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-28 through A-69 of the Company's 2021 Annual Report to Shareholders which is
Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders.
Introduction
Management's discussion and analysis of earnings and related data are
presented to assist in understanding the consolidated financial condition and
results of operations of the Company. The Company is the parent company of the
Bank and a registered bank holding company operating under the supervision of
the Board of Governors of the Federal Reserve System (the "Federal Reserve").
The Bank is a North Carolina -chartered bank, with offices in Catawba , Lincoln ,
Alexander , Mecklenburg , Iredell , Wake , Rowan and Forsyth counties, operating
under the banking laws of North Carolina and the rules and regulations of the
Federal Deposit Insurance Corporation .
Overview
Our business consists principally of attracting deposits from the general public
and investing these funds in commercial loans, real estate mortgage loans, real
estate construction loans and consumer loans. Our profitability depends
primarily on our net interest income, which is the difference between the income
we receive on our loan and investment securities portfolios and our cost of
funds, which consists of interest paid on deposits and borrowed funds. Net
interest income also is affected by the relative amounts of our interest-earning
assets and interest-bearing liabilities. When interest-earning assets
approximate or exceed interest-bearing liabilities, a positive interest rate
spread will generate net interest income. Our profitability is also affected by
the level of other income and operating expenses. Other income consists
primarily of miscellaneous fees related to our loans and deposits, mortgage
banking income and commissions from sales of annuities and mutual funds.
Operating expenses consist of compensation and benefits, occupancy related
expenses, federal deposit and other insurance premiums, data processing,
advertising and other expenses.
Our operations are influenced significantly by local economic conditions and by
policies of financial institution regulatory authorities. The earnings on our
assets are influenced by the effects of, and changes in, trade, monetary and
fiscal policies and laws, including interest rate policies of the Federal
Reserve , inflation, interest rates, market and monetary fluctuations. Lending
activities are affected by the demand for commercial and other types of loans,
which in turn is affected by the interest rates at which such financing may be
offered. Our cost of funds is influenced by interest rates on competing
investments and by rates offered on similar investments by competing financial
institutions in our market area, as well as general market interest rates. These
factors can cause fluctuations in our net interest income and other income. In
addition, local economic conditions can impact the credit risk of our loan
portfolio, in that (1) local employers may be required to eliminate employment
positions of individual borrowers, and (2) small businesses and commercial
borrowers may experience a downturn in their operating performance and become
unable to make timely payments on their loans. Management evaluates these
factors in estimating the allowance for loan and lease losses ("ALLL",
"allowance for loan losses", or "allowance") and changes in these economic
factors could result in increases or decreases to the provision for loan losses.
COVID-19 has adversely affected, and may continue to adversely affect economic
activity globally, nationally and locally. Following the COVID-19 outbreak in
December 2019 and January 2020 , market interest rates declined significantly,
with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the
first time. Such events generally had an adverse effect on business and consumer
confidence and the Company and its customers. On March 3, 2020 , the Federal
Reserve Federal Open Market Committee ("FOMC") reduced the target federal funds
rate by 50 basis points to a range of 1.00% to 1.25%. Subsequently on March 16,
2020 , the FOMC further reduced the target federal funds rate by an additional
100 basis points to a range of 0.00% to 0.25%. These reductions in interest
rates and other effects of the COVID-19 pandemic had an adverse effect on the
Company's financial condition and results of operations. 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. See "COVID-19 Impact"
below for additional information regarding the impact of the COVID-19 pandemic
on the Company's business. Subsequently, concern over the ongoing economic
effects of COVID19, continuing supply-chain disruption and rising inflation has
caused the FOMC to increase the target federal funds rate by 225 basis points in
2022 to a range of 2.25% to 2.50% at July 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.
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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.
COVID 19 Impact
Overview. The COVID-19 pandemic has caused unprecedented disruption that has
affected daily living and negatively impacted the global economy, the banking
industry and the Company. While we are unable to estimate the magnitude, the
COVID-19 pandemic and the related global economic crisis may adversely affect
our future operating results. As such, the impact of the COVID-19 pandemic on
future fiscal periods is subject to a high degree of uncertainty. The emergence
of COVID-19 and new variants of the virus around the world, and particularly in
the United States and Canada , continues to present significant risks to the
Company, not all of which the Company is able to fully evaluate or even to
foresee at the current time. The pandemic has affected the Company's financial
results and business operations, and economic and health conditions in the
United States and across most of the globe have continued to change since the
beginning of the pandemic. Management cannot predict the full impact of the
pandemic on the Company's management and employees, its customers nor to
economic conditions generally, and such effects could exist for an extended
period of time.
Effects on Our Market Areas. Our commercial and consumer banking products and
services are offered primarily in North Carolina where individual and
governmental responses to the COVID-19 pandemic led to a broad curtailment of
economic activity beginning in March 2020 . In North Carolina , schools closed for
the remainder of the 2019-2020 academic year, businesses were ordered to
temporarily close or reduce their business operations to accommodate social
distancing and shelter in place requirements, non-critical healthcare services
were significantly curtailed and unemployment levels rose. Since the initial
shut down in March 2020 , phased reopening plans began in mid-May of 2020 and
continued throughout 2021. While COVID-19 cases and restrictions are currently
decreasing, we are unable to predict if COVID-19 cases will continue to
decrease, if additional policies, procedures, restrictions, limitations and
mandates will be implemented requiring employees to be vaccinated and/or be
subject to regular COVID-19 testing and the impact that the foregoing will have
on businesses, including the business of the Company and its customers.
Policy and Regulatory Developments. Federal, state and local governments and
regulatory authorities enacted and issued a range of policy responses to the
COVID-19 pandemic, including the following:
· The FOMC decreased the range for the federal funds target rate by 0.5
percent on March 3, 2020 , and by another 1.0 percent on March 16, 2020 .
· On
a
individuals, supplemental unemployment insurance benefits and a
billion loan program administered through the SBA, referred to as the PPP.
Under the PPP, small businesses, sole proprietorships, independent
contractors and self-employed individuals could apply for loans from
existing SBA lenders and other approved regulated lenders that enrolled in
the PPP loan program, subject to certain limitations and eligibility
criteria. After the initial
exhausted, an additional
authorized. On
Businesses, Nonprofits and Venues Act (the "Economic Aid Act") became law.
The Economic Aid Act reopened and expanded the PPP loan program. The
changes to the PPP loan program allowed new borrowers to apply for a loan
under the original PPP loan program and the creation of an additional PPP
loan for eligible borrowers. The Economic Aid Act also revised certain PPP
requirements, including aspects of loan forgiveness on existing PPP loans.
Under the Economic Aid Act, the PPP loan program was set to expire on
on March 30, 2021 extended the PPP loan program until May 31, 2021 . The
Bank participated as a lender in the PPP loan program. In addition, the
CARES Act provides financial institutions the option to temporarily
suspend certain requirements under GAAP related to troubled debtrestructurings ("TDR loans") for a limited period of time to account for
the effects of COVID-19. See Note 3 of the financial statements for
additional disclosure of loan modifications as of June 30, 2022 .
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· On
Statement on Loan Modifications and Reporting for Financial Institutions,
which, among other things, encouraged financial institutions to work
prudently with borrowers who are or may be unable to meet their
contractual payment obligations because of the effects of COVID-19, and
stated that institutions generally do not need to categorize
COVID-19-related modifications as TDRs and that the agencies will notdirect supervised institutions to automatically categorize all COVID-19
related loan modifications as TDRs. See Note 3 of the financial statements
for additional disclosure of loan modifications as of June 30, 2022 .
· In addition to the policy responses described above, the federal bank
regulatory agencies, along with their state counterparts, issued a stream
of guidance in response to the COVID-19 pandemic and taken a number ofunprecedented steps to help banks navigate the pandemic and mitigate its
impact. These included, without limitation: requiring banks to focus on
business continuity and pandemic planning; adding pandemic scenarios to
stress testing; encouraging bank use of capital buffers and reserves in
lending programs; permitting certain regulatory reporting extensions;
reducing margin requirements on swaps; permitting certain otherwise
prohibited investments in investment funds; issuing guidance to encourage
banks to work with customers affected by the pandemic and encourage loan
workouts; and providing credit under the Community Reinvestment Act
("CRA") for certain pandemic related loans, investments and publicservice. Moreover, because of the need for social distancing measures, the
agencies revamped the manner in which they conducted periodic examinations
of their regular institutions, including making greater use of off-site
reviews. The
institutions to utilize its discount window for loans and intraday credit
extended by its Reserve Banks to help households and businesses impacted
by the pandemic and announced numerous funding facilities. The FDIC also
acted to mitigate the deposit insurance assessment effects of
participating in the PPP loan program and the Federal Reserve's PPP
Liquidity Facility and Money Market Mutual Fund Liquidity Facility.
Effects on Our Business. The COVID-19 pandemic and the specific developments
referred to above have had and will likely continue to have an impact on our
business. In particular, we anticipate that a significant portion of the Bank's
borrowers in the hotel, restaurant and retail industries will continue to endure
economic distress, which has caused, and may continue to cause, them to draw on
their existing lines of credit and adversely affect their ability to repay
existing indebtedness, and is expected to adversely impact the value of
collateral. These developments, together with economic conditions generally,
including labor shortages, may also impact our commercial real estate portfolio,
particularly with respect to real estate with exposure to these industries, and
the value of certain collateral securing our loans. As a result, our financial
condition, capital levels and results of operations may be adversely affected,
as described in further detail below.
Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:
· On
resources to achieve appropriate social distancing protocols in all
facilities; in addition, we established mandatory remote work through June
30, 2021 to isolate certain personnel essential to critical business
continuity operations. We also expanded and tested remote access for the
core banking system, funds transfer and loan operations.
· We continue to actively work with loan customers to evaluate prudent loan
modification terms.
· We continue to promote our digital banking options through our website.
Customers are encouraged to utilize online and mobile banking tools, and
our customer service and retail departments are fully staffed and
available to assist customers remotely.
· We were a participating lender in the PPP loan program. We believed it was
our responsibility as a community bank to assist the SBA in the
distribution of funds authorized under the CARES Act to our customers and
communities.
· On
appointment only services. Branch lobbies were reopened on
One small branch located in an assisted living facility was permanently
closed effective
restrictions. All business functions continue to be operational. We
continue to pay all employees according to their normal work schedule,
even if their work has been reduced. No employees have been furloughed.
While the majority of employees are now working on-site, some employees
whose job responsibilities can be effectively carried out remotely
continue to work from home. Employees working on-site are observing
current public health guidelines.
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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 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders. 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. 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 loan 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$0.59 per share and$0.57 per diluted share for the three months endedJune 30, 2022 , as compared to$4.6 million or$0.82 per share and$0.80 per diluted share for the prior year period. The decrease in second quarter net earnings is primarily the result of a decrease in net interest income, 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 compared to the three months endedJune 30, 2022 , as discussed below.
The annualized return on average assets was 0.77% for the three months ended
Year-to-date net earnings as ofJune 30, 2022 were$6.7 million or$1.21 per share and$1.18 per diluted share for the six months endedJune 30, 2022 , as compared to$8.7 million or$1.55 per share and$1.51 per diluted share for the prior year period. The decrease in year-to-date net earnings is primarily attributable to a decrease in net interest income, 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 compared to the prior year period, as discussed below.
The annualized return on average assets was 0.81% for the six months endedJune 30, 2022 , compared to 0.89% for the same period one year ago, and annualized return on average shareholders' equity was 10.39% for the six months endedJune 30, 2022 , compared to 9.43% 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. 31 Table of Contents Net interest income was$11.3 million for the three months endedJune 30, 2022 , compared to$11.7 million for the three months endedJune 30, 2021 . The decrease in net interest income is due to a$525,000 decrease in interest income, which was partially offset by a$198,000 decrease in interest expense. The decrease in interest income is primarily due to a$1.1 million decrease in interest income and fees on loans, which was partially offset by an increase in interest income on balances due from banks and an increase in interest income on investment securities. The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. Interest income was$12.0 million for the three months endedJune 30, 2022 , compared to$12.5 million for the three months endedJune 30, 2021 . The decrease in interest income is primarily due to a$1.1 million decrease in interest income and fees on loans, which was partially offset by an increase in interest income on balances due from banks and an increase in interest income on investment securities. The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans. The Bank recognized$293,000 and$1.5 million of PPP loan fee income for the three months endedJune 30, 2022 and the three months endedJune 30, 2021 , respectively. During the three months endedJune 30, 2022 , average loans were$917.8 million , an increase of$1.4 million from average loans of$916.4 million for the three months endedJune 30, 2021 . During the three months endedJune 30, 2022 , average PPP loans were$4.0 million , a reduction of$53.0 million from average PPP loans of$57.0 million for the three months endedJune 30, 2021 . During the three months endedJune 30, 2022 , average investment securities available for sale were$455.3 million , an increase of$108.4 million from average investment securities available for sale of$346.9 million for the three months endedJune 30, 2021 . The average yield on loans for the three months endedJune 30, 2022 and 2021 was 4.34% and 4.82%, respectively. The average yield on investment securities available for sale was 1.48% and 1.80% for the three months endedJune 30, 2022 and 2021, respectively. The average yield on earning assets was 3.03% and 3.43% for the three months endedJune 30, 2022 and 2021, respectively. Interest expense was$644,000 for the three months endedJune 30, 2022 , compared to$842,000 for the three months endedJune 30, 2021 . The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the three months endedJune 30, 2022 , average interest-bearing non-maturity deposits were$823.3 million , an increase of$88.3 million from average interest-bearing non-maturity deposits of$735.0 million for the three months endedJune 30, 2021 . During the three months endedJune 30, 2022 , average certificates of deposit were$101.6 million , a reduction of$5.0 million from average certificates of deposit of$106.6 million for the three months endedJune 30, 2021 . The average rate paid on interest-bearing checking and savings accounts was 0.18% and 0.30% for the three months endedJune 30, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.56% for the three months endedJune 30, 2022 , compared to 0.72% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.26% for the three months endedJune 30, 2022 , compared to 0.38% for the same period one year ago. 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 endedJune 30, 2022 and 2021. 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 endedJune 30, 2022 and 2021 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. 32 Table of Contents Three months ended Three months ended June 30, 2022 June 30, 2021 (Dollars in Yield / Yield / thousands) Average Balance Interest Rate Average Balance Interest Rate Interest-earning assets: Loans receivable $ 917,833$ 9,934 4.34 % $ 916,393$ 11,003 4.82 % Investments - taxable 325,268 1,060 1.31 % 211,422 650 1.23 % Investments - nontaxable* 133,529 645 1.94 % 139,704 936 2.69 % Other 222,839 442 0.80 % 209,737 48 0.09 % Total interest-earning assets 1,599,469 12,081 3.03 % 1,477,256 12,637 3.43 % Non-interest earning assets: Cash and due from banks 38,145 32,350 Allowance for loan losses (9,427 ) (9,572 ) Other assets 39,842 63,536 Total assets$ 1,668,029 $ 1,563,570 Interest-bearing liabilities: Interest-bearing demand, MMDA & savings deposits $ 823,286$ 366 0.18 % $ 734,988$ 543 0.30 % Time deposits 101,641 141 0.56 % 106,669 191 0.72 % Junior subordinated debentures 15,464 103 2.67 % 15,464 71 1.84 % Other 37,460 34 0.36 % 30,295 37 0.49 % Total interest-bearing liabilities 977,851 644 0.26 % 887,416 842 0.38 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 560,803 528,502 Other liabilities 12,234 6,485 Shareholders' equity 117,141 141,167 Total liabilities and shareholders' equity$ 1,668,029 $ 1,563,570 Net interest spread$ 11,437 2.77 %$ 11,795 3.05 % Net yield on interest-earning assets 2.87 % 3.20 % Taxable equivalent adjustment Investment securities$ 89 $ 120 Net interest income$ 11,348 $ 11,675
*IncludesU.S. Government agency securities that are non-taxable for state income tax purposes of$13.6 million in 2022 and$13.9 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2022 and 2021. Year-to-date net interest income as ofJune 30, 2022 was$22.0 million , compared to$22.8 million for the six months endedJune 30, 2021 . The decrease in net interest income is due to a$1.1 million decrease in interest income, which was partially offset by a$350,000 decrease in interest expense. The decrease in interest income is primarily due to a$2.0 million decrease in interest income and fees on loans, which was partially offset by an increase in interest income on balances due from banks and an increase in interest income on investment securities. The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. 33 Table of Contents Interest income was$23.3 million for the six months endedJune 30, 2022 , compared to$24.4 million for the six months endedJune 30, 2021 . The decrease in interest income is primarily due to a$2.0 million decrease in interest income and fees on loans, which was partially offset by an increase in interest income on balances due from banks and an increase in interest income on investment securities. The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans. The Bank recognized$893,000 and$2.5 million of PPP loan fee income for the six months endedJune 30, 2022 and the six months endedJune 30, 2021 , respectively. During the six months endedJune 30, 2022 , average loans were$901.6 million , a decrease of$30.1 million from average loans of$931.7 million for the six months endedJune 30, 2021 . During the six months endedJune 30, 2022 , average PPP loans were$9.7 million , a decrease of$46.0 million from average PPP loans of$55.7 million for the six months endedJune 30, 2021 . During the six months endedJune 30, 2022 , average investment securities available for sale were$434.4 million , an increase of$129.3 million from average investment securities available for sale of$305.1 million for the six months endedJune 30, 2021 . The average yield on loans for the six months endedJune 30, 2022 and 2021 was 4.40% and 4.69%, respectively. The average yield on investment securities available for sale was 1.49% and 1.87% for the six months endedJune 30, 2022 and 2021, respectively. The average yield on earning assets was 3.00% and 3.49% for the six months endedJune 30, 2022 and 2021, respectively. Interest expense was$1.3 million for the six months endedJune 30, 2022 , compared to$1.7 million for the six months endedJune 30, 2021 . The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the six months endedJune 30, 2022 , average interest-bearing non-maturity deposits were$811.4 million , an increase of$107.8 million from average interest-bearing non-maturity deposits of$703.6 million for the six months endedJune 30, 2021 . During the six months endedJune 30, 2022 , average certificates of deposit were$101.0 million , a decrease of$6.3 million from average certificates of deposit of$107.3 million for the six months endedJune 30, 2021 . The average rate paid on interest-bearing checking and savings accounts was 0.19% and 0.30% for the six months endedJune 30, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.57% for the six months endedJune 30, 2022 , compared to 0.76% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.27% for the six months endedJune 30, 2022 , compared to 0.39% for the same period one year ago.
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 six months endedJune 30, 2022 and 2021. 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 six months endedJune 30, 2022 and 2021 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. 34 Table of Contents Six months ended Six months ended June 30, 2022 June 30, 2021 (Dollars in Yield / Yield / thousands) Average Balance Interest Rate Average Balance Interest Rate Interest-earning assets: Loans receivable $ 901,586 19,676 4.40 % $ 931,714 21,667 4.69 % Investments - taxable 306,986 2,067 1.36 % 185,350 1,191 1.30 % Investments - nontaxable* 131,228 1,204 1.85 % 124,171 1,741 2.83 % Other 241,126 553 0.46 % 184,755 83 0.09 % Total interest-earning assets 1,580,926 23,500 3.00 % 1,425,990 24,682 3.49 % Non-interest earning assets: Cash and due from banks 36,099 31,164 Allowance for loan losses (9,408 ) (9,749 ) Other assets 47,539 63,384 Total assets$ 1,655,156 $ 1,510,789 Interest-bearing liabilities: NOW, MMDA & savings deposits $ 811,372 769 0.19 % $ 703,610 1,040 0.30 % Time deposits 101,006 287 0.57 % 107,343 403 0.76 % Trust preferred securities 15,464 178 2.32 % 15,464 142 1.85 % Other 37,963 73 0.39 % 28,841 72 0.50 % Total interest-bearing liabilities 965,805 1,307 0.27 % 855,258 1,657 0.39 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 549,942 508,801 Other liabilities 9,996 4,164 Shareholders' equity 129,413 142,566 Total liabilities and shareholders' equity$ 1,655,156 $ 1,510,789 Net interest spread$ 22,193 2.73 %$ 23,025 3.10 % Net yield on interest-earning assets 2.83 % 3.26 % Taxable equivalent adjustment Investment securities$ 179 $ 243 Net interest income$ 22,014 $ 22,782
*IncludesU.S. Government agency securities that are non-taxable for state income tax purposes of$13.8 million in 2022 and$10.7 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2021 and 2020. 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. 35 Table of Contents Three months endedJune 30, 2022 Six months endedJune 30, 2022 compared to three months endedJune 30, 2021
compared to six months ended
Changes in Changes in Changes in
(Dollars in Changes in average Total Increase average average Total Increase
thousands) average volume rates (Decrease) volume rates (Decrease)
Interest
income:
Loans: Net
of unearned
income $ 16 (1,085 ) (1,069 ) (679 ) (1,312 ) (1,991 )
Investments
- taxable 360 50 410 800 77 877
Investments
-
nontaxable (36 ) (255 ) (291 ) 82 (619 ) (537 )
Other 15 379 394 77 392 469
Total
interest
income 355 (911 ) (556 ) 280 (1,462 ) (1,182 )
Interest
expense:
NOW, MMDA &
savings
deposits 52 (229 ) (177 ) 131 (402 ) (271 )
Time
deposits (8 ) (41 ) (49 ) (21 ) (95 ) (116 )
Trust
preferred
securities - 32 32 - 36 36
Other 8 (12 ) (4 ) 20 (19 ) 1
Total
interest
expense 52 (250 ) (198 ) 130 (480 ) (350 )
Net
interest
income $ 303 (661 ) (358 ) 150 (982 ) (832 )
Provision for Loan Losses. The provision for loan losses for the three
months ended June 30, 2022 was $410,000 , compared to a recovery of $226,000 for
the three months ended June 30, 2021 . The increase in the provision for loan
losses is primarily attributable to an increase in reserves due to a net
increase in the volume of loans in the general reserve pool. There were no loans
with modifications as a result of the COVID-19 pandemic at June 30, 2022 and
December 31, 2021 .
The provision for loan losses for the six months ended June 30, 2022 was
$481,000 , compared to a recovery of $681,000 for the six months ended June 30,
2021 . The increase in the provision for loan losses is primarily attributable to
an increase in reserves due to a net increase in the volume of loans in the
general reserve pool.
Non-Interest Income. Total non-interest income was $7.3 million for the
three months ended June 30, 2022 , compared to $6.0 million for the three months
ended June 30, 2021 . The increase in non-interest income is primarily
attributable to a $1.4 million increase in appraisal management fee income due
to an increase in the volume of appraisals and an increase in service charge
income primarily due to service charge changes implemented in March 2022 , which
were partially offset by a $624,000 decrease in mortgage banking income due to a
decrease in mortgage loan volume and additional mortgage loans being retained
for the Bank's portfolio.
Non-interest income was $14.4 million for the six months ended June 30, 2022 ,
compared to $11.9 million for the six months ended June 30, 2021 . The increase
in non-interest income is primarily attributable to a $3.1 million increase in
appraisal management fee income due to an increase in the volume of appraisals
and an increase in service charge income primarily due to service charge changes
implemented in March 2022 , which were partially offset by a $1.3 million
decrease in mortgage banking income due to a decrease in mortgage loan volume
and additional mortgage loans being retained for the Bank's portfolio.
Non-Interest Expense. Total non-interest expense was $14.2 million for the three
months ended June 30, 2022 , compared to $12.1 million for the three months ended
June 30, 2021 . The increase in non-interest expense is primarily attributable to
a $1.1 million increase in appraisal management fee expense due to an increase
in the volume of appraisals and a $777,000 increase in salaries and employee
benefits expense primarily due to an increase in insurance costs.
Non-interest expense was $27.6 million for the six months ended June 30, 2022 ,
compared to $24.4 million for the six months ended June 30, 2021 . The increase
in non-interest expense is primarily attributable to a $2.4 million increase in
appraisal management fee expense due to an increase in the volume of appraisals
and a $443,000 increase in salaries and employee benefits expense primarily due
to an increase in insurance costs.
Income Taxes. Income tax expense was $806,000 for the three months ended June
30, 2022 , compared to $1.2 million for the three months ended June 30, 2021 . The
effective tax rate was 20.03% for the three months ended June 30, 2022 , compared
to 20.55% for the three months ended June 30, 2021 . Income tax expense was $1.7
million for the six months ended June 30, 2022 , compared to $2.2 million for the
six months ended June 30, 2021 . The effective tax rate was 19.87% for the six
months ended June 30, 2022 , compared to 20.41% for the six months ended June 30,
2021 .
36
Table of Contents
Analysis of Financial Condition
Investment Securities . Available for sale securities were$426.8 million atJune 30, 2022 , compared to$406.5 million atDecember 31, 2021 . Average investment securities available for sale for the six months endedJune 30, 2022 were$434.4 million , compared to$349.6 million for the year endedDecember 31, 2021 . Loans. AtJune 30, 2022 , loans were$959.5 million , compared to$884.9 million atDecember 31, 2021 . The Bank had$1.4 million and$18.0 million in PPP loans atJune 30, 2022 andDecember 31, 2021 , respectively. Average loans represented 57% and 61% of average earning assets for the six months endedJune 30, 2022 and the year endedDecember 31, 2021 , respectively.
The Bank had
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. AtJune 30, 2022 , the Bank had$93.1 million in residential mortgage loans,$92.3 million in home equity loans and$574.0 million in commercial mortgage loans, which include$443.5 million secured by commercial property and$130.5 million secured by residential property. Residential mortgage loans atJune 30, 2022 include$21.4 million in non-traditional mortgage loans from the former Banco division of the Bank. AtDecember 31, 2021 , the Bank had$101.5 million in residential mortgage loans,$85.6 million in home equity loans and$494.4 million in commercial mortgage loans, which include$381.0 million secured by commercial property and$113.4 million secured by residential property. Residential mortgage loans include$23.1 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. Past due TDR loans and non-accrual TDR loans totaled$2.4 million and$2.2 million atJune 30, 2022 andDecember 31, 2021 , 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 no performing loans classified as TDR loans atJune 30, 2022 andDecember 31, 2021 .
There were no new TDR modifications during the three and six months ended
Allowance for Loan Losses (ALLL). 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 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 (including those arising out
of the COVID-19 pandemic); 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'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 Board of Directors of the Bank ("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 . 37 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 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 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. The allowance 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. Qualitative factors applied in the Bank's ALLL model include the impact to the economy from the COVID-19 pandemic and reserves on loans with payment modifications as a result of the COVID-19 pandemic. AtJune 30, 2022 andDecember 31, 2021 , there were no loans with existing modifications as a result of the COVID-19 pandemic. AtJune 30, 2022 , the Bank continues to maintain a pool of loans that were previously modified as a result of the COVID-19 pandemic. The loan balances associated with those loans that were previously modified as a result of the COVID-19 pandemic related modifications have been grouped into their own pool within the Bank's ALLL model as management considers that they have a higher risk profile, and a higher reserve rate has been applied to this pool. Loans included in this pool totaled$77.9 million and$88.7 million atJune 30, 2022 andDecember 31, 2021 , respectively. 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. There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for the three and six months endedJune 30, 2022 as compared to the three and six months endedJune 30, 2021 . 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. EffectiveDecember 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.
PPP loans are excluded from the allowance as PPP loans are 100 percent guaranteed by the SBA.
38
Table of Contents
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 GAAP, 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.
Percentage of Loans
By Risk Grade
Risk Grade 30.6.22 31.12.21
Risk Grade 1 (Excellent Quality) 0.57 % 0.78 %
Risk Grade 2 (High Quality) 19.38 % 19.12 %
Risk Grade 3 (Good Quality) 72.85 % 70.41 %
Risk Grade 4 (Management Attention) 5.79 % 7.70 %
Risk Grade 5 (Watch) 0.71 % 1.23 %
Risk Grade 6 (Substandard) 0.70 % 0.76 %
Risk Grade 7 (Doubtful) 0.00 % 0.00 %
Risk Grade 8 (Loss) 0.00 % 0.00 %
At
Non-performing Assets. Non-performing assets totaled$3.6 million atJune 30, 2022 or 0.21% of total assets, compared to$3.2 million or 0.20% of total assets atDecember 31, 2021 . Non-accrual loans were$3.6 million atJune 30, 2022 and$3.2 million atDecember 31, 2021 . As a percentage of total loans outstanding, non-accrual loans were 0.37% atJune 30, 2022 andDecember 31, 2021 , respectively. Non-performing assets include$3.6 million in commercial and residential mortgage loans and$21,000 in other loans atJune 30, 2022 , compared to$3.2 million in commercial and residential mortgage loans,$51,000 in other loans atDecember 31, 2021 . The Bank had no loans 90 days past due and still accruing atJune 30, 2022 andDecember 31, 2021 . The Bank had no other real estate owned atJune 30, 2022 andDecember 31, 2021 . Deposits. Total deposits atJune 30, 2022 were$1.5 billion compared to$1.4 billion atDecember 31, 2021 . Core deposits, a non-GAAP measure, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than$250,000 , amounted to$1.5 billion and$1.4 billion atJune 30, 2022 andDecember 31, 2021 , 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.
Borrowed Funds. There were no FHLB borrowings outstanding at
Securities sold under agreements to repurchase were
Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were$15.5 million atJune 30, 2022 andDecember 31, 2021 . InJune 2006 , the Company formed a 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 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 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. 39 Table of Contents 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-month
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.
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 six months ended June 30, 2022 totaled
$1.6 billion , exceeding average rate sensitive liabilities of $977.9 million by
$621.6 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 June 30, 2022 .
Included in the rate sensitive assets are $175.7 million in variable rate loans
indexed to prime rate subject to immediate repricing upon changes by the FOMC .
The Company utilizes interest rate floors on certain variable rate loans to
protect against further downward movements in the prime rate. At June 30, 2022 ,
the Company had $113.2 million in loans with interest rate floors. The floors
were in effect on $8.5 million of these loans pursuant to the terms of the
promissory notes on these loans. The weighted average rate on these loans is
0.61% 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 June 30, 2022 , such unfunded commitments to extend credit were $359.0
million , while commitments in the form of standby letters of credit totaled $4.9
million . As of December 31, 2021 , such unfunded commitments to extend credit
were $304.3 million , while commitments in the form of standby letters of credit
totaled $4.9 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 of June 30, 2022 , the Bank's core deposits, a non-GAAP
measure, totaled $1.5 billion , or 97.93% of total deposits. As of December 31,
2021 , the Bank's core deposits totaled $1.4 billion , or 98.14% of total
deposits.
40
Table of Contents
The other sources of funding for the Bank are through largedenomination 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 0.91% and 0.68% as ofJune 30, 2022 andDecember 31, 2021 , 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 atJune 30, 2022 andDecember 31, 2021 . AtJune 30, 2022 , the carrying value of loans pledged as collateral to the FHLB totaled$140.2 million compared to$137.4 million atDecember 31, 2021 . The remaining availability under the line of credit with the FHLB was$85.9 million atJune 30, 2022 compared to$90.9 million atDecember 31, 2021 . The Bank had no borrowings from the FRB atJune 30, 2022 orDecember 31, 2021 . FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. AtJune 30, 2022 , the carrying value of loans pledged as collateral to the FRB totaled$527.4 million compared to$475.2 million atDecember 31, 2021 . Availability under the line of credit with the FRB was$410.4 million and$346.20 million atJune 30, 2022 andDecember 31, 2021 , respectively. The Bank also had the ability to borrow up to$110.5 million for the purchase of overnight federal funds from five correspondent financial institutions as ofJune 30, 2022 . The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 38.50% atJune 30, 2022 and 43.28% atDecember 31, 2021 . The minimum required liquidity ratio as defined in the Bank's Asset/Liability and Interest Rate Risk Management Policy was 10% atJune 30, 2022 andDecember 31, 2021 . Contractual Obligations and Off-Balance Sheet Arrangements. The Company's contractual obligations and other commitments as ofJune 30, 2022 andDecember 31, 2021 are summarized in the table below. The Company's contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit. Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below. (Dollars in thousands)June 30 ,December 2022 31, 2021 Contractual Cash Obligations
Junior subordinated debentures$ 15,464
15,464
Operating lease obligations 6,717
5,168
Total$ 22,181
20,632
Other Commitments Commitments to extend credit$ 358,990
304,258
Standby letters of credit and financial guarantees written 4,946 4,892 SBIC Investments 1,753 2,204 Income tax credits 101 101 Total$ 365,790 311,455 Capital Resources.
Shareholders' equity was$112.4 million , or 6.70% of total assets, atJune 30, 2022 , compared to$142.4 million , or 8.77% of total assets, atDecember 31, 2021 . The decrease in shareholders' equity is primarily due to an increase in the unrealized loss on investment securities available for sale due to rate changes fromDecember 31, 2021 toJune 30, 2022 . Annualized return on average equity for the six months endedJune 30, 2022 was 10.39%, compared to 12.36% for the six months endedJune 30, 2021 . Total cash dividends paid on common stock were$2.9 million and$1.9 million for the six months endedJune 30, 2022 and 2021, respectively. In February of 2022, 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 has repurchased approximately$594,000 , or 22,000 shares of its common stock, under this stock repurchase program as ofJune 30, 2022 . 41 Table of Contents 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 atJune 30, 2022 andDecember 31, 2021 . The Company's Tier 1 capital ratio was 13.79% and 15.43% atJune 30, 2022 andDecember 31, 2021 , 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 14.63% and 16.35% atJune 30, 2022 andDecember 31, 2021 , 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 12.50% and 13.96% atJune 30, 2022 andDecember 31, 2021 , 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 9.47% and 9.64% atJune 30, 2022 andDecember 31, 2021 , respectively. The Bank's Tier 1 risk-based capital ratio was 13.66% and 15.27% atJune 30, 2022 andDecember 31, 2021 , respectively. The total risk-based capital ratio for the Bank was 14.50% and 16.19% atJune 30, 2022 andDecember 31, 2021 , respectively. The Bank's common equity Tier 1 capital ratio was 13.66% and 15.27% atJune 30, 2022 andDecember 31, 2021 , respectively. The Bank's Tier 1 leverage capital ratio was 9.32% and 9.50% atJune 30, 2022 andDecember 31, 2021 , 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" atJune 30, 2022 . 42 Table of Contents
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