PEOPLES BANCORP OF NORTH CAROLINA, INC. The following is a discussion of the financial position and results of operations of the Company and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company's Annual Report of Form 10-K and the Company's Consolidated Financial Statements and Notes thereto on pages A-28 through A-69 of the Company's 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders. Introduction Management's discussion and analysis of earnings and related data are presented to assist in understanding the consolidated financial condition and results of operations of the Company. The Company is the parent company of the Bank and a registered bank holding company operating under the supervision of theBoard of Governors of theFederal Reserve System (the "Federal Reserve"). The Bank is aNorth Carolina -chartered bank, with offices inCatawba ,Lincoln ,Alexander ,Mecklenburg ,Iredell ,Wake ,Rowan andForsyth counties, operating under the banking laws ofNorth Carolina and the rules and regulations of theFederal Deposit Insurance Corporation . Overview Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses. Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of theFederal Reserve , inflation, interest rates, market and monetary fluctuations. Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered. Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating the allowance for 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 inDecember 2019 andJanuary 2020 , market interest rates declined significantly, with the 10-yearTreasury bond falling below 1.00% onMarch 3, 2020 for the first time. Such events generally had an adverse effect on business and consumer confidence and the Company and its customers. OnMarch 3, 2020 , the Federal ReserveFederal Open Market Committee ("FOMC") reduced the target federal funds rate by 50 basis points to a range of 1.00% to 1.25%. Subsequently onMarch 16, 2020 , theFOMC 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. Subsequently, continuing supply-chain disruption and rising inflation has caused theFOMC to increase the target federal funds rate by 300 basis points in 2022 to a range of 3.00% to 3.25% atOctober 31, 2022 . 27 Table of Contents Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends. Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plants and inventories. During periods of high inflation there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits. Also, general increases in the price of goods and services can be expected to result in increased operating expenses. Our business emphasis has been and continues to be to operate as a well-capitalized, profitable and independent community-oriented financial institution dedicated to providing quality customer service. We are committed to meeting the financial needs of the communities in which we operate. We expect growth to be achieved in our local markets and through expansion opportunities in contiguous or nearby markets. While we would be willing to consider growth by acquisition in certain circumstances, we do not consider the acquisition of another company to be necessary for our continued ability to provide a reasonable return to our shareholders. We believe that we can be more effective in serving our customers than many of our non-local competitors because of our ability to quickly and effectively provide senior management responses to customer needs and inquiries. Our ability to provide these services is enhanced by the stability and experience of our Bank officers and managers.
Summary of Significant Accounting Policies
The Company's accounting policies are fundamental to understanding management's discussion and analysis of results of operations and financial condition. Many of the Company's accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. The following is a summary of some of the more subjective and complex accounting policies of the Company. A more complete description of the Company's significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company's 2021 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders. The allowance for loan losses reflects management's assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance for loan losses that management believes will be adequate in light of anticipated risks and
loan losses. Many of the Company's assets and liabilities are recorded using various techniques that require significant judgment as to recoverability. The collectability of loans is reflected through the Company's estimate of the allowance for loan losses. The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability. In addition, certain assets and liabilities are reflected at their estimated fair value in the Consolidated Financial Statements. Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques. The Company's internal models generally involve present value of cash flow techniques. The various techniques are discussed in greater detail elsewhere in this management's discussion and analysis and the Notes to the Consolidated Financial Statements. Fair value of the Company's financial instruments is discussed in Note 5 of the Notes to Consolidated Financial Statements (Unaudited) included in this Quarterly Report. There are other complex accounting standards that require the Company to employ significant judgment in interpreting and applying certain of the principles prescribed by those standards. These judgments include, but are not limited to, the determination of whether a financial instrument or other contract meets the definition of a derivative in accordance withU.S. Generally Accepted Accounting Principles ("GAAP").
Management of the Company has made a number of estimates and assumptions relating to reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the accompanying Consolidated Financial Statements in conformity with GAAP. Actual results could differ from those estimates.
Results of Operations Summary. Net earnings were$5.3 million or$0.96 per share and$0.93 per diluted share for the three months endedSeptember 30, 2022 , as compared to$3.4 million or$0.61 per share and$0.59 per diluted share for the prior year period. The increase in third quarter net earnings is primarily the result of an increase in net interest income and an increase in non-interest income, which were partially offset by an increase in the provision for loan losses and an increase in non-interest expense, compared to the prior year period, as discussed below. The annualized return on average assets was 1.25% for the three months endedSeptember 30, 2022 , compared to 0.83% for the same period one year ago, and annualized return on average shareholders' equity was 18.42% for the three months endedSeptember 30, 2022 , compared to 9.30% for the same period one
year
ago.
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Year-to-date net earnings as of September 30, 2022 were $12.0 million or $2.18
per share and $2.11 per diluted share for the nine months ended September 30,
2022 , as compared to $12.1 million or $2.16 per share and $2.10 per diluted
share for the prior year period. The decrease in year-to-date net earnings is
primarily attributable to an increase in non-interest expense and an increase in
the provision for loan losses, which were partially offset by an increase in net
interest income and an increase in non-interest income compared to the prior
year period, as discussed below.
The annualized return on average assets was 0.96% for the nine months ended
September 30, 2022 , compared to 1.05 % for the same period one year ago, and
annualized return on average shareholders' equity was 12.53% for the nine months
ended September 30, 2022 , compared to 11.04% 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.
Net interest income was $13.8 million for the three months ended September 30,
2022 , compared to $10.6 million for the three months ended September 30, 2021 .
The increase in net interest income is due to a $3.2 million increase in
interest income and a $43,000 decrease in interest expense. The increase in
interest income is due to a $1.2 million increase in interest income and fees on
loans, a $811,000 increase in interest income on balances due from banks and a
$1.1 million increase in interest income on investment securities. The increase
in interest income and fees on loans is primarily due to an increase in total
loans and rate increases by the Federal Reserve , partially offset by a decrease
in fee income on SBA PPP loans. The increase in interest income on balances due
from banks is primarily due to rate increases by the Federal Reserve . The
increase in interest income on investment securities is primarily due to
additional securities purchased with additional cash resulting from an increase
in deposits combined with higher yields on securities purchased during the
second and third quarters of 2022. The decrease in interest expense is
primarily due to a decrease in rates paid on interest-bearing liabilities
Interest income was $14.6 million for the three months ended September 30, 2022 ,
compared to $11.4 million for the three months ended September 30, 2021 . The
increase in interest income is due to a $1.2 million increase in interest income
and fees on loans, a $811,000 increase in interest income on balances due from
banks and a $1.1 million increase in interest income on investment securities.
The increase in interest income and fees on loans is primarily due to an
increase in total loans and rate increases by the Federal Reserve , partially
offset by a decrease in fee income on SBA PPP loans. The increase in interest
income on balances due from banks is primarily due to rate increases by the
Federal Reserve . The increase in interest income on investment securities is
primarily due to additional securities purchased with additional cash resulting
from an increase in deposits combined with higher yields on securities purchased
during the second and third quarters of 2022. The Bank recognized $54,000 and
$489,000 of PPP loan fee income for the three months ended September 30, 2022
and the three months ended September 30, 2021 , respectively. During the three
months ended September 30, 2022 , average loans were $971.6 million , an increase
of $82.1 million from average loans of $889.5 million for the three months ended
September 30, 2021 . During the three months ended September 30, 2022 , average
PPP loans were $739,000 , a reduction of $29.9 million from average PPP loans of
$30.7 million for the three months ended September 30, 2021 . During the three
months ended September 30, 2022 , average investment securities available for
sale were $490.6 million , an increase of $111.8 million from average investment
securities available for sale of $378.8 million for the three months ended
September 30, 2021 . The average yield on loans for the three months ended
September 30, 2022 and 2021 was 4.51% and 4.37%, respectively. The average
yield on investment securities available for sale was 2.23% and 1.70% for the
three months ended September 30, 2022 and 2021, respectively. The average yield
on earning assets was 3.59% and 2.98% for the three months ended September30, 2022 and 2021, respectively.
Interest expense was$818,000 for the three months endedSeptember 30, 2022 , compared to$861,000 for the three months endedSeptember 30, 2021 . The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the three months endedSeptember 30, 2022 , average interest-bearing non-maturity deposits were$843.8 million , an increase of$55.8 million from average interest-bearing non-maturity deposits of$788.0 million for the three months endedSeptember 30, 2021 . During the three months endedSeptember 30, 2022 , average certificates of deposit were$99.9 million , a reduction of$3.9 million from average certificates of deposit of$103.8 million for the three months endedSeptember 30, 2021 . The average rate paid on interest-bearing checking and savings accounts was 0.23% and 0.29% for the three months endedSeptember 30, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.53% for the three months endedSeptember 30, 2022 , compared to 0.69% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.33% for the three months endedSeptember 30, 2022 , compared to 0.36% for the same period one year ago. 29 Table of Contents
The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the three months endedSeptember 30, 2022 and 2021. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders' equity. Yields and interest income on tax-exempt investments for the three months endedSeptember 30, 2022 and 2021 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors' understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below. Three months ended Three months ended September 30, 2022 September 30, 2021 (Dollars in Yield / Yield / thousands) Average Balance Interest Rate Average Balance Interest Rate Interest-earning assets: Loans receivable $ 971,592$ 11,051 4.51 % $ 889,455$ 9,807 4.37 % Investments - taxable 357,269 2,074 2.30 % 227,026 657 1.15 % Investments - nontaxable* 136,587 687 2.00 % 155,986 972 2.47 % Other 158,680 899 2.25 % 262,205 89 0.13 % Total interest-earning assets 1,624,128 14,711 3.59 % 1,534,672 11,525 2.98 % Non-interest earning assets: Cash and due from banks 37,514 29,644 Allowance for loan losses (9,785 ) (9,313 ) Other assets 34,290 64,439 Total assets$ 1,686,147 $ 1,619,442 Interest-bearing liabilities: Interest-bearing demand, MMDA & savings deposits $ 843,798$ 494 0.23 % $ 787,985$ 577 0.29 % Time deposits 99,889 134 0.53 % 103,828 181 0.69 % Junior subordinated debentures 15,464 146 3.75 % 15,464 69 1.77 % Other 37,965 44 0.46 % 29,595 34 0.46 % Total interest-bearing liabilities 997,116 818 0.33 % 936,872 861 0.36 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 562,979 528,481 Other liabilities 11,763 9,439 Shareholders' equity 114,289 144,650 Total liabilities and shareholders' equity$ 1,686,147 $ 1,619,442 Net interest spread$ 13,893 3.26 %$ 10,664 2.62 % Net yield on interest-earning assets 3.39 % 2.76 % Taxable equivalent adjustment Investment securities$ 100 $ 104 Net interest income$ 13,793 $ 10,560
*IncludesU.S. Government agency securities that are non-taxable for state income tax purposes of$13.0 million in 2022 and$14.9 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2022 and
2021.
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Year-to-date net interest income as ofSeptember 30, 2022 was$35.8 million for the nine months endedSeptember 30, 2022 , compared to$33.3 million for the nine months endedSeptember 30, 2021 . The increase in net interest income is due to a$2.1 million increase in interest income and a$393,000 decrease in interest expense. The increase in interest income is primarily due to a$1.5 million increase in interest income on investment securities and a$1.3 million increase in interest income on balances due from banks, which were partially offset by a$747,000 decrease in interest income and fees on loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased during the second and third quarters of 2022. The increase in interest income on balances due from banks is primarily due to rate increases by theFederal Reserve . The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans. The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. Interest income was$37.9 million for the nine months endedSeptember 30, 2022 , compared to$35.9 million for the nine months endedSeptember 30, 2021 . The increase in net interest income is due to a$2.1 million increase in interest income and a$393,000 decrease in interest expense. The increase in interest income is primarily due to a$1.5 million increase in interest income on investment securities and a$1.3 million increase in interest income on balances due from banks, which were partially offset by a$747,000 decrease in interest income and fees on loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased during the second and third quarters of 2022. The increase in interest income on balances due from banks is primarily due to rate increases by theFederal Reserve . The decrease in interest income and fees on loans is primarily due to a decrease in fee income on SBA PPP loans, which offset the increase in interest income resulting from rate increases by theFederal Reserve . The Bank recognized$948,000 and$3.0 million of PPP loan fee income for the nine months endedSeptember 30, 2022 and the nine months endedSeptember 30, 2021 , respectively. During the nine months endedSeptember 30, 2022 , average loans were$925.2 million , an increase of$7.7 million from average loans of$917.5 million for the nine months endedSeptember 30, 2021 . During the nine months endedSeptember 30, 2022 , average PPP loans were$9.1 million , a decrease of$41.6 million from average PPP loans of$50.7 million for the nine months endedSeptember 30, 2021 . During the nine months endedSeptember 30, 2022 , average investment securities available for sale were$453.4 million , an increase of$123.4 million from average investment securities available for sale of$330.0 million for the nine months endedSeptember 30, 2021 . The average yield on loans for the nine months endedSeptember 30, 2022 and 2021 was 4.44% and 4.59%, respectively. The average yield on investment securities available for sale was 1.75% and 1.81% for the nine months endedSeptember 30, 2022 and 2021, respectively. The average yield on earning assets was 3.20% and 3.31% for the nine months endedSeptember 30, 2022 and 2021, respectively. Interest expense was$2.1 million for the nine months endedSeptember 30, 2022 , compared to$2.5 million for the nine months endedSeptember 30, 2021 . The decrease in interest expense is primarily due to a decrease in rates paid on interest-bearing liabilities. During the nine months endedSeptember 30, 2022 , average interest-bearing non-maturity deposits were$822.3 million , an increase of$90.3 million from average interest-bearing non-maturity deposits of$732.0 million for the nine months endedSeptember 30, 2021 . During the nine months endedSeptember 30, 2022 , average certificates of deposit were$100.6 million , a decrease of$5.5 million from average certificates of deposit of$106.1 million for the nine months endedSeptember 30, 2021 . The average rate paid on interest-bearing checking and savings accounts was 0.21% and 0.30% for the nine months endedSeptember 30, 2022 and 2021, respectively. The average rate paid on certificates of deposit was 0.56% for the nine months endedSeptember 30, 2022 , compared to 0.74% for the same period one year ago. The average rate paid on interest-bearing liabilities was 0.29% for the nine months endedSeptember 30, 2022 , compared to 0.38% for the same period one year ago. The following table sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the nine months endedSeptember 30, 2022 and 2021. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders' equity. Yields and interest income on tax-exempt investments for the nine months endedSeptember 30, 2022 and 2021 have been adjusted to a tax equivalent basis using an effective tax rate of 22.98% for securities that are both federal and state tax exempt and an effective tax rate of 20.48% for federal tax-exempt securities. Non-accrual loans and the interest income that was recorded on non-accrual loans, if any, are included in the yield calculations for loans in all periods reported. The Company believes the presentation of net interest income on a tax-equivalent basis provides comparability of net interest income from both taxable and tax-exempt sources and facilitates comparability within the industry. Although the Company believes these non-GAAP financial measures enhance investors' understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures are presented below. 31 Table of Contents Nine months ended Nine months ended September 30, 2022 September 30, 2021 (Dollars in Yield / Yield / thousands) Average Balance Interest Rate Average Balance Interest Rate Interest-earning assets: Loans receivable $ 925,178 30,727 4.44 % $ 917,473 31,474 4.59 % Investments - taxable 324,664 4,140 1.70 % 199,395 1,847 1.24 % Investments - nontaxable* 132,301 1,891 1.91 % 134,893 2,714 2.69 % Other 213,342 1,453 0.91 % 210,855 172 0.11 % Total interest-earning assets 1,595,485 38,211 3.20 % 1,462,616 36,207 3.31 % Non-interest earning assets: Cash and due from banks 36,576 30,652 Allowance for loan losses (9,535 ) (9,602 ) Other assets 43,074 63,739 Total assets$ 1,665,600 $ 1,547,405 Interest-bearing liabilities: Interest-bearing demand, MMDA & savings deposits $ 822,299 1,263 0.21 % $ 732,045 1,617 0.30 % Time deposits 100,630 421 0.56 % 106,158 584 0.74 % Trust preferred securities 15,464 324 2.80 % 15,464 211 1.82 % Other 37,964 117 0.41 % 29,095 106 0.49 % Total interest-bearing liabilities 976,357 2,125 0.29 % 882,762 2,518 0.38 % Non-interest bearing liabilities and shareholders' equity: Demand deposits 554,335 515,433 Other liabilities 7,073 2,298 Shareholders' equity 127,835 146,912 Total liabilities and shareholders' equity$ 1,665,600 $ 1,547,405 Net interest spread$ 36,086 2.91 %$ 33,689 2.93 % Net yield on interest-earning assets 3.02 % 3.08 % Taxable equivalent adjustment Investment securities$ 279 $ 347 Net interest income$ 35,807 $ 33,342
*IncludesU.S. Government agency securities that are non-taxable for state income tax purposes of$13.5 million in 2022 and$12.1 million in 2021. A tax rate of 2.50% was used to calculate the tax equivalent yield on these securities in 2022 and 2021. 32 Table of Contents Changes in interest income and interest expense can result from variances in both volume and rates. The following table describes the impact on the Company's tax equivalent net interest income resulting from changes in average balances and average rates for the periods indicated. The changes in net interest income due to both volume and rate changes have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each. Three months ended September 30, 2022 compared to three Nine months ended September 30, 2022 compared to nine months ended September 30, 2021 months ended September 30, 2021 Changes Changes in Changes in in Changes in (Dollars in average average Total Increase average average Total Increase thousands) volume rates (Decrease) volume rates (Decrease) Interest income: Loans: Net of unearned income$ 920 324 1,244 260 (1,007 ) (747 ) Investments - taxable 566 851 1,417 1,379 914 2,293 Investments - nontaxable (109 ) (176 ) (285 ) (45 ) (778 ) (823 ) Other (311 ) 1,121 810 9 1,272 1,281 Total interest income 1,066 2,120 3,186 1,603 401 2,004 Interest expense: NOW, MMDA & savings deposits 37 (120 ) (83 ) 169 (523 ) (354 ) Time deposits (6 ) (41 ) (47 ) (27 ) (136 ) (163 ) Trust preferred securities - 77 77 - 113 113 Other 10 - 10 30 (19 ) 11 Total interest expense 41 (84 ) (43 ) 172 (565 ) (393 ) Net interest income$ 1,025 2,204 3,229 1,431 966 2,397 Provision for Loan Losses. The provision for loan losses for the three months endedSeptember 30, 2022 was$408,000 , compared to a recovery of$182,000 for the three months endedSeptember 30, 2021 . The increase in the provision for loan losses is primarily attributable to an increase in reserves due to a net increase in the volume of loans in the general reserve pool. The recovery of provision for loan losses for the three months endedSeptember 30, 2021 was primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves in the general reserve pool. There were no loans with modifications as a result of the COVID-19 pandemic atSeptember 30, 2022 andDecember 31, 2021 . The provision for loan losses for the nine months endedSeptember 30, 2022 was$889,000 , compared to a recovery of$863,000 for the nine months endedSeptember 30, 2021 . The increase in the provision for loan losses is primarily attributable to an increase in reserves due to a net increase in the volume of loans in the general reserve pool. The recovery of provision for loan losses for the nine months endedSeptember 30, 2021 was primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves in the general reserve pool. Non-Interest Income. Total non-interest income was$6.8 million for the three months endedSeptember 30, 2022 , compared to$6.0 million for the three months endedSeptember 30, 2021 . The increase in non-interest income is primarily attributable to a$757,000 increase in appraisal management fee income due to an increase in appraisal volume and a$435,000 increase in service charge income, primarily due to service charge changes implemented inMarch 2022 , which were partially offset by a$457,000 decrease in mortgage banking income due to a decrease in mortgage loan volume and additional mortgage loans being retained in the Bank's portfolio. Non-interest income was$21.2 million for the nine months endedSeptember 30, 2022 , compared to$18.0 million for the nine months endedSeptember 30, 2021 . The increase in non-interest income is primarily attributable to a$3.9 million increase in appraisal management fee income due to an increase in appraisal volume and a$1.1 million increase in service charge income, primarily due to service charge changes implemented inMarch 2022 , which were partially offset by a$1.8 million decrease in mortgage banking income due to a decrease in mortgage loan volume and additional mortgage loans being retained in the Bank's portfolio. Non-Interest Expense. Total non-interest expense was$13.5 million for the three months endedSeptember 30, 2022 , compared to$12.6 million for the three months endedSeptember 30, 2021 . The increase in non-interest expense is primarily attributable to a$595,000 increase in appraisal management fee expense due to an increase in appraisal volume, a$123,000 increase in salaries and employee benefits expense primarily due to an increase in insurance costs and a$218,000 increase in other non-interest expenses. Non-interest expense was$41.0 million for the nine months endedSeptember 30, 2022 , compared to$37.0 million for the nine months endedSeptember 30, 2021 . The increase in non-interest expense is primarily attributable to a$3.0 million increase in appraisal management fee expense due to an increase in appraisal volume and a$566,000 increase in salaries and employee benefits expense primarily due to an increase in insurance costs and a$340,000 increase in
other
non-interest expenses.
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Table of Contents
Income Taxes. Income tax expense was $1.4 million for the three months ended
September 30, 2022 , compared to $824,000 for the three months ended September
30, 2021 . The effective tax rate was 21.06% for the three months ended
September 30, 2022 , compared to 19.55% for the three months ended September 30,
2021 . Income tax expense was $3.1 million for the nine months ended September
30, 2022 and 2021. The effective tax rate was 20.40% for the nine months ended
September 30, 2022 , compared to 20.17% for the nine months ended September30, 2021.
Analysis of Financial Condition
Investment Securities . Available for sale securities were$444.4 million as ofSeptember 30, 2022 , compared to$406.5 million as ofDecember 31, 2021 . Average investment securities available for sale for the nine months endedSeptember 30, 2022 were$490.6 million , compared to$349.6 million for the year endedDecember 31, 2021 .
Loans. Total loans were
The Bank had
Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market. Real estate mortgage loans include both commercial and residential mortgage loans. AtSeptember 30, 2022 , the Bank had$97.7 million in residential mortgage loans,$97.4 million in home equity loans and$596.4 million in commercial mortgage loans, which include$460.1 million secured by commercial property and$136.3 million secured by residential property. Residential mortgage loans atSeptember 30, 2022 include$20.5 million in non-traditional mortgage loans from the former Banco division of the Bank. AtDecember 31, 2021 , the Bank had$101.5 million in residential mortgage loans,$85.6 million in home equity loans and$494.4 million in commercial mortgage loans, which include$381.0 million secured by commercial property and$113.4 million secured by residential property. Residential mortgage loans include$23.1 million in non-traditional mortgage loans from the former Banco division of the Bank. All residential mortgage loans are originated as fully amortizing loans, with no negative amortization. Past due TDR loans and non-accrual TDR loans totaled$2.4 million and$2.2 million atSeptember 30, 2022 andDecember 31, 2021 , respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were no performing loans classified as TDR loans atSeptember 30, 2022 andDecember 31, 2021 .
There were no new TDR modifications during the three and nine months ended
Allowance for Loan Losses (ALLL). The allowance for loan losses reflects
management's assessment and estimate of the risks associated with extending
credit and its evaluation of the quality of the loan portfolio. The Bank
periodically analyzes the loan portfolio in an effort to review asset quality
and to establish an allowance that management believes will be adequate in light
of anticipated risks and loan losses. In assessing the adequacy of the
allowance, size, quality and risk of loans in the portfolio are reviewed. Other
factors considered are:
· the Bank's loan loss experience;
· the amount of past due and non-performing loans;
· specific known risks;
· the status and amount of other past due and non-performing assets;
· underlying estimated values of collateral securing loans;
· current and anticipated economic conditions (including those arising out
of the COVID-19 pandemic); and
· other factors which management believes affect the allowance for potential
credit losses.
Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectability becomes doubtful. Upon loan origination, the Bank's originating loan officer evaluates the quality of the loan and assigns one of eight risk grades. The loan officer monitors the loan's performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank'sCredit Administration . Before making any changes in these risk grades, management considers assessments as determined by the third-party credit review firm (as described below), regulatory examiners and the Bank'sCredit Administration . Any issues regarding the risk assessments are addressed by the Bank's senior credit administrators and factored into management's decision to originate or renew the loan. The Board of Directors of the Bank ("Bank Board") reviews, on a monthly basis, an analysis of the Bank's reserves relative to the range of reserves estimated by the Bank'sCredit Administration . 34 Table of Contents As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third party reviews and evaluates loan relationships greater than or equal to$1.5 million as well as a periodic sample of commercial relationships with exposures below$1.5 million , excluding loans in default, and loans in process of litigation or liquidation. The third party's evaluation and report is shared with management and the Bank Board. Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk. Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance. The provision for loan losses charged or credited to earnings is based upon management's judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management's assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance. The allowance is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management's current evaluation of the Bank's loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below. The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two, three, four, or five years' loss experience. This charge-off experience may be adjusted to reflect the effects of current conditions. The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves. Qualitative factors applied in the Bank's ALLL model include the impact to the economy from the COVID-19 pandemic and reserves on loans with payment modifications as a result of the COVID-19 pandemic. AtSeptember 30, 2022 andDecember 31, 2021 , there were no loans with existing modifications as a result of the COVID-19 pandemic. AtSeptember 30, 2022 , the Bank continues to maintain a pool of loans that were previously modified as a result of the COVID-19 pandemic. The loan balances associated with those loans that were previously modified as a result of the COVID-19 pandemic related modifications have been grouped into their own pool within the Bank's ALLL model as management considers that they have a higher risk profile, and a higher reserve rate has been applied to this pool. Loans included in this pool totaled$74.0 million and$88.7 million atSeptember 30, 2022 andDecember 31, 2021 , respectively.
The unallocated allowance is determined through management's assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management's acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management's evaluation of the factors affecting the assumptions used in calculating the allowance. There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for the three and nine months endedSeptember 30, 2022 as compared to the three and nine months endedSeptember 30, 2021 . Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates. EffectiveDecember 31, 2012 , certain mortgage loans from the former Banco division of the Bank were analyzed separately from other single-family residential loans in the Bank's loan portfolio. These loans are first mortgage loans made to the Latino market, primarily inMecklenburg, North Carolina and surrounding counties. These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers. 35 Table of Contents
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.
Percentage of Loans
By Risk Grade
Risk Grade 9/30/2022 12/31/2021
Risk Grade 1 (Excellent Quality) 0.57 % 0.78 %
Risk Grade 2 (High Quality) 19.68 % 19.12 %
Risk Grade 3 (Good Quality) 72.87 % 70.41 %
Risk Grade 4 (Management Attention) 5.63 % 7.70 %
Risk Grade 5 (Watch) 0.59 % 1.23 %
Risk Grade 6 (Substandard) 0.66 % 0.76 %
Risk Grade 7 (Doubtful) 0.00 % 0.00 %
Risk Grade 8 (Loss) 0.00 % 0.00 %
At
Non-performing Assets. Non-performing assets totaled$3.7 million atSeptember 30, 2022 or 0.22% of total assets, compared to$3.2 million or 0.20% of total assets atDecember 31, 2021 . Non-accrual loans were$3.7 million atSeptember 30, 2022 and$3.2 million atDecember 31, 2021 . As a percentage of total loans outstanding, non-accrual loans were 0.37% atSeptember 30, 2022 andDecember 31, 2021 , respectively. Non-performing assets include$3.7 million in commercial and residential mortgage loans and$19,000 in other loans atSeptember 30, 2022 , compared to$3.2 million in commercial and residential mortgage loans,$51,000 in other loans atDecember 31, 2021 . The Bank had no loans 90 days past due and still accruing atSeptember 30, 2022 andDecember 31, 2021 . The Bank had no other real estate owned atSeptember 30, 2022 andDecember 31, 2021 . Deposits. Total deposits atSeptember 30, 2022 were$1.5 billion compared to$1.4 billion atDecember 31, 2021 . Core deposits, a non-GAAP measure, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than$250,000 , amounted to$1.5 billion and$1.4 billion atSeptember 30, 2022 andDecember 31, 2021 , respectively. Management believes it is useful to calculate and present core deposits because of the positive impact this low cost funding source provides to the Bank's funding base.
Borrowed Funds. There were no FHLB borrowings outstanding at
Securities sold under agreements to repurchase were
Junior Subordinated Debentures (related to Trust Preferred Securities). Junior subordinated debentures were$15.5 million atSeptember 30, 2022 andDecember 31, 2021 . InJune 2006 , the Company formed a wholly ownedDelaware statutory trust, PEBK Capital Trust II ("PEBK Trust II"), which issued$20.0 million of guaranteed preferred beneficial interests in the Company's junior subordinated deferrable interest debentures. All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase$20.6 million of junior subordinated debentures of the Company. The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay the trust preferred securities issued inDecember 2001 byPEBK Capital Trust , a wholly ownedDelaware statutory trust of the Company, and for general purposes. The debentures represent the sole assets of PEBK Trust II. PEBK Trust II is not included in the Consolidated Financial Statements. 36 Table of Contents The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities. The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities. These trust preferred securities are mandatorily redeemable upon maturity of the debentures onJune 28, 2036 . The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.
The Company has no financial instruments tied to LIBOR other than the trust
preferred securities issued by PEBK Trust II, which are tied to three-month
LIBOR. The one-week and two-month
Asset Liability and Interest Rate Risk Management. The objective of the Company's Asset Liability and Interest Rate Risk strategies is to identify and manage the sensitivity of net interest income to changing interest rates and to minimize the interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities. This is done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income.
The Company manages its exposure to fluctuations in interest rates through policies established by the Asset/Liability Committee ("ALCO") of the Bank.
The
ALCO meets quarterly and has the responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company. ALCO seeks to minimize interest rate risk between interest-earning assets and interest-bearing liabilities by attempting to minimize wide fluctuations in net interest income due to interest rate movements. The ability to control these fluctuations has a direct impact on the profitability of the Company. Management monitors this activity on a regular basis through analysis of its portfolios to determine the difference between rate sensitive assets
and rate sensitive liabilities.
The Company's rate sensitive assets are those earning interest at
variable rates and those with contractual maturities within one year. Rate
sensitive assets therefore include both loans and available for sale
securities. Rate sensitive liabilities include interest-bearing checking
accounts, money market deposit accounts, savings accounts, time deposits and
borrowed funds. Average rate sensitive assets for the nine months ended
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 ofSeptember 30, 2022 . Included in the rate sensitive assets are$183.3 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by theFOMC .The Company utilizes interest rate floors on certain variable rate loans to protect against downward movements in the prime rate. AtSeptember 30, 2022 , the Company had$110.8 million in loans with interest rate floors. The floors were in effect on$9,000 of these loans. Liquidity. The objectives of the Company's liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements. Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities. In addition, the Company's liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit. As ofSeptember 30, 2022 , such unfunded commitments to extend credit were$373.9 million , while commitments in the form of standby letters of credit totaled$5.5 million . As ofDecember 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 . 37 Table of Contents 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 ofSeptember 30, 2022 , the Bank's core deposits, a non-GAAP measure, totaled$1.5 billion , or 97.99% of total deposits. As ofDecember 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 theFederal Reserve Bank ("FRB") on a short-term basis. The Bank's policies include the ability to access wholesale funding of up to 40% of total assets. The Bank's wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits, internet certificates of deposit and certificates of deposit issued to theState of North Carolina . The Bank's ratio of wholesale funding to total assets was 0.91% and 0.68% as ofSeptember 30, 2022 andDecember 31, 2021 , respectively. The Bank has a line of credit with the FHLB equal to 20% of the Bank's total assets. There were no FHLB borrowings outstanding atSeptember 30, 2022 andDecember 31, 2021 . AtSeptember 30, 2022 , the carrying value of loans pledged as collateral to the FHLB totaled$143.4 million compared to$137.4 million atDecember 31, 2021 . The remaining availability under the line of credit with the FHLB was$88.2 million atSeptember 30, 2022 compared to$90.9 million atDecember 31, 2021 . The Bank had no borrowings from the FRB atSeptember 30, 2022 orDecember 31, 2021 . FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. AtSeptember 30, 2022 , the carrying value of loans pledged as collateral to the FRB totaled$565.1 million compared to$475.2 million atDecember 31, 2021 . Availability under the line of credit with the FRB was$427.2 million and$346.20 million atSeptember 30, 2022 andDecember 31, 2021 , respectively. The Bank also had the ability to borrow up to$110.5 million for the purchase of overnight federal funds from five correspondent financial institutions as ofSeptember 30, 2022 . The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 34.62% atSeptember 30, 2022 and 43.28% atDecember 31, 2021 . The minimum required liquidity ratio as defined in the Bank's Asset/Liability and Interest Rate Risk Management Policy was 10% atSeptember 30, 2022 andDecember 31, 2021 . Contractual Obligations and Off-Balance Sheet Arrangements. The Company's contractual obligations and other commitments as ofSeptember 30, 2022 andDecember 31, 2021 are summarized in the table below. The Company's contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit. Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below. (Dollars in thousands) SeptemberDecember 30, 2022 31, 2021 Contractual Cash Obligations
Junior subordinated debentures$ 15,464
15,464
Operating lease obligations 6,487
5,168
Total$ 21,951
20,632
Other Commitments Commitments to extend credit$ 373,939
304,258
Standby letters of credit and financial guarantees written 5,511 4,892 SBIC Investments 1,684 2,204 Income tax credits 101 101 Total$ 381,235 311,455 Capital Resources. Shareholders' equity was$103.9 million , or 6.78% of total assets, atSeptember 30, 2022 , compared to$142.4 million , or 8.77% of total assets, atDecember 31, 2021 . The decrease in shareholders' equity is primarily due to an increase in the unrealized loss on investment securities available for sale due to rate changes fromDecember 31, 2021 toSeptember 30, 2022 . Annualized return on average equity for the nine months endedSeptember 30, 2022 was 12.53%, compared to 11.04% for the nine months endedSeptember 30, 2021 . Total cash dividends paid on common stock were$3.9 million and$2.8 million for the nine months endedSeptember 30, 2022 and 2021, respectively. In February of 2022, the Board of Directors authorized a stock repurchase program, whereby up to$2.0 million may be allocated to repurchase the Company's common stock. Any purchases under the Company's stock repurchase program may be made periodically as permitted by securities laws and other legal requirements in the open market or in privately-negotiated transactions. The timing and amount of any repurchase of shares will be determined by the Company's management, based on its evaluation of market conditions and other factors. The stock repurchase program may be suspended at any time or from time-to-time without prior notice. The Company has repurchased approximately$594,000 , or 22,000 shares of its common stock, under this stock repurchase program as ofSeptember 30, 2022 . 38 Table of Contents In 2013, the FRB approved its final rule on the Basel III capital standards, which implement changes to the regulatory capital framework for banking organizations. The Basel III capital standards, which became effectiveJanuary 1, 2015 , include new risk-based capital and leverage ratios, which were phased in from 2015 to 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are as follows: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total risk based capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% (unchanged from previous rules). An additional capital conservation buffer was added to the minimum requirements for capital adequacy purposes beginning onJanuary 1, 2016 and was phased in through 2019 (increasing by 0.625% onJanuary 1, 2016 and each subsequentJanuary 1 , until it reached 2.5% onJanuary 1, 2019 ). This resulted in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained earnings that could be utilized for such actions. Under the regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 6.0% or greater and a common equity Tier 1 capital ratio of 4.5% or greater, as required by the Basel III capital standards referenced above. Tier 1 capital is generally defined as shareholders' equity and trust preferred securities less all intangible assets and goodwill. Tier 1 capital includes$15.0 million in trust preferred securities atSeptember 30, 2022 andDecember 31, 2021 . The Company's Tier 1 capital ratio was 13.39% and 15.43% atSeptember 30, 2022 andDecember 31, 2021 , respectively. Total risk-based capital is defined as Tier 1 capital plus supplementary capital. Supplementary capital, or Tier 2 capital, consists of the Company's allowance for loan losses, not exceeding 1.25% of the Company's risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets. The Company's total risk-based capital ratio was 14.20% and 16.35% atSeptember 30, 2022 andDecember 31, 2021 , respectively. The Company's common equity Tier 1 capital consists of common stock and retained earnings. The Company's common equity Tier 1 capital ratio was 12.17% and 13.96% atSeptember 30, 2022 andDecember 31, 2021 , respectively. Financial institutions are also required to maintain a leverage ratio of Tier 1 capital to total average assets of 4.0% or greater. The Company's Tier 1 leverage capital ratio was 9.58% and 9.64% atSeptember 30, 2022 andDecember 31, 2021 , respectively. The Bank's Tier 1 risk-based capital ratio was 13.27% and 15.27% atSeptember 30, 2022 andDecember 31, 2021 , respectively. The total risk-based capital ratio for the Bank was 14.08% and 16.19% atSeptember 30, 2022 andDecember 31, 2021 , respectively. The Bank's common equity Tier 1 capital ratio was 13.27% and 15.27% atSeptember 30, 2022 andDecember 31, 2021 , respectively. The Bank's Tier 1 leverage capital ratio was 9.43% and 9.50% atSeptember 30, 2022 andDecember 31, 2021 , respectively. A bank is considered to be "well capitalized" if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater and a leverage ratio of 5.0% or greater. Based upon these guidelines, the Bank was considered to be "well capitalized" atSeptember 30, 2022 .
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