PEOPLES BANCORP OF NORTH CAROLINA INC - Quarter Report: 2022 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2022

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

000-27205

(Commission File No.)

PEOPLES BANCORP OF NORTH CAROLINA, INC.

(Exact name of registrant as specified in its charter)

North Carolina		56-2132396
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

518 West C Street, Newton, North Carolina		28658
(Address of principal executive offices)		(Zip Code)

(828) 464-5620

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name on each exchange on which registered

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated Filer	☒	Smaller reporting company	☒
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) ☐

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. 5,656,030 shares of common stock, outstanding at April 30, 2022.

INDEX

PART I. FINANCIAL INFORMATION

		PAGE(S)
Item 1.	Financial Statements	4

	Consolidated Balance Sheets at March 31, 2022 (Unaudited) and December 31, 2021 (Audited)	4

	Consolidated Statements of Earnings for the three months ended March 31, 2022 and 2021 (Unaudited)	5

	Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2022 and 2021 (Unaudited)	6

	Consolidated Statements of Changes in Shareholders' Equity for the three months ended March 31, 2022 and 2021 (Unaudited)	7

	Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021 (Unaudited)	8-9

	Notes to Consolidated Financial Statements (Unaudited)	10-25

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26-38

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39

Item 4.	Controls and Procedures	39

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	40

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3.	Defaults upon Senior Securities	40

Item 5.	Other Information	40

Item 6.	Exhibits	41

Signatures		42

Certifications

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FORWARD-LOOKING STATEMENTS

Statements made in this Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Form 10-Q was prepared. These statements can be identified by the use of words like “expect,” “anticipate,” “estimate,” and “believe,” variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ include, but are not limited to, (1) competition in the markets served by the registrant and its subsidiaries, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environments and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in other filings with the Securities and Exchange Commission, including but not limited to, those described in the registrant’s Annual Report on Form 10-K for the year ended December 31, 2021.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Balance Sheets

March 31, 2022 and December 31, 2021

(Dollars in thousands)

	March 31,			December 31,
Assets	2022			2021
	(Unaudited)			(Audited)

Cash and due from banks, including reserve requirements
of $0 at both 3/31/22 and 12/31/21	$	47,462			44,711
Interest-bearing deposits		257,644			232,788
Cash and cash equivalents		305,106			277,499

Investment securities available for sale		408,037			406,549
Other investments		3,569			3,668
Total securities		411,606			410,217

Mortgage loans held for sale		885			3,637

Loans		889,758			884,869
Less allowance for loan losses		(9,426	)		(9,355	)
Net loans		880,332			875,514

Premises and equipment, net		15,658			16,104
Cash surrender value of life insurance		17,401			17,365
Right of use lease asset		6,204			4,612
Accrued interest receivable and other assets		25,467			19,245
Total assets	$	1,662,659			1,624,193

Liabilities and Shareholders' Equity

Deposits:
Noninterest-bearing demand	$	553,185			514,319
Interest-bearing demand, MMDA & savings		816,779			797,179
Time, $250,000 or more		25,516			26,333
Other time		73,255			74,917
Total deposits		1,468,735			1,412,748

Securities sold under agreements to repurchase		34,823			37,094
Junior subordinated debentures		15,464			15,464
Lease liability		6,275			4,677
Accrued interest payable and other liabilities		11,918			11,841
Total liabilities		1,537,215			1,481,824

Commitments

Shareholders' equity:
Preferred stock, no par value; authorized
5,000,000 shares; no shares issued and outstanding		-			-
Common stock, no par value; authorized
20,000,000 shares; issued and outstanding 5,656,030 shares
at March 31, 2022 and 5,661,569 shares at December 31, 2021		53,147			53,305
Common stock held by deferred compensation trust, at cost; 163,883
shares at March 31, 2022 and 162,193 shares at December 31, 2021		(2,042	)		(1,992	)
Deferred compensation		2,042			1,992
Retained earnings		90,543			88,968
Accumulated other comprehensive income (loss)		(18,246	)		96
Total shareholders' equity		125,444			142,369

Total liabilities and shareholders' equity	$	1,662,659			1,624,193

See accompanying Notes to Consolidated Financial Statements.

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Consolidated Statements of Earnings

Three Months Ended March 31, 2022 and 2021

(Dollars in thousands, except per share amounts)


	2022		2021
	(Unaudited)		(Unaudited)

Interest income:
Interest and fees on loans	$	9,742		10,664
Interest on due from banks		111		35
Interest on investment securities:
U.S. Government sponsored enterprises		511		538
State and political subdivisions		943		639
Other		22		46
Total interest income		11,329		11,922

Interest expense:
Interest-bearing demand, MMDA & savings deposits		403		497
Time deposits		146		212
Junior subordinated debentures		75		71
Other		39		35
Total interest expense		663		815

Net interest income		10,666		11,107

Provision for (reduction of) loan losses		71		(455	)

Net interest income after provision for loan losses		10,595		11,562

Non-interest income:
Service charges		1,168		926
Other service charges and fees		193		212
Mortgage banking income		200		870
Insurance and brokerage commissions		240		260
Appraisal management fee income		3,506		1,816
Miscellaneous		1,739		1,789
Total non-interest income		7,046		5,873

Non-interest expense:
Salaries and employee benefits		5,849		6,183
Occupancy		1,916		1,953
Professional fees		373		337
Advertising		165		143
Debit card expense		276		232
FDIC insurance		110		92
Appraisal management fee expense		2,772		1,456
Other		1,880		1,872
Total non-interest expense		13,341		12,268

Earnings before income taxes		4,300		5,167

Income tax expense		848		1,046

Net earnings	$	3,452		4,121

Basic net earnings per share	$	0.63		0.73
Diluted net earnings per share	$	0.61		0.71
Cash dividends declared per share	$	0.33		0.16

See accompanying Notes to Consolidated Financial Statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Comprehensive Income (Loss)

Three Months Ended March 31, 2022 and 2021

(Dollars in thousands)

	2022			2021
	(Unaudited)			(Unaudited)

Net earnings	$	3,452			4,121

Other comprehensive loss:

Unrealized holding losses on securities available for sale		(23,813	)		(4,026	)

Income tax benefit related to other comprehensive loss:

Unrealized holding losses on securities available for sale		(5,471	)		(926	)

Total other comprehensive loss, net of tax		(18,342	)		(3,100	)

Total comprehensive income (loss)	$	(14,890	)		1,021

See accompanying Notes to Consolidated Financial Statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Changes in Shareholders' Equity

Three Months Ended March 31, 2022 and 2021

(Dollars in thousands)

												Common Stock
												Held By			Accumulated
												Deferred			Other
	Common Stock						Retained			Deferred		Compensation			Comprehensive
	Shares			Amount			Earnings			Compensation		Trust			Income (Loss)			Total
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)		(Unaudited)			(Unaudited)			(Unaudited)

Balance, December 31, 2021		5,661,569		$	53,305			88,968			1,992		(1,992	)		96			142,369

Common stock repurchase		(7,000	)		(199	)		-			-		-			-			(199	)

Cash dividends declared on common stock		-			-			(1,877	)		-		-			-			(1,877	)
Restricted stock units exercised		1,461			41			-			-		-			-			41
Equity incentive plan, net		-			-			-			50		(50	)		-			-
Net earnings		-			-			3,452			-		-			-			3,452

Change in accumulated other comprehensive loss, net of tax		-			-			-			-		-			(18,342	)		(18,342	)
Balance, March 31, 2022		5,656,030		$	53,147			90,543			2,042		(2,042	)		(18,246	)		125,444

Balance, December 31, 2020		5,787,504		$	56,871			77,628			1,796		(1,796	)		5,400			139,899

Common stock repurchase		-			-			-			-		-			-			-

Cash dividends declared on common stock		-			-			(930	)		-		-			-			(930	)
Restricted stock units exercised		1,662			39			-			-		-			-			39
Equity incentive plan, net		-			-			-			53		(53	)		-			-
Net earnings		-			-			4,121			-		-			-			4,121

Change in accumulated other comprehensive income, net of tax		-			-			-			-		-			(3,100	)		(3,100	)
Balance, March 31, 2021		5,789,166		$	56,910			80,819			1,849		(1,849	)		2,300			140,029

See accompanying Notes to Consolidated Financial Statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2022 and 2021

(Dollars in thousands)

	2022			2021
	(Unaudited)			(Unaudited)

Cash flows from operating activities:
Net earnings	$	3,452			4,121
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation, amortization and accretion		1,616			1,198
Provision for (reduction of) loan losses		71			(455	)
Deferred income taxes		(10	)		(9	)
Restricted stock expense		(56	)		(44	)
Proceeds from sales of mortgage loans held for sale		10,817			28,939
Origination of mortgage loans held for sale		(8,065	)		(24,036	)
Change in:
Cash surrender value of life insurance		(101	)		(97	)
Right of use lease asset		167			241
Other assets		(700	)		(297	)
Lease liability		(161	)		(239	)
Other liabilities		133			2,462

Net cash provided by operating activities		7,163			11,784

Cash flows from investing activities:
Purchases of investment securities available for sale		(41,600	)		(90,470	)
Proceeds from sales, calls and maturities of investment securities available for sale		6,440			645
Proceeds from paydowns of investment securities available for sale		8,829			4,981
Proceeds from paydowns of other investment securities		215			44
Redemption (purchase) of FHLB stock		(105	)		331
Net change in loans		(4,889	)		2,221
Purchases of premises and equipment		(151	)		(243	)
Proceeds from bank owned life insurance		65			-

Net cash used in investing activities		(31,196	)		(82,491	)

Cash flows from financing activities:
Net change in deposits		55,987			113,379
Net change in securities sold under agreement to repurchase		(2,271	)		5,715
Common stock repurchased		(199	)		-
Cash dividends paid on common stock		(1,877	)		(930	)

Net cash provided by financing activities		51,640			118,164

Net change in cash and cash equivalents		27,607			47,457

Cash and cash equivalents at beginning of period		277,499			161,580

Cash and cash equivalents at end of period	$	305,106			209,037

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows, continued

Three Months Ended March 31, 2022 and 2021

(Dollars in thousands)

	2022			2021
	(Unaudited)			(Unaudited)

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	653			802
Income taxes	$	-			-

Noncash investing and financing activities:

Change in unrealized loss on investment securities available for sale, net	$	(18,342	)		(3,100	)
Issuance of accrued restricted stock units	$	41			39
Initial recognition of lease right-of-use asset and lease liability	$	1,759			-

See accompanying Notes to Consolidated Financial Statements.

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PEOPLES BANCORP OF NORTH CAROLINA, INC.

Notes to Consolidated Financial Statements (Unaudited)

(1) Summary of Significant Accounting Policies

The Consolidated Financial Statements include the financial statements of Peoples Bancorp of North Carolina, Inc. (the “Company”) and its wholly owned subsidiary, Peoples Bank (the “Bank”), along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc. (“PIS”), Real Estate Advisory Services, Inc. (“REAS”), Community Bank Real Estate Solutions, LLC (“CBRES”) and PB Real Estate Holdings, LLC. All significant intercompany balances and transactions have been eliminated in consolidation.

In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), to facilitate the issuance of $20.6 million of trust preferred securities. PEBK Trust II is not included in the consolidated financial statements.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a separate division of the Bank under the name Banco de la Gente (“Banco”). These offices, which offer the same banking services as our other branches offer, now operate under the same name as our other offices; however, we continue to separately categorize mortgage loans originated from these offices.

The Consolidated Financial Statements in this report (other than the Consolidated Balance Sheet at December 31, 2021) are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”). Actual results could differ from those estimates.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of the specific accounting guidance. A description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders.

Recent Accounting Pronouncements

The following table provides a summary of Accounting Standards Updates (“ASU’s”) issued by the FASB that the Company has not adopted as of March 31, 2022, which may impact the Company’s financial statements.

Recently Issued Accounting Guidance Not Yet Adopted
ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2016-13: Measurement of Credit Losses on Financial Instruments	Provides guidance to change the accounting for credit losses and modify the impairment model for certain debt securities.	See ASU 2019-10 below.	The Company will apply this guidance through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is still evaluating the impact of this guidance on its consolidated financial statements. The Company has formed a Current Expected Credit Losses (“CECL”) committee and implemented a model from a third-party vendor for running CECL calculations. The Company is currently developing CECL model assumptions and comparing results to current allowance for loan loss calculations. The Company plans to run parallel calculations leading up to the effective date of this guidance to ensure it is prepared for implementation by the effective date. In addition to the Company’s allowance for loan losses, it will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.

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ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic.	See ASU 2019-10 below.	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above.
ASU 2019-04: Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments	Addresses unintended issues accountants flagged when implementing ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, ASU 2016-13, Measurement of Credit Losses on Financial Instruments, and ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities.	See ASU 2019-10 below.	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above.
ASU 2019-05: Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief	Guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments.	See ASU 2019-10 below.	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures. See ASU 2016-13 above.
ASU 2019-10: Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates	Guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (CECL), leases and hedging.	January 1, 2023	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2019-11: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the ASC.	January 1, 2023	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2020-03: Codification Improvements to Financial Instruments	Guidance to clarify that the contractual term of a net investment in a lease, determined in accordance with the leases standard, should be the contractual term used to measure expected credit losses under ASC 326.	January 1, 2023	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2020-04: Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting	Guidance that provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The ASU is intended to help stakeholders during the global market-wide reference rate transition period. Therefore, it will be in effect for a limited time through December 31, 2022.	March 12, 2020 through December 31, 2022	The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

Reclassification

Certain amounts in the 2021 Consolidated Financial Statements have been reclassified to conform to the 2022 presentation. These reclassifications did not have any impact on shareholders’ equity or net earnings.

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(2) Investment Securities

Investment securities available for sale at March 31, 2022 and December 31, 2021 are as follows:

(Dollars in thousands)
	March 31, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S Treasuries	$	10,934		-		565		10,369
U.S. Government
sponsored enterprises		13,724		56		372		13,408
Mortgage-backed securities		233,773		783		9,901		224,655
State and political subdivisions		173,292		691		14,378		159,605
Total	$	431,723		1,530		25,216		408,037

(Dollars in thousands)
	December 31, 2021
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S Treasuries	$	7,964		-		75		7,889
U.S. Government
sponsored enterprises		14,252		200		185		14,267
Mortgage-backed securities		218,402		1,769		3,019		217,152
State and political subdivisions		165,804		3,694		2,257		167,241
Total	$	406,422		5,663		5,536		406,549

The current fair value and associated unrealized losses on investments in securities with unrealized losses at March 31, 2022 and December 31, 2021 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)
	March 31, 2022
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasuries	$	10,369		565		-		-		10,369		565
U.S. Government
sponsored enterprises		2,415		182		7,949		190		10,364		372
Mortgage-backed securities		146,319		8,509		21,727		1,392		168,046		9,901
State and political subdivisions		106,097		11,285		16,608		3,093		122,705		14,378
Total	$	265,200		20,541		46,284		4,675		311,484		25,216

(Dollars in thousands)
	December 31, 2021
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Treasuries	$	7,889		75		-		-		7,889		75
U.S. Government
sponsored enterprises		5,232		15		3,263		170		8,495		185
Mortgage-backed securities		131,483		2,477		19,632		542		151,115		3,019
State and political subdivisions		80,076		1,981		5,922		276		85,998		2,257
Total	$	224,680		4,548		28,817		988		253,497		5,536

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At March 31, 2022, unrealized losses in the investment securities portfolio relating to debt securities totaled $25.2 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the March 31, 2022 tables above, all three U.S. Treasury securities, 113 out of 156 securities issued by state and political subdivisions and 75 out of 108 securities issued by U.S. Government sponsored enterprises contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed. At December 31, 2021, unrealized losses in the investment securities portfolio relating to debt securities totaled $5.5 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the December 31, 2021 tables above, both of the U.S. Treasury securities, 70 of the 146 securities issued by state and political subdivisions contained unrealized losses and 54 of the 99 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of the acceptable financial condition and results of operations of the entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The amortized cost and estimated fair value of investment securities available for sale at March 31, 2022, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

March 31, 2022
(Dollars in thousands)
	Amortized Cost		Fair Value
Due within one year	$	2,608		2,623
Due from one to five years		11,047		11,150
Due from five to ten years		83,496		80,272
Due after ten years		100,799		89,337
Mortgage-backed securities		233,773		224,655
Total	$	431,723		408,037

No securities available for sale were sold during the three months ended March 31, 2022 and 2021.

Securities with a fair value of approximately $99.7 million and $98.6 million at March 31, 2022 and December 31, 2021, respectively, were pledged to secure public deposits and for other purposes as required by law.

(3)

Loans

Major classifications of loans at March 31, 2022 and December 31, 2021 are summarized as follows:

(Dollars in thousands)
	March 31, 2022			December 31, 2021
Real estate loans:
Construction and land development	$	95,025			95,760
Single-family residential		272,991			266,111
Single-family residential -
Banco de la Gente non-traditional		22,137			23,147
Commercial		354,169			337,841
Multifamily and farmland		58,927			58,366
Total real estate loans		803,249			781,225

Loans not secured by real estate:
Commercial loans		73,409			91,172
Farm loans		863			796
Consumer loans		6,170			6,436
All other loans		6,067			5,240

Total loans		889,758			884,869

Less allowance for loan losses		(9,426	)		(9,355	)

Total net loans	$	880,332			875,514

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The Bank makes loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Wake, Rowan and Forsyth counties of North Carolina. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market. Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

	·	Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of March 31, 2022, construction and land development loans comprised approximately 11% of the Bank’s total loan portfolio.

	·	Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of March 31, 2022, single-family residential loans comprised approximately 33% of the Bank’s total loan portfolio, including Banco single-family residential non-traditional loans which were approximately 2% of the Bank’s total loan portfolio.

	·	Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over the loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of March 31, 2022, commercial real estate loans comprised approximately 40% of the Bank’s total loan portfolio.

	·	Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. As of March 31, 2022, commercial loans comprised approximately 8% of the Bank’s total loan portfolio, including $6.6 million in Paycheck Protection Program (“PPP”) loans.

	·	Multifamily and farmland loans – Decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of March 31, 2022, construction and land development loans comprised approximately 7% of the Bank’s total loan portfolio.

Loans are considered past due if the required principal and interest payments have not been received within 30 days of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Generally, a loan is placed on non-accrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present an age analysis of past due loans, by loan type, as of March 31, 2022 and December 31, 2021:

Table of Contents

March 31, 2022
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	274		-		274		94,751		95,025		-
Single-family residential		3,545		542		4,087		268,904		272,991		-
Single-family residential -
Banco de la Gente non-traditional		2,700		136		2,836		19,301		22,137		-
Commercial		219		-		219		353,950		354,169		-
Multifamily and farmland		-		-		-		58,927		58,927		-
Total real estate loans		6,738		678		7,416		795,833		803,249		-

Loans not secured by real estate:
Commercial loans		17		-		17		73,392		73,409		-
Farm loans		-		-		-		863		863		-
Consumer loans		74		-		74		6,096		6,170		-
All other loans		-		-		-		6,067		6,067		-
Total loans	$	6,829		678		7,507		882,251		889,758		-

December 31, 2021
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	-		-		-		95,760		95,760		-
Single-family residential		2,323		634		2,957		263,154		266,111		-
Single-family residential -
Banco de la Gente non-traditional		2,593		112		2,705		20,442		23,147		-
Commercial		488		-		488		337,353		337,841		-
Multifamily and farmland		-		-		-		58,366		58,366		-
Total real estate loans		5,404		746		6,150		775,075		781,225		-

Loans not secured by real estate:
Commercial loans		43		-		43		91,129		91,172		-
Farm loans		-		-		-		796		796		-
Consumer loans		38		-		38		6,398		6,436		-
All other loans		-		-		-		5,240		5,240		-
Total loans	$	5,485		746		6,231		878,638		884,869		-

The following table presents non-accrual loans as of March 31, 2022 and December 31, 2021:

(Dollars in thousands)
	March 31, 2022		December 31, 2021
Real estate loans:
Construction and land development	$	-		-
Single-family residential		1,793		1,642
Single-family residential -
Banco de la Gente non-traditional		1,215		1,232
Commercial		191		200
Multifamily and farmland		102		105
Total real estate loans		3,301		3,179

Loans not secured by real estate:
Commercial loans		-		49
Consumer loans		8		2
Total	$	3,309		3,230

Table of Contents

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral less estimated selling costs. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $250,000 are not individually evaluated for impairment with the exception of the Bank’s Troubled Debt Restructurings (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Impaired loans were $17.1 million, $18.3 million and $20.6 million at March 31, 2022, December 31, 2021 and March 31, 2021, respectively. Interest income recognized on accruing impaired loans was $216,000, $1.0 million, and $283,000 for the three months ended March 31, 2022, the year ended December 31, 2021 and the three months ended March 31, 2021, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following table presents impaired loans as of March 31, 2022:

March 31, 2022
(Dollars in thousands)

	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance
Real estate loans:
Construction and land development	$	68		-		68		68		2
Single-family residential		4,361		520		3,581		4,101		64
Single-family residential -
Banco de la Gente non-traditional		11,306		-		10,658		10,658		671
Commercial		2,112		433		1,587		2,020		10
Multifamily and farmland		111		-		101		101		-
Total impaired real estate loans		17,958		953		15,995		16,948		747

Loans not secured by real estate:
Commercial loans		157		-		157		157		2
Consumer loans		14		-		10		10		-
Total impaired loans	$	18,129		953		16,162		17,115		749

Table of Contents

The following table presents impaired loans as of and for the year ended December 31, 2021:

December 31, 2021
(Dollars in thousands)

	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance
Real estate loans:
Construction and land development	$	73		-		73		73		3
Single-family residential		5,138		524		4,374		4,898		86
Single-family residential -
Banco de la Gente non-traditional		11,753		-		10,922		10,922		687
Commercial		2,138		435		1,608		2,043		11
Multifamily and farmland		113		-		105		105		-
Total impaired real estate loans		19,215		959		17,082		18,041		787

Loans not secured by real estate:
Commercial loans		282		49		170		219		2
Consumer loans		8		-		4		4		-
Total impaired loans	$	19,505		1,008		17,256		18,264		789

The following table presents the average impaired loan balance and the interest income recognized by loan class for the three months ended March 31, 2022 and 2021 and the year ended December 31, 2021:

(Dollars in thousands)
	Three months ended								Twelve months ended
	March 31, 2022				March 31,2021				December 31, 2021
	Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized
Real estate loans:
Construction and land development	$	71		2		106		2		82		6
Single-family residential		5,723		47		5,490		60		6,017		253
Single-family residential -
Banco de la Gente stated income		9,566		139		11,832		177		10,325		609
Commercial		2,032		25		2,955		36		2,385		109
Multifamily and farmland		103		1		116		1		110		6
Total impaired real estate loans		17,495		214		20,499		276		18,919		983

Loans not secured by real estate:
Commercial loans		188		2		413		6		271		19
Consumer loans		7		-		28		1		11		1
Total impaired loans	$	17,690		216		20,940		283		19,201		1,003

Impaired loans collectively evaluated for impairment totaled $5.3 million at March 31, 2022 and December 31, 2021 and are included in the tables above. Allowance on impaired loans collectively evaluated for impairment totaled $47,000 and $52,000 at March 31, 2022 and December 31, 2021, respectively.

The following tables present changes in the allowance for loan losses for the three months ended March 31, 2022 and 2021. Unallocated balances in the following tables include allowance for loan losses based on qualitative factors such as economic outlook, concentrations of credit, interest rate risk and loan volume trends. PPP loans are excluded from the allowance for loan losses as PPP loans are 100 percent guaranteed by the Small Business Administration (“SBA”).

Table of Contents

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente non-traditional			Commercial		Multifamily and Farmland			Commercial			Farm		Consumer and All Other			Unallocated			Total
Three months ended March 31, 2022
Allowance for loan losses:
Beginning balance	$	1,193			2,013			864			2,234		150			711			-		110			2,080			9,355
Charge-offs		-			(31	)		-			-		-			(4	)		-		(125	)		-			(160	)
Recoveries		-			117			-			2		-			19			-		22			-			160
Provision (recovery)		(30	)		(4	)		(23	)		775		(3	)		(80	)		-		121			(685	)		71
Ending balance	$	1,163			2,095			841			3,011		147			646			-		128			1,395			9,426

Allowance for loan losses March 31, 2022
Ending balance: individually
evaluated for impairment	$	1			38			657			6		-			-			-		-			-			702
Ending balance: collectively
evaluated for impairment		1,162			2,057			184			3,005		147			646			-		128			1,395			8,724
Ending balance	$	1,163			2,095			841			3,011		147			646			-		128			1,395			9,426

Loans at March 31, 2022:
Ending balance	$	95,025			272,991			22,137			354,169		58,927			73,409			863		12,237			-			889,758

Ending balance: individually
evaluated for impairment	$	4			859			9,494			1,426		-			-			-		-			-			11,783
Ending balance: collectively
evaluated for impairment	$	95,021			272,132			12,643			352,743		58,927			73,409			863		12,237			-			877,975

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente non-traditional			Commercial		Multifamily and Farmland		Commercial			Farm		Consumer and All Other			Unallocated			Total
Three months ended March 31, 2021
Allowance for loan losses:
Beginning balance	$	1,196			1,843			1,052			2,212		122		1,345			-		128			2,010			9,908
Charge-offs		-			-			-			-		-		-			-		(85	)		-			(85	)
Recoveries		50			60			-			12		-		3			-		39			-			164
Provision (recovery)		(185	)		(53	)		(19	)		28		23		(104	)		-		9			(154	)		(455	)
Ending balance	$	1,061			1,850			1,033			2,252		145		1,244			-		91			1,856			9,532

Allowance for loan losses March 31, 2021
Ending balance: individually
evaluated for impairment	$	2			4			826			8		-		-			-		-			-			840
Ending balance: collectively
evaluated for impairment		1,059			1,846			207			2,244		145		1,244			-		91			1,856			8,692
Ending balance	$	1,061			1,850			1,033			2,252		145		1,244			-		91			1,856			9,532

Loans March 31, 2021:
Ending balance	$	87,878			264,356			26,278			337,943		57,914		160,892			860		10,376			-			946,497

Ending balance: individually
evaluated for impairment	$	7			1,444			11,193			2,098		-		141			-		-			-			14,883
Ending balance: collectively
evaluated for impairment	$	87,871			262,912			15,085			335,845		57,914		160,751			860		10,376			-			931,614

Table of Contents

The provision for loan losses for the three months ended March 31, 2022 was $71,000, compared to a recovery of $455,000 for the three months ended March 31, 2021. The increase in the provision for loan losses is primarily attributable to an increase in reserves on loans in a pool that had once been given payment modifications as a result of the COVID-19 pandemic, and an increase in reserves due to a net increase in the volume of loans in the general reserve pool. Loans that were previously modified have been separated from the pools for the general reserve to recognize their heightened susceptibility to an environment still affected by the economic effects of the pandemic. Separating the previously modified loans into their own pool allows for more specific reserving factors to be considered that would not be applicable to loans in the pools for the general reserve. There were no loans with modifications as a result of the COVID-19 pandemic at March 31, 2022 and December 31, 2021. The Bank continues to track all loans that were previously modified as a result of the COVID-19 pandemic. The loan balances associated with COVID-19 pandemic related modifications have been grouped into their own pool within the Bank’s Allowance for Loan and Lease Losses (“ALLL”) model as management considers that they have a higher likelihood of risk, and a higher reserve rate has been applied to that pool. Loans included in this pool totaled $82.2 million and $88.7 million at March 31, 2022 and December 31, 2021, respectively. The full effects of stimulus in the current environment are still unknown, and additional losses in this pool of loans may be present but not as yet identified. Loan payment modifications associated with the COVID-19 pandemic are not classified as TDR due to Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), which provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP.

The Bank utilizes an internal risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 8. These risk grades are evaluated on an ongoing basis. A description of the general characteristics of the eight risk grades is as follows:

	·	Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.

	·	Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Bank’s range of acceptability. The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.

	·	Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Bank’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change). PPP loans are classified as risk grade 3.

	·	Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

	·	Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank’s position at some future date.

	·	Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any). There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

	·	Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.

	·	Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of March 31, 2022 and December 31, 2021:

March 31, 2022
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total

1- Excellent Quality	$	-		3,134		-		-		-		360		-		566		-		4,060
2- High Quality		14,575		110,673		-		28,727		18		14,907		-		1,868		1,232		172,000
3- Good Quality		77,106		140,596		8,314		289,913		55,602		54,571		861		3,412		4,835		635,210
4- Management Attention		3,205		13,430		10,146		32,259		2,668		2,474		2		306		-		64,490
5- Watch		71		1,612		1,450		2,646		537		1,097		-		1		-		7,414
6- Substandard		68		3,546		2,227		624		102		-		-		17		-		6,584
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	95,025		272,991		22,137		354,169		58,927		73,409		863		6,170		6,067		889,758

Table of Contents

December 31, 2021
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total

1- Excellent Quality	$	-		5,923		-		-		-		371		-		581		-		6,875
2- High Quality		11,752		109,337		-		28,546		19		16,177		-		2,039		1,309		169,179
3- Good Quality		80,325		129,856		8,712		272,786		54,945		68,183		792		3,510		3,931		623,040
4- Management Attention		3,534		14,964		10,478		30,937		2,754		5,214		4		284		-		68,169
5- Watch		76		2,464		1,703		4,938		543		1,177		-		1		-		10,902
6- Substandard		73		3,567		2,254		634		105		50		-		21		-		6,704
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	95,760		266,111		23,147		337,841		58,366		91,172		796		6,436		5,240		884,869

Past due TDR loans and non-accrual TDR loans totaled $3.3 million and $2.2 million at March 31, 2022 and December 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 at March 31, 2022 and December 31, 2021.

There were no new TDR modifications during the three months ended March 31, 2022 and 2021.

There were no loans modified as TDR loans that defaulted during the three months ended March 31, 2022 and 2021, which were within 12 months of their modification date. Generally, a TDR loan is considered to be in default once it becomes 90 days or more past due following a modification.

On March 27, 2020, President Trump signed the CARES Act, which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the PPP. Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals were able to apply for loans from existing SBA lenders and other approved regulated lenders, subject to certain limitations and eligibility criteria. A second round of PPP funding provided a total of $320 billion additional funding for the PPP. The Bank participated as a lender in the PPP. Total PPP loans originated during the years ended December 31, 2020 and 2021 amounted to $128.1 million. The outstanding balance of PPP loans was $6.6 million and $18.0 million at March 31, 2022 and December 31, 2021, respectively. The Bank has received $5.7 million in fees from the SBA for PPP loans originated during the years ended December 31, 2020 and 2021. The Bank recognized $600,000 and $999,000 of PPP loan fee income for the three months ended March 31, 2022 and the three months ended March 31, 2021, respectively.

(4) Net Earnings Per Share

Net earnings per share is based on the weighted average number of shares outstanding during the period while the effects of potential shares outstanding during the period are included in diluted earnings per share. The average market price during the applicable period is used to compute equivalent shares.

The reconciliation of the amounts used in the computation of both “basic earnings per share” and “diluted earnings per share” for the three months ended March 31, 2022 and 2021 is as follows:

For the three months ended March 31, 2022
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	3,452		5,497,107	$	0.63
Effect of dilutive securities:
Restricted stock units - unvested				13,159
Shares held in deferred comp plan
by deferred compensation trust				163,038
Diluted earnings per share	$	3,452		5,673,304	$	0.61

Table of Contents

For the three months ended March 31, 2021
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	4,121		5,631,414	$	0.73
Effect of dilutive securities:
Restricted stock units - unvested				12,169
Shares held in deferred comp plan
by deferred compensation trust				156,662
Diluted earnings per share	$	4,121		5,800,245	$	0.71

(5) Fair Value

The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance.

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

	·	Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

	·	Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

	·	Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Cash and Cash Equivalents

For cash, due from banks and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value. Cash and cash equivalents are reported in the Level 1 fair value category.

Investment Securities Available for Sale

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category. Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category. All other fair value measurements are reported in the Level 3 fair value category.

Other Investments

For other investments, the carrying value is a reasonable estimate of fair value. Other investments are reported in the Level 3 fair value category.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value. Mortgage loans held for sale are reported in the Level 3 fair value category.

Loans

The fair value of loans, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated using discounted cash flow analyses. The discount rates used to determine fair value use interest rate spreads that reflect factors such as liquidity, credit, and nonperformance risk of the loans. Loans are reported in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

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Mutual Funds

For mutual funds held in the deferred compensation trust, the carrying value is a reasonable estimate of fair value. Mutual funds held in the deferred compensation trust are included in other assets on the balance sheet and reported in the Level 2 fair value category.

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Deposits are reported in the Level 3 fair value category.

Securities Sold Under Agreements to Repurchase

For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value. Securities sold under agreements to repurchase are reported in the Level 2 fair value category.

FHLB Borrowings

The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings. FHLB borrowings are reported in the Level 3 fair value category.

Junior Subordinated Debentures

Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value. Junior subordinated debentures are reported in the Level 2 fair value category.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The tables below present the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy, as of March 31, 2022 and December 31, 2021.

(Dollars in thousands)
	March 31, 2022
	Fair Value		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
U. S Treasuries	$	10,369		-		10,369		-
U.S. Government
sponsored enterprises	$	13,408		-		13,408		-
Mortgage-backed securities	$	224,655		-		224,655		-
State and political subdivisions	$	159,605		-		159,605		-

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(Dollars in thousands)
	December 31, 2021
	Fair Value		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
U. S Treasuries	$	7,889		-		7,889		-
U.S. Government
sponsored enterprises	$	14,267		-		14,267		-
Mortgage-backed securities	$	217,152		-		217,152		-
State and political subdivisions	$	167,241		-		167,241		-

The tables below present the balance of mutual funds held in the deferred compensation trust, which are measured at fair value on a recurring basis by level within the fair value hierarchy, as of March 31, 2022 and December 31, 2021.

(Dollars in thousands)
	March 31, 2022
	Fair Value		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mutual funds held in deferred compensation trust	$	1,410		-		1,410		-

(Dollars in thousands)
	December 31, 2021
	Fair Value		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mutual funds held in deferred compensation trust	$	1,510		-		1,510		-

The fair value measurements for mortgage loans held for sale and impaired loans on a non-recurring basis at March 31, 2022 and December 31, 2021 are presented below. The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of, and judgment about, current market conditions, specific issues relating to the collateral and other matters. As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements March 31, 2022		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	885		-		-		885
Impaired loans	$	16,366		-		-		16,366

(Dollars in thousands)
	Fair Value Measurements December 31, 2021		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	3,637		-		-		3,637
Impaired loans	$	17,475		-		-		17,475

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(Dollars in thousands)

Fair Value

March 31, 2022

Fair Value December 31, 2021

Valuation Technique

Significant Unobservable Inputs

General Range of Significant Unobservable Input Values

Mortgage loans held for sale

885

3,637

Rate lock commitment

N/A

Impaired loans

16,366

17,475

Appraised value and discounted cash flows

Discounts to reflect current market conditions and ultimate collectability

0 - 25

The carrying amount and estimated fair value of financial instruments at March 31, 2022 and December 31, 2021 are as follows:

(Dollars in thousands)
			Fair Value Measurements at March 31, 2022
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	305,106		305,106		-		-		305,106
Investment securities available for sale		408,037		-		408,037		-		408,037
Other investments		3,569		-		-		3,569		3,569
Mortgage loans held for sale		885		-		-		885		885
Loans, net		880,332		-		-		858,361		858,361
Mutual funds held in deferred
compensation trust		1,410		-		1,410		-		1,410

Liabilities:
Deposits	$	1,468,735		-		-		1,430,431		1,430,431
Securities sold under agreements
to repurchase		34,823		-		34,823		-		34,823
Junior subordinated debentures		15,464		-		15,464		-		15,464

(Dollars in thousands)
			Fair Value Measurements at December 31, 2021
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	277,499		277,499		-		-		277,499
Investment securities available for sale		406,549		-		406,549		-		406,549
Other investments		3,668		-		-		3,668		3,668
Mortgage loans held for sale		3,637		-		-		3,637		3,637
Loans, net		875,514		-		-		855,814		855,814
Mutual funds held in deferred
compensation trust		1,510		-		1,510		-		1,510

Liabilities:
Deposits	$	1,412,748		-		-		1,401,833		1,401,833
Securities sold under agreements
to repurchase		37,094		-		37,094		-		37,094
Junior subordinated debentures		15,464		-		15,464		-		15,464

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(6) Leases

As of March 31, 2022, the Bank had operating right of use assets of $6.2 million and operating lease liabilities of $6.3 million. The Bank maintains operating leases on land and buildings for some of the Bank’s branch facilities and loan production offices. Most leases include one option to renew, with renewal terms extending up to 15 years. The exercise of renewal options is based on the judgment of management as to whether or not the renewal option is reasonably certain to be exercised. Factors in determining whether an option is reasonably certain of exercise include, but are not limited to, the value of leasehold improvements, the value of renewal rates compared to market rates, and the presence of factors that would cause a significant economic penalty to the Bank if the option is not exercised. Leases with a term of 12 months or less are not recorded on the balance sheet and instead are recognized in lease expense on a straight-line basis over the lease term.

The following table presents lease cost and other lease information as of March 31, 2022 and 2021.

(Dollars in thousands)
	March 31,2022			March 31,2021

Operating lease cost	$	189		$	195

Other information:
Cash paid for amounts included in the measurement of lease liabilities		575			189
Right-of-use assets obtained in exchange for new lease liabilities - operating leases		1,759			-
Weighted-average remaining lease term - operating leases		8.92			6.95
Weighted-average discount rate - operating leases		2.04	%		2.69	%

The following table presents lease maturities as of March 31, 2022 and December 31, 2021.

(Dollars in thousands)

Maturity Analysis of Operating Lease Liabilities:	March 31, 2022			December 31, 2021

2022	$	690		$	740
2023		922			746
2024		867			691
2025		812			635
2026		694			518
Thereafter		2,975			1,838
Total		6,960			5,168
Less: Imputed Interest		(685	)		(491	)
Operating Lease Liability	$	6,275		$	4,677

(7) Subsequent Events

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

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

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. On March 16, 2022 the FOMC increased the target federal funds rate by 25 basis points to a range of 0.25% to 0.50%.

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.

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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 March 27, 2020, President Trump signed the CARES Act, which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the Small Business Administration (“SBA”), referred to as the Paycheck Protection Program (“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 $349 billion in funds for the PPP was exhausted, an additional $320 billion in funding for PPP loans was authorized. On December 27, 2020, the Economic Aid to Hard-Hit Small 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 March 31, 2021; however, the PPP Extension Act which was signed into law 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 debt restructurings (“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 March 31, 2022.

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	·	On April 7, 2020, federal banking regulators issued a revised Interagency 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 not direct 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 December 31, 2021.

	·	On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small-and mid-sized businesses, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which established two new loan facilities intended to facilitate lending to small and mid-sized businesses: (1) the Main Street New Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or MSELF. The Bank did not participate in the MSELF or MSNLF.

	·	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 of unprecedented 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 public service. 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 Federal Reserve also issued guidance encouraging banking 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 March 13, 2020 we enacted our Pandemic Plan. We used available physical 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 March 19, 2020, we restricted branch customer activity to drive-up and appointment only services. Branch lobbies were reopened on May 20, 2020. One small branch located in an assisted living facility was permanently closed effective December 31, 2020 due to limited lobby space and COVID-19 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. Effective August 19, 2021, the Company implemented mask requirements for employees. On January 6, 2022, we restricted branch customer activity to drive-up and appointment only services due to an increase in COVID-19 cases.

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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 with U.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 $3.5 million or $0.63 per share and $0.61 per diluted share for the three months ended March 31, 2022, as compared to $4.1 million or $0.73 per share and $0.71 per diluted share for the prior year period. The decrease in first 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 ended March 31, 2021, as discussed below.

The annualized return on average assets was 0.85% for the three months ended March 31, 2022, compared to 1.14% for the same period one year ago, and annualized return on average shareholders’ equity was 10.10% for the three months ended March 31, 2022, compared to 11.99% 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.

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Net interest income was $10.7 million for the three months ended March 31, 2022, compared to $11.1 million for the three months ended March 31, 2021. The decrease in net interest income is due to a $593,000 decrease in interest income, which was partially offset by a $152,000 decrease in interest expense. The decrease in interest income is primarily due to a $922,000 decrease in interest income and fees on loans, which was partially offset by an increase in interest income on investment securities. The decrease in interest income and fees on loans is primarily due to a decrease in total loans and a decrease in fee income on SBA PPP loans. The increase in interest income on investment securities is primarily due to additional securities purchased from an increase in cash resulting from increased deposits. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities.

Interest income was $11.3 million for the three months ended March 31, 2022, compared to $11.9 million for the three months ended March 31, 2021. The decrease in interest income is primarily due to a $922,000 decrease in interest income and fees on loans, which was partially offset by an increase in interest income on investment securities. The decrease in interest income and fees on loans is primarily due to a decrease in total loans and a decrease in fee income on SBA PPP loans. The Bank recognized $600,000 and $999,000 of PPP loan fee income for the three months ended March 31, 2022 and the three months ended March 31, 2021, respectively. During the three months ended March 31, 2022, average loans decreased $62.0 million to $885.2 million from $947.2 million for the three months ended March 31, 2021. During the three months ended March 31, 2022, average PPP loans decreased $63.3 million to $10.3 million from $73.6 million for the three months ended March 31, 2021. During the three months ended March 31, 2022, average investment securities available for sale increased $148.4 million to $413.3 million from $264.9 million for the three months ended March 31, 2021. The average yield on loans for the three months ended March 31, 2022 and 2021 was 4.46% and 4.57%, respectively. The average yield on investment securities available for sale was 1.49% and 1.96% for the three months ended March 31, 2022 and 2021, respectively. The average yield on earning assets was 2.96% and 3.55% for the three months ended March 31, 2022 and 2021, respectively.

Interest expense was $663,000 for the three months ended March 31, 2022, compared to $815,000 for the three months ended March 31, 2021. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the three months ended March 31, 2022, average interest-bearing non-maturity deposits increased $127.4 million to $799.3 million from $671.9 million for the three months ended March 31, 2021. During the three months ended March 31, 2022, average certificates of deposit decreased $7.6 million to $100.4 million from $108.0 million for the three months ended March 31, 2021. The average rate paid on interest-bearing checking and savings accounts was 0.20% and 0.30% for the three months ended March 31, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.59% for the three months ended March 31, 2022, compared to 0.80% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.28% for the three months ended March 31, 2022, compared to 0.40% 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 ended March 31, 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 ended March 31, 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.

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	Three months ended								Three months ended
	March 31, 2022								March 31, 2021
(Dollars in thousands)	Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate
Interest-earning assets:

Loans receivable	$	885,159		$	9,742		4.46	%	$	947,205		$	10,664		4.57	%
Investments - taxable		288,532			1,005		1.41	%		161,029			539		1.36	%
Investments - nontaxable*		128,873			561		1.77	%		108,466			804		3.01	%
Other		259,613			111		0.17	%		159,495			35		0.09	%

Total interest-earning assets		1,562,177			11,419		2.96	%		1,376,195			12,042		3.55	%

Non-interest earning assets:
Cash and due from banks		34,030								29,965
Allowance for loan losses		(9,390	)							(9,928	)
Other assets		55,324								64,601

Total assets	$	1,642,141							$	1,460,833

Interest-bearing liabilities:

Interest-bearing demand, MMDA & savings deposits	$	799,327		$	403		0.20	%	$	671,883		$	497		0.30	%
Time deposits		100,364			147		0.59	%		108,024			212		0.80	%
Junior subordinated debentures		15,464			75		1.97	%		15,464			71		1.86	%
Other		38,471			38		0.40	%		27,372			35		0.52	%

Total interest-bearing liabilities		953,626			663		0.28	%		822,743			815		0.40	%

Non-interest bearing liabilities and shareholders' equity:
Demand deposits		538,961								488,883
Other liabilities		10,950								9,841
Shareholders' equity		138,604								139,366

Total liabilities and shareholders' equity	$	1,642,141							$	1,460,833

Net interest spread				$	10,756		2.68	%				$	11,227		3.15	%

Net yield on interest-earning assets							2.79	%							3.31	%

Taxable equivalent adjustment
Investment securities				$	90							$	120

Net interest income				$	10,666							$	11,107

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $14.1 million in 2022 and $26.7 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2022 and 2021.

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.

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	Three months ended March 31, 2022 compared to three months ended March 31, 2021									Three months ended March 31, 2021 compared to three months ended March 31, 2020
(Dollars in thousands)	Changes in average volume			Changes in average rates			Total Increase (Decrease)			Changes in average volume			Changes in average rates			Total Increase (Decrease)
Interest income:
Loans: Net of unearned income	$	(691	)		(231	)		(922	)		1,012			(1,028	)		(16	)
Investments - taxable		435			31			466			419			(501	)		(82	)
Investments - nontaxable		120			(363	)		(243	)		(29	)		(106	)		(135	)
Federal funds sold		-			-			-			(62	)		(61	)		(123	)
Other		32			44			76			193			(201	)		(8	)
Total interest income		(104	)		(519	)		(623	)		1,533			(1,897	)		(364	)

Interest expense:
NOW, MMDA & savings deposits		79			(173	)		(94	)		132			(160	)		(28	)
Time deposits		(13	)		(52	)		(65	)		4			(69	)		(65	)
FHLB borrowings		-			-			-			(33	)		(32	)		(65	)
Trust preferred securities		-			4			4			-			(59	)		(59	)
Other		13			(10	)		3			7			(15	)		(8	)
Total interest expense		79			(231	)		(152	)		110			(335	)		(225	)
Net interest income	$	(183	)		(288	)		(471	)		1,423			(1,562	)		(139	)

Provision for Loan Losses.The provision for loan losses for the three months ended March 31, 2022 was $71,000, compared to a recovery of $455,000 for the three months ended March 31, 2021. The increase in the provision for loan losses is primarily attributable to an increase in reserves on loans in a pool that had once been given payment modifications as a result of the COVID-19 pandemic, and an increase in reserves due to a net increase in the volume of loans in the general reserve pool. Loans that were previously modified have been separated from the pools for the general reserve to recognize their heightened susceptibility to an environment still affected by the spread of the virus. Separating the previously modified loans into their own pool allows for more specific reserving factors to be considered that would not be applicable to loans in the pools for the general reserve. There were no loans with modifications as a result of the COVID-19 pandemic at March 31, 2022 and December 31, 2021. The Bank continues to track all loans that were previously modified as a result of the COVID-19 pandemic. The loan balances associated with 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 likelihood of risk, and a higher reserve rate has been applied to that pool. Loans included in this pool totaled $82.2 million and $88.7 million at March 31, 2022 and December 31, 2021, respectively. The full effects of stimulus in the current environment are still unknown, and additional losses in this pool of loans may be present but not as yet identified. Loan payment modifications associated with the COVID-19 pandemic are not classified as TDR due to Section 4013 of the CARES Act, which provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP.

Non-Interest Income. Total non-interest income was $7.0 million for the three months ended March 31, 2022, compared to $5.9 million for the three months ended March 31, 2021. The increase in non-interest income is primarily attributable to a $1.7 million increase in appraisal management fee income due to an increase in the volume of appraisals, which was partially offset by a $670,000 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 Expense. Total non-interest expense was $13.3 million for the three months ended March 31, 2022, compared to $12.3 million for the three months ended March 31, 2021. The increase in non-interest expense is primarily attributable to a $1.3 million increase in appraisal management fee expense due to an increase in the volume of appraisals, which was partially offset by a $334,000 decrease in salaries and employee benefits expense primarily due to a decrease in insurance costs.

Income Taxes.Income tax expense was $848,000 for the three months ended March 31, 2022, compared to $1.0 million for the three months ended March 31, 2021. The effective tax rate was 19.72% for the three months ended March 31, 2022, compared to 20.24% for the three months ended March 31, 2021.

Analysis of Financial Condition

Investment Securities.Available for sale securities were $408.0 million at March 31, 2022, compared to $406.5 million at December 31, 2021. Average investment securities available for sale for the three months ended March 31, 2022 were $413.3 million, compared to $349.6 million for the year ended December 31, 2021.

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Loans. At March 31, 2022, loans were $889.8 million, compared to $884.9 million at December 31, 2021. The Bank had $6.6 million and $18.0 million in PPP loans at March 31, 2022 and December 31, 2021, respectively. Average loans represented 57% and 61% of average earning assets for the three months ended March 31, 2022 and the year ended December 31, 2021, respectively.

The Bank had $885,000 and $3.6 million in mortgage loans held for sale as of March 31, 2022 and December 31, 2021, respectively.

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, 2022, the Bank had $87.1 million in residential mortgage loans, $87.1 million in home equity loans and $516.1 million in commercial mortgage loans, which include $399.3 million secured by commercial property and $116.8 million secured by residential property. Residential mortgage loans at March 31, 2022 include $22.1 million in non-traditional mortgage loans from the former Banco division of the Bank. At December 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.

There were no new TDR modifications during the three months ended March 31, 2022 and 2021.

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’s Credit Administration. Before making any changes in these risk grades, management considers assessments as determined by the third-party credit review firm (as described below), regulatory examiners and the Bank’s Credit Administration. Any issues regarding the risk assessments are addressed by the Bank’s senior credit administrators and factored into management’s decision to originate or renew the loan. The 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’s Credit Administration.

As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third party reviews and evaluates loan relationships greater than 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.

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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. At March 31, 2022 and December 31, 2021, there were no loans with existing modifications as a result of the COVID-19 pandemic. At March 31, 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 $82.2 million and $88.7 million at March 31, 2022 and December 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 months ended March 31, 2022 as compared to the three months ended March 31, 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.

Effective December 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 in Mecklenburg, 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.

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.

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	Percentage of Loans
	By Risk Grade
Risk Grade	31-3-22			31-12-21
Risk Grade 1 (Excellent Quality)		0.46	%		0.78	%
Risk Grade 2 (High Quality)		19.33	%		19.12	%
Risk Grade 3 (Good Quality)		71.39	%		70.41	%
Risk Grade 4 (Management Attention)		7.25	%		7.70	%
Risk Grade 5 (Watch)		0.83	%		1.23	%
Risk Grade 6 (Substandard)		0.74	%		0.76	%
Risk Grade 7 (Doubtful)		0.00	%		0.00	%
Risk Grade 8 (Loss)		0.00	%		0.00	%

At March 31, 2022, including non-accrual loans, there were no relationships exceeding $1.0 million in the Watch and Substandard risk grades.

Non-performing Assets.Non-performing assets totaled $3.3 million at March 31, 2022 or 0.20% of total assets, compared to $3.2 million or 0.20% of total assets at December 31, 2021. Non-accrual loans were $3.3 million at March 31, 2022 and $3.2 million at December 31, 2021. As a percentage of total loans outstanding, non-accrual loans were 0.37% at March 31, 2022 and December 31, 2021, respectively. Non-performing assets include $3.3 million in commercial and residential mortgage loans and $8,000 in other loans at March 31, 2022, compared to $3.2 million in commercial and residential mortgage loans, $51,000 in other loans at December 31, 2021. The Bank had no loans 90 days past due and still accruing at March 31, 2022 and December 31, 2021. The Bank had no other real estate owned at March 31, 2022 and December 31, 2021.

Deposits.Total deposits at March 31, 2022 were $1.5 billion compared to $1.4 billion at December 31, 2021. Core deposits, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $250,000, amounted to $1.4 billion at March 31, 2022 and December 31, 2021.

Borrowed Funds.There were no FHLB borrowings outstanding at March 31, 2022 and December 31, 2021.

Securities sold under agreements to repurchase were $34.8 million at March 31, 2022, compared to $37.1 million at December 31, 2021.

Junior Subordinated Debentures (related to Trust Preferred Securities).Junior subordinated debentures were $15.5 million at March 31, 2022 and December 31, 2021.

In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes. The debentures represent the sole 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.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 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 U.S. dollar-denominated (USD) LIBOR rates ceased to be published on December 31, 2021. The overnight, one-month, three-month, nine-month, and 12-month USD LIBOR rates will continue to be published through June 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.

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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 three months ended March 31, 2022 totaled $1.6 billion, exceeding average rate sensitive liabilities of $953.6 million by $608.6 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 March 31, 2022.

Included in the rate sensitive assets are $185.0 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 March 31, 2022, the Company had $115.9 million in loans with interest rate floors. The floors were in effect on $74.5 million of these loans pursuant to the terms of the promissory notes on these loans. The weighted average rate on these loans is 0.64% higher than the indexed rate on the promissory notes without interest rate floors.

Liquidity.The objectives of the Company’s liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As of March 31, 2022, such unfunded commitments to extend credit were $317.9 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 March 31, 2022, the Bank’s core deposits totaled $1.4 billion, or 98.26% of total deposits. As of December 31, 2021, the Bank’s core deposits totaled $1.4 billion, or 98.14% 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 the Federal 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 the State of North Carolina. The Bank’s ratio of wholesale funding to total assets was 0.67% and 0.68% as of March 31, 2022 and December 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 at March 31, 2022 and December 31, 2021. At March 31, 2022, the carrying value of loans pledged as collateral to the FHLB totaled $136.4 million compared to $137.4 million at December 31, 2021. The remaining availability under the line of credit with the FHLB was $87.0 million at March 31, 2022 compared to $90.9 million at December 31, 2021. The Bank had no borrowings from the FRB at March 31, 2022 or December 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. At March 31, 2022, the carrying value of loans pledged as collateral to the FRB totaled $496.8 million compared to $475.2 million at December 31, 2021. Availability under the line of credit with the FRB was $392.9 million and $346.20 million at March 31, 2022 and December 31, 2021, respectively.

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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 of March 31, 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 43.65% at March 31, 2022 and 43.28% at December 31, 2021. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy was 10% at March 31, 2022 and December 31, 2021.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations and other commitments as of March 31, 2022 and December 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)
	March 31, 2022		December 31, 2021
Contractual Cash Obligations
Junior subordinated debentures	$	15,464		15,464
Operating lease obligations		6,948		5,168
Total	$	22,412		20,632
Other Commitments
Commitments to extend credit	$	317,862		304,258
Standby letters of credit and financial guarantees written		4,873		4,892
SBIC Investments		2,029		2,204
Income tax credits		101		101
Total	$	324,865		311,455

Capital Resources. Shareholders’ equity was $125.4 million, or 7.54% of total assets, at March 31, 2022, compared to $142.4 million, or 8.77% of total assets, at December 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 from December 31, 2021 to March 31, 2022.

Annualized return on average equity for the three months ended March 31, 2022 was 10.10%, compared to 11.99% for the three months ended March 31, 2021. Total cash dividends paid on common stock were $1.9 million and $930,000 for the three months ended March 31, 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 $199,000, or 7,000 shares of its common stock, under this stock repurchase program as of March 31, 2022.

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 effective January 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 on January 1, 2016 and was phased in through 2019 (increasing by 0.625% on January 1, 2016 and each subsequent January 1, until it reached 2.5% on January 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.

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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 at March 31, 2022 and December 31, 2021. The Company’s Tier 1 capital ratio was 14.91% and 15.43% at March 31, 2022 and December 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 15.79% and 16.35% at March 31, 2022 and December 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 13.50% and 13.96% at March 31, 2022 and December 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 9.62% and 9.64% at March 31, 2022 and December 31, 2021, respectively.

The Bank’s Tier 1 risk-based capital ratio was 14.75% and 15.27% at March 31, 2022 and December 31, 2021, respectively. The total risk-based capital ratio for the Bank was 15.64% and 16.19% at March 31, 2022 and December 31, 2021, respectively. The Bank’s common equity Tier 1 capital ratio was 14.75% and 15.27% at March 31, 2022 and December 31, 2021, respectively. The Bank’s Tier 1 leverage capital ratio was 9.47% and 9.50% at March 31, 2022 and December 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” at March 31, 2022.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the Quantitative and Qualitative Disclosures About Market Risk from those previously disclosed in Item 7A of Part II of the Company’s Annual Report on Form 10-K, filed with the SEC on March 18, 2022.

Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, which are our controls and other procedures that are designed to ensure that information required to be disclosed in our periodic reports with the SEC is recorded, processed, summarized and reported within the required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed is communicated to our management to allow timely decisions regarding required disclosure. Based on the evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in allowing timely decisions regarding disclosure to be made about material information required to be included in our periodic reports with the SEC. In addition, no change in our internal control over financial reporting has occurred during, or subsequent to, the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On October 19, 2018, the Bank received a draft audit report from the North Carolina Department of Revenue (“NCDOR”) setting forth certain proposed adjustments to the North Carolina income tax returns for the Bank for the tax years January 1, 2014 through December 31, 2016. The NCDOR sought to disallow certain tax credits taken by the Bank in tax years January 1, 2014 through December 31, 2016 from an investment made by the Bank. The total proposed adjustments sought by the NCDOR as of the date of the draft audit report (including additional tax, penalties and interest up to the date of the draft audit report) was approximately $1.4 million. The Bank disagreed with the NCDOR’s proposed adjustments and the disallowance of certain tax credits, and challenged the proposed adjustments and the disallowance of such tax credits. During the second quarter of 2019, the Bank paid the NCDOR $1.2 million in taxes and interest associated with the proposed adjustments noted above. This payment stopped the accrual of interest during the period while the proposed adjustments and disallowance are being contested, and the NCDOR waived associated penalties. The Bank purchased a Guaranty Agreement along with this tax credit investment that unconditionally guarantees the amount of its investment plus associated penalties and interest which management believes would limit the Bank’s exposure to approximately $125,000. The Tax Credit Guaranty Agreement by State Tax Credit Exchange, LLC dated September 10, 2014 was attached to the Company’s September 30, 2018 Quarterly Report on Form 10-Q as Exhibit 99.

Item 1A. Risk Factors

For information regarding the risk factors that could affect the Company’s business, results of operations, financial condition and liquidity, see the information under Part I, Item 1A. “Risk Factors” in the Form 10-K filed with the SEC on March 18, 2022, which is accessible on the SEC’s website at www.sec.gov. There have been no material changes to the risk factors previously disclosed in the Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES

Period	Total Number of Shares Purchased (1)		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (3)

January 1 - 31, 2022		1,123	$	29.38		-	$	2,000,000

February 1 - 28, 2022		1,077		29.00		-	$	2,000,000

March 1 - 31, 2022		7,000		28.50		7,000	$	1,800,500

Total		9,200	$	29.05		7,000

(1) The Company purchased 2,200 shares on the open market in the three months ended March 31, 2022 for its deferred compensation plan. All purchases were funded by participant contributions to the plan.

(2) Reflects shares purchased under the Company's publicly announced stock repurchase program.

(3) Reflects dollar value of balance available for repurchase at end of period under the Company's stock repurchase program, which was authorized in February 2022 and expires in February 2023.

Item 3. Defaults Upon Senior Securities

Not applicable

Item 5. Other Information

Not applicable

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Item 6. Exhibits

Exhibit (3)(i)(a)				Articles of Incorporation of the Registrant, incorporated by reference to Exhibit (3)(i) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999

Exhibit (3)(i)(b)				Articles of Amendment dated December 19, 2008, regarding the Series A Preferred Stock, incorporated by reference to Exhibit (3)(1) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

Exhibit (3)(i)(c)				Articles of Amendment dated February 26, 2010, incorporated by reference to Exhibit (3)(2) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2010

Exhibit (3)(i)(d)				Articles of Amendment dated May 6, 2021, incorporated by reference to Exhibit (3)(i)(d) to the Form 10-K filed with the Securities and Exchange Commission on March 18, 2022

Exhibit (3)(ii)				Second Amended and Restated Bylaws of the Registrant, incorporated by reference to Exhibit (3)(ii) to the Form 8-K filed with the Securities and Exchange Commission on June 24, 2015

Exhibit (4)(i)				Specimen Stock Certificate, incorporated by reference to Exhibit (4) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999

Exhibit (31)(a)				Certification of principal executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit (31)(b)				Certification of principal financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

Exhibit (32)				Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit (101)				The following materials from the Company’s 10-Q Report for the quarterly period ended March 31, 2022, formatted in eXtensible Business Reporting Language (“XBRL”): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Earnings, (iii) the Condensed Consolidated Statements of Comprehensive Income (iv) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) the Condensed Consolidated Statements of Cash Flows, and (vi) the Notes to the Condensed Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		Peoples Bancorp of North Carolina, Inc.

May 6, 2022		/s/ Lance A. Sellers
Date		Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer)

May 6, 2022

/s/ Jeffrey N. Hooper

Date

Jeffrey N. Hooper

Executive Vice President and Chief Financial Officer

(Principal Financial and Principal Accounting Officer)