pebk_ex13.htm

EXHIBIT (13)

The Annual Report to Security Holders is Appendix A to the Proxy Statement for the 2022 Annual Meeting of Shareholders and is incorporated herein by reference.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

General Description of Business

Peoples Bancorp of North Carolina, Inc. (the “Company”), was formed in 1999 to serve as the holding company for Peoples Bank (the “Bank”). The Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company’s principal source of income is dividends declared and paid by the Bank on its capital stock, if any. The Company has no operations and conducts no business of its own other than owning the Bank and PEBK Capital Trust II. Accordingly, the discussion of the business which follows primarily concerns the business conducted by the Bank. Our principal executive offices are located at 518 West C Street, Newtown, North Carolina, 28658, and our telephone number is (828) 464-5620.

The Bank, founded in 1912, is a state-chartered commercial bank serving the citizens and business interests of the Catawba Valley and surrounding communities through 17 banking offices, located in Lincolnton, Newton, Denver, Catawba, Conover, Maiden, Claremont, Hiddenite, Hickory, Charlotte, Huntersville, Mooresville, Raleigh, and Cary, North Carolina. The Bank also operates loan production offices in Charlotte, Denver, Salisbury and Winston-Salem North Carolina. The Company’s fiscal year ends December 31. At December 31, 2022, the Company had total assets of $1.6 billion, net loans of $1.0 billion, deposits of $1.4 billion, total securities of $448.1 million, and shareholders’ equity of $105.2 million.

The Bank operates three banking offices focused on the Latino population that were formerly operated as a 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 Bank has a diversified loan portfolio, with no foreign loans and few agricultural loans. Real estate loans are predominately variable rate and fixed rate commercial property loans, which include residential development loans to commercial customers. Commercial loans are spread throughout a variety of industries with no one particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio. The majority of the Bank’s deposit and loan customers are individuals and small-to medium-sized businesses located in the Bank’s market area. The Bank’s loan portfolio also includes Individual Taxpayer Identification Number (ITIN) mortgage loans generated through the Bank’s former Banco offices. Additional discussion of the Bank’s loan portfolio and sources of funds for loans can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-26 of the Annual Report, which is included in this Form 10-K as Exhibit (13).

The operations of the Bank are significantly influenced by general economic conditions and by related monetary and fiscal policies of the Company and the Bank’s regulatory agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Commissioner of Banks (the “Commissioner”).

At December 31, 2022, the Company employed 279 full-time employees and 21 part-time employees, which equated to 291 full-time equivalent employees.

Subsidiaries

The Bank is a subsidiary of the Company. At December 31, 2022, the Bank had four subsidiaries, Peoples Investment Services, Inc., Real Estate Advisory Services, Inc., Community Bank Real Estate Solutions, LLC (“CBRES”) and PB Real Estate Holdings, LLC. Through a relationship with Raymond James Financial Services, Inc., Peoples Investment Services, Inc. provides the Bank’s customers access to investment counseling and non-deposit investment products such as stocks, bonds, mutual funds, tax deferred annuities, and related brokerage services. Real Estate Advisory Services, Inc. provides real estate appraisal and real estate brokerage services. CBRES serves as a “clearing-house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies. As a separate legal entity, CBRES’s services and the appraisal process are conducted independent from the financing process of the Bank. PB Real Estate Holdings, LLC acquires, manages and disposes of real property, other collateral and assets obtained in the ordinary course of collecting debts previously contracted. In 2019, the Company launched PB Insurance Agency, which operated as a division of CBRES, until it was discontinued in 2022. All of the Bank’s subsidiaries are incorporated in the state of North Carolina.

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 Company redeemed $5.0 million of outstanding trust preferred securities in 2019. The trust preferred securities issued by PEBK Trust II accrue and pay quarterly dividends at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed payment of these dividends and other payments due on the trust preferred securities.

A-1

This report contains certain forward-looking statements with respect to the financial condition, results of operations and business of the Company. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on the information available to management at the time that these disclosures were 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 materially include, but are not limited to, (1) competition in the markets served by the Company’s subsidiary, Peoples Bank, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environment 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 the Company’s other filings with the Securities and Exchange Commission. The Company undertakes no obligation to update any forward-looking statements.

A-2

SELECTED FINANCIAL DATA
Dollars in Thousands Except Per Share Amounts

	2022			2021			2020
Summary of Operations
Interest income	$	54,431			47,179			47,958
Interest expense		3,323			3,205			3,836
Net interest income		51,108			43,974			44,122
Provision for (recovery of) loan losses		1,472			(1,163	)		4,259
Net interest income after provision for loan losses		49,636			45,137			39,863
Non-interest income		26,689			24,919			22,914
Non-interest expense		56,030			51,127			48,931
Earnings before income taxes		20,295			18,929			13,846
Income tax expense		4,172			3,796			2,489
Net earnings	$	16,123			15,133			11,357

Selected Year-End Balances
Assets	$	1,620,927			1,624,193			1,416,175
Investment securities available for sale		445,394			406,549			245,249
Net loans		1,022,114			875,514			938,731
Mortgage loans held for sale		211			3,637			9,139
Interest-earning assets		1,502,868			1,531,975			1,326,489
Deposits		1,435,215			1,412,748			1,221,086
Interest-bearing liabilities		975,279			950,987			805,771
Shareholders' equity	$	105,195			142,369			139,899
Shares outstanding		5,636,830			5,661,569			5,632,035

Selected Average Balances
Assets	$	1,663,665			1,568,417			1,366,962
Investment securities available for sale		467,484			349,647			200,821
Loans		949,175			908,682			935,970
Interest-earning assets		1,601,168			1,483,519			1,271,764
Deposits		1,480,113			1,372,855			1,115,019
Interest-bearing liabilities		979,315			896,903			793,188
Shareholders' equity	$	123,887			147,740			141,287
Shares outstanding		5,480,123			5,576,099			5,657,025

Profitability Ratios
Return on average total assets		0.97	%		0.96	%		0.83	%
Return on average shareholders' equity		13.01	%		10.24	%		8.04	%
Dividend payout ratio		30.61	%		24.83	%		38.67	%

Liquidity and Capital Ratios (averages)
Loan to deposit		64.13	%		66.19	%		83.94	%
Shareholders' equity to total assets		7.45	%		9.42	%		10.35	%

Per share of Common Stock
Basic net earnings	$	2.94			2.71			2.01
Diluted net earnings	$	2.85			2.63			1.95
Cash dividends	$	0.87			0.66			0.75
Book value	$	19.24			25.89			24.84

A-3

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following is a discussion of our financial position and results of operations and should be read in conjunction with the information set forth under Item 1A Risk Factors in the Company’s Annual Report on Form 10-K and the Company’s consolidated financial statements and notes thereto on pages A-19 through A-59.

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, for the years ended December 31, 2022, 2021 and 2020. The Company is a registered bank holding company operating under the supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the parent company of the “Bank. 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 (the “FDIC”).

Overview

Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses.

Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve, inflation, interest rates, market and monetary fluctuations. Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered. Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating 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. Subsequently, continuing supply-chain disruption and rising inflation has caused the FOMC to increase the target federal funds rate by 425 basis points in 2022 to a range of 4.25% to 4.50% at December 31, 2022.

A-4

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.

The Company does not have specific plans for additional offices in 2023 but will continue to look for growth opportunities in nearby markets and may expand if considered a worthwhile opportunity.

Summary of Significant and Critical Accounting Policies

The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiary, the Bank, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc., 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.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance. The following is a summary of some of the more subjective and complex accounting policies of the Company. A more complete description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2022 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 4, 2023 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 Consolidated Financial Statements.

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”).

The Company has an overall interest rate risk management strategy that has, in prior years, incorporated the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. When 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 minimized the credit risk in derivative instruments by entering into transactions with high-quality counterparties that were reviewed periodically by the Company. The Company did not have any interest rate derivatives outstanding as of December 31, 2022 or 2021.

A-5

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. The Company reported earnings of $16.1 million or $2.94 per share and $2.85 per diluted share for the year ended December 31, 2022, as compared to $15.1 million or $2.71 per share and $2.63 per diluted share for the prior year. The increase in year-to-date net earnings is primarily attributable to 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 for the year ended December 31, 2022, compared to the year ended December 31, 2021, as discussed below.

The Company reported earnings of $15.1 million or $2.71 per share and $2.63 per diluted share for the year ended December 31, 2021, as compared to $11.4 million or $2.01 per share and $1.95 per diluted share for the prior year. The increase in year-to-date net earnings is primarily attributable to a recovery in the provision for loan losses and an increase in non-interest income, which were partially offset by a decrease in net interest income and an increase in non-interest expense.

The return on average assets in 2022 was 0.97%, as compared to 0.96% in 2021 and 0.83% in 2020. The return on average shareholders’ equity was 13.01% in 2022, as compared to 10.24% in 2021 and 8.04% in 2020.

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 in 2022 was $51.1 million, compared to $44.0 million in 2021. The increase in net interest income is due to a $7.3 million increase in interest income, partially offset by a $118,000 increase in interest expense. The increase in interest income is primarily due to a $1.9 million increase in interest income and fees on loans, a $2.0 million increase in interest income on balances due from banks and a $3.4 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 $2.4 million 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 in 2022. The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities. Net interest income decreased to $44.0 million in 2021 from $44.1 million in 2020.

Table 1 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 years ended December 31, 2022, 2021 and 2020. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on total average interest-earning assets for the same periods. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields and interest income on tax-exempt investments have been adjusted to a tax equivalent basis using an effective tax rate of 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.

A-6

Table 1 - Average Balance Table

	December 31, 2022								December 31, 2021								December 31, 2020
(Dollars in thousands)	Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate			Average Balance			Interest		Yield / Rate
Interest-earning assets:
Loans	$	949,175			43,077		4.54	%		908,682			41,186		4.53	%		935,970			42,314		4.52	%
Investments - taxable		399,036			7,159		1.79	%		283,521			4,381		1.55	%		132,468			2,299		1.74	%
Investments - nontaxable*		71,943			2,355		3.27	%		70,413			1,802		2.56	%		75,609			3,634		4.81	%
Federal funds sold		-			-		-			-			-		-			91,166			204		0.22	%
Due from banks		181,014			2,223		1.23	%		220,903			258		0.12	%		36,551			127		0.35	%

Total interest-earning assets		1,601,168			54,814		3.42	%		1,483,519			47,627		3.21	%		1,271,764			48,578		3.82	%

Cash and due from banks		36,778								32,104								34,569
Other assets		35,373								62,322								69,062
Allowance for loan losses		(9,654	)							(9,528	)							(8,433	)

Total assets	$	1,663,665								1,568,417								1,366,962

Interest-bearing liabilities:

NOW, MMDA & savings deposits	$	824,955			2,019		0.24	%		745,616			2,029		0.27	%		584,177			1,962		0.34	%
Time deposits		99,880			562		0.56	%		105,127			752		0.72	%		103,694			947		0.91	%
FHLB borrowings		-			-		-			-			-		-			60,820			357		0.59	%
Trust preferred securities		15,464			529		3.42	%		15,464			280		1.81	%		15,478			370		2.39	%
Other		39,016			213		0.55	%		30,696			144		0.47	%		29,019			200		0.69	%

Total interest-bearing liabilities		979,315			3,323		0.34	%		896,903			3,205		0.36	%		793,188			3,836		0.48	%

Demand deposits		555,278								522,114								427,148
Other liabilities		5,185								1,659								5,339
Shareholders' equity		123,887								147,741								141,287

Total liabilities and shareholder's equity	$	1,663,665								1,568,417								1,366,962

Net interest spread				$	51,491		3.08	%				$	44,422		2.85	%				$	44,742		3.34	%

Net yield on interest-earning assets							3.22	%							2.99	%							3.52	%

Taxable equivalent adjustment Investment securities				$	383							$	448							$	620

Net interest income				$	51,108							$	43,974							$	44,122

*Includes U.S. Government agency securities that are non-taxable for state income tax purposes of $13.3 million in 2022, $12.7 million in 2021 and $19.2 million in 2020. A tax rate of 2.50% was used to calculate the tax equivalent yields on these securities in 2022, 2021 and 2020.

Changes in interest income and interest expense can result from variances in both volume and rates. Table 2 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.

A-7

Table 2 - Rate/Volume Variance Analysis-Tax Equivalent Basis

	December 31, 2022									December 31, 2021
(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	$	1,837			54			1,891		$	(1,235	)		107			(1,128	)
Investments - taxable		1,929			849			2,778			3,489			(3,149	)		340
Investments - nontaxable		45			508			553			(84	)		(6	)		(90	)
Federal funds sold		-			-			-			(102	)		(102	)		(204	)
Due from banks		(268	)		2,233			1,965			428			(297	)		131
Total interest income		3,543			3,644			7,187			2,496			(3,447	)		(951	)

Interest expense:
NOW, MMDA & savings deposits		205			(215	)		(10	)		491			(424	)		67
Time deposits		(34	)		(156	)		(190	)		12			(207	)		(195	)
FHLB borrowings		-			-			-			(179	)		(178	)		(357	)
Trust preferred securities		-			249			249			-			(90	)		(90	)
Other		42			27			69			10			(66	)		(56	)
Total interest expense		213			(95	)		118			334			(965	)		(631	)
Net interest income	$	3,330			3,739			7,069		$	2,162			(2,482	)		(320	)

Net interest income on a tax equivalent basis totaled $51.5 million in 2022, as compared to $44.4 million in 2021. The net interest spread, which represents the rate earned on interest-earning assets less the rate paid on interest-bearing liabilities, was 3.08% in 2022, as compared to a net interest spread of 2.85% in 2021. The net yield on interest-earning assets was 3.22% in 2022 and 2.99% in 2021.

Tax equivalent interest income increased $7.2 million in 2022 primarily due to a $1.9 million increase in interest income and fees on loans, a $3.3 million increase in tax equivalent interest income on investment securities and a $2.0 million increase in interest income on balances due from banks. 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 $2.4 million decrease in fee income on SBA PPP loans. The increase in interest income on investment securities is primarily due to additional securities purchased with additional cash resulting from an increase in deposits combined with higher yields on securities purchased in 2022. The increase in interest income on balances due from banks is primarily due to rate increases by the Federal Reserve. The yield on interest-earning assets was 3.42% in 2022, as compared to 3.21% in 2021.

Interest expense increased $118,000 in 2022, as compared to 2021. The increase in interest expense is primarily due to an increase in rates paid on interest-bearing liabilities. Average interest-bearing liabilities increased by $82.4 million to $979.3 million in 2022, as compared to $896.9 million in 2021. The cost of funds decreased to 0.34% in 2022 from 0.36% in 2021.

In 2021, net interest income on a tax equivalent basis was $44.4 million, as compared to $44.7 million in 2020. The net interest spread was 2.85% in 2021, as compared to 3.34% in 2020. The net yield on interest-earning assets was 2.99% in 2021, as compared to 3.52% in 2020.

Provision for Loan Losses. Provisions for loan losses are charged to income in order to bring the total allowance for loan losses to a level deemed appropriate by management of the Company based on factors such as management’s judgment as to losses within the Bank’s loan portfolio, including the valuation of impaired loans, loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies and management’s assessment of the quality of the loan portfolio and general economic climate.

The provision for loan losses for the year ended December 31, 2022 was $1.5 million, compared to a recovery of $1.2 million for the year ended December 31, 2021. The increase in the provision for loan losses is primarily attributable to an increase in reserves due to an increase in the balance of loans in the general reserve pool. The recovery of provision for loan losses for the year ended December 31, 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 at December 31, 2022 and 2021.

A-8

Net charge-offs for 2022 were $333,000. Net recoveries for 2021 were $610,000. Net charge-offs for 2020 were $1.0 million. The ratio of net charge-offs/(recoveries) to average total loans was 0.03% in 2022, -0.07% in 2021 and 0.11% in 2020. The allowance for loan losses was $10.5 million or 1.02% of total loans outstanding at December 31, 2022. For December 31, 2021 and 2020, the allowance for loan losses amounted to $9.4 million or 1.06% of total loans outstanding and $9.9 million, or 1.04% of total loans outstanding, respectively.

Table 3 presents a summary of net charge off activity for the years ended December 31, 2022, 2021 and 2020.

Table 3 - Net Charge-off Analysis

	Net charge-offs/(recoveries)									Net charge-offs/(recoveries) as a percent of average loans outstanding
	Years ended December 31,									Years ended December 31,
(Dollars in thousands)	2022			2021			2020			2022			2021			2020
Real estate loans
Construction and land development	$	-			(121	)		(31	)		0.00	%		-0.13	%		-0.03	%
Single-family residential		(101	)		(182	)		(5	)		-0.03	%		-0.07	%		0.00	%
Single-family residential - Banco de la Gente non-traditional		-			-			-			0.00	%		0.00	%		0.00	%
Commercial		(9	)		(52	)		(63	)		0.00	%		-0.02	%		-0.02	%
Multifamily and farmland		-			(3	)		-			0.00	%		-0.01	%		0.00	%
Total real estate loans		(110	)		(358	)		(99	)		-0.01	%		-0.05	%		-0.01	%

Loans not secured by real estate
Commercial loans		(39	)		(493	)		869			-0.05	%		-0.54	%		0.54	%
Farm loans		-			-			-			0.00	%		0.00	%		0.00	%
Consumer loans (1)		482			241			254			7.06	%		3.75	%		3.57	%
All other loans		-			-			7			0.00	%		0.00	%		0.20	%
Total loans	$	333			(610	)		1,031			0.03	%		-0.07	%		0.11	%

Provision for (recovery of) loan losses for the period	$	1,472		$	(1,163	)		4,259

Allowance for loan losses at end of period	$	10,494		$	9,355			9,908

Total loans at end of period	$	1,032,608		$	884,869			948,639

Non-accrual loans at end of period	$	3,728		$	3,230			3,758

Allowance for loan losses as a percent of total loans outstanding at end of period		1.02	%		1.06	%		1.04	%

Non-accrual loans as a percent of total loans outstanding at end of period		0.36	%		0.37	%		0.40	%

Allowance for loan losses as a percent of nonaccrual loans at end of period		281.49	%		289.63	%		263.58	%

(1) The loss ratio for consumer loans is elevated because overdraft charge-offs related to DDA and NOW accounts are reported in consumer loan charge-offs and recoveries. The net overdraft charge-offs are not considered material and are therefore not shown separately.

Please see the section below entitled “Allowance for Loan Losses” for a more complete discussion of the Bank’s policy for addressing potential loan losses.

Non-Interest Income. Non-interest income was $26.7 million for the year ended December 31, 2022, compared to $24.9 million for the year ended December 31, 2021. The increase in non-interest income is primarily attributable to a $2.8 million increase in appraisal management fee income due to an increase in appraisal volume and a $1.3 million increase in service charge income, primarily due to service charge changes implemented in March 2022, which were partially offset by a $2.1 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 income was $24.9 million for the year ended December 31, 2021, compared to $22.9 million for the year ended December 31, 2020. The increase in non-interest income is primarily attributable to a $2.1 million increase in appraisal management fee income due to an increase in the volume of appraisals and a $1.7 million increase in miscellaneous non-interest income primarily due to an increase in debit card income resulting from increased debit card activity and an increase in income on Small Business Investment Company (“SBIC”) investments. These increases in non-interest income were partially offset by a $2.6 million decrease in gains on sale of securities.

A-9

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary. No investment impairments were deemed other-than-temporary in 2022, 2021 or 2020.

Table 4 presents a summary of non-interest income for the years ended December 31, 2022, 2021 and 2020.

Table 4 - Non-Interest Income

(Dollars in thousands)	2022		2021		2020
Service charges	$	5,290	$	3,921	$	3,528
Other service charges and fees		734		803		742
Gain on sale of securities		-		-		2,639
Mortgage banking income		393		2,505		2,469
Insurance and brokerage commissions		945		1,035		897
Gain/(loss) on sale and write-down of other real estate		-		21		(47	)
Visa debit card income		4,901		5,045		4,237
Appraisal management fee income		11,663		8,890		6,754
Miscellaneous		2,763		2,699		1,695
Total non-interest income	$	26,689	$	24,919	$	22,914

Non-Interest Expense. Non-interest expense was $56.0 million for the year ended December 31, 2022, compared to $51.1 million for the year ended December 31, 2021. The increase in non-interest expense is primarily attributable to a $2.2 million increase in appraisal management fee expense due to an increase in appraisal volume and a $1.6 million increase in salaries and employee benefits expense primarily due to increases in insurance costs and salary expense and a $421,000 increase in other non-interest expenses primarily due to increases in consulting expense, online banking expense and office supplies expense.

Non-interest expense was $51.1 million for the year ended December 31, 2021, compared to $48.9 million for the year ended December 31, 2020. The increase in non-interest expense was primarily attributable to a $968,000 increase in salaries and employee benefits expense primarily due to an increase in incentive compensation and a $1.8 million increase in appraisal management fee expense due to an increase in the volume of appraisals.

Table 5 presents a summary of non-interest expense for the years ended December 31, 2022, 2021 and 2020.

Table 5 - Non-Interest Expense

(Dollars in thousands)	2022		2021		2020
Salaries and employee benefits	$	26,130	$	24,506	$	23,538
Occupancy expense		8,048		7,858		7,933
Office supplies		532		374		528
FDIC deposit insurance		461		415		263
Visa debit card expense		1,224		1,000		1,012
Professional services		451		489		502
Postage		238		230		190
Telephone		691		730		794
Director fees and expense		454		381		360
Advertising		693		536		787
Consulting fees		1,464		1,337		1,078
Taxes and licenses		277		254		295
Foreclosure/OREO expense		7		5		20
Internet banking expense		949		768		729
FHLB advance prepayment penalty		-		-		1,100
Appraisal management fee expense		9,264		7,112		5,274
Other operating expense		5,147		5,132		4,528
Total non-interest expense	$	56,030	$	51,127	$	48,931

A-10

Income Taxes. The Company reported income tax expense of $4.2 million, $3.8 million and $2.5 million for the years ended December 31, 2022, 2021 and 2020, respectively. The Company’s effective tax rates were 20.56%, 20.05% and 17.98% in 2022, 2021 and 2020, respectively. The increase in the effective tax rate in 2021 and 2022 was primarily due to a reduction in non-taxable investments combined with an increase in earnings before income taxes.

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 December 31, 2022, such unfunded commitments to extend credit were $382.7 million, while commitments in the form of standby letters of credit totaled $4.4 million.

The Company uses several funding sources to meet its liquidity requirements. The primary funding source is core deposits, a non-GAAP measure, which includes demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $250,000. 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 The Company considers these to be a stable portion of the Company’s liability mix and the result of on-going consumer and commercial banking relationships. As of December 31, 2022, the Company’s core deposits totaled $1.4 billion, or 98% of total deposits.

The Bank’s five largest deposit relationships, including securities sold under agreements to repurchase, amounted to $117.0 million and $118.9 million at December 31, 2022 and 2021, respectively. These balances represent 7.89% of total deposits and securities sold under agreements to repurchase combined at December 31, 2022, as compared to 8.20% of total deposits and securities sold under agreements to repurchase combined at December 31, 2021. Total deposits for the five largest relationships referenced above amounted to $85.7 million, or 5.97% of total deposits at December 31, 2022, as compared to $100.5 million, or 7.12% of total deposits at December 31, 2021. Total securities sold under agreements to repurchase for the five largest relationships referenced above amounted to $31.4 million, or 65.76% of total securities sold under agreements to repurchase at December 31, 2022, as compared to $18.3 million, or 49.44% of total securities sold under agreements to repurchase at December 31, 2021.

The other sources of funding for the Company are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreement 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 up to 40% of total assets. The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits and internet certificates of deposit. The Bank’s ratio of wholesale funding to total assets was 0.92% as of December 31, 2022.

The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets, with no balances outstanding at December 31, 2022. At December 31, 2022, the carrying value of loans pledged as collateral totaled approximately $149.4 million. The remaining availability under the line of credit with the FHLB was $86.5 million at December 31, 2022. The Bank had no borrowings from the FRB at December 31, 2022. FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At December 31, 2022, the carrying value of loans pledged as collateral to the FRB totaled approximately $585.0 million. Availability under the line of credit with the FRB was $445.1 million at December 31, 2021.

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 December 31, 2022.

The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits with banks, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 30.32%, 43.28% and 28.12% at December 31, 2022, 2021 and 2020, respectively. The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy for on balance sheet liquidity was 10% at December 31, 2022, 2021 and 2020.

As disclosed in the Company’s Consolidated Statements of Cash Flows included elsewhere herein, net cash provided by operating activities was approximately $22.7 million during 2022. Net cash used in investing activities was $256.0 million during 2021 and net cash provided by financing activities was $27.4 million during 2022.

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. Table 6 presents an interest rate sensitivity analysis for the interest-earning assets and interest-bearing liabilities for the year ended December 31, 2022.

A-11

Table 6 - Interest Sensitivity Analysis

(Dollars in thousands)	Immediate			1-3 months			4-12 months			Total Within One Year			Over One Year & Non-sensitive			Total
Interest-earning assets:
Loans	$	197,430			5,381			19,499			222,310			810,298			1,032,608
Mortgage loans held for sale		211			-			-			211			-			211
Investment securities available for sale		-			1,162			1,691			2,853			442,541			445,394
Interest-bearing deposit accounts		21,535			-			-			21,535			-			21,535
Other interest-earning assets		-			-			-			-			4,132			4,132
Total interest-earning assets		219,176			6,543			21,190			246,909			1,256,971			1,503,880

Interest-bearing liabilities:
NOW, savings, and money market deposits		814,128			-			-			814,128			-			814,128
Time deposits		15,035			9,189			34,875			59,099			38,900			97,999
Securities sold under agreement to repurchase		47,688			-			-			47,688			-			47,688
Trust preferred securities		-			15,464			-			15,464			-			15,464
Total interest-bearing liabilities		876,851			24,653			34,875			936,379			38,900			975,279

Interest-sensitive gap	$	(657,675	)		(18,110	)		(13,685	)		(689,470	)		1,218,071			528,601

Cumulative interest-sensitive gap	$	(657,675	)		(675,785	)		(689,470	)		(689,470	)		528,601

Interest-earning assets as a percentage of interest-bearing liabilities		25.00	%		26.54	%		60.76	%		26.37	%		3,231.29	%

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 (“AFS”) securities. Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds. At December 31, 2022, rate sensitive assets and rate sensitive liabilities totaled $1.6 billion and $979.0 million, respectively.

Included in the rate sensitive assets are $185.2 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the Federal Open Market Committee (“FOMC”). The Bank utilizes interest rate floors on certain variable rate loans to protect against further downward movements in the prime rate. At December 31, 2022, the Bank had $111.6 million in loans with interest rate floors. The floors were in effect on $8,000 of these loans.

An analysis of the Company’s financial condition and growth can be made by examining the changes and trends in interest-earning assets and interest-bearing liabilities. A discussion of these changes and trends follows.

Analysis of Financial Condition

Investment Securities. The composition of the investment securities portfolio reflects the Company’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits.

All of the Company’s investment securities are held in the available for sale (“AFS”) category. At December 31, 2022 the market value of AFS securities totaled $445.4 million, as compared to $406.5 million and $245.2 million at December 31, 2021 and 2020, respectively.

A-12

The Company’s investment portfolio consists of U.S. Government sponsored enterprise securities, municipal securities, U.S. Treasury securities, U.S. Government sponsored enterprise mortgage-backed securities, trust preferred securities and equity securities. AFS securities averaged $467.5 million in 2022, $349.6 million in 2021 and $200.8 million in 2020. Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity. Yields are calculated on a tax equivalent basis. Yields and interest income on tax-exempt investments 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.

Loans. The loan portfolio is the largest category of the Company’s earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. 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 in North Carolina.

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 December 31, 2022, the Bank had $101.5 million in residential mortgage loans, $101.1 million in home equity loans and $610.0 million in commercial mortgage loans, which include $472.3 million secured by commercial property and $137.7 million secured by residential property. Residential mortgage loans include $20.0 million in non-traditional mortgage loans from the former Banco division of the Bank. All residential mortgage loans are originated as fully amortizing loans, with no negative amortization.

The mortgage loans originated in the traditional banking offices are generally 15 –30-year fixed rate loans with attributes that prevent the loans from being sellable in the secondary market. These factors may include higher loan-to-value ratio, limited documentation on income, non-conforming appraisal or non-conforming property type. These loans are generally made to existing Bank customers and have been originated throughout the Bank’s seven county service area, with no geographic concentration.

As of December 31, 2022, gross loans outstanding were $1.0 billion, as compared to $884.9 million at December 31, 2021. Average loans represented 59% and 61% of average total earning assets for the years ended December 31, 2022 and 2021, respectively. The Bank had $211,000 and $3.6 million in mortgage loans held for sale as of December 31, 2022 and 2021, respectively.

Past due TDR loans and non-accrual TDR loans totaled $3.7 million and $2.2 million at December 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 December 31, 2022 and December 31, 2021.

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”) Paycheck Protection Program (“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 $103,000 and $18.0 million at December 31, 2022 and 2021, respectively. These loans are classified as commercial loans in the tables above. The Bank recognized $948,000 and $3.4 million of PPP loan fee income for the year ended December 31, 2022 and year ended December, 2021, respectively. PPP loan fee income is reported in interest and fees on loans in the Consolidated Statements of Earnings on page A-23.

There were no loans with existing modifications as a result of the COVID-19 pandemic at December 31, 2022 and 2021. At December 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. As such, a higher reserve rate has been applied to this pool. Loans included in this pool totaled $70.5 million and $88.7 million at December 31, 2022 and December 31, 2021, respectively. 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.

A-13

Table 7 identifies the maturities of all loans as of December 31, 2022 and addresses the sensitivity of these loans to changes in interest rates.

Table 7 - Maturity and Repricing Data for Loans

(Dollars in thousands)	Within one year or less		After one year through five years		After five years through 15 years		After fifteen years		Total loans
Real estate loans
Construction and land development	$	39,401		32,795		41,664		586		114,446
Single-family residential		116,876		83,201		78,754		43,431		322,262
Single-family residential- Banco de la Gente stated income		9,432		-		5,384		5,203		20,019
Commercial		46,751		183,754		170,049		6,196		406,750
Multifamily and farmland		3,933		23,052		19,598		18,979		65,562
Total real estate loans		216,393		322,802		315,449		74,395		929,039

Loans not secured by real estate
Commercial loans		37,081		22,005		19,461		2,760		81,307
Farm loans		473		465		-		-		938
Consumer loans		2,972		2,795		1,067		-		6,834
All other loans		7,096		1,959		5,435		-		14,490
Total loans	$	264,015		350,026		341,412		77,155		1,032,608

Total fixed rate loans	$	41,705		337,736		331,308		77,155		787,904
Total floating rate loans		222,310		12,290		10,104		-		244,704

Total loans	$	264,015		350,026		341,412		77,155		1,032,608

In the normal course of business, there are various commitments outstanding to extend credit that are not reflected in the financial statements. At December 31, 2022, outstanding loan commitments totaled $382.7 million. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Additional information regarding commitments is provided below in the section entitled “Commitments and Contingencies” and in Note 11 to the Consolidated Financial Statements.

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 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.

A-14

As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third party reviews and evaluates loan relationships greater than or equal to $1.5 million as well as a periodic sample of commercial relationships with exposures below $1.5 million, excluding loans in default, and loans in process of litigation or liquidation. The third party’s evaluation and report is shared with management and the Board of Directors of the Bank (“Bank Board”).

Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance. The provision for 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. There were no loans with existing modifications as a result of the COVID-19 pandemic at December 31, 2022 and 2021. At December 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. As such, a higher reserve rate has been applied to this pool. Loans included in this pool totaled $70.5 million and $88.7 million at December 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 year ended December 31, 2022 as compared to the year ended December 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. The Company adopted CECL as of January 1, 2023.

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.

A-15

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.

Non-performing Assets. Non-performing assets were $3.7 million or 0.23% of total assets at December 31, 2022, compared to $3.2 million or 0.20% of total assets at December 31, 2021. Non-performing assets include $3.7 million in commercial and residential mortgage loans and $8,000 in other loans at December 31, 2022, compared to $3.2 million in commercial and residential mortgage loans and $51,000 in other loans at December 31, 2021. The Bank had no other real estate owned as of December 31, 2022 and 2021. The Bank had no repossessed assets as of December 31, 2022 and 2021.

At December 31, 2022, the Bank had non-performing loans, defined as non-accrual and accruing loans past due more than 90 days, of $3.7 million or 0.36% of total loans. Non-performing loans at December 31, 2021 were $3.2 million or 0.38% of total loans.

Management continually monitors the loan portfolio to ensure that all loans potentially having a material adverse impact on future operating results, liquidity or capital resources have been classified as non-performing. Should economic conditions deteriorate, the inability of distressed customers to service their existing debt could cause higher levels of non-performing loans. Management expects the future level of non-accrual loans to continue to be in-line with the level of non-accrual loans at December 31, 2022 and 2021.

It is the general policy of the Bank to stop accruing interest income when a loan is placed on non-accrual status and any interest previously accrued but not collected is reversed against current income. 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.

Deposits. The Bank primarily uses deposits to fund its loan and investment portfolios. The Bank offers a variety of deposit accounts to individuals and businesses. Deposit accounts include checking, savings, money market and time deposits. Total deposits were $1.4 billion as of December 31, 2022 and 2021. Core deposits, a non-GAAP measure, which include noninterest-bearing demand deposits, NOW, MMDA, savings and non-brokered certificates of deposit of denominations less than $250,000, were $1.4 billion at December 31, 2022 and 2021. 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.

Time deposits in amounts of $250,000 or more totaled $31.0 million and $26.3 million at December 31, 2022 and 2021, respectively. At December 31, 2022 and 2021, the Bank had approximately $15.2 million and $11.1 million, respectively, in time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers. CDARS balances totaled $7.1 million and $3.0 million as of December 31, 2022 and 2021, respectively. The weighted average rate of brokered deposits as of December 31, 2022 and 2021 was 1.27% and 1.49%, respectively.

Table 8 is a summary of the maturity distribution of time deposits in amounts of $250,000 or more as of December 31, 2022.

Table 8 - Maturities of Time Deposits of $250,000 or greater

(Dollars in thousands)	2022
Three months or less	$	7,589
Over three months through six months		4,732
Over six months through twelve months		5,802
Over twelve months		12,878
Total	$	31,001

Borrowed Funds. The Bank has access to various short-term borrowings, including the purchase of federal funds and borrowing arrangements from the FHLB and other financial institutions. There were no FHLB borrowings outstanding at December 31, 2022 and 2021. Average FHLB borrowings for 2022 and 2021 were zero. Additional information regarding FHLB borrowings is provided in Note 7 to the Consolidated Financial Statements.

A-16

The Bank had no borrowings from the FRB at December 31, 2021 and 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 December 31, 2022, the carrying value of loans pledged as collateral totaled approximately $585.0 million.

Securities sold under agreements to repurchase were $47.7 million at December 31, 2022, compared to $37.1 million at December 31, 2021.

Junior subordinated debentures were $15.5 million at December 31, 2022 and December 31, 2021.

Contractual Obligations and Off-Balance Sheet Arrangements. The Company’s contractual obligations include junior subordinated debentures, as well as certain payments under current lease agreements. Other commitments include commitments to extend credit.

The Company enters into derivative contracts to manage various financial risks. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date. Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk. Therefore, the derivative amounts recorded on the balance sheet do not represent the amounts that may ultimately be paid under these contracts. Further discussions of derivative instruments are included above in the section entitled “Asset Liability and Interest Rate Risk Management” beginning on page A-11 and in Note 1 to the Consolidated Financial Statements. There were no derivatives at December 31, 2022 or 2021.

Capital Resources. Shareholders’ equity was $105.2 million, or 6.49% of total assets, at December 31, 2022, compared to $142.4 million, or 8.77% of total assets, at December 31, 2021.

Average shareholders’ equity as a percentage of total average assets is one measure used to determine capital strength. Average shareholders’ equity as a percentage of total average assets was 7.45%, 9.42% and 10.35% for 2022, 2021 and 2020, respectively. The return on average shareholders’ equity was 13.01% at December 31, 2022, as compared to 10.24% and 8.04% at December 31, 2021 and December 31, 2020, respectively. Total cash dividends paid on common stock were $4.9 million, $3.8 million and $4.4 million during 2022, 2021 and 2020, respectively.

The Board of Directors, at its discretion, can issue up to 5,000,000 shares of preferred stock. The Board is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights.

In 2021, the Board of Directors authorized a stock repurchase program, whereby up to $4.0 million was 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 repurchased approximately $3.6 million, or 127,597 shares of its common stock, under this stock repurchase program through December 31, 2021.

In 2022, the Board of Directors authorized a stock repurchase program, whereby up to $2.0 million was 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 repurchased approximately $711,000, or 26,200 shares of its common stock, under this stock repurchase program through December 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.

A-17

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 December 31, 2022 and December 31, 2021. The Company’s Tier 1 capital ratio was 13.21% and 15.43% at December 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 14.04% and 16.35% at December 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 12.03% and 13.96% at December 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 9.82% and 9.64% at December 31, 2022 and December 31, 2021, respectively.

The Bank’s Tier 1 risk-based capital ratio was 13.10% and 15.27% at December 31, 2022 and December 31, 2021, respectively. The total risk-based capital ratio for the Bank was 13.93% and 16.19% at December 31, 2022 and December 31, 2021, respectively. The Bank’s common equity Tier 1 capital ratio was 13.10% and 15.27% at December 31, 2022 and December 31, 2021, respectively. The Bank’s Tier 1 leverage capital ratio was 9.68% and 9.50% at December 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 December 31, 2022.

A-18

PEOPLES BANCORP OF NORTH CAROLINA, INC.
Consolidated Financial Statements
December 31, 2022, 2021 and 2020

INDEX

		PAGE(S)

Reports of Independent Registered Public Accounting Firm on the Consolidated Financial Statements PCAOB #149		A-20 - A-21

Financial Statements
Consolidated Balance Sheets at December 31, 2022 and 2021		A-22

Consolidated Statements of Earnings for the years ended December 31, 2022, 2021 and 2020		A-23

Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2022, 2021 and 2020		A-24

Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2022, 2021 and 2020		A-25

Consolidated Statements of Cash Flows for the years ended December 31, 2022, 2021 and 2020		A-26 - A-27

Notes to Consolidated Financial Statements		A-28 - A-59

A-19

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of Peoples Bancorp of North Carolina, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Peoples Bancorp of North Carolina, Inc. and its subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of earnings, comprehensive income (loss), shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

A-20

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Loan Losses – Qualitative Factors

As discussed in Note 3 to the Company’s financial statements, the Company had a gross loan portfolio of approximately $1.0 billion and associated allowance for loan losses of approximately $10.5 million as of December 31, 2022. As described by the Company in Note 1, the allowance for loan losses is evaluated on a regular basis by management and is based on management’s periodic review of the collectability of the loans in light of the Company’s historical loan loss experience, the amount of past due and non-performing loans, specific known risks, underlying estimated values of collateral securing loans, current and anticipated economic conditions, and other factors which management believes represents the best estimate of the allowance for loan losses.

We identified the Company’s estimate of qualitative factors applied to adjust the historical loss experience of the allowance for loan losses as a critical audit matter. The principal considerations for our determination of the allowance for loan losses as a critical audit matter related to the high degree of subjectivity in the Company’s judgments in determining the qualitative factors. Auditing these complex judgments and assumptions by the Company involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.

The primary procedures we performed to address this critical audit matter included the following:

·	We evaluated the relevance and the reasonableness of assumptions related to evaluation of the loan portfolio, current economic conditions, and other risk factors used in development of the qualitative factors for collectively evaluated loans.
·	We evaluated the reasonableness of assumptions and data used by the Company in developing the qualitative factors by comparing these data points to internally developed and third-party sources, as well as other audit evidence gathered.
·	Analytical procedures were performed to evaluate the directional consistency of changes that occurred in the allowance for loan losses for loans collectively evaluated for impairment.

/s/ Elliott Davis, PLLC

We have served as the Company's auditor since 2015.

Raleigh, North Carolina

March 17, 2023

A-21

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Balance Sheets

December 31, 2022 and December 31, 2021

(Dollars in thousands)
	December 31,			December 31,
Assets	2022			2021
	(Audited)			(Audited)

Cash and due from banks, including reserve requirements of $0 at both 12/31/22 and 12/31/21	$	50,061			44,711
Interest-bearing deposits		21,535			232,788
Cash and cash equivalents		71,596			277,499

Investment securities available for sale		445,394			406,549
Other investments		2,656			3,668
Total securities		448,050			410,217

Mortgage loans held for sale		211			3,637

Loans		1,032,608			884,869
Less allowance for loan losses		(10,494	)		(9,355	)
Net loans		1,022,114			875,514

Premises and equipment, net		18,205			16,104
Cash surrender value of life insurance		17,703			17,365
Right of use lease asset		5,116			4,612
Accrued interest receivable and other assets		37,932			19,245
Total assets	$	1,620,927			1,624,193

Liabilities and Shareholders' Equity

Deposits:
Noninterest-bearing demand	$	523,088			514,319
Interest-bearing demand, MMDA & savings		814,128			797,179
Time, $250,000 or more		31,001			26,333
Other time		66,998			74,917
Total deposits		1,435,215			1,412,748

Securities sold under agreements to repurchase		47,688			37,094
Junior subordinated debentures		15,464			15,464
Lease liability		5,185			4,677
Accrued interest payable and other liabilities		12,180			11,841
Total liabilities		1,515,732			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 5,636,830 shares at December 31, 2022 and 5,661,569 shares at December 31, 2021		52,636			53,305
Common stock held by deferred compensation trust, at cost; 169,004 shares at December 31, 2022 and 162,193 shares at December 31, 2021		(2,181	)		(1,992	)
Deferred compensation		2,181			1,992
Retained earnings		100,156			88,968
Accumulated other comprehensive income (loss)		(47,597	)		96
Total shareholders' equity		105,195			142,369

Total liabilities and shareholders' equity	$	1,620,927			1,624,193

See accompanying Notes to Consolidated Financial Statements.

A-22

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Earnings

For the Years Ended December 31, 2022, 2021 and 2020

(Dollars in thousands, except per share amounts)

	2022			2021			2020

Interest income:
Interest and fees on loans	$	43,077			41,186			42,314
Interest on due from banks		2,223			258			127
Interest on federal funds sold		-			-			204
Interest on investment securities:
U.S. Government sponsored enterprises		4,962			2,478			2,361
States and political subdivisions		4,075			3,146			2,691
Other		94			111			261
Total interest income		54,431			47,179			47,958

Interest expense:
Demand deposits, MMDA & savings deposits		2,019			2,029			1,962
Time deposits		562			752			947
FHLB borrowings		-			-			357
Junior subordinated debentures		529			280			370
Other		213			144			200
Total interest expense		3,323			3,205			3,836

Net interest income		51,108			43,974			44,122

Provision for (recovery of) loan losses		1,472			(1,163	)		4,259

Net interest income after provision for loan losses		49,636			45,137			39,863

Non-interest income:
Service charges		5,290			3,921			3,528
Other service charges and fees		734			803			742
Gain on sale of securities		-			-			2,639
Mortgage banking income		393			2,505			2,469
Insurance and brokerage commissions		945			1,035			897
Appraisal management fee income		11,663			8,890			6,754
Gain (loss) on sale of premises and equipment		(85	)		105			-
Gain (loss) on sales and write-downs of other real estate, net		-			21			(47	)
Miscellaneous		7,749			7,639			5,932
Total non-interest income		26,689			24,919			22,914

Non-interest expense:
Salaries and employee benefits		26,130			24,506			23,538
Occupancy		8,048			7,858			7,933
Professional fees		1,915			1,826			1,580
Advertising		693			536			787
Debit card expense		1,224			1,000			1,012
FDIC insurance		461			415			263
Appraisal management fee expense		9,264			7,112			5,274
Other		8,295			7,874			8,544
Total non-interest expense		56,030			51,127			48,931

Earnings before income taxes		20,295			18,929			13,846

Income tax expense		4,172			3,796			2,489

Net earnings	$	16,123			15,133			11,357

Basic net earnings per share	$	2.94			2.71			2.01
Diluted net earnings per share	$	2.85			2.63			1.95
Cash dividends declared per share	$	0.87			0.66			0.75

See accompanying Notes to Consolidated Financial Statements.

A-23

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Comprehensive Income (Loss)

For the Years Ended December 31, 2022, 2021 and 2020

(Dollars in thousands)

	2022			2021			2020

Net earnings	$	16,123			15,133			11,357

Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale		(61,919	)		(6,886	)		4,919
Reclassification adjustment for gains on securities available for sale included in net earnings		-			-			(2,639	)

Total other comprehensive income (loss), before income taxes		(61,919	)		(6,886	)		2,280

Income tax expense (benefit) related to other comprehensive income (loss):

Unrealized holding gain (losses) on securities available for sale		(14,226	)		(1,582	)		1,130
Reclassification adjustment for gains on securities available for sale included in net earnings		-			-			(606	)

Total income tax expense (benefit) related to other comprehensive income (loss)		(14,226	)		(1,582	)		524

Total other comprehensive income (loss), net of tax		(47,693	)		(5,304	)		1,756

Total comprehensive income (loss)	$	(31,570	)		9,829			13,113

See accompanying Notes to Consolidated Financial Statements.

A-24

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Changes in Shareholders' Equity

For the Years Ended December 31, 2022, 2021 and 2020

(Dollars in thousands)
												Common Stock
												Held By			Accumulated
	Common			Common								Deferred			Other
	Stock			Stock			Retained			Deferred		Compensation			Comprehensive
	Shares			Amount			Earnings			Compensation		Trust			Income (Loss)			Total
Balance, December 31, 2019		5,912,300		$	59,813			70,663			1,588		(1,588	)		3,644			134,120

Common stock repurchase		(126,800	)		(2,999	)		-			-		-			-			(2,999	)
Cash dividends declared on common stock		-			-			(4,392	)		-		-			-			(4,392	)
Restricted stock units exercised		2004			57			-			-		-			-			57
Equity incentive plan, net		-			-			-			208		(208	)		-			-
Net earnings		-			-			11,357			-		-			-			11,357
Change in accumulated other comprehensive income, net of tax		-			-			-			-		-			1,756			1,756
Balance, December 31, 2020		5,787,504		$	56,871			77,628			1,796		(1,796	)		5,400			139,899

Common stock repurchase		(127,597	)		(3,605	)		-			-		-			-			(3,605	)
Cash dividends declared on common stock		-			-			(3,793	)							-			(3,793	)
Restricted stock units exercised		1,662			39			-			-		-			-			39
Equity incentive plan, net		-			-			-			196		(196	)		-			-
Net earnings		-			-			15,133			-		-			-			15,133
Change in accumulated other comprehensive loss, net of tax		-			-			-			-		-			(5,304	)		(5,304	)
Balance, December 31, 2021		5,661,569		$	53,305			88,968			1,992		(1,992	)		96			142,369

Common stock repurchase		(26,200	)		(710	)		-			-		-			-			(710	)
Cash dividends declared on common stock		-			-			(4,935	)							-			(4,935	)
Restricted stock units exercised		1,461			41			-			-		-			-			41
Equity incentive plan, net		-			-			-			189		(189	)		-			-
Net earnings		-			-			16,123			-		-			-			16,123
Change in accumulated other comprehensive loss, net of tax		-			-			-			-		-			(47,693	)		(47,693	)
Balance, December 31, 2022		5,636,830		$	52,636			100,156			2,181		(2,181	)		(47,597	)		105,195

See accompanying Notes to Consolidated Financial Statements.

A-25

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2022, 2021 and 2020

(Dollars in thousands)

	2022			2021			2020

Cash flows from operating activities:
Net earnings	$	16,123			15,133			11,357
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation, amortization and accretion		6,031			5,569			4,183
Provision for (recovery of) loan losses		1,472			(1,163	)		4,259
Deferred income taxes		(541	)		(227	)		(560	)
Gain on sale of investment securities		-			-			(2,639	)
Gain on sale of other real estate		-			(21	)		-
Write-down of other real estate		-			-			47
(Gain) loss on sale and writedowns of premises and equipment		85			(105	)		-
Restricted stock units expense		249			181			27
Proceeds from sales of loans held for sale		22,659			98,365			112,426
Origination of loans held for sale		(19,233	)		(92,863	)		(117,148	)
Change in:
Cash surrender value of life insurance		(403	)		(397	)		(380	)
Right of use lease asset		1,677			738			199
Other assets		(3,920	)		(554	)		(596	)
Lease liability		(1,673	)		(721	)		(176	)
Other liabilities		131			2,965			(1,837	)

Net cash provided by operating activities		22,657			26,900			9,162

Cash flows from investing activities:
Purchases of investment securities available for sale		(149,738	)		(209,306	)		(127,893	)
Proceeds from sales, calls and maturities of investment securities available for sale		7,875			9,540			62,408
Proceeds from paydowns of investment securities available for sale		37,400			28,536			19,169
Purchases of other investments		-			-			(45	)
Proceeds from paydowns of other investment securities		1,162			201			176
Net change in FHLB stock		(105	)		331			(55	)
Net change in loans		(148,072	)		64,380			(99,971	)
Purchases of premises and equipment		(4,563	)		(484	)		(2,492	)
Purchases of bank owned life insurance		-			-			(269	)
Proceeds from sale of premises and equipment		-			515			-
Proceeds from sale of other real estate and repossessions		-			149
Proceeds from bank owned life insurance		65			-			-

Net cash used by investing activities		(255,976	)		(106,138	)		(148,972	)

Cash flows from financing activities:
Net change in deposits		22,467			191,662			254,569
Net change in securities sold under agreement to repurchase		10,594			10,893			1,980
Proceeds from FHLB borrowings		-			-			70,000
Repayments of FHLB borrowings		-			-			(70,000	)
Proceeds from FRB borrowings		1			1			1
Repayments of FRB borrowings		(1	)		(1	)		(1	)
Proceeds from Fed Funds Purchased		162			162			7,011
Repayments of Fed Funds Purchased		(162	)		(162	)		(7,011	)
Repayments of Junior Subordinated Debentures		-			-			(155	)
Common stock repurchased		(710	)		(3,605	)		(2,999	)
Cash dividends paid on common stock		(4,935	)		(3,793	)		(4,392	)

Net cash provided by financing activities		27,416			195,157			249,003

Net change in cash and cash equivalents		(205,903	)		115,919			109,193

Cash and cash equivalents at beginning of period		277,499			161,580			52,387

Cash and cash equivalents at end of period	$	71,596			277,499			161,580

A-26

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Consolidated Statements of Cash Flows, continued

For the Years Ended December 31, 2022, 2021 and 2020

(Dollars in thousands)

	2022			2021			2020

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	3,284			3,224			3,856
Income taxes	$	4,659			3,669			2,781

Noncash investing and financing activities:
Change in unrealized gain (loss) on investment securities available for sale, net	$	(47,693	)		(5,304	)		1,756
Transfer of loans to other real estate	$	-			-			175
Issuance of accrued restricted stock units	$	41			39			57
Initial recognition of lease right of use asset and lease liability	$	2,181			1,927			942

See accompanying Notes to Consolidated Financial Statements.

A-27

PEOPLES BANCORP OF NORTH CAROLINA, INC.

Notes to Consolidated Financial Statements

(1) Summary of Significant Accounting Policies

Organization

Peoples Bancorp of North Carolina, Inc. (the “Company”) has served as the holding company to Peoples Bank (the “Bank”) since 1999. The Company is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for the Bank.

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is primarily regulated by the Commissioner and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell and Wake counties in North Carolina.

Peoples Investment Services, Inc. (“PIS”) is a wholly owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC (“CBRES”) is a wholly owned subsidiary of the Bank and began operations in 2009 as a “clearing house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies. In 2019, the Company launched PB Insurance Agency, which operated as a division of CBRES, until it was discontinued in 2022.

PB Real Estate Holdings, LLC (“PBREH”) is a wholly owned subsidiary of the Bank and began operation in 2015. PBREH acquires, manages and disposes of real property, other collateral and other assets obtained in the ordinary course of collecting debts previously contracted.

Principles of Consolidation

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Business Segments

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by management in deciding how to allocate resources and in assessing performance. Management has determined that the Company has two significant operating segment: Banking Operations and CBRES, as discussed more fully in Note 16. In determining the appropriateness of segment definition, the Company considers the criteria of ASC 280, Segment Reporting.

A-28

Cash and Cash Equivalents

Cash, due from banks, interest-bearing deposits and federal funds sold are considered cash and cash equivalents for cash flow reporting purposes.

Investment Securities

The Company uses three classifications for its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2022 and 2021, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on a quarterly basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

The allowance for loan losses (“ALLL” or “allowance”) 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; and
	·	other factors which management believes affect the allowance for potential credit losses.

A-29

Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectability becomes doubtful. Upon loan origination, the Bank’s originating loan officer evaluates the quality of the loan and assigns one of eight risk grades. The loan officer monitors the loan’s performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank’s Credit Administration. Before making any changes in these risk grades, management considers assessments as determined by the third party credit review firm (as described below), regulatory examiners and the Bank’s Credit Administration. Any issues regarding the risk assessments are addressed by the Bank’s senior credit administrators and factored into management’s decision to originate or renew the loan. The Bank’s Board of Directors reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration.

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. There were no loans with existing modifications as a result of the COVID-19 pandemic at December 31, 2022 and 2021. At December 31, 2022 and 2021, the Bank maintained 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. As such, a higher reserve rate has been applied to this pool. Loans included in this pool totaled $70.5 million and $88.7 million at December 31, 2022 and December 31, 2021, respectively.

A-30

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.

SBA PPP loans are excluded from the allowance as PPP loans are 100 percent guaranteed by the SBA.

Mortgage Banking Activities

Mortgage banking income represents income from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $285,000, $351,000 and $578,000 at December 31, 2022, 2021 and 2020, respectively. Mortgage servicing rights related to these loans are immaterial for all periods presented.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale. The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts. The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Mortgage loans held for sale are carried at the lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for that period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

Buildings and improvements		10 - 50 years
Furniture and equipment		3 - 10 years

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan. Foreclosed assets are reported at fair value less estimated selling costs. Any write-downs at the time of foreclosure are charged to the allowance. Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value less estimated selling costs declines below carrying value. Costs relating to the development and improvement of the property are capitalized. Revenues and expenses from operations are included in other expenses. Changes in the valuation allowance are included in loss on sale and write-down of other real estate.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

A-31

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Advertising Costs

Advertising costs are expensed as incurred.

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. The 2009 Plan expired on May 7, 2019 but still governs the rights and obligations of the parties for grants made thereunder. No new awards may be made after May 7, 2019.

The Company granted 16,583 restricted stock units under the 2009 Plan at a grant date fair value of $16.34 per share during the first quarter of 2015. The Company granted 5,544 restricted stock units under the 2009 Plan at a grant date fair value of $16.91 per share during the first quarter of 2016. The Company granted 4,114 restricted stock units under the 2009 Plan at a grant date fair value of $25.00 per share during the first quarter of 2017. The Company granted 3,725 restricted stock units under the 2009 Plan at a grant date fair value of $31.43 per share during the first quarter of 2018. The Company granted 5,290 restricted stock units under the 2009 Plan at a grant date fair value of $28.43 per share during the first quarter of 2019. The number of restricted stock units granted and grant date fair values for the restricted stock units granted in 2015 through 2017 have been restated to reflect the 10% stock dividend that was paid in the fourth quarter of 2017. The Company recognizes compensation expense on the restricted stock units over the vesting period (four years from the grant date for the 2015, 2016, 2017, 2018 and 2019 grants). The amount of expense recorded each period reflects the changes in the Company’s stock price during such period. As of December 31, 2022, the total unrecognized compensation expense related to the restricted stock unit grants under the 2009 Plan was $3,000.

The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by shareholders on May 7, 2020 (the “2020 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights or book value shares, may be granted to eligible directors and employees. A total of 300,000 shares were reserved for possible issuance under the 2020 Plan when it was adopted. As of December 31, 2021, a total of 285,305 shares out of the initial 300,000 shares reserved remain available for future issuance under the 2020 Plan. No new awards may be made after May 7, 2030 (ten years from the 2020 Plan effective date).

The Company granted 7,635 restricted stock units under the 2020 Plan at a grant date fair value of $17.08 per share during the second quarter of 2020. The Company granted 7,060 restricted stock units under the 2020 Plan at a grant date fair value of $22.04 per share during the first quarter of 2021. The Company granted 5,385 restricted stock units under the 2020 Plan at a grant date fair value of $27.99 per share during the first quarter of 2022. The Company recognizes compensation expense on the restricted stock units over the vesting period (four years from the grant date for 2020, 2021 and 2022 grants). As of December 31, 2022, the total unrecognized compensation expense related to the restricted stock unit grants under the 2020 Plan was $334,000.

A-32

The Company recognized compensation expense for restricted stock units granted under the 2009 Plan and 2020 Plan of $249,000, $181,000 and $27,000 for the years ended December 31, 2022, 2021 and 2020, respectively.

Net Earnings Per Share

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

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2022, 2021 and 2020 are as follows:

For the year ended December 31, 2022
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	16,123		5,480,123	$	2.94
Effect of dilutive securities:
Restricted stock units - unvested		-		15,467
Shares held in deferred comp plan by deferred compensation trust				165,599
Diluted earnings per share	$	16,123		5,661,189	$	2.85

For the year ended December 31, 2021
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	15,133		5,576,099	$	2.71
Effect of dilutive securities:
Restricted stock units - unvested		-		13,935
Shares held in deferred comp plan by deferred compensation trust				158,831
Diluted earnings per share	$	15,133		5,748,865	$	2.63

For the year ended December 31, 2020
	Net Earnings (Dollars in thousands)		Weighted Average Number of Shares		Per Share Amount
Basic earnings per share	$	11,357		5,657,025	$	2.01
Effect of dilutive securities:
Restricted stock units		-		14,203
Shares held in deferred comp plan by deferred compensation trust		-		150,394
Diluted earnings per share	$	11,357		5,821,622	$	1.95

A-33

Recent Accounting Pronouncements

The following tables provide a summary of Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”) that the Company has recently adopted.

Recently Adopted Accounting Guidance

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
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 did not have a material impact on the Company’s results of operations, financial position or disclosures.

The following tables provide a summary of ASU’s issued by the FASB that the Company has not adopted as of December 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 has developed CECL model assumptions and is comparing results to current allowance for loan loss calculations. Parallel processing of the existing allowance for loan losses model with the CECL was completed during the fourth quarter of 2022. At this time, the Company expects its allowance for credit losses related to all financial assets will increase by approximately $1.1 million upon adoption compared to its allowance for loan losses at December 31, 2022 of approximately $10.5 million. The impact of the initial adoption will be reflected in the Company's SEC Form 10-Q for the period ended March 31, 2023.
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.

A-34

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
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 2022-02: Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures	Eliminates the guidance on troubled debt restructurings (TDRs) for creditors in ASC 310-40 2 and amends the guidance on vintage disclosures to require disclosure of current-period gross write-offs by year of origination.	January 1, 2023	The adoption of this guidance is not expected to have a material impact on the Company s results of operations or financial position but will impact future disclosure requirements and reduce individually evaluated loan totals.

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 and 2020 consolidated financial statements have been reclassified to conform to the 2022 presentation.

(2) Investment Securities

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

(Dollars in thousands)
	December 31, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S Treasuries	$	10,951		-		1,137		9,814
U.S. Government sponsored enterprises		12,245		-		706		11,539
Mortgage-backed securities		299,222		445		25,829		273,838
State and political subdivisions		184,768		91		34,656		150,203
Total	$	507,186		536		62,328		445,394

(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

A-35

The current fair value and associated unrealized losses on investments in debt securities with unrealized losses at December 31, 2022 and 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)
	December 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	$	2,878		104		6,936		1,033		9,814		1,137
U.S. Government sponsored enterprises		2,904		87		8,635		619		11,539		706
Mortgage-backed securities		128,241		8,740		120,464		17,089		248,705		25,829
State and political subdivisions		65,880		7,766		76,291		26,890		142,171		34,656
Total	$	199,903		16,697		212,326		45,631		412,229		62,328

(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

At December 31, 2022, unrealized losses in the investment securities portfolio relating to debt securities totaled $62.3 million. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary. From the December 31, 2022 tables above, all three of the U.S. Treasury securities, 149 of the 158 securities issued by state and political subdivisions contained unrealized losses, all seven of the securities issued by U.S. Government sponsored enterprises, and 123 of the 133 mortgage-backed securities, contained unrealized losses. These unrealized losses are considered temporary because of acceptable financial condition and results of operations on each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary. No investment impairments were deemed other-than-temporary in 2022, 2021 or 2020.

The amortized cost and estimated fair value of investment securities available for sale at December 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.

December 31, 2022
(Dollars in thousands)
	Amortized Cost		Fair Value
Due within one year	$	240		240
Due from one to five years		8,434		8,128
Due from five to ten years		58,540		49,599
Due after ten years		140,750		113,589
Mortgage-backed securities		299,222		273,838
Total	$	507,186		445,394

No securities available for sale were sold during 2022 and 2021. During 2020, proceeds from sales of securities available for sale were $56.3 million and resulted in gross gains of $2.7 million and gross losses of $56,000.

A-36

Securities with a fair value of approximately $96.0 million and $98.6 million at December 31, 2022 and 2021, respectively, were pledged to secure public deposits, FHLB borrowings and for other purposes as required by law.

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements. Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2022 and 2021.

(Dollars in thousands)
	December 31, 2022
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
U. S Treasuries	$	9,814		-		9,814		-
U.S. Government sponsored enterprises	$	11,539		-		11,539		-
Mortgage-backed securities	$	273,838		-		273,838		-
State and political subdivisions	$	150,203		-		150,203		-

(Dollars in thousands)
	December 31, 2021
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
U. S Treasuries	$	7,889		-		7,889		-88.7
U.S. Government sponsored enterprises	$	14,267		-		14,267		-
Mortgage-backed securities	$	217,152		-		217,152		-
State and political subdivisions	$	167,241		-		167,241		-

(3) Loans

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

A-37

(Dollars in thousands)
	December 31, 2022			December 31, 2021
Real estate loans:
Construction and land development	$	114,446			95,760
Single-family residential		322,262			266,111
Single-family residential - Banco de la Gente non-traditional		20,019			23,147
Commercial		406,750			337,841
Multifamily and farmland		65,562			58,366
Total real estate loans		929,039			781,225

Loans not secured by real estate:
Commercial loans		81,307			91,172
Farm loans		938			796
Consumer loans		6,834			6,436
All other loans		14,490			5,240

Total loans		1,032,608			884,869

Less allowance for loan losses		(10,494	)		(9,355	)

Total net loans	$	1,022,114			875,514

The above table includes deferred costs, net of deferred fees, totaling $909,000 at December 31, 2022. The above table includes deferred costs, net of deferred fees, totaling $198,000 at December 31, 2021 including $945,000 in deferred PPP loan fees.

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.

	·	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.

	·	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.

	·	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.

	·	Multifamily and farmland loans – Decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.

A-38

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.

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 $103,000 and $18.0 million at December 31, 2022 and 2021, respectively. These loans are classified as commercial loans in the tables above. The Bank recognized $948,000 and $3.4 million of PPP loan fee income for the year ended December 31, 2022 and year ended December, 2021, respectively.

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

December 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	$	363		-		363		114,083		114,446		-
Single-family residential		4,318		256		4,574		317,688		322,262		-
Single-family residential - Banco de la Gente non-traditional		2,977		264		3,241		16,778		20,019		-
Commercial		306		-		306		406,444		406,750		-
Multifamily and farmland		-		-		-		65,562		65,562		-
Total real estate loans		7,964		520		8,484		920,555		929,039		-

Loans not secured by real estate:
Commercial loans		3		-		3		81,304		81,307		-
Farm loans		-		-		-		938		938		-
Consumer loans		71		-		71		6,763		6,834		-
All other loans		-		-		-		14,490		14,490		-
Total loans	$	8,038		520		8,558		1,024,050		1,032,608		-

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		-

A-39

The following table presents the Bank’s non-accrual loans as of December 31, 2022 and 2021:

(Dollars in thousands)
	December 31, 2022		December 31, 2021
Real estate loans:
Construction and land development	$	53		-
Single-family residential		1,914		1,642
Single-family residential - Banco de la Gente non-traditional		1,532		1,232
Commercial		129		200
Multifamily and farmland		91		105
Total real estate loans		3,719		3,179

Loans not secured by real estate:
Commercial loans		-		49
Consumer loans		9		2
Total	$	3,728		3,230

At the end of each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers who also perform appraisals for third parties. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management in determining the fair value of collateral. 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 collectively evaluated for impairment totaled $4.9 million and $5.3 million at December 31, 2022 and 2021, respectively. Accruing impaired loans were $15.4 and $18.3 million at December 31, 2022 and December 31, 2021, respectively. Interest income recognized on accruing impaired loans was $862,000 and $1.0 million for the years ended December 31, 2022 and 2021, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Bank’s impaired loans as of December 31, 2022, 2021 and 2020:

December 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		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	110		-		110		110		2		75		8
Single-family residential		3,912		236		3,300		3,536		60		5,194		194
Single-family residential - Banco de la Gente non-traditional		10,441		-		9,748		9,748		611		8,757		552
Commercial		1,785		421		1,346		1,767		9		1,916		93
Multifamily and farmland		104		-		91		91		-		96		5
Total impaired real estate loans		16,352		657		14,595		15,252		682		16,038		852

Loans not secured by real estate:
Commercial loans		116		-		116		116		1		137		8
Consumer loans		11		-		9		9		-		15		2
Total impaired loans	$	16,479		657		14,720		15,377		683		16,190		862

A-40

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		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	73		-		73		73		3		82		6
Single-family residential		5,138		524		4,374		4,898		86		6,017		253
Single-family residential - Banco de la Gente non-traditional		11,753		-		10,922		10,922		687		10,325		609
Commercial		2,138		435		1,608		2,043		11		2,385		109
Multifamily and farmland		113		-		105		105		-		110		6
Total impaired real estate loans		19,215		959		17,082		18,041		787		18,919		983

Loans not secured by real estate:
Commercial loans		282		49		170		219		2		271		19
Consumer loans		8		-		4		4		-		11		1
Total impaired loans	$	19,505		1,008		17,256		18,264		789		19,201		1,003

December 31, 2020
(Dollars in thousands)

	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	108		-		108		108		4		134		8
Single-family residential		5,302		379		4,466		4,845		33		4,741		262
Single-family residential - Banco de la Gente non-traditional		13,417		-		12,753		12,753		862		13,380		798
Commercial		2,999		1,082		1,891		2,973		14		2,940		139
Multifamily and farmland		119		-		117		117		-		29		6
Total impaired real estate loans		21,945		1,461		19,335		20,796		913		21,224		1,213

Loans not secured by real estate:
Commercial loans		515		211		244		455		5		564		32
Consumer loans		41		-		37		37		1		60		5
Total impaired loans	$	22,501		1,672		19,616		21,288		919		21,848		1,250

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at December 31, 2022 and 2021 are presented below. The Bank’s valuation methodology is discussed in Note 16.

(Dollars in thousands)
	Fair Value Measurements December 31, 2022		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	211		-		-		211
Impaired loans	$	14,694		-		-		14,694

(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

A-41

Fair Value

December 31, 2022

Fair Value

December 31, 2021

Valuation

Technique

Significant

Unobservable

Inputs

General Range of Significant Unobservable Input Values

Mortgage loans held for sale

211

3,637

Rate lock commitment

N/A

Impaired loans

14,694

17,475

Appraised value and discounted cash flows

Discounts to reflect current market conditions and ultimate collectability

0 - 25%

The following table presents changes in the allowance for loan losses for the year ended December 31, 2022. PPP loans are excluded from the allowance for loan losses as PPP loans are 100 percent guaranteed by the SBA.

(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
Twelve months ended December 31, 2022
Allowance for loan losses:
Beginning balance	$	1,193		2,013			864			2,234		150		711			-		110			2,080			9,355
Charge-offs		-		(128	)		-			-		-		(33	)		-		(591	)		-			(752	)
Recoveries		-		229			-			9		-		72			-		109			-			419
Provision		222		208			(101	)		964		14		(93	)		-		586			(328	)		1,472
Ending balance	$	1,415		2,322			763			3,207		164		657			-		214			1,752			10,494

Allowance for loan losses December 31, 2022
Ending balance: individually evaluated for impairment	$	-		36			597			6		-		-			-		-			-			639
Ending balance: collectively evaluated for impairment		1,415		2,286			166			3,201		164		657			-		214			1,752			9,855
Ending balance	$	1,415		2,322			763			3,207		164		657			-		214			1,752			10,494

Loans at December 31, 2022
Ending balance	$	114,446		322,262			20,019			406,750		65,562		81,307			938		21,324			-			1,032,608

Ending balance: individually evaluated for impairment	$	-		537			8,555			1,388		-		-			-		-			-			10,480
Ending balance: collectively evaluated for impairment	$	114,446		321,725			11,464			405,362		65,562		81,307			938		21,324			-			1,022,128

Changes in the allowance for loan losses for the year ended December 31, 2021 were as follows:

A-42

(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
Twelve months ended December 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		-			(89	)		-			-			-		(293	)		-		(380	)		-		(762	)
Recoveries		121			271			-			52			3		786			-		139			-		1,372
Provision		(124	)		(12	)		(188	)		(30	)		25		(1,127	)		-		223			70		(1,163	)
Ending balance	$	1,193			2,013			864			2,234			150		711			-		110			2,080		9,355

Allowance for loan losses December 31, 2021
Ending balance: individually evaluated for impairment	$	1			57			672			7			-		-			-		-			-		737
Ending balance: collectively evaluated for impairment		1,192			1,956			192			2,227			150		711			-		110			2,080		8,618
Ending balance	$	1,193			2,013			864			2,234			150		711			-		110			2,080		9,355

Loans at December 31, 2021
Ending balance	$	95,760			266,111			23,147			337,841			58,366		91,172			796		11,676			-		884,869

Ending balance: individually evaluated for impairment	$	6			1,633			9,795			1,437			-		49			-		-			-		12,920
Ending balance: collectively evaluated for impairment	$	95,754			264,478			13,352			336,404			58,366		91,123			796		11,676			-		871,949

Changes in the allowance for loan losses for the year ended December 31, 2020 were as follows:

(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
Twelve months ended December 31, 2020
Allowance for loan losses:
Beginning balance	$	694			1,274			1,073			1,305			120		688			-		138			1,388		6,680
Charge-offs		(5	)		(65	)		-			(7	)		-		(903	)		-		(434	)		-		(1,414	)
Recoveries		36			70			-			70			-		34			-		173			-		383
Provision		471			564			(21	)		844			2		1,526			-		251			622		4,259
Ending balance	$	1,196			1,843			1,052			2,212			122		1,345			-		128			2,010		9,908

Allowance for loan losses December 31, 2020
Ending balance: individually evaluated for impairment	$	1			4			844			8			-		-			-		-			-		857
Ending balance: collectively evaluated for impairment		1,195			1,839			208			2,204			122		1,345			-		128			2,010		9,051
Ending balance	$	1,196			1,843			1,052			2,212			122		1,345			-		128			2,010		9,908

Loans at December 31, 2020
Ending balance	$	94,124			272,325			26,883			332,971			48,880		161,740			855		10,861			-		948,639

Ending balance: individually evaluated for impairment	$	7			1,558			11,353			2,118			-		212			-		-			-		15,248
Ending balance: collectively evaluated for impairment	$	94,117			270,767			15,530			330,853			48,880		161,528			855		10,861			-		933,391

Impaired loans collectively evaluated for impairment totaled $4.9 million, $5.3 million and $5.8 million at December 31, 2022, 2021 and 2020, respectively and are included in the tables above. Allowance on impaired loans collectively evaluated for impairment totaled $44,000, $42,000 and 61,000 at December 31, 2022, 2021 and 2020, respectively.

A-43

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).
	·	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 December 31, 2022 and 2021.

December 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	$	-		2,782		-		-		-		1,365		-		527		-		4,674
2- High Quality		14,912		138,124		-		33,353		17		13,302		-		2,384		1,366		203,458
3- Good Quality		94,113		166,329		7,442		340,926		63,270		64,422		938		3,663		12,851		753,954
4- Management Attention		5,257		10,615		8,968		27,957		2,061		1,507		-		244		128		56,737
5- Watch		54		922		1,136		3,963		123		711		-		1		145		7,055
6- Substandard		110		3,490		2,473		551		91		-		-		15		-		6,730
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	114,446		322,262		20,019		406,750		65,562		81,307		938		6,834		14,490		1,032,608

A-44

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

There were no new TDR modifications during the years ended December 31, 2022 and 2021.

There were no TDR loans with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the years ended December 31, 2022 and 2021. TDR loans are deemed to be in default if they become past due by 90 days or more.

(4) Premises and Equipment

Major classifications of premises and equipment at December 31, 2022 and 2021 are summarized as follows:

(Dollars in thousands)
	2022			2021

Land	$	3,851			3,857
Buildings and improvements		18,371			18,359
Furniture and equipment		26,156			25,420
Construction in process		3,028			-

Total premises and equipment		51,406			47,636

Less accumulated depreciation		(33,201	)		(31,532	)

Total net premises and equipment	$	18,205			16,104

The Bank recognized depreciation expense totaling $2.4 million, $2.6 million and $2.5 million for the years ended December 31, 2022, 2021 and 2020, respectively.

The Bank had $85,000 net losses on the sale of and write-downs on premises and equipment for the year ended December 31, 2022. The Bank had $105,000 net gains on the sale of and write-downs on premises and equipment for the year ended December 31, 2021. The Bank had no gains or losses on the sale of or write-downs on premises and equipment for the year ended December 31, 2020.

(5) Leases

The Bank leases various office spaces for banking and operational facilities and equipment under operating lease arrangements.

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Total rent expense was approximately $976,000, $703,000 and $880,000 for the years ended December 31, 2022, 2021 and 2020, respectively.

As of December 31, 2022, the Bank had operating right of use assets of $5.1 million and operating lease liabilities of $5.2 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 December 31, 2022.

(Dollars in thousands)
	December 31, 2022

Operating lease cost	$	888

Other information:
Cash paid for amounts included in the measurement of lease liabilities		873
Operating cash flows from operating leases		-
Right-of-use assets obtained in exchange for new lease liabilities - operating leases		1,726
Weighted-average remaining lease term - operating leases		9.26
Weighted-average discount rate - operating leases		2.23	%

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

(Dollars in thousands)

Maturity Analysis of Operating Lease Liabilities:	December 31, 2022

2023	$	805
2024		750
2025		694
2026		577
2027		528
Thereafter		2,418
Total		5,727
Less: Imputed Interest		(542	)
Operating Lease Liability	$	5,185

(6) Time Deposits

At December 31, 2022, the scheduled maturities of time deposits are as follows:

(Dollars in thousands)

2023	$	59,099
2024		26,526
2025		7,380
2026		3,420
2027 and thereafter		1,574
Total	$	97,999

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At December 31, 2022 and 2021, the Bank had approximately $15.0 million and $11.1 million, respectively, in time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers. CDARS balances totaled $7.1 million and $3.0 million as of December 31, 2022 and 2021, respectively. The weighted average rate of brokered deposits as of December 31, 2022 and 2021 was 1.27% and 1.49%, respectively.

(7) Federal Home Loan Bank (FHLB) and Federal Reserve Bank Borrowings

The Bank had no borrowings from the FHLB at December 31, 2022 and 2021. FHLB borrowings are collateralized by a blanket assignment on all residential first mortgage loans, home equity lines of credit and loans secured by multi-family real estate that the Bank owns. At December 31, 2022, the carrying value of loans pledged as collateral totaled approximately $149.4 million. The remaining availability under the line of credit with the FHLB was $86.5 million at December 31, 2022. The Bank incurred a $1.1 million prepayment penalty on the prepayment of a $70.0 million FHLB advance in 2020.

The Bank is required to purchase and hold certain amounts of FHLB stock in order to obtain FHLB borrowings. No ready market exists for the FHLB stock, and it has no quoted market value. The stock is redeemable at $100 per share subject to certain limitations set by the FHLB. The Bank owned $812,000 and $707,000 of FHLB stock, included in other investments, at December 31, 2022 and 2021, respectively.

As of December 31, 2022 and 2021, the Bank had no borrowings from the Federal Reserve Bank (“FRB”). FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB. At December 31, 2022, the carrying value of loans pledged as collateral totaled approximately $585.0 million. Availability under the line of credit with the FRB was $445.1 million at December 31, 2022.

(8) Junior Subordinated Debentures

In June 2006, the Company formed a second 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 in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes. The debentures represent the sole assets of PEBK Trust II. PEBK Trust II is not included in the consolidated financial statements. The Company redeemed $5.0 million of outstanding trust preferred securities in 2019.

The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities. The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures 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. Management has reviewed the implications of the Adjustable Interest Rate Act (LIBOR Act) enacted in March 2022 and the related Federal Reserve regulations with legal counsel, and is currently working with the trustee to complete required updates prior to June 30, 2023.

(9) Income Taxes

The provision for income taxes is summarized as follows:

A-47

(Dollars in thousands)
	2022			2021			2020
Current expense	$	4,713			4,023			3,049
Deferred income tax benefit		(541	)		(227	)		(560	)
Total income tax	$	4,172			3,796			2,489

The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to earnings before income taxes are as follows:

(Dollars in thousands)
	2022			2021			2020
Tax expense at statutory rate	$	4,262			3,975			2,908
State income tax, net of federal income tax effect		395			339			261
Tax-exempt interest income		(445	)		(497	)		(649	)
Increase in cash surrender value of life insurance		(71	)		(83	)		(80	)
Tax credits		(230	)		(234	)		(234	)
Nondeductible interest and other expense		24			30			46
Other		237			266			237
Total	$	4,172			3,796			2,489

The following summarizes the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities. The net deferred tax asset is included as a component of other assets at December 31, 2022 and 2021.

(Dollars in thousands)
	2022			2021
Deferred tax assets:
Allowance for loan losses	$	2,411			2,149
Accrued retirement expense		1,174			1,148
Restricted stock		245			209
Interest income on nonaccrual loans		1			2
Lease liability		1,191			1,075
Unrealized loss on available for sale securities		14,197			-
Total gross deferred tax assets		19,219			4,583

Deferred tax liabilities:
Deferred loan fees		209			263
Accumulated depreciation		438			563
Prepaid expenses		3			4
ROU Asset		1,175			1,060
Other		(93	)		(55	)
Unrealized gain on available for sale securities		-			29
Total gross deferred tax liabilities		1,732			1,864

Net deferred tax asset	$	17,487			2,719

The Company has analyzed the tax positions taken or expected to be taken in its tax returns and has concluded that it has no liability related to uncertain tax positions.

As of December 31, 2022, the Company’s Federal income tax filings for years 2019 through 2021 are open to audit by the Internal Revenue Service. The Company’s North Carolina income tax returns are currently under audit for tax year 2014-2016, tax years 2019, 2020, 2021 and 2022 remain open to audit by the North Carolina Department of Revenue.

(10) Related Party Transactions

The Company conducts transactions with its directors and executive officers, including companies in which they have beneficial interests, in the normal course of business. In accordance with Regulation O of the Federal Reserve, it is the policy of the Bank that loan transactions with directors and officers are made on substantially the same terms as those prevailing at the time made for comparable loans to other persons. The following is a summary of activity for related party loans for 2022 and 2021:

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(Dollars in thousands)
	2022			2021
Beginning balance	$	2,687			1,852
Disbursements		4,090			3,636
Repayments		(3,396	)		(2,801	)
Ending balance	$	3,381			2,687

At December 31, 2022 and 2021, the Company had deposit relationships with related parties of approximately $44.5 million and $43.4 million, respectively.

(11) Commitments and Contingencies

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

In most cases, the Bank requires collateral or other security to support financial instruments with credit risk.

(Dollars in thousands)
	Contractual Amount
	2022		2021
Financial instruments whose contract amount represent credit risk:

Commitments to extend credit	$	382,699		304,258

Standby letters of credit	$	4,352		4,892

Commitments to extend credit are conditional agreements to lend to a customer. Commitments generally have fixed expiration dates and because they may expire without being drawn upon, the total commitment amount of $387.1 million does not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Bank to pay a third party on behalf of a customer. Those letters of credit are primarily issued to businesses in the Bank’s delineated market area. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds real estate, equipment, automobiles and customer deposits as collateral supporting those commitments for which collateral is deemed necessary.

In the normal course of business, the Company is a party (both as plaintiff and defendant) to lawsuits. In the opinion of management and counsel, none of these cases should have a material adverse effect on the financial position of the Company.

The Company and the Bank have entered into employment agreements with certain key employees. The agreements, among other things, include salary, bonus, incentive compensation, and change in control provisions.

The Company has $110.5 million available for the purchase of overnight federal funds from five correspondent financial institutions as of December 31, 2022.

At December 31, 2017, the Bank committed to invest $3.0 million in an income tax credit partnership owning and developing two multifamily housing developments in Charlotte, North Carolina, with $1.5 million allocated to each property. As of December 31, 2022, the Bank has funded $2.9 million of this commitment. At December 31, 2022, the Bank had $1.5 million in unfunded commitments for SBA Small Business Investment Company (“SBIC”) investments.

A-49

(12) Employee and Director Benefit Programs

The Bank has a profit sharing and 401(k) plan for the benefit of substantially all employees subject to certain minimum age and service requirements. Under the 401(k) plan, the Bank matched employee contributions to a maximum of 4.00% of annual compensation in 2020, 2021 and 2022. The Company’s contribution pursuant to this formula was approximately $719,000, $709,000 and $692,000 for the years ended December 31, 2022, 2021 and 2020, respectively. Investments made available under the 401(k) plan are determined by a committee comprised of senior management. No investments in Company stock are available under the 401(k) plan. Contributions to the 401(k) plan are vested immediately.

In December 2001, the Company initiated a retirement benefit plan to provide retirement benefits to key officers and its Board of Directors and to provide death benefits for their designated beneficiaries. Under the postretirement benefit plan, the Company purchased life insurance policies on the lives of the key officers and each director. The increase in cash surrender value of the policies constitutes the Company’s contribution to the postretirement benefit plan each year. Postretirement benefit plan participants are to be paid annual benefits for a specified number of years commencing upon retirement. Expenses incurred for benefits relating to the postretirement benefit plan were approximately $369,000, $447,000 and $368,000 for the years ended December 31, 2022, 2021 and 2020, respectively.

The Company paid medical benefits for certain retired employees through the first quarter of 2022. The Company did not incur any postretirement medical benefits expense in 2022, 2021 and 2020 due to an excess accrual balance.

The following table sets forth the change in the accumulated benefit obligation for the Company’s two postretirement benefit plans described above:

(Dollars in thousands)
	2022			2021

Benefit obligation at beginning of period	$	5,011			4,870
Service cost		325			359
Interest cost		63			70
Benefits paid		(289	)		(288	)

Benefit obligation at end of period	$	5,110			5,011

The amounts recognized in the Company’s Consolidated Balance Sheet as of December 31, 2022 and 2021 are shown in the following two tables:

(Dollars in thousands)
	2022		2021

Benefit obligation	$	5,110		5,011
Fair value of plan assets		-		-

A-50

(Dollars in thousands)
	2022			2021

Funded status	$	(5,110	)		(5,011	)
Unrecognized prior service cost/benefit		-			-
Unrecognized net actuarial loss		-			-

Net amount recognized	$	(5,110	)		(5,011	)

Unfunded accrued liability	$	(5,110	)		(5,011	)
Intangible assets		-			-

Net amount recognized	$	(5,110	)		(5,011	)

Net periodic benefit cost of the Company’s postretirement benefit plans for the years ended December 31, 2022, 2021 and 2020 consisted of the following:

(Dollars in thousands)
	2022			2021			2020

Service cost	$	325			359			359
Interest cost		63			70			70

Net periodic cost	$	388			429			429

Weighted average discount rate assumption used to determine benefit obligation		5.50	%		5.50	%		5.49	%

The Company paid postretirement plan benefits totaling $289,000, $288,000 and $216,000 during the years ended December 31, 2022, 2021 and 2020, respectively. Information about the expected benefit payments for the Company’s two postretirement benefit plans is as follows:

(Dollars in thousands)

Year ending December 31,
2023	$	329
2024	$	353
2025	$	370
2026	$	368
2027	$	494
Thereafter	$	8,358

(13) Regulatory Matters

The Company and the Bank are subject to regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum capital ratios in relation to both on- and off-balance sheet items at various risk weights. Total capital consists of two tiers of capital. Tier 1 capital includes common shareholders’ equity and trust preferred securities less adjustments for intangible assets. Tier 2 capital consists of the allowance for loan losses, up to 1.25% of risk-weighted assets and other adjustments. Management believes, as of December 31, 2022, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

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As of December 31, 2022, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

In 2013, the Federal Reserve 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. 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.

The Company’s and the Bank’s actual capital amounts and ratios are presented below:

(Dollars in thousands)
	Actual					Minimum Regulatory Capital Ratio					Minimum Ratio plus Capital Conservation Buffer
	Amount		Ratio			Amount		Ratio			Amount		Ratio

As of December 31, 2022:

Total Capital (to Risk-Weighted Assets)
Consolidated	$	178,286		14.04	%		101,608		8.00	%		N/A		N/A
Bank	$	176,923		13.93	%		101,606		8.00	%		133,357		10.50	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	167,792		13.21	%		76,206		6.00	%		N/A		N/A
Bank	$	166,429		13.10	%		76,204		6.00	%		107,956		8.50	%
Tier 1 Capital (to Average Assets)
Consolidated	$	167,792		9.82	%		68,347		4.00	%		N/A		N/A
Bank	$	166,429		9.68	%		68,780		4.00	%		68,780		4.00	%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	152,792		12.03	%		57,154		4.50	%		N/A		N/A
Bank	$	166,429		13.10	%		57,153		4.50	%		88,905		7.00	%

(Dollars in thousands)
	Actual					Minimum Regulatory Capital Ratio					Minimum Ratio plus Capital Conservation Buffer
	Amount		Ratio			Amount		Ratio			Amount		Ratio

As of December 31, 2021:

Total Capital (to Risk-Weighted Assets)
Consolidated	$	166,628		16.35	%		81,547		8.00	%		N/A		N/A
Bank	$	164,975		16.19	%		81,539		8.00	%		107,020		10.50	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	157,273		15.43	%		61,160		6.00	%		N/A		N/A
Bank	$	155,620		15.27	%		61,154		6.00	%		86,635		8.50	%
Tier 1 Capital (to Average Assets)
Consolidated	$	157,273		9.64	%		65,258		4.00	%		N/A		N/A
Bank	$	155,620		9.50	%		65,557		4.00	%		65,557		4.00	%
Common Equity Tier 1 (to Risk-Weighted Assets)
Consolidated	$	142,273		13.96	%		45,870		4.50	%		N/A		N/A
Bank	$	155,620		15.27	%		45,866		4.50	%		71,347		7.00	%

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(14) Other Operating Income and Expense

Miscellaneous non-interest income for the years ended December 31, 2022, 2021 and 2020 included the following items:

(Dollars in thousands)
	2022		2021		2020
Visa debit card income	$	4,901		5,045		4,237
Bank owned life insurance income		458		397		380
Other		2,390		2,197		1,315
	$	7,749		7,639		5,932

Other non-interest expense for the years ended December 31, 2022, 2021 and 2020 included the following items:

(Dollars in thousands)
	2022		2021		2020
ATM expense	$	629		619		567
Data processing		777		643		635
Deposit program expense		348		415		426
Dues and subscriptions		628		588		538
FHLB advance prepayment penalty		-		-		1,100
Internet banking expense		949		768		729
Office supplies		532		374		538
Telephone		691		730		794
Other		3,741		3,737		3,217
	$	8,295		7,874		8,544

(15) Fair Value of Financial Instruments

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.

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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.

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.

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The fair value presentation for recurring assets is presented in Note 2. There were no recurring liabilities at December 31, 2022 and 2021. The fair value presentation for non-recurring assets is presented in Note 3. There were no non-recurring liabilities at December 31, 2022 and 2021. The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2022 and 2021 are as follows:

(Dollars in thousands)
			Fair Value Measurements at December 31, 2022
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	71,596		71,596		-		-		71,596
Investment securities available for sale		445,394		-		445,394		-		445,394
Other investments		2,656		-		-		2,656		2,656
Mortgage loans held for sale		211		-		-		211		211
Loans, net		1,022,114		-		-		998,587		998,587
Mutual funds held in deferred compensation trust		1,327		-		1,327		-		1,327

Liabilities:
Deposits	$	1,435,215		-		-		1,434,871		1,434,871
Securities sold under agreements to repurchase		47,688		-		47,688		-		47,688
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

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 December 31, 2022 and 2021.

(Dollars in thousands)
	December 31, 2022
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mutual funds held in deferred compensation trust	$	1,327		-		1,327		-

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

(16) Reportable Segments

The Company has two reportable segments as described below.

Banking Operations – This segment reflects the consolidated Bank, excluding CBRES. The primary source of revenue for this segment is net interest income.

CBRES – A Bank subsidiary that provides appraisal management services to community banks. The primary source of revenue for this segment is appraisal management fee income.

The following table presents financial information for the reportable segments. The information provided under the caption “Other” represents the parent company, which is not considered to be a reportable segment, is included to reconcile the results of the operating segments to the consolidated financial statements prepared in conformity with GAAP.

(Dollars in thousands)
	Banking
	Operations			CBRES		Other			Consolidated
As of and for the year ended December 31, 2022
Interest income	$	54,416		$	-	$	15		$	54,431
Interest expense		2,796			-		527			3,323
Net interest income		51,620			-		(512	)		51,108
Provision for loan losses		1,472			-		-			1,472
Noninterest income		15,012			14		-			15,026
Appraisal management fee income		-			11,663		-			11,663
Noninterest expense		44,433			1,695		638			46,766
Appraisal management fee expense		-			9,264		-			9,264
Income tax expense (benefit)		4,248			166		(242	)		4,172
Net income (loss)	$	16,479		$	552	$	(908	)	$	16,123
Total assets	$	1,617,212		$	3,227	$	488		$	1,620,927
As of and for the year ended December 31, 2021
Interest income	$	47,171		$	-	$	8		$	47,179
Interest expense		2,930			-		275			3,205
Net interest income		44,241			-		(267	)		43,974
Recovery of loan losses		(1,163	)		-		-			(1,163	)
Noninterest income		16,014			15		-			16,029
Appraisal management fee income		-			8,890		-			8,890
Noninterest expense		42,239			1,163		613			44,015
Appraisal management fee expense		-			7,112		-			7,112
Income tax expense (benefit)		3,836			145		(185	)		3,796
Net income (loss)	$	15,343		$	485	$	(695	)	$	15,133
Total assets	$	1,620,933		$	2,692	$	568		$	1,624,193
As of and for the year ended December 31, 2020
Interest income	$	47,926		$	-	$	32		$	47,958
Interest expense		3,473			-		363			3,836
Net interest income		44,453			-		(331	)		44,122
Provision for loan losses		4,259			-		-			4,259
Noninterest income		16,148			12		-			16,160
Appraisal management fee income		-			6,754		-			6,754
Noninterest expense		42,041			991		625			43,657
Appraisal management fee expense		-			5,274		-			5,274
Income tax expense (benefit)		2,574			116		(201	)		2,489
Net income (loss)	$	11,727		$	385	$	(755	)	$	11,357

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(17) Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements

Balance Sheets

December 31, 2022 and 2021
(Dollars in thousands)

Assets	2022		2021

Cash	$	384		561
Interest-bearing time deposit		1,000		1,000
Investment in subsidiaries		118,832		155,716
Investment in PEBK Capital Trust II		464		464
Other assets		24		105

Total assets	$	120,704		157,846

Liabilities and Shareholders' Equity

Junior subordinated debentures	$	15,464		15,464
Liabilities		45		13
Shareholders' equity		105,195		142,369

Total liabilities and shareholders' equity	$	120,704		157,846

Statements of Earnings

For the Years Ended December 31, 2022, 2021 and 2020
(Dollars in thousands)

Revenues:	2022		2021		2020

Interest and dividend from subsidiary	$	6,240		7,419		7,539

Total revenues		6,240		7,419		7,539

Expenses:

Interest		529		280		370
Other operating expenses		639		613		625

Total expenses		1,168		893		995

Income before income tax benefit and equity in undistributed earnings of subsidiaries		5,072		6,526		6,544

Income tax benefit		242		185		201

Income before equity in undistributed earnings of subsidiaries		5,314		6,711		6,745

Equity in undistributed earnings of subsidiaries		10,809		8,422		4,612

Net earnings	$	16,123		15,133		11,357

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Statements of Cash Flows

For the Years Ended December 31, 2022, 2021 and 2020
(Dollars in thousands)

	2022			2021			2020
Cash flows from operating activities:

Net earnings	$	16,123			15,133			11,357
Adjustments to reconcile net earnings to net cash provided by operating activities:
Equity in undistributed earnings of subsidiaries		(10,809	)		(8,422	)		(4,612	)
Change in:
Other assets		81			545			(19	)
Other liabilities		32			-			(10	)

Net cash provided by operating activities		5,427			7,256			6,716

Cash flows from investing activities:

Proceeds from calls and maturities of investment securities available for sale		-			-			250

Net cash provided by investing activities		-			-			250

Cash flows from financing activities:

Repayment of junior subordinated debentures		-			-			(155	)
Cash dividends paid on common stock		(4,935	)		(3,793	)		(4,392	)
Stock repurchase		(710	)		(3,605	)		(2,999	)
Proceeds from exercise of restricted stock units		41			39			57

Net cash used by financing activities		(5,604	)		(7,359	)		(7,489	)

Net change in cash		(177	)		(103	)		(523	)

Cash at beginning of year		561			664			1,187

Cash at end of year	$	384			561			664

(18) Quarterly Data

	2022								2021
(Dollars in thousands, except per share amounts)	First		Second		Third		Fourth		First			Second			Third			Fourth
Total interest income	$	11,329		11,992		14,611		16,499	$	11,922			12,517			11,421			11,319
Total interest expense		663		644		818		1,198		815			842			861			687
Net interest income		10,666		11,348		13,793		15,301		11,107			11,675			10,560			10,632

Provision for loan losses		71		410		408		583		(455	)		(226	)		(182	)		(300	)
Other income		7,046		7,328		6,793		5,522		5,873			6,040			6,040			6,966
Other expense		13,341		14,243		13,455		14,991		12,268			12,132			12,568			14,159
Income before income taxes		4,300		4,023		6,723		5,249		5,167			5,809			4,214			3,739

Income tax expense		848		806		1,416		1,102		1,046			1,194			824			732
Net earnings		3,452		3,217		5,307		4,147		4,121			4,615			3,390			3,007

Basic net earnings per share	$	0.63		0.59		0.96		0.76	$	0.73			0.82			0.61			0.55
Diluted net earnings per share	$	0.61		0.57		0.93		0.74	$	0.71			0.80			0.59			0.53

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(19) 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 other than the event noted below.

In January and February 2023, the Bank sold securities available for sale totaling $53.5 million, which resulted in gross losses of $2.7 million and gross gains of $177,000. The transaction was intended to reduce risk in the investment portfolio provided by favorable conditions that had developed for this class of security in the first part of 2023, and to provide the Bank with more flexibility to take advantage of a higher interest rate environment in 2023.

Between March 10, 2023 and March 12, 2023, two financial institutions unrelated to the Company experienced a significant run on deposits, leading to insolvency. These institutions failed and were placed into receivership by the FDIC. These institutions also had deposit concentrations related to higher-risk customer types, such as venture capital and cryptocurrency. The Federal Reserve determined that these institutions were a systemic risk and therefore, in concert with the FDIC, have determined that all deposits held by these two institutions will be insured. These events have created market volatility for the financial sector; however, the ongoing ramifications of these events have yet to be seen. These events have not caused any significant changes in deposit balances at Peoples Bank.

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DIRECTORS AND OFFICERS OF THE COMPANY

DIRECTORS

Robert C. Abernethy – Chairman

Chairman of the Board, Peoples Bancorp of North Carolina, Inc. and Peoples Bank;

President, Secretary and Treasurer, Carolina Glove Company, Inc. (glove manufacturer)

Secretary and Assistant Treasurer, Midstate Contractors, Inc. (paving company)

James S. Abernethy

Vice President, Carolina Glove Company, Inc. (glove manufacturer)

President and Assistant Secretary, Midstate Contractors, Inc. (paving company)

Vice President, Secretary and Chairman of the Board of Directors, Alexander Railroad Company

Kimberly Boyd-Leaks

Executive Vice President – Chief Retail Banking Support Officer, Peoples Bank

Douglas S. Howard

Vice President and Treasurer, Denver Equipment Company of Charlotte, Inc.

John W. Lineberger, Jr.

Vice President, Lineberger Brothers, Inc. (real estate development)

Gary E. Matthews

President and Director, Matthews Construction Company, Inc. (general contractor)

Director, Conover Metal Products

Billy L. Price, Jr. MD

Practitioner of Internal Medicine, BL Price Jr. Medical Consultants, PLLC

Larry E. Robinson

Chairman of the Board and Chief Executive Officer, The Blue Ridge Distributing Co., Inc. (beer and wine distributor)

Director, United Beverages of North Carolina, LLC (beer distributor)

William Gregory (Greg) Terry

President, Clemson Legacy Designs

Director/Consultant, Drum & Willis-Reynolds Funeral Homes & Crematory

Dan Ray Timmerman, Sr.

Chairman of the Board and Chief Executive Officer, Timmerman Manufacturing, Inc. (wrought iron furniture, railings and gates manufacturer)

Benjamin I. Zachary

President, Treasurer, General Manager and Director, Alexander Railroad Company

OFFICERS

Lance A. Sellers

President and Chief Executive Officer

Jeffrey N. Hooper

Executive Vice President, Chief Financial Officer, Corporate Treasurer and Assistant Corporate Secretary

William D. Cable, Sr.

Executive Vice President, Corporate Secretary and Assistant Corporate Treasurer

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