PEOPLES BANCORP OF NORTH CAROLINA INC quarterly report, Q2 FY2020

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Peoples Bancorp of North Carolina, Inc. — Q2 2020 Form 10-Q

Reporting period: Three and six months ended June 30, 2020. The company is a North Carolina community bank holding company. Unless otherwise noted, dollar amounts below are in millions.

Financial performance and condition

  • Q2 earnings: Net earnings were $2.56 million, or $0.44 per diluted share, versus $3.81 million, or $0.64 per share, in Q2 2019. First-half earnings were $4.93 million, or $0.84 per diluted share, compared with $7.48 million, or $1.25, a year earlier.
  • Interest income and margin: Q2 net interest income declined to $10.73 million from $11.59 million. The tax-equivalent net yield on interest-earning assets was 3.48%, down from 4.61%; net interest spread was 3.30%, down from 4.43%. First-half net interest income was $21.94 million versus $23.02 million, and net yield was 3.79% versus 4.63%.
  • Other income and expenses: Q2 noninterest income rose to $5.24 million from $4.39 million, while noninterest expense increased to $11.45 million from $11.24 million. First-half figures were $9.83 million and $22.90 million, respectively, compared with $8.51 million and $22.16 million.
  • Credit costs: Q2 provision for loan losses was $1.42 million versus $0.08 million; first-half provision was $2.94 million versus $0.26 million. The allowance for loan losses was $9.43 million, or 0.98% of loans, at June 30, compared with $6.68 million, or 0.79%, at year-end 2019.
  • Balance sheet growth: Total assets were $1.426 billion at June 30, up from $1.155 billion at December 31, 2019. Loans were $966.5 million versus $849.9 million; deposits were $1.154 billion versus $966.5 million.
  • Liquidity and funding: Cash and cash equivalents were $189.6 million, compared with $52.4 million at year-end. The bank’s liquidity ratio was 29.19%, up from 18.20%, against a 10% policy minimum. Core deposits were $1.1 billion, or 97.88% of deposits. The company reported $70 million of FHLB borrowings, versus none at year-end, and $31.7 million in repurchase-agreement funding.
  • Cash flow: For the first half, operating activities provided $6.0 million, investing activities used $128.3 million, and financing activities provided $259.6 million. Net cash increased $137.3 million. Deposit growth of $187.8 million and FHLB borrowing proceeds of $70 million were significant funding sources.
  • Capital and returns: Shareholders’ equity was $137.0 million, or 9.61% of assets, versus $134.1 million, or 11.61%, at year-end. The company’s Tier 1 leverage ratio was 10.69% and total risk-based capital ratio was 15.05%; the bank was described as well capitalized. First-half annualized return on average assets was 0.76% for Q2 and 7.30% for the six-month period; Q2 annualized return on average equity was 7.64%. The company declared dividends of $0.15 per share for Q2 and $0.45 for the first half.

Material changes versus comparable periods

  • Earnings fell as lower rates reduced loan yields and net interest income, while credit-loss provisions rose sharply. Management attributed the provision increase to COVID-19-related economic uncertainty, portfolio growth, and reserves on modified loans.
  • Q2 average loans increased to $947.3 million from $832.2 million a year earlier, but average loan yield fell to 4.32% from 5.25%. The company cited the 1.50 percentage-point reduction in Prime Rate in March 2020.
  • Noninterest income benefited from higher appraisal-management and mortgage-banking income and a $457,000 securities-sale gain. Service charges and fees declined, partly because of pandemic-related customer concessions.
  • Loans grew partly through the Paycheck Protection Program (PPP). The allowance, deposits, cash, and FHLB funding also increased substantially from year-end.

Outlook, risks and unusual items

  • COVID-19: Management said pandemic effects were significant and highly uncertain, with possible adverse impacts on borrowers, loan collections, collateral values, earnings, and capital. It particularly identified hotel, restaurant, retail, and related commercial real estate exposures. No quantified earnings or growth guidance was provided.
  • PPP and loan modifications: The bank originated approximately $98.8 million of PPP loans by June 30 and reported $4.0 million in SBA fees received. It had $120.6 million of pandemic-related payment modifications, primarily interest-only arrangements for three to six months; associated reserves were $1.6 million. PPP loans were excluded from the allowance because they are SBA-guaranteed. The filing warns of possible PPP litigation and the risk that the SBA could deny or reduce a guaranty if it finds origination, funding, or servicing deficiencies.
  • Asset quality and concentration: Nonaccrual loans were $4.0 million, or 0.41% of loans, versus $3.6 million, or 0.42%, at year-end. The portfolio has significant real estate exposure; commercial real estate represented about 31% of loans, and construction and land development about 11%. Management cautioned that future economic deterioration could require additional reserves.
  • Funding and rate exposure: The $70 million FHLB advance was executed in February at 0.58% under a ten-year convertible advance program. Management noted that lower rates pressured asset yields; $245.5 million of variable-rate loans were indexed to Prime, and $147.5 million had rate floors. No interest-rate derivatives were outstanding at quarter-end.
  • Contingency: The North Carolina Department of Revenue proposed approximately $1.4 million of tax adjustments for 2014–2016. The bank disputes the assessment, paid $1.2 million in taxes and interest, and says a guaranty agreement it purchased is expected to limit exposure to approximately $125,000.
  • Share repurchases: The company reported completing approximately $3 million of repurchases under a January 2020 program by June 30. Separately, 2,592 shares purchased during Q2 were for the deferred compensation plan and funded by participant contributions.
  • Other: Management reported no material subsequent events and no material changes to internal control over financial reporting. The company was still evaluating the impact of the expected credit-loss standard (CECL), with adoption stated as January 1, 2023.

Most important facts for investors to verify

  • Whether loan performance, borrower payment modifications, and the $9.43 million allowance adequately reflect continuing pandemic-related risks.
  • How much of the $98.8 million PPP portfolio is ultimately forgiven and whether SBA guaranties and reported fees are realized without disputes or deficiencies.
  • Whether lower interest rates, variable-rate loan repricing, deposit costs, and the FHLB advance continue to compress net interest income and margins.
  • Whether deposit growth and the elevated liquidity position persist, and how loan growth is funded without further pressure on capital.
  • The resolution and ultimate financial exposure from the disputed state tax assessment, and the timing and scope of any remaining repurchases under the program.