form10qformar312015.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
     
 
FORM 10-Q
 
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:     March 31, 2015
 
OR
 
[   ] 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 to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes
  X
No
   
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
  X
No
   
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large Accelerate Filer
   
Accelerated Filer
   
Non-Accelerated Filer
   
 
Smaller Reporting Company
X
 
 
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
  X  
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
5,612,588 shares of common stock, outstanding at April 30, 2015.
 
 
 
 

 
 
 
INDEX
         
PART I.
FINANCIAL INFORMATION
PAGE(S)
 
         
Item 1.
 
Financial Statements
   
         
   
Consolidated Balance Sheets at March 31, 2015 (Unaudited) and
   
   
December 31, 2014 (Audited)
3
 
         
   
Consolidated Statements of Earnings for the three months ended March
   
   
31, 2015 and 2014 (Unaudited)
4
 
         
   
Consolidated Statements of Comprehensive Income for the three months
   
   
ended March 31, 2015 and 2014 (Unaudited)
5
 
         
   
Consolidated Statements of Cash Flows for the three months ended March
   
   
31, 2015 and 2014 (Unaudited)
6-7
 
         
   
Notes to Consolidated Financial Statements (Unaudited)
8-23
 
         
Item 2.
 
Management's Discussion and Analysis of Financial Condition
   
   
and Results of Operations
24-36
 
         
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
37
 
         
Item 4T.
 
Controls and Procedures
38
 
         
PART II.
OTHER INFORMATION
   
         
Item 1.
 
Legal Proceedings
39
 
Item 1A.
 
Risk Factors
39
 
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
39
 
Item 3.
 
Defaults upon Senior Securities
39
 
Item 5.
 
Other Information
39
 
Item 6.
 
Exhibits
39-42
 
Signatures
 
43
 
Certifications
 
44-46
 
 
 
 
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 Peoples Bank, (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 Peoples Bancorp of North Carolina, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2014.

 
2

 
 
 
PART I.
FINANCIAL INFORMATION
     
Item 1.
Financial Statements
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
           
Consolidated Balance Sheets
           
March 31, 2015 and December 31, 2014
           
(Dollars in thousands)
 
March 31,
 
December 31,
Assets
2015
 
2014
 
(Unaudited)
 
(Audited)
           
Cash and due from banks, including reserve requirements
$ 47,730       51,213  
of $11,391 and $12,569
             
Interest-bearing deposits
  19,783       17,885  
Cash and cash equivalents
  67,513       69,098  
               
Investment securities available for sale
  282,575       281,099  
Other investments
  3,912       4,031  
Total securities
  286,487       285,130  
               
Mortgage loans held for sale
  806       1,375  
               
Loans
  660,477       651,891  
Less allowance for loan losses
  (10,843   )   (11,082 )
Net loans
  649,634       640,809  
               
Premises and equipment, net
  16,745       17,000  
Cash surrender value of life insurance
  14,229       14,125  
Other real estate
  3,424       2,016  
Accrued interest receivable and other assets
  10,617       10,941  
Total assets
$ 1,049,455       1,040,494  
               
Liabilities and Shareholders' Equity
             
               
Deposits:
             
Noninterest-bearing demand
$ 217,603       210,758  
NOW, MMDA & savings
  432,541       407,504  
Time, $250,000 or more
  36,237       47,872  
Other time
  143,579       148,566  
Total deposits
  829,960       814,700  
               
Securities sold under agreements to repurchase
  38,702       48,430  
FHLB borrowings
  50,000       50,000  
Junior subordinated debentures
  20,619       20,619  
Accrued interest payable and other liabilities
  8,660       8,080  
Total liabilities
  947,941       941,829  
               
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 5,612,588
             
shares at March 31, 2015 and December 31, 2014
  48,088       48,088  
Retained earnings
  47,110       45,124  
Accumulated other comprehensive income
  6,316       5,453  
Total shareholders' equity
  101,514       98,665  
               
Total liabilities and shareholders' equity
$ 1,049,455       1,040,494  
               
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
3

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
           
Consolidated Statements of Earnings
           
Three Months Ended March 31, 2015 and 2014
           
(Dollars in thousands, except per share amounts)
           
 
2015
 
2014
 
(Unaudited)
 
(Unaudited)
           
Interest income:
         
Interest and fees on loans
$ 7,593       7,401  
Interest on due from banks
  10       12  
Interest on investment securities:
             
U.S. Government sponsored enterprises
  713       847  
State and political subdivisions
  1,163       1,177  
Other
  88       108  
Total interest income
  9,567       9,545  
               
Interest expense:
             
NOW, MMDA & savings deposits
  111       126  
Time deposits
  247       334  
FHLB borrowings
  418       545  
Junior subordinated debentures
  97       96  
Other
  11       10  
Total interest expense
  884       1,111  
               
Net interest income
  8,683       8,434  
               
Provision for (reduction of provision for) loan losses
  173       (349 )
               
Net interest income after provision for loan losses
  8,510       8,783  
               
Non-interest income:
             
Service charges
  1,134       1,129  
Other service charges and fees
  355       419  
Gain on sale of securities
  -         26  
Mortgage banking income
  239       104  
Insurance and brokerage commissions
  161       198  
Gain/(loss) on sale and write-down of
             
other real estate
  87       (162 )
Miscellaneous
  1,269       1,127  
Total non-interest income
  3,245       2,841  
               
Non-interest expense:
             
Salaries and employee benefits
  4,801       4,276  
Occupancy
  1,483       1,521  
Other
  2,464       2,326  
Total non-interest expense
  8,748       8,123  
               
Earnings before income taxes
  3,007       3,501  
               
Income tax expense
  679       923  
               
Net earnings
  2,328       2,578  
               
Basic and diluted net earnings per share
$ 0.41       0.46  
Cash dividends declared per share
$ 0.06       0.04  
               
               
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
4

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
           
Consolidated Statements of Comprehensive Income
           
Three Months Ended March 31, 2015 and 2014
           
(Dollars in thousands)
           
 
2015
 
2014
 
(Unaudited)
 
(Unaudited)
           
Net earnings
$ 2,328     2,578  
             
Other comprehensive income:
           
Unrealized holding gains on securities
           
available for sale
  1,413     3,860  
Reclassification adjustment for gains on
           
securities available for sale
           
included in net earnings
  -       (26 )
             
Total other comprehensive income,
           
before income taxes
  1,413     3,834  
             
Income tax expense related to other
           
comprehensive income:
           
             
Unrealized holding gains on securities
           
available for sale
  550     1,503  
Reclassification adjustment for gains on sales
           
of securities available for sale
           
included in net earnings
  -       (10 )
             
Total income tax expense related to
           
other comprehensive income
  550     1,493  
             
Total other comprehensive income,
           
net of tax
  863     2,341  
             
Total comprehensive income
$ 3,191     4,919  
             
See accompanying Notes to Consolidated Financial Statements.
           
 
 
 
5

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Statements of Cash Flows
         
Three Months Ended March 31, 2015 and 2014
         
(Dollars in thousands)
         
 
2015
 
2014
 
(Unaudited)
 
(Unaudited)
         
Cash flows from operating activities:
       
Net earnings
$ 2,328   2,578  
Adjustments to reconcile net earnings to
         
net cash provided (used) by operating activities:
         
Depreciation, amortization and accretion
  1,471   1,712  
Provision for (reduction of provision for) loan losses
  173   (349 )
Gain on sale of investment securities
  -     (26 )
(Gain)/loss on sale of other real estate
  (87 ) 10  
Write-down of other real estate
  -     152  
Restricted stock expense
  117   82  
Change in:
         
Mortgage loans held for sale
  569   (138 )
Cash surrender value of life insurance
  (104 ) (103 )
Other assets
  (344 ) (1,428 )
Other liabilities
  580   (9,709 )
           
Net cash provided (used) by operating activities
  4,703   (7,219 )
           
Cash flows from investing activities:
         
Purchases of investment securities available for sale
  (7,359 ) (10,566 )
Proceeds from calls, maturities and paydowns of investment securities
         
available for sale
  6,377   9,738  
Proceeds from sales of investment securities available for sale
 
-   
  677  
Purchases of FHLB stock
  (6 ) -    
FHLB stock redemption
  125   284  
Net change in loans
  (11,601 ) 500  
Purchases of premises and equipment
  (297 ) (627 )
Proceeds from sales of other real estate and repossessions
  1,283   482  
           
Net cash (used) provided by investing activities
  (11,478 ) 488  
           
Cash flows from financing activities:
         
Net change in deposits
  15,260   11,174  
Net change in securities sold under agreements to repurchase
  (9,728 ) (2,077 )
Cash dividends paid on common stock
  (342 ) (227 )
           
Net cash provided by financing activities
  5,190   8,870  
           
Net change in cash and cash equivalents
  (1,585 ) 2,139  
           
Cash and cash equivalents at beginning of period
  69,098   76,773  
           
Cash and cash equivalents at end of period
$ 67,513   78,912  
 
 
 
6

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
       
Consolidated Statements of Cash Flows, continued
       
Three Months Ended March 31, 2015 and 2014
       
(Dollars in thousands)
       
       
 
2015
 
2014
 
(Unaudited)
 
(Unaudited)
       
Supplemental disclosures of cash flow information:
     
Cash paid during the period for:
     
Interest
$ 904   1,267
Income taxes
$ -     -  
         
Noncash investing and financing activities:
       
Change in unrealized gain on investment securities
       
 available for sale, net
$ 863   2,341
Transfers of loans to other real estate and repossessions
$ 2,603   2,246
         
See accompanying Notes to Consolidated Financial Statements.
       
 
 
 
7

 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

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 subsidiaries, Peoples Bank (the “Bank”) and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc. and Real Estate Advisory Services, Inc. (“REAS”) (collectively called the “Company”).  All significant intercompany balances and transactions have been eliminated in consolidation.

The consolidated financial statements in this report (other than the Consolidated Balance Sheet at December 31, 2014) 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 2014 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 7, 2015 Annual Meeting of Shareholders.

Recently Issued Accounting Pronouncements
In January 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-01, (Subtopic 225-20):  Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.  ASU No. 2015-01 eliminates the concept of extraordinary items from GAAP.  ASU No. 2015-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  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 February 2015, FASB issued ASU No. 2015-02, (Topic 810):  Amendments to the Consolidation Analysis.  ASU No. 2015-02 provides amendments to respond to stakeholders’ concerns about the current accounting for consolidation of certain legal entities.  Stakeholders expressed concerns that GAAP might require a reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights, or the reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations.  ASU No. 2015-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  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 April 2015, FASB issued ASU No. 2015-03, (Subtopic 835-30):  Simplifying the Presentation of Debt Issuance Costs.  ASU No. 2015-03 provides guidance that will require debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. ASU No. 2015-03 affects disclosures related to debt issuance costs but does not affect existing recognition and measurement guidance for these items.  ASU No. 2015-03 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  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 April 2015, FASB issued ASU No. 2015-04, (Topic 715):  Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets.  ASU No. 2015-04 simplifies the fair value measurement of defined benefit pension plans and other retirement plans for entities with a fiscal year-end that does not coincide with a month-end.   ASU No. 2015-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
 
 
8

 
 
In April 2015, FASB issued ASU No. 2015-05, (Subtopic 350-40):  Customer’s Accounting for Fees Paid in a Cloud Computing Arrangements.  ASU No. 2015-05 provides guidance on a customer’s accounting for fees paid in a cloud computing arrangement, which includes software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements.  ASU No. 2015-05 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  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 March 31, 2015 and December 31, 2014 are as follows:

(Dollars in thousands)
             
 
March 31, 2015
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Mortgage-backed securities
$ 86,230   2,331   8   88,553
U.S. Government
               
sponsored enterprises
  36,977   526   141   37,362
State and political subdivisions
  145,568   7,044   138   152,474
Corporate bonds
  1,957   11   5   1,963
Trust preferred securities
  750   -     -     750
Equity securities
  748   725   -     1,473
Total
$ 272,230   10,637   292   282,575
                 
(Dollars in thousands)
               
 
December 31, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Mortgage-backed securities
$ 88,496   1,766   52   90,210
U.S. Government
               
sponsored enterprises
  33,766   418   136   34,048
State and political subdivisions
  145,938   6,534   226   152,246
Corporate bonds
  2,469   16   18   2,467
Trust preferred securities
  750   -     -     750
Equity securities
  748   630   -     1,378
Total
$ 272,167   9,364   432   281,099
 
The current fair value and associated unrealized losses on investments in securities with unrealized losses at March 31, 2015 and December 31, 2014 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.
 
(Dollars in thousands)
                     
 
March 31, 2015
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
 Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 127   -     2,954   8   3,081   8
U.S. Government
                       
sponsored enterprises
  2,549   21   9,639   120   12,188   141
State and political subdivisions
  6,328   30   6,784   108   13,112   138
Corporate bonds
  -     -     533   5   533   5
Total
$ 9,004   51   19,910   241   28,914   292
 
 
 
9

 

 
(Dollars in thousands)
                     
 
December 31, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
 
Unrealized Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 436   1   2,963   51   3,399   52
U.S. Government
                       
sponsored enterprises
  2,996   4   9,850   132   12,846   136
State and political subdivisions
  567   1   14,998   225   15,565   226
Corporate bonds
  -     -     525   18   525   18
Total
$ 3,999   6   28,336   426   32,335   432
 
At March 31, 2015, unrealized losses in the investment securities portfolio relating to debt securities totaled $292,000.  The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  From the March 31, 2015 tables above, 14 out of 173 securities issued by state and political subdivisions contained unrealized losses, seven out of 82 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses, and one out of three 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 March 31, 2015, 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.

March 31, 2015
     
(Dollars in thousands)
     
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$ 4,399   4,412
Due from one to five years
  50,121   52,794
Due from five to ten years
  111,462   115,413
Due after ten years
  19,270   19,930
Mortgage-backed securities
  86,230   88,553
Equity securities
  748   1,473
Total
$ 272,230   282,575
 
No securities available for sale were sold during the three months ended March 31, 2015.  Proceeds from sales of securities available for sale during the three months ended March 31, 2014 were $677,000 and resulted in gross gains of $26,000.
 
Securities with a fair value of approximately $85.9 million and $89.9 million at March 31, 2015 and December 31, 2014, respectively, were pledged to secure public deposits and for other purposes as required by law.
 
 
10

 
 
 
(3)
    Loans

Major classifications of loans at March 31, 2015 and December 31, 2014 are summarized as follows:

(Dollars in thousands)
     
 
March 31, 2015
 
December 31, 2014
Real estate loans:
     
Construction and land development
$ 57,247   57,617
Single-family residential
  207,113   206,417
Single-family residential -
       
Banco de la Gente stated income
  46,272   47,015
Commercial
  227,471   228,558
Multifamily and farmland
  12,331   12,400
Total real estate loans
  550,434   552,007
         
Loans not secured by real estate:
       
Commercial loans
  87,055   76,262
Farm loans
  5   7
Consumer loans
  9,857   10,060
All other loans
  13,126   13,555
         
Total loans
  660,477   651,891
         
Less allowance for loan losses
  10,843   11,082
         
Total net loans
$ 649,634   640,809
 
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, Union, 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 March 31, 2015, construction and land development loans comprised approximately 9% 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 March 31, 2015, single-family residential loans comprised approximately 38% of the Bank’s total loan portfolio, and include Banco de la Gente single-family residential stated income loans, which were approximately 7% 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 March 31, 2015, commercial real estate loans comprised approximately 34% 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 March 31, 2015, commercial loans comprised approximately 13% of the Bank’s total loan portfolio.
 
 
 
11

 
 
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 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 March 31, 2015 and December 31, 2014:

March 31, 2015
           
(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
$ 62   257   319   56,928   57,247   -  
Single-family residential
  4,313   1,286   5,599   201,514   207,113   -  
Single-family residential -
                       
Banco de la Gente stated income
  5,727   442   6,169   40,103   46,272   -  
Commercial
  1,875   381   2,256   225,215   227,471   -  
Multifamily and farmland
  -     -     -     12,331   12,331   -  
Total real estate loans
  11,977   2,366   14,343   536,091   550,434   -  
                         
Loans not secured by real estate:
                       
Commercial loans
  162   -     162   86,893   87,055   -  
Farm loans
  -     -     -     5   5   -  
Consumer loans
  97   9   106   9,751   9,857   -  
All other loans
  -     -     -     13,126   13,126   -  
Total loans
$ 12,236   2,375   14,611   645,866   660,477   -  
                         
                         
December 31, 2014
                       
(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
$ 294   3,540   3,834   53,783   57,617   -  
Single-family residential
  5,988   268   6,256   200,161   206,417   -  
Single-family residential -
                       
Banco de la Gente stated income
  8,998   610   9,608   37,407   47,015   -  
Commercial
  3,205   366   3,571   224,987   228,558   -  
Multifamily and farmland
  85   -     85   12,315   12,400   -  
Total real estate loans
  18,570   4,784   23,354   528,653   552,007   -  
                         
Loans not secured by real estate:
                       
Commercial loans
  241   49   290   75,972   76,262   -  
Farm loans
  -     -     -     7   7   -  
Consumer loans
  184   -     184   9,876   10,060   -  
All other loans
  -     -     -     13,555   13,555   -  
Total loans
$ 18,995   4,833   23,828   628,063   651,891   -  
 
 
 
12

 
 
The following table presents the Company’s non-accrual loans as of March 31, 2015 and December 31, 2014:

(Dollars in thousands)
     
 
March 31, 2015
 
December 31, 2014
Real estate loans:
     
Construction and land development
$ 565   3,854
Single-family residential
  3,891   2,370
Single-family residential -
       
Banco de la Gente stated income
  1,432   1,545
Commercial
  2,755   2,598
Multifamily and farmland
  99   110
Total real estate loans
  8,742   10,477
         
Loans not secured by real estate:
       
Commercial loans
  111   176
Consumer loans
  81   75
Total
$ 8,934   10,728
 
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 $25.9 million, $25.6 million and $28.8 million at March 31, 2015, December 31, 2014 and March 31, 2014, respectively.  Interest income recognized on accruing impaired loans was $335,000, $356,000 and $1.3 million for the three months ended March 31, 2015, the three months ended March 31, 2014 and the year ended December 31, 2014, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Company’s impaired loans as of March 31, 2015 and December 31, 2014:

March 31, 2015
             
(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
Real estate loans:
                     
Construction and land development
$ 1,174   266   647   913   35   2,554
Single-family residential
  9,169   2,092   6,496   8,588   170   8,246
Single-family residential -
                       
Banco de la Gente stated income
  20,886   -     20,310   20,310   1,179   19,764
Commercial
  4,824   1,794   2,701   4,495   256   4,423
Multifamily and farmland
  102   -   100   100   1   105
Total impaired real estate loans
  36,155   4,152   30,254   34,406   1,641   35,092
                         
Loans not secured by real estate:
                       
Commercial loans
  152   -     136   136   3   168
Consumer loans
  317   -     310   310   4   312
Total impaired loans
$ 36,624   4,152   30,700   34,852   1,648   35,572
 
 
 
13

 
 
 
December 31, 2014
           
(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
Real estate loans:
                     
Construction and land development
$ 5,481   3,639   555   4,194   31   5,248
Single-family residential
  6,717   933   5,540   6,473   154   7,430
Single-family residential -
                       
Banco de la Gente stated income
  21,243   -     20,649   20,649   1,191   19,964
Commercial
  4,752   1,485   2,866   4,351   272   4,399
Multifamily and farmland
  111   -     110   110   1   154
Total impaired real estate loans
  38,304   6,057   29,720   35,777   1,649   37,195
                         
Loans not secured by real estate:
                       
Commercial loans
  218   -     201   201   4   641
Farm loans (non RE)
          -              
Consumer loans
  318   -     313   313   5   309
All other loans (not secured by real estate)
  -     -     -     -     -     -  
Total impaired loans
$ 38,840   6,057   30,234   36,291   1,658   38,145
 
Changes in the allowance for loan losses for the three months ended March 31, 2015 and 2014 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
 
Three months ended March 31, 2015
                                     
Allowance for loan losses:
                                       
Beginning balance
$ 2,785   2,566   1,610   1,902   7   1,098   -   233   881   11,082  
Charge-offs
  (88 ) (291 ) (42 ) (2 ) -   -   -   (107 ) -   (530 )
Recoveries
  5   6   22   5   -   36   -   44   -   118  
Provision
  56   318   (4 ) (119 ) (1 ) 47   -   38   (162 ) 173  
Ending balance
$ 2,758   2,599   1,586   1,786   6   1,181   -   208   719   10,843  
                                           
Allowance for loan losses March 31, 2015:
                                     
Ending balance: individually
                                         
evaluated for impairment
$ -   82   1,145   245   -   -   -   -   -   1,472  
Ending balance: collectively
                                         
evaluated for impairment
  2,758   2,517   441   1,541   6   1,181   -   208   719   9,371  
Ending balance
$ 2,758   2,599   1,586   1,786   6   1,181   -   208   719   10,843  
                                           
Loans March 31, 2015:
                                         
Ending balance
$ 57,247   207,113   46,272   227,471   12,331   87,055   5   22,983   -   660,477  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 266   3,448   18,655   3,633   -   -   -   -   -   26,002  
Ending balance: collectively
                                         
evaluated for impairment
$ 56,981   203,665   27,617   223,838   12,331   87,055   5   22,983   -   634,475  
 
 
 
14

 
 
 
(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
 
Three months ended March 31, 2014
                                     
Allowance for loan losses:
                                       
Beginning balance
$ 3,218   3,123   1,863   2,219   37   1,069   -   245   1,727   13,501  
Charge-offs
  (260 ) (22 ) (32 ) (111 ) -   (12 ) -   (138 ) -   (575 )
Recoveries
  279   9   12   60   -   5   -   36   -   401  
Provision
  (104 ) 22   (76 ) 28   (1 ) (117 ) -   87   (188 ) (349 )
Ending balance
$ 3,133   3,132   1,767   2,196   36   945   -   230   1,539   12,978  
                                           
Allowance for loan losses March 31, 2014:
                                     
Ending balance: individually
                                         
evaluated for impairment
$ -   68   1,187   174   -   -   -   -   -   1,429  
Ending balance: collectively
                                         
evaluated for impairment
  3,133   3,064   580   2,022   36   945   -   230   1,539   11,549  
Ending balance
$ 3,133   3,132   1,767   2,196   36   945   -   230   1,539   12,978  
                                           
Loans March 31, 2014:
                                         
Ending balance
$ 61,162   196,447   48,926   211,882   11,566   65,456   16   22,585   -   618,040  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 5,464   3,220   19,625   3,577   -   253   -   257   -   32,396  
Ending balance: collectively
                                         
evaluated for impairment
$ 55,698   193,227   29,301   208,305   11,566   65,203   16   22,328   -   585,644  
 
The provision for loan losses for the three months ended March 31, 2015 was an expense of $173,000, as compared to a credit of $349,000 for the three months ended March 31, 2014.  The increase in the provision for loan losses is primarily attributable to a $42.5 million increase in loans from March 31, 2014 to March 31, 2015 and a $238,000 increase in net charge-offs during the three months ended March 31, 2015, as 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.  CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.
·  
Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the 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.
 
 
 
15

 
 
The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of March 31, 2015 and December 31, 2014:

March 31, 2015
                                     
(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
$ -   13,705   -   -   -   1,026   -   1,245   -   15,976
2- High Quality
  7,768   76,955   -   38,374   231   26,199   -   3,465   1,798   154,790
3- Good Quality
  26,737   74,746   20,561   140,510   8,978   47,317   5   4,494   10,392   333,740
4- Management Attention
  12,918   29,884   12,714   38,734   369   11,995   -   514   936   108,064
5- Watch
  9,176   4,619   5,677   5,706   2,653   379   -   47   -   28,257
6- Substandard
  648   7,204   7,320   4,147   100   139   -   92   -   19,650
7- Doubtful
  -   -   -   -   -   -   -   -   -   -
8- Loss
  -   -   -   -   -   -   -   -   -   -
Total
$ 57,247   207,113   46,272   227,471   12,331   87,055   5   9,857   13,126   660,477
                                         
                                         
                                         
December 31, 2014
                                       
(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
$ -   15,099   -   -   -   924   -   1,232   -   17,255
2- High Quality
  6,741   74,367   -   39,888   241   18,730   -   3,576   1,860   145,403
3- Good Quality
  24,641   74,453   21,022   142,141   8,376   44,649   7   4,549   8,055   327,893
4- Management Attention
  13,013   30,954   12,721   36,433   1,001   11,312   -   566   3,640   109,640
5- Watch
  9,294   5,749   5,799   6,153   2,672   383   -   46   -   30,096
6- Substandard
  3,928   5,795   7,473   3,943   110   264   -   87   -   21,600
7- Doubtful
  -   -   -   -   -   -   -   -   -   -
8- Loss
  -   -   -   -   -   -   -   4   -   4
Total
$ 57,617   206,417   47,015   228,558   12,400   76,262   7   10,060   13,555   651,891
 
Total TDR loans amounted to $5.5 million and $15.0 million at March 31, 2015 and December 31, 2014, 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 $146,000 and $1.4 million in performing loans classified as TDR loans at March 31, 2015 and December 31, 2014, respectively.

The following tables present an analysis of loan modifications during the three months ended March 31, 2015 and 2014:

Three months ended March 31, 2015
         
(Dollars in thousands)
         
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
 Investment
 
Post-Modification Outstanding
Recorded
Investment
Real estate loans
         
Single-family residential
1   $ 146   146
Total real estate TDR loans
1     146   146
             
Total TDR loans
1   $ 146   146
 
 
 
16

 
 
 
Three months ended March 31, 2014
         
(Dollars in thousands)
         
 
Number of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification Outstanding
Recorded
Investment
Real estate loans
         
Construction and land development
1   $ 316   316
    Single family residential 1      737    737
Single-family residential -
           
Banco de la Gente stated income
6     497   497
Total real estate TDR loans
8     1,550   1,550
             
Total TDR loans
8   $ 1,550   1,550
 
(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 months ended March 31, 2015 and 2014 is as follows:

For the three months ended March 31, 2015
         
 
Net Earnings
 (Dollars in
thousands)
 
Shares
 
Per Share
Amount
           
Basic earnings per share
$ 2,328   5,612,588   $ 0.41
Effect of dilutive securities:
             
Stock options
  -     38,470      
Diluted earnings per share
$ 2,328   5,651,058   $ 0.41
               
               
For the three months ended March 31, 2014
             
 
Net Earnings
(Dollars in
thousands)
 
Shares
 
Per Share
Amount
               
Basic earnings per share
$ 2,578   5,613,495   $ 0.46
Effect of dilutive securities:
             
Stock options
  -     19,359      
Diluted earnings per share
$ 2,578   5,632,854   $ 0.46
 
(5)
    Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan (the “1999 Plan”) whereby certain stock-based rights, such as stock options and restricted stock units, were granted to eligible directors and employees.  The 1999 Plan expired on May 13, 2009 but still governs the rights and obligations of the parties for grants made thereunder.  As of March 31, 2015, there were no outstanding options under the 1999 Plan.
 
Under the 1999 Plan, the Company granted 3,000 restricted stock units in 2007 at a grant date fair value of $17.40 per share. The Company granted 1,750 restricted stock units at a grant date fair value of $12.80 per share during the third quarter of 2008 and 2,000 restricted stock units at a grant date fair value of $11.37 per share during the fourth quarter of 2008. The Company recognized compensation expense on the restricted stock units over the period of time the restrictions were in place (three years from the grant date for the grants of restricted stock units under the 1999 Plan).  The amount of expense recorded in each period reflected the changes in the Company’s stock price during such period.  As of March 31, 2015, there was no unrecognized compensation expense related to the 2007 and 2008 restricted stock unit grants granted under the 1999 Plan.
 
 
17

 
 
The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees.  A total of 267,560 shares are currently reserved for possible issuance under the 2009 Plan.   All stock-based rights under the 2009 Plan must be granted or awarded by May 7, 2019 (or ten years from the 2009 Plan effective date).

The Company granted 29,514 restricted stock units under the 2009 Plan at a grant date fair value of $7.90 per share during the first quarter of 2012, of which 5,355 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”).  In July 2012, the Company granted 5,355 restricted stock units at a grant date fair value of $8.25 per share. The Company granted 26,795 restricted stock units under the 2009 Plan at a grant date fair value of $11.90 per share during the second quarter of 2013.  The Company granted 21,056 restricted stock units under the 2009 Plan at a grant date fair value of $15.70 per share during the first quarter of 2014.  The Company granted 15,075 restricted stock units under the 2009 Plan at a grant date fair value of $17.97 per share during the first quarter of 2015.  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 and 2015 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 March 31, 2015, the total unrecognized compensation expense related to the restricted stock unit grants under the 2009 Plan was $968,000.

The Company recognized compensation expense for restricted stock unit awards granted under the 2009 Plan of $117,000 and $82,000 for the three months ended March 31, 2015 and 2014, 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 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.
 
 
18

 
 
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 fair value of fixed rate loans is estimated by discounting 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 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 2 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”) 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 2 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.
 
 
19

 
 
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 March 31, 2015 and December 31, 2014.
 
(Dollars in thousands)
             
 
March 31, 2015
 
Fair Value
Measurements
 
Level 1
Valuation
 
Level 2
Valuation
 
Level 3
Valuation
Mortgage-backed securities
$ 88,553   -   88,553   -
U.S. Government
               
sponsored enterprises
$ 37,362   -   37,362   -
State and political subdivisions
$ 152,474   -   152,474   -
Corporate bonds
$ 1,963   -   1,963   -
Trust preferred securities
$ 750   -   -   750
Equity securities
$ 1,473   1,473   -   -
                 
(Dollars in thousands)
               
 
December 31, 2014
 
Fair Value
Measurements
 
Level 1
Valuation
 
Level 2
Valuation
 
Level 3
Valuation
Mortgage-backed securities
$ 90,210   -   90,210   -
U.S. Government
               
sponsored enterprises
$ 34,048   -   34,048   -
State and political subdivisions
$ 152,246   -   152,246   -
Corporate bonds
$ 2,467   -   2,467   -
Trust preferred securities
$ 750   -   -   750
Equity securities
$ 1,378   1,378   -   -
 
The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the three months ended March 31, 2015.
 
(Dollars in thousands)
   
   
Investment Securities
Available for Sale
   
Level 3 Valuation
Balance, beginning of period
  $ 750
Change in book value
    -
Change in gain/(loss) realized and unrealized
    -
Purchases/(sales and calls)
    -
Transfers in and/or (out) of Level 3
    -
Balance, end of period
  $ 750
       
Change in unrealized gain/(loss) for assets still held in Level 3
  $ -
 
The fair value measurements for impaired loans and other real estate on a non-recurring basis at March 31, 2015 and December 31, 2014 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.
 
 
20

 
 
 
(Dollars in thousands)
                 
 
Fair Value
Measurements
March 31, 2015
 
Level 1
Valuation
 
Level 2
Valuation
 
Level 3
 Valuation
 
Total Gains/(Losses) for
the Three Months Ended
March 31, 2015
Impaired loans
$ 33,204   -   -   33,204   (412 )
Other real estate
$ 3,424   -   -   3,424   87  
 
 
(Dollars in thousands)
                 
 
Fair Value
Measurements
December 31, 2014
 
Level 1
Valuation
 
Level 2
Valuation
 
Level 3
Valuation
 
Total Gains/(Losses) for
the Year Ended
December 31, 2014
Impaired loans
$ 34,633   -   -   34,633   (1,444 )
Other real estate
$ 2,016   -   -   2,016   (622 )
 
The carrying amount and estimated fair value of financial instruments at March 31, 2015 and December 31, 2014 are as follows:
 
(Dollars in thousands)
                   
     
Fair Value Measurements at March 31, 2015
 
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Assets:
                   
Cash and cash equivalents
$ 67,513   67,513   -   -   67,513  
Investment securities available for sale
$ 282,575   1,473   280,352   750   282,575  
Other investments
$ 3,912   -   -   3,912   3,912  
Mortgage loans held for sale
$ 806   -   -   806   806  
Loans, net
$ 649,634   -   -   653,303   653,303  
Cash surrender value of life insurance
$ 14,229   -   14,229   -   14,229  
                       
Liabilities:
                     
Deposits
$ 829,960   -   -   828,245   828,245  
Securities sold under agreements
                     
to repurchase
$ 38,702   -   38,702   -   38,702  
FHLB borrowings
$ 50,000   -   49,593   -   49,593  
Junior subordinated debentures
$ 20,619   -   20,619   -   20,619  
                       
                       
(Dollars in thousands)
                     
       
Fair Value Measurements at December 31, 2014
 
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Assets:
                     
Cash and cash equivalents
$ 69,098   69,098   -   -   69,098  
Investment securities available for sale
$ 281,099   1,378   278,971   750   281,099  
Other investments
$ 4,031   -   -   4,031   4,031  
Mortgage loans held for sale
$ 1,375   -   -   1,375   1,375  
Loans, net
$ 640,809   -   -   644,708   644,708  
Cash surrender value of life insurance
$ 14,125   -   14,125   -   14,125  
                       
Liabilities:
                     
Deposits
$ 814,700   -   -   813,288   813,288  
Securities sold under agreements
                     
to repurchase
$ 48,430   -   48,430   -   48,430  
FHLB borrowings
$ 50,000   -   49,598   -   49,598  
Junior subordinated debentures
$ 20,619   -   20,619   -   20,619  
 
 
 
21

 
 
 
 (7)
Subsequent Events

The Company has reviewed and evaluated subsequent events and transactions for material subsequent events through the date the financial statements are issued.  Management has concluded that there were no material subsequent events.
 
 
22

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

The following is a discussion of our financial position and results of operations and should be read in conjunction with the information set forth under Item 1A Risk Factors and the Company’s Consolidated Financial Statements and Notes thereto on pages A-26 through A-62 of the Company’s 2014 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 7, 2015 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, Union, Wake and Durham counties, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”).

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

Economic conditions in 2015 continue to demonstrate signs of improvement.  However, with the unemployment rate continuing to be higher than historical norms and home prices still well below pre-crisis levels, the primary indicators of economic activity for our markets continue to point to uncertain business conditions.

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. The Company expects growth to be achieved in its local markets and through expansion opportunities in contiguous or nearby markets.  While the Company would be willing to consider growth by acquisition in certain circumstances, it does not consider the acquisition of another company to be necessary for its continued ability to provide a reasonable return to its 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 has maintained the Federal Funds Rate at 0.25% since December 2008.  This historically low rate has had a negative impact on earnings and will continue to have a negative impact on our net interest income in future periods.  The negative impact of low interest rates has been partially offset by earnings realized on interest rate contracts utilized by the Bank.  Additional information regarding the Bank’s interest rate contacts is provided below in the section entitled “Asset Liability and Interest Rate Risk Management.”
 
 
23

 
 
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 2014 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 7, 2015 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 $2.3 million or $0.41 basic and diluted net earnings per share for the three months ended March 31, 2015, as compared to $2.6 million or $0.46 basic and diluted net earnings per share for the same period one year ago.  The decrease in first quarter earnings is attributable to an increase in the provision for loan losses and an increase in non-interest expense, which were partially offset by an increase in non-interest income and an increase in net interest income, as discussed below.

The annualized return on average assets was 0.91% for the three months ended March 31, 2015, compared to 1.03% for the same period one year ago, and annualized return on average shareholders’ equity was 9.32% for the three months ended March 31, 2015, compared to 11.92% for the same period one year ago.

Net Interest Income.  Net interest income, the major component of the Company’s net earnings, was $8.7 million for the three months ended March 31, 2015, compared to $8.4 million for the same period one year ago.  The increase in net interest income was primarily due to an increase in interest income resulting from an increase in the average outstanding principal balance of loans and was augmented by a decrease in interest expense resulting from a reduction in the cost of funds and a decrease in the average outstanding balance of interest bearing liabilities

Interest income increased $22,000 for the three months ended March 31, 2015, compared to the same period one year ago.  The increase in interest income was primarily due to an increase in the average outstanding principal balance of loans, which was partially offset by a decrease in the average outstanding principal balance of available for sale securities.  During the quarter ended March 31, 2015, average loans increased $37.2 million to $654.7 million from $617.5 million for the quarter ended March 31, 2014.  During the quarter ended March 31, 2015, average investment securities available for sale decreased $26.9 million to $272.1 million from $299.0 million for the quarter ended March 31, 2014.  The average yield on loans for the quarters ended March 31, 2015 and 2014 was 4.70% and 4.86%, respectively.  The average yield on investment securities available for sale for the quarters ended March 31, 2015 and 2014 was 3.68% and 3.58%, respectively.  The average yield on earning assets for the quarters ended March 31, 2015 and 2014 was 4.34% and 4.36%, respectively.

Interest expense decreased $227,000 or 20% for the three months ended March 31, 2015, compared to the same period one year ago.  The decrease in interest expense was the result of lower cost of funds and a reduction in certificates of deposit.  The average rate paid on interest-bearing checking and savings accounts was 0.11% for the quarter ended March 31, 2015, as compared to 0.13% for the same period one year ago.  The average rate paid on certificates of deposit was 0.54% for the quarter ended March 31, 2015, as compared to 0.62% for the same period one year ago.  The average rate paid on interest-bearing liabilities was 0.50% for the quarter ended March 31, 2015, as compared to 0.61% for the same period one year ago.  During the quarter ended March 31, 2015, average certificates of deposit decreased $33.1 million to $186.3 million from $219.4 million for the quarter ended March 31, 2014.
 
 
24

 
 
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 March 31, 2015 and 2014. 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 have been adjusted to a tax equivalent basis using an effective tax rate of 37.30% for securities that are both federal and state tax exempt and an effective tax rate of 32.30% 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.

 
Three months ended
 
Three months ended
 
March 31, 2015
 
March 31, 2014
(Dollars in thousands)
Average
Balance
   
Interest
 
Yield /
Rate
 
Average
Balance
   
Interest
 
Yield /
Rate
Interest-earning assets:
                         
                           
Loans receivable
$ 654,728     7,593   4.70%   $ 617,461     7,401   4.86%
Investments - taxable
  97,143     621   2.59%     130,593     810   2.52%
Investments - nontaxable*
  179,606     1,932   4.36%     173,999     1,913   4.46%
Other
  16,802     10   0.24%     20,670     12   0.24%
                               
Total interest-earning assets
  948,279     10,156   4.34%     942,723     10,136   4.36%
                               
Cash and due from banks
  44,311               43,386          
Other assets
  54,809               46,766          
Allowance for loan losses
  (11,100 )             (13,600 )        
                               
Total assets
$ 1,036,299             $ 1,019,275          
                               
                               
Interest-bearing liabilities:
                             
                               
NOW, MMDA & savings deposits
$ 419,633     111   0.11%   $ 386,278     126   0.13%
Time deposits
  186,266     247   0.54%     219,449     334   0.62%
FHLB borrowings
  50,000     418   3.39%     65,000     545   3.40%
Trust preferred securities
  20,619     97   1.91%     20,619     96   1.89%
Other
  41,637     11   0.11%     43,555     10   0.09%
                               
Total interest-bearing liabilities
  718,155     884   0.50%     734,901     1,111   0.61%
                               
Demand deposits
  213,755               192,570          
Other liabilities
  4,197               5,589          
Shareholders' equity
  101,328               87,712          
                               
Total liabilities and shareholder's equity
$ 1,037,435             $ 1,020,772          
                               
Net interest spread
      $ 9,272   3.84%         $ 9,025   3.75%
                               
Net yield on interest-earning assets
            3.97%               3.88%
                               
Taxable equivalent adjustment
                             
Investment securities
      $ 589              $ 591    
                               
Net interest income
       $ 8,683              $ 8,434    
                               
*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $33.8 million in 2015 and $22.9 million in 2014. Tax rates of 5.00% and 6.00% were used to calculate the tax equivalent yield on these securities in 2015 and 2014, respectively.
 
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.
 
 
25

 
 

 
Three months ended March 31, 2015
compared to three months ended March
31, 2014
 
Three months ended March 31, 2014
compared to three months ended March
31, 2013
 
(Dollars in thousands)
Changes in
average
volume
 
Changes in
average
rates
 
Total
Increase
(Decrease)
 
Changes in
average
volume
 
Changes in
average
rates
 
Total
Increase
(Decrease)
 
Interest income:
                       
Loans: Net of unearned income
$ 440   (248 ) 192   $ (44 ) (195 ) (239 )
Investments - taxable
  (231 ) 42   (189 )   (77 ) 527   450  
Investments - nontaxable
  100   (81 ) 19     337   (1 ) 336  
Other
  (2 ) -   (2 )   (1 ) 1   -  
Total interest income
  307   (287 ) 20     215   332   547  
                             
Interest expense:
                           
NOW, MMDA & savings deposits
  10   (25 ) (15 )   8   (100 ) (92 )
Time deposits
  (47 ) (40 ) (87 )   (40 ) (93 ) (133 )
FHLB borrowings
  (126 ) (1 ) (127 )   (45 ) (71 ) (116 )
Trust preferred securities
  -   1   1     -   (4 ) (4 )
Other
  -   1   1     2   (9 ) (7 )
Total interest expense
  (163 ) (64 ) (227 )   (75 ) (277 ) (352 )
Net interest income
$ 470   (223 ) 247   $ 290   609   899  
 
Provision for Loan Losses. The provision for loan losses for the three months ended March 31, 2015 was an expense of $173,000, as compared to a credit of $349,000 for the three months ended March 31, 2014.  The increase in the provision for loan losses is primarily attributable to a $42.5 million increase in loans from March 31, 2014 to March 31, 2015 and a $238,000 increase in net charge-offs during the three months ended March 31, 2015, as compared to the same period one year ago.

Non-Interest Income.  Total non-interest income was $3.2 million for the three months ended March 31, 2015, compared to $2.8 million for the three months ended March 31, 2014.  The increase in non-interest income is primarily attributable to a $391,000 increase in miscellaneous non-interest income and a $135,000 increase in mortgage banking income.  The increase in miscellaneous non-interest income is primarily due to $87,000 in net gains on other real estate owned properties for the three months ended March 31, 2015, as compared to $162,000 in net losses and write-downs on other real estate owned properties for the three months ended March 31, 2014.

Non-Interest Expense.  Total non-interest expense was $8.7 million for the three months ended March 31, 2015, compared to $8.1 million for the three months ended March 31, 2014.  The increase in non-interest expense was primarily due to a $525,000 increase in salaries and benefits expense resulting primarily from an increase in the number of full-time equivalent employees and annual salary increases combined with a $138,000 increase in other non-interest expenses primarily due to a $49,000 increase in foreclosed property expense and a $25,000 increase in legal fees, which were partially offset by a $38,000 decrease in occupancy expense during the three months ended March 31, 2015, as compared to the three months ended March 31, 2014.

Income Taxes.  The Company reported income tax expense of $679,000 and $923,000 for the three months ended March 31, 2015 and 2014, respectively.  This represented an effective tax rate of 23% and 26% for the respective periods.

Analysis of Financial Condition
Investment Securities.  Available for sale securities were $282.6 million at March 31, 2015, compared to $281.1 million at December 31, 2014.  Average investment securities available for sale for the three months ended March 31, 2015 were $272.1 million, compared to $287.4 million for the year ended December 31, 2014.

Loans.  At March 31, 2015, loans were $660.5 million, compared to $651.9 million at December 31, 2014.  The increase in loans is primarily attributable to a $10.8 million increase in commercial loans not secured by real estate.  Loans originated or renewed during the three months ended March 31, 2015, of approximately $42.8 million, were offset by paydowns and payoffs of existing loans.  Average loans represented 69% and 66% of average earning assets for the three months ended March 31, 2015 and the year ended December 31, 2014, respectively.  The Company had $806,000 and $1.4 million in mortgage loans held for sale as of March 31, 2015 and December 31, 2014, respectively.
 
 
26

 
 
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 March 31, 2015, the Company had $105.7 million in residential mortgage loans, $89.7 million in home equity loans and $296.4 million in commercial mortgage loans, which include $238.2 million secured by commercial property and $58.2 million secured by residential property.   Residential mortgage loans include $59.4 million made to customers in the Company’s traditional banking offices and $46.3 million in mortgage loans originated in the Company’s Latino banking offices.  All residential mortgage loans are originated as fully amortizing loans, with no negative amortization.

At March 31, 2015, the Company had $57.0 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
Land acquisition and development - commercial purposes
63   $ 11,827   $ 34
Land acquisition and development - residential purposes
262     29,531     531
1 to 4 family residential construction
54     11,430     -
Commercial construction
7     4,459     -
Total construction and land development
386   $ 57,247   $ 565
 
Total TDR loans amounted to $5.5 million and $15.0 million at March 31, 2015 and December 31, 2014, 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 $146,000 and $1.4 million in performing loans classified as TDR loans at March 31, 2015 and December 31, 2014, respectively.

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.
 
 
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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 mortgage loans from the Banco de la Gente 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 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 three months ended March 31, 2015 as compared to the three months ended March 31, 2014. 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 March 31, 2015 was $10.8 million or 1.64% of total loans, compared to $11.1 million or 1.70% of total loans at December 31, 2014.  

The following table presents the percentage of loans assigned to each risk grade at March 31, 2015 and December 31, 2014.
 
 
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Percentage of Loans
 
By Risk Grade
Risk Grade
3/31/2015
12/31/2014
Risk Grade 1 (Excellent Quality)
2.03%
2.18%
Risk Grade 2 (High Quality)
23.44%
22.30%
Risk Grade 3 (Good Quality)
50.69%
50.76%
Risk Grade 4 (Management Attention)
16.36%
16.54%
Risk Grade 5 (Watch)
4.28%
4.62%
Risk Grade 6 (Substandard)
2.96%
3.30%
Risk Grade 7 (Doubtful)
0.00%
0.00%
Risk Grade 8 (Loss)
0.00%
0.00%
 
At March 31, 2015, including non-accrual loans, there were six relationships exceeding $1.0 million in the Watch risk grade (which totaled $14.2 million) and one relationship exceeding $1.0 million in the Substandard risk grade (which totaled $1.3 million).  There was one relationship with loans in both the Watch and Substandard risk grades, which totaled $1.3 million for loans in both risk grades combined.

Non-performing Assets.  Non-performing assets totaled $12.4 million at March 31, 2015 or 1.18% of total assets, compared to $12.7 million or 1.22% of total assets at December 31, 2014.  Non-accrual loans were $8.9 million at March 31, 2015 and $10.7 million at December 31, 2014.  As a percentage of total loans outstanding, non-accrual loans were 1.35% at March 31, 2015, compared to 1.65% at December 31, 2014.  Non-accrual loans include $8.1 million in commercial and residential mortgage loans, $565,000 in construction and land development loans and $192,000 in other loans at March 31, 2015, compared to $6.6 million in commercial and residential mortgage loans, $3.9 million in construction and land development loans and $251,000 in other loans at December 31, 2014.  The Bank did not have any loans 90 days past due and still accruing at March 31, 2015 and December 31, 2014.  Other real estate totaled $3.4 million at March 31, 2015, compared to $2.0 million at December 31, 2014.

           Deposits.  Total deposits at March 31, 2015 were $830.0 million compared to $814.7 million at December 31, 2014. Core deposits, which include non-interest bearing demand deposits, NOW, MMDA, savings and non-brokered certificates of deposit of denominations less than $250,000, were $786.2 million at March 31, 2015 as compared to $755.8 million at December 31, 2014.  Certificates of deposit in amounts of $250,000 or more totaled $36.2 million at March 31, 2015, as compared to $47.9 million at December 31, 2014.  At March 31, 2015, brokered deposits were $7.5 million as compared to $11.1 million at December 31, 2014.  Brokered deposits outstanding as of March 31, 2015 had a weighted average rate of 0.09% with a weighted average original term of 12 months as compared to brokered deposits outstanding at December 31, 2014, which had a weighted average rate of 0.13% with a weighted average original term of 11 months.

Borrowed Funds. Borrowings from the FHLB totaled $50.0 million at March 31, 2015 and December 31, 2014.  The average balance of FHLB borrowings for the three months ended March 31, 2015 was $50.0 million, compared to $63.7 million for the year ended December 31, 2014.  The FHLB borrowings outstanding at March 31, 2015 had interest rates ranging from 1.82% to 3.67% and maturity dates in 2018.

Securities sold under agreements to repurchase were $38.7 million at March 31, 2015 compared to $48.4 million at December 31, 2014.

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.
 
 
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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 right 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 monthly 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 three months ended March 31, 2015 totaled $948.3 million, exceeding average rate sensitive liabilities of $718.2 million by $230.1 million.

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.  By using derivative instruments, the Company is exposed to credit and market risk.  If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative.  The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company.  The Company did not have any interest rate derivatives outstanding as of March 31, 2015.

Included in the rate sensitive assets are $292.5 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 March 31, 2015, the Company had $192.6 million in loans with interest rate floors.  The floors were in effect on $190.2 million of these loans pursuant to the terms of the promissory notes on these loans.   The weighted average rate on these loans is 0.91% 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 March 31, 2015, such unfunded commitments to extend credit were $170.9 million, while commitments in the form of standby letters of credit totaled $4.1 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 March 31, 2015, the Company’s core deposits totaled $786.2 million, or 95% 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 5.52% as of March 31, 2015.
 
 
30

 
 
The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets, with an outstanding balance of $50.0 million at March 31, 2015 and December 31, 2014.  At March 31, 2015, the carrying value of loans pledged as collateral to the FHLB totaled $122.4 million compared to $126.0 million at December 31, 2014.  The remaining availability under the line of credit with the FHLB was $25.1 million at March 31, 2015 compared to $27.7 million at December 31, 2014.  The Bank had no borrowings from the FRB at March 31, 2015 or December 31, 2014.  FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB.  At March 31, 2015, the carrying value of loans pledged as collateral to the FRB totaled $354.6 million compared to $340.5 million at December 31, 2014.

The Bank also had the ability to borrow up to $54.5 million for the purchase of overnight federal funds from five correspondent financial institutions as of March 31, 2015.

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 32.05% at March 31, 2015 and 31.76% at December 31, 2014.  The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at March 31, 2015 and December 31, 2014.

Contractual Obligations and Off-Balance Sheet Arrangements.  The Company’s contractual obligations and other commitments as of March 31, 2015 and December 31, 2014 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)
     
 
March 31, 2015
 
December 31, 2014
Contractual Cash Obligations
     
Long-term borrowings
$ 50,000   50,000
Junior subordinated debentures
  20,619   20,619
Operating lease obligations
  4,436   4,585
Total
$ 75,055   75,204
Other Commitments
       
Commitments to extend credit
$ 170,894   168,733
Standby letters of credit and financial guarantees written
  4,064   3,911
Total
$ 174,958   172,644
 
The Company enters into derivative contracts 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 $101.5 million, or 9.7% of total assets, as of March 31, 2015, compared to $88.4 million, or 8.5% of total assets, as of March 31, 2014.  This increase is primarily due to an increase in retained earnings and an increase in accumulated other comprehensive income resulting from an increase in the unrealized gain on investment securities.
 
Annualized return on average equity for the three months ended March 31, 2015 was 9.32% compared to 11.92% for the three months ended March 31, 2014.  Total cash dividends paid on common stock were $341,000 and $227,000 for the three months ended March 31, 2015 and 2014, 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 2014, the Company’s Board of Directors authorized a stock repurchase program, pursuant to which up to $2 million will be allocated to repurchase the Company’s common stock.  Any purchases under the Company’s stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately negotiated transactions.  The timing and amount of any repurchase of shares will be determined by the Company’s management, based on its evaluation of market conditions and other factors.  The repurchase program may be suspended at any time or from time-to-time without prior notice.  The Company has repurchased $82,000, or 4,537 shares, of its common stock under this program as of March 31, 2015.
 
 
31

 
 
In 2013, the Federal Reserve Board 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 will be 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 will be added to the minimum requirements for capital adequacy purposes beginning on January 1, 2016 at 0.625% and will be phased in through 2019 (increasing by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019).  This will result 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 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 March 31, 2015 and December 31, 2014 includes $20.0 million in trust preferred securities.  The Company’s Tier 1 capital ratio was 15.07% and 15.33% at March 31, 2015 and December 31, 2014, 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 16.36% and 16.62% at March 31, 2015 and December 31, 2014, respectively.  The Company's common equity Tier 1 capital consists of common stock and retained earnings.  The Company's common equity Tier 1 capital ration was 12.45% and 12.62% at March 31, 2015 and December 31, 2014, 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 11.12% and 10.74% at March 31, 2015 and December 31, 2014, respectively.

The Bank’s Tier 1 risk-based capital ratio was 14.60% and 14.78% at March 31, 2015 and December 31, 2014, respectively.  The total risk-based capital ratio for the Bank was 15.88% and 16.06% at March 31, 2015 and December 31, 2014, respectively.   The Bank's common equity Tier 1 capital ratio was 14.60% and 14.78% at March 31, 2015 and December 31, 2014, respectively.  The Bank’s Tier 1 leverage capital ratio was 10.75% and 10.33% at March 31, 2015 and December 31, 2014, 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 March 31, 2015.
 
 
32

 

Item 3.     Quantitative and Qualitative Disclosures About Market Risk
 
Not required for smaller reporting companies.
 
 
 
 
33

 
 
Item 4T.    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.



 
34

 
 
 
PART II.
OTHER INFORMATION
   
Item 1.
Legal Proceedings
   
 
On April 2, 2013, the Bank received notice that a lawsuit was filed against it in the General Court of Justice, Superior Court Division, Lincoln County, North Carolina. The complaint alleges (i) breach of contract and the covenants of good faith and fair dealing by the Bank, (ii) conversion, (iii) unjust enrichment and (iv) violations of the North Carolina Unfair and Deceptive Trade Practices Act in its assessment and collection of overdraft fees. It seeks the refund of overdraft fees, treble damages, attorneys’ fees and injunctive relief. The Plaintiff seeks to have the lawsuit certified as a class action.  The Court has not acted on that request.  The Bank has filed, briefed and argued to the Court a motion for summary judgment.  The Court has not ruled on that motion.  The Bank continues to believe that the allegations in the complaint are without merit and intends to vigorously defend the lawsuit, including the request that the lawsuit be certified as a class action.  
   
Item 1A.
Risk Factors
   
 
Not required for smaller reporting companies.
   
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

  ISSUER PURCHASES OF EQUITY SECURITIES
                 
                           
                 
Total
   Maximum
                 
Number of
   Number (or
                 
Shares
 
Approximate
                 
Purchased as
 
Dollar Value) of
                 
Part of
 
Shares that
   
Total
         
Publicly
 
May Yet Be
   
Number of
   
Average
 
Announced
 
Purchased
   
Shares
   
Price Paid
 
Plans or
 
Under the Plans
Period
 
Purchased
   
per Share
 
Programs
 
or Programs (2)
                           
January 1 - 31, 2015
  527       $ 18.97     -       $ 1,917,648  
                               
February 1 - 28, 2015
  715         18.97     -       $ 1,917,648  
                               
March 1 - 31, 2015
  -           -       -       $ 1,917,648  
                               
Total
  1,242   (1)   $ 18.91     -            
                               
(1) The Company purchased 1,242 shares on the open market in the three months ended March 31, 2015 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.
 
                               
(2) Reflects dollar value of shares that may yet be purchased under the Stock Repurchase Plan authorized by the Company's Board of Directors in 2014.
 
 
Item 3.
Defaults Upon Senior Securities
   
 
Not applicable
   
Item 5.
Other Information
   
 
Not applicable
 
 
 
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Item 6. Exhibits  
     
  Exhibit (3)(i)(a) Articles of Incorporation of the Registrant, incorporated by reference to
    Exhibit (3)(i) to the Form 8-A filed with the Securities and Exchange
    Commission on September 2, 1999
     
 
Exhibit (3)(i)(b)
Articles of Amendment dated December 19, 2008, regarding the Series A
   
Preferred Stock, incorporated by reference to Exhibit (3)(1) to the Form 8-K filed
   
with the Securities and Exchange Commission on December 29, 2008
     
 
Exhibit (3)(i)(c)
Articles of Amendment dated February 26, 2010, incorporated by reference to
   
Exhibit (3)(2) to the Form 10-K filed with the Securities and Exchange
   
Commission on March 25, 2010
     
 
Exhibit (3)(ii)
Amended and Restated Bylaws of the Registrant, incorporated by reference to
   
Exhibit (3)(ii) to the Form 10-K filed with the Securities and Exchange
   
Commission on March 25, 2010
     
 
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)
Employment Letter Agreement dated December 23, 2008 between the Registrant
   
and Joseph F. Beaman, Jr., incorporated by reference to Exhibit (10(b)(i) to the
   
Form 8-K filed with the Securities and Exchange Commission on December 29,
   
2008
     
 
Exhibit (10)(iii)
Amendment to Employment Agreement between Peoples Bank and Joseph F.
   
Beaman, Jr. dated December 18, 2008, incorporated by reference to Exhibit
   
(10)(b)(ii) to the Form 8-K filed with the Securities and Exchange Commission
   
on December 29, 2008
     
 
Exhibit (10)(iv)
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)(v)
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)(vi)
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)(vii)
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)(viii)
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)(ix)
Peoples Bancorp of North Carolina, Inc. Omnibus Stock Ownership and Long
   
Term Incentive Plan incorporated by reference to Exhibit (10)(f) to the Form 10-K
   
filed with the Securities and Exchange Commission on March 30, 2000
 
 
 
36

 
 
 
 
Exhibit (10)(x)
Amendment No. 1 to the Peoples Bancorp of North Carolina, Inc. Omnibus Stock
   
Ownership and Long Term Incentive Plan incorporated by reference to Exhibit
   
(10)(e)(i) to the Form 10-K filed with the Securities and Exchange Commission
   
on March 15, 2007
     
 
Exhibit (10)(xi)
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)(xii)
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)(xiii)
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)(xiv)
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)(xv)
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)(xvi)
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)(xvii)
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)(xviii)
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)(xix)
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)(xx)
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)(xxi)
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 (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
 
 
 
37

 
 
 
 
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 March 31, 2015, formatted in XBRL: (i) the Condensed Consolidated
   
Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the
   
Condensed Consolidated Statements of Changes in Shareholders' Equity, (iv) the
   
Condensed Consolidated Statements of Cash Flows, and (v) the Notes to the
   
Condensed Consolidated Financial Statements, tagged as blocks of text.*
     
   
*Furnished, not filed.
 
 
 
38

 
 
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.
     
     
     
May 8, 2015
 
 /s/ Lance A. Sellers
Date
 
Lance A. Sellers
   
President and Chief Executive Officer
   
(Principal Executive Officer)
     
     
     
May 8, 2015
 
 /s/ A. Joseph Lampron, Jr.
Date
 
A. Joseph Lampron, Jr.
   
Executive Vice President and Chief Financial Officer
   
(Principal Financial and Principal Accounting Officer)
 
 
 
 
 
 
39