988	33,426

Interest expense:
NOW, MMDA & savings deposits	455	189	1,057	551
Time deposits	259	127	581	342
FHLB borrowings	21	-	70	-
Junior subordinated debentures	210	209	656	578
Other	49	32	168	66
Total interest expense	994	557	2,532	1,537
Net interest income	11,436	11,051	34,456	31,889

Provision for loan losses	422	110	677	372
Net interest income after provision for loan losses	11,014	10,941	33,779	31,517

Non-interest income:
Service charges	1,178	1,083	3,409	3,163
Other service charges and fees	202	173	548	528
Gain (loss) on sale of investment securities	(5)	-	226	50
Mortgage banking income	376	216	834	672
Insurance and brokerage commissions	206	206	642	591
Appraisal management fee income	1,311	799	3,285	2,442
Gain/(loss) on sale and write-down of other real estate	(1)	14	(18)	17
Miscellaneous	1,441	1,424	4,287	4,204
Total non-interest income	4,708	3,915	13,213	11,667

Non-interest expense:
Salaries and employee benefits	5,695	5,519	17,060	15,866
Occupancy	1,861	1,761	5,409	5,367
Professional fees	237	314	955	1,067
Advertising	234	207	775	708
Debit card expense	201	282	667	774
FDIC Insurance	(36)	81	116	248
Appraisal management fee expense	1,012	627	2,538	1,873
Other	2,063	1,911	5,907	5,401
Total non-interest expense	11,267	10,702	33,427	31,304
Earnings before income taxes	4,455	4,154	13,565	11,880
Income tax expense	834	687	2,464	1,934
Net earnings	$3,621	3,467	11,101	9,946

Basic net earnings per share	$0.62	0.58	1.87	1.66
Diluted net earnings per share	$0.61	0.57	1.86	1.65
Cash dividends declared per share	$0.14	0.13	0.42	0.39

See accompanying Notes to Consolidated Financial Statements.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of ~~Earnings~~

Comprehensive Income

Three and Nine Months Ended September 30, ~~2017~~2019 and ~~2016~~

2018

(Dollars in ~~thousands, except per share amounts)~~thousands)

	Three months ended		Nine months ended
	September 30,		September 30,
	2019	2018	2019	2018
	(Unaudited)	(Unaudited)	(Unaudited)	(Unaudited)

Net earnings	$3,621	3,467	11,101	9,946

Other comprehensive income:
Unrealized holding gains (losses) on securities available for sale	701	(1,469)	4,584	(4,951)
Reclassification adjustment for (gains) losses on securities available for sale included in net earnings	5	-	(226)	(50)

Total other comprehensive income (loss), before income taxes	706	(1,469)	4,358	(5,001)

Income tax expense related to other comprehensive income:

Unrealized holding gains (losses) on securities available for sale	161	(338)	1,054	(1,138)
Reclassification adjustment for (gains) losses on securities available for sale included in net earnings	1	-	(52)	(11)

Total income tax expense related to other comprehensive income (loss)	162	(338)	1,002	(1,149)

Total other comprehensive income (loss), net of tax	543	(1,131)	3,356	(3,852)

Total comprehensive income	$4,164	2,336	14,457	6,094

Three months ended

Nine months ended

September 30,

September 30,

2017

2016

2017

2016

(Unaudited)

(Unaudited)

(Unaudited)

(Unaudited)

Interest income:

Interest and fees on loans
$8,966
  8,188
  25,935
  24,185
Interest on due from banks
  60
  32
  138
  67
Interest on investment securities:




U.S. Government sponsored enterprises
  578
  603
  1,795
  1,910
State and political subdivisions
  1,047
  1,105
  3,198
  3,350
Other
  47
  54
  157
  191
Total interest income
  10,698
  9,982
  31,223
  29,703





Interest expense:




NOW, MMDA & savings deposits
  156
  126
  431
  367
Time deposits
  112
  142
  360
  452
FHLB borrowings
  211
  426
  604
  1,248
Junior subordinated debentures
  152
  122
  432
  353
Other
  19
  12
  43
  30
Total interest expense
  650
  828
  1,870
  2,450





Net interest income
  10,048
  9,154
  29,353
  27,253





Provision for (reduction of provision for) loan losses
  (218)
  (360)
  (405)
  (1,108)





Net interest income after provision for loan losses
  10,266
  9,514
  29,758
  28,361





Non-interest income:




Service charges
  1,140
  1,163
  3,340
  3,291
Other service charges and fees
  145
  210
  447
  746
Gain on sale of securities
  -
  -
  -
  324
Mortgage banking income
  280
  426
  945
  1,088
Insurance and brokerage commissions
  221
  163
  568
  476
Gain/(loss) on sale and write-down of




other real estate
  43
  (16)
  (240)
  64
Miscellaneous
  1,675
  1,468
  4,601
  4,320
Total non-interest income
  3,504
  3,414
  9,661
  10,309





Non-interest expense:




Salaries and employee benefits
  4,933
  4,829
  15,038
  14,114
Occupancy
  1,669
  1,755
  4,981
  5,243
Professional fees
  303
  429
  788
  1,603
Advertising
  247
  313
  859
  623
Debit card expense
  320
  271
  894
  870
FDIC Insurance
  87
  71
  260
  406
Other
  1,792
  1,930
  5,661
  5,339
Total non-interest expense
  9,351
  9,598
  28,481
  28,198





Earnings before income taxes
  4,419
  3,330
  10,938
  10,472





Income tax expense
  1,177
  872
  2,680
  2,597





Net earnings
$3,242
  2,458
  8,258
  7,875





Basic net earnings per share
$0.59
  0.45
  1.52
  1.43
Diluted net earnings per share
$0.58
  0.44
  1.49
  1.42
Cash dividends declared per share
$0.12
  0.10
  0.36
  0.28






See accompanying Notes to Consolidated Financial Statements.




See accompanying Notes to Consolidated Financial Statements.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of ~~Comprehensive Income~~

Changes in Shareholders' Equity

Three and Nine Months Ended September 30, ~~2017~~2019 and ~~2016~~

2018

(Dollars in thousands)

Three months ended

Nine months ended

September 30,

September 30,

2017

2016

2017

2016

(Unaudited)

(Unaudited)

(Unaudited)

(Unaudited)

Net earnings
$3,242
  2,458
  8,258
  7,875





Other comprehensive income (loss):




Unrealized holding (losses) gains on securities




available for sale
  (666)
  (1,676)
  2,027
  2,597
Reclassification adjustment for gains on




securities available for sale




included in net earnings
  -
  -
  -
  (324)





Total other comprehensive (loss) income,




before income taxes
  (666)
  (1,676)
  2,027
  2,273





Income tax (benefit) expense related to other




comprehensive (loss) income:









Unrealized holding (losses) gains on securities




available for sale
  (239)
  (614)
  502
  951
Reclassification adjustment for gains




on securities available for sale




included in net earnings
  -
  -
  -
  (126)





Total income tax expense (benefit) related to




other comprehensive income (loss)
  (239)
  (614)
  502
  825





Total other comprehensive (loss) income,




net of tax
  (427)
  (1,062)
  1,525
  1,448





Total comprehensive income
$2,815
  1,396
  9,783
  9,323






See accompanying Notes to Consolidated Financial Statements.

				Accumulated
				Other
	Common Stock		Retained	Comprehensive
	Shares	Amount	Earnings	Income	Total
	(Unaudited)	(Unaudited)	(Unaudited)	(Unaudited)	(Unaudited)

Balance, June 30, 2019	5,933,140	$60,390	65,738	3,799	129,927
Common stock repurchase	(20,840)	(577)	-	-	(577)
Cash dividends declared on
common stock	-	-	(831)	-	(831)
Net earnings	-	-	3,621	-	3,621
Change in accumulated other
comprehensive income, net of tax	-	-	-	543	543
Balance, September 30, 2019	5,912,300	$59,813	68,528	4,342	132,683

Balance, December 31, 2018	5,995,256	$62,096	60,535	986	123,617
Common stock repurchase	(90,354)	(2,490)	-	-	(2,490)
Cash dividends declared on
common stock	-	-	(3,108)	-	(3,108)
Restricted stock units exercised	7,398	207	-	-	207
Net earnings	-	-	11,101	-	11,101
Change in accumulated other
comprehensive income, net of tax	-	-	-	3,356	3,356
Balance, September 30, 2019	5,912,300	$59,813	68,528	4,342	132,683


Balance, June 30, 2018	5,995,256	$62,096	55,198	872	118,166

Cash dividends declared on
common stock	-	-	(783)	-	(783)
Net earnings	-	-	3,467	-	3,467
Change in accumulated other
comprehensive income, net of tax	-	-	-	(1,131)	(1,131)
Balance, September 30, 2018	5,995,256	$62,096	57,882	(259)	119,719

Balance, December 31, 2017	5,995,256	$62,096	50,286	3,593	115,975
Cash dividends declared on
common stock	-	-	(2,350)	-	(2,350)
Net earnings	-	-	9,946	-	9,946
Change in accumulated other
comprehensive income, net of tax	-	-	-	(3,852)	(3,852)
Balance, September 30, 2018	5,995,256	$62,096	57,882	(259)	119,719

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Changes in Shareholders' Equity

Nine Months Ended September 30, 2017 and 2016

(Dollars in thousands)

Accumulated

Other

Common Stock

Retained

Comprehensive

Shares

Amount

Earnings

Income

Total

(Unaudited)

(Unaudited)

(Unaudited)

(Unaudited)

(Unaudited)

Balance, December 31, 2016
  5,417,800
$44,187
  60,254
  2,987
  107,428






Common stock repurchase
  -
  -
  -
  -
  -
Cash dividends declared on





common stock
  -
  -
  (1,973)
  -
  (1,973)
Restricted stock units exercised
  32,612
  915
  -
  -
  915
Net earnings
  -
  -
  8,258
  -
  8,258
Change in accumulated other





comprehensive income, net of tax
  -
  -
  -
  1,525
  1,525
Balance, September 30, 2017
  5,450,412
$45,102
  66,539
  4,512
  116,153






Balance, December 31, 2015
  5,510,538
$46,171
  53,183
  5,510
  104,864






Common stock repurchase
  (92,738)
  (1,983)
  -
  -
  (1,983)
Cash dividends declared on





common stock
  -
  -
  (1,556)
  -
  (1,556)
Net earnings
  -
  -
  7,875
  -
  7,875
Change in accumulated other





comprehensive income, net of tax
  -
  -
  -
  1,448
  1,448
Balance, September 30, 2016
  5,417,800
$44,188
  59,502
  6,958
  110,648






See accompanying Notes to Consolidated Financial Statements.





See accompanying Notes to Consolidated Financial Statements.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash ~~Flows~~

Flows

Nine Months Ended ~~September~~Septemer 30, ~~2017~~2019 and ~~2016~~

2018

(Dollars in thousands)

			2019	2018
	2017	2016	(Unaudited)
	(Unaudited)
Cash flows from operating activities:
Net earnings	$8,258	7,875	$11,101	9,946
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation, amortization and accretion	3,764	4,181	2,949	3,508
Reduction of provision for loan losses	(405)	(1,108)
Right of use lease asset amortization			585	-
Provision for loan losses			677	372
Deferred income taxes	(1,122)		(7)	(1,159)
Gain on sale of investment securities	-	(324)	(226)	(50)
Gain on sale of other real estate	-	(81)
Loss (gain) on sale of other real estate			1	(17)
Write-down of other real estate	240	17	17	-
Loss on sale of premises and equipment			138	2
Restricted stock expense	32	476	201	131
Proceeds from sales of mortgage loans held for sale			34,002	27,209
Origination of mortgage loans held for sale	(46,173)	(50,813)	(37,585)	(28,092)
Proceeds from sales of mortgage loans held for sale	49,259	52,186
Change in:
Cash surrender value of life insurance	(500)	(307)	(286)	(287)
Other assets	763	897	(790)	754
Other liabilities	(408)	49	(1,700)	(265)

Net cash provided by operating activities	14,274	12,441	9,077	12,052

Cash flows from investing activities:
Purchases of investment securities available for sale	(6,492)	(12,642)	(36,515)	(20,218)
Proceeds from sales, calls and maturities of investment securities
available for sale	6,535	2,899
Proceeds from sales, calls and maturities of investment securities available for sale			36,700	24,203
Proceeds from paydowns of investment securities available for sale	13,963	15,946	11,416	12,651
Purchases of other investments			-	(2,611)
Proceeds from paydowns on other investments			132	73
Purchases of FHLB stock	-		(2,976)	(4)
FHLB stock redemption	(45)	2
Net change in loans	(23,927)	(24,639)	(42,146)	(27,500)
Purchases of premises and equipment	(4,810)	(1,257)	(2,800)	(1,307)
Purchases of bank owned life insurance	-
Proceeds from sale of premises and equipment	-		697	-
Proceeds from sale of other real estate and repossessions	43	1,052	9	232

Net cash used by investing activities	(14,733)	(18,639)	(35,483)	(14,481)

Cash flows from financing activities:
Net change in deposits	8,721	29,772	84,355	(13,493)
Net change in securities sold under agreement to repurchase	16,873	23,046	(36,168)	18,009
Proceeds from FHLB borrowings			184,500	-
Repayments of FHLB borrowings			(114,500)	-
Proceeds from Fed Funds purchased	-	(8,985)	100,075	850
Repayments of Fed Funds purchased	-	8,985	(100,075)	(850)
Common stock repurchased	-	(1,983)	(2,490)	-
Cash dividends paid on common stock	(1,973)	(1,556)	(3,108)	(2,350)

Net cash provided by financing activities	23,621	49,279	112,589	2,166

Net change in cash and cash equivalents	23,162	43,081	86,183	(263)

Cash and cash equivalents at beginning of period	70,094	39,763	43,370	57,304

Cash and cash equivalents at end of period	$93,256	82,844	$129,553	57,041

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows, continued

Nine Months Ended September 30, ~~2017~~2019 and ~~2016~~2018

(Dollars in thousands)

	2017	2016	2019	2018
	(Unaudited)		(Unaudited)

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$1,858	2,425	$2,510	1,531
Income taxes	$872	3,180	$2,463	905

Noncash investing and financing activities:
Change in unrealized gain (loss) on investment securities
available for sale, net	$1,525	1,448
Change in unrealized gain on derivative financial
instruments, net	$-	-
Change in unrealized gain on investment securities available for sale, net			$3,356	(3,852)
Issuance of accrued restricted stock units	$(915)	-	$207	-
Transfers of loans to other real estate and repossessions	$-	275	$26	97

See accompanying Notes to Consolidated Financial Statements.
Initial recognition of lease right of use asset and lease liability			$4,401	-

See accompanying Notes to Consolidated Financial Statements.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

~~Notes~~Notes to Consolidated Financial Statements (Unaudited)

(1)

Summary of Significant Accounting Policies

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

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

The consolidated financial statements in this report (other than the Consolidated Balance Sheet at December 31, ~~2016)~~2018) are unaudited. In the opinion of management, all adjustments (none of which were other than normal accruals) necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Management ~~of the Company~~ 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 ~~2016~~2018 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May ~~4, 2017~~2, 2019 Annual Meeting of Shareholders.

~~Recently Issued~~Recent Accounting Pronouncements

~~In May 2014,~~

The following tables provide a summary of Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”) ~~issued Accounting Standards Update (“ASU”) No. 2014-09, (Topic 606):~~ ~~Revenue from Contracts with Customers. ASU No. 2014-09 provides guidance on~~that the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. ASU No. 2014-09 is effective for reporting periods beginning after December 15, 2017.Company has recently adopted.

Recently Adopted Accounting Guidance

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2014-09: Revenue from Contracts with Customers	Provides guidance on the recognition of revenue from contracts with customers. The core principle of this guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive.	January 1, 2018	See section titled "ASU 2014-09" below for a description of the effect on the Company’s results of operations, financial position and disclosures.
ASU 2016-01: Recognition and Measurement of Financial Assets and Financial Liabilities	Addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-07: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs	Amended the requirements related to the income statement presentation of the components of net periodic beneﬁt cost for an entity’s sponsored deﬁned beneﬁt pension and other postretirement plans.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2017-09: Scope of Modification Accounting	Amended the requirements related to changes to the terms or conditions of a share-based payment award.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2017-14: Income Statement—Reporting Comprehensive, Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)	Incorporates into the ASC recent SEC guidance related to revenue recognition.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-03: Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities	Clarifies certain aspects of the guidance issued in ASU 2016-01.	January 1, 2018	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-04: Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update)	Incorporates recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulation.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-06: Codification Improvements to Topic 942: Financial Services—Depository and Lending	Eliminates a reference to the Office of the Comptroller of the Currency’s Banking Circular 202, Accounting for Net Deferred Tax Charges, from the ASC. The Office of the Comptroller of the Currency published the guidance in 1985 but has since rescinded it.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2016-02: Leases	Increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.	January 1, 2019	See section titled "ASU 2016-02" below for a description of the effect on the Company’s results of operations, financial position and disclosures.
ASU 2017-08: Premium Amortization on Purchased Callable Debt Securities	Amended the requirements related to the amortization period for certain purchased callable debt securities held at a premium.	January 1, 2019	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-11: Leases (Topic 842): Targeted Improvements	Intended to reduce costs and ease implementation of ASU 2016-02.	January 1, 2019	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-20: Narrow- Scope Improvements for Lessors	Provides narrow-scope improvements for lessors, that provide relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components.	January 1, 2019	See comments for ASU 2016-02 below.
ASU 2019-07: Codification Updates to SEC Sections	Guidance updated for various Topics of the Accounting Standards Codification to align the guidance in various SEC sections of the Codification with the requirements of certain SEC final rules.	Effective upon issuance	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.

ASU 2014-09

The Company ~~will apply~~has applied ASU ~~No.~~ 2014-09 using a modified retrospective approach. The Company’s revenue is comprised of net interest income and noninterest income. The scope of ASU ~~No.~~ 2014-09 explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. Accordingly, the majority of the Company’s revenues ~~will~~are not be affected. ~~The Company~~Appraisal management fee income and expense from the Bank’s subsidiary, CBRES, was reported as a net amount prior to March 31, 2018, which was included in miscellaneous non-interest income. This income and expense is ~~currently assessing its revenue contracts~~now reported on separate line items under non-interest income and non-interest expense. See below for additional information related to revenue generated from contracts with customers.

Revenue and Method of Adoption

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

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

The following disclosures involve the Company’s material income streams ~~that~~derived from contracts with customers which are within the scope of ASU ~~No.~~ 2014-09. Through the Company’s wholly-owned subsidiary, PIS, the Company contracts with a registered investment advisor to perform investment advisory services on behalf of the Company’s customers. The Company receives commissions from this third party investment advisor based on the volume of business that the Company’s customers do with such investment advisor. Total revenue recognized from these contracts was $641,000 and $590,000 for the nine months ended September 30, 2019 and 2018, respectively. The Company utilizes third parties to contract with the Company’s customers to perform debit and credit card clearing services. These third parties pay the Company commissions based on the volume of transactions that they process on behalf of the Company’s customers. Total revenue recognized from these contracts with these third parties was $3.1 million and $2.9 million for the nine months ended September 30, 2019 and 2018, respectively. Through the Company’s wholly-owned subsidiary, REAS, the Company provides property appraisal services for negotiated fee amounts on a per appraisal basis. Total revenue recognized from these contracts with customers was $500,000 and $422,000 for the nine months ended September 30, 2019 and 2018, respectively. Through the Company’s wholly-owned subsidiary, CBRES, the Company provides appraisal management services. Total revenue recognized from these contracts with customers was $3.3 million and $2.4 million for the nine months ended September 30, 2019 and 2018, respectively. Due to the nature of the Company’s relationship with the customers that the Company provides services, the Company does not incur costs to obtain contracts and there are no material incremental costs to fulfill these contracts that should be capitalized.

Disaggregation of Revenue. The Company’s ~~accounting policies will~~portfolio of services provided to the Company’s customers consists of over 50,000 active contracts. The Company has disaggregated revenue according to timing of the transfer of service. Total revenue for the nine months ended September 30, 2019 derived from contracts in which services are transferred at a point in time was approximately $6.7 million. None of the Company’s revenue is derived from contracts in which services are transferred over time. Revenue is recognized as the services are provided to the customers. Economic factors impacting the customers could affect the nature, amount, and timing of these cash flows, as unfavorable economic conditions could impair the customers’ ability to provide payment for services. For the Company’s deposit contracts, this risk is mitigated as the Company generally deducts payments from customers’ accounts as services are rendered. For the Company’s appraisal services, the risk is mitigated in that the appraisal is not ~~change materially since the principles~~released until payment is received.

Contract Balances. The timing of revenue recognition, billings, and cash collections results in billed accounts receivable on the balance sheet. Most contracts call for payment by a charge or deduction to the respective customer account but there are some that require a receipt of payment from ~~ASU No. 2014-09~~the customer. For fee per transaction contracts, the customers are ~~largely consistent with existing guidance and~~billed as the ~~Company’s current practices.~~transactions are processed. The Company has ~~not identified~~no contracts in which customers are billed in advance for services to be performed. These types of contracts would create contract liabilities or deferred revenue, as the customers pay in advance for services. There are no contract liabilities or accounts receivables balances that are material ~~changes~~ to the ~~timing~~Company’s balance sheet.

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

~~In February 2016, FASB issued~~ Significant Judgements. All of the Company’s contracts create performance obligations that are satisfied at a point in time excluding some immaterial deposit revenues. Revenue is recognized as services are billed to the customers. Variable consideration does exist for contracts related to the Company’s contract with its registered investment advisor as some revenues earned pursuant to that contract are based on market values of accounts at the end of the period.

ASU ~~No.~~ 2016-02

On January 1, 2019, the Company adopted the requirements of ASU 2016-02, Leases (Topic 842): ~~Leases~~. Topic 842 was subsequently amended by ASU ~~No. 2016-02 increases~~2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU 2018-10, Codification Improvements to Topic 842, Leases; and ASU 2018-11, Targeted Improvements. The purpose of Topic 842 is to increase transparency and comparability between organizations that enter into lease agreements. The key difference of Topic 842 from the previous guidance (Topic 840) is the recognition of a right-of-use (“ROU”) asset and lease liability on the statement of financial position for those leases previously classified as operating leases under the previous guidance. Topic 842 states that a contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. The Company reviewed its material non-real estate contracts to determine if they included a lease and did not note any that would need to be considered under Topic 842. The Company’s lease agreements in which Topic 842 has been applied are primarily for retail branch real estate properties. These real estate leases have lease terms from less than 12 months to leases with options up to 15 years, and payment terms vary, with some being fixed payments or based on a fixed annual increase while others are variable and the annual increases are based on market rates or other indexes.

Initially transition from Topic 840 to Topic 842 required a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. ASU 2018-11, which, among ~~organizations~~other things, provided an additional transition method that would allow entities to not apply the initial guidance of ASU 2016-02 to the comparative periods presented in the financial statements and instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company chose the transition method of adoption provided by ~~recognizing~~ASU 2018-11, therefore, the Company will apply this standard to all existing leases as of the adoption date of January 1, 2019, recording a ROU asset and a lease liability and a cumulative-effect adjustment to the opening balance of retained earnings (if applicable) in the period of adoption. With this transition method, comparative prior period disclosures will be under the previous accounting guidance for leases (Topic 840). This adoption method is considered a change in accounting principle requiring additional disclosure of the nature of and reason for the change, which is solely a result of the adoption of the required standard.

Topic 842 provides a package of practical expedients in applying the lease standard to be chosen at the date of adoption. The Company has chosen to elect the package of practical expedients provided under ASU 2016-02 whereby it will not reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. The Company has also chosen not to apply the recognition requirements of ASU 2016-02 to any short-term leases (as defined by related accounting guidance). The Company will account for lease and non-lease components separately because such amounts are readily determinable under its lease contracts. Additionally, the Company has chosen to elect the use of hindsight, when applicable, in determining the lease term, in assessing the likelihood that a lessee purchase option will be exercised; and in assessing the impairment of ROU assets.

ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities onrepresent the balance sheet and disclosing key information about leasing arrangements. ASU No. 2016-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018.

Company’s obligation to make lease payments arising from the lease. The Company expects to adopt ASU No. 2016-02 using the modified retrospective method and practical expedients for transition. The practical expedients allow the Company to largely account for its existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. The Company has started an initial evaluationdetermined that all of its ~~leasing contracts~~leases are classified as operating leases under Topic 842. For operating and ~~activities and has started developing its methodology to estimate the right-of use assets and~~finance leases, lease liabilities ~~which is~~are initially measured at commencement date based on the present value of lease payments ~~(the December 31, 2016 future minimum~~not yet paid, discounted using the discount rate for the lease at the lease commencement date over the lease term. For operating and finance leases, ROU assets are measured at the commencement date as the amount of the initial liability, adjusted for lease payments ~~were $4.6 million). While~~made to the lessor at or before commencement date, minus incentives; and for any initial direct costs incurred by the lessee. Based on the transition method that the Company ~~does not expect there~~has chosen to follow, the initial application date of the lease term for all existing leases is January 1, 2019.

For operating leases, after lease commencement, the lease liability is recorded at the present value of the unpaid lease payments discounted at the discount rate for the lease established at the commencement date. Lease expense is determined by the sum of the lease payments to be recognized on a ~~material change~~straight-line basis over the lease term. The ROU asset is subsequently amortized as the difference between the straight line lease cost for the period and the periodic accretion of the lease liability. The lease term used for the calculation of the initial operating ROU asset and lease liability will include the initial lease term in addition to one renewal option the ~~timing of expense recognition,~~Company thinks it is ~~too early~~reasonably certain to exercise or incur. Regarding the discount rate, Topic 842 requires that the implicit rate within the lease agreement be used if available. If not available, the Company should use its incremental borrowing rate in effect at the ~~evaluation process to determine if there will be a material change to~~time of the ~~timing of expense recognition.~~lease commencement date. The Company ~~is evaluating its existing disclosures and may need to provide additional information as a result of adoption of ASU No. 2016-02.~~

utilized Federal Home Loan Bank (“FHLB”) Atlanta’s Fixed Rate Credit rates for terms consistent with the Company’s lease terms.

~~In June 2016, FASB issued ASU No. 2016-13, (Topic 326):~~ ~~Measurement of Credit Losses on Financial Instruments~~. ASU No. 2016-13 provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. ASU No. 2016-13 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted for all organizations for periods beginning after December 15, 2018.

The Company ~~will apply~~recorded operating ROU assets and operating lease liabilities of $4.4 million and $4.4 million, respectively at the ~~amendments to ASU No. 2016-13 through~~commencement date of January 1, 2019. The Company did not have a cumulative-effect adjustment to the opening balance of retained earnings as of the beginning of the year of adoption. While early adoption is permitted beginning in the first quarter of 2019, the Company does not expect to elect that option. The Company is evaluating the impact of ASU No. 2016-13 on its consolidated financial statements. The Company anticipates that ASU No. 2016-13 will have no material impact on the recorded allowance for loan losses given the change to estimated losses over the contractual life of the loans adjusted for expected prepayments. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.

~~In January 2017, FASB issued ASU No. 2017-01, (Topic 805):~~ ~~Clarifying the Definition of a Business.~~ ASU No. 2017-01 adds guidance to assist companies and other reporting organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU No. 2017-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017.earnings. The adoption of ~~this guidance is~~ASU 2016-02 did not ~~expected to~~ have a material impact on the Company’s results of operations, financial position or disclosures.

~~In January 2017,~~A director of the Company has a membership interest in a company that leases two branch facilities to the Bank. The Bank’s lease payments for these facilities totaled $173,000 for the nine months ended September 30, 2019 and 2018.

The following tables provide a summary of ASU’s issued by the FASB ~~issued ASU No. 2017-04, (Topic 350):~~ ~~Simplifying~~that the ~~Test for Goodwill Impairment. ASU No. 2017-04 provides guidance to simplify~~Company has not adopted as of September 30, 2019, which may impact the ~~accounting related to goodwill impairment. ASU No. 2017-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019.~~ Company’s financial statements.

Recently Adopted Accounting Guidance

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.	January 1, 2020 Early adoption permitted On October 16, 2019 the FASB voted to approve a delay in implementation for smaller reporting companies. Under the delay, the standard would be effective for the Company January 1, 2023. The delay is pending issuance of a final ASU.	The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company is currently developing CECL model assumptions and comparing results to current allowance for loan loss calculations. The Company plans to run parallel calculations leading up to the effective date of this guidance to ensure it is prepared for implementation by the effective date. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.
ASU 2018-13: Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (Topic 820)	Updates the disclosure requirements on fair value measurements in ASC 820, Fair Value Measurement.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-14: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans (Subtopic 715-20)	Updates disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.	January 1, 2021	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2018-18: Clarifying the Interaction between Topic 808 and Topic 606	Clarifies the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard.	January 1, 2020 Early adoption permitted	The Company does not intend to adopt this guidance early. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic.	See ASU 2016-13 above.	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 2018-19: Leases (Topic 842): Codification Improvements	Provides guidance to address concerns companies had raised about an accounting exception they would lose when assessing the fair value of underlying assets under the leases standard and clarify that lessees and lessors are exempt from a certain interim disclosure requirement associated with adopting the new standard.	January 1, 2020	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
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 2016-13 above.	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 2016-13 above.	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.

~~In February 2017, FASB issued ASU No. 2017-05, (Subtopic 610-20):~~ ~~Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. ASU No. 2017-05 clarifies the scope of established guidance on nonfinancial asset derecognition (issued as part of the new revenue standard, ASU No. 2014-09,~~ ~~Revenue from Contracts with Customers~~), as well as the accounting for partial sales of nonfinancial assets. ASU No. 2017-05 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

~~In March 2017, FASB issued ASU No. 2017-07, (Topic 715):~~ ~~Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs~~. ASU No. 2017-07 amended the requirements related to the income statement presentation of the components of net periodic beneﬁt cost for an entity’s sponsored deﬁned beneﬁt pension and other postretirement plans. ASU No. 2017-07 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

~~In March 2017, FASB issued ASU No. 2017-08, (Subtopic 310-20):~~ ~~Premium Amortization on Purchased Callable Debt Securities.~~ ASU No. 2017-08 amended the requirements related to the amortization period for certain purchased callable debt securities held at a premium. ASU No. 2017-08 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

~~In May 2017, FASB issued ASU No. 2017-09, (Topic 718):~~ ~~Scope of Modification Accounting~~. ASU No. 2017-09 amended the requirements related to changes to the terms or conditions of a share-based payment award. ASU No. 2017-09 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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

(2)

Investment Securities

Investment securities available for sale at September 30, ~~2017~~2019 and December 31, ~~2016~~2018 are as follows:

(Dollars in thousands)

September 30, 2017

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Estimated Fair Value

Mortgage-backed securities
$55,947
  1,142
  196
  56,893
U.S. Government




sponsored enterprises
  40,815
  290
  151
  40,954
State and political subdivisions
  130,175
  5,954
  20
  136,109
Corporate bonds
  1,500
  30
  -
  1,530
Trust preferred securities
  250
  -
  -
  250
Total
$228,687
  7,416
  367
  235,736

(Dollars in thousands)

	September 30, 2019
	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Mortgage-backed securities	$69,330	1,534	164	70,700
U.S. Government
sponsored enterprises	28,800	620	302	29,118
State and political subdivisions	82,243	3,952	-	86,195
Trust preferred securities	250	-	-	250
Total	$180,623	6,106	466	186,263

(Dollars in thousands)

December 31, 2016

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Estimated Fair Value

Mortgage-backed securities
$66,654
  1,221
  290
  67,585
U.S. Government




sponsored enterprises
  38,188
  308
  274
  38,222
State and political subdivisions
  137,832
  4,176
  152
  141,856
Corporate bonds
  1,500
  33
  -
  1,533
Trust preferred securities
  750
  -
  -
  750
Total
$244,924
  5,738
  716
  249,946

(Dollars in thousands)

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

The current fair value and associated unrealized losses on investments in securities with unrealized losses at September 30, ~~2017~~2019 and December 31, ~~2016~~2018 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, 2017

Less than 12 Months

12 Months or More

Total

Fair Value

Unrealized Losses

Fair Value

Unrealized Losses

Fair Value

Unrealized Losses

Mortgage-backed securities
$10,540
  95
  4,792
  101
  15,332
  196
U.S. Government






sponsored enterprises
  5,424
  47
  10,762
  104
  16,186
  151
State and political subdivisions
  545
  2
  986 24
  18
  1,531
  20
Total
$16,509
  144
  16,540
  223
  33,049
  367

(Dollars in thousands)

	December 31, 2016						September 30, 2019
	Less than 12 Months		12 Months or More		Total		Less than 12 Months		12 Months or More		Total
	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses
Mortgage-backed securities	$15,594	290	-		15,594	290	$12,273	77	7,689	87	19,962	164
U.S. Government
sponsored enterprises	10,120	94	9,562	180	19,682	274	-		6,482	302	6,482	302
State and political subdivisions	10,441	123	561 24	29	11,002	152
Total	$36,155	507	10,123	209	46,278	716	$12,273	77	14,171	389	26,444	466

(Dollars in thousands)

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

At September 30, ~~2017,~~2019, unrealized losses in the investment securities portfolio relating to debt securities totaled ~~$367,000.~~$466,000. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the September 30, ~~2017~~2019 tables above, ~~three out of 160 securities issued by state and political subdivisions contained unrealized losses,~~ 17 out of 7843 securities issued by U.S. Government sponsored enterprises ~~contained unrealized losses, and no securities issued by corporations~~ contained unrealized losses. These unrealized losses are considered temporary because of acceptable financial condition and results of operations of entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The amortized cost and estimated fair value of investment securities available for sale at September 30, ~~2017,~~2019, 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, 2017

(Dollars in thousands)

Amortized Cost

Estimated Fair Value

Due within one year
$13,299 12,273
  13,397
Due from one to five years
  95,096
  99,142
Due from five to ten years
  55,333
  57,069
Due after ten years
  8,762
  8,985
Mortgage-backed securities
  55,947
  56,893
Trust preferred securities
  250
  250
Total
$228,687
  235,736

September 30, 2019

(Dollars in thousands)

	Amortized Cost	Estimated Fair Value
Due within one year	$8,551	8,506
Due from one to five years	57,481	59,511
Due from five to ten years	39,650	41,658
Due after ten years	5,361	5,638
Mortgage-backed securities	69,330	70,700
Trust preferred securities	250	250
Total	$180,623	186,263

NoProceeds from sales of securities available for sale ~~were sold~~ during the ~~nine~~three months ended September 30, ~~2017.~~2019 were $8.4 million and resulted in net losses of $5,000. Proceeds from sales of securities available for sale during the nine months ended September 30, ~~2016~~2019 were ~~$804,000~~$20.7 million and resulted in ~~gross~~net gains of ~~$324,000.~~$226,000. No securities available for sal e during the three months ended September 30, 2018. Proceeds from sales of securities available for sale during the nine months ended September 30, 2018 were $14.0 million and resulted in net gains of $50,000.

Securities with a fair value of approximately ~~$88.2~~$64.3 million and ~~$95.6~~$93.0 million at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively, were pledged to secure public deposits and for other purposes as required by law.

(3)

~~(3)~~ Loans

Major classifications of loans at September 30, ~~2017~~2019 and December 31, ~~2016~~2018 are summarized as follows:

(Dollars in thousands)

September 30, 2017

December 31, 2016

Real estate loans:

Construction and land development
$75,483
  61,749
Single-family residential
  247,184
  240,700
Single-family residential -


Banco de la Gente stated income
  37,840
  40,189
Commercial
  245,279
  247,521
Multifamily and farmland
  28,662
  21,047
Total real estate loans
  634,448
  611,206



Loans not secured by real estate:


Commercial loans
  87,019
  87,596
Farm loans
  895
  -
Consumer loans
  10,005
  9,832
All other loans
  15,070
  15,177



Total loans
  747,437
  723,811



Less allowance for loan losses
  6,844
  7,550



Total net loans
$740,593
  716,261

(Dollars in thousands)

	September 30, 2019	December 31, 2018
Real estate loans:
Construction and land development	$95,622	94,178
Single-family residential	269,304	252,983
Single-family residential -
Banco de la Gente non-traditional	31,673	34,261
Commercial	281,607	270,055
Multifamily and farmland	47,266	33,163
Total real estate loans	725,472	684,640

Loans not secured by real estate:
Commercial loans	99,382	97,465
Farm loans	1,101	926
Consumer loans	8,473	9,165
All other loans	11,171	11,827

Total loans	845,599	804,023

Less allowance for loan losses	6,578	6,445

Total net loans	$839,021	797,578

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

●

Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of September 30, ~~2017,~~2019, construction and land development loans comprised approximately ~~10%~~11% of the Bank’s total loan portfolio.

●

Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of September 30, ~~2017,~~2019, single-family residential loans comprised approximately ~~38%~~36% of the Bank’s total loan portfolio, and include Banco’s non-traditional single-family residential ~~stated income~~ loans, which were approximately 5%4% of the Bank’s total loan portfolio.

●

Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of September 30, ~~2017,~~2019, commercial real estate loans comprised approximately 33% of the Bank’s total loan portfolio.

●

Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid or fluctuate in value based on the success of the business. As of September 30, ~~2017,~~2019, commercial loans comprised approximately 12% of the Bank’s total loan portfolio.

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

The following tables present an age analysis of past due loans, by loan type, as of September 30, ~~2017~~2019 and December 31, ~~2016:~~2018:

September 30, 2017

(Dollars in thousands)

Loans 30-89 Days Past Due

Loans 90 or More Days Past Due

Total Past Due Loans

Total Current Loans

Total Loans

Accruing Loans 90 or More Days Past Due

Real estate loans:

Construction and land development
$206
  -
  206
  75,277
  75,483
  -
Single-family residential
  2,268
  416
  2,684
  244,500
  247,184
  -
Single-family residential -






Banco de la Gente stated income
  1,363
  462
  1,825
  36,015
  37,840
  -
Commercial
  27
  229
  256
  245,023
  245,279
  -
Multifamily and farmland
  -
  12
  12
  28,650
  28,662
  -
Total real estate loans
  3,864
  1,119
  4,983
  629,465
  634,448
  -







Loans not secured by real estate:






Commercial loans
  121
  1,013
  1,134
  85,885
  87,019
  -
Farm loans
  -
  -
  -
  895
  895
  -
Consumer loans
  93
  5
  98
  9,907
  10,005
  -
All other loans
  -
  -
  -
  15,070
  15,070
  -
Total loans
$4,078
  2,137
  6,215
  741,222
  747,437
  -

September 30, 2019

(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	$123	-	123	95,499	95,622	-
Single-family residential	1,854	189	2,043	267,261	269,304	-
Single-family residential - Banco de la Gente non-traditional	1,568	50	1,618	30,055	31,673	-
Commercial	98	178	276	281,331	281,607	-
Multifamily and farmland	-	-	-	47,266	47,266	-
Total real estate loans	3,643	417	4,060	721,412	725,472	-

Loans not secured by real estate:
Commercial loans	412	-	412	98,970	99,382	-
Farm loans	-	-	-	1,101	1,101	-
Consumer loans	115	4	119	8,354	8,473	-
All other loans	-	-	-	11,171	11,171	-
Total loans	$4,170	421	4,591	841,008	845,599	-

December 31, 2016

(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
$-
  10
  10
  61,739
  61,749
  -
Single-family residential
  4,890
  80
  4,970
  235,730
  240,700
  -
Single-family residential -






Banco de la Gente stated income
  5,250
  249
  5,499
  34,690
  40,189
  -
Commercial
  342
  126
  468
  247,053
  247,521
  -
Multifamily and farmland
  471
  -
  471
  20,576
  21,047
  -
Total real estate loans
  10,953
  465
  11,418
  599,788
  611,206
  -







Loans not secured by real estate:






Commercial loans
  273
  -
  273
  87,323
  87,596
  -
Farm loans
  -
  -
  -
  -
  -
  -
Consumer loans
  68
  6
  74
  9,758
  9,832
  -
All other loans
  3
  -
  3
  15,174
  15,177
  -
Total loans
$11,297
  471
  11,768
  712,043
  723,811
  -

December 31, 2018

(Dollars in thousands)

	Loans 30-89 Days Past Due	Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$3	-	3	94,175	94,178	-
Single-family residential	4,162	570	4,732	248,251	252,983	-
Single-family residential - Banco de la Gente non-traditional	4,627	580	5,207	29,054	34,261	-
Commercial	228	-	228	269,827	270,055	-
Multifamily and farmland	-	-	-	33,163	33,163	-
Total real estate loans	9,020	1,150	10,170	674,470	684,640	-

Loans not secured by real estate:
Commercial loans	445	90	535	96,930	97,465	-
Farm loans	-	-	-	926	926	-
Consumer loans	99	4	103	9,062	9,165	-
All other loans	-	-	-	11,827	11,827	-
Total loans	$9,564	1,244	10,808	793,215	804,023	-

The following table presents non-accrual loans as of September 30, ~~2017~~2019 and December 31, ~~2016:~~2018:

(Dollars in thousands)

September 30, 2017

December 31, 2016

Real estate loans:

Construction and land development
$16
  22
Single-family residential
  1,728
  1,662
Single-family residential -


Banco de la Gente stated income
  1,502
  1,340
Commercial
  1,422
  669
Multifamily and farmland
  12
  78
Total real estate loans
  4,680
  3,771



Loans not secured by real estate:


Commercial loans
  229
  21
Consumer loans
  22
  33
Total
$4,931
  3,825

(Dollars in thousands)

	September 30, 2019	December 31, 2018
Real estate loans:
Construction and land development	$-	1
Single-family residential	1,293	1,530
Single-family residential - Banco de la Gente non-traditional	1,559	1,440
Commercial	260	244
Multifamily and farmland	-	-
Total real estate loans	3,112	3,215

Loans not secured by real estate:
Commercial loans	131	89
Consumer loans	15	10
Total	$3,258	3,314

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $250,000 are not individually evaluated for impairment with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Accruing impaired loans were ~~$21.3~~$21.4 million, ~~$23.5~~$22.8 million and ~~$22.9~~$23.6 million at September 30, ~~2017,~~2019, December 31, ~~2016~~2018 and September 30, ~~2016,~~2018, respectively. Interest income recognized on accruing impaired loans was ~~$1.1~~$1.0 million, ~~$871,000~~$1.3 million, and ~~$1.2~~$1.0 million for the nine months ended September 30, ~~2017,~~2019, the year ended December 31, 2018 and the nine months ended September 30, ~~2016 and the year ended December 31, 2016,~~2018, 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, ~~2017:~~2019:

September 30, 2017

(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
$216
  -
  221
  221
  7
Single-family residential
  4,978
  1,142
  4,232
  5,374
  42
Single-family residential -





Banco de la Gente stated income
  17,127
  -
  17,743
  17,743
  1,123
Commercial
  3,513
  1,619
  2,181
  3,800
  45
Multifamily and farmland
  12
  -
  78
  78
  -
Total impaired real estate loans
  25,846
  2,761
  24,455
  27,216
  1,217






Loans not secured by real estate:





Commercial loans
  233
  229
  39
  268
  -
Consumer loans
  179
  -
  189
  189
  3
Total impaired loans
$26,258
  2,990
  24,683
  27,673
  1,220

September 30, 2019

(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	$187	-	187	187	5
Single-family residential	4,900	409	4,010	4,419	31
Single-family residential - Banco de la Gente stated income	15,392	-	14,634	14,634	966
Commercial	1,896	-	1,888	1,888	12
Multifamily and farmland	-	-	-	-	-
Total impaired real estate loans	22,375	409	20,719	21,128	1,014

Loans not secured by real estate:
Commercial loans	578	100	88	188	1
Consumer loans	92	-	88	88	1
Total impaired loans	$23,045	509	20,895	21,404	1,016

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, ~~2017~~2019 and ~~2016.~~2018.

(Dollars in thousands)

Three months ended

Nine months ended

September 30, 2017

September 30, 2016

September 30, 2017

September 30, 2016

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
$246
  5
  369
  3
  253
  11
  375
  10
Single-family residential
  4,783
  71
  6,556
  40
  5,113
  202
  8,921
  122
Single-family residential -








Banco de la Gente stated income
  17,283
  225
  17,395
  207
  17,235
  694
  17,673
  657
Commercial
  3,852
  18
  4,013
  24
  3,712
  144
  5,376
  73
Multifamily and farmland
  12
  -
  78
  -
  45
  -
  79
  3
Total impaired real estate loans
  26,176
  319
  28,411
  274
  26,358
  1,051
  32,424
  865









Loans not secured by real estate:








Commercial loans
  243
  -
  116
  -
  130
  3
  123
  -
Consumer loans
  183
  3
  225
  2
  206
  8
  235
  6
Total impaired loans
$26,602
  322
  28,752
  276
  26,694
  1,062
  32,782
  871

(Dollars in thousands)

	Three months ended				Nine months ended
	September 30, 2019		September 30, 2018		September 30, 2019		September 30, 2018
	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	$188	3	320	2	232	9	326	14
Single-family residential	4,360	70	6,441	73	4,724	188	6,350	207
Single-family residential - Banco de la Gente stated income	14,805	241	14,602	236	14,916	732	14,851	703
Commercial	1,808	26	2,320	17	1,823	71	2,307	97
Multifamily and farmland	-	-	-	-	-	-	3	-
Total impaired real estate loans	21,161	340	23,683	328	21,695	1,000	23,837	1,021

Loans not secured by real estate:
Commercial loans	153	16	96	-	127	20	99	-
Farm loans (non RE)	-	-	-	-	-	-	-	-
Consumer loans	94	1	144	3	102	5	147	7
Total impaired loans	$21,408	357	23,923	331	21,924	1,025	24,083	1,028

The following table presents impaired loans as of and for the year ended December 31, ~~2016:~~2018:

December 31, 2016

(Dollars in thousands)

Unpaid Contractual Principal Balance

Recorded Investment With No Allowance

Recorded Investment With Allowance

Recorded Investment in Impaired Loans

Related Allowance

Average Outstanding Impaired Loans

YTD Interest Income Recognized

Real estate loans:

Construction and land development
$282
  -
  278
  278
  11
  330
  13
Single-family residential
  5,354
  703
  4,323
  5,026
  47
  7,247
  164
Single-family residential -







Banco de la Gente stated income
  18,611
  -
  18,074
  18,074
  1,182
  17,673
  861
Commercial
  3,750
  1,299
  2,197
  3,496
  166
  4,657
  152
Multifamily and farmland
  78
  -
  78
  78
  -
  78
  -
Total impaired real estate loans
  28,075
  2,002
  24,950
  26,952
  1,406
  29,985
  1,190








Loans not secured by real estate:







Commercial loans
  27
  -
  27
  27
  -
  95
  -
Consumer loans
  211
  -
  202
  202
  3
  222
  8
Total impaired loans
$28,313
  2,002
  25,179
  27,181
  1,409
  30,302
  1,198

December 31, 2018

(Dollars in thousands)

	Unpaid Contractual Principal Balance	Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans	YTD Interest Income Recognized
Real estate loans:
Construction and land development	$281	-	279	279	5	327	19
Single-family residential	5,059	422	4,188	4,610	32	6,271	261
Single-family residential -
Banco de la Gente non-traditional	16,424	-	15,776	15,776	1,042	14,619	944
Commercial	1,995	-	1,925	1,925	17	2,171	111
Total impaired real estate loans	23,759	422	22,168	22,590	1,096	23,388	1,335

Loans not secured by real estate:
Commercial loans	251	89	1	90	-	96	-
Consumer loans	116	-	113	113	2	137	7
Total impaired loans	$24,126	511	22,282	22,793	1,098	23,621	1,342

Changes in the allowance for loan losses for the three and nine months ended September 30, ~~2017~~2019 and ~~2016~~2018 were as follows:

(Dollars in thousands)

Real Estate Loans

Construction and Land Development

Single-Family Residential

Single-Family Residential - Banco de la Gente Stated Income

Commercial

Multifamily and Farmland

Commercial

Farm

Consumer and All Other

Unallocated

Total

Nine months ended September 30, 2017:

Allowance for loan losses:

Beginning balance
$1,152
  2,126
  1,377
  1,593
  52
  675
  -
  204
  371
  7,550
Charge-offs
  -
  (64)
  -
  -
  (66)
  (63)
  -
  (288)
  -
  (481)
Recoveries
  12
  26
  -
  17
  -
  23
  -
  102
  -
  180
Provision
  (178)
  (211)
  (101)
  (192)
  86
  (74)
  -
  143
  122
  (405)
Ending balance
$986
  1,877
  1,276
  1,418
  72
  561
  -
  161
  493
  6,844











Three months ended September 30, 2017:










Allowance for loan losses:










Beginning balance
$1,183
  1,819
  1,293
  1,463
  75
  704
  -
  158
  472
  7,167
Charge-offs
  -
  (20)
  -
  -
  -
  (26)
  -
  (106)
  -
  (152)
Recoveries
  2
  9
  -
  4
  -
  8
  -
  24
  -
  47
Provision
  (199)
  69
  (17)
  (49)
  (3)
  (125)
  -
  85
  21
  (218)
Ending balance
$986
  1,877
  1,276
  1,418
  72
  561
  -
  161
  493
  6,844











Allowance for loan losses at September 30, 2017:










Ending balance: individually










evaluated for impairment
$-
  -
  1,104
  42
  -
  -
  -
  -
  -
  1,146
Ending balance: collectively










evaluated for impairment
  986
  1,877
  172
  1,376
  72
  561
  -
  161
  493
  5,698
Ending balance
$986
  1,877
  1,276
  1,418
  72
  561
  -
  161
  493
  6,844











Loans at September 30, 2017:










Ending balance
$75,483
  247,184
  37,840
  245,279
28,662
87,019
895
  25,075
  -
  747,437











Ending balance: individually










evaluated for impairment
$10
  1,875
  15,732
  3,069
  -
  229
  -
  -
  -
  20,915
Ending balance: collectively










evaluated for impairment
$75,473
  245,309
  22,108
  242,210
28,662
86,790
895
  25,075
  -
  726,522

(Dollars in thousands)

(Dollars in thousands)

Real Estate Loans

Construction and Land Development

Single-Family Residential

Single-Family Residential - Banco de la Gente Stated Income

Commercial

Multifamily and Farmland

Commercial

Farm

Consumer and All Other

Unallocated

Total

Nine months ended September 30, 2016:

Allowance for loan losses:

Beginning balance
$2,185
  2,534
  1,460
  1,917
  -
  842
  -
  172
  479
  9,589
Charge-offs
  -
  (158)
  -
  (106)
  -
  (129)
  -
  (361)
  -
  (754)
Recoveries
  8
  18
  -
  15
  -
  165
  -
  112
  -
  318
Provision
  (808)
  (388)
  (60)
  (250)
  47
  (118)
  -
  291
  178
  (1,108)
Ending balance
$1,385
  2,006
  1,400
  1,576
  47
  760
  -
  214
  657
  8,045











Three months ended September 30, 2016:










Allowance for loan losses:










Beginning balance
$1,582
  2,233
  1,354
  1,650
  46
  803
  -
  234
  638
  8,540
Charge-offs
  -
  (35)
  -
  -
  -
  (89)
  -
  (122)
  -
  (246)
Recoveries
  2
  6
  -
  5
  -
  60
  -
  38
  -
  111
Provision
  (199)
  (198)
  46
  (79)
  1
  (14)
  -
  64
  19
  (360)
Ending balance
$1,385
  2,006
  1,400
  1,576
  47
  760
  -
  214
  657
  8,045











Allowance for loan losses at September 30, 2016:










Ending balance: individually










evaluated for impairment
$-
  -
  1,164
  167
  -
  -
  -
  -
  -
  1,331
Ending balance: collectively










evaluated for impairment
  1,385
  2,006
  236
  1,409
  47
  760
  -
  214
  657
  6,714
Ending balance
$1,385
  2,006
  1,400
  1,576
  47
  760
  -
  214
  657
  8,045











Loans at September 30, 2016:










Ending balance
$59,456
  231,958
  40,934
  240,150
  18,727
  94,790
  -
  27,004
  -
  713,019











Ending balance: individually










evaluated for impairment
$-
  1,019
  16,890
  3,586
  -
  -
  -
  -
  -
  21,495
Ending balance: collectively










evaluated for impairment
$59,456
  230,939
  24,044
  236,564
  18,727
  94,790
  -
  27,004
  -
  691,524

	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, 2019:
Allowance for loan losses:
Beginning balance	$813	1,325	1,177	1,278	83	626	-	161	982	6,445
Charge-offs	(21)	(42)	-	-	-	(389)	-	(459)	-	(911)
Recoveries	44	59	-	27	-	80	-	157	-	367
Provision	(141)	22	(87)	(26)	35	333	-	303	238	677
Ending balance	$695	1,364	1,090	1,279	118	650	-	162	1,220	6,578

Three months ended September 30, 2019:
Allowance for loan losses:
Beginning balance	$763	1,312	1,116	1,334	110	548	-	161	1,197	6,541
Charge-offs	-	(19)	-	-	-	(388)	-	(144)	-	(551)
Recoveries	41	6	-	4	-	66	-	49	-	166
Provision	(109)	65	(26)	(59)	8	424	-	96	23	422
Ending balance	$695	1,364	1,090	1,279	118	650	-	162	1,220	6,578

Allowance for loan losses at September 30, 2019:
Ending balance: individually
evaluated for impairment	$-	2	948	10	-	-	-	-	-	960
Ending balance: collectively
evaluated for impairment	695	1,362	142	1,269	118	650	-	162	1,220	5,618
Ending balance	$695	1,364	1,090	1,279	118	650	-	162	1,220	6,578

Loans at September 30, 2019:
Ending balance	$95,622	269,304	31,673	281,607	47,266	99,382	1,101	19,644	-	845,599

Ending balance: individually
evaluated for impairment	$11	1,719	13,196	1,628	-	100	-	-	-	16,654
Ending balance: collectively
evaluated for impairment	$95,611	267,585	18,477	279,979	47,266	99,282	1,101	19,644	-	828,945

(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, 2018:
Allowance for loan losses:
Beginning balance	$804	1,812	1,280	1,193	72	574	-	155	476	6,366
Charge-offs	(53)	(115)	-	(271)	(5)	(4)	-	(318)	-	(766)
Recoveries	4	55	-	101	1	23	-	139	-	323
Provision	(63)	(293)	(75)	438	10	12	-	182	161	372
Ending balance	$692	1,459	1,205	1,461	78	605	-	158	637	6,295

Three months ended September 30, 2018:
Allowance for loan losses:
Beginning balance	$668	1,638	1,233	1,420	72	587	-	150	509	6,277
Charge-offs	(53)	(73)	-	-	-	(1)	-	(132)	-	(259)
Recoveries	1	28	-	94	-	7	-	37	-	167
Provision	76	(134)	(28)	(53)	6	12	-	103	128	110
Ending balance	$692	1,459	1,205	1,461	78	605	-	158	637	6,295

Allowance for loan losses at September 30, 2018:
Ending balance: individually
evaluated for impairment	$5	2	1,036	12	-	-	-	-	-	1,055
Ending balance: collectively
evaluated for impairment	687	1,457	169	1,449	78	605	-	158	637	5,240
Ending balance	$692	1,459	1,205	1,461	78	605	-	158	637	6,295

Loans at September 30, 2018:
Ending balance	$76,987	249,812	34,742	275,629	31,102	97,085	994	20,373	-	786,724

Ending balance: individually
evaluated for impairment	$98	2,171	14,557	1,879	-	94	-	-	-	18,799
Ending balance: collectively
evaluated for impairment	$76,889	247,641	20,185	273,750	31,102	96,991	994	20,373	-	767,925

The provision for loan losses for the three months ended September 30, ~~2017~~2019 was ~~a credit of $218,000, as~~$422,000, compared to ~~a credit of $360,000~~$110,000 for the three months ended September 30, ~~2016.~~2018. The ~~decrease~~increase in ~~the credit to~~ the provision for loan losses is primarily attributable to a ~~$34.4~~$58.9 million increase in loans from September 30, ~~2016~~2018 to September 30, ~~2017.~~2019 and a $293,000 increase in net charge-offs during the third quarter of 2019 compared to the same period one year ago.

The provision for loan losses for the nine months ended September 30, ~~2017~~2019 was ~~a credit of $405,000, as~~$677,000, compared to ~~a credit of $1.1 million~~$372,000 for the nine months ended September 30, ~~2016.~~2018. The ~~decrease~~increase in ~~the credit to~~ the provision for loan losses is primarily attributable to a ~~$34.4~~$58.9 million increase in loans from September 30, ~~2016~~2018 to September 30, ~~2017.~~2019 and a $101,000 increase in net charge-offs during the nine months ended September 30, 2019 compared to the same period one year ago.

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

●

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

●

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

●

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

●

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

●

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

●

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

●

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

●

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

The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of September 30, ~~2017~~2019 and December 31, ~~2016:~~2018:

September 30, 2017

(Dollars in thousands)

Real Estate Loans

Construction and Land Development

Single-Family Residential

Single-Family Residential - Banco de la Gente Stated Income

Commercial

Multifamily and Farmland

Commercial

Farm

Consumer

All Other

Total

1- Excellent Quality
$-
  11,007
  -
  -
  -
  562
  -
  838
  -
  12,407
2- High Quality
  11,541
  118,964
  -
  35,461
  1,986
  18,836
  -
  3,502
  1,161
  191,451
3- Good Quality
  51,307
  87,337
  15,318
  190,950
  23,565
  62,767
  756
  5,015
  13,096
  450,111
4- Management Attention
  6,063
  21,783
  15,318
  13,366
  1,942
  4,362
  139
  582
  813
  64,368
5- Watch
  6,285
  4,679
  3,506
  4,034
  1,157
  235
  -
  24
  -
  19,920
6- Substandard
  287
  3,414
  3,698
  1,468
  12
  257
  -
  44
  -
  9,180
7- Doubtful
  -
  -
  -
  -
  -
  -
  -
  -
  -
  -
8- Loss
  -
  -
  -
  -
  -
  -
  -
  -
  -
  -
Total
$75,483
  247,184
  37,840
  245,279
  28,662
  87,019
  895
  10,005
  15,070
  747,437

September 30, 2019

(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	$-	9,078	-	-	-	632	-	700	-	10,410
2- High Quality	29,679	132,304	-	22,363	291	22,014	-	2,756	1,999	211,406
3- Good Quality	57,270	103,843	12,494	219,509	41,730	69,335	980	4,534	8,441	518,136
4- Management Attention	5,582	17,828	14,213	36,583	4,694	7,033	121	450	731	87,235
5- Watch	3,025	3,261	2,147	2,892	551	231	-	8	-	12,115
6- Substandard	66	2,990	2,819	260	-	137	-	25	-	6,297
7- Doubtful	-	-	-	-	-	-	-	-	-	-
8- Loss	-	-	-	-	-	-	-	-	-	-
Total	$95,622	269,304	31,673	281,607	47,266	99,382	1,101	8,473	11,171	845,599

December 31, ~~2016~~2018

(Dollars in thousands)

(Dollars in thousands)

Real Estate Loans

Construction and Land Development

Single-Family Residential

Single-Family Residential - Banco de la Gente Stated Income

Commercial

Multifamily and Farmland

Commercial

Farm

Consumer

All Other

Total

1- Excellent Quality
$-
  14,996
  -
  -
  -
  541
  -
  959
  -
  16,496
2- High Quality
  9,784
  109,809
  -
  39,769
  2,884
  26,006
  -
  3,335
  2,507
  194,094
3- Good Quality
  33,633
  82,147
  16,703
  176,109
  14,529
  55,155
  -
  4,842
  10,921
  394,039
4- Management Attention
  10,892
  25,219
  15,580
  24,753
  2,355
  5,586
  -
  619
  1,749
  86,753
5- Watch
  7,229
  4,682
  3,943
  4,906
  1,201
  246
  -
  31
  -
  22,238
6- Substandard
  211
  3,847
  3,963
  1,984
  78
  62
  -
  42
  -
  10,187
7- Doubtful
  -
  -
  -
  -
  -
  -
  -
  -
  -
  -
8- Loss
  -
  -
  -
  -
  -
  -
  -
  4
  -
  4
Total
$61,749
  240,700
  40,189
  247,521
  21,047
  87,596
  -
  9,832
  15,177
  723,811

	Real Estate Loans
	Construction and Land Development	Single-Family Residential	Single-Family Residential - Banco de la Gente non-traditional	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total

1- Excellent Quality	$504	5,795	-	-	-	605	-	673	-	7,577
2- High Quality	24,594	128,588	-	25,321	395	20,520	-	3,229	2,145	204,792
3- Good Quality	59,549	92,435	13,776	211,541	27,774	69,651	785	4,699	8,932	489,142
4- Management Attention	5,707	19,200	15,012	30,333	3,906	6,325	141	529	750	81,903
5- Watch	3,669	3,761	2,408	2,616	1,088	264	-	18	-	13,824
6- Substandard	155	3,204	3,065	244	-	100	-	17	-	6,785
7- Doubtful	-	-	-	-	-	-	-	-	-	-
8- Loss	-	-	-	-	-	-	-	-	-	-
Total	$94,178	252,983	34,261	270,055	33,163	97,465	926	9,165	11,827	804,023

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled ~~$2.6~~$2.2 million and ~~$5.9~~$4.7 million at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, 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 $22,000~~was zero and ~~$81,000~~$92,000 in performing loans classified as TDR loans at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively.

There were no new TDR modifications during the three and nine months ended September 30, 2019.

The following table presents an analysis of TDR loan modifications during the three ~~and nine~~ months ended September 30, ~~2017.~~2018.

Three and nine months ended September 30, 2017

(Dollars in thousands)

Number of Contracts

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

Real estate loans

Single-family residential
  2
$22
  22
Total real estate TDR loans
  2
  22
  22
Total TDR loans
  2
$22
  22

Three months ended September 30, 2018

(Dollars in thousands)

	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	1	$61	61
Total real estate TDR loans	1	61	61

Total TDR loans	1	$61	61

During the three ~~and nine~~ months ended September 30, ~~2017, two loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.~~

~~The following table presents an analysis of TDR loan modifications during the three and nine months ended September 30, 2016.~~

~~Three and nine months ended September 30, 2016~~

(Dollars in thousands)

Number of Contracts

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

Real estate loans

Single-family residential
  1
$41
  41
Total real estate TDR loans
  1
  41
  41




Total TDR loans
  1
$41
  41

~~During the three and nine months ended September 30, 2016,~~2018, one loan was modified that was considered to be a new TDR loan. The interest rate was modified on this TDR loan.

The following table presents an analysis of TDR loan modifications during the nine months ended September 30, 2018.

Nine months ended September 30, 2018

(Dollars in thousands)

	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	2	$94	94
Total real estate TDR loans	2	94	94

Total TDR loans	2	$94	94

During the nine months ended September 30, 2018, two loans were modified that were considered to be new TDR loans. The interest rates were modified on these TDR loans.

There were no loans modified as TDR that defaulted during the three and nine months ended September 30, ~~2017~~2019 and ~~2016,~~2018, which were within 12 months of their modification date. Generally, a TDR loan is considered to be in default once it becomes 90 days or more past due following a modification.

(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 year 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, ~~2017~~2019 and ~~2016~~2018 is as follows:

For the three months ended September 30, 2017

Net Earnings (Dollars in thousands)

Weighted Average Number of Shares

Per Share Amount

Basic earnings per share
$3,242
  5,450,412
$0.59
Effect of dilutive securities:



Restricted stock units
  -
  87,581

Diluted earnings per share
$3,242
  5,537,993
$0.58

For the three months ended September 30, 2019

	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$3,621	5,919,322	$0.62
Effect of dilutive securities:
Restricted stock units	-	25,883
Diluted earnings per share	$3,621	5,945,205	$0.61

For the nine months ended September 30, 2017

Net Earnings (Dollars in thousands)

Weighted Average Number of Shares

Per Share Amount

Basic earnings per share
$8,258
  5,440,995
$1.52
Effect of dilutive securities:



Restricted stock units
  -
  85,969

Diluted earnings per share
$8,258
  5,526,964
$1.49

For the nine months ended September 30, 2019

	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$11,101	5,951,840	$1.87
Effect of dilutive securities:
Restricted stock units	-	24,908
Diluted earnings per share	$11,101	5,976,748	$1.86

For the three months ended September 30, 2018

	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$3,467	5,995,256	$0.58
Effect of dilutive securities:
Restricted stock units	-	21,445
Diluted earnings per share	$3,467	6,016,701	$0.57

For the nine months ended September 30, 2018

For the three months ended September 30, 2016

Net Earnings (Dollars in thousands)

Weighted Average Number of Shares

Per Share Amount

Basic earnings per share
$2,458
  5,470,826
$0.45
Effect of dilutive securities:



Restricted stock units
  -
  74,042

Diluted earnings per share
$2,458
  5,544,868
$0.44

For the nine months ended September 30, 2016
	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount	Net Earnings (Dollars in thousands)	Weighted Average Number of Shares	Per Share Amount
Basic earnings per share	$7,875	5,497,204	$1.43	$9,946	5,995,256	$1.66
Effect of dilutive securities:
Restricted stock units	-	68,122		-	19,137
Diluted earnings per share	$7,875	5,565,326	$1.42	$9,946	6,014,393	$1.65

(5)

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. ~~A total of 258,780~~No shares ~~are currently reserved~~were available for ~~possible~~ issuance under the ~~Plan. All~~Plan at September 30, 2019 as all stock-based rights under the Plan must behave been granted or awarded by May 7, 2019 ~~(or~~(i.e., ten years from the Plan effective date).

The Company granted ~~29,514~~32,465 restricted stock units under the Plan at a grant date fair value of ~~$7.90~~$7.18 per share during the first quarter of 2012, of which ~~5,355~~5,891 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury ~~(“UST”)~~ in conjunction with the Company’s participation in the Capital Purchase Program ~~(“CPP”)~~ under the Troubled Asset Relief ~~Program (“TARP”).~~Program. In July 2012, the Company granted ~~5,355~~5,891 restricted stock units at a grant date fair value of ~~$8.25~~$7.50 per share. The Company granted ~~26,795~~29,475 restricted stock units under the Plan at a grant date fair value of ~~$11.90~~$10.82 per share during the second quarter of 2013. The Company granted ~~21,056~~23,162 restricted stock units under the Plan at a grant date fair value of ~~$15.70~~$14.27 per share during the first quarter of 2014. The Company granted ~~15,075~~16,583 restricted stock units under the Plan at a grant date fair value of ~~$17.97~~$16.34 per share during the first quarter of 2015. The Company granted ~~5,040~~5,544 restricted stock units under the Plan at a grant date fair value of ~~$18.60~~$16.91 per share during the first quarter of 2016. The Company granted ~~3,740~~4,114 restricted stock units under the Plan at a grant date fair value of ~~$27.50~~$25.00 per share during the first quarter of 2017. The Company granted 3,725 restricted stock units under the Plan at a grant date fair value of $31.43 per share during the first quarter of 2018. The Company granted 5,290 restricted stock units under the Plan at a grant date fair value of $28.43 per share during the first quarter of 2019. The number of restricted stock units granted and grant date fair values have been restated to reflect the 10% stock dividend that was paid in the fourth quarter of 2017. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the 2012 grants, four years from the grant date for the 2013, 2015, 2016, 2017, 2018 and ~~2017~~2019 grants and three years from the grant date for the 2014 grants). The amount of expense recorded each period reflects the changes in the Company’s stock price during such period. As of September 30, ~~2017,~~2019, the total unrecognized compensation expense related to the restricted stock unit grants under the Plan was ~~$389,000.~~$249,000.

The Company recognized compensation expense for restricted stock unit awards granted under the Plan of ~~$566,000~~$201,000 and ~~$476,000~~$131,000 for the nine months ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively.

(6)

Fair Value

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

The methods of determining the fair value of assets and liabilities presented in this note are consistent with methodologies disclosed in Note 15 of the Company’s 2018 Form 10-K, except for the valuation of loans which was impacted by the adoption of ASU No. 2016-01.

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

●

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

●

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

●

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

Cash and Cash Equivalents

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

Investment Securities Available for Sale

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

Other Investments

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

Mortgage Loans Held for Sale

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

Loans

~~The~~In accordance with ASU No. 2016-01, the fair value of ~~fixed rate~~ loans, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated ~~by discounting~~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 future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value.loans. Loans are reported in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

Cash Surrender Value of Life Insurance

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

Other Real Estate

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

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Deposits are reported in the Level 23 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.

~~Federal Home Loan Bank (“FHLB”)~~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 23 fair value category.

Junior Subordinated Debentures

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

Commitments to Extend Credit and Standby Letters of Credit

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

Limitations

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

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

The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy, as of September 30, ~~2017~~2019 and December 31, ~~2016.~~2018.

(Dollars in thousands)
	September 30, 2017				September 30, 2019
	Fair Value Measurements	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Fair Value Measurements	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation
Mortgage-backed securities	$56,893	-	56,893	-	$70,700	-	70,700	-
U.S. Government
sponsored enterprises	$40,954	-	40,954	-	$29,118	-	29,118	-
State and political subdivisions	$136,109	-	136,109	-	$86,195	-	86,195	-
Corporate bonds	$1,530	-	1,530	-
Trust preferred securities	$250	-		250	$250	-		250

(Dollars in thousands)

December 31, 2016

Fair Value Measurements

Level 1 Valuation

Level 2 Valuation

Level 3 Valuation

Mortgage-backed securities
$67,585
  -
  67,585
  -
U.S. Government




sponsored enterprises
$38,222
  -
  38,222
  -
State and political subdivisions
$141,856
  -
  141,856
  -
Corporate bonds
$1,533
  -
  1,533
  -
Trust preferred securities
$750
  -
  -
  750

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

The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the nine months ended September 30, ~~2017.~~2019.

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$~~750~~250
Change in book value	-
Change in gain/(loss) realized and unrealized	-
Purchases/(sales and calls)	~~(500~~-)
Transfers in and/or (out) of Level 3	-
Balance, end of period	$250

Change in unrealized gain/(loss) for assets still held in Level 3	$-

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at September 30, ~~2017~~2019 and December 31, ~~2016~~2018 are presented below. The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of, and judgment about, current market conditions, specific issues relating to the collateral and other matters. As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements September 30, 2017	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Fair Value Measurements September 30, 2019	Level 1 Valuation	Level 2 Valuation	Level 3 Valuation
Mortgage loans held for sale	$2,623	-		2,623	$4,263	-		4,263
Impaired loans	$26,453	-		26,453	$20,388	-		20,388
Other real estate	$-	-			$26	-		26

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

(Dollars in thousands)

Fair Value Measurements December 31, 2016

Level 1 Valuation

Level 2 Valuation

Level 3 Valuation

Mortgage loans held for sale
$5,709
  -
  -
  5,709
Impaired loans
$25,772
  -
  -
  25,772
Other real estate
$283
  -
  -
  283

(Dollars in thousands)

Fair Value September 30, 2017

Fair Value December 31, 2016

Valuation Technique

Significant Unobservable Inputs

General Range of Significant Unobservable Input Values

Mortgage loans held for sale
$2,623
  5,709
Rate lock commitment
  N/A
  N/A
Impaired loans
$26,453
  25,772
Appraised value
and discounted cash flows

Discounts to reflect current market conditions and ultimate collectability

  0 - 25%
Other real estate
$-
  283
Appraised value

Discounts to reflect current market conditions and estimated costs to sell

  0 - 25%

(Dollars in thousands)
	Fair Value September 30, 2019	Fair Value December 31, 2018	Valuation Technique	Significant Unobservable Inputs	General Range of Significant Unobservable Input Values
Mortgage loans held for sale	$4,263	680	Rate lock commitment	N/A	N/A
Impaired loans	$20,388	21,695	Appraised value and discounted cash flows	Discounts to reflect current market conditions and ultimate collectability	0 - 25%
Other real estate	$26	27	Appraised value	Discounts to reflect current market conditions and estimated costs to sell	0 - 25%

The carrying amount and estimated fair value of financial instruments at September 30, ~~2017~~2019 and December 31, ~~2016~~2018 are as follows:

(Dollars in thousands)
		Fair Value Measurements at September 30, 2017					Fair Value Measurements at September 30, 2019
	Carrying Amount	Level 1	Level 2	Level 3	Total	Carrying Amount	Level 1	Level 2	Level 3	Total
Assets:
Cash and cash equivalents	$93,256	93,256	-		93,256	$129,553	129,553	-		129,553
Investment securities available for sale	$235,736	-	235,486	250	235,736	$186,263	-	186,013	250	186,263
Other investments	$2,680	-		2,680		$7,239	-		7,239
Mortgage loans held for sale	$2,623	-		2,623		$4,263	-		4,263
Loans, net	$740,593	-		745,481		$839,021	-		816,260
Cash surrender value of life insurance	$15,452	-	15,452	-	15,452	$16,222	-	16,222	-	16,222

Liabilities:
Deposits	$901,639	-		890,957		$961,568	-		949,309
Securities sold under agreements
to repurchase	$53,307	-	53,307	-	53,307	$21,927	-	21,927	-	21,927
FHLB borrowings	$20,000	-	19,967	-	19,967	$70,000	-		70,555
Junior subordinated debentures	$20,619	-	20,619	-	20,619	$20,619	-	20,619	-	20,619

(Dollars in thousands)
		Fair Value Measurements at December 31, 2018
	Carrying Amount	Level 1	Level 2	Level 3	Total
Assets:
Cash and cash equivalents	$43,370	43,370	-	-	43,370
Investment securities available for sale	$194,578	-	194,328	250	194,578
Other investments	$4,361	-	-	4,361	4,361
Mortgage loans held for sale	$680	-	-	680	680
Loans, net	$797,578	-	-	748,917	748,917
Cash surrender value of life insurance	$15,936	-	15,936	-	15,936

Liabilities:
Deposits	$877,213	-	-	857,999	857,999
Securities sold under agreements
to repurchase	$58,095	-	58,095	-	58,095
Junior subordinated debentures	$20,619	-	20,619	-	20,619

(Dollars in thousands)

Fair Value Measurements at December 31, 2016

Carrying Amount

Level 1

Level 2

Level 3

Total

Assets:

Cash and cash equivalents
$70,094
  70,094
  -
  -
  70,094
Investment securities available for sale
$249,946
  -
  249,196
  750
  249,946
Other investments
$2,635
  -
  -
  2,635
  2,635
Mortgage loans held for sale
$5,709
  -
  -
  5,709
  5,709
Loans, net
$716,261
  -
  -
  720,675
  720,675
Cash surrender value of life insurance
$14,952
  -
  14,952
  -
  14,952






Liabilities:





Deposits
$892,918
  -
  -
  884,510
  884,510
Securities sold under agreements





to repurchase
$36,434
  -
  36,434
  -
  36,434
FHLB borrowings
$20,000
  -
  18,864
  -
  18,864
Junior subordinated debentures
$20,619
  -
  20,619
  -
  20,619

(7)

Leases

~~(7)~~ ~~Regulatory Matters~~

~~On August 31, 2015,~~As of September 30, 2019 the ~~Federal Deposit Insurance Corporation (“FDIC”)~~Company had operating ROU assets of $3.8 million and operating lease liabilities of $3.8 million. The Company maintains operating leases on land and buildings for some of the Bank’s branch facilities and loan production offices. Most leases include one option to renew, with renewal terms extending up to 15 years. The exercise of renewal options is based on the judgment of management as to whether or not the renewal option is reasonably certain to be exercised. Factors in determining whether an option is reasonably certain of exercise include, but are not limited to, the value of leasehold improvements, the value of renewal rates compared to market rates, and the ~~North Carolina Office~~presence of factors that would cause a significant economic penalty to the ~~Commissioner of Banks (“Commissioner”) issued a Consent Order (the “Order”) in connection with compliance~~Company if the option is not exercised. As allowed by the ~~Bank~~standard, leases with a term of 12 months or less are not recorded on the ~~Bank Secrecy Act~~balance sheet and ~~its implementing regulations (collectively,~~instead are recognized in lease expense on a straight-line basis over the “BSA”). The Order was issued pursuant to the consent of the Bank. In consenting to the issuance of the Order, the Bank did not admit or deny any unsafe or unsound banking practices or violations of law or regulation.lease term.

The ~~Order required the Bank to take certain affirmative actions to comply with its obligations under the BSA, including, without limitation, strengthening its Board~~following table presents lease cost and other lease information as of Directors’ oversight of BSA activities; reviewing, enhancing, adopting and implementing a revised BSA compliance program; completing a BSA risk assessment; developing a revised system of internal controls designed to ensure full compliance with the BSA; reviewing and revising customer due diligence and risk assessment processes, policies and procedures; developing, adopting and implementing effective BSA training programs; assessing BSA staffing needs and resources and appointing a qualified BSA officer; establishing an independent BSA testing program; ensuring that all reports required by the BSA are accurately and properly filed and engaging an independent firm to review past account activity to determine whether suspicious activity was properly identified and reported.September 30, 2019.

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

(Dollars in thousands)
	September 30, 2019

Operating lease cost	$3,816

Other information:
Cash paid for amounts included in the measurement of lease liabilities	650
Operating cash flows from operating leases	-
Right-of-use assets obtained in exchange for new finance operating liabilities	9
Weighted-average remaining lease term - operating leases	4
Weighted-average discount rate - operating leases	2.88%

The following table presents lease maturities as of September 30, 2019.

(Dollars in thousands)

Maturity Analysis of Operating Lease Liabilities:	September 30, 2019
2020	$841
2021	803
2022	569
2023	424
2024	346
Thereafter	1,369
Total	$4,352
Less: Imputed Interest	(517)
Operating Lease Liability	$3,835

(8)

Subsequent Events

The Company has reviewed and evaluated subsequent events and transactions for material subsequent events through the date the financial statements are issued. Management has concluded that there were no material subsequent events other than the ~~FHLB borrowings prepayment~~event noted below.

On October ~~26, 2017,~~17, 2019 the ~~Bank repaid~~Board of Directors of the ~~remaining FHLB borrowings totaling $20.0 million. Prepayment penalties totaling $508,000~~Company approved a $5 million redemption of the Company's outstanding trust preferred securities in December 2019. Notification of this redemption was sent to the Trustee on October 31, 2019. Security holders will be ~~reflected in fourth quarter 2017 non-interest expense and will be partially offset by a reduction of approximately $150,000 in fourth quarter 2017 interest expense based on current interest rates.~~notified at least 30 days prior to the redemption date.

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

The following is a discussion of ~~our~~the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors and the Company’s Consolidated Financial Statements and Notes thereto on pages A-24 through ~~A-67~~A-68 of the Company’s ~~2016~~2018 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May ~~4, 2017~~2, 2019 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 and Durham counties, operating under the banking laws of North Carolina and the rules and regulations of the ~~FDIC.~~Federal Deposit Insurance Corporation.

Overview

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

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

Current economic conditions, while not as robust as those experienced in the pre-crisis period from 2004 to 2007, have stabilized such that businesses in our market area are growing and investing again. The uncertainty expressed in the local, national and international markets through the primary economic indicators of activity ~~however, continues~~are currently sufficiently stable to ~~limit the level of activity~~allow for reasonable economic growth in our markets.

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.

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

The Federal Reserve maintained the Federal Funds rate at 0.25% from December 2008 to December 2015 before increasing the Fed Funds rate to 0.50% on December 16, 2015, 0.75% on December 14, 2016, 1.00% on March 15, 2017 and 1.25% on June 14, 2017. This continued period of historically low interest rates has presented a challenge to the Company to maintain its net interest margin as loan rates fell and remained low, primarily because of competition for credit worthy customers. The cost of deposits has also fallen but has reached the point where there is little room left to reduce this cost. While the 0.25% Fed Funds rate increases innine times since December 2015 ~~December 2016, March 2017 and June 2017 will be helpful, the negative impact of such low interest rates will remain until~~to the Fed Funds rate of 2.50% at June 30, 2019. Those increases ~~to levels approaching the historical norms experienced prior to the crisis beginning~~had a positive impact on earnings in ~~2008.~~

~~On August 31, 2015, the FDIC and the Commissioner issued the Order in connection with compliance by the Bank with the BSA.~~recent periods. The Order was issued pursuant to the consent of the Bank. In consenting to the issuance of the Order, the Bank did not admit or deny any unsafe or unsound banking practices or violations of law or regulation.

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

~~During~~Fed Funds rate decreased 0.25% two times during the third quarter of ~~2017~~2019 to a rate of 2.00% at September 30, 2019. These recent Fed Funds rate reductions are expected to have a negative impact on the ~~Bank received notice that the Order was terminated effective August 30, 2017.~~Bank’s net interest income in future periods.

Summary of Significant Accounting Policies

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. A more complete description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s ~~2016~~2018 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May ~~4, 2017~~2, 2019 Annual Meeting of Shareholders.

Many of the Company’s assets and liabilities are recorded using various techniques that require significant judgment as to recoverability. The collectibility of loans is reflected through the Company’s estimate of the allowance for loan losses. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectibility. In addition, certain assets and liabilities are reflected at their estimated fair value in the consolidated financial statements. Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques. The Company’s internal models generally involve present value of cash flow techniques. The various techniques are discussed in greater detail elsewhere in this management’s discussion and analysis and the Notes to the Consolidated Financial Statements. Fair value of the Company’s financial instruments is discussed in Note (6) of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report.

Results of Operations

Summary. Net earnings were ~~$3.2~~$3.6 million or ~~$0.59~~$0.62 basic net earnings per share and ~~$0.58~~$0.61 diluted net earnings per share for the three months ended September 30, ~~2017, as~~2019, compared to ~~$2.5~~$3.5 million or ~~$0.45~~$0.58 basic net earnings per share and ~~$0.44~~$0.57 diluted net earnings per share for the same period one year ago. The increase in third quarter net earnings is primarily attributable to an increase in net interest income and an increase in non-interest income, ~~and a decrease in non-interest expense,~~ which were partially offset by ~~a decrease~~an increase in ~~the credit to~~ the provision for loan losses and an increase in non-interest expense during the three months ended September 30, 2019, compared to the three months ended September 30, 2018, as discussed below.

The annualized return on average assets was ~~1.17%~~1.26% for the three months ended September 30, ~~2017,~~2019, compared to ~~0.90%~~1.25% for the same period one year ago, and annualized return on average shareholders’ equity was ~~11.14%~~10.89% for the three months ended September 30, ~~2017,~~2019, compared to ~~8.68%~~11.49% for the same period one year ago.

Year-to-date net earnings as of September 30, ~~2017~~2019 were ~~$8.3~~$11.1 million or ~~$1.52~~$1.87 basic net earnings per share and ~~$1.49~~$1.86 diluted net earnings per share, as compared to ~~$7.9~~$9.9 million or ~~$1.43~~$1.66 basic net earnings per share and ~~$1.42~~$1.65 diluted net earnings per share for the same period one year ago. The increase in year-to-date net earnings is primarily attributable to an increase in net interest income ~~which was partially offset by a decrease in the credit to the provision for loan losses, a decrease in non-interest income~~ and an increase in non-interest ~~expense,~~income, which were partially offset by an increase in ~~net interest income,~~the provision for loan losses and an increase in non-interest expense, as discussed below.

The annualized return on average assets was ~~1.01%~~1.32% for the nine months ended September 30, ~~2017,~~2019, as compared to ~~0.99%~~1.21% for the same period one year ago, and annualized return on average shareholders’ equity was ~~9.59%~~11.24% for the nine months ended September 30, ~~2017,~~2019, as compared to ~~9.29%~~10.97% for the same period one year ago.

Net Interest Income. Net interest income, the major component of the Company’s net earnings, was ~~$10.0~~$11.4 million for the three months ended September 30, ~~2017,~~2019, compared to ~~$9.2~~$11.1 million for the three months ended September 30, ~~2016.~~2018. The increase in net interest income was primarily due to ~~a $716,000~~an $822,000 increase in interest income, which was partially offset by a $437,000 increase in interest expense. The increase in interest income was primarily attributable to an increase in the average outstanding balance of loans and a ~~0.75% increase in the~~higher average prime rate ~~since September 2016, combined with a $178,000 decrease in interest expense, which was primarily attributable to a decrease in the average outstanding balances of FHLB borrowings and time deposits~~ during the ~~three months ended September 30, 2017, as~~third quarter of 2019, compared to the same period one year ago. The increase in interest expense was primarily due to an increase in interest rates on deposits.

Interest income was ~~$10.7~~$12.4 million for the three months ended September 30, ~~2017,~~2019, compared to ~~$10.0~~$11.6 million for the three months ended September 30, ~~2016.~~2018. The increase in interest income was primarily due to an increase in interest income on loans, which was partially offset by a decrease in interest income on investment securities. During the quarter ended September 30, ~~2017,~~2019, average loans increased ~~$36.9~~$58.9 million to ~~$746.6~~$840.5 million from ~~$709.7~~$781.6 million for the quarter ended September 30, ~~2016.~~2018. During the quarter ended September 30, ~~2017,~~2019, average investment securities available for sale decreased ~~$21.2~~$28.8 million to ~~$231.1~~$180.4 million from ~~$252.3~~$209.2 million for the quarter ended September 30, ~~2016.~~2018. The average yield on loans for the quarters ended September 30, ~~2017~~2019 and ~~2016~~2018 was ~~4.76%~~5.19% and ~~4.59%~~5.03%, respectively. The average yield on investment securities available for sale was ~~3.77%~~3.29% and ~~3.63%~~3.52% for the quarters ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively. The average yield on earning assets was ~~4.45%~~4.79% and ~~4.23%~~4.65% for the quarters ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively.

Interest expense was ~~$650,000~~$994,000 for the three months ended September 30, ~~2017,~~2019, compared to ~~$828,000~~$557,000 for the three months ended September 30, ~~2016.~~2018. The ~~decrease~~increase in interest expense was primarily due to an increase in the ~~result of lower~~ cost of ~~funds and reductions in FHLB borrowings and certificates of deposit.~~funds. The average rate paid on interest-bearing checking and savings accounts was ~~0.13%~~0.36% and ~~0.11%~~0.16% for the three months ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively. The average rate paid on certificates of deposit was ~~0.34%~~0.97% for the three months ended September 30, ~~2017, as~~2019, compared to ~~0.38%~~0.46% for the same period one year ago. The average rate paid on interest-bearing liabilities was ~~0.37%~~0.60% for the three months ended September 30, ~~2017, as~~2019, compared to ~~0.46%~~0.33% for the same period one year ago. During the quarter ended September 30, ~~2017,~~2019, average certificates of deposit decreased ~~$20.3~~$3.8 million to ~~$129.6~~$106.4 million from ~~$149.9~~$110.2 million for the quarter ended September 30, ~~2016.~~2018. Average FHLB borrowings ~~decreased $23.5~~increased $6.7 million to ~~$20.0~~$6.7 million for the three months ended September 30, ~~2017~~2019 from ~~$43.5 million~~zero for the three months ended September 30, ~~2016.~~2018.

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, ~~2017~~2019 and ~~2016.~~2018. 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, 2019 and 2018 have been adjusted to a tax equivalent basis using an effective tax rate of ~~35.98%~~22.98% for securities that are both federal and state tax exempt and an effective tax rate of ~~32.98%~~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			Three months ended
	September 30, 2017			September 30, 2016			September 30, 2019			September 30, 2018
(Dollars in thousands)	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate
Interest-earning assets:

Loans receivable	$746,633	8,966	4.76%	$709,742	8,189	4.59%	$840,523	11,004	5.19%	$781,596	9,907	5.03%
Investments - taxable	62,730	409	2.59%	78,033	454	2.31%	68,527	517	2.99%	54,045	404	2.97%
Investments - nontaxable*	171,704	1,798	4.15%	178,500	1,869	4.17%	117,140	1,004	3.40%	160,203	1,472	3.65%
Other	19,725	59	1.19%	26,327	32	0.48%	17,969	87	1.90%	17,103	86	2.04%

Total interest-earning assets	1,000,792	11,232	4.45%	992,602	10,544	4.23%	1,044,159	12,612	4.79%	1,012,947	11,869	4.65%

Non-interest earning assets:
Cash and due from banks	53,828			47,263			40,415			46,124
Allowance for loan losses	( 7,129)			( 8,603)			(6,440)			(6,263)
Other assets	54,095			55,894			61,122			51,233

Total assets	$1,101,586			$1,087,156			$1,139,256			$1,104,041


Interest-bearing liabilities:

NOW, MMDA & savings deposits	$476,851	156	0.13%	$453,008	126	0.11%	$495,992	455	0.36%	$481,835	189	0.16%
Time deposits	129,559	112	0.34%	149,914	142	0.38%	106,366	259	0.97%	110,163	127	0.46%
FHLB borrowings	20,000	211	4.19%	43,500	426	3.90%	6,659	21	1.19%	-
Trust preferred securities	20,619	152	2.92%	20,619	122	2.35%	20,619	210	4.04%	20,619	209	4.02%
Other	52,718	19	0.14%	47,217	12	0.10%	32,773	49	0.61%	51,477	32	0.25%

Total interest-bearing liabilities	699,747	650	0.37%	714,258	828	0.46%	662,409	994	0.60%	664,094	557	0.33%

Non-interest bearing liabilities and shareholders' equity:							Non-interest bearing liabilities and shareholders' equity:
Demand deposits	282,336			257,707			336,896			315,537
Other liabilities	3,991			2,610			8,051			4,700
Shareholders' equity	115,512			112,581			131,900			119,710

Total liabilities and shareholder's equity	$1,101,586			$1,087,156			$1,139,256			$1,104,041

Net interest spread		$10,582	4.08%		9,716	3.77%		$11,618	4.19%		$11,312	4.32%

Net yield on interest-earning assets			4.20%			3.89%			4.41%			4.43%

Taxable equivalent adjustment
Investment securities		$534			562			$182			$261

Net interest income		$10,048			9,154			$11,436			$11,051

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of ~~$40.1~~$31.2 million in ~~2017~~2019 and ~~$39.5~~$37.8 million in ~~2016. Tax rates~~2018. A tax rate of ~~3.00% and 4.00% were~~2.50% was used to calculate the tax equivalent yield on these securities in ~~2017~~2019 and ~~2016, respectively.~~

2018.

Year-to-date net interest income as of September 30, ~~2017~~2019 was ~~$29.4~~$34.5 million, compared to ~~$27.3~~$31.9 million for the same period one year ago. The increase in net interest income was primarily due to a ~~$1.5~~$3.6 million increase in interest income, which was partially offset by a $995,000 increase in interest expense. The increase in interest income was primarily attributable to an increase in the average outstanding balance of loans and a ~~0.75% increase in the~~higher average prime rate ~~since September 2016, combined with a $580,000 decrease in interest expense, which was primarily attributable to a decrease in the average outstanding balances of FHLB borrowings and time deposits~~ during the nine months ended September 30 ~~2017, as~~2019, compared to the same period one year ago. The increase in interest expense was primarily due to an increase in interest rates on deposits.

Interest income was ~~$31.2~~$37.0 million for the nine months ended September 30, ~~2017,~~2019, compared to ~~$29.7~~$33.4 million for the nine months ended September 30, ~~2016.~~2018. The increase in interest income was primarily due to an increase in interest income on loans, which was partially offset by a decrease in interest income on investment securities. During the nine months ended September 30, ~~2017,~~2019, average loans increased ~~$41.5~~$57.4 million to ~~$739.9~~$829.4 million from ~~$698.3~~$772.0 million for the nine months ended September 30, ~~2016.~~2018. During the nine months ended September 30, ~~2017,~~2019, average investment securities available for sale decreased ~~$18.2~~$27.1 million to ~~$235.9~~$185.1 million from ~~$254.1~~$212.2 million for the nine months ended September 30, ~~2016 primarily due to paydowns on mortgage-backed securities.~~2018. The average yield on loans for the nine months ended September 30, ~~2017~~2019 and ~~2016~~2018 was ~~4.69%~~5.24% and ~~4.63%~~4.91%, respectively. The average yield on investment securities available for sale was ~~3.77%~~3.48% and ~~3.69%~~3.47% for the nine months ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively. The average yield on earning assets was ~~4.41%~~4.89% and ~~4.30%~~4.54% for the nine months ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively.

Interest expense was ~~$1.9 million for the nine months ended September 30, 2017, compared to~~ $2.5 million for the nine months ended September 30, ~~2016.~~2019, compared to $1.5 million for the nine months ended September 30, 2018. The ~~decrease~~increase in interest expense was primarily due to an increase in the ~~result of lower~~ cost of ~~funds and reductions in FHLB borrowings and certificates of deposit.~~funds. The average rate paid on interest-bearing checking and savings accounts was ~~0.12%~~0.29% and ~~0.11%~~0.15% for the nine months ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively. The average rate paid on certificates of deposit was ~~0.36%~~0.75% for the nine months ended September 30, ~~2017, as~~2019, compared to 0.40% for the same period one year ago. The average rate paid on interest-bearing liabilities was ~~0.36%~~0.52% for the nine months ended September 30, ~~2017, as~~2019, compared to ~~0.47%~~0.31% for the same period one year ago. During the nine months ended September 30, ~~2017,~~2019, average certificates of deposit decreased ~~$16.8~~$11.6 million to ~~$135.3~~$103.2 million from ~~$152.1~~$114.8 million for the nine months ended September 30, ~~2016.~~2018. Average FHLB borrowings ~~decreased $23.6~~increased $4.7 million to ~~$20.0~~$4.7 million for the nine months ended September 30, ~~2017~~2019 from ~~$43.6 million~~zero for the nine months ended September 30, ~~2016.~~2018.

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, ~~2017~~2019 and ~~2016.~~2018. 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, 2019 and 2018 have been adjusted to a tax equivalent basis using an effective tax rate of ~~35.98%~~22.98% for securities that are both federal and state tax exempt and an effective tax rate of ~~32.98%~~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.

	Nine months ended			Nine months ended			Nine months ended
	September 30, 2017			September 30, 2016			September 30, 2019			September 30, 2018
(Dollars in thousands)	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate	Average Balance	Interest	Yield / Rate
Interest-earning assets:

Loans receivable	$739,857	25,935	4.69%	$698,313	24,185	4.63%	$829,385	32,517	5.24%	$771,951	28,362	4.91%
Investments - taxable	66,120	1,272	2.57%	79,476	1,485	2.50%	62,230	1,457	3.13%	54,184	1,181	2.91%
Investments - nontaxable*	173,113	5,512	4.26%	178,921	5,671	4.23%	128,024	3,493	3.65%	161,947	4,428	3.66%
Other	18,048	138	1.02%	18,816	67	0.48%	8,934	136	2.04%	19,101	255	1.78%

Total interest-earning assets	997,138	32,857	4.41%	975,526	31,408	4.30%	1,028,573	37,603	4.89%	1,007,183	34,226	4.54%

Non-interest earning assets:
Cash and due from banks	53,837			43,050			36,882			42,281
Allowance for loan losses	( 7,335)			( 9,144)			(6,475)			(6,326)
Other assets	52,862			55,223			63,246			52,117

Total assets	$1,096,502			$1,064,655			$1,122,226			$1,095,255


Interest-bearing liabilities:

NOW, MMDA & savings deposits	$479,715	431	0.12%	$441,161	367	0.11%	$488,467	1,057	0.29%	$487,657	551	0.15%
Time deposits	135,291	360	0.36%	152,050	452	0.40%	103,204	581	0.75%	114,803	342	0.40%
FHLB borrowings	20,000	604	4.04%	43,646	1,248	3.82%	4,700	70	1.99%	-
Trust preferred securities	20,619	432	2.80%	20,619	353	2.29%	20,619	656	4.25%	20,619	578	3.75%
Other	47,675	43	0.12%	39,941	30	0.10%	39,666	168	0.57%	44,970	66	0.20%

Total interest-bearing liabilities	703,300	1,870	0.36%	697,417	2,450	0.47%	656,656	2,532	0.52%	668,049	1,537	0.31%

Non-interest bearing liabilities and shareholders' equity:							Non-interest bearing liabilities and shareholders' equity:
Demand deposits	277,052			254,829			324,749			305,514
Other liabilities	989			( 798)			8,768			455
Shareholders' equity	115,161			113,207			132,053			121,237

Total liabilities and shareholder's equity	$1,096,502			$1,064,655			$1,122,226			$1,095,255

Net interest spread		$30,987	4.05%		28,958	3.83%		$35,071	4.37%		$32,689	4.24%

Net yield on interest-earning assets			4.15%			3.97%			4.56%			4.34%

Taxable equivalent adjustment
Investment securities		$1,634			1,705			$615			$800

Net interest income		$29,353			27,253			$34,456			$31,889
*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $39.3 million in 2017 and $38.8 million in 2016. Tax rates of 3.00% and 4.00% were used to calculate the tax equivalent yield on these securities in 2017 and 2016, respectively.

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $33.2 million in 2019 and $38.7 million in 2018. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2019 and 2018.

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

	Three months ended September 30, 2017 compared to three months ended September 30, 2016			Nine months ended September 30, 2017 compared to nine months ended September 30, 2016			Three months ended September 30, 2019 compared to three months ended September 30, 2018			Nine months ended September 30, 2019 compared to nine months ended September 30, 2018
(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)	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	$434	343	777	1,448	302	1,750	$759	338	1,097	2,181	1,974	4,155
Investments - taxable	(94)	49	(45)	(253)	40	(213)	109	4	113	182	94	276
Investments - nontaxable	(71)	-	(71)	(185)	26	(159)	(382)	(86)	(468)	(927)	(8)	(935)
Other	(14)	41	27	(4)	75	71	4	(6)	(2)	(145)	26	(119)
Total interest income	255	433	688	1,006	443	1,449	490	250	740	1,291	2,086	3,377

Interest expense:
NOW, MMDA & savings deposits	7	23	30	33	31	64	9	257	266	1	505	506
Time deposits	(18)	(12)	(30)	(47)	(45)	(92)	(7)	139	132	(50)	289	239
FHLB borrowings	(238)	23	(215)	(695)	51	(644)	10		20	35		70
Trust preferred securities	-	30		-	79		-	1		-	78
Other	1	5	6		7	13	(20)	38	18	(15)	117	102
Total interest expense	(248)	69	(179)	(703)	123	(580)	(8)	445	437	(29)	1,024	995
Net interest income	$503	364	867	1,709	320	2,029	$498	(195)	303	1,320	1,062	2,382

Provision for Loan Losses. The provision for loan losses for the three months ended September 30, ~~2017~~2019 was ~~a credit of $218,000, as~~$422,000, compared to ~~a credit of $360,000~~$110,000 for the three months ended September 30, ~~2016.~~2018. The ~~decrease~~increase in ~~the credit to~~ the provision for loan losses is primarily attributable to a ~~$34.4~~$58.9 million increase in loans from September 30, ~~2016~~2018 to September 30, ~~2017.~~2019 and a $293,000 increase in net charge-offs during the third quarter of 2019 compared to the same period a year ago.

Non-Interest Income. Total non-interest income was ~~$3.5~~$4.7 million for the three months ended September 30, ~~2017,~~2019, compared to ~~$3.4~~$3.9 million for the three months ended September 30, ~~2016.~~2018. The increase in non-interest income is primarily attributable to a ~~$266,000~~$512,000 increase in ~~miscellaneous non-interest~~appraisal management fee income ~~during the three months ended September 30, 2017, compared~~due to ~~the same period one year ago. The~~an increase in ~~miscellaneous non-interest income is primarily attributable to a $159,000 increase in net Mastercard debit card incentives during~~ the ~~three months ended September 30, 2017, compared to the same period one year ago.~~volume of appraisals.

Non-interest income was ~~$9.7~~$13.2 million for the nine months ended September 30, ~~2017,~~2019, compared to ~~$10.3~~$11.7 million for the nine months ended September 30, ~~2016.~~2018. The ~~decrease~~increase in non-interest income is primarily attributable to ~~a $324,000 decrease~~an $843,000 increase in ~~gains on~~appraisal management fee income due to an increase in the ~~sale~~volume of securities, a $250,000 decrease in service charges and fees and a $143,000 decrease in mortgage banking income during the nine months ended September 30, 2017, as compared to the nine months ended September 30, 2016.appraisals.

Non-Interest Expense. Total non-interest expense was ~~$9.4~~$11.3 million for the three months ended September 30, ~~2017,~~2019, compared to ~~$9.6~~$10.7 million for the three months ended September 30, ~~2016.~~2018. The ~~decrease~~increase in non-interest expense was primarily attributable to a $385,000 increase in appraisal management fee expense due to ~~a $138,000 decrease~~an increase in ~~other non-interest expense~~the volume of appraisals and a ~~$126,000 decrease in professional fees, which were partially offset by a $104,000~~$176,000 increase in salaries and benefits expense, during the three months ended September 30, 2017, as compared to the three months ended September 30, 2016. The decrease in professional fees is primarily due to a decrease in consulting fees. The decrease in other non-interest expense is primarily due to a decrease in fraud losses. The increase in salaries and benefits expense iswhich was primarily due to an increase in the number of full-time equivalent employees and annual salary increases.

Non-interest expense was ~~$28.5~~$33.4 million for the nine months ended September 30, ~~2017,~~2019, compared to ~~$28.2~~$31.3 million for the nine months ended September 30, ~~2016.~~2018. The increase in non-interest expense was primarily due to a ~~$924,000~~$665,000 increase in appraisal management fee expense due to an increase in the volume of appraisals and a $1.2 million increase in salaries and benefits expense a $322,000 increase in other non-interest expense and a $236,000 increase in advertising expenses, which were partially offset by a $815,000 decrease in professional fees and a $262,000 decrease in occupancy expense during the nine months ended September 30, 2017, as compared to the nine months ended September 30, 2016. The increase in salaries and benefits expense is primarily due to an increase in the number of full-time equivalent employees and annual salary increases and an increase in expenses associated with restricted stock units issued to officers resulting from an increase in the Company’s stock price from $25.07 at December 31, 2016 to $35.62 at September 30, 2017. The increase in other non-interest expense is primarily due to increases in telecommunications expense and deposit program expense. The increase in advertising expenses is primarily due to costs associated with the Bank’s rebranding initiative, which was introduced in March 2017. The decrease in professional fees is primarily due to a decrease in consulting fees associated with the Order issued in August 2015. The decrease in occupancy expense is primarily due to a reduction in depreciation expense.increases.

Income Taxes. ~~The Company reported income~~Income tax expense ~~of $1.2 million and $872,000~~was $834,000 for the three months ended September 30, ~~2017 and 2016, respectively. This represented an~~2019, compared to $687,000 for the three months ended September 30, 2018. The effective tax rate ~~of 27% and 26%~~was 18.72% for the ~~respective periods.~~

~~The Company reported income~~three months ended September 30, 2019, compared to 16.54% for the three months ended September 30, 2018. Income tax expense ~~of $2.7 million and $2.6~~was $2.5 million for the nine months ended September 30, ~~2017 and 2016, respectively. This represented an effective tax rate of 25%~~2019, compared to $1.9 million for the nine months ended September 30, ~~2017 and 2016.~~2018. The effective tax rate was 18.16% for the nine months ended September 30, 2019, compared to 16.28% for the nine months ended September 30, 2018.

On October 26, 2017, the Bank repaid the remaining FHLB borrowings totaling $20.0 million. Prepayment penalties totaling $508,000 will be reflected in fourth quarter 2017 non-interest expense and will be partially offset by a reduction of approximately $150,000 in fourth quarter 2017 interest expense based on current interest rates.

Analysis of Financial Condition

Investment Securities. Available for sale securities were ~~$235.7~~$186.3 million at September 30, ~~2017,~~2019, compared to ~~$249.9~~$194.6 million at December 31, ~~2016.~~2018. Average investment securities available for sale for the nine months ended September 30, ~~2017~~2019 were ~~$235.9~~$180.4 million, compared to ~~$252.7~~$209.7 million for the year ended December 31, ~~2016.~~2018.

Loans. At September 30, ~~2017,~~2019, loans were ~~$747.4~~$845.6 million, compared to ~~$723.8~~$804.0 million at December 31, ~~2016.~~2018. Average loans represented ~~74%~~81% and 71% of average earning assets for the nine months ended September 30, ~~2017~~2019 and the year ended December 31, ~~2016,~~2018, respectively.

Total loans increased $2.4 million to $747.4 million at September 30, 2017, compared to $745.0 million at June 30, 2017. Loan activity during the third quarter of 2017 reflects an $8.5 million payoff of a syndication loan in which the Bank held a participation interest. The Bank did not have a participation interest in any syndicated loans at September 30, 2017. Third quarter 2017 loan activity also reflects an increase in construction lending. Unfunded construction loan commitments were $44.2 million at September 30, 2017, compared to $31.0 million at June 30, 2017 and $26.2 million at December 31, 2016.

The Company had ~~$2.6~~$4.3 million and ~~$5.7 million~~$680,000 in mortgage loans held for sale as of September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. The increase in mortgage loans held for sale is primarily due to an increase in mortgage loans held for sale activity in September 2019, compared to mortgage loans held for sale activity in December 2018.

Although the Company has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market. Real estate mortgage loans include both commercial and residential mortgage loans. At September 30, ~~2017,~~2019, the Company had ~~$105.1~~$103.9 million in residential mortgage loans, ~~$100.8~~$109.1 million in home equity loans and ~~$349.7~~$412.9 million in commercial mortgage loans, which include ~~$272.9~~$328.2 million secured by commercial property and ~~$76.8~~$84.7 million secured by residential property. Residential mortgage loans include ~~$67.3 million made to customers in the Company’s traditional banking offices and $37.8~~$31.7 million in non-traditional mortgage loans ~~originated in~~from the ~~Company’s Latino banking offices.~~former Banco division of the Bank. All residential mortgage loans are originated as fully amortizing loans, with no negative amortization.

At September 30, ~~2017,~~2019, the Company had ~~$75.5~~$95.6 million in construction and land development loans. The following table presents a breakout of these loans.

(Dollars in thousands)
	Number of Loans	Balance Outstanding	Non-accrual Balance	Number of Loans	Balance Outstanding	Non-accrual Balance
Land acquisition and development - commercial purposes	43	$6,980	$-	41	$9,269	$-
Land acquisition and development - residential purposes	204	23,029	16	171	18,770	-
1 to 4 family residential construction	117	23,668	-	120	27,708	-
Commercial construction	30	21,806	-	23	39,875	-
Total construction and land development	394	$75,483	$16	355	$95,622	$-

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

●

the Bank’s loan loss experience;

●

the amount of past due and non-performing loans;

●

specific known risks;

●

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

●

underlying estimated values of collateral securing loans;

●

current and anticipated economic conditions; and

●

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

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

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

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

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

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

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

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

Effective December 31, 2012, ~~stated income~~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. ~~These loans were made as stated income loans rather than full documentation loans because the customer may not have had complete documentation on the income supporting the loan.~~

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

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the nine months ended September 30, ~~2017 as~~2019 compared to the nine months ended September 30, ~~2016.~~2018. 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.

The allowance for loan losses at September 30, ~~2017~~2019 was ~~$6.8~~$6.6 million or ~~0.92%~~0.78% of total loans, compared to ~~$7.6~~$6.4 million or ~~1.04%~~0.80% of total loans at December 31, ~~2016.~~2018.

The following table presents the percentage of loans assigned to each risk grade at September 30, ~~2017~~2019 and December 31, ~~2016.~~2018.

	Percentage of Loans		Percentage of Loans
	By Risk Grade		By Risk Grade
Risk Grade	9/30/2017	12/31/2016	9/30/2019	12/31/2018
Risk Grade 1 (Excellent Quality)	1.16%	2.28%	1.23%	0.94%
Risk Grade 2 (High Quality)	25.61%	26.82%	25.00%	25.47%
Risk Grade 3 (Good Quality)	60.40%	54.43%	61.28%	60.84%
Risk Grade 4 (Management Attention)	8.61%	11.99%	10.32%	10.19%
Risk Grade 5 (Watch)	2.67%	3.07%	1.43%	1.72%
Risk Grade 6 (Substandard)	1.23%	1.41%	0.74%	0.84%
Risk Grade 7 (Doubtful)	0.00%		0.00%
Risk Grade 8 (Loss)	0.00%		0.00%

At September 30, ~~2017,~~2019, including non-accrual loans, there were ~~three~~two relationships exceeding $1.0 million in the Watch risk grade (which totaled ~~$5.8~~$3.1 million) ~~and one relationship~~. There were no relationships exceeding $1.0 million in the Substandard risk ~~grade (which totaled $1.0 million).~~grade.

Non-performing Assets. Non-performing assets totaled ~~$4.9~~$3.3 million at September 30, ~~2017~~2019 or ~~0.44%~~0.27% of total assets, compared to ~~$4.1~~$3.3 million or ~~0.38%~~0.31% of total assets at December 31, ~~2016.~~2018. Non-accrual loans were ~~$4.9~~$3.3 million at September 30, ~~2017~~2019 and ~~$3.8~~$3.3 million at December 31, ~~2016.~~2018. As a percentage of total loans outstanding, non-accrual loans were ~~0.66%~~0.39% at September 30, ~~2017,~~2019, compared to ~~0.53%~~0.41% at December 31, ~~2016.~~2018. Non-accrual loans include ~~$4.7~~$3.1 million in commercial and residential mortgage loans ~~$16,000~~and $146,000 in other loans at September 30, 2019, compared to $3.2 million in commercial and residential mortgage loans, $1,000 in construction and land development loans and ~~$251,000 in other loans at September 30, 2017, compared to $3.7 million in commercial and residential mortgage loans, $22,000 in construction and land development loans and $54,000~~$99,000 in other loans at December 31, ~~2016.~~2018. The Bank had no loans 90 days past due and still accruing at September 30, ~~2017~~2019 or December 31, ~~2016.~~2018. The Bank had no$26,000 in other real estate owned at September 30, ~~2017, and $283,000 in other real estate owned~~2019, compared to $27,000 at December 31, ~~2016.~~2018.

Deposits. Total deposits at September 30, ~~2017~~2019 were ~~$901.6~~$961.6 million compared to ~~$892.9~~$877.2 million at December 31, ~~2016.~~2018. Core deposits, which include ~~non-interest bearing~~ demand deposits, ~~NOW, MMDA,~~ savings accounts and non-brokered certificates of ~~deposit~~deposits of denominations less than $250,000, ~~were $879.6~~amounted to $889.8 million at September 30, ~~2017 as~~2019, compared to ~~$865.4~~$859.2 million at December 31, 2016. Certificates of deposit in amounts of $250,000 or more totaled $21.3 million at September 30, 2017, as compared to $26.8 million at December 31, 2016. At September 30, 2017, brokered deposits were $5.4 million as compared to $7.2 million at December 31, 2016. Brokered deposits outstanding as of September 30, 2017 had a weighted average rate of 0.07% with a weighted average original term of 29 months as compared to brokered deposits outstanding at December 31, 2016, which had a weighted average rate of 0.05% with a weighted average original term of 23 months.2018.

Borrowed Funds. ~~Borrowings from the~~ FHLB borrowings totaled ~~$20.0~~$70.0 million at September 30, ~~2017 and~~2019, compared to zero at December 31, ~~2016.~~2018. The ~~average balance of~~increase in FHLB borrowings ~~for~~reflects a new $70.0 million FHLB advance executed in September 2019 to take advantage of a ten-year convertible advance program available from the ~~nine months ended September 30, 2017 was $20.0 million, compared~~FHLB of Atlanta at a rate of 0.83%. The funds will be utilized to ~~$42.9 million for~~replace higher cost funding along with investing in low risk, short-term assets at yields higher than the ~~year ended December 31, 2016. The FHLB borrowings outstanding at September 30, 2017 had~~advance rate in order to increase the Bank’s net interest ~~rates ranging from 3.11% to 4.54% and all mature in 2018.~~income.

Securities sold under agreements to repurchase were ~~$53.3~~$21.9 million at September 30, ~~2017~~2019, compared to ~~$36.4~~$58.1 million at December 31, ~~2016.~~2018. The decrease in securities sold under agreements to repurchase is primarily due to approximately $21.0 million transferred from securities sold under agreements to repurchase to Money Market Deposit aAccounts (MMDA) during the third quarter of 2019.

Junior Subordinated Debentures (related to Trust Preferred Securities). In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company, which pay a floating rate equal to three-month LIBOR plus 163 basis points. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes. The debentures represent the sole asset of PEBK Trust II. PEBK Trust II is not included in the Consolidated Financial Statements.

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

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

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

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

The Company’s rate sensitive assets are those earning interest at variable rates and those with contractual maturities within one year. Rate sensitive assets therefore include both loans and available for sale securities. Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds. Average rate sensitive assets for the nine months ended September 30, ~~2017~~2019 totaled ~~$997.1 million,~~$1.0 billion, exceeding average rate sensitive liabilities of ~~$703.3~~$656.7 million by ~~$293.8~~$371.9 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, ~~2017.~~2019.

Included in the rate sensitive assets are ~~$283.1~~$251.3 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the Federal Open Market Committee (“FOMC”). The Company utilizes interest rate floors on certain variable rate loans to protect against further downward movements in the prime rate. At September 30, ~~2017,~~2019, the Company had ~~$171.9~~$145.9 million in loans with interest rate floors. The floors were in effect on ~~$35.6~~$9.7 million of these loans pursuant to the terms of the promissory notes on these loans. The weighted average rate on these loans is ~~0.69%~~0.56% higher than the indexed rate on the promissory notes without interest rate floors.

Liquidity. The objectives of the Company’s liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As of September 30, ~~2017,~~2019, such unfunded commitments to extend credit were ~~$218.3~~$278.2 million, while commitments in the form of standby letters of credit totaled ~~$3.3~~$2.8 million.

The Company uses several sources to meet its liquidity requirements. The primary source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposit of denominations less than $250,000. The Company considers these to be a stable portion of the Company’s liability mix and the result of on-going consumer and commercial banking relationships. As of September 30, ~~2017,~~2019, the Company’s core deposits totaled ~~$879.6~~$928.3 million, or ~~98%~~96.54% of total deposits.

The other sources of funding for the Company are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreements to repurchase and FHLB borrowings. The Bank is also able to borrow from the Federal Reserve Bank (“FRB”) on a short-term basis. The Company’s policies include the ability to access wholesale funding of up to 40% of total assets. The Company’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to the State of North Carolina. The Company’s ratio of wholesale funding to total assets was ~~2.27%~~7.51% as of September 30, ~~2017.~~2019.

The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total ~~assets, with an outstanding balance of $20.0~~assets. FHLB borrowings totaled $70.0 million at September 30, ~~2017 and~~2019, compared to zero at December 31, ~~2016.~~2018. At September 30, ~~2017,~~2019, the carrying value of loans pledged as collateral to the FHLB totaled ~~$128.9~~$145.9 million compared to ~~$128.3~~$140.0 million at December 31, ~~2016.~~2018. The remaining availability under the line of credit with the FHLB was ~~$60.7~~$21.7 million at September 30, ~~2017~~2019 compared to ~~$66.8~~$84.9 million at December 31, ~~2016.~~2018. The Bank had no borrowings from the FRB at September 30, ~~2017~~2019 or December 31, ~~2016.~~2018. 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, ~~2017,~~2019, the carrying value of loans pledged as collateral to the FRB totaled ~~$394.5~~$451.9 million compared to ~~$374.5~~$442.6 million at December 31, ~~2016.~~2018.

The Bank also had the ability to borrow up to ~~$79.5~~$82.5 million for the purchase of overnight federal funds from ~~five~~six correspondent financial institutions as of September 30, ~~2017.~~2019.

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 ~~26.46%~~25.91% at September 30, ~~2017~~2019 and ~~24.78%~~16.09% at December 31, ~~2016.~~2018. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at September 30, ~~2017~~2019 and December 31, ~~2016.~~2018. The increase in the Bank's liquidity ratio is primarily due to a $86.2 million increase in cash and cash equivalents from December 31, 2018 to September 30, 2019 primarily due to a $84.4 million increase in total deposits and a $70.0 million increase in FHLB borrowings, which were partially offset by a $41.6 million increase in loans and a $36.2 million decrease in securities sold under agreements to repurchase.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations and other commitments as of September 30, ~~2017~~2019 and December 31, ~~2016~~2018 are summarized in the table below. The Company’s contractual obligations include ~~the repayment of principal and interest related to FHLB advances and~~ 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, 2017	December 31, 2016	September 30, 2019	December 31, 2018
Contractual Cash Obligations
Long-term borrowings	$20,000	20,000	$70,000	-
Junior subordinated debentures	20,619		$20,619	20,619
Corporate Center renovation	74	2,170
Operating lease obligations	4,290	4,648	4,216	4,318
Total	$44,983	47,437	$94,835	24,937
Other Commitments
Commitments to extend credit	$218,267	195,528	$278,158	268,708
Standby letters of credit and financial guarantees written	3,292	3,728	2,796	3,651
Commitments to purchase AFS securities			4,015	-
Income tax credits	2,397	2,864	517	755
Total	$223,956	202,120	$285,486	273,114

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

Capital Resources. Shareholders’ equity was ~~$116.2~~$132.7 million, or ~~10.4%~~10.85% of total assets, as of September 30, ~~2017,~~2019, compared to ~~$107.4~~$123.6 million, or ~~9.9%~~11.31% of total assets, as of December 31, 2016. The increase in shareholders’ equity is primarily due to an increase in retained earnings due to net income and an increase in accumulated other comprehensive income resulting from an increase in unrealized gain on investment securities.2018.

Annualized return on average equity for the nine months ended September 30, ~~2017~~2019 was ~~9.59%~~11.24%, compared to ~~9.29%~~10.97% for the nine months ended September 30, ~~2016.~~2018. Total cash dividends paid on common stock were ~~$2.0~~$3.1 million and ~~$1.6~~$2.4 million for the nine months ended September 30, ~~2017~~2019 and ~~2016,~~2018, respectively.

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

In ~~2016,~~February of 2019, the Company’s Board of Directors authorized a stock repurchase program, ~~pursuant to which~~whereby up to $2$5 million ~~was~~will be allocated to repurchase the Company’s common stock. Any purchases under the Company’s stock repurchase program ~~were~~may be made periodically as permitted by securities laws and other legal requirements in the open market or in ~~privately negotiated~~privately-negotiated transactions. The timing and amount of any repurchase of shares ~~were~~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 ~~$2.0~~$2.5 million, or ~~92,738~~90,354 shares of its common stock, under this stock repurchase program as of September 30, ~~2017.~~2019.

In 2013, the ~~Federal Reserve Board~~FRB approved its final rule on the Basel III capital standards, which implement changes to the regulatory capital framework for banking organizations. The Basel III capital standards, which became effective January 1, 2015, include new risk-based capital and leverage ratios, which ~~are being~~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 ~~at 0.625%~~ and ~~is being~~was phased in through 2019 (increasing by 0.625% on January 1, 2016 and each subsequent January 1, until it ~~reaches~~reached 2.5% on January 1, 2019). This ~~will result~~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 at September 30, ~~2017~~2019 and December 31, ~~2016~~2018 includes $20.0 million in trust preferred securities. The Company’s Tier 1 capital ratio was ~~15.44%~~15.70% and ~~15.20%~~15.46% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. Total risk-based capital is defined as Tier 1 capital plus supplementary capital. Supplementary capital, or Tier 2 capital, consists of the Company’s allowance for loan losses, not exceeding 1.25% of the Company’s risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets. The Company’s total risk-based capital ratio was ~~16.24%~~16.40% and ~~16.12%~~16.15% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. The Company’s common equity Tier 1 capital consists of common stock and retained earnings. The Company’s common equity Tier 1 capital ratio was ~~13.09%~~13.58% and ~~12.75%~~13.29% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, 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 ~~11.93%~~13.07% and ~~11.19%~~13.05% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively.

The Bank’s Tier 1 risk-based capital ratio was ~~15.11%~~16.00% and ~~14.85%~~15.21% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. The total risk-based capital ratio for the Bank was ~~15.91%~~16.00% and ~~15.78%~~15.91% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. The Bank’s common equity Tier 1 capital ratio was ~~15.11%~~15.30% and ~~14.85%~~15.21% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. The Bank’s Tier 1 leverage capital ratio was ~~11.59%~~12.66% and ~~10.88%~~12.76% at September 30, ~~2017~~2019 and December 31, ~~2016,~~2018, 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, ~~2017.~~2019.

~~Item~~Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the Quantitative and Qualitative Disclosures About Market Risk from those previously disclosed in Part 7A. of Part II of the Company’s Form 10-K, filed with the ~~Securities and Exchange Commission~~SEC on March ~~16, 2017.~~14, 2019.

~~Item~~Item 4. Controls and Procedures

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

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

PART II. OTHER INFORMATION

~~Item~~Item 1. Legal Proceedings

~~In the opinion of management, the Company is not involved in any material pending legal proceedings other than routine proceedings occurring in the ordinary course of business.~~

~~Item 1A. Risk Factors~~

~~As discussed in Note (7) to the Consolidated Financial Statements in Item 1,~~On October 19, 2018, the Bank received ~~notice that~~a draft audit report from the ~~Order was terminated effective August 30, 2017. As a result~~North Carolina Department of Revenue (“NCDOR”) setting forth certain proposed adjustments to the North Carolina income tax returns for the Bank for the tax years January 1, 2014 through December 31, 2016. The NCDOR is seeking to disallow certain tax credits taken by the Bank in tax years January 1, 2014 through December 31, 2016 from an investment made by the Bank. The total proposed adjustments sought by the NCDOR as of the ~~termination~~date of the ~~Order,~~draft audit report (including additional tax, penalties and interest up to the ~~Risk Factors regarding~~date of the ~~Order~~draft audit report) was approximately $1.4 million. The Bank disagrees with the NCDOR’s proposed adjustments and the disallowance of certain tax credits, and intends to challenge 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 ~~were previously disclosed in~~unconditionally guarantees the amount of its investment plus associated penalties and interest which management believes would limit the Bank’s exposure to approximately $125,000. The Tax Credit Guaranty Agreement from State Tax Credit Exchange, LLC dated September 10, 2014 was attached to the Company’s September 30, 2018 Form ~~10-K in response to Item 1A. of Part I to Form 10-K, filed with the Securities and Exchange Commission on March 16, 2017 are no longer applicable.~~10-Q as Exhibit 99.

~~Except as set forth above, there have been no material changes from the~~Item 1A. Risk Factors ~~from those previously disclosed in the Company’s Form 10-K in response to Item 1A. of Part I to Form 10-K, filed with the Securities and Exchange Commission on March 16, 2017.~~

Not applicable.

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

ISSUER PURCHASES OF EQUITY SECURITIES

Period

Total Number of Shares Purchased

Average Price Paid per Share

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (2)

July 1 - 31, 2017
  775
$37.55
  -
$16,180





August 1 - 31, 2017
  -
  -
  -
$16,180





September 1 - 30, 2017
  197
  30.50
  -
$16,180





Total
  972(1)
$36.52
  -

ISSUER PURCHASES OF EQUITY SECURITIES

Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (3)

July 1 - 31, 2019	958	$27.50	-	$3,087,071

August 1 - 31, 2019	458	28.16	20,840	$2,509,871

September 1 - 30, 2019	-	-	-	$2,509,871

Total	1,416(1)	$27.66	20,840

(1) The Company purchased ~~972~~1,416 shares on the open market in the three months ended September 30, ~~2017~~2019 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.

(2) Reflects shares purchased under the Company's stock repurchase program.

(3) Reflects dollar value of shares that may yet be purchased under the ~~Stock Repurchase Plan authorized by the~~ Company's ~~Board of Directors~~stock repurchase program , which was funded in ~~2016.~~

February 2019.

~~Item~~Item 3. Defaults Upon Senior Securities

Not applicable

~~Item~~

Item 5. Other Information

Not applicable

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

Exhibit (10)(xviii)	First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Lance A. Sellers dated February 16, 2018, incorporated by reference to Exhibit (10)(xx) to the Form 10-Q filed with the Securities and Exchange Commission on March 18, 2018

Exhibit (10)(xix)	First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated February 16, 2018, incorporated by reference to Exhibit (10)(xxi) to the Form 10-Q filed with the Securities and Exchange Commission on March 18, 2018

Exhibit (10)(xx)	First Amendment to Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and William D. Cable, Sr. dated February 16, 2018, incorporated by reference to Exhibit (10)(xxii) to the Form 10-Q filed with the Securities and Exchange Commission on March 18, 2018

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

Exhibit (31)(a)	Certification of principal executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit (31)(b)	Certification of principal financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit (32)	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit (101)	The following materials from the Company’s 10-Q Report for the quarterly period ended September 30, ~~2017,~~2019, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Earnings, (iii) the Condensed Consolidated Statements of Comprehensive Income ~~(iii)~~(iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, ~~(iv)~~(v) the Condensed Consolidated Statements of Cash Flows, and ~~(v)~~(vi) the Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text.*

	*Furnished, not filed.

~~SIGNATURES~~SIGNATURES

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

Peoples Bancorp of North Carolina, Inc.

November ~~7, 2017~~6, 2019		/s/ Lance A. Sellers
Date		Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer)

November ~~7, 2017~~6, 2019		/s/ A. Joseph Lampron, Jr.
Date		A. Joseph Lampron, Jr. Executive Vice President and Chief Financial Officer (Principal Financial and Principal Accounting Officer)

4648

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Balance Sheets

September 30, 2017 and December 31, 2016

(Dollars in thousands)
	September 30,	December 31,
Assets	2017	2016
	(Unaudited)	(Audited)

Cash and due from banks, including reserve requirements	$55,718	53,613
of $9,337 at 9/30/17 and $6,075 at 12/31/16
Interest-bearing deposits	37,538	16,481
Cash and cash equivalents	93,256	70,094

Investment securities available for sale	235,736	249,946
Other investments	2,680	2,635
Total securities	238,416	252,581

Mortgage loans held for sale	2,623	5,709

Loans	747,437	723,811
Less allowance for loan losses	(6,844)	(7,550)
Net loans	740,593	716,261

Premises and equipment, net	19,697	16,452
Cash surrender value of life insurance	15,452	14,952
Other real estate	-	283
Accrued interest receivable and other assets	11,516	11,659
Total assets	$1,121,553	1,087,991

Liabilities and Shareholders' Equity

Deposits:
Noninterest-bearing demand	$287,794	271,851
NOW, MMDA & savings	486,051	477,054
Time, $250,000 or more	21,318	26,771
Other time	106,476	117,242
Total deposits	901,639	892,918

Securities sold under agreements to repurchase	53,307	36,434
Short-term Federal Reserve Bank borrowings	-	-
FHLB borrowings	20,000	20,000
Junior subordinated debentures	20,619	20,619
Accrued interest payable and other liabilities	9,835	10,592
Total liabilities	1,005,400	980,563

Commitments

Shareholders' equity:
Series A preferred stock, $1,000 stated value; authorized
5,000,000 shares; no shares issued and outstanding	-	-
Common stock, no par value; authorized
20,000,000 shares; issued and outstanding 5,450,412 shares
at September 30, 2017 and 5,417,800 shares at December 31, 2016	45,102	44,187
Retained earnings	66,539	60,254
Accumulated other comprehensive income	4,512	2,987
Total shareholders' equity	116,153	107,428
Total liabilities and shareholders' equity	$1,121,553	1,087,991

See accompanying Notes to Consolidated Financial Statements.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Changes in Shareholders' Equity

Nine Months Ended September 30, 2017 and 2016

(Dollars in thousands)

				Accumulated
				Other
	Common Stock		Retained	Comprehensive
	Shares	Amount	Earnings	Income	Total
	(Unaudited)	(Unaudited)	(Unaudited)	(Unaudited)	(Unaudited)

Balance, December 31, 2016	5,417,800	$44,187	60,254	2,987	107,428

Common stock repurchase	-	-	-	-	-
Cash dividends declared on
common stock	-	-	(1,973)	-	(1,973)
Restricted stock units exercised	32,612	915	-	-	915
Net earnings	-	-	8,258	-	8,258
Change in accumulated other
comprehensive income, net of tax	-	-	-	1,525	1,525
Balance, September 30, 2017	5,450,412	$45,102	66,539	4,512	116,153

Balance, December 31, 2015	5,510,538	$46,171	53,183	5,510	104,864

Common stock repurchase	(92,738)	(1,983)	-	-	(1,983)
Cash dividends declared on
common stock	-	-	(1,556)	-	(1,556)
Net earnings	-	-	7,875	-	7,875
Change in accumulated other
comprehensive income, net of tax	-	-	-	1,448	1,448
Balance, September 30, 2016	5,417,800	$44,188	59,502	6,958	110,648

See accompanying Notes to Consolidated Financial Statements.

(Dollars in thousands)
	Fair Value September 30, 2017	Fair Value December 31, 2016	Valuation Technique	Significant Unobservable Inputs	General Range of Significant Unobservable Input Values
Mortgage loans held for sale	$2,623	5,709	Rate lock commitment	N/A	N/A
Impaired loans	$26,453	25,772	Appraised value and discounted cash flows	Discounts to reflect current market conditions and ultimate collectability	0 - 25%
Other real estate	$-	283	Appraised value	Discounts to reflect current market conditions and estimated costs to sell	0 - 25%

ISSUER PURCHASES OF EQUITY SECURITIES

Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (2)

July 1 - 31, 2017	775	$37.55	-	$16,180

August 1 - 31, 2017	-	-	-	$16,180

September 1 - 30, 2017	197	30.50	-	$16,180

Total	972(1)	$36.52	-