PEOPLES BANCORP OF NORTH CAROLINA INC quarterly report, Q3 FY2022

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Peoples Bancorp of North Carolina, Inc. — Q3 2022 Form 10-Q

Reporting period: Three and nine months ended September 30, 2022. Financial amounts below are in U.S. dollars; unless stated otherwise, dollar figures are in millions. Comparisons are with the corresponding 2021 period or December 31, 2021, as applicable.

Business context and financial performance

The company is a North Carolina bank holding company whose business is primarily deposit-taking and lending, with operations concentrated in North Carolina. Its earnings are driven mainly by net interest income, alongside fees and other noninterest income.

  • Q3 earnings: Net earnings were $5.31 million, versus $3.39 million; diluted EPS was $0.93, versus $0.59. Net interest income was $13.79 million, up from $10.56 million. Noninterest income was $6.79 million, versus $6.04 million; noninterest expense was $13.46 million, versus $12.57 million. Provision for loan losses was $0.41 million, compared with a $0.18 million recovery.
  • First nine months: Net earnings were $11.98 million, versus $12.13 million; diluted EPS was $2.11, versus $2.10. Net interest income was $35.81 million, versus $33.34 million. Noninterest income rose to $21.17 million from $17.95 million, while noninterest expense increased to $41.04 million from $36.97 million. Provision for loan losses was $0.89 million, compared with a $0.86 million recovery.
  • Margins and returns: Q3 net yield on interest-earning assets was 3.39%, versus 2.76% (tax-equivalent net interest margin is not clearly stated). For the nine-month period, that yield was 3.02%, versus 3.08%. Annualized return on average assets and equity was 1.25% and 18.42% in Q3, and 0.96% and 12.53% year to date.

Financial position, cash flow and liquidity

  • Balance sheet at September 30: Total assets were $1.676 billion, compared with $1.624 billion at year-end 2021. Loans were $1.005 billion, up from $884.9 million; net loans were $994.9 million. Available-for-sale securities were $444.4 million, up from $406.5 million.
  • Funding and debt: Deposits were $1.501 billion, up from $1.413 billion. Repurchase-agreement balances were $38.0 million and junior subordinated debentures were $15.5 million. There were no FHLB borrowings outstanding. Cash and cash equivalents were $155.5 million, down from $277.5 million.
  • Capital: Shareholders’ equity was $103.9 million, or 6.78% of assets, versus $142.4 million, or 8.77%, at year-end. The decrease was primarily attributed to unrealized securities losses. The company’s total risk-based, common equity Tier 1 and Tier 1 leverage ratios were 14.20%, 12.17% and 9.58%, respectively. The Bank was reported as well capitalized.
  • Nine-month cash flow: Operating activities provided $17.3 million; investing activities used $224.1 million, principally reflecting securities purchases and loan growth; financing activities provided $84.7 million, including deposit growth. Cash and cash equivalents decreased by $122.0 million.
  • Liquidity: The Bank’s liquidity ratio was 34.62%, above its 10% policy minimum. Reported available borrowing capacity included $88.2 million under its FHLB line and $427.2 million under its FRB line; it also had up to $110.5 million of overnight federal funds lines.

Material changes and management commentary

  • Q3 earnings improved as higher net interest income and noninterest income more than offset higher credit provision and operating expense. Year-to-date earnings were slightly lower, as increased noninterest expense and provision offset revenue growth.
  • Q3 interest income benefited from loan growth, higher Federal Reserve rates and increased investment securities income. Year-to-date loan interest income declined, primarily due to lower PPP loan fee income; PPP fee income was $0.95 million year to date versus $3.0 million in 2021.
  • Appraisal management fees and related expense increased with appraisal volume. Service-charge income also rose following changes implemented in March 2022. Mortgage banking income declined as loan volume fell and more mortgages were retained in the Bank’s portfolio.
  • Total loans grew despite PPP balances declining to $0.10 million from $18.0 million at year-end. Commercial real estate and other real estate lending are significant portfolio exposures.
  • Management cited continued supply-chain disruption and rising inflation; it reported that the Federal Reserve had raised the target federal funds rate by 300 basis points in 2022, to 3.00%–3.25% as of October 31. Management’s stated approach includes maintaining liquidity, managing interest-rate exposure and monitoring credit quality. It described local-market growth as a business focus but provided no specific earnings or growth guidance.

Risks, contingencies and unusual items

  • Market-value losses: Available-for-sale securities had $59.8 million of gross unrealized losses at September 30, compared with $5.5 million at year-end 2021. Management attributed the losses to changing interest rates and considered them temporary. After-tax other comprehensive loss for the first nine months was $46.0 million; accumulated other comprehensive loss reached $45.9 million.
  • Credit quality: The allowance for loan losses was $10.0 million, compared with $9.4 million at year-end. Nonperforming assets were $3.7 million, or 0.22% of assets, versus $3.2 million, or 0.20%. Nonaccrual loans were 0.37% of loans at both dates. The filing notes that real estate collateral values, borrower conditions and economic changes can affect losses.
  • Off-balance-sheet commitments: Commitments to extend credit were $373.9 million and standby letters of credit were $5.5 million. Actual funding needs may be lower because not all commitments will be drawn.
  • CECL adoption: The company expected to adopt the current expected credit losses standard on January 1, 2023 and anticipated a one-time retained-earnings adjustment to increase the loan-loss allowance. The amount remained under evaluation; management said capital adequacy and business strategies were not expected to be materially affected.
  • Tax matter: North Carolina tax authorities proposed approximately $1.4 million of adjustments relating to 2014–2016 tax credits. The Bank paid $1.2 million in taxes and interest while contesting the matter; management believes a guaranty limits remaining exposure to approximately $125,000.
  • Management reported no material subsequent events, no material changes to previously disclosed risk factors, and effective disclosure controls. Interest-rate changes, local economic conditions, competition, credit quality and regulatory or accounting changes remain identified risks.

Key investor verification points

  • Review the size, duration and sensitivity of securities unrealized losses, including their effect on equity and regulatory capital.
  • Assess loan growth and portfolio composition, particularly commercial real estate, nontraditional residential mortgages, past-due and nonaccrual balances, and allowance adequacy.
  • Track deposit pricing and funding costs as rates change, alongside net interest yield and the Bank’s liquidity and borrowing capacity.
  • Confirm the final CECL allowance and retained-earnings impact at adoption, and the outcome and remaining exposure of the disputed tax-credit assessment.
  • Monitor expense growth, appraisal-related revenue and costs, mortgage banking trends, and whether earnings growth is sustained beyond Q3.