PEOPLES BANCORP OF NORTH CAROLINA, INC. The following is a discussion of the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company's Annual Report of Form 10-K and the Company's Consolidated Financial Statements and Notes thereto on pages A-19 through A-59 of the Company's 2022 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2023 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 theBoard of Governors of theFederal Reserve System (the "Federal Reserve"). The Bank is aNorth Carolina -chartered bank, with offices inCatawba ,Lincoln ,Alexander ,Mecklenburg ,Iredell ,Wake ,Rowan andForsyth counties, operating under the banking laws ofNorth Carolina and the rules and regulations of theFederal Deposit Insurance Corporation . Overview Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses. Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of theFederal Reserve , inflation, interest rates, market and monetary fluctuations. Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered. Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating the allowance for credit losses ("ACL", "allowance for credit losses", or "allowance") and changes in these economic factors could result in increases or decreases to the provision for loan losses. Prior to the occurrence of the COVID-19 pandemic, economic conditions, while not as robust as the economic conditions during the period from 2004 to 2007, had stabilized such that businesses in our market area were growing and investing again. The uncertainty expressed in the local, national and international markets through the primary economic indicators of activity were previously sufficiently stable to allow for reasonable economic growth in our markets. Subsequently, continuing supply-chain disruption and rising inflation has caused the Federal Reserve Federal Open Market Committee ("FOMC") to increase the target federal funds rate 475 basis points sinceMarch 1, 2022 to a range of 4.75% to 5.00% atDecember 31, 2022 . Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends. Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plants and inventories. During periods of high inflation there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits. Also, general increases in the price of goods and services can be expected to result in increased operating expenses. 29 Table of Contents Our business emphasis has been and continues to be to operate as a well-capitalized, profitable and independent community-oriented financial institution dedicated to providing quality customer service. We are committed to meeting the financial needs of the communities in which we operate. We expect growth to be achieved in our local markets and through expansion opportunities in contiguous or nearby markets. While we would be willing to consider growth by acquisition in certain circumstances, we do not consider the acquisition of another company to be necessary for our continued ability to provide a reasonable return to our shareholders. We believe that we can be more effective in serving our customers than many of our non-local competitors because of our ability to quickly and effectively provide senior management responses to customer needs and inquiries. Our ability to provide these services is enhanced by the stability and experience of our Bank officers and managers.
Summary of Significant Accounting Policies
The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. Many of the Company's accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. The following is a summary of some of the more subjective and complex accounting policies of the Company. A more complete description of the Company's significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company's 2022 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2023 Annual Meeting of Shareholders. There have been no significant changes to the application of significant accounting policies sinceDecember 31, 2022 , except for the adoption of ASC 326 noted in Note 1 above. The allowance for credit 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 credit losses that management believes will be adequate in light of anticipated risks and loan losses. Many of the Company's assets and liabilities are recorded using various techniques that require significant judgment as to recoverability. The collectability of loans is reflected through the Company's estimate of the allowance for credit losses. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability. In addition, certain assets and liabilities are reflected at their estimated fair value in the Consolidated Financial Statements. Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques. The Company's internal models generally involve present value of cash flow techniques. The various techniques are discussed in greater detail elsewhere in this management's discussion and analysis and the Notes to the Consolidated Financial Statements. Fair value of the Company's financial instruments is discussed in Note 5 of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report. There are other complex accounting standards that require the Company to employ significant judgment in interpreting and applying certain of the principles prescribed by those standards. These judgments include, but are not limited to, the determination of whether a financial instrument or other contract meets the definition of a derivative in accordance withU.S. Generally Accepted Accounting Principles ("GAAP").
Management of the Company has made a number of estimates and assumptions relating to reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the accompanying Consolidated Financial Statements in conformity with GAAP. Actual results could differ from those estimates.
Results of Operations Summary. Net earnings were$3.2 million or$0.58 per share and$0.56 per diluted share for the three months endedMarch 31, 2023 , as compared to$3.5 million or$0.63 per share and$0.61 per diluted share for the prior year period. The decrease in first quarter net earnings is primarily the result of a decrease in non-interest income, an increase in non-interest expense and an increase in the provision for credit losses, which were partially offset by an increase in net interest income, compared to the prior year period, as discussed below. The annualized return on average assets was 0.81% for the three months endedMarch 31, 2023 , compared to 0.85% for the same period one year ago, and annualized return on average shareholders' equity was 11.78% for the three months endedMarch 31, 2023 , compared to 10.10% for the same period one year ago. Net Interest Income. Net interest income, the major component of the Company's net income, is the amount by which interest and fees generated by interest-earning assets exceed the total cost of funds used to carry them. Net interest income is affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned and rates paid. Net interest margin is calculated by dividing tax-equivalent net interest income by average interest-earning assets, and represents the Company's net yield on its interest-earning assets. 30 Table of Contents
Net interest income was$14.3 million for the three months endedMarch 31, 2023 , compared to$10.7 million for the three months endedMarch 31, 2022 . The increase in net interest income is due to a$5.5 million increase in interest income, partially offset by a$1.8 million increase in interest expense. The increase in interest income is due to a$3.1 million increase in interest income and fees on loans, a$272,000 increase in interest income on balances due from banks and a$2.1 million increase in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by theFederal Reserve , partially offset by a$600,000 decrease in fee income on SBA PPP loans. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve The increase in interest income on investment securities is primarily due to higher yields on securities purchased afterMarch 31, 2022 . The increase in interest expense is primarily due to an increase in rates paid
on interest-bearing liabilities. Interest income was$16.8 million for the three months endedMarch 31, 2023 , compared to$11.3 million for the three months endedMarch 31, 2022 . The increase in interest income is due to a$3.1 million increase in interest income and fees on loans, a$272,000 increase in interest income on balances due from banks and a$2.1 million increase in interest income on investment securities. The increase in interest income and fees on loans is primarily due to an increase in total loans and rate increases by theFederal Reserve , partially offset by a$600,000 decrease in fee income on SBA PPP loans. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve The increase in interest income on investment securities is primarily due to higher yields on securities purchased afterMarch 31, 2022 . The Bank recognized zero and$600,000 of PPP loan fee income for the three months endedMarch 31, 2023 and the three months endedMarch 31, 2022 , respectively. During the three months endedMarch 31, 2023 , average loans were$1.0 billion , an increase of$152.0 million from average loans of$885.2 million for the three months endedMarch 31, 2022 . During the three months endedMarch 31, 2023 , average PPP loans were zero, compared to average PPP loans of$12.3 million for the three months endedMarch 31, 2022 . During the three months endedMarch 31, 2023 , average investment securities available for sale were$476.3 million , an increase of$63.0 million from average investment securities available for sale of$413.3 million for the three months endedMarch 31, 2022 . The average yield on loans for the three months endedMarch 31, 2023 and 2022 was 5.04% and 4.46%, respectively. The average yield on investment securities available for sale was 2.98% and 1.49% for the three months endedMarch 31, 2023 and 2022, respectively. The average yield on earning assets was 4.41% and 2.96% for the three months endedMarch 31, 2023 and 2022, respectively. Interest expense was$2.5 million for the three months endedMarch 31, 2023 , compared to$663,000 for the three months endedMarch 31, 2022 . The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities and an increase in certificates of deposit. During the three months endedMarch 31, 2023 , average interest-bearing non-maturity deposits were$775.1 million , a decrease of$24.2 million from average interest-bearing non-maturity deposits of$799.3 million for the three months endedMarch 31, 2022 . During the three months endedMarch 31, 2023 , average certificates of deposit were$118.8 million , an increase of$18.4 million from average certificates of deposit of$100.4 million for the three months endedMarch 31, 2022 . The average rate paid on interest-bearing checking and savings accounts was 0.78% and 0.20% for the three months endedMarch 31, 2023 and 2022, respectively. The average rate paid on certificates of deposit was 1.76% for the three months endedMarch 31, 2023 , compared to 0.59% for the same period one year ago. The average rate paid on interest-bearing liabilities was 1.05% for the three months endedMarch 31, 2023 , compared to 0.28% for the same period one year ago. 31 Table of Contents
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 endedMarch 31, 2023 and 2022. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders' equity. Yields and interest income on tax-exempt investments for the three months endedMarch 31, 2023 and 2022 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors' understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below. Three months ended Three months ended March 31, 2023 March 31, 2022 (Dollars in Yield / Yield / thousands) Average Balance Interest Rate Average Balance Interest Rate Interest-earning assets: Loans receivable$ 1,037,124 $ 12,883 5.04 % $ 885,159$ 9,742 4.46 % Investments - taxable 340,536 2,829 3.37 % 288,532 1,005 1.41 % Investments - nontaxable* 138,819 754 2.20 % 128,873 561 1.77 % Due from banks 32,453 383 4.79 % 259,613 111 0.17 % Total interest-earning assets 1,548,932 16,849 4.41 % 1,562,177 11,419 2.96 % Non-interest earning assets: Cash and due from banks 37,515 34,030 Allowance for credit losses (10,443 ) (9,390 ) Other assets 20,784 55,324 Total assets$ 1,596,788 $ 1,642,141 Interest-bearing liabilities: Interest-bearing demand, MMDA & savings deposits $ 775,101$ 1,488 0.78 % $ 799,327$ 403 0.20 % Time deposits 118,763 516 1.76 % 100,364 147 0.59 % Junior subordinated debentures 15,464 248 6.50 % 15,464 75 1.97 % Other 42,233 211 2.03 % 38,471 38 0.40 % Total interest-bearing liabilities 951,561 2,463 1.05 % 953,626 663 0.28 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 523,544 538,961 Other liabilities 12,433 10,950 Shareholders' equity 109,250 138,604 Total liabilities and shareholders' equity$ 1,596,788 $ 1,642,141 Net interest spread$ 14,386 3.36 %$ 10,756 2.69 % Net yield on interest-earning assets 3.77 % 2.79 % Taxable equivalent adjustment Investment securities$ 48 $ 90 Net interest income$ 14,338 $ 10,666
*IncludesU.S. Government agency securities that are non-taxable for state income tax purposes of$12.2 million in 2023 and$14.1 million in 2022. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2023 and 2022. 32 Table of Contents Changes in interest income and interest expense can result from variances in both volume and rates. The following table describes the impact on the Company's tax equivalent net interest income resulting from changes in average balances and average rates for the periods indicated. The changes in net interest income due to both volume and rate changes have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each. Three months ended March 31, 2023 compared to three months Three months ended March 31, 2022 compared to three months ended ended March 31, 2022 March 31, 2021 Changes in Changes in Changes in (Dollars in average average Total Increase average Changes in Total
Increase
thousands) volume rates (Decrease) volume average rates (Decrease) Interest income: Loans: Net of unearned income$ 1,780 1,361 3,141 (691 ) (231 ) (922 ) Investments - taxable 307 1,517 1,824 435 31 466 Investments - nontaxable 49 144 193 120 (363 ) (243 ) Due from banks (1,389 ) 1,661 272 32 44 76 Total interest income 747 4,683 5,430 (104 ) (519 ) (623 ) Interest expense: Interest-bearing demand, MMDA & savings deposits (29 ) 1,114 1,085 79 (173 ) (94 ) Time deposits 53 316 369 (13 ) (52 ) (65 ) Trust preferred securities - 173 173 - 4 4 Other 11 162 173 13 (10 ) 3 Total interest expense 35 1,765 1,800 79 (231 ) (152 ) Net interest income$ 712 2,918 3,630 (183 ) (288 ) (471 )
Provision for Credit Losses. The provision for credit losses for the three months endedMarch 31, 2023 was$224,000 , compared to$71,000 for the three months endedMarch 31, 2022 . The increase in the provision for credit losses is primarily attributable to an increase in loan balances and qualitative adjustments for economic conditions and other factors. The provision for credit losses for the three months endedMarch 31, 2023 includes a$203,000 credit to the provision on unfunded commitments primarily due to a reduction in unfunded commitments fromDecember 31, 2022 toMarch 31, 2023 . Non-Interest Income. Total non-interest income was$3.6 million for the three months endedMarch 31, 2023 , compared to$7.0 million for the three months endedMarch 31, 2022 . The decrease in non-interest income is primarily attributable to a$2.5 million net loss on the sale of securities and a$1.4 million decrease in appraisal management fee income due to a decrease in appraisal volume. The securities sale transaction was executed in January andFebruary 2023 to reduce risk in the investment portfolio provided by favorable conditions that had developed for municipal securities in the first quarter of 2023, and to provide the Bank with more flexibility to support loan growth and reduce the need for other borrowings.
Non-Interest Expense. Total non-interest expense was$13.7 million for the three months endedMarch 31, 2023 , compared to$13.3 million for the three months endedMarch 31, 2022 . The increase in non-interest expense is primarily attributable to a$651,000 increase in salaries and employee benefits expense primarily due to a reduction in loan origination costs due to lower loan demand and an increase in supplemental retirement plan expense and a$687,000 increase in other non-interest expenses primarily due to an increase in deferred compensation expense, which were partially offset by a$1.1 million decrease in appraisal management fee expense due to a decrease in appraisal volume. Income Taxes. Income tax expense was$851,000 for the three months endedMarch 31, 2023 , compared to$848,000 for the three months endedMarch 31, 2022 . The effective tax rate was 21.15% for the three months endedMarch 31, 2023 , compared to 19.72% for the three months endedMarch 31, 2022 . The increase in the effective tax rate is primarily due to a reduction in non-taxable investments.
Analysis of Financial Condition
Investment Securities . Available for sale securities were$399.1 million as ofMarch 31, 2023 , compared to$445.4 million as ofDecember 31, 2022 . Average investment securities available for sale for the three months endedMarch 31, 2023 were$476.3 million , compared to$467.5 million for the year endedDecember 31, 2022 .
Loans. Total loans were
The Bank had
33
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Although the Bank has a diversified loan portfolio, a substantial portion of the
loan portfolio is collateralized by real estate, which is dependent upon the
real estate market. Real estate mortgage loans include both commercial and
residential mortgage loans. At March 31, 2023 , the Bank had $104.0 million in
residential mortgage loans, $102.1 million in home equity loans and $614.7
million in commercial mortgage loans, which include $476.0 million secured by
commercial property and $138.7 million secured by residential property.
Residential mortgage loans at March 31, 2023 include $19.4 million in
non-traditional mortgage loans from the former Banco division of the Bank. At
December 31, 2022 , the Bank had $101.5 million in residential mortgage loans,
$101.1 million in home equity loans and $610.0 million in commercial mortgage
loans, which include $472.3 million secured by commercial property and $137.7
million secured by residential property. Residential mortgage loans include
$20.0 million in non-traditional mortgage loans from the former Banco division
of the Bank. All residential mortgage loans are originated as fully amortizing
loans, with no negative amortization
Allowance for Credit Losses (ACL).The allowance for credit losses reflects
management's assessment and estimate of the risks associated with extending
credit and its evaluation of the quality of the loan portfolio. The Bank
periodically analyzes the loan portfolio in an effort to review asset quality
and to establish an allowance that management believes will be adequate in light
of anticipated risks and loan losses. In assessing the adequacy of the
allowance, size, quality and risk of loans in the portfolio are reviewed.
The allowance for credit losses on loans is a valuation account that is deducted
from the loans' amortized cost basis to present the net amount expected to be
collected on the loans. Loans are charged off against the allowance when
management believes the uncollectibility of a loan balance is confirmed.
Expected recoveries do not exceed the aggregate of amounts previously
charged-off and expected to be charged-off. Accrued interest receivable is
excluded from the estimate of credit losses. The allowance for credit losses
represents management's estimate of lifetime credit losses inherent in loans as
of March 31, 2023 . The allowance for credit losses is estimated by management
using relevant available information, from both internal and external sources,
relating to past events, current conditions, and reasonable and supportable
forecasts. The Company measures expected credit losses for loans on a pooled
basis when similar risk characteristics exist. The Company calculates the
allowance for credit losses using a Weighted Average Remaining Maturity
methodology.
Additionally, the allowance for credit losses calculation includes subjective
adjustments for qualitative risk factors that are likely to cause estimated
credit losses to differ from historical experience. These qualitative
adjustments may increase or reduce reserve levels and include adjustments for:
local, state and national economic outlook; levels and trends of delinquencies;
trends in volume, mix and size of loans; seasoning of the loan portfolio;
experience of staff; concentrations of credit; and interest rate risk.
Loans that do not share risk characteristics are evaluated on an individual
basis. When management determines that foreclosure is probable and the borrower
is experiencing financial difficulty, the expected credit losses are based on
the fair value of collateral at the reporting dated unadjusted for selling costs
as appropriate. The Company did not have any loans evaluated on an individual
basis at March 31, 2023 .
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded. The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company's consolidated balance sheets. 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'sCredit 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'sCredit 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 Board reviews, on a monthly basis, an analysis of the Bank's reserves relative to the range of reserves estimated by the Bank'sCredit Administration . 34 Table of Contents As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third party reviews and evaluates loan relationships greater than or equal to$1.5 million as well as a periodic sample of commercial relationships with exposures below$1.5 million , excluding loans in default, and loans in process of litigation or liquidation. The third party's evaluation and report is shared with management and the board of directors of the Bank ("Bank Board"). Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk. Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance. The provision for credit 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. Since the adoption of CECL onJanuary 1, 2023 , the allowance for credit losses represents management's estimate of credit losses for the remaining estimated life of the Bank's financial assets, including loan receivables and some off-balance sheet credit exposures. Estimating the amount of the allowance for credit losses requires significant judgment and the use of estimates related to historical experience, current conditions, reasonable and supportable forecasts, and the value of collateral on collateral-dependent loans. The loan portfolio also represents the largest asset type on our consolidated balance sheet. Loan losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors. There are many factors affecting the allowance for credit losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and is susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for credit losses could be required that could adversely affect our earnings or financial position in future periods. BeginningDecember 31, 2012 , certain mortgage loans from the former Banco division of the Bank were analyzed separately from other single-family residential loans in the Bank's loan portfolio. These loans are first mortgage loans made to the Latino market, primarily inMecklenburg, North Carolina and surrounding counties. These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations. Management believes it has established the allowance for credit losses pursuant to CECL, and has taken into account the views of its regulators and the current economic environment. Management considers the allowance adequate to cover the estimated losses inherent in the Bank's loan portfolio as of the date of the financial statements. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company. Non-performing Assets. Non-performing assets were$3.6 million or 0.23% of total assets atMarch 31, 2023 , compared to$3.7 million or 0.23% of total assets atDecember 31, 2022 . Non-accrual loans were$3.6 million atMarch 31, 2023 and$3.7 million atDecember 31, 2022 . As a percentage of total loans outstanding, non-accrual loans were 0.35% and 0.36% atMarch 31, 2023 andDecember 31, 2022 , respectively. Non-performing assets include$3.6 million in commercial and residential mortgage loans and$3,000 in other loans atMarch 31, 2023 , compared to$3.7 million in commercial and residential mortgage loans and$8,000 in other loans atDecember 31, 2022 . The Bank had no loans 90 days past due and still accruing atMarch 31, 2023 andDecember 31, 2022 . The Bank had no other real estate owned atMarch 31, 2023 andDecember 31, 2022 . 35 Table of Contents Deposits. Total deposits were$1.4 billion atMarch 31, 2023 andDecember 31, 2022 . Core deposits, a non-GAAP measure, which include noninterest-bearing demand deposits, NOW, MMDA, savings and non-brokered certificates of deposit of denominations of$250,000 or less, were$1.3 billion and$1.4 billion atMarch 31, 2023 andDecember 31, 2022 , respectively. Management believes it is useful to calculate and present core deposits because of the positive impact this low cost funding source provides to the Bank's funding base. Certificates of deposit in amounts of more than$250,000 totaled$67.6 million atMarch 31, 2023 , compared to$31.0 million atDecember 31, 2022 . Other time deposits totaled$100.7 million atMarch 31, 2023 , compared to$67.0 million atDecember 31, 2022 . The increases in certificates of deposit in amounts of$250,000 or more and other time deposits are primarily due to promotional rates offered on select certificates of deposit products during the first quarter of 2023. Estimated uninsured deposits totaled$407.8 million , or 28.85% of total deposits, atMarch 31, 2023 , compared to$439.8 million , or 30.64% of total deposits, atDecember 31, 2022 . Uninsured amounts are estimated based on the portion of account balances in excess ofFDIC insurance limits. The Bank did not have any significant deposit concentrations atMarch 31, 2023 . Borrowed Funds. There were no FHLB borrowings outstanding atMarch 31, 2023 andDecember 31, 2022 . Securities sold under agreements to repurchase were$39.5 million atMarch 31, 2023 , compared to$47.7 million atDecember 31, 2022 . Junior Subordinated Debentures (related to Trust Preferred Securities).Junior subordinated debentures were$15.5 million atMarch 31, 2023 andDecember 31, 2022 . InJune 2006 , the Company formed a second wholly ownedDelaware statutory trust, PEBK Capital Trust II ("PEBK Trust II"), which issued$20.0 million of guaranteed preferred beneficial interests in the Company's junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase$20.6 million of junior subordinated debentures of the Company. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay inDecember 2006 the trust preferred securities issued inDecember 2001 byPEBK Capital Trust , a wholly ownedDelaware statutory trust of the Company, and for general purposes. The debentures represent the sole assets of PEBK Trust II. PEBK Trust II is not included in the consolidated financial statements. The Company redeemed$5.0 million of outstanding trust preferred securities in 2019. The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities. The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities. These trust preferred securities are mandatorily redeemable upon maturity of the debentures onJune 28, 2036 . The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.
The Company has no financial instruments tied to LIBOR other than the trust preferred securities issued by PEBK Trust II, which are tied to three-month LIBOR. The one-week and two-monthU.S. dollar-denominated (USD) LIBOR rates ceased to be published onDecember 31, 2021 . The overnight, one-month, three-month, nine-month, and 12-month USD LIBOR rates will continue to be published throughJune 30, 2023 . Management has reviewed the implications of the Adjustable Interest Rate Act (LIBOR Act) enacted inMarch 2022 and the relatedFederal Reserve regulations with legal counsel, and is currently working with the trustee to complete required updates prior toJune 30, 2023 . Asset Liability and Interest Rate Risk Management. The objective of the Company's Asset Liability and Interest Rate Risk strategies is to identify and manage the sensitivity of net interest income to changing interest rates and to minimize the interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities. This is done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income.
The Company manages its exposure to fluctuations in interest rates through
policies established by the Asset/Liability Committee ("ALCO") of the Bank. The
ALCO meets quarterly and has the responsibility for approving asset/liability
management policies, formulating and implementing strategies to improve balance
sheet positioning and/or earnings and reviewing the interest rate sensitivity of
the Company. ALCO seeks to minimize interest rate risk between interest-earning
assets and interest-bearing liabilities by attempting to minimize wide
fluctuations in net interest income due to interest rate movements. The ability
to control these fluctuations has a direct impact on the profitability of the
Company. Management monitors this activity on a regular basis through analysis
of its portfolios to determine the difference between rate sensitive assets and
rate sensitive liabilities.
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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 endedMarch 31, 2023 totaled$1.5 billion , exceeding average rate sensitive liabilities of$951.6 million by$597.4 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 ofMarch 31, 2023 . Included in the rate sensitive assets are$183.4 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by theFOMC .The Company utilizes interest rate floors on certain variable rate loans to protect against downward movements in the prime rate. AtMarch 31, 2023 , the Company had$112.3 million in loans with interest rate floors. The floors were in effect on$8,000 of these loans. Liquidity. The objectives of the Company's liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company's liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As ofMarch 31, 2023 , such unfunded commitments to extend credit were$376.9 million , while commitments in the form of standby letters of credit totaled$4.4 million . As ofDecember 31, 2022 , such unfunded commitments to extend credit were$382.7 million , while commitments in the form of standby letters of credit totaled
$4.4 million . The Bank uses several sources to meet its liquidity requirements. The primary source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposit of denominations less than$250,000 . The Bank considers these to be a stable portion of the Bank's liability mix and the result of on-going consumer and commercial banking relationships. As ofMarch 31, 2023 , the Bank's core deposits, a non-GAAP measure, totaled$1.4 billion , or 96.33% of total deposits. As ofDecember 31, 2022 , the Bank's core deposits totaled$1.4 billion , or 97.84% of total deposits. The other sources of funding for the Bank are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreements to repurchase and FHLB borrowings. The Bank is also able to borrow from theFederal Reserve Bank ("FRB") on a short-term basis. The Bank's policies include the ability to access wholesale funding of up to 40% of total assets. The Bank's wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to theState of North Carolina . The Bank's ratio of wholesale funding to total assets was 1.29% and 0.92% as ofMarch 31, 2023 andDecember 31, 2022 , respectively. The Bank has a line of credit with the FHLB equal to 20% of the Bank's total assets. There were no FHLB borrowings outstanding atMarch 31, 2023 andDecember 31, 2022 . AtMarch 31, 2023 , the carrying value of loans pledged as collateral to the FHLB totaled$195.1 million compared to$149.4 million atDecember 31, 2022 . The remaining availability under the line of credit with the FHLB was$124.4 million atMarch 31, 2023 compared to$86.5 million atDecember 31, 2022 . The Bank had no borrowings from the FRB atMarch 31, 2023 orDecember 31, 2022 . FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. AtMarch 31, 2023 , the carrying value of loans pledged as collateral to the FRB totaled$594.1 million compared to$585.0 million atDecember 31, 2022 . Availability under the line of credit with the FRB was$449.2 million and$445.1 million atMarch 31, 2023 andDecember 31, 2022 , respectively. The Bank has completed the necessary steps in order to access the FRB's Bank Term Funding Program ("BTFP"), should it wish to do so at any time in the future. The Bank has not pledged any collateral to the BTFP as ofMarch 31, 2023 . The Bank also had the ability to borrow up to$90.5 million for the purchase of overnight federal funds from four correspondent financial institutions as ofMarch 31, 2023 . 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 28.23% atMarch 31, 2023 and 30.32% atDecember 31, 2022 . The minimum required liquidity ratio as defined in the Bank's Asset/Liability and Interest Rate Risk Management Policy was 10% atMarch 31, 2023 andDecember 31, 2022 . 37 Table of Contents
Contractual Obligations and Off-Balance Sheet Arrangements. The Company's contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit.
Capital Resources. Shareholders' equity was$114.8 million , or 7.16% of total assets, atMarch 31, 2023 , compared to 105.2 million, or 6.49% of total assets, atDecember 31, 2022 . The increase in shareholders' equity is primarily due to a decrease in the unrealized loss on investment securities available for sale due to rate changes betweenDecember 31, 2022 andMarch 31, 2023 . Annualized return on average equity for the three months endedMarch 31, 2023 was 11.78%, compared to 10.10% for the three months endedMarch 31, 2022 . Total cash dividends paid on common stock were$1.9 million for the three months
endedMarch 31, 2023 and 2022. In March of 2023, the Board of Directors authorized a stock repurchase program, whereby up to$2.0 million may be allocated to repurchase the Company's common stock. Any purchases under the Company's stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately-negotiated transactions. The timing and amount of any repurchase of shares will be determined by the Company's management, based on its evaluation of market conditions and other factors. The stock repurchase program may be suspended at any time or from time-to-time without prior notice. The Company had not repurchased any shares of its common stock, under this stock repurchase program as ofMarch 31, 2023 . In 2013, the FRB approved its final rule on the Basel III capital standards, which implement changes to the regulatory capital framework for banking organizations. The Basel III capital standards, which became effectiveJanuary 1, 2015 , include new risk-based capital and leverage ratios, which were phased in from 2015 to 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are as follows: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total risk based capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% (unchanged from previous rules). An additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes beginning onJanuary 1, 2016 and was phased in through 2019 (increasing by 0.625% onJanuary 1, 2016 and each subsequentJanuary 1 , until it reached 2.5% onJanuary 1, 2019 ). This resulted in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained earnings that could be utilized for such actions. Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. Tier 1 capital is generally defined as shareholders' equity and trust preferred securities less all intangible assets and goodwill. Tier 1 capital includes$15.0 million in trust preferred securities atMarch 31, 2023 andDecember 31, 2022 . The Company's Tier 1 capital ratio was 13.34% and 13.21% atMarch 31, 2023 andDecember 31, 2022 , 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 credit losses, not exceeding 1.25% of the Company's risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets. The Company's total risk-based capital ratio was 14.27% and 14.04% atMarch 31, 2023 andDecember 31, 2022 , respectively. The Company's common equity Tier 1 capital consists of common stock and retained earnings. The Company's common equity Tier 1 capital ratio was 12.15% and 12.03% atMarch 31, 2023 andDecember 31, 2022 , 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 10.27% and 9.82% atMarch 31, 2023 and December
31, 2022, respectively. The Bank's Tier 1 risk-based capital ratio was 13.24% and 13.10% atMarch 31, 2023 andDecember 31, 2022 , respectively. The total risk-based capital ratio for the Bank was 14.17% and 13.93% atMarch 31, 2023 andDecember 31, 2022 , respectively. The Bank's common equity Tier 1 capital ratio was 13.24% and 13.10% atMarch 31, 2023 andDecember 31, 2022 , respectively. The Bank's Tier 1 leverage capital ratio was 10.12% and 9.68% atMarch 31, 2023 and December
31, 2022, 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" atMarch 31, 2023 . 38 Table of Contents
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