FIRST US BANCSHARES, INC. 10-Q

10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2023 OR ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission File Number: 0-14549 First US Bancshares, Inc. (Exact Name of Registrant as Specified in Its Charter) Delaware 63-0843362 (State or Other Jurisdiction of Incorporation or Organization) (IRS Employer Identification No.) 3291 U.S. Highway 280 Birmingham , AL 35243 (Address of Principal Executive Offices) (Zip Code) ( 205 ) 582-1200 (Registrant’s Telephone Number, Including Area Code) N/A (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Securities registered pursuant to Section 12(b) of the Act: Title of each class Trading Symbol(s) Name of each exchange on which registered Common Stock, $0.01 par value FUSB The Nasdaq Stock Market LLC Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☒ Smaller reporting company ☒ Emerging growth company ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Class Outstanding at November 6, 2023 Common Stock, $0.01 par value 5,874,781 shares FIRST US BANCSHARES, INC. AND SUBSIDIARIES PAGE PART I. FINANCIAL INFORMATION 4 ITEM 1. FINANCIAL STATEMENTS 4 Interim Condensed Consolidated Balance Sheets at September 30, 2023 (Unaudited) and December 31, 2022 4 Interim Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2023 and 2022 (Unaudited) 5 Interim Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2023 and 2022 (Unaudited) 6 Interim Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2023 and 2022 (Unaudited) 7 Interim Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2023 and 2022 (Unaudited) 9 Notes to Interim Condensed Consolidated Financial Statements (Unaudited) 10 ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 43 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 59 ITEM 4. CONTROLS AND PROCEDURES 60 PART II. OTHER INFORMATION 61 ITEM 1. LEGAL PROCEEDINGS 61 ITEM 1A. RISK FACTORS 61 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 61 ITEM 6. EXHIBITS 62 Signature Page 63 2 FORWARD-LOOKING STATEMENTS Statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In addition, First US Bancshares, Inc. (“Bancshares” and, together with its subsidiaries, the “Company”), through its senior management, from time to time makes forward-looking statements concerning its expected future operations, performance and other developments. The words “estimate,” “project,” “intend,” “anticipate,” “expect,” “believe,” “continues” and similar expressions are indicative of forward-looking statements. Such forward-looking statements are necessarily estimates reflecting the Company’s best judgment based on current information and involve a number of risks and uncertainties. Certain factors that could affect the accuracy of such forward-looking statements and cause actual results to differ materially from those projected in such forward-looking statements are identified in the Company’s filings with the Securities and Exchange Commission (“SEC”), and forward-looking statements contained herein or in other public statements of the Company or its senior management should be considered in light of those factors. Such factors may include adverse developments in the financial services industry; the effects of any government shutdown; loan losses may be greater than anticipated; our ability to ensure that sufficient cash flow and liquid assets are available to satisfy current and future financial obligations; the impact of national and local market conditions on the Company’s business and operations; strong competition in the banking industry; the impact of changes in interest rates and monetary policy on the Company’s performance and financial condition; the pending discontinuation of LIBOR as an interest rate benchmark; the impact of technological changes in the banking and financial service industries and potential information system failures; cybersecurity and data privacy threats; the costs of complying with extensive governmental regulation; the risk that internal controls and procedures might fail or be circumvented; the impact of changing tax laws on the Company’s financial results; the potential impact of climate change and related legislative and regulatory initiatives; the possibility that acquisitions may not produce anticipated results and result in unforeseen integration difficulties; the rate of growth (or lack thereof) in the economy generally and in the Company’s service areas; the volatility of our stock price and our dependence on the soundness of other financial institutions; and other risk factors described from time to time in the Company’s public filings, including, but not limited to, the Company’s most recent Annual Report on Form 10-K. Relative to the Company’s dividend policy, the payment of cash dividends is subject to the discretion of the Board of Directors and will be determined in light of then-current conditions, including the Company’s earnings, leverage, operations, financial conditions, capital requirements and other factors deemed relevant by the Board of Directors. In the future, the Board of Directors may change the Company’s dividend policy, including the frequency or amount of any dividend, in light of then-existing conditions. 3 PART I. FINANCI AL INFORMATION ITEM 1. FINANCI AL STATEMENTS FIRST US BANCSHARES, INC. AND SUBSIDIARIES INTERIM CONDENSED CONS OLIDATED BALANCE SHEETS (Dollars in Thousands, Except Share Amounts) September 30, December 31, 2023 2022 (Unaudited) ASSETS Cash and due from banks $ 10,311 $ 11,844 Interest-bearing deposits in banks 55,818 18,308 Total cash and cash equivalents 66,129 30,152 Federal funds sold 1,143 1,768 Investment securities available-for-sale, at fair value 126,551 130,795 Investment securities held-to-maturity, at amortized cost 1,272 1,862 Federal Home Loan Bank stock, at cost 2,151 1,359 Loans and leases held for investment 815,300 773,873 Less allowance for credit losses 11,380 9,422 Net loans and leases held for investment 803,920 764,451 Premises and equipment, net of accumulated depreciation 24,259 24,439 Cash surrender value of bank-owned life insurance 16,622 16,399 Accrued interest receivable 3,522 3,011 Goodwill and core deposit intangible, net 7,642 7,801 Other real estate owned 617 686 Other assets 11,411 11,944 Total assets $ 1,065,239 $ 994,667 LIABILITIES AND SHAREHOLDERS’ EQUITY Deposits: Non-interest-bearing $ 157,652 $ 169,822 Interest-bearing 769,386 700,203 Total deposits 927,038 870,025 Accrued interest expense 1,864 607 Other liabilities 8,148 8,136 Short-term borrowings 30,000 20,038 Long-term borrowings 10,781 10,726 Total liabilities 977,831 909,532 Shareholders’ equity: Common stock, par value $ 0.01 per share, 10,000,000 shares authorized; 7,738,156 and 7,680,856 shares issued, respectively; 5,874,781 and 5,812,258 shares outstanding, respectively 75 75 Additional paid-in capital 14,824 14,510 Accumulated other comprehensive loss, net of tax ( 8,907 ) ( 7,241 ) Retained earnings 107,976 104,460 Less treasury stock: 1,863,375 and 1,868,598 shares at cost, respectively ( 26,560 ) ( 26,669 ) Total shareholders’ equity 87,408 85,135 Total liabilities and shareholders’ equity $ 1,065,239 $ 994,667 The accompanying notes are an integral part of these Interim Condensed Consolidated Statements. 4 FIRST US BANCSHARES, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDAT ED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Per Share Data) Three Months Ended Nine Months Ended September 30, September 30, 2023 2022 2023 2022 (Unaudited) (Unaudited) Interest income: Interest and fees on loans $ 12,584 $ 9,750 $ 35,330 $ 27,339 Interest on investment securities 685 756 2,043 1,927 Interest on deposits in banks 598 136 1,362 265 Other 35 28 126 45 Total interest income 13,902 10,670 38,861 29,576 Interest expense: Interest on deposits 4,222 864 9,681 1,964 Interest on borrowings 197 291 940 562 Total interest expense 4,419 1,155 10,621 2,526 Net interest income 9,483 9,515 28,240 27,050 Provision for credit losses 184 1,165 753 2,781 Net interest income after provision for credit losses 9,299 8,350 27,487 24,269 Non-interest income: Service and other charges on deposit accounts 302 311 869 904 Lease income 241 210 707 635 Other income, net 294 567 889 1,234 Total non-interest income 837 1,088 2,465 2,773 Non-interest expense: Salaries and employee benefits 4,120 4,007 12,310 12,389 Net occupancy and equipment 897 861 2,625 2,468 Computer services 464 417 1,315 1,224 Insurance expense and assessments 423 310 1,156 970 Fees for professional services 331 263 735 811 Other expense 1,084 1,174 3,599 3,104 Total non-interest expense 7,319 7,032 21,740 20,966 Income before income taxes 2,817 2,406 8,212 6,076 Provision for income taxes 704 546 2,004 1,440 Net income $ 2,113 $ 1,860 $ 6,208 $ 4,636 Basic net income per share $ 0.35 $ 0.31 $ 1.04 $ 0.76 Diluted net income per share $ 0.33 $ 0.29 $ 0.97 $ 0.71 Dividends per share $ 0.05 $ 0.03 $ 0.15 $ 0.09 The accompanying notes are an integral part of these Interim Condensed Consolidated Statements. 5 FIRST US BANCSHARES, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED ST ATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Dollars in Thousands) Three Months Ended Nine Months Ended September 30, September 30, 2023 2022 2023 2022 (Unaudited) (Unaudited) Net income $ 2,113 $ 1,860 $ 6,208 $ 4,636 Other comprehensive income (loss): Unrealized holding losses on securities available-for-sale arising during period, net of tax benefit of $ 58 , $ 350 , $ 425 , and $ 2,768 , respectively ( 167 ) ( 1,048 ) ( 1,271 ) ( 8,307 ) Unrealized holding gains (losses) arising during the period on effective cash flow hedge derivatives, net of tax benefit (expense) of $ 0 , ($ 130 ), $ 18 and ($ 443 ), respectively — 393 ( 50 ) 1,330 Reclassification adjustments on cash flow hedge derivatives realized in net income, net of tax benefit (expense) of $ 39 , ($ 9 ), $ 116 and ($ 14 ), respectively ( 118 ) 27 ( 345 ) 41 Other comprehensive loss ( 285 ) ( 628 ) ( 1,666 ) ( 6,936 ) Total comprehensive income (loss) $ 1,828 $ 1,232 $ 4,542 $ ( 2,300 ) The accompanying notes are an integral part of these Interim Condensed Consolidated Statements. 6 FIRST US BANCSHARES, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED STATEME NTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Dollars in Thousands, Except Share and Per Share Data) For the three months ended September 30, 2023 and 2022 (Unaudited) Common Stock Shares Outstanding Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Loss Retained Earnings Treasury Stock, at Cost Total Shareholders’ Equity Balance, June 30, 2022 5,876,258 $ 75 $ 14,263 $ ( 6,584 ) $ 100,838 $ ( 26,016 ) $ 82,576 Net income — — — — 1,860 — 1,860 Net change in fair value of securities available-for-sale, net of tax — — — ( 1,048 ) — — ( 1,048 ) Net change in fair value of derivative instruments, net of tax — — — 420 — — 420 Dividends declared: $ .03 per share — — — — ( 175 ) — ( 175 ) Impact of stock-based compensation plans, net — — 123 — — — 123 Impact of common stock share repurchases ( 64,000 ) — — — — ( 653 ) ( 653 ) Balance, September 30, 2022 5,812,258 $ 75 $ 14,386 $ ( 7,212 ) $ 102,523 $ ( 26,669 ) $ 83,103 Balance, June 30, 2023 5,874,765 $ 75 $ 14,675 $ ( 8,622 ) $ 106,157 $ ( 26,560 ) $ 85,725 Net income — — — — 2,113 — 2,113 Net change in fair value of securities available-for-sale, net of tax — — — ( 167 ) — — ( 167 ) Net change in fair value of derivative instruments, net of tax — — — ( 118 ) — — ( 118 ) Dividends declared: $ .05 per share — — — — ( 294 ) — ( 294 ) Impact of stock-based compensation plans, net — — 149 — — — 149 Reissuance of treasury stock as compensation 16 — — — — — — Balance, September 30, 2023 5,874,781 $ 75 $ 14,824 $ ( 8,907 ) $ 107,976 $ ( 26,560 ) $ 87,408 The accompanying notes are an integral part of these Interim Condensed Consolidated Statements. 7 FIRST US BANCSHARES, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Dollars in Thousands, Except Share and Per Share Data) For the nine months ended September 30, 2023 and 2022 (Unaudited) Common Stock Shares Outstanding Common Stock Additional Paid-in Capital Accumulated Other Comprehensive Loss Retained Earnings Treasury Stock, at Cost Total Shareholders’ Equity Balance, December 31, 2021 6,172,378 $ 75 $ 14,163 $ ( 276 ) $ 98,428 $ ( 22,326 ) $ 90,064 Net income — — — — 4,636 — 4,636 Net change in fair value of securities available-for-sale, net of tax — — — ( 8,307 ) — — ( 8,307 ) Net change in fair value of derivative instruments, net of tax — — — 1,371 — — 1,371 Dividends declared: $ .09 per share — — — — ( 541 ) — ( 541 ) Impact of stock-based compensation plans, net 43,096 — 361 — — — 361 Reissuance of treasury stock as compensation 9,184 — ( 138 ) — — 138 — Impact of common stock share repurchases ( 412,400 ) — — — — ( 4,481 ) ( 4,481 ) Balance, September 30, 2022 5,812,258 $ 75 $ 14,386 $ ( 7,212 ) $ 102,523 $ ( 26,669 ) $ 83,103 Balance, December 31, 2022 5,812,258 $ 75 $ 14,510 $ ( 7,241 ) $ 104,460 $ ( 26,669 ) $ 85,135 Net income — — — — 6,208 — 6,208 Net change in fair value of securities available-for-sale, net of tax — — — ( 1,271 ) — — ( 1,271 ) Net change in fair value of derivative instruments, net of tax — — — ( 395 ) — — ( 395 ) Dividends declared: $ .15 per share — — — — ( 881 ) — ( 881 ) Impact of stock-based compensation plans, net 53,141 — 448 — — ( 25 ) 423 Reissuance of treasury stock as compensation 9,382 ( 134 ) 134 — Impact of adopting current expected credit loss accounting model, net of tax — — — — ( 1,811 ) — ( 1,811 ) Balance, September 30, 2023 5,874,781 $ 75 $ 14,824 $ ( 8,907 ) $ 107,976 $ ( 26,560 ) $ 87,408 The accompanying notes are an integral part of these Interim Condensed Consolidated Statements. 8 FIRST US BANCSHARES, INC. AND SUBSIDIARIES INTERIM CONDENSED CONSOLIDA TED STATEMENTS OF CASH FLOWS (Dollars in Thousands) Nine Months Ended September 30, 2023 2022 (Unaudited) Cash flows from operating activities: Net income $ 6,208 $ 4,636 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 1,180 1,201 Provision for credit losses 753 2,781 Deferred income tax benefit ( 566 ) ( 309 ) Proceeds from settlement of derivative contracts 2,166 — Reclassification of unrealized gains on terminated derivative contracts ( 848 ) — Stock-based compensation expense 448 361 Net amortization of securities 40 169 Amortization of intangible assets 159 213 Net loss (gain) on premises and equipment and other real estate 613 ( 350 ) Changes in assets and liabilities: Increase in accrued interest receivable ( 511 ) ( 135 ) Decrease in other assets 333 750 Increase in accrued interest expense 1,257 495 Decrease in other liabilities ( 225 ) ( 310 ) Net cash provided by operating activities 11,007 9,502 Cash flows from investing activities: Net decrease (increase) in federal funds sold 625 ( 38 ) Purchases of investment securities, available-for-sale ( 6,756 ) ( 39,256 ) Proceeds from maturities and prepayments of investment securities, available-for-sale 9,267 15,111 Proceeds from maturities and prepayments of investment securities, held-to-maturity 587 1,317 Net increase in Federal Home Loan Bank stock ( 792 ) ( 1,139 ) Net increase in loans ( 43,533 ) ( 45,590 ) Proceeds from the sale of premises and equipment and other real estate 482 2,892 Purchases of premises and equipment ( 979 ) ( 672 ) Net cash used in investing activities ( 41,099 ) ( 67,375 ) Cash flows from financing activities: Net increase in deposits 57,013 8,411 Net increase in short-term borrowings 9,962 30,060 Net share-based compensation transactions ( 25 ) — Repurchases of common stock — ( 4,481 ) Dividends paid ( 881 ) ( 541 ) Net cash provided by financing activities 66,069 33,449 Net increase (decrease) in cash and cash equivalents 35,977 ( 24,424 ) Cash and cash equivalents, beginning of period 30,152 61,244 Cash and cash equivalents, end of period $ 66,129 $ 36,820 Supplemental disclosures: Cash paid for: Interest $ 9,364 $ 2,031 Income taxes 2,374 1,804 Non-cash transactions: Assets acquired in settlement of loans 1,178 656 The accompanying notes are an integral part of these Interim Condensed Consolidated Statements. 9 FIRST US BANCSHARES, INC. AND SUBSIDIARIES NOTES TO INTERIM CONDENSED CONS OLIDATED FINANCIAL STATEMENTS (Unaudited) 1. GENERAL The accompanying unaudited interim condensed consolidated financial statements include the accounts of First US Bancshares, Inc. (“Bancshares”) and its subsidiaries (collectively, the “Company”). Bancshares is the parent holding company of First US Bank (the “Bank”). The Company and the Bank are both headquartered in Birmingham, Alabama. As of September 30, 2023, the Bank operated a finance company subsidiary, Acceptance Loan Company, Inc. (“ALC”). During the third quarter of 2021, ALC ceased new business development and permanently closed its 20 branch lending locations in Alabama and Mississippi to the public. Through the third quarter of 2023, ALC continued to service its remaining portfolio of loans from its headquarters in Mobile, Alabama. Effective October 1, 2023, all of ALC’s remaining loans were sold to the Bank in an intercompany transaction. Due to this transaction, management determined that ALC was no longer a separate reportable operating segment. The Bank intends to manage the remaining portfolio through final resolution. All significant intercompany transactions and accounts have been eliminated. The unaudited interim condensed consolidated financial statements, in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s consolidated financial position, results of operations and cash flows for the periods presented. Such adjustments are of a normal, recurring nature, except for the adoption of Accounting Standards Codification (“ASC”) 326, Measurement of Credit Losses on Financial Instruments , as discussed below. The results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2023. While certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), management believes that the disclosures herein are adequate to make the information presented not misleading. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2022 (the "Company's 2022 Form 10-K"). 2. BASIS OF PRESENTATION Reclassification Certain amounts in the prior period consolidated financial statements and the notes to the prior period consolidated financial statements have been reclassified to conform to the 2023 presentation. These reclassifications had no effect on the Company’s results of operations, financial position or net cash flow. Summary of Significant Accounting Policies Certain significant accounting policies followed by the Company are set forth in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in the Company’s 2022 Form 10-K. Adoption of ASC 326 On January 1, 2023, the Company adopted Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments , as subsequently updated for certain clarifications, targeted relief and codification improvements. ASC 326 replaces the previous "incurred loss" model for measuring credit losses, which required allowances for current known and inherent losses within the loan portfolio, with an "expected loss" model. The newly adopted current expected credit loss ("CECL") model requires the measurement of all expected credit losses for financial assets measured at amortized cost and certain off-balance-sheet credit exposures based on historical experience, current conditions, and reasonable and supportable forecasts. ASC 326 also requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. In addition, ASC 326 includes certain changes to the accounting for available-for-sale securities including the requirement to present credit losses as an allowance rather than as a direct write-down. The Company adopted ASC 326 using the modified retrospective method for financial assets measured at amortized cost and off-balance-sheet credit exposures. Upon adoption, the Company recognized an increase in the allowance for credit losses (including both loans and unfunded lending commitments) of $ 2.4 million, which included an after-tax cumulative effect decrease to retained earnings totaling $ 1.8 million. Operating results for periods after January 1, 2023 are presented in accordance with ASC 326 while prior period amounts continue to be reported in accordance with previously applicable standards and the accounting policies described in Note 2 of the Company's 2022 Form 10-K. In connection with the adoption of ASC 326, the Company revised certain accounting policies and implemented certain accounting policy elections. The revised accounting policies are described below. 10 Loans and Leases Held for Investment Loans and leases held for investment (“loans”) represent financial instruments that the Company has the intent and the ability to hold for the foreseeable future or until maturity or payoff. Loans are reported at amortized cost, net of the allowance for credit losses. Amortized cost is the principal balance outstanding, net of purchase premiums and discounts, fair value hedge accounting adjustments, as well as deferred loan fees and costs. Accrued interest receivable on loans and leases is reported separately on the Company’s consolidated balance sheets and is excluded from the estimate of credit losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. At the time a loan is 90 days delinquent, it is placed on nonaccrual status unless it is well-secured and in process of collection. Interest income is discontinued on all loans on nonaccrual status. Past-due status is based on the contractual terms of the loan. In all cases, loans are moved to nonaccrual status, or charged off at an earlier date, if collection of principal and interest is considered doubtful. All interest accrued but not received on loans on nonaccrual status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery methods, until qualifying for return to accrual. Under the cash-basis method, interest income is recorded when the payment is received in cash. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Loans are returned to accrual status when all of the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Allowance for Credit Losses – Loans and Leases The allowance for credit losses is a contra-asset valuation account that is deducted from the amortized cost basis of the loans to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged off and expected to be charged off. The allowance for credit losses on loans and leases is adjusted through the provision for (recovery of) credit losses. Management estimates the allowance balance by using relevant available information from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for estimation of expected credit losses. Adjustments to historical loss information are made for differences in loan-specific risk characteristics such as changes in economic and business conditions, underwriting standards, portfolio mix, and delinquency level. Considerations related to environmental conditions include reasonable and supportable current and forecasted data related to economic factors such as inflation, unemployment levels, and interest rates. The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation. When management determines that foreclosure is probable or when the borrower is experiencing financial difficulty as of the reporting date and repayment is expected to be provided substantially through the operation or sale of the collateral, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for estimated selling costs as appropriate. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company, or management has a reasonable expectation at the reporting date that a loan modification will be made to a borrower experiencing financial difficulty. Additional information related to the factors considered in evaluating credit losses on loans and leases is included in Note 4. Allowance for Credit Losses on Off-Balance Sheet Credit Exposures The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The following categories of off-balance sheet credit exposures have been identified: unfunded loan commitments, standby letters of credit, and financial guarantees (collectively, “unfunded lending commitments”). The allowance for credit losses on unfunded lending commitments is adjusted through the provision for (recovery of) credit losses. The estimate may include consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded, as well as reasonable practical expedients or industry practices to assist in the evaluation of estimated funding amounts. 11 Additional information related to the factors considered in evaluating credit losses on unfunded lending commitments is included in Note 4. Allowance for Credit Losses – Investment Securities Held-to-Maturity Expected credit losses on held-to-maturity debt securities are measured on a collective basis by major security type. Accrued interest receivable on held-to-maturity securities is excluded from the estimate of credit losses. The estimate of expected credit losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The allowance for credit losses on investment securities held-to-maturity is adjusted through the provision for (recovery of) credit losses. Additional information related to the factors considered in evaluating credit losses in the held-to-maturity investment portfolio is included in Note 3. Allowance for Credit Losses – Investment Securities Available-for-Sale For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For debt securities available-for-sale that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes in the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Changes in the allowance for credit losses are recorded in the provision for (recovery of) credit losses. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest receivable on available-for-sale debt securities is excluded from the estimate of credit losses. Additional information related to the factors considered in evaluating credit losses in the available-for-sale investment portfolio is included in Note 3. Net Income Per Share Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding ("basic shares"). Included in basic shares are stock equivalent shares that have been accrued as of the balance sheet date as deferred compensation for members of Bancshares’ Board of Directors under the Non-Employee Directors' Deferred Compensation Plan (as defined below and discussed further in Note 9). Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding, adjusted for the effect of potentially dilutive stock awards outstanding during the period ("dilutive shares"). The dilutive shares consist of unexercised nonqualified stock option grants issued to employees and members of Bancshares’ Board of Directors pursuant to the Company's Incentive Plan (as defined below and discussed further in Note 10). The following table reflects the weighted average shares used to calculate basic and diluted net income per share for the periods presented. Three Months Ended Nine Months Ended September 30, September 30, 2023 2022 2023 2022 Weighted average shares outstanding 5,874,769 5,839,658 5,858,812 6,016,770 Weighted average director stock equivalent shares 109,793 111,608 113,142 114,853 Basic shares 5,984,562 5,951,266 5,971,954 6,131,623 Dilutive shares 419,650 419,650 419,650 419,650 Diluted shares 6,404,212 6,370,916 6,391,604 6,551,273 12 Three Months Ended Nine Months Ended September 30, September 30, 2023 2022 2023 2022 (Dollars in Thousands, Except Per Share Data) Net income $ 2,113 $ 1,860 $ 6,208 $ 4,636 Basic net income per share $ 0.35 $ 0.31 $ 1.04 $ 0.76 Diluted net income per share $ 0.33 $ 0.29 $ 0.97 $ 0.71 Comprehensive Income Comprehensive income consists of net income, as well as unrealized holding gains and losses that arise during the period associated with the Company’s available-for-sale securities portfolio and the effective portion of cash flow hedge derivatives. In the calculation of comprehensive income, reclassification adjustments are made for gains or losses realized in the statement of operations associated with the sale of available-for-sale securities or settlement of derivative contracts. Recently Adopted Accounting Guidance Reference Rate Reform ASU 2020-04 and ASU 2021-01, "Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting." These ASUs provide temporary relief, in the form of optional expedients and exceptions, for applying GAAP to modifications of contracts, hedging relationships and other transactions affected by reference rate (e.g. LIBOR) reforms. Historically, the Company utilized LIBOR, among other indexes, as a reference rate for underwriting certain variable rate loans and interest rate hedging instruments. Since the issuance of this guidance, cessation of U.S. dollar LIBOR was extended to June 30, 2023. Accordingly, in December 2022, the FASB issued ASU 2022-06, Reference Rate Reform (Topic 848) : Deferral of the Sunset Date of Topic 848 , which deferred the sunset date of ASC Topic 848 from December 31, 2022 to December 31, 2024. The amendments in this update provide optional expedients designed to provide relief from accounting analysis and the impacts that may otherwise be required for modifications to agreements necessitated by reference rate reform. The optional expedients provided by the update include guidance related to modifications of contracts within the scope of ASC Topics 310, Receivables , and 470, Debt , that indicates the modifications should be accounted for by prospectively adjusting the effective interest rate. As of September 30, 2023, the Company’s contracts referencing LIBOR were limited to certain variable-rate loan agreements for which the pricing reset date has not yet occurred. Management has implemented a process to convert the agreements to another reference rate at the next applicable pricing reset date. Due to the prospective nature of the implementation of the revised guidance, the adoption did not have a material impact on the Company’s consolidated financial statements. Portfolio Layer Hedging Method ASU 2022-01, "Fair Value Hedging - Portfolio Layer Method - Derivatives and Hedging (Topic 815) ." In March 2022, the FASB issued ASU 2022-01. The amendments in this standard expand the current last-of-layer method of hedge accounting to allow multiple hedged layers of a single closed portfolio. The Company adopted ASU 2022-01 on January 1, 2023. Due to the prospective nature of the implementation of this revised guidance, the adoption of this standard update did not have a material impact on the Company's consolidated financial statements. Intangibles and Goodwill ASU 2017-04 , “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” Issued in January 2017, ASU 2017-04 simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill under Step 2, an entity, prior to the amendments in ASU 2017-04, had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities, including unrecognized assets and liabilities, in accordance with the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. However, under the amendments in ASU 2017-04, an entity should (1) perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU 2017-04 removes the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. As originally issued, ASU 2017-04 was effective prospectively for annual, or any interim, goodwill impairment tests in fiscal years beginning after December 15, 2019. On October 16, 2019, the FASB approved a delay in the implementation of ASU 2017-04 by three years for smaller reporting companies, including the Company. The ASU became effective for the Company on January 1, 2023. The adoption of this standard update did not have a material effect on the Company’s consolidated financial statements. 13 Current Expected Credit Loss Accounting Guidance ASU 2016-13 , "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." Issued in June 2016, ASU 2016-13 removed the thresholds that entities previously applied to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables and held-to-maturity debt securities. Known as the Current Expected Credit Loss (CECL) model, the revised guidance removed all recognition thresholds under previously used incurred loss models and required entities to recognize an allowance for lifetime expected credit losses. The standard also added disclosure requirements intended to enable users of the financial statements to understand credit risk in the portfolio and how management monitors credit quality, management’s estimate of expected credit losses, and changes in the estimate of credit losses during the period. In addition, the standard made changes to the accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management does not intend to sell and does not believe that it is more likely than not they will be required to sell. As originally issued, ASU 2016-13 was effective for financial statements issued for fiscal years and for interim periods within those fiscal years beginning after December 15, 2019, with institutions required to apply the changes through a cumulative-effect adjustment to their retained earnings balance as of the beginning of the first reporting period in which the guidance is effective. On October 16, 2019, the FASB approved a delay in the implementation of ASU 2016-13 by three years for smaller reporting companies, including the Company. The ASU became effective for the Company on January 1, 2023, and the Company recorded a cumulative-effect adjustment that increased the allowance for credit losses by approximately $ 2.1 million. In addition, the Company recorded a cumulative-effect adjustment that increased other liabilities by $ 0.3 million as an allowance for credit losses for unfunded commitments. In accordance with transition accounting guidance, the transition adjustments were recorded directly to retained earnings (net of tax) during the first quarter of 2023 and did not impact then-current period earnings. Troubled Debt Restructurings and Vintage Disclosures ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings (“TDRs”) and Vintage Disclosures. ” Issued in March 2022, ASU 2022-02 sought to improve the decision usefulness of information provided to investors concerning certain loan refinancings, restructurings and write-offs. The ASU eliminated the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL accounting model and enhanced the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The Company adopted the amendments of ASU 2022-02 on January 1, 2023, concurrent with the adoption of the CECL accounting model. The amendments of ASU 2022-02 include only changes to certain financial statement disclosures; and, therefore, adoption of ASU 2022-02 did not have a material impact on the Company’s consolidated financial statements. 3. INVESTMENT SECURITIES Details of investment securities available-for-sale and held-to-maturity as of September 30, 2023 and December 31, 2022 were as follows: Available-for-Sale September 30, 2023 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in Thousands) Mortgage-backed securities: Residential $ 41,071 $ — $ ( 4,071 ) $ 37,000 Commercial 10,020 1 ( 521 ) 9,500 Obligations of U.S. government-sponsored agencies 11,851 — ( 919 ) 10,932 Obligations of states and political subdivisions 1,633 — ( 90 ) 1,543 Corporate notes 17,772 — ( 3,091 ) 14,681 U.S. Treasury securities 56,988 — ( 4,093 ) 52,895 Total $ 139,335 $ 1 $ ( 12,785 ) $ 126,551 14 Held-to-Maturity September 30, 2023 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in Thousands) Mortgage-backed securities: Commercial $ 704 $ — $ ( 30 ) $ 674 Obligations of U.S. government-sponsored agencies 502 — ( 49 ) 453 Obligations of states and political subdivisions 66 — ( 10 ) 56 Total $ 1,272 $ — $ ( 89 ) $ 1,183 Available-for-Sale December 31, 2022 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in Thousands) Mortgage-backed securities: Residential $ 47,659 $ 2 $ ( 3,704 ) $ 43,957 Commercial 12,169 4 ( 480 ) 11,693 Obligations of U.S. government-sponsored agencies 5,116 — ( 846 ) 4,270 Obligations of states and political subdivisions 2,166 — ( 94 ) 2,072 Corporate notes 17,817 2 ( 1,898 ) 15,921 U.S. Treasury securities 56,956 — ( 4,074 ) 52,882 Total $ 141,883 $ 8 $ ( 11,096 ) $ 130,795 Held-to-Maturity December 31, 2022 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (Dollars in Thousands) Mortgage-backed securities: Commercial $ 1,167 $ — $ ( 41 ) $ 1,126 Obligations of U.S. government-sponsored agencies 610 — ( 40 ) 570 Obligations of states and political subdivisions 85 — ( 12 ) 73 Total $ 1,862 $ — $ ( 93 ) $ 1,769 The scheduled maturities of investment securities available-for-sale and held-to-maturity as of September 30, 2023 are presented in the following table: Available-for-Sale Held-to-Maturity Amortized Cost Estimated Fair Value Amortized Cost Estimated Fair Value (Dollars in Thousands) Maturing within one year $ 12,988 $ 12,783 $ — $ — Maturing after one to five years 53,676 49,249 324 308 Maturing after five to ten years 60,121 52,780 738 686 Maturing after ten years 12,550 11,739 210 189 Total $ 139,335 $ 126,551 $ 1,272 $ 1,183 For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities generally mature earlier than their weighted-average contractual maturities because of principal prepayments. 15 The following tables reflect gross unrealized losses and fair value for securities for which an allowance for credit losses has not been recorded, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of September 30, 2023. Available-for-Sale September 30, 2023 Less than 12 Months 12 Months or More Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in Thousands) Mortgage-backed securities: Residential $ 105 $ ( 5 ) $ 36,860 $ ( 4,066 ) Commercial 1,532 ( 13 ) 7,934 ( 508 ) Obligations of U.S. government-sponsored agencies — — 4,176 ( 919 ) Obligations of states and political subdivisions — — 1,543 ( 90 ) Corporate notes 802 ( 198 ) 13,879 ( 2,893 ) U.S. Treasury securities — — 52,895 ( 4,093 ) Total $ 2,439 $ ( 216 ) $ 117,287 $ ( 12,569 ) Held-to-Maturity September 30, 2023 Less than 12 Months 12 Months or More Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in Thousands) Mortgage-backed securities: Commercial $ — $ — $ 674 $ ( 30 ) Obligations of U.S. government-sponsored agencies — — 453 ( 49 ) Obligations of states and political subdivisions — — 56 ( 10 ) Total $ — $ — $ 1,183 $ ( 89 ) The following tables reflect gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2022. No determination was made concerning the need for an allowance for credit losses as this table reflects information prior to the adoption of ASC 326. Available-for-Sale December 31, 2022 Less than 12 Months 12 Months or More Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in Thousands) Mortgage-backed securities: Residential $ 19,876 $ ( 952 ) $ 23,903 $ ( 2,752 ) Commercial 9,720 ( 357 ) 1,247 ( 123 ) Obligations of U.S. government-sponsored agencies — — 4,270 ( 846 ) Obligations of states and political subdivisions 1,559 ( 41 ) 513 ( 53 ) Corporate notes 6,845 ( 898 ) 8,075 ( 1,000 ) U.S. Treasury securities 21,240 ( 698 ) 31,642 ( 3,376 ) Total $ 59,240 $ ( 2,946 ) $ 69,650 $ ( 8,150 ) 16 Held-to-Maturity December 31, 2022 Less than 12 Months 12 Months or More Fair Value Unrealized Losses Fair Value Unrealized Losses (Dollars in Thousands) Mortgage-backed securities: Commercial $ 1,126 $ ( 41 ) $ — $ — Obligations of U.S. government-sponsored agencies 214 ( 7 ) 356 ( 33 ) Obligations of states and political subdivisions 73 ( 12 ) — — Total $ 1,413 $ ( 60 ) $ 356 $ ( 33 ) Available-for-Sale Considerations For any securities classified as available-for-sale that are in an unrealized loss position as of the balance sheet date, the Company assesses whether or not it intends to sell the security, or more-likely-than-not will be required to sell the security, before recovery of its amortized cost basis which would require a write-down to fair value through net income. As of September 30, 2023 , 109 available-for-sale debt securities had been in a loss position for more than 12 months, and six available-for-sale debt securities had been in a loss position for less than 12 months. As of December 31, 2022 , 37 available-for-sale debt securities had been in a loss position for more than 12 months, and 75 available-for-sale debt securities had been in a loss position for less than 12 months. The increase in the number of debt securities in a loss position for greater than 12 months was due to the sustained higher interest rate environment during the nine months ended September 30, 2023. As of September 30, 2023, the Company had the current intent and ability to retain its investments for a period of time that management believes to be sufficient to allow for any anticipated recovery of fair value. As of September 30, 2023, the losses for all available-for-sale securities were considered to be a direct result of the effect that the prevailing interest rate environment had on the value of debt securities and were not related to the creditworthiness of the issuers. Accordingly, no allowance for credit losses was considered necessary related to available-for-sale securities as of September 30, 2023. Held-to-Maturity Considerations Effective January 1, 2023, the Company adopted the CECL accounting model to evaluate credit losses in the held-to-maturity investment portfolio. Each quarter, management evaluates the portfolio on a collective basis by major security type to determine whether an allowance for credit losses is needed. Qualitative factors are used in the Company’s credit loss assessments, including current and forecasted economic conditions, the characteristics of the debt issuer, and the historic ability of the issuer to make contractual principal and interest payments. Based on these evaluations, no allowance for credit losses was recorded by the Company for the held-to-maturity investment portfolio upon adoption of the CECL accounting model or as of September 30, 2023. Pledged Securities Investment securities with a carrying value of $ 42.3 million and $ 54.7 million as of September 30, 2023 and December 31, 2022 , respectively, were pledged to secure public deposits and for other purposes. 4. LOANS AND ALLOWANCE FOR CREDIT LOSSES Portfolio Segments The Company has divided the loan portfolio into the following portfolio segments based on risk characteristics: Construction, land development and other land loans – Commercial construction, land and land development loans include loans for the development of residential housing projects, loans for the development of commercial and industrial use property, loans for the purchase and improvement of raw land and loans primarily for agricultural production that are secured by farmland. These loans are secured in whole or in part by the underlying real estate collateral and are generally guaranteed by the principals of the borrowing entity. Secured by 1-4 family residential properties – These loans include conventional mortgage loans on one-to-four family residential properties. These properties may serve as the borrower’s primary residence, vacation home or investment property. Also included in this portfolio are home equity loans and lines of credit. This type of lending, which is secured by a first or second mortgage on the borrower’s residence, allows customers to borrow against the equity in their home. 17 Secured by multi-family residential properties – This portfolio segment includes mortgage loans secured by apartment buildings. Secured by non-farm, non-residential properties – This portfolio segment includes real estate loans secured by commercial and industrial properties, office or mixed-use facilities, strip shopping centers or other commercial property. These loans are generally guaranteed by the principals of the borrowing entity. Commercial and industrial loans and leases – This portfolio segment includes loans and leases to commercial customers for use in the normal course of business. These credits may be loans, lines of credit and leases to financially strong borrowers, secured by inventories, equipment or receivables, and are generally guaranteed by the principals of the borrowing entity. Direct consumer – This portfolio segment includes a variety of secured and unsecured personal loans, including automobile loans, loans for household and personal purposes and all other direct consumer installment loans. Branch retail – This portfolio segment includes loans secured by collateral purchased by consumers at retail stores with whom ALC previously had an established relationship through its branch network to provide financing for the retail products sold if applicable underwriting standards were met. The collateral securing these loans generally includes personal property items such as furniture, ATVs and home appliances. Indirect c onsumer – This portfolio segment includes loans secured by collateral purchased by consumers at retail stores with whom the Company has an established relationship to provide financing for the retail products sold if applicable underwriting standards are met. The collateral securing these loans generally includes recreational vehicles, campers, boats, horse trailers and cargo trailers. As of September 30, 2023 and December 31, 2022, the composition of the loan portfolio by portfolio segment was as follows: September 30, 2023 December 31, 2022 Real estate loans: Construction, land development and other land loans $ 90,051 $ 53,914 Secured by 1-4 family residential properties 83,876 87,995 Secured by multi-family residential properties 56,506 67,852 Secured by non-farm, non-residential properties 199,116 200,156 Commercial and industrial loans and leases (1) 59,369 73,546 Consumer loans: Direct 6,544 9,851 Branch retail 9,648 13,992 Indirect 310,190 266,567 Total loans 815,300 773,873 Allowance for credit losses 11,380 9,422 Net loans $ 803,920 $ 764,451 (1) Includes equipment financing leases, which totaled $ 10.2 million and $ 10.3 million as of September 30, 2023 and December 31, 2022 , respectively. The Company makes commercial, real estate and installment loans to its customers. Although the Company has a diversified loan portfolio, 52.7 % and 53.0 % of the portfolio was concentrated in loans secured by real estate as of September 30, 2023 and December 31, 2022, respectively. Loans with a carrying value of $ 100.8 million and $ 100.2 million were pledged as collateral to secure Federal Home Loan Bank (“FHLB”) borrowings as of September 30, 2023 and December 31, 2022 , respectively. In addition, loans with a carrying value of $ 282.6 million were pledged to secure borrowings with the Federal Reserve Bank ("FRB") as of September 30, 2023 . No loans were pledged to the FRB as of December 31, 2022. Measures were undertaken by management in 2023 to pledge loans to the FRB in order to provide additional borrowing capacity to the Company in response to heightened liquidity concerns in the banking industry. 18 Related Party Loans In the ordinary course of business, the Bank makes loans to certain officers and directors of the Company, including companies with which they are associated. These loans are made on the same terms as those prevailing for comparable transactions with unrelated parties. Management believes that such loans do not represent more than a normal risk of collectability, nor do they present other unfavorable features. The aggregate balances of such related party loans and commitments were $ 1.4 million and $ 0.2 million as of September 30, 2023 and December 31, 2022, respectively. During the nine months ended September 30, 2023 , there was one new loan to these parties and no repayments made. During the year ended December 31, 2022 , there were no new loans to these parties, and repayments by active related parties totaled $ 0.1 million. Allowances for Credit Losses Effective J anuary 1, 2023, the Company adopted the CECL model to account for credit losses on financial instruments, including loans and leases held for investment, as well as off-balance sheet credit exposures including unfunded lending commitments. In accordance with the CECL accounting guidance, the Company recorded a cumulative-effect adjustment totaling $ 2.4 million, of which $ 1.8 million (net of tax) was recorded through retained earnings upon adoption of the model. This amount included estimates for credit losses associated with both loan and lease receivables, as well as unfunded lending commitments. Prospectively, following the date of adoption, all adjustments for credit losses are required to be recorded as a provision for (recovery of) credit losses in the Company’s consolidated statement of operations. Allowance for Credit Losses - Loans and Leases Determining the appropriateness of the allowance for credit losses is complex and requires judgment by management about the effects of matters that are inherently uncertain. In future periods, evaluations of the overall loan portfolio, or particular segments of the portfolio, in the context of factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods. The level of the allowance is influenced by loan volumes and mix, historical credit loss experience, average remaining life of portfolio segments, asset quality characteristics, delinquency status, and other conditions including reasonable and supportable forecasts of economic conditions and qualitative adjustment factors based on management’s understanding of various attributes that could impact life-of-loan losses as of the balance sheet date. The methodology to estimate losses includes two basic components: (1) an asset-specific component for individual loans that do not share similar risk characteristics with other loans, and (2) a pooled component for estimated expected credit losses for loans that share similar risk characteristics. Loans that do not share risk characteristics with other loans are evaluated on an individual basis. The process for determining whether a loan should be evaluated on an individual basis begins with a determination of credit rating. All loans graded substandard or worse with a total commitment of $ 0.5 million or more are evaluated on an individual basis. At management's discretion, other loans may be evaluated, including loans less than $ 0.5 million, if management determines that the loans exhibit unique risk characteristics. For loans individually evaluated, the allowance is based primarily on the fair value of the underlying collateral, utilizing independent third-party appraisals, and assessment of borrower guarantees. For estimating the component of the allowance for credit losses that share similar risk characteristics, loans are segregated into loan segments or categories that share risk characteristics. Loans are designated into pooled segments based on product types, business lines, collateral, and other risk characteristics. For all pooled loan categories, the Company uses a loss-rate methodology to calculate estimated life-of-loan and lease credit losses. This methodology focuses on historical credit loss rates applied over the estimated weighted average remaining life of each loan segment, adjusted by qualitative factors, to estimate life-of-loan losses for each pooled segment. The qualitative factors utilized include, among others, reasonable and supportable forecasts of economic data, including inflation and unemployment levels, as well as interest rates. The Company’s cumulative-effect adjustment upon the adoption of CECL increased the Company’s allowance for credit losses on loans and leases by $ 2.1 million. Subsequent to January 1, 2023, the Company recorded additional increases to the allowance for credit losses on loans and leases totaling $ 0.5 million which were included in the provision for credit losses in the Company’s consolidated statement of operations during the nine months ended September 30, 2023. 19 The following tables present changes in the allowance for credit losses on loans and leases during the nine months ended September 30, 2023 and 2022: As of and for the Nine Months Ended September 30, 2023 Construction, Land Development, and Other Real Estate 1-4 Family Real Estate Multi- Family Non- Farm Non- Residential Commercial and Industrial Direct Consumer Branch Retail Indirect Consumer Total (Dollars in Thousands) Allowance for credit losses: Beginning balance $ 517 $ 832 $ 646 $ 1,970 $ 919 $ 866 $ 518 $ 3,154 $ 9,422 Impact of adopting CECL accounting guidance ( 94 ) ( 39 ) ( 85 ) ( 147 ) ( 20 ) 47 628 1,833 2,123 Charge-offs — ( 96 ) — — — ( 521 ) ( 359 ) ( 500 ) ( 1,476 ) Recoveries — 39 — — — 499 195 40 773 Provision for (recovery of) credit losses 157 18 ( 156 ) ( 201 ) ( 369 ) ( 404 ) ( 147 ) 1,640 538 Ending balance $ 580 $ 754 $ 405 $ 1,622 $ 530 $ 487 $ 835 $ 6,167 $ 11,380 As of and for the Nine Months Ended September 30, 2022 Construction, Land Development, and Other Real Estate 1-4 Family Real Estate Multi- Family Non- Farm Non- Residential Commercial and Industrial Direct Consumer Branch Retail Indirect Consumer Total (Dollars in Thousands) Allowance for loan and lease losses: Beginning balance $ 628 $ 690 $ 437 $ 1,958 $ 860 $ 1,004 $ 304 $ 2,439 $ 8,320 Charge-offs — ( 10 ) — — — ( 1,604 ) ( 423 ) ( 238 ) ( 2,275 ) Recoveries 2 23 — 4 — 387 97 34 547 Provision for (recovery of) loan and lease losses ( 246 ) 89 210 30 244 1,161 445 848 2,781 Ending balance $ 384 $ 792 $ 647 $ 1,992 $ 1,104 $ 948 $ 423 $ 3,083 $ 9,373 The following table details the allowance for loan and lease losses and recorded investment in loans by loan classification and by impairment evaluation as of December 31, 2022, as determined in accordance with ASC 310, Receivables , prior to the adoption of ASC 326: As of the Year Ended December 31, 2022 Construction, Land Development, and Other Real Estate 1-4 Family Real Estate Multi- Family Non- Farm Non- Residential Commercial and Industrial Direct Consumer Branch Retail Indirect Consumer Total (Dollars in Thousands) Ending balance of allowance attributable to loans: Individually evaluated for impairment $ — $ 7 $ — $ — $ 252 $ — $ — $ — $ 259 Collectively evaluated for impairment 517 825 646 1,970 667 886 518 3,154 $ 9,183 Total allowance for loan and lease losses $ 517 $ 832 $ 646 $ 1,970 $ 919 $ 886 $ 518 $ 3,154 $ 9,442 Ending balance of loans receivable: Individually evaluated for impairment $ — $ 582 $ — $ 2,492 $ 2,429 $ 18 $ — $ — $ 5,521 Collectively evaluated for impairment 53,914 87,413 67,852 197,664 71,117 9,833 13,992 266,567 768,352 Total loans receivable $ 53,914 $ 87,995 $ 67,852 $ 200,156 $ 73,546 $ 9,851 $ 13,992 $ 266,567 $ 773,873 Allowance for Credit Losses - Unfunded Lending Commitments Unfunded lending commitments are off-balance sheet arrangements that represent unconditional commitments of the Company to lend to a borrower that are unfunded as of the balance sheet date. These may include unfunded loan commitments, standby letters of credit, and financial guarantees. The CECL accounting guidance requires that an estimate of expected credit loss be measured on commitments in which an entity is exposed to credit risk via a present contractual obligation to extend credit unless the obligation is unconditionally cancellable by the issuer. For the Company, unconditional lending commitments generally include unfunded term loan agreements, home equity lines of credit, lines of credit, and demand deposit account overdraft protection. The Company’s cumulative-effect adjustment upon the adoption of CECL included a reserve for unfunded commitments of $ 0.3 million. Subsequent to January 1, 2023, the Company recorded additional increases to the reserve for unfunded commitments totaling $0.2 million which were included in the provision for credit losses in the Company's consolidated statement of operations during the nine months ended September 30, 2023. As of September 30, 2023, the reserve, which is recorded in other liabilities on the Company’s consolidated balance sheets, totaled $ 0.5 million. No reserve for unfunded commitments was recorded by the Company as of December 31, 2022. 20 Credit Quality Indicators The Company utilizes a credit grading system that provides a uniform framework for establishing and monitoring credit risk in the loan portfolio. Under this system, construction, land, multi-family real estate, other commercial real estate, and commercial and industrial loans are graded based on pre-determined risk metrics and categorized into one of nine risk grades. These risk grades can be summarized into categories described as pass, special mention, substandard, doubtful and loss, as described in further detail below. • Pass (Risk Grades 1-5): Loans in this category include obligations in which the probability of default is considered low. • Special Mention (Risk Grade 6): Loans in this category exhibit potential credit weaknesses or downward trends deserving management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. Although a special mention asset has a higher probability of default than pass-rated categories, its default is not imminent. • Substandard (Risk Grade 7): Loans in this category have defined weaknesses that jeopardize the orderly liquidation of debt. A substandard loan is inadequately protected by the current worth and paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified as substandard. • Doubtful (Risk Grade 8): Loans classified as doubtful have all of the weaknesses found in substandard loans, with the added characteristic that the weaknesses make collection of debt in full, based on currently existing facts, conditions and values, highly questionable or improbable. Serious problems exist such that partial loss of principal is likely; however, because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Such pending factors may include proposed merger, acquisition or liquidation procedures, capital injection, perfection of liens on additional collateral and refinancing plans. Loans classified as doubtful may include loans to borrowers that have demonstrated a history of failing to live up to agreements. The Company did not have any loans classified as Doubtful (Risk Grade 8) as of September 30, 2023 or December 31, 2022. • Loss (Risk Grade 9): Loans are classified in this category when borrowers are deemed incapable of repayment of unsecured debt. Loans to such borrowers are considered uncollectable and of such little value that continuance as active assets of the Company is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not prudent to defer writing off these assets, even though partial recovery may be realized in the future. The Company did not have any loans classified as Loss (Risk Grade 9) as of September 30, 2023 or December 31, 2022. Because residential real estate and consumer loans are more uniform in nature, each loan is categorized into one of two risk grades, depending on whether the loan is considered to be performing or nonperforming. Performing loans are loans that are paying principal and interest in accordance with a contractual agreement. Nonperforming loans are loans that have demonstrated characteristics that indicate a probability of loss. 21 The tables below illustrate the carrying amount of loans and leases by credit quality indicator and year of origination as of September 30, 2023: September 30, 2023 Loans at Amortized Cost Basis by Origination Year 2023 2022 2021 2020 2019 Prior Total (Dollars in Thousands) Commercial: Construction, land development and other land loans Pass $ 3,716 $ 38,961 $ 40,404 $ 6,377 $ — $ 593 $ 90,051 Special Mention — — — — — — — Substandard — — — — — — — Doubtful — — — — — — — Loss — — — — — — — Subtotal $ 3,716 $ 38,961 $ 40,404 $ 6,377 $ — $ 593 $ 90,051 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — Secured by multi-family residential properties Pass $ 383 $ 28,513 $ 5,991 $ 686 $ 7,151 $ 13,782 $ 56,506 Special Mention — — — — — — — Substandard — — — — — — — Doubtful — — — — — — — Loss — — — — — — — Subtotal $ 383 $ 28,513 $ 5,991 $ 686 $ 7,151 $ 13,782 $ 56,506 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — Secured by non-farm, non-residential properties Pass $ 8,683 $ 35,499 $ 25,519 $ 56,913 $ 18,618 $ 47,516 $ 192,748 Special Mention — 536 1,295 347 — 1,690 3,868 Substandard — — — 152 — 2,348 2,500 Doubtful — — — — — — — Loss — — — — — — — Subtotal $ 8,683 $ 36,035 $ 26,814 $ 57,412 $ 18,618 $ 51,554 $ 199,116 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — Commercial and industrial loans and leases Pass $ 7,435 $ 7,401 $ 15,424 $ 2,494 $ 3,802 $ 20,643 $ 57,199 Special Mention — 170 899 199 57 — 1,325 Substandard — 44 209 25 305 262 845 Doubtful — — — — — — — Loss — — — — — — — Subtotal $ 7,435 $ 7,615 $ 16,532 $ 2,718 $ 4,164 $ 20,905 $ 59,369 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — Total commercial Pass $ 20,217 $ 110,374 $ 87,338 $ 66,470 $ 29,571 $ 82,534 $ 396,504 Special Mention — 706 2,194 546 57 1,690 5,193 Substandard — 44 209 177 305 2,610 3,345 Doubtful — — — — — — — Loss — — — — — — — $ 20,217 $ 111,124 $ 89,741 $ 67,193 $ 29,933 $ 86,834 $ 405,042 Current period gross charge-offs $ — $ — $ — $ — $ — $ — $ — 22 September 30, 2023 Loans at Amortized Cost Basis by Origination Year 2023 2022 2021 2020 2019 Prior Total (Dollars in Thousands) Consumer: Secured by 1-4 family residential properties Performing $ 4,282 $ 21,592 $ 14,886 $ 12,028 $ 9,323 $ 20,917 $ 83,028 Non-performing — — — — — 848 848 Subtotal $ 4,282 $ 21,592 $ 14,886 $ 12,028 $ 9,323 $ 21,765 $ 83,876 Current period gross charge-offs $ — $ — $ — $ — $ — $ 96 $ 96 Direct Performing $ 2,052 $ 1,379 $ 1,961 $ 739 $ 288 $ 125 $ 6,544 Non-performing — — — — — — — Subtotal $ 2,052 $ 1,379 $ 1,961 $ 739 $ 288 $ 125 $ 6,544 Current period gross charge-offs $ — $ 5 $ 274 $ 115 $ 39 $ 88 $ 521 Branch retail Performing $ — $ — $ 2,405 $ 2,990 $ 1,794 $ 2,459 $ 9,648 Non-performing — — — — — — — Subtotal $ — $ — $ 2,405 $ 2,990 $ 1,794 $ 2,459 $ 9,648 Current period gross charge-offs $ — $ — $ 84 $ 127 $ 28 $ 120 $ 359 Indirect Performing $ 82,347 $ 92,898 $ 69,122 $ 53,564 $ 5,878 $ 6,239 $ 310,048 Non-performing — 34 — 108 — — 142 Subtotal $ 82,347 $ 92,932 $ 69,122 $ 53,672 $ 5,878 $ 6,239 $ 310,190 Current period gross charge-offs $ — $ 128 $ 171 $ 153 $ 13 $ 35 $ 500 Total consumer Performing $ 88,681 $ 115,869 $ 88,374 $ 69,321 $ 17,283 $ 29,740 $ 409,268 Non-performing — 34 — 108 — 848 990 $ 88,681 $ 115,903 $ 88,374 $ 69,429 $ 17,283 $ 30,588 $ 410,258 Current period gross charge-offs $ — $ 133 $ 529 $ 395 $ 80 $ 339 $ 1,476 23 The tables below illustrate the carrying amount of loans by credit quality indicator as of December 31, 2022: December 31, 2022 Pass 1-5 Special Mention 6 Substandard 7 Total (Dollars in Thousands) Loans secured by real estate: Construction, land development and other land loans $ 53,914 $ — $ — $ 53,914 Secured by multi-family residential properties 67,852 — — 67,852 Secured by non-farm, non-residential properties 197,004 651 2,501 200,156 Commercial and industrial loans 70,500 — 3,046 73,546 Total $ 389,270 $ 651 $ 5,547 $ 395,468 As a percentage of total loans 98.43 % 0.17 % 1.40 % 100.00 % December 31, 2022 Performing Nonperforming Total (Dollars in Thousands) Loans secured by real estate: Secured by 1-4 family residential properties $ 86,871 $ 1,124 $ 87,995 Consumer loans: Direct 9,805 46 9,851 Branch retail 13,960 32 13,992 Indirect 266,496 71 266,567 Total $ 377,132 $ 1,273 $ 378,405 As a percentage of total loans 99.66 % 0.34 % 100.00 % The following table provides an aging analysis of past due loans by class as of September 30, 2023: As of September 30, 2023 30-59 Days Past Due 60-89 Days Past Due 90 Days Or Greater Total Past Due Current Total Loans Recorded Investment > 90 Days And Accruing (Dollars in Thousands) Loans secured by real estate: Construction, land development and other land loans $ — $ — $ — $ — $ 90,051 $ 90,051 $ — Secured by 1-4 family residential properties 93 36 — 129 83,747 83,876 — Secured by multi-family residential properties — — — — 56,506 56,506 — Secured by non-farm, non-residential properties 1,314 — — 1,314 197,802 199,116 — Commercial and industrial loans 22 — 62 84 59,285 59,369 — Consumer loans: — Direct 52 — — 52 6,492 6,544 — Branch retail 100 — — 100 9,548 9,648 — Indirect 335 171 142 648 309,542 310,190 — Total $ 1,916 $ 207 $ 204 $ 2,327 $ 812,973 $ 815,300 $ — As a percentage of total loans 0.24 % 0.02 % 0.03 % 0.29 % 99.71 % 100.00 % 24 The following table provides an aging analysis of past due loans by class as of December 31, 2022: As of December 31, 2022 30-59 Days Past Due 60-89 Days Past Due 90 Days Or Greater Total Past Due Current Total Loans Recorded Investment > 90 Days And Accruing (Dollars in Thousands) Loans secured by real estate: Construction, land development and other land loans $ — $ — $ — $ — $ 53,914 $ 53,914 $ — Secured by 1-4 family residential properties 801 87 78 966 87,029 87,995 — Secured by multi-family residential properties — — — — 67,852 67,852 — Secured by non-farm, non-residential properties 137 — — 137 200,019 200,156 — Commercial and industrial loans 61 — 300 361 73,185 73,546 — Consumer loans: Direct 251 50 30 330 9,521 9,851 — Branch retail 258 85 32 375 13,617 13,992 — Indirect 186 55 71 312 266,255 266,567 — Total $ 1,694 $ 277 $ 511 $ 2,481 $ 771,392 $ 773,873 $ — As a percentage of total loans 0.21 % 0.04 % 0.07 % 0.32 % 99.68 % 100.00 % The table below presents the amortized cost of loans on nonaccrual status and loans past due 90 days or more and still accruing interest as of September 30, 2023. Also presented is the balance of loans on nonaccrual status at September 30, 2023 for which there was no related allowance for credit losses recorded. Loans on Non-Accrual Status September 30, 2023 (Dollars in Thousands) Total nonaccrual loans Nonaccrual loans with no allowance for credit losses Loans past due 90 days or more and still accruing Loans secured by real estate: Construction, land development and other land loans $ — $ — $ — Secured by 1-4 family residential properties 891 462 — Secured by multi-family residential properties — — — Secured by non-farm, non-residential properties 1,314 1,314 — Commercial and industrial loans 85 77 — Consumer loans: — Direct — — — Branch retail — — — Indirect 142 — — Total loans $ 2,432 $ 1,853 $ — 25 The following table provides an analysis of nonaccruing loans by portfolio segment as of December 31, 2022: Loans on Non-Accrual Status December 31, 2022 (Dollars in Thousands) Loans secured by real estate: Construction, land development and other land loans $ — Secured by 1-4 family residential properties 914 Secured by multi-family residential properties — Secured by non-farm, non-residential properties — Commercial and industrial loans 605 Consumer loans: Direct 29 Branch retail 32 Indirect 71 Total loans $ 1,651 The following table presents the amortized cost basis of collateral dependent loans as of September 30, 2023, which loans are individually evaluated to determine credit losses: September 30, 2023 Real Estate Other Total (Dollars in Thousands) Loans secured by real estate Construction, land development and other land loans $ — $ — $ — Secured by 1-4 family residential properties 498 — 498 Secured by multi-family residential properties — — — Secured by non-farm, non-residential properties 2,353 — 2,353 Commercial and industrial — 126 126 Direct consumer — — — Total loans individually evaluated $ 2,851 $ 126 $ 2,977 26 The following table presents impaired loans as of December 31, 2022 as determined under ASC 310 prior to the adoption of ASC 326. Impaired loans generally include nonaccrual loans and other loans deemed to be impaired but that continue to accrue interest. Presented are the carrying amount, unpaid principal balance and related allowance of impaired loans as of December 31, 2022 by portfolio segment: December 31, 2022 Carrying Amount Unpaid Principal Balance Related Allowances (Dollars in Thousands) Impaired loans with no related allowance recorded Loans secured by real estate Construction, land development and other land loans $ — $ — $ — Secured by 1-4 family residential properties 568 568 — Secured by multi-family residential properties — — — Secured by non-farm, non-residential properties 2,492 2,492 — Commercial and industrial 2,076 2,076 — Direct consumer 18 18 — Total impaired loans with no related allowance recorded $ 5,154 $ 5,154 $ — Impaired loans with an allowance recorded Loans secured by real estate Construction, land development and other land loans $ — $ — $ — Secured by 1-4 family residential properties 14 14 7 Secured by multi-family residential properties — — — Secured by non-farm, non-residential properties — — — Commercial and industrial 353 353 252 Direct consumer — — — Total impaired loans with an allowance recorded $ 367 $ 367 $ 259 Total impaired loans Loans secured by real estate Construction, land development and other land loans $ — $ — $ — Secured by 1-4 family residential properties 582 582 7 Secured by multi-family residential properties — — — Secured by non-farm, non-residential properties 2,492 2,492 — Commercial and industrial 2,429 2,429 252 Direct consumer 18 18 — Total impaired loans $ 5,521 $ 5,521 $ 259 The following table details the average recorded investment and the amount of interest income recognized and received for the nine months ended September 30, 2022, respectively, related to impaired loans as determined under ASC 310 prior to the adoption of ASC 326: Nine Months Ended September 30, 2022 Average Recorded Investment Interest Income Recognized Interest Income Received (Dollars in Thousands) Loans secured by real estate Construction, land development and other land loans $ 116 $ 2 $ — Secured by 1-4 family residential properties 624 4 4 Secured by multi-family residential properties — — — Secured by non-farm, non-residential properties 1,116 38 35 Commercial and industrial 872 7 4 Direct consumer 19 1 1 Total $ 2,747 $ 52 $ 44 27 Loan Modifications Made to Borrowers Experiencing Financial Difficulty From time to time, the Company may modify the terms of loan agreements with borrowers that are experiencing financial difficulties. Modification of the terms of such loans typically include one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. No modifications in 2023 or 2022 resulted in the permanent reduction of the recorded investment in the loan. During the nine months ended September 30, 2023 , the Company did not modify any loans to borrowers experiencing financial difficulty, and there were no payment defaults on loans that were modified in the previous twelve months. 5. OTHER REAL ESTATE OWNED AND REPOSSESSED ASSETS Other Real Estate Owned Other real estate and certain other assets acquired in foreclosure are reported at the net realizable value of the property, less estimated costs to sell. The following table summarizes foreclosed property activity as of the nine months ended September 30, 2023 and 2022 : September 30, 2023 September 30, 2022 (Dollars in Thousands) Beginning balance $ 686 $ 2,149 Additions — 411 Sales proceeds — ( 2,215 ) Gross gains — 369 Gross losses — ( 27 ) Net gains — 342 Impairment ( 69 ) ( 1 ) Ending balance $ 617 $ 686 Valuation adjustments are recorded in other non-interest expense and are primarily post-foreclosure write-downs that are a result of continued declining property values based on updated appraisals or other indications of value, such as offers to purchase. Net realizable value less estimated costs to sell of foreclosed residential real estate held by the Company was $ 20 thousand and zero as of September 30, 2023 and September 30, 2022 , respectively. In addition, the Company held zero and $ 19 thousand in consumer mortgage loans collateralized by residential real estate that were in the process of foreclosure as of September 30, 2023 and 2022, respectively. Repossessed Assets The Company also acquires assets through the repossession of the underlying collateral of loans in default. The following table summarizes repossessed asset activity as of the nine months ended September 30, 2023 and 2022 : September 30, 2023 September 30, 2022 (Dollars in Thousands) Beginning balance $ 83 $ 154 Transfers from loans 1,178 635 Sales proceeds ( 453 ) ( 331 ) Gross gains — — Gross losses ( 535 ) ( 292 ) Net losses ( 535 ) ( 292 ) Impairment — — Ending balance $ 273 $ 166 Repossessed assets are included in Other Assets in the Company’s condensed consolidated balance sheets. 28 6. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill is tested for impairment annually, or more often if circumstances warrant. If, as a result of impairment testing, it is determined that the implied fair value of goodwill is lower than its carrying amount, impairment is indicated, and goodwill must be written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the consolidated financial statements. Goodwill, originally recorded as a result of the Company's acquisition of The Peoples Bank ("TPB") in 2018, totaled $ 7.4 million as of both September 30, 2023 and December 31, 2022. Goodwill impairment was neither indicated nor recorded during the nine months ended September 30, 2023 or the year ended December 31, 2022. Core deposit premiums are amortized over a seven-year period and are periodically evaluated, at least annually, as to the recoverability of their carrying value. Core deposit premiums of $ 2.0 million were recorded during 2018 as part of the TPB acquisition. The Company’s goodwill and other intangible assets (carrying basis and accumulated amortization) as of September 30, 2023 and December 31, 2022 were as follows: September 30, 2023 December 31, 2022 (Dollars in Thousands) Goodwill $ 7,435 $ 7,435 Core deposit intangible: Gross carrying amount 2,048 2,048 Accumulated amortization ( 1,841 ) ( 1,682 ) Core deposit intangible, net 207 366 Total $ 7,642 $ 7,801 The Company’s estimated remaining amortization expense on intangible assets as of September 30, 2023 was as follows: Amortization Expense (Dollars in Thousands) 2023 $ 36 2024 122 2025 49 Total $ 207 The net carrying amount of the Company’s core deposit premiums is not considered recoverable if it exceeds the sum of the undiscounted cash flows expected to result from use and eventual disposition. That assessment is based on the carrying amount of the intangible assets subject to amortization at the date on which it is tested for recoverability. Intangible assets subject to amortization are tested by the Company for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. 7. BORROWINGS Short-Term Borrowings Short-term borrowings consist of federal funds purchased, securities sold under repurchase agreements, and short-term FHLB advances with original maturities of one year or less. • Federal funds purchased, which represent unsecured lines of credit that generally mature within one to 90 days , are available to the Bank through arrangements with correspondent banks and the FRB. As of both September 30, 2023 and December 31, 2022 , there were no federal funds purchased outstanding. • Securities sold under repurchase agreements, which are secured borrowings, generally are reflected at the amount of cash received in connection with the transaction. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. The Bank monitors the fair value of the underlying securities on a daily basis. There were no securities sold under repurchase agreements as of September 30, 2023. As of December 31, 2022, securities sold under repurchase agreements totaled $ 38 thousand. • Short-term FHLB advances are secured borrowings available to the Bank as an alternative funding source. As of September 30, 2023 and December 31, 2022, the Bank had $ 30.0 million and $ 20.0 million, respectively, in outstanding FHLB advances with original maturities of less than one year. 29 Long-Term Borrowings FHLB Advances The Company may use FHLB advances with original maturities of more than one year as an alternative to funding sources with similar maturities, such as certificates of deposit or other deposit programs. These advances generally offer more attractive rates than other mid-term financing options. They are also flexible, allowing the Company to quickly obtain the necessary maturities and rates that best suit its overall asset/liability strategy. FHLB advances with an original maturity of more than one year are classified as long-term. As of both September 30, 2023 and December 31, 2022 , the Company did no t have any long-term FHLB advances outstanding. Subordinated Debt On October 1, 2021, the Company completed a private placement of $ 11.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes that will mature on October 1, 2031 (the “Notes”). The Notes bear interest at a rate of 3.50 % per annum for the first five years, after which the interest rate will be reset quarterly to a benchmark interest rate per annum which, subject to certain conditions provided in the Notes, will be equal to the then current three-month term Secured Overnight Financing Rate (“SOFR”) plus 275 basis points . The Company used the net proceeds for general corporate purposes, including repurchasing of the Company’s common stock, and supporting organic growth plans, including the maintenance of capital ratios. Net of unamortized debt issuance costs, the Notes were recorded as long-term borrowings totaling $ 10.8 million and $ 10.7 million as of September 30, 2023 and December 31, 2022 , respectively. The table below provides additional information related to the Notes as of and for the nine months ended September 30, 2023 and 2022. September 30, September 30, 2023 2022 (Dollars in Thousands) Balance at period-end $ 10,781 $ 10,708 Average balance during the period $ 10,775 $ 10,702 Maximum month-end balance during the year $ 10,781 $ 10,708 Average rate paid during the period, including amortization of debt issuance costs 4.16 % 4.16 % Weighted average remaining maturity (in years) 8.00 9.00 Available Credit As an additional funding source, the Company has available unused lines of credit with correspondent banks, the FRB and the FHLB. Certain of these funding sources are subject to underlying collateral. As of September 30, 2023 and December 31, 2022, the Company’s available unused lines of credit consisted of the following: Available Unused Lines of Credit Collateral Requirements September 30, 2023 December 31, 2022 Correspondent banks None $ 48.0 million $ 45.0 million FHLB advances (1) Subject to collateral $ 260.3 million $ 246.8 million FRB (2) Subject to collateral $ 146.6 million $ 1.2 million (1) These amounts represent the total remaining credit the Company has from the FHLB, but this credit can only be utilized to the extent that underlying collateral exists. The total lendable collateral value of assets pledged (including loans and investment securities) associated with FHLB advances and letters of credit totaled $ 66.7 million and $ 68.2 million as of September 30, 2023 and December 31, 2022, respectively. The Company’s collateral exposure with the FHLB in the form of advances and letters of credit was $ 60.0 million and $ 50.0 million as of September 30, 2023 and December 31, 2022, respectively, leaving an excess of collateral of $ 6.7 million and $ 18.2 million, respectively, available to utilize for additional credit as of the respective dates. The Company also has the ability to pledge additional assets to increase the availability of borrowings. (2) The Company has access to the FRB's discount window and its Bank Term Funding Program (BTFP), the latter of which was established during the first quarter of 2023 in response to the liquidity events that occurred in the banking industry. Both the discount window and the BTFP allow borrowing on pledged collateral that includes eligible investment securities and, in certain circumstances, eligible loans. The discount window allows borrowing under 90-day terms, while borrowing terms under the BTFP are up to one year. The BTFP also allows investment securities to be pledged as collateral at 100 % of par value when par value is greater than fair value. The amounts shown in the table represent the Company's unused borrowing capacity as of the applicable date based on collateral pledged to the FRB's discount window. No collateral was pledged by the Company under the BTFP as of September 30, 2023. 30 8. INCOME TAXES The provision for income taxes was $ 2.0 million and $ 1.4 million for the nine months ended September 30, 2023 and 2022, respectively. The Company’s effective tax rate was 24.4 % and 23.7 % , respectively, for the same periods. The effective tax rate is impacted by recurring permanent differences, such as those associated with bank-owned life insurance and tax-exempt investment and loan income. The Company had a net deferred tax asset of $ 6.3 million and $ 5.2 million as of September 30, 2023 and December 31, 2022, respectively. The net deferred tax asset, which is included on the interim condensed consolidated balance sheet in other assets, is impacted by changes in the fair value of securities available-for-sale and cash flow hedges, changes in net operating loss carryforwards, changes in the allowance for credit losses, and other book-to-tax temporary differences. The net deferred tax asset increased by $ 0.6 million as a result of the cumulative effect adjustment to adopt ASC 326, effective January 1, 2023. 9. DEFERRED COMPENSATION PLANS Supplemental Retirement Benefits The Company has entered into supplemental retirement compensation benefits agreements with certain directors and former executive officers. The measurement of the liability under these agreements includes estimates involving life expectancy, length of time before retirement and the expected returns on the bank-owned life insurance policies used to fund those agreements. Should these estimates prove to be materially wrong, the cost of these agreements could change accordingly. The related deferred compensation obligation to these directors and executive officers included in other liabilities was $ 3.0 million and $ 3.1 million as of September 30, 2023 and December 31, 2022, respectively. Non-Employee Directors' Deferred Compensation Plan Non-employee directors may elect to defer payment of all or any portion of their director fees under Bancshares’ Non-Employee Directors’ Deferred Compensation Plan (the “Deferral Plan”). The Deferral Plan permits non-employee directors to invest their directors’ fees and to receive the adjusted value of the deferred amounts in cash and/or shares of Bancshares’ common stock, as applicable. Neither Bancshares nor the Bank makes any contribution to participants’ accounts under the Deferral Plan. As of September 30, 2023 and December 31, 2022, a total of 111,340 and 114,190 shares of Bancshares common stock, respectively, were being held as stock equivalents in connection with the Deferral Plan. All deferred fees and shares of Bancshares common stock are reflected as compensation expense in the period earned. The Company classifies all deferred directors’ fees allocated to be paid in shares as equity as additional paid-in capital. The Company may use issued shares or shares of treasury stock to satisfy these obligations when due. 10. STOCK AWARDS In 2013, Bancshares’ shareholders authorized the Company, under the direction of the Compensation Committee of the Board of Directors, to provide share-based compensation awards to eligible employees, directors and consultants of the Company and its affiliates pursuant to the 2013 Incentive Plan. Available award types included stock options, stock appreciation rights, restricted stock and restricted stock units, and performance share awards. The 2013 Incentive Plan, as amended in 2019, expired in March 2023. In April 2023, Bancshares’ shareholders approved the 2023 Incentive Plan, which authorizes the Compensation Committee to grant substantially the same types of share-based awards to eligible employees, directors and consultants. Collectively, the 2013 Incentive Plan and the 2023 Incentive Plan are herein referred to as the Company’s “Incentive Plan.” In accordance with the Incentive Plan, shares of common stock available for issuance pursuant to the grants may consist, in whole or in part, of authorized and unissued shares, treasury shares or shares reacquired by the Company in any manner. Since the origination of the Incentive Plan, through September 30, 2023, only stock options and restricted stock have been granted. For the nine months ended September 30, 2023, stock-based compensation expense related to stock awards totaled $ 0.4 million, compared to $ 0.3 million for the nine months ended September 30, 2022. 31 Stock Options Stock option awards have been granted with an exercise price equal to the market price of the Company’s common stock on the date of the grant and have vesting periods ranging from one to three years , with 10 -year contractual terms. The Company recognizes the cost of services received in exchange for stock option awards based on the grant date fair value of the award, with compensation expense recognized on a straight-line basis over the award’s vesting period. The fair value of outstanding awards was determined using the Black-Scholes option pricing model. The Company did no t grant any stock option awards during the nine months ended September 30, 2023 or 2022. The following table summarizes the Company’s stock option activity for the periods presented. Nine Months Ended September 30, 2023 September 30, 2022 Number of Shares Average Exercise Price Number of Shares Average Exercise Price Options: Outstanding, beginning of period 419,650 $ 9.79 420,250 $ 9.79 Granted — — — — Exercised — — — — Expired — — — — Forfeited — — 600 10.86 Options outstanding, end of period 419,650 $ 9.79 419,650 $ 9.79 Options exercisable, end of period 419,650 $ 9.79 416,249 $ 9.77 The aggregate intrinsic value of stock options outstanding (calculated as the amount by which the market value of underlying stock exceeds the exercise price of the option) was $ 0.1 million and zero as of September 30, 2023 and 2022, respectively. Restricted Stock During the nine months ended September 30, 2023 and 2022, 57,300 shares and 45,938 shares, respectively, of restricted stock were granted. The Company recognizes the cost of services received in exchange for restricted stock awards based on the grant date closing price of the stock, with compensation expense recognized on a straight-line basis over the award’s vesting period. 11. LEASES The Bank and ALC are involved in a number of operating leases, primarily for branch locations. Branch leases have remaining lease terms ranging from two years to six years , some of which include options to extend the leases for up to five years , and some of which include an option to terminate the lease within one year . The Bank also leases certain office facilities to third parties and classifies these leases as operating leases. The following table provides a summary of the components of lease income and expense, as well as the reporting location in the interim condensed consolidated statements of operations, for the three and nine months ended September 30, 2023 and 2022: Location in the Condensed Three Months Ended Nine Months Ended Consolidated Statements of Operations September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (Dollars in Thousands) (Dollars in Thousands) Operating lease income (1) Lease income $ 241 $ 210 $ 707 $ 635 Operating lease expense (2) Net occupancy and equipment $ 108 $ 108 $ 324 $ 326 (1) Operating lease income includes rental income from owned properties (2) Includes short-term lease costs. For the three and nine months ended September 30, 2023 and 2022 , short-term lease costs were nominal in amount. 32 The following table provides supplemental lease information for operating leases on the interim condensed consolidated balance sheet as of September 30, 2023 and December 31, 2022: Location in the Condensed Consolidated Balance Sheet September 30, 2023 December 31, 2022 (Dollars in Thousands) Operating lease right-of-use assets Other assets $ 1,605 $ 1,883 Operating lease liabilities Other liabilities $ 1,684 $ 1,961 Weighted-average remaining lease term (in years) 4.28 5.03 Weighted-average discount rate 3.30 % 3.30 % The following table provides supplemental lease information for the interim condensed consolidated statements of cash flows for the nine months ended September 30, 2023 and 2022: Nine Months Ended September 30, 2023 September 30, 2022 (Dollars in Thousands) Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases $ 323 $ 320 The following table is a schedule of remaining future minimum lease payments for operating leases that had an initial or remaining non-cancellable lease term in excess of one year as of September 30, 2023: Minimum Rental Payments (Dollars in Thousands) 2023 $ 109 2024 438 2025 339 2026 346 2027 353 2028 and thereafter 238 Total future minimum lease payments 1,823 Less: Imputed interest 139 Total operating lease liabilities $ 1,684 12. DERIVATIVE FINANCIAL INSTRUMENTS The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of certain balance sheet assets and liabilities. In the normal course of business, the Company also uses derivative financial instruments to add stability to interest income or expense and to manage its exposure to movements in interest rates. The Company does not use derivatives for trading or speculative purposes and only enters into transactions that have a qualifying hedge relationship. The Company’s hedging strategies involving interest rate derivatives are classified as either cash flow hedges or fair value hedges, depending upon the rate characteristic of the hedged item. Active Hedges In June 2023, the Company entered into three forward interest rate swap contracts on a pool of fixed rate indirect consumer loans. Each of the three hedge contracts has a $ 10.0 million notional amount. The interest rate swaps were designated as derivative instruments in fair value hedges with the objective of effectively converting a pool of fixed rate indirect consumer loans to a variable rate throughout the hedge durations in accordance with the portfolio layer method. Under the contractual arrangements, for each swap, the Company pays a fixed interest rate and receives a variable interest rate based on the Secured Overnight Financing Rate (SOFR), on the notional amounts, with monthly net settlements. 33 Hedges Terminated in 2023 In February 2023, the Company voluntarily terminated four interest rates swap agreements each with notional amounts of $ 10.0 million, or an aggregate amount of $ 40.0 million. Two of the swaps were previously designated as cash flow hedges, while two were previously designated as fair value hedges. The termination of the cash flow hedges resulted in a net unrealized gain totaling $ 1.1 million. The unrealized gain was initially recorded in accumulated other comprehensive income, net of tax, and is being reclassified to reduce interest expense over the original terms of the swap contracts. The termination of the fair value hedges resulted in an unrealized gain totaling $ 1.0 million which is being reclassified to increase interest income over the original terms of the swap contracts. Hedge Terminated in 2022 In May 2022, the Company voluntarily terminated one interest rate swap agreement with a notional amount of $ 10.0 million. The swap was previously designated as a cash flow hedge. The termination resulted in a net unrealized gain of $ 0.3 million. The unrealized gain was initially recorded in accumulated other comprehensive income, net of tax, and is being reclassified to reduce interest expense over the original term of the swap contract. Presentation The table below reflects the notional amount and fair value of active derivative instruments included on the Company’s consolidated balance sheets on a net basis as of September 30, 2023 and December 31, 2022. As of September 30, 2023 As of December 31, 2022 Notional Estimated Fair Value Notional Estimated Fair Value Amount Gain (Loss) (1) Amount Gain (Loss) (1) (Dollars in Thousands) Derivatives designated as hedging instruments: Fair value hedges: Interest rate swaps related to fixed rate commercial real estate loans $ — $ — $ 20,000 $ 1,101 Interest rate swaps related to fixed rate indirect consumer loans 30,000 537 — — Total fair value hedges 537 1,101 Cash flow hedges: Interest rate swaps related to variable-rate money market deposit accounts — — 20,000 1,205 Interest rate swaps related to FHLB advances — — — — Total cash flow hedges — 1,205 Total hedges designated as hedging instruments, net $ 537 $ 2,306 (1) Derivatives in a gain position are recorded as other assets and derivatives in a loss position are recorded as other liabilities in the consolidated balance sheets. 34 The following table presents the net effects of derivative hedging instruments on the Company’s interim condensed consolidated statements of operations for the three and nine months ended September 30, 2023 and 2022 . The effects, which include the reclassification of unrealized gains on terminated swap contracts, are presented as either an increase or decrease to income before income taxes in the relevant caption of the Company’s interim condensed consolidated statements of operations. Location in the Condensed Three Months Ended Nine Months Ended Consolidated Statements of Operations September 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022 (Dollars in Thousands) (Dollars in Thousands) Interest income Interest and fees on loans $ 258 $ 45 $ 603 $ ( 42 ) Interest expense Interest on deposits 120 24 376 ( 103 ) Interest expense Interest on borrowings 36 36 108 20 Net increase (decrease) to income before income taxes $ 414 $ 105 $ 1,087 $ ( 125 ) 13. OTHER OPERATING INCOME AND EXPENSE Other Operating Income Other operating income for the three and nine months ended September 30, 2023 and 2022 consisted of the following: Three Months Ended Nine Months Ended September 30, September 30, 2023 2022 2023 2022 (Dollars in Thousands) Bank-owned life insurance $ 119 $ 112 $ 348 $ 335 ATM fee income 93 125 315 403 Gain on sales of premises and equipment and other assets 18 278 18 301 Other income 64 52 208 195 Total $ 294 $ 567 $ 889 $ 1,234 Other Operating Expense Other operating expense for the three and nine months ended September 30, 2023 and 2022 consisted of the following: Three Months Ended Nine Months Ended September 30, September 30, 2023 2022 2023 2022 (Dollars in Thousands) Postage, stationery and supplies $ 151 $ 164 $ 472 $ 469 Telephone/data communication 128 159 479 518 Collection and recoveries 71 57 252 176 Directors fees 94 98 284 301 Software amortization 86 133 313 331 Other real estate/foreclosure expense, net 9 ( 5 ) 30 ( 320 ) Other expense 545 568 1,769 1,629 Total $ 1,084 $ 1,174 $ 3,599 $ 3,104 35 14. GUARANTEES, COMMITMENTS AND CONTINGENCIES Credit The Bank’s exposure to credit loss in the event of nonperformance by the other party for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments as it does for on-balance sheet instruments. In the normal course of business, there are outstanding commitments and contingent liabilities, such as commitments to extend credit, letters of credit and others, that are not included in the consolidated financial statements. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the financial statements. A summary of these commitments and contingent liabilities is presented below: September 30, 2023 December 31, 2022 (Dollars in Thousands) Standby letters of credit $ — $ — Standby performance letters of credit $ 664 $ 556 Commitments to extend credit $ 155,614 $ 186,169 Standby letters of credit and standby performance letters of credit are contingent commitments issued by the Bank generally to guarantee the performance of a customer to a third party. The Bank has recourse against the customer for any amount that it is required to pay to a third party under a standby letter of credit or standby performance letter of credit. Revenues are recognized over the lives of the standby letters of credit and standby performance letters of credit. As of September 30, 2023 and December 31, 2022, the potential amounts of future payments that the Bank could be required to make under its standby letters of credit and standby performance letters of credit, which represent the Bank’s total credit risk in these categories, are included in the table above. A commitment to extend credit is an agreement to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon the extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. In accordance with the adoption of ASC 326 on January 1, 2023, the Company recorded a reserve for unfunded commitments of $ 0.3 million. The reserve, which is included in other liabilities in the Company’s balance sheet, totaled $ 0.5 million as of September 30, 2023. Additional discussion related to the calculation of the reserve for unfunded commitments is included in Note 4. Self-Insurance The Company is self-insured for a significant portion of employee health benefits. However, the Company maintains stop-loss coverage with third-party insurers to limit the Company’s individual claim and total exposure related to self-insurance. The Company estimates a liability for the ultimate costs to settle known claims, as well as claims incurred but not yet reported, as of the balance sheet date. The Company’s recorded estimated liability for self-insurance is based on the insurance companies' incurred loss estimates and management’s judgment, including assumptions and evaluation of factors related to the frequency and severity of claims, the Company’s claims development history and the Company’s claims settlement practices. The assessment of loss contingencies and self-insurance reserves is a highly subjective process that requires judgments about future events. Contingencies are reviewed at least quarterly to determine the adequacy of self-insurance accruals. Self-insurance accruals totaled $ 0.2 million as of both September 30, 2023 and December 31, 2022. The ultimate settlement of loss contingencies and self-insurance reserves may differ significantly from amounts accrued in the Company’s consolidated financial statements. Litigation The Company is party to certain ordinary course litigation from time to time, and the Company intends to vigorously defend itself in all such litigation. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such ordinary course litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations. 36 15. FAIR VALUE OF FINANCIAL INSTRUMENTS The assumptions used in the Company’s estimation of the fair value of the Company’s financial instruments are detailed below. The following disclosures should not be considered a representation of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination or issuance. Fair Value Hierarchy Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date. In determining fair value, the Company uses various methods, including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market-corroborated or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair value. Assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories: • Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange or Nasdaq. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. • Level 2 — Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third-party pricing services for identical or similar assets or liabilities. • Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. The Company rarely transfers assets and liabilities measured at fair value between Level 1 and Level 2 measurements. Trading account assets and securities available-for-sale may be periodically transferred to or from Level 3 valuation based on management’s conclusion regarding the best method of pricing for an individual security. Such transfers are accounted for as if they occurred at the beginning of a reporting period. There were no such transfers during the nine months ended September 30, 2023 or the year ended December 31, 2022. 37 Fair Value Measurements on a Recurring Basis Securities Available-for-Sale Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include U.S. Treasury securities. Level 2 securities include agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. Level 2 fair values are obtained from quoted prices of securities with similar characteristics. In certain cases, where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Interest Rate Derivative Agreements Interest rate derivative agreements are used by the Company to mitigate risk associated with changes in interest rates. The fair value of these agreements is based on information obtained from third-party financial institutions. This information is periodically evaluated by the Company and, as necessary, corroborated against other third-party valuations. The Company classifies these derivative assets within Level 2 of the valuation hierarchy. The following table presents assets and liabilities measured at fair value on a recurring basis as of September 30, 2023 and December 31, 2022. Fair Value Measurements as of September 30, 2023 Using Totals At September 30, 2023 Quoted Prices in Active Markets For Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (Dollars in Thousands) Investment securities, available-for-sale Mortgage-backed securities: Residential $ 37,000 $ — $ 37,000 $ — Commercial 9,500 — 9,500 — Obligations of U.S. government-sponsored agencies 10,932 — 10,932 — Obligations of states and political subdivisions 1,543 — 1,543 — Corporate notes 14,681 — 14,681 — U.S. Treasury securities 52,895 52,895 — — Other assets - derivatives 537 — 537 — Fair Value Measurements as of December 31, 2022 Using Totals At December 31, 2022 Quoted Prices in Active Markets For Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (Dollars in Thousands) Investment securities, available-for-sale Mortgage-backed securities: Residential $ 43,957 $ — $ 43,957 $ — Commercial 11,693 — 11,693 — Obligations of U.S. government-sponsored agencies 4,270 — 4,270 Obligations of states and political subdivisions 2,072 — 2,072 — Corporate notes 15,921 14,921 1,000 U.S. Treasury securities 52,882 52,882 — — Other assets - derivatives 2,306 — 2,306 — 38 Fair Value Measurements on a Non-recurring Basis Collateral Dependent Loans Collateral dependent loans are measured at the fair value of the collateral securing the loan less estimated selling costs. The fair value of real estate collateral is determined based on real estate appraisals, which are generally based on recent sales of comparable properties which are then adjusted for property specific factors. Non-real estate collateral value is based on various sources, including third party asset valuations and internally determined values based on cost, adjusted for depreciation and other judgmentally determined discount factors. Collateral dependent loans are classified as Level 3 of the valuation hierarchy due to the unobservable inputs used in determining their fair value, such as collateral values and the borrower's underlying financial condition. OREO and Other Assets Held-for-Sale OREO consists of properties obtained through foreclosure or in satisfaction of loans and is recorded at net realizable value, less estimated cost to sell. Estimates of fair value are generally based on third-party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes discounted based on management’s knowledge of the property and/or changes in market conditions from the date of the most recent appraisal. Such discounts are typically significant unobservable inputs for determining fair value. As of September 30, 2023 and December 31, 2022, included within OREO were certain assets that were formerly included as premises and equipment but have been removed from service, and as of the balance sheet date, were designated as assets to be disposed of by sale. These include assets associated with branches of the Bank and ALC that have been closed. When an asset is designated as held-for-sale, the Company ceases depreciation of the asset, and the asset is recorded at the lower of its carrying amount or fair value less estimated cost to sell. Estimates of fair value are generally based on third-party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes discounted based on management’s knowledge of the property and/or changes in market conditions from the date of the most recent appraisal. Such discounts are typically unobservable inputs for determining fair value. The following table presents the balances of impaired loans, OREO and other assets held-for-sale measured at fair value on a non-recurring basis as of September 30, 2023 and December 31, 2022: Fair Value Measurements as of September 30, 2023 Using Totals At September 30, 2023 Quoted Prices in Active Markets For Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (Dollars in Thousands) Collateral dependent loans $ 62 $ — $ — $ 62 OREO and other assets held-for-sale 617 — — 617 Fair Value Measurements as of December 31, 2022 Using Totals At December 31, 2022 Quoted Prices in Active Markets For Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) (Dollars in Thousands) Impaired loans $ 108 $ — $ — $ 108 OREO and other assets held-for-sale 686 — — 686 39 Non-recurring Fair Value Measurements Using Significant Unobservable Inputs The following table presents information regarding assets and liabilities measured at fair value using significant unobservable inputs (Level 3) as of September 30, 2023. The table includes the valuation techniques and the significant unobservable inputs utilized. The range of each unobservable input and the weighted average within the range utilized as of September 30, 2023 are both included. Following the table is a description of the valuation technique and the sensitivity of the technique to changes in the significant unobservable input. Level 3 Significant Unobservable Input Assumptions Fair Value September 30, 2023 Valuation Technique Unobservable Input Quantitative Range of Unobservable Inputs (Weighted Average) (Dollars in Thousands) Non-recurring fair value measurements: Collateral dependent loans $ 62 Multiple data points, including discount to appraised value of collateral based on recent market activity Appraisal comparability adjustment (discount) 9 %- 10 % ( 9.5 %) OREO and other assets held-for-sale $ 617 Discount to appraised value of property based on recent market activity for sales of similar properties Appraisal comparability adjustment (discount) 9 %- 10 % ( 9.5 %) Collateral Dependent Loans Collateral dependent loans are valued based on multiple data points indicating the fair value for each loan. The primary data point is the appraisal value of the underlying collateral, to which a discount is applied. Management establishes this discount or comparability adjustment based on recent sales of similar property types. As liquidity in the market increases or decreases, the comparability adjustment and the resulting asset valuation are impacted. OREO OREO under a binding contract for sale is valued based on contract price. If no sales contract is pending for a specific property, management establishes a comparability adjustment to the appraised value based on historical activity, considering proceeds for properties sold versus the corresponding appraised value. Increases or decreases in realization for properties sold impact the comparability adjustment for similar assets remaining on the balance sheet. Other Assets Held-for-Sale Assets designated as held-for-sale that are under a binding contract are valued based on the contract price. If no sales contract is pending for a specific property, management establishes a comparability adjustment to the appraised value based on historical activity, considering proceeds for properties sold versus the corresponding appraised value. Increases or decreases in realization for properties sold impact the comparability adjustment for similar assets remaining on the balance sheet. 40 Fair Value of Financial Instruments ASC Topic 825, Financial Instruments , requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: Cash, due from banks and federal funds sold: The carrying amount of cash, due from banks and federal funds sold approximates fair value. Federal Home Loan Bank stock: Based on the redemption provision of the FHLB, the stock has no quoted market value and is carried at cost. Investment securities: Fair values of investment securities are based on quoted market prices where available. If quoted market prices are not available, estimated fair values are based on market prices of comparable instruments. Derivative instruments: The fair value of derivative instruments is based on information obtained from a third-party financial institution. This information is periodically evaluated by the Company and, as necessary, corroborated against other third-party information. Accrued interest receivable and payable: The carrying amount of accrued interest approximates fair value. Loans, net: The fair value of loans is estimated on an exit price basis incorporating contractual cash flow, prepayment discount spreads, credit loss and liquidity premiums. Demand and savings deposits: The fair values of demand deposits are equal to the carrying value of such deposits. Demand deposits include non-interest-bearing demand deposits, savings accounts, NOW accounts and money market demand accounts. Time deposits: The fair values of relatively short-term time deposits are equal to their carrying values. Discounted cash flows are used to value long-term time deposits. The discount rate used is based on interest rates currently offered by the Company on comparable deposits as to amount and term. Short-term borrowings: These borrowings may consist of federal funds purchased, securities sold under agreements to repurchase and the floating rate borrowings from the FHLB account. Due to the short-term nature of these borrowings, fair values approximate carrying values. Long-term debt: The fair value of this debt is estimated using discounted cash flows based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements as of the determination date. Off-balance sheet instruments: The carrying amount of commitments to extend credit and standby letters of credit approximates fair value. The carrying amount of the off-balance sheet financial instruments is based on fees currently charged to enter into such agreements. The estimated fair value and related carrying or notional amounts, as well as the level within the fair value hierarchy, of the Company’s financial instruments as of September 30, 2023 and December 31, 2022 were as follows: September 30, 2023 Carrying Amount Estimated Fair Value Level 1 Level 2 Level 3 (Dollars in Thousands) Assets: Cash and cash equivalents $ 66,129 $ 66,129 $ 66,129 $ — $ — Investment securities available-for-sale 126,551 126,551 52,895 73,656 — Investment securities held-to-maturity 1,272 1,183 — 1,183 — Federal funds sold 1,143 1,143 — 1,143 — Federal Home Loan Bank stock 2,151 2,151 — — 2,151 Loans, net of allowance for credit losses 803,920 769,466 — — 769,466 Other assets - derivatives 537 537 — 537 — Liabilities: Deposits 927,038 829,435 — 829,435 — Short-term borrowings 30,000 30,000 — 30,000 — Long-term borrowings 10,781 9,226 — 9,226 — 41 December 31, 2022 Carrying Amount Estimated Fair Value Level 1 Level 2 Level 3 (Dollars in Thousands) Assets: Cash and cash equivalents $ 30,152 $ 30,152 $ 30,152 $ — $ — Investment securities available-for-sale 130,795 130,795 52,882 76,913 1,000 Investment securities held-to-maturity 1,862 1,769 — 1,769 — Federal funds sold 1,768 1,768 — 1,768 — Federal Home Loan Bank stock 1,359 1,359 — — 1,359 Loans, net of allowance for loan and lease losses 764,451 730,961 — — 730,961 Other assets - derivatives 2,306 2,306 — 2,306 — Liabilities: Deposits 870,025 788,161 — 788,161 — Short-term borrowings 20,038 20,038 — 20,038 — Long-term borrowings 10,726 9,702 9,702 42 ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS DESCRIPTION OF THE BUSINESS First US Bancshares, Inc., a Delaware corporation (“Bancshares” and, together with its subsidiaries, the “Company”), is a bank holding company with its principal offices in Birmingham, Alabama. Bancshares operates one commercial banking subsidiary, First US Bank (the “Bank”). As of September 30, 2023, the Bank operated and served its customers through 15 banking offices located in Birmingham, Butler, Calera, Centreville, Gilbertown, Grove Hill, Harpersville, Jackson, Thomasville, Tuscaloosa and Woodstock, Alabama; Knoxville and Powell, Tennessee; and Rose Hill, Virginia. In addition, the Bank operates loan production offices in Mobile, Alabama and the Chattanooga, Tennessee area. The Bank provides a wide range of commercial banking services to small- and medium-sized businesses, property managers, business executives, professionals and other individuals. The Bank also performs indirect lending through third-party retailers and currently conducts this lending in 17 states, including Alabama, Arkansas, Florida, Georgia, Indiana, Iowa, Kansas, Kentucky, Mississippi, Missouri, Nebraska, North Carolina, Oklahoma, South Carolina, Tennessee, Texas and Virginia. The Bank owns all of the stock of Acceptance Loan Company, Inc., an Alabama corporation (“ALC”). ALC is a finance company headquartered in Mobile, Alabama. During the third quarter of 2021, ALC ceased new business development and permanently closed its 20 branch lending locations in Alabama and Mississippi to the public. Through the third quarter of 2023, ALC continued to service its remaining portfolio of loans from its headquarters. Effective October 1, 2023, all of ALC’s remaining loans were sold to the Bank in an intercompany transaction. The Bank intends to manage the remaining portfolio through final resolution. Delivery of the best possible financial services to customers remains an overall operational focus of the Company. The Company recognizes that attention to detail and responsiveness to customers’ desires are critical to customer satisfaction. The Company continues to upgrade technology, both in its financial services and in the training of its 156 full-time equivalent employees (as of September 30, 2023), to ensure customer satisfaction and convenience. The preparation of the Company’s consolidated financial statements requires management to make subjective judgments associated with estimates. These estimates are necessary to comply with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and general banking practices. These estimates include accounting for the allowance for credit losses, the right-of-use asset and lease liability, the value of other real estate owned and certain collateral-dependent loans, consideration related to goodwill impairment testing and deferred tax asset valuation. A description of these estimates, which significantly affect the determination of the Company’s consolidated financial position, results of operations and cash flows, is set forth in Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in the Company's 2022 Form 10-K, as amended in 2023 by the adoption of ASC 326, Measurement of Credit Losses on Financial Instruments , as discussed in Note 2, “Basis of Presentation,” in the Notes to the Interim Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. The emphasis of this discussion is a comparison of assets, liabilities and shareholders’ equity as of September 30, 2023 to December 31, 2022, while comparing income and expense for the nine months ended September 30, 2023 and 2022. All yields and ratios presented and discussed herein are recorded and presented on the accrual basis and not on the tax-equivalent basis, unless otherwise indicated. This information should be read in conjunction with the Company’s unaudited interim condensed consolidated financial statements and related notes appearing elsewhere in this report and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in Bancshares’ the Company's 2022 Form 10-K. As used in the following discussion, the words “we,” “us,” “our” and the “Company” refer to Bancshares and its consolidated subsidiaries, unless the context indicates otherwise. 43 RECENT MARKET CONDITIONS During the nine months ended September 30, 2023 the banking industry saw a significant level of volatility due to notable banking failures that began during the first quarter of 2023, as well as ongoing increases in interest rates that have generally led to contraction of net interest margin throughout the industry. While year-over-year inflation levels have eased from 40-year highs that were reached during 2022, inflation remains elevated over the Federal Reserve Bank's ("FRB") long run target. In its ongoing effort to reduce inflation levels, the FRB has continued to raise the target federal funds rate, with four additional increases of 25 basis points during the first nine months of 2023. As of September 30, 2023, the target federal funds rate was a range of 5.25% to 5.50%. As interest rates have increased, competitive pressures have also increased, particularly related to deposit pricing. Due primarily to the rising cost of funding, net interest margin compressed significantly throughout the banking industry during the nine months ended September 30, 2023. The substantial pace and magnitude of changes in interest rates introduced a higher level of uncertainty throughout the industry, and the impact that such change will have on the Company’s future operating results cannot be predicted with certainty. During this still-ongoing and still-volatile transition period, the yield curve has become significantly inverted at times, indicating substantial economic uncertainty, including the possibility of economic recession. The unusual yield curve effects, including inversion, may continue. Further, if the rate of inflation remains elevated or accelerates, the Company’s operations could be impacted by, among other things, accelerating cost of goods and services, including the cost of salaries and benefits. Additionally, the Company’s borrowers could be negatively impacted by rising expense levels, leading to deterioration of credit quality and/or reductions in the Company’s lending activity. The higher interest rate environment has also led to unrealized losses in the Company's investment portfolio, which consists primarily of fixed-rate instruments. EXECUTIVE OVERVIEW Strategic Focus and Impact on Asset Quality During the third quarter of 2021, the Company executed strategic initiatives that were designed to improve operating efficiency, focus the Company’s loan growth activities, and fortify asset quality. The most significant component of these initiatives was the cessation of new business at ALC. This initiative, which included the closure of ALC’s branch lending locations in September 2021, served to significantly decrease the Company’s non-interest expense, and has led to substantial improvement in the Company’s consumer lending asset quality as ALC’s remaining loans pay down. Historically, ALC’s loans have produced significantly higher levels of charge-offs than the Bank’s other loan portfolios. As of September 30, 2023, remaining loans at ALC totaled $12.1 million, compared to $20.2 million as of December 31, 2022. In 2023, as ALC’s loans have continued to decrease, the Company has realized substantially lower levels of net charge-offs on the portfolio compared to prior periods. Net charge-offs on ALC loans totaled $0.3 million, or 2.09% of average loans, during the nine months ended September 30, 2023, compared to $1.5 million, or 6.38% of average loans, during the nine months ended September 30, 2022. As of September 30, 2023, $0.2 million, or 1.3% of ALC's loans, were past due, compared to $0.8 million, or 3.8%, as of December 31, 2022. Effective October 1, 2023, the Company sold all of ALC’s remaining loans to the Bank in an intercompany transaction. The Bank will continue to manage the remaining loans in the portfolio through final resolution. It is expected that all other assets and liabilities of ALC will be transferred to the Bank via an intercompany transaction by the end 2023. Financial Highlights The Company earned net income of $2.1 million, or $0.33 per diluted common share, during the three months ended September 30, 2023, compared to $1.9 million, or $0.29 per diluted common share, for the three months ended September 30, 2022. For the nine months ended September 30, 2023, net income totaled $6.2 million, or $0.97 per diluted common share, compared to $4.6 million, or $0.71 per diluted common share, for the nine months ended September 30, 2022. 44 Summarized condensed consolidated statements of operations are included below for the three and nine months ended September 30, 2023 and 2022. Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2023 2022 2023 2022 (Dollars in Thousands, Except Per Share Data) Interest income $ 13,902 $ 10,670 $ 38,861 $ 29,576 Interest expense 4,419 1,155 10,621 2,526 Net interest income 9,483 9,515 28,240 27,050 Provision for credit losses 184 1,165 753 2,781 Net interest income after provision for credit losses 9,299 8,350 27,487 24,269 Non-interest income 837 1,088 2,465 2,773 Non-interest expense 7,319 7,032 21,740 20,966 Income before income taxes 2,817 2,406 8,212 6,076 Provision for income taxes 704 546 2,004 1,440 Net income $ 2,113 $ 1,860 $ 6,208 $ 4,636 Basic net income per share $ 0.35 $ 0.31 $ 1.04 $ 0.76 Diluted net income per share $ 0.33 $ 0.29 $ 0.97 $ 0.71 Dividends per share $ 0.05 $ 0.03 $ 0.15 $ 0.09 The discussion that follows summarizes the most significant activity that drove changes in the Company’s net income during the nine months ended September 30, 2023, as compared to the nine months ended September 30, 2022. Net Interest Income and Margin Net interest income increased by $1.2 million, or 4.4%, comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022. The increase was primarily attributable to growth in loans which averaged $795.0 million during the nine months ended September 30, 2023, compared to $713.0 million during the nine months ended September 30, 2022. The average rate on earning assets totaled 5.41% for the nine months ended September 30, 2023, compared to 4.37% for the nine months ended September 30, 2022. While yields on earning assets increased significantly in 2023, rates on interest-bearing liabilities increased at a faster pace, causing margin compression. Net interest margin was 3.93% for the nine months ended September 30, 2023, compared to 4.00% for the nine months ended September 30, 2022. The Company’s total funding costs, including the cost of interest and non-interest deposits, as well as borrowings, increased to 1.53% during the nine months ended September 30, 2023, compared to 0.39% during the nine months ended September 30, 2022. Provision for Credit Losses The provision for credit losses was $0.8 million during the nine months ended September 30, 2023, compared to $2.8 million during the nine months ended September 30, 2022. The reduction resulted primarily from reduced charge-off levels comparing the two periods, mostly related to ALC’s loans which continued to reduce following implementation of the cessation of business strategy. The Company’s net charge-offs totaled $0.7 million during the nine months ended September 30, 2023, compared to $1.7 million during the nine months ended September 30, 2022. The reduction included a decrease of $1.3 million in net charge-offs associated with ALC’s portfolio, partially offset by an increase in net charge-offs associated with the indirect consumer portfolio totaling $0.3 million. The Company’s net charge-offs as a percentage of average loans totaled 0.12% during the nine months ended September 30, 2023, compared to 0.24% during the nine months ended September 30, 2022. Non-interest Income Non-interest income totaled $2.5 million for the nine months ended September 30, 2023, compared to $2.8 million for the nine months ended September 30, 2022. The reduction resulted primarily from gains on the sale of premises and equipment that occurred during the third quarter of 2022, but were not repeated in 2023. 45 Non-interest Expense Non-interest expense totaled $21.7 million for the nine months ended September 30, 2023, compared to $21.0 million for the nine months ended September 30, 2022. The increase resulted primarily from nonrecurring gains on the sale of OREO properties that offset non-interest expense in 2022, but were not repeated in 2023. Balance Sheet Levels As of September 30, 2023, the Company’s assets totaled $1,065.2 million, compared to $994.7 million as of December 31, 2022, an increase of 7.1%. Loans Total loans increased by $41.4 million, or 5.4%, as of September 30, 2023, compared to December 31, 2022. Loan volume increases during the first nine months of 2023 were driven primarily by growth in indirect consumer and commercial construction loans. Growth in indirect consumer lending was consistent with continued demand for the products collateralized through the Company's indirect program, including recreational vehicles, campers, boats, horse trailers and cargo trailers. Indirect loan growth tends to be seasonal due to its emphasis on outdoor recreational products, with growth typically more pronounced in the spring and early summer months. The increase in commercial construction (construction, land development and other land loans) was primarily attributable to continued growth in construction fundings on multi-family residential projects. The loan growth during the first nine months of 2023 was partially offset by decreases in the residential real estate (including 1-4 family and multi-family) and commercial and industrial categories, as well as the direct consumer and branch retail consumer categories. Loans in direct consumer and branch retail were expected to decrease as they comprise the majority of ALC’s remaining loan balances. Deposit Growth Deposits totaled $927.0 million as of September 30, 2023, compared to $870.0 million as of December 31, 2022. The year-to-date growth included an increase of $69.2 million in interest-bearing deposits, partially offset by a decrease of $12.2 million in noninterest-bearing deposits. The year-to-date shift to interest-bearing deposits is consistent with deposit holders seeking to maximize interest earnings on their accounts. In addition, deposit growth for the first nine months of 2023 included growth of $30.2 million in wholesale brokered deposits that were acquired in order to further enhance the Company’s liquidity position following the bank failures that began during the first quarter of 2023. As of September 30, 2023, core deposits, which exclude time deposits of $250 thousand or more and all brokered deposits, totaled $786.8 million, or 84.9% of total deposits, compared to $778.1 million, or 89.4% of total deposits, as of December 31, 2022. Deployment of Funds Management seeks to deploy earning assets in an efficient manner to maximize net interest income while maintaining appropriate levels of liquidity to protect the safety and soundness of the organization. Management’s decisions during the first nine months of 2023, particularly following the bank failures that occurred, were focused on maintaining the Company’s strong liquidity position. As part of this focus, management elected to hold higher levels of cash and cash equivalents. Cash and cash equivalents totaled $66.1 million as of September 30, 2023, compared to $30.2 million as of December 31, 2022. Investment securities, including both the available-for-sale and held-to-maturity portfolios, totaled $127.8 million as of September 30, 2023, compared to $132.7 million as of December 31, 2022. The expected average life of securities in the investment portfolio was 3.9 years as of September 30, 2023, compared to 3.5 years as of December 31, 2022. Management will continue to evaluate opportunities to invest excess cash balances within the context of anticipated loan and deposit growth and current liquidity needs. Shareholders’ Equity Shareholders’ equity increased by $2.3 million, or 2.7%, as of September 30, 2023, compared to December 31, 2022. The increase in shareholders’ equity resulted from earnings, net of dividends paid, partially offset by the CECL transition adjustment which reduced retained earnings by $1.8 million, net of tax, as well as a net increase in accumulated other comprehensive loss of $1.7 million associated with fair value declines in the available-for-sale investment portfolio and reclassification adjustments associated with terminated interest rate swaps. Cash Dividends The Company declared cash dividends totaling $0.15 per share on its common stock during the nine months ended September 30, 2023, compared to cash dividends totaling $0.09 per share on its common stock during the nine months ended September 30, 2022. 46 Regulatory Capital During the nine months ended September 30, 2023, the Bank continued to maintain capital ratios at higher levels than required to be considered a “well-capitalized” institution under applicable banking regulations. As of September 30, 2023, the Bank’s common equity Tier 1 capital and Tier 1 risk-based capital ratios were each 10.81%. Its total capital ratio was 12.06%, and its Tier 1 leverage ratio was 9.09%. Liquidity As of September 30, 2023, the Company continued to maintain excess funding capacity sufficient to provide adequate liquidity for loan growth, capital expenditures and ongoing operations. The Company benefits from a strong core deposit base, a liquid investment securities portfolio and access to funding from a variety of sources, including federal funds lines, FHLB advances and brokered deposits. In addition, the Company has access to the FRB's discount window and its Bank Term Funding Program (BTFP), the latter of which was established in response to the recent liquidity events that have occurred in the banking industry. Both the discount window and the BTFP allow borrowing on pledged collateral that includes eligible investment securities and, in certain circumstances, eligible loans. In response to heightened liquidity concerns in the banking industry, during 2023 management undertook measures designed to enhance the Company’s liquidity position. These procedures included holding higher levels of on-balance sheet cash, as well as enhancing the availability of off-balance sheet borrowing capacity. As part of these efforts, during the third quarter of 2023, the Company completed the establishment of additional borrowing capacity through the FRB's discount window, primarily via the pledging of the majority of the Company’s indirect loan portfolio as collateral. Due to these efforts, the Company’s immediate borrowing capacity based on collateral pledged through the discount window increased to $146.6 million as of September 30, 2023, compared to $1.2 million as of December 31, 2022. RESULTS OF OPERATIONS Net Interest Income Net interest income is calculated as the difference between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates, as well as volume and mix changes in earning assets and interest-bearing liabilities, can materially impact net interest income. The Company’s earning assets consist of loans, taxable and tax-exempt investments, Federal Home Loan Bank stock, federal funds sold by the Bank and interest-bearing deposits in banks. Interest-bearing liabilities consist of interest-bearing demand deposits and savings and time deposits, as well as short- and long-term borrowings. The following tables show the average balances of each principal category of assets, liabilities and shareholders’ equity for the three and nine months ended September 30, 2023 and 2022. Additionally, the tables provide an analysis of interest revenue or expense associated with each category, along with the accompanying yield or rate percentage. Net interest margin is calculated for each period presented as net interest income divided by average total interest-earning assets. 47 Three Months Ended Three Months Ended September 30, 2023 September 30, 2022 Average Balance Interest Annualized Yield/ Rate % Average Balance Interest Annualized Yield/ Rate % ASSETS Interest-earning assets: Total loans (Note A) $ 821,294 $ 12,584 6.08 % $ 743,145 $ 9,750 5.21 % Taxable investment securities 123,290 682 2.19 % 148,964 748 1.99 % Tax-exempt investment securities 1,037 3 1.15 % 2,322 8 1.37 % Federal Home Loan Bank stock 1,001 21 8.32 % 1,808 17 3.73 % Federal funds sold 1,069 14 5.20 % 1,984 11 2.20 % Interest-bearing deposits in banks 44,379 598 5.35 % 23,166 136 2.33 % Total interest-earning assets 992,070 13,902 5.56 % 921,389 10,670 4.59 % Noninterest-earning assets 61,235 64,593 Total $ 1,053,305 $ 985,982 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing deposits: Demand deposits $ 206,540 $ 176 0.34 % $ 243,131 $ 182 0.30 % Savings deposits 244,932 1,570 2.54 % 211,724 342 0.64 % Time deposits 323,824 2,476 3.03 % 209,361 340 0.64 % Total interest-bearing deposits 775,296 4,222 2.16 % 664,216 864 0.52 % Noninterest-bearing demand deposits 161,381 — — 183,612 — — Total deposits 936,677 4,222 1.79 % 847,828 864 0.40 % Borrowings 19,468 197 4.01 % 45,427 291 2.54 % Total funding costs 956,145 4,419 1.83 % 893,255 1,155 0.51 % Other noninterest-bearing liabilities 10,263 8,642 Shareholders’ equity 86,897 84,085 Total $ 1,053,305 $ 985,982 Net interest income (Note B) $ 9,483 $ 9,515 Net interest margin 3.79 % 4.10 % Note A — For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. These loans averaged $2.0 million and $1.7 million for the three months ended September 30, 2023 and 2022, respectively. Note B — Loan fees are included in interest amounts presented. Loan fees totaled $0.1 million for both the three months ended September 30, 2023 and 2022. 48 Nine Months Ended Nine Months Ended September 30, 2023 September 30, 2022 Average Balance Interest Annualized Yield/ Rate % Average Balance Interest Annualized Yield/ Rate % ASSETS Interest-earning assets: Total loans (Note A) $ 795,033 $ 35,330 5.94 % $ 713,015 $ 27,339 5.13 % Taxable investment securities 126,341 2,033 2.15 % 142,425 1,896 1.78 % Tax-exempt investment securities 1,048 10 1.28 % 2,543 31 1.63 % Federal Home Loan Bank stock 1,347 75 7.44 % 1,165 33 3.79 % Federal funds sold 1,415 51 4.82 % 853 12 1.88 % Interest-bearing deposits in banks 35,437 1,362 5.14 % 45,133 265 0.79 % Total interest-earning assets 960,621 38,861 5.41 % 905,134 29,576 4.37 % Noninterest-earning assets 61,484 65,379 Total $ 1,022,105 $ 970,513 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing deposits: Demand deposits $ 216,445 $ 557 0.34 % $ 249,183 $ 438 0.24 % Savings deposits 221,293 3,279 1.98 % 206,294 693 0.45 % Time deposits 297,708 5,845 2.62 % 208,621 833 0.53 % Total interest-bearing deposits 735,446 9,681 1.76 % 664,098 1,964 0.40 % Noninterest-bearing demand deposits 162,084 — — 182,862 — — Total deposits 897,530 9,681 1.44 % 846,960 1,964 0.31 % Borrowings 29,375 940 4.28 % 27,994 562 2.68 % Total funding costs 926,905 10,621 1.53 % 874,954 2,526 0.39 % Other noninterest-bearing liabilities 9,722 8,833 Shareholders’ equity 85,478 86,726 Total $ 1,022,105 $ 970,513 Net interest income (Note B) $ 28,240 $ 27,050 Net interest margin 3.93 % 4.00 % Note A — For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. These loans averaged $1.5 million and $1.8 million for the nine months ended September 30, 2023 and 2022, respectively. Note B — Loan fees are included in interest amounts presented. Loan fees totaled $0.4 million for both the nine months ended September 30, 2023 and 2022. 49 The following tables summarize the impact of variances in volume and rate of interest-earning assets and interest-bearing liabilities on components of net interest income. Three Months Ended September 30, 2023 Nine Months Ended September 30, 2023 Compared to Compared to Three Months Ended September 30, 2022 Nine Months Ended September 30, 2022 Increase (Decrease) Increase (Decrease) Due to Change In: Due to Change In: Volume Average Yield/Rate Net Volume Average Yield/Rate Net (Dollars in Thousands) Interest earned on: Total loans $ 1,025 $ 1,809 $ 2,834 $ 3,145 $ 4,846 $ 7,991 Taxable investment securities (129 ) 63 (66 ) (214 ) 351 137 Tax-exempt investment securities (4 ) (1 ) (5 ) (18 ) (3 ) (21 ) Federal Home Loan Bank stock (8 ) 12 4 5 37 42 Federal funds sold (5 ) 8 3 8 31 39 Interest-bearing deposits in banks 125 337 462 (57 ) 1,154 1,097 Total interest-earning assets 1,004 2,228 3,232 2,869 6,416 9,285 Interest expense on: Demand deposits (27 ) 21 (6 ) (58 ) 177 119 Savings deposits 54 1,174 1,228 50 2,536 2,586 Time deposits 186 1,950 2,136 356 4,656 5,012 Borrowings (166 ) 72 (94 ) 28 350 378 Total interest-bearing liabilities 47 3,217 3,264 376 7,719 8,095 Increase (decrease) in net interest income $ 957 $ (989 ) $ (32 ) $ 2,493 $ (1,303 ) $ 1,190 Interest income increased by $9.3 million, comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022. Of the increase, $6.4 million was attributable to higher average yields on interest-earning assets, while $2.9 million was attributable to growth in average loan volume comparing the two periods. The increase in average yield was attributable to the rise in market interest rates that began in 2022 and has continued in 2023. The increase in interest income associated with loan volume increases was attributable to loan growth during the nine months ended September 30, 2023 of $41.4 million, or 5.4%. The increase in interest income was partially offset by an increase in interest expense of $8.1 million, comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022. Of the increase, $7.7 million was attributable to the rise in market interest rates, while $0.4 million was attributable to growth in interest-bearing liabilities, primarily time deposits and borrowings. During the latter half of 2022 and through the first nine months of 2023, the Company has focused a portion of its deposit marketing efforts on growth in time deposits of various maturities in an effort to increase the predictability of funding cash flows. Additionally, the Company has utilized wholesale brokered deposits and short-term FHLB borrowings to a larger extent, particularly during the nine months ended September 30, 2023, in order to enhance the Company’s on-balance sheet liquidity position. Efforts to enhance the Company’s on-balance sheet liquidity were taken primarily as precautionary measures in the wake of liquidity events that impacted the banking industry during 2023. The rising market interest rate environment has had, and continues to have, a significant impact on the Company and the banking industry in general. Beginning in March 2022 and through September 30, 2023, the FRB raised the federal funds rate by a total of 525 basis points. Statements by FRB officials have indicated that further interest rate increases are possible to address ongoing inflationary pressures. While the Company has generally been positioned to benefit from the rising interest rate environment that has occurred, the Company’s net interest margin began to decline during the nine months ended September 30, 2023 as the cost of interest-bearing liabilities increased at a faster pace than interest-earning assets. Further, in connection with the liquidity events that have occurred in the banking industry, competition for deposits has intensified significantly. This increased competition, coupled with the volatility of the industry, has introduced additional uncertainty into the market. Should market interest rates continue to rise or reduce at significant levels, the Company’s net interest income could be negatively impacted. 50 Provision for Credit Losses The provision for credit losses was $0.8 million during the nine months ended September 30, 2023, compared to $2.8 million during the nine months ended September 30, 2022. The year-to-date decrease in 2023 compared to 2022 was primarily the result of the cessation of business strategy at ALC, which has led to significantly reduced net charge-offs as ALC’s loans have paid down. Net charge-offs on ALC loans totaled $0.3 million, or 2.09% of average loans, during the nine months ended September 30, 2023, compared to $1.5 million, or 6.38% of average loans, during the nine months ended September 30, 2022. While the Company experienced improved charge-off metrics during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, the timing of charge-offs, economic developments, and other factors that could impact the provision for credit losses cannot be fully predicted with certainty. Sustained levels of high inflation, combined with the recent rapid rise in market interest rates, could negatively impact the Company’s borrowers, which could lead to increased provisions for credit losses in the future. Effective January 1, 2023, the Company adopted the CECL model to account for credit losses on financial instruments, including loans and leases, unfunded commitments and held-to-maturity securities. The adoption of the CECL model resulted in a transition adjustment totaling $2.4 million, increasing the Company’s allowance for credit losses on loans and leases by $2.1 million, and establishing a reserve for unfunded commitments of $0.3 million. As of September 30, 2023, the Company’s allowance for credit losses totaled 1.40% of total loans, compared to 1.22% as of December 31, 2022. While management believes that the allowance for credit losses on loans and leases, as well as the reserve for unfunded commitments, was sufficient to absorb life-of-loan credit losses based on circumstances existing as of the balance sheet date, combined with reasonable and supportable forecasts, the determination of the allowance is complex and requires judgment by management about the effects of matters that are inherently uncertain. Changing economic circumstances or forecasts, or changes in management’s judgments and estimates, could result in additional credit loss expense in future periods. Non-Interest Income Non-interest income represents fees and income derived from sources other than interest-earning assets. The following table presents the major components of non-interest income for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 $ Change % Change 2023 2022 $ Change % Change (Dollars in Thousands) (Dollars in Thousands) Service charges and other fees on deposit accounts $ 302 $ 311 $ (9 ) (2.9 )% $ 869 $ 904 $ (35 ) (3.9 )% Bank-owned life insurance 119 112 7 6.3 % 348 335 13 3.9 % Gain on sales of premises and equipment and other assets 18 278 (260 ) (93.5 )% 18 301 (283 ) (94.0 )% Lease income 241 210 31 14.8 % 707 635 72 11.3 % ATM fee income 93 125 (32 ) (25.6 )% 315 403 (88 ) (21.8 )% Other income 64 52 12 23.1 % 208 195 13 6.7 % Total non-interest income $ 837 $ 1,088 $ (251 ) (23.1 )% $ 2,465 $ 2,773 $ (308 ) (11.1 )% 51 The Company’s non-interest income decreased by $0.3 million comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022 due primarily to gains on the sale of premises and equipment that occurred during the third quarter of 2022, but were not repeated in 2023. In recent periods, the Company’s sources of non-interest revenue have not fluctuated significantly, with the exception of nonrecurring increases or decreases that have occurred from time to time due to gains or losses on sales of assets or other nonrecurring sources. The majority of the Company’s sources of non-interest income are relatively stable and are not expected to change significantly in the near term. However, non-interest revenues earned from service charges and other fees on deposit accounts have generally declined in recent years for a number of reasons, including a changing regulatory environment associated with these types of revenues. Management continues to evaluate opportunities to add non-interest revenue streams or grow existing streams; however, significant growth in non-interest income is not expected in the near term. Non-Interest Expense Non-interest expense represents expenses incurred from sources other than interest-bearing liabilities. The following table presents the major components of non-interest expense for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 $ Change % Change 2023 2022 $ Change % Change (Dollars in Thousands) (Dollars in Thousands) Salaries and employee benefits $ 4,120 $ 4,007 $ 113 2.8 % $ 12,310 $ 12,389 $ (79 ) (0.6 )% Net occupancy and equipment 897 861 36 4.2 % 2,625 2,468 157 6.4 % Computer services 464 417 47 11.3 % 1,315 1,224 91 7.4 % Insurance expense and assessments 423 310 113 36.5 % 1,156 970 186 19.2 % Fees for professional services 331 263 68 25.9 % 735 811 (76 ) (9.4 )% Postage, stationery and supplies 151 164 (13 ) (7.9 )% 472 469 3 0.6 % Telephone/data communications 128 159 (31 ) (19.5 )% 479 518 (39 ) (7.5 )% Collection and recoveries 71 57 14 24.6 % 252 176 76 43.2 % Directors fees 94 98 (4 ) (4.1 )% 284 301 (17 ) (5.6 )% Software amortization 86 133 (47 ) (35.3 )% 313 331 (18 ) (5.4 )% Other real estate/foreclosure expense, net 9 (5 ) 14 (280.0 )% 30 (320 ) 350 (109.4 )% Other expense 545 568 (23 ) (4.0 )% 1,769 1,629 140 8.6 % Total non-interest expense $ 7,319 $ 7,032 $ 287 4.1 % $ 21,740 $ 20,966 $ 774 3.7 % The Company’s non-interest expense increased by 3.7% comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022. The majority of the increase resulted from nonrecurring gains on the sale of properties that reduced other real/estate expense in 2022, but were not repeated in 2023. In addition, the Company has experienced increases in other expense categories commensurate with the inflationary environment. Increases in certain categories of non-interest expense were partially offset by decreases in other categories, most notably salaries and employee benefits which decreased by 0.6% comparing the nine months ended September 30, 2023 to the nine months ended September 30, 2022. The reduction in salaries and benefits expense resulted from the impact of the strategic initiatives undertaken by the Company beginning in the third quarter of 2021 to, among other things, improve the Company’s operating efficiency. These initiatives reduced the Company’s expense profile significantly in 2022 and, in some expense areas such as salaries and benefits, continued to benefit the Company during the nine months ended September 30, 2023. However, the current inflationary environment is expected to continue to put upward pressure on non-interest expenses. Accordingly, management will remain focused on efforts to streamline business processes in an effort to continue to improve the Company’s overall efficiency levels. Provision for Income Taxes The provision for income taxes was $2.0 million and $1.4 million for the nine months ended September 30, 2023 and 2022, respectively, and the Company’s effective tax rate was 24.4% and 23.7%, respectively, for the same periods. The effective tax rate is impacted by recurring items, such as changes in tax-exempt interest income earned from bank-qualified municipal bonds and loans and the cash surrender value of bank-owned life insurance. Management makes decisions about whether to invest in tax-exempt instruments on a case-by-case basis after considering a number of factors, including investment return, credit quality and the consistency of such investments with the Company’s overall strategy. The Company’s effective tax rate is expected to fluctuate commensurate with the level of these investments as compared to total pre-tax income. 52 BALANCE SHEET ANALYSIS Investment Securities The investment securities portfolio is used by management to provide liquidity, to generate interest income and for use as collateral for public deposits and wholesale funding. Risk and return can be adjusted by altering the duration, composition and/or balance of the portfolio. The expected average life of securities in the investment portfolio was 3.9 years and 3.5 years as of September 30, 2023 and December 31, 2022, respectively. Available-for-sale securities are recorded at estimated fair value, with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive loss, a separate component of shareholders’ equity. As of September 30, 2023, available-for-sale securities totaled $126.6 million, or 99.0% of the total investment portfolio, compared to $130.8 million, or 98.6% of the total investment portfolio, as of December 31, 2022. Available-for-sale securities consisted of residential and commercial mortgage-backed securities, U.S. Treasury securities, corporate bonds, obligations of U.S. government-sponsored agencies, and obligations of state and political subdivisions. Held-to-maturity securities are recorded at amortized cost and represent securities that the Company both intends and has the ability to hold to maturity. As of September 30, 2023, held-to-maturity securities totaled $1.3 million, or 1.0% of the total investment portfolio, compared to $1.9 million, or 1.4% of the total investment portfolio, as of December 31, 2022. Held-to-maturity securities consisted of commercial mortgage-backed securities, obligations of U.S. government-sponsored agencies, and obligations of state and political subdivisions. Due to the increasing interest rate environment, during the nine months ended September 30, 2023, gross unrealized losses increased, particularly within the Company’s available-for-sale portfolio. Gross unrealized losses in the available-for-sale portfolio totaled $12.8 million as of September 30, 2023, compared to $11.1 million as of December 31, 2022. Unrealized losses within the available-for-sale portfolio were recognized, net of tax, in accumulated other comprehensive loss. As of September 30, 2023, the Company evaluated both the available-for-sale and held-to-maturity portfolios for credit loss in accordance with the revised accounting guidance of ASC 326. Based on these evaluations, management concluded that no credit losses were included in either portfolio and that the unrealized losses in both portfolios resulted from the prevailing interest rate environment. Loans and Allowance for Credit Losses The Company’s total loan portfolio increased by $41.4 million, or 5.4%, as of September 30, 2023, compared to December 31, 2022. The tables below summarize loan balances by portfolio category, as well as the allowance for credit losses, as of the end of each of the most recent five quarters as of September 30, 2023: Quarter Ended 2023 2022 September 30, June 30, March 31, December 31, September 30, (Dollars in Thousands) Real estate loans: Construction, land development and other land loans $ 90,051 $ 91,231 $ 69,398 $ 53,914 $ 36,230 Secured by 1-4 family residential properties 83,876 85,101 86,622 87,995 84,452 Secured by multi-family residential properties 56,506 54,719 63,368 67,852 72,377 Secured by non-farm, non-residential properties 199,116 204,270 198,266 200,156 200,707 Commercial and industrial loans 59,369 60,568 65,708 73,546 65,935 Consumer loans: Direct 6,544 7,593 8,435 9,851 11,950 Branch retail 9,648 10,830 12,222 13,992 15,878 Indirect 310,190 300,182 271,870 266,567 262,742 Total loans $ 815,300 $ 814,494 $ 775,889 $ 773,873 $ 750,271 Allowance for credit losses 11,380 11,536 11,599 9,422 9,373 Net loans $ 803,920 $ 802,958 $ 764,290 $ 764,451 $ 740,898 53 The tables below summarize changes in the allowance for credit losses on loans and leases for each of the most recent five quarters as of September 30, 2023: Quarter Ended 2023 2022 September 30, June 30, March 31, December 31, September 30, (Dollars in Thousands) Balance at beginning of period $ 11,536 $ 11,599 $ 9,422 $ 9,373 $ 8,751 Charge-offs: Real estate loans: Construction, land development and other land loans — — — — — Secured by 1-4 family residential properties (41 ) (47 ) (8 ) (30 ) (3 ) Secured by multi-family residential properties — — — — — Secured by non-farm, non-residential properties — — — — — Commercial and industrial loans — — — — — Consumer loans: Direct (109 ) (197 ) (215 ) (451 ) (417 ) Branch retail (93 ) (111 ) (155 ) (111 ) (200 ) Indirect (198 ) (146 ) (156 ) (144 ) (136 ) Total charge-offs (441 ) (501 ) (534 ) (736 ) (756 ) Recoveries 225 228 319 258 213 Net charge-offs (216 ) (273 ) (215 ) (478 ) (543 ) Impact of adopting CECL — — 2,123 — — Provision for credit losses 60 210 269 527 1,165 Ending balance $ 11,380 $ 11,536 $ 11,599 $ 9,422 $ 9,373 Ending balance as a percentage of loans 1.40 % 1.42 % 1.49 % 1.22 % 1.25 % Net charge-offs as a percentage of average loans 0.10 % 0.14 % 0.11 % 0.25 % 0.29 % The adoption of CECL was most impactful on the Company’s consumer indirect loan portfolio due primarily to the extension of the loss estimate period to the estimated life of loans in this category. As of January 1, 2023, the estimated average remaining life of the indirect portfolio was between four and five years. As of September 30, 2023, the estimated average remaining life of the indirect portfolio was between five and six years. The branch retail portfolio, which represents indirect lending conducted by ALC, was similarly impacted by the transition to CECL. In addition, the Company’s consumer portfolios were impacted by current economic forecasts using data provided by the Federal Reserve on inflation, unemployment, and the forecasted movement of interest rates. Reserve for Unfunded Lending Commitments In connection with the adoption of the CECL accounting model, the Company also reserved approximately $0.3 million in other liabilities for unfunded lending commitments. Unfunded lending commitments are off-balance sheet arrangements that represent unconditional commitments of the Company to lend to a borrower that are unfunded as of the balance sheet date. These may include unfunded loan commitments, standby letters of credit, and financial guarantees. The CECL accounting guidance requires that an estimate of expected credit loss be measured on commitments in which an entity is exposed to credit risk via a present contractual obligation to extend credit unless the obligation is unconditionally cancellable by the issuer. For the Company, unconditional lending commitments generally include unfunded term loan agreements, home equity lines of credit, lines of credit, and demand deposit account overdraft protection. As of September 30, 2023, the Company’s reserve for unfunded commitments, which is recorded in other liabilities in the Company’s consolidated balance sheets, totaled $0.5 million. No reserve for unfunded commitments was recorded by the Company as of December 31, 2022. 54 Nonperforming Assets Nonperforming assets at the end of the five most recent quarters as of September 30, 2023 were as follows: Quarter Ended 2023 2022 September 30, June 30, March 31, December 31, September 30, (Dollars in Thousands) Non-accrual loans $ 2,432 $ 979 $ 1,214 $ 1,651 $ 2,077 Other real estate owned 617 617 617 686 686 Total $ 3,049 $ 1,596 $ 1,831 $ 2,337 $ 2,763 Nonperforming assets as a percentage of total assets 0.29 % 0.15 % 0.18 % 0.24 % 0.28 % The increase in nonperforming assets during the third quarter of 2023 resulted primarily from one commercial real estate loan that moved into non-accrual status during the quarter. Allocation of Allowance for Credit Losses While no portion of the allowance for credit losses is in any way restricted to any individual loan or group of loans and the entire allowance is available to absorb losses from any and all loans, the following table shows an allocation of the allowance for credit losses as of September 30, 2023 and December 31, 2022: September 30, 2023 December 31, 2022 Allocation Allowance Percent of Allowance in Each Category to Total Allowance Percent of Loans in Each Category to Total Loans Allocation Allowance Percent of Allowance in Each Category to Total Allowance Percent of Loans in Each Category to Total Loans (Dollars in Thousands) Real estate loans: Construction, land development and other land loans $ 580 5.1 % 11.0 % $ 517 5.5 % 7.0 % Secured by 1-4 family residential properties 754 6.6 % 10.3 % 832 8.8 % 11.4 % Secured by multi-family residential properties 405 3.6 % 6.9 % 646 6.9 % 8.8 % Secured by non-farm, non-residential properties 1,622 14.3 % 24.4 % 1,970 20.9 % 25.8 % Commercial and industrial loans 530 4.7 % 7.3 % 919 9.8 % 9.5 % Consumer loans: Direct 487 4.3 % 0.8 % 866 9.2 % 1.3 % Branch retail 835 7.3 % 1.3 % 518 5.5 % 1.8 % Indirect 6,167 54.1 % 38.0 % 3,154 33.4 % 34.4 % Total allowance for credit losses $ 11,380 100.0 % 100.0 % $ 9,422 100.0 % 100.0 % Deposits Total deposits increased to $927.0 million as of September 30, 2023, from $870.0 million as of December 31, 2022, an increase of 6.6%. Core deposits, which exclude time deposits of $250 thousand or more and all brokered deposits, provide a relatively stable funding source that supports earning assets. Core deposits totaled $786.8 million, or 84.9% of total deposits, as of September 30, 2023, compared to $778.1 million, or 89.4% of total deposits, as of December 31, 2022. Core deposits, have historically been the Company’s primary source of funding and have enabled the Company to successfully meet both short-term and long-term liquidity needs. Management anticipates that core deposits will continue to be the Company’s primary source of funding in the future. Management will continue to monitor deposit levels closely to help ensure an adequate level of funding for the Company’s activities. However, various economic and competitive factors could affect this funding source in the future, including increased competition from other financial institutions in deposit gathering, national and local economic conditions and interest rate policies adopted by the FRB and other central banks. 55 Other Interest-Bearing Liabilities Other interest-bearing liabilities consist of federal funds purchased, securities sold under agreements to repurchase, FHLB advances, and subordinated debt that are used by the Company as an alternative source of funds. As of September 30, 2023, other interest-bearing liabilities totaled 5.0% of total interest-bearing liabilities, compared to 4.2% as of December 31, 2022. Shareholders’ Equity As of September 30, 2023, shareholders’ equity totaled $87.4 million, or 8.2% of total assets, compared to $85.1 million, or 8.6% of total assets, as of December 31, 2022. The increase in shareholders’ equity resulted from earnings, net of dividends paid, partially offset by the CECL transition adjustment which reduced retained earnings by $1.8 million, net of tax, as well as a net increase in accumulated other comprehensive loss of $1.7 million associated with fair value declines in the available-for-sale investment portfolio and reclassification adjustments associated with terminated interest rate swaps. During the nine months ended September 30, 2023, the Company declared dividends totaling $0.15 per common share, or approximately $0.9 million in aggregate amount, compared to $0.09 per common share, or approximately $0.5 million in aggregate amount, during the nine months ended September 30, 2022. Bancshares’ Board of Directors evaluates dividend payments based on the Company’s level of earnings and the desire to maintain a strong capital base, as well as regulatory requirements relating to the payment of dividends. 56 LIQUIDITY AND CAPITAL RESOURCES The asset portion of the balance sheet provides liquidity primarily from the following sources: (1) excess cash and interest-bearing deposits in banks, (2) federal funds sold, (3) principal payments and maturities of loans and (4) principal payments and maturities from the investment portfolio. Loans maturing or repricing in one year or less amounted to $227.8 million as of September 30, 2023 and $212.5 million as of December 31, 2022. Investment securities forecasted to mature or reprice in one year or less were estimated to be $20.5 million and $7.1 million of the investment portfolio as of September 30, 2023 and December 31, 2022, respectively. Although some securities in the investment portfolio have legal final maturities exceeding 10 years, a substantial percentage of the portfolio provides monthly principal and interest payments and consists of securities that are readily marketable and easily convertible into cash on short notice. The investment securities portfolio had an estimated average life of 3.9 years and 3.5 years as of September 30, 2023 and December 31, 2022, respectively. However, management does not rely solely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment and other cash requirements. These activities are also funded by cash flows from loan payments, as well as increases in deposits and short-term borrowings. The liability portion of the balance sheet provides liquidity through interest-bearing and non-interest-bearing deposit accounts, which represent the Company’s primary sources of funds. In addition, federal funds purchased, FHLB advances, securities sold under agreements to repurchase and short-term and long-term borrowings are additional sources of available liquidity. Liquidity management involves the continual monitoring of the sources and uses of funds to maintain an acceptable cash position. Long-term liquidity management focuses on considerations related to the total balance sheet structure. The Bank manages the pricing of its deposits to maintain a desired deposit balance. The Company had $30.0 million and $20.0 million of outstanding borrowings under FHLB advances as of September 30, 2023 and December 31, 2022, respectively. In addition, on October 1, 2021, the Company completed a private placement of $11.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes that will mature on October 1, 2031. Net of unamortized debt issuance costs, the subordinated notes were recorded as long-term borrowings totaling $10.8 million and $10.7 million as of September 30, 2023 and December 31, 2022, respectively. The Company had up to $260.3 million and $246.8 million in remaining unused credit from the FHLB (subject to available collateral, which may include eligible investment securities and loans) as of September 30, 2023 and December 31, 2022, respectively. In addition, the Company had $48.0 million and $45.0 million in unused established federal funds lines as of September 30, 2023 and December 31, 2022, respectively. The Company also has access to the FRB’s discount window and its Bank Term Funding Program (BTFP), the latter of which was established in response to the recent liquidity events that have occurred in the banking industry. Both the discount window and the BTFP allow borrowing on pledged collateral that includes eligible investment securities and, in certain circumstances, eligible loans. In response to heightened liquidity concerns in the banking industry, during 2023 management undertook measures designed to enhance the Company’s liquidity position. These procedures included holding higher levels of on-balance sheet cash, as well as enhancing the availability of off-balance sheet borrowing capacity. As part of these efforts, during the third quarter of 2023, the Company completed the establishment of additional borrowing capacity through the FRB's discount window, primarily via the pledging of the majority of the Company’s indirect loan portfolio as collateral. Due to these efforts, the Company’s immediate borrowing capacity based on collateral pledged through the discount window increased to $146.6 million as of September 30, 2023, compared to $1.2 million as of December 31, 2022. 57 RESPONSE TO RECENT LIQUIDITY EVENTS In response to heightened liquidity concerns for the banking industry during 2023, management undertook measures designed to enhance the Company’s liquidity position, including holding higher levels of on-balance sheet cash and enhancing the Company’s off-balance sheet borrowing capacity through both secured and unsecured sources. Although the liquidity events that have occurred in 2023 have strained the banking industry as a whole, the Company’s management remains confident in the stability of the Company’s core deposit base which has served as the Company’s primary funding source for many years. Excluding wholesale brokered deposits, as of September 30, 2023, the Company had over 29 thousand deposit accounts with an average balance of approximately $28.9 thousand per account. Estimated uninsured/uncollateralized deposits (calculated as deposit amounts per deposit holder in excess of $250 thousand, the maximum amount of federal deposit insurance, and excluding deposits secured by pledged assets) totaled $173.0 million, or 18.7% of total deposits, as of September 30, 2023, compared to $148.3 million, or 17.1% of total deposits, as of December 31, 2022. The table below provides information on the Company’s on-balance sheet liquidity, as well as readily available off-balance sheet sources of liquidity as of both September 30, 2023 and December 31, 2022. September 30, 2023 December 31, 2022 (Dollars in Thousands) (Unaudited) (Unaudited) Liquidity from cash and federal funds sold: Cash and cash equivalents $ 66,129 $ 30,152 Federal funds sold 1,143 1,768 Liquidity from cash and federal funds sold 67,272 31,920 Liquidity from pledgeable investment securities: Investment securities available-for sale, at fair value 126,551 130,795 Investment securities held-to-maturity, at amortized cost 1,272 1,862 Less: securities pledged (42,340 ) (54,717 ) Less: estimated collateral value discounts (10,943 ) (7,833 ) Liquidity from pledgeable investment securities 74,540 70,107 Liquidity from unused lendable collateral (loans) at FHLB 6,676 18,215 Liquidity from unused lendable collateral (loans and securities) at FRB 146,613 1,198 Unsecured lines of credit with banks 48,000 45,000 Total readily available liquidity $ 343,101 $ 166,440 The table calculates readily available sources of liquidity, including cash and cash equivalents, federal funds sold, and other liquidity sources. Certain of the measures have not been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”); however, management believes that the non-GAAP measures are beneficial to the reader as they enhance the overall understanding of the Company’s liquidity position and can be used as a supplement to GAAP-based measures of liquidity. Specifically, liquidity from pledgeable investment securities and total readily available liquidity are non-GAAP measures used by management and regulators to analyze a portion of the Company's liquidity. Pledgeable investment securities are considered by management as a readily available source of liquidity since the Company has the ability to pledge the securities with the FHLB or FRB to obtain immediate funding. Both available-for-sale and held-for-maturity securities may be pledged at fair value with the FHLB and through the FRB discount window. The amounts shown as liquidity from pledgeable investment securities represents total investment securities as recorded on the balance sheet, less reductions for securities already pledged and discounts expected to be taken by the lender to determine collateral value. The calculations are intended to reflect minimum levels of liquidity readily available to the Company through the pledging of investment securities, and do not contemplate the additional available liquidity that could be available from the FRB through the BTFP. The non-GAAP financial measures that are discussed in this Quarterly Report should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Management believes that the Company has adequate sources of liquidity to cover its contractual obligations and commitments over the next twelve months. 58 ITEM 3. QUANTITATIVE AND QUALITATI VE DISCLOSURES ABOUT MARKET RISK The primary purpose of managing interest rate risk is to invest capital effectively and preserve the value created by the Company’s core banking business. This is accomplished through the development and implementation of lending, funding, pricing and hedging strategies designed to maximize net interest income performance under varying interest rate environments, subject to liquidity and interest rate risk guidelines. Effective interest rate sensitivity management ensures that both assets and liabilities respond to changes in interest rates within an acceptable timeframe, thereby minimizing the effect of such interest rate movements on short- and long-term net interest margin and net interest income. Financial simulation models are the primary tools used by the Asset/Liability Committee of the Bank’s board of directors to measure interest rate exposure. Using a wide range of scenarios, management is provided with extensive information on the potential impact on net interest income caused by changes in interest rates. In these simulations, assumptions are made about the direction and volatility of interest rates, the slope of the yield curve and the changing composition of the Company’s balance sheet resulting from both strategic plans and customer behavior. Simulation models also incorporate management’s assumptions regarding such factors as loan and deposit growth, pricing, prepayment speeds and spreads between interest rates paid on deposits and charged on loans. Because of limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on our results but rather as a means to better plan and execute appropriate asset-liability management strategies and manage our interest rate risk. Assessing Short-Term Interest Rate Risk – Net Interest Margin Simulation On a quarterly basis, management simulates how changes in short- and long-term interest rates will impact future profitability, as reflected by changes in the Bank’s net interest margin and net interest income. The tables below depict how, as of September 30, 2023, pre-tax net interest margin and net interest income are forecasted to change over timeframes of one year and two years under the six listed interest rate scenarios. The interest rate scenarios contemplate immediate and parallel shifts in short- and long-term interest rates. Average Change in Net Interest Margin from Level Interest Rate Forecast (basis points, pre-tax): 1 Year 2 Years +1% 11 10 +2% 19 17 +3% 23 19 -1% (13 ) (11 ) -2% (28 ) (26 ) -3% (44 ) (41 ) Cumulative Change in Net Interest Income from Level Interest Rate Forecast (dollars in thousands, pre-tax): 1 Year 2 Years +1% $ 1,149 $ 2,119 +2% 2,047 3,646 +3% 2,461 4,119 -1% (1,378 ) (2,468 ) -2% (3,056 ) (5,592 ) -3% (4,736 ) (8,842 ) 59 ITEM 4. CONTROLS AND PROCEDURES Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures Bancshares maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in Bancshares’ reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to Bancshares’ management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Bancshares’ management carried out an evaluation, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of Bancshares’ disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of September 30, 2023, pursuant to the evaluation of these controls and procedures required by Rule 13a-15 of the Exchange Act. Based on that evaluation, Bancshares’ management concluded, as of September 30, 2023, that Bancshares’ disclosure controls and procedures were effective at the reasonable assurance level to ensure that the information required to be disclosed in Bancshares’ periodic filings with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Changes in Internal Control Over Financial Reporting There were no changes in Bancshares’ internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. 60 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is a party to certain ordinary course litigation, and the Company intends to vigorously defend itself in all such litigation. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such ordinary course litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations. ITEM 1A. RISK FACTORS A list of factors that could materially affect the Company’s business, financial condition and/or operating results is included in Part I, Item 1A, “Risk Factors” in the Company's 2022 Form 10-K. There have been no material changes to such risk factors, except as set forth below. Additional risks and uncertainties not currently known to the Company or that the Company currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results. Adverse developments affecting the financial services industry, such as recent bank failures or concerns involving liquidity, may have a material effect on the Company’s operations. Recent events relating to the failures of certain banking entities in March and April 2023, including Silicon Valley Bank, Signature Bank and First Republic Bank, have caused general uncertainty and concern regarding the liquidity adequacy of the banking sector as a whole. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, banks, investment banks, mutual funds, and other institutional entities. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. Any such losses could be material and could materially and adversely affect our business, financial condition and results of operations. In addition, we anticipate increased regulatory scrutiny and new regulations directed towards regional banks, and potentially community banks of similar size to us, designed to address the recent negative developments in the banking industry, all of which may increase our costs of doing business and reduce our profitability. In addition, the cost of resolving recent bank failures may prompt the FDIC to increase its premium above the recently increased levels or to issue additional special assessments. ITEM 2. UNREGISTERED SALES OF EQUI TY SECURITIES AND USE OF PROCEEDS The following table sets forth purchases made by or on behalf of Bancshares or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) of the Exchange Act, of shares of Bancshares’ common stock during the third quarter of 2023: Issuer Purchases of Equity Securities Period Total Number of Shares Purchased (1) Average Price Paid per Share Total Number of Shares Purchased as Part of Publicly Announced Programs (2) Maximum Number of Shares that May Yet Be Purchased Under the Programs (2) July 1 – July 31 1,181 $ 8.62 — 596,813 August 1 – August 31 110 $ 8.93 — 596,813 September 1 – September 30 110 $ 8.80 — 596,813 Total 1,401 $ 8.65 — 596,813 (1) 1,401 shares were purchased in open-market transactions by an independent trustee for Bancshares’ 401(k) Plan during the third quarter of 2023. (2) No shares were repurchased during the third quarter pursuant to Bancshares’ publicly announced share repurchase program, which was initially approved by the Board of Directors on January 19, 2006 and authorized the repurchase of up to 642,785 shares of common stock. On each of December 18, 2019 and April 28, 2021, the Board approved the repurchase of additional shares of common stock under the share repurchase program, and the Board has periodically extended the expiration date of the program, most recently to December 31, 2023. As of September 30, 2023, Bancshares was authorized to repurchase up to 596,813 shares of common stock under the share repurchase program. 61 ITEM 6. EXHIBITS Exhibit No. Description 3.1 Certificate of Incorporation of United Security Bancshares, Inc. (incorporated by reference to Exhibit 3(i) to the Quarterly Report on Form 10-Q (File No. 000-14549), filed on November 12, 1999). 3.1A Certificate of Amendment to the Certificate of Incorporation of United Security Bancshares, Inc., effective as of October 11, 2016 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K (File No. 000-14549), filed on October 11, 2016). 3.2 Amended and Restated Bylaws of First US Bancshares, Inc., effective as of November 16, 2022 (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K (File No. 000-14549), filed on November 16, 2022). 10.1 First US Bancshares, Inc. Non-Employee Directors' Deferred Compensation Plan 31.1* Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. 31.2* Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. 32* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 101 The following financial statements from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline XBRL: (i) Interim Condensed Consolidated Balance Sheets, (ii) Interim Condensed Consolidated Statements of Comprehensive Income, (iii) Interim Condensed Consolidated Statements of Operations, (iv) Interim Condensed Consolidated Statements of Changes in Shareholders' Equity, (v) Interim Condensed Consolidated Statements of Cash Flows, and (vi) Notes to the Interim Condensed Consolidated Financial Statements, tagged as blocks of text and including detailed tags. 104 The cover page from the Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in Inline XBRL. ________________ *Filed herewith 62 SIGNAT URES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST US BANCSHARES, INC. DATE: November 8, 2023 By: /s/ Thomas S. Elley Thomas S. Elley Its Senior Executive Vice President, Treasurer and Assistant Secretary, Chief Financial Officer and Principal Accounting Officer (Duly Authorized Officer and Principal Financial Officer) 63