SOUTHERN FIRST BANCSHARES INC 10-K

Item 5. Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities. Market Information and Holders of Record Our common stock is currently traded on the NASDAQ Global Market under the symbol “SFST.” We had approximately 2,600 shareholders of record on February 10, 2021. Dividends We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future, we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay cash dividends depends primarily on the ability of our subsidiary, the Bank to pay dividends to us. As a South Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by the S.C. Board, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the S.C. Board. The FDIC also has the authority under federal law to enjoin a bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances. Equity Compensation Plan Information The following table sets forth equity compensation plan information at December 31, 2020. The number of shares and the exercise prices for options have been adjusted for the 10% stock dividends in 2006, 2011, 2012, and 2013.   Plan Category Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) Weighted-average exercise price of outstanding options, warrants and rights (b) Number of securities remaining available for future issuance under equity compensation plans (c) (excluding securities reflected in column(a)) Equity compensation plans approved by security holders 2010 Stock Incentive Plan – options 226,585 $ 21.49 - 2016 Equity Incentive Plan – options 268,610 37.05 123,827 2016 Equity Incentive Plan – restricted stock - - 25,524 2020 Equity Incentive Plan - - 450,000 Total 495,195 $ 29.93 599,351   (1) Under the terms of the 2010 Plan no further incentive stock option awards may be granted, effective March 16, 2020; however, the Plan will remain in effect until all awards have been exercised or forfeited and we determine to terminate the Plan. 42 Table of Contents Stock Performance Graph The performance graph below compares the Company’s cumulative total return over the most recent five-year period with the SNL Southeast Bank Index, a banking industry performance index for the southeastern United States, and the Russell 2000 Index, a small-cap stock market index which the Company was added to in June 201z6. Returns are shown on a total return basis, assuming the reinvestment of dividends and a beginning stock index value of $100 per share.     Period Ending 12/31/2015 12/31/2016 12/31/2017 12/31/2018 12/31/2019 12/31/2020 Southern First Bancshares 100.00 158.59 181.72 141.28 187.18 155.73 SNL Southeast Bank Index 100.00 132.75 164.21 135.67 191.06 172.07 Russell 2000 Index 100.00 121.31 139.08 123.76 155.35 186.36 On March 11, 2020, the Company announced a share repurchase plan allowing us to repurchase up to 383,650 shares of our common stock (the “Repurchase Plan”). As of December 31, 2020, we have not repurchased any of the shares authorized for repurchase under the Repurchase Plan. The Company is not obligated to purchase any such shares under the Repurchase Plan, and the Repurchase Plan may be discontinued, suspended or restarted at any time; however, repurchases under the Repurchase Plan after December 31, 2020 would require additional approval of our Board of Directors and the Federal Reserve. 43 Table of Contents The following table reflects share repurchase activity during the fourth quarter of 2020: (d) Maximum (c) Total Number (or Number of Approximate Shares (or Dollar Value) of Units) Shares (or (a) Total Purchased as Units) that May Number of Part of Publicly Yet Be Shares (or (b) Average Announced Purchased Units) Price Paid per Plans or Under the Plans Period Purchased Share (or Unit) Programs or Programs   October 1 – October 31 - $ - - 383,650 November 1 – November 30 - - - 383,650 December 1 – December 31 - - - 383,650 Total - - 383,650 44 Table of Contents Item 6. Selected Financial Data The following table sets forth our selected historical consolidated financial information for the periods and as of the dates indicated. We derived our balance sheet and income statement data for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 from our audited consolidated financial statements. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes thereto, which are included elsewhere in this Annual Report on Form 10-K.   Years Ended December 31, (dollars in thousands, except per share data) 2020 2019 2018 2017 2016 BALANCE SHEET DATA Total assets $ 2,482,587 $ 2,267,195 $ 1,900,614 $ 1,624,625 $ 1,340,908 Investment securities 98,364 74,642 79,026 72,065 70,222 Loans (1) 2,142,867 1,943,525 1,677,332 1,387,070 1,163,644 Allowance for loan losses 44,149 16,642 15,762 15,523 14,855 Deposits 2,142,758 1,876,124 1,648,136 1,381,123 1,091,151 FHLB advances and other borrowings 25,000 110,000 50,000 67,200 115,200 Subordinated debentures 35,998 35,890 13,403 13,403 13,403 Common equity 228,294 205,860 173,916 149,686 109,872 Preferred stock - - - - - Shareholders’ equity 228,294 205,860 173,916 149,686 109,872 SELECTED RESULTS OF OPERATIONS DATA Interest income $ 94,818 $ 92,652 $ 76,657 $ 61,209 $ 51,191 Interest expense 15,008 25,383 16,505 10,333 8,192 Net interest income 79,810 67,269 60,152 50,876 42,999 Provision for loan losses 29,600 2,300 1,900 2,000 2,300 Net interest income after provision for loan losses 50,210 64,969 58,252 48,876 40,699 Noninterest income 27,353 14,983 10,201 9,337 10,846 Noninterest expenses 53,744 44,473 39,763 34,552 31,176 Income before income tax expense 23,819 35,479 28,690 23,661 20,369 Income tax expense 5,491 7,621 6,401 10,616 7,333 Net income 18,328 27,858 22,289 13,045 13,036 Preferred stock dividends - - - - - Net income available to common shareholders $ 18,328 $ 27,858 $ 22,289 $ 13,045 $ 13,036 PER COMMON SHARE DATA Basic $ 2.37 $ 3.70 $ 3.02 $ 1.86 $ 2.06 Diluted 2.34 3.58 2.88 1.76 1.94 Book value 29.37 26.83 23.29 20.37 17.00 Weighted average number of common shares outstanding: Basic, in thousands 7,719 7,528 7,384 7,006 6,318 Diluted, in thousands 7,824 7,773 7,737 7,393 6,721 SELECTED FINANCIAL RATIOS Performance Ratios: Return on average assets 0.76 % 1.35% 1.27% 0.87% 1.04% Return on average equity 8.49 % 14.72% 13.83% 9.66% 12.73% Return on average common equity 8.49 % 14.72% 13.83% 9.66% 12.73% Net interest margin, tax equivalent(2) 3.55 % 3.43% 3.58% 3.57% 3.63% Efficiency ratio (3) 50.15 % 54.07% 56.52% 57.38% 57.90% Asset Quality Ratios: Nonperforming assets to total loans (1) 0.43 % 0.35% 0.35% 0.54% 0.53% Nonperforming assets to total assets 0.37 % 0.30% 0.31% 0.46% 0.46% Net charge-offs to average total loans 0.10 % 0.08% 0.11% 0.10% 0.10% Allowance for loan losses to nonperforming loans 547.14 % 244.95% 270.36% 212.60% 270.95% Allowance for loan losses to total loans 2.06 % 0.86% 0.94% 1.12% 1.28% Holding Company Capital Ratios: Total risk-based capital ratio 14.38 % 13.73% 12.49% 13.27% 12.11% Tier 1 risk-based capital ratio 11.97 % 11.63% 11.53% 12.11% 10.86% Leverage ratio 9.70 % 10.10% 10.14% 10.26% 9.42% Common equity tier 1 ratio(4) 11.32 % 10.94% 10.73% 11.15% 9.71% Tangible common equity(5) 9.20 % 9.08% 9.15% 9.21% 8.19% Growth Ratios: Change in assets 9.50 % 19.29% 16.99% 21.16% 10.15% Change in loans 10.26 % 15.87% 20.93% 19.20% 15.79% Change in deposits 14.21 % 13.83% 19.33% 26.57% 10.69% Change in net income to common shareholders -34.21 % 24.99% 70.86% 0.07% 28.22% Change in earnings per common share - diluted -34.64 % 24.31% 63.64% -9.28% 25.16% 45 Table of Contents Footnotes to table: (1) Excludes loans held for sale. (2) The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. (3) Noninterest expense divided by the sum of net interest income and noninterest income. (4) The common equity tier 1 ratio is calculated as the sum of common equity divided by risk-weighted assets. (5) The common equity ratio is calculated as total equity less preferred stock divided by total assets. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this Annual Report on Form 10-K. OVERVIEW Our business model continues to be client-focused, utilizing relationship teams to provide our clients with a specific banker contact and support team responsible for all of their banking needs. The purpose of this structure is to provide a consistent and superior level of professional service, and we believe it provides us with a distinct competitive advantage. We consider exceptional client service to be a critical part of our culture, which we refer to as "ClientFIRST." At December 31, 2020, we had total assets of $2.48 billion, a 9.5% increase from total assets of $2.27 billion at December 31, 2019. The largest components of our total assets are loans which were $2.14 billion and $1.94 billion at December 31, 2020 and 2019, respectively. Our liabilities and shareholders’ equity at December 31, 2020 totaled $2.25 billion and $228.3 million, respectively, compared to liabilities of $2.06 billion and shareholders’ equity of $205.9 million at December 31, 2019. The principal component of our liabilities is deposits which were $2.14 billion and $1.88 billion at December 31, 2020 and 2019, respectively. Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the difference between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread. In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients. Our net income available to common shareholders for the years ended December 31, 2020 and 2019 was $18.3 million and $27.9 million, or diluted earnings per share (“EPS”) of $2.34 and $3.58 for the years ended December 31, 2020 and 2019, respectively. The decrease in net income resulted primarily from increases in our provision for loan loss and noninterest expense, partially offset by an increase in net interest income and noninterest income. In addition, our net income available to shareholders was $22.3 million, or EPS of $2.88 for the year ended December 31, 2018. COVID-19 PANDEMIC The COVID-19 pandemic continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. In particular, the COVID-19 pandemic has severely restricted the level of economic activity in our markets. Federal and state governments have taken, and may continue to take, unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed and businesses and schools have reopened with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief. 46 Table of Contents The impact of the COVID-19 pandemic is fluid and continues to evolve, adversely affecting many of the Bank’s clients. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020, for the first time, although bond yields have recently begun to rise, nearing where they were before the pandemic in February 2020. In March 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range to 0% to 0.25%. These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on our business, financial condition and results of operations. For instance, the pandemic has had negative effects on the Bank’s interest income, provision for loan losses, and certain transaction-based line items of noninterest income. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including, the effect of governmental and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strains, and the ability for customers and businesses to return to their pre-pandemic routine. Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and in the United States as a whole. As we progress through the pandemic, the majority of our team has returned to working in the office at this time; however, we maintain the ability to shift to working remotely as needed. Our offices continue to operate in a drive-thru only mode with “in-person” client meetings available by appointment to maintain the safety of our team and our clients. We believe this strategy, combined with our digital technology, has been extremely effective in serving our clients, and allowed us to consolidate our three Columbia, South Carolina offices into one location. The sale of our two Columbia office buildings was completed on October 9, 2020. We are focused on servicing the financial needs of our commercial and consumer clients and have offered flexible loan payment arrangements, including short-term loan modifications or forbearance payments, and reduced or waived certain fees on deposit accounts. We continue to assist clients with these accommodations on a case by case basis. Future governmental actions may require these and other types of client-related responses. In response to the Paycheck Protection Program (“PPP”), established under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, we became a small business administration approved lender in an effort to assist our clients through this challenging time. In 2020, we processed 853 loans under the PPP for a total of $97.5 million, receiving lender fee income of $3.9 million. As the regulations and guidance for PPP loans and the forgiveness process continued to change and evolve, management recognized the operational risk and complexity associated with this portfolio and decided to pursue the sale of the PPP loan portfolio to a third party better suited to support and serve our PPP clients through the loan forgiveness process. We believe this loan sale allowed our team to focus on serving our clients and proactively monitoring and addressing credit risk brought on by the pandemic. On June 26, 2020, we completed the sale of our PPP loan portfolio to The Loan Source Inc., together with its servicing partner, ACAP SME LLC, and immediately recognized SBA lender fee income of $2.2 million, net of sale and processing costs, which is included in other noninterest income in the consolidated financial statements. Through December 31, 2020, we had granted deferrals on loan payments for 864 loans, with aggregate outstanding loan principal balances of approximately $599.6 million as of December 31, 2020, of which 91% were commercial loans. As of December 31, 2020, 98% of these loans have reached the end of their deferral period and have begun to resume normal payments. The table below provides a breakdown of loan modification requests due to the COVID-19 pandemic by type of concession. At December 31, 2020, there were two modified loan totaling $13.5 million with a remaining deferral period. December 31, 2020 (dollars in thousands) # Loans Amount % of Total Portfolio Payment deferrals 590 $ 452,897 21.1 % Interest only 265 143,596 6.7 % Financial difficulty (TDR) 9 3,154 0.1 % 864 $ 599,647 27.9 % In accordance with the CARES Act, the Company implemented loan modification programs in response to the COVID-19 pandemic and the Company elected the accounting policy in the CARES Act to not apply TDR accounting to loans modified for borrowers impacted by the COVID-19 pandemic. The Company granted short-term loan deferrals to six client relationships, with loans totaling $3.2 million at December 31, 2020, which were considered TDRs due to the client experiencing financial difficulty before the pandemic. In certain cases, we have made a second three-month deferral to our clients based on individual circumstances for the borrower. 47 Table of Contents As we closely monitor credit risk and our exposure to increased loan losses resulting from the impact of COVID-19 on our commercial clients, we have identified two industries considered to be at higher risk for credit loss. The table below identifies the outstanding and committed loan balances for each of these industries. Of the $61.5 million of loans modified in these industries as of December 31, 2020, 78% have begun to resume normal payments.   December 31, 2020 (dollars in thousands) # Loans Balance Outstanding % of Total Loans Outstanding Total Modified Balance % Modified Deferral Complete % Deferral Complete % Past Due 30 Days or More % on Nonaccrual Hotels 23 $ 110,138 5.1% $ 56,161 51.0% $ 42,679 76.0% -% -% Restaurants 57 13,315 0.6% 5,291 39.7% 5,291 100.0% -% -% Total 80 $ 123,453 5.7% $ 61,452 49.8% $ 47,969 78.1% -% -% We continue to monitor unfunded commitments through the pandemic, including home equity lines of credit, for evidence of increased credit exposure as borrowers utilize these lines for liquidity purposes. We are also monitoring the impact of the COVID-19 pandemic on the operations and value of our investments. We mark to market our publicly traded investments and review our investment portfolio for impairment at each period end. Because of changing economic and market conditions affecting issuers, we may be required to recognize further impairments on the securities we hold as well as reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our investment portfolio. We believe there could be potential stresses on liquidity management as a result of the COVID-19 pandemic. For instance, as clients manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit. As of December 31, 2020, all of our capital ratios, and the Bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by further credit losses. We maintain access to multiple sources of liquidity, including a $15.0 million holding company line of credit with another bank which could be used to support capital ratios at the Bank. CRITICAL ACCOUNTING POLICIES AND ESTIMATES We have adopted various accounting policies that govern the application of accounting principles generally accepted in the U.S. and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our Consolidated Financial Statements as of December 31, 2020. Certain accounting policies inherently involve a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. We consider these accounting policies and estimates to be critical accounting policies. We have identified the determination of the allowance for loan losses, the fair valuation of financial instruments and income taxes to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Therefore, management has reviewed and approved these critical accounting policies and estimates and has discussed these policies with the Company’s Audit Committee. Allowance for Loan Losses The allowance for loan loss is management’s estimate of credit losses inherent in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. 48 Table of Contents We have an established process to determine the adequacy of the allowance for loan losses that assesses the losses inherent in our portfolio. While we attribute portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. Our process involves procedures to appropriately consider the unique risk characteristics of our commercial and consumer loan portfolio segments. For each portfolio segment, impairment is measured individually for each impaired loan. Our allowance levels are influenced by loan volume, loan grade or delinquency status, historic loss experience and other economic conditions. The allowance consists of general and specific components. Commercial loans are assessed for estimated losses by grading each loan using various risk factors identified through periodic reviews. We apply historic grade-specific loss factors to each loan class. In the development of our statistically derived loan grade loss factors, we observe historical losses over 20 quarters for each loan grade. These loss estimates are adjusted as appropriate based on additional analysis of external loss data or other risks identified from current economic conditions and credit quality trends. For consumer loans, we determine the allowance on a collective basis utilizing historical losses over 20 quarters to represent our best estimate of inherent loss. We pool loans, generally by loan class with similar risk characteristics. Included in the general component of the allowance for loan losses for both portfolio segments is a margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating general losses in the portfolio. Uncertainties and subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity or problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons are qualitative and environmental factors considered. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the value of the impaired loan is lower than the carrying value of that loan. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan by loan basis for commercial and consumer loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The specific component also includes an amount for the estimated impairment on commercial and consumer loans modified in a troubled debt restructuring (“TDR”), whether on accrual or nonaccrual status. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. 49 Table of Contents Fair Valuation of Financial Instruments We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Additionally, we may be required to record other assets at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. Further, we include in the Notes to the Consolidated Financial Statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used, and the related impact to income. Additionally, for financial instruments not recorded at fair value, we disclose the estimate of their fair value. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer the liability in an orderly transaction between market participants at the measurement date. Accounting standards establish a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. The three levels of inputs that are used to classify fair value measurements are as follows: • Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments generally include securities traded on active exchange markets, such as the New York Stock Exchange, as well as securities that are traded by dealers or brokers in active over-the-counter markets. Instruments we classify as Level 1 are instruments that have been priced directly from dealer trading desks and represent actual prices at which such securities have traded within active markets.   • Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques, such as matrix pricing, for which all significant assumptions are observable in the market. Instruments we classify as Level 2 include securities that are valued based on pricing models that use relevant observable information generated by transactions that have occurred in the market place that involve similar securities.   • Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models, and similar techniques.   We attempt to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. Specifically, we use independent pricing services to obtain fair values based on quoted prices. Quoted prices are subject to our internal price verification procedures. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently-sourced market parameters. Most of our financial instruments use either of the foregoing methodologies, collectively Level 1 and Level 2 measurements, to determine fair value adjustments recorded to our financial statements. However, in certain cases, when market observable inputs for model-based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in estimating the fair value of the financial instrument. The degree of management judgment involved in determining the fair value of an instrument is dependent upon the availability of quoted market prices or observable market parameters. For instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management’s judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. When significant adjustments are required to available observable inputs, it may be appropriate to utilize an estimate based primarily on unobservable inputs. When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable. Significant judgment may be required to determine whether certain assets measured at fair value are included in Level 2 or Level 3. If fair value measurement is based upon recent observable market activity of such assets or comparable assets (other than forced or distressed transactions) that occur in sufficient volume and do not require significant adjustment using unobservable inputs, those assets are classified as Level 2. If not, they are classified as Level 3. Making this assessment requires significant judgment. 50 Table of Contents Income Taxes The financial statements have been prepared on the accrual basis. When income and expenses are recognized in different periods for financial reporting purposes versus for the purposes of computing income taxes currently payable, deferred taxes are provided on such temporary differences. Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The Company believes that its income tax filing positions taken or expected to be taken on its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company's financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded. RESULTS OF OPERATIONS Net Interest Income and Margin Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. For the years ended December 31, 2020, 2019, and 2018, our net interest income was $79.8 million, $67.3 million, and $60.2 million, respectively. The $12.5 million, or 18.6%, increase in net interest income during 2020, compared to 2019, was driven by a $328.1 million increase in average earning assets, partially offset by a $152.2 million increase in our average interest-bearing liabilities. The increase in average earning assets was primarily related to an increase in average loans, while the increase in average interest-bearing liabilities was primarily driven by an increase in interest-bearing deposits. During 2019, our net interest income increased $7.1 million, or 11.8%, compared to 2018, while average interest-earning assets increased $281.1 million and average interest-bearing liabilities increased $190.4 million. Interest income for the years ended December 31, 2020, 2019, and 2018 was $94.8 million, $92.7 million, and $76.7 million, respectively. A significant portion of our interest income relates to our strategy to maintain a large portion of our assets in higher earning loans compared to lower yielding investments and federal funds sold. As such, 98.2% of our interest income related to interest on loans during 2020, compared to 96.0% during 2019 and 96.2% during 2018. Also, included in interest income on loans was $1.4 million, $1.2 million and $1.1 million related to the net amortization of loan fees and capitalized loan origination costs for the years ended December 31, 2020, 2019 and 2018, respectively. Interest expense was $15.0 million, $25.4 million, and $16.5 million for the years ended December 31, 2020, 2019, and 2018, respectively. Interest expense on deposits for 2020 represented 87.0% of total interest expense, compared to 93.5% for 2019, and 89.9% for 2018, while interest expense on borrowings represented 13.0% of total interest expense for 2020, compared to 6.5% for 2019, and 10.1% for 2018. The decrease in interest expense on deposits during 2020 resulted from a decrease in deposit rates. We have included a number of tables to assist in our description of various measures of our financial performance. For example, the “Average Balances, Income and Expenses, Yields and Rates” table shows the average balance of each category of our assets and liabilities as well as the yield we earned or the rate we paid with respect to each category during 2020, 2019, and 2018. Similarly, the “Rate/Volume Analysis” table demonstrates the effect of changing interest rates and changing volume of assets and liabilities on our financial condition during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included tables to illustrate our interest rate sensitivity with respect to interest-earning and interest-bearing accounts. The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities at December 31, 2020, 2019 and 2018. We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments were owned at an original maturity of over one year. Nonaccrual loans are included in earning assets in the following tables. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. The net of capitalized loan costs and fees are amortized into interest income on loans. 51 Table of Contents Average Balances, Income and Expenses, Yields and Rates   For the Year Ended December 31, 2020 2019 2018 Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ (dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate Interest-earning assets Federal funds sold and interest-bearing deposits with banks $ 105,344 $ 270 0.26% $ 71,797 $ 1,622 2.26% $ 61,811 $ 1,138 1.84% Investment securities, taxable 74,517 1,253 1.68% 72,137 1,961 2.72% 64,426 1,623 2.52% Investment securities, nontaxable (1) 6,262 210 3.36% 7,376 182 2.46% 5,886 231 3.93% Loans (2) 2,106,569 93,133 4.42% 1,813,259 88,929 4.90% 1,551,354 73,718 4.75% Total earning assets 2,292,692 94,866 4.14% 1,964,569 92,694 4.72% 1,683,477 76,710 4.56% Nonearning assets 103,212 101,647 77,127 Total assets $ 2,395,904 $ 2,066,216 $ 1,760,604 Interest-bearing liabilities NOW accounts $ 255,514 352 0.14% $ 205,513 555 0.27% $ 235,623 401 0.17% Savings & money market 1,003,339 7,513 0.75% 864,708 15,086 1.74% 669,306 8,766 1.31% Time deposits 301,078 5,190 1.72% 363,431 8,089 2.23% 332,201 5,669 1.71% Total interest-bearing deposits 1,559,931 13,055 0.84% 1,433,652 23,730 1.66% 1,237,130 14,836 1.20% FHLB advances and other borrowings 30,990 338 1.09% 21,914 736 3.36% 33,781 1,089 3.22% Subordinated debt 35,940 1,615 4.49% 19,133 917 4.79% 13,403 580 4.33% Total interest-bearing liabilities 1,626,861 15,008 0.92% 1,474,699 25,383 1.72% 1,284,314 16,505 1.29% Noninterest-bearing liabilities 553,098 402,216 315,118 Shareholders’ equity 215,945 189,301 161,172 Total liabilities and shareholders’ equity $ 2,395,904 $ 2,066,216 $ 1,760,604 Net interest spread 3.22% 3.00% 3.27% Net interest income(tax equivalent)/margin $ 79,858 3.48% $ 67,311 3.43% $ 60,205 3.58% Less: tax-equivalent adjustment (1) (48 ) (42 ) (53 ) Net interest income $ 79,810 $ 67,269 $ 60,152   (1) The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. (2) Includes loans held for sale. Our net interest margin, on a tax-equivalent basis (TE), was 3.48%, 3.43% and 3.58% for the years ended December 31, 2020, 2019 and 2018, respectively. Our net interest margin (TE) increased five basis points in 2020, compared to 2019, as the cost of our interest-bearing liabilities decreased quicker than the yield on our interest-earning assets due to our deposits repricing more frequently to market prices than our loan yields. During 2019, our net interest margin decreased 15 basis points, compared to 2018, as the cost of our interest-bearing liabilities increased by 43 basis points, while the yield on our interest-earning assets increased by 16 basis points. Our average interest-earning assets increased by $328.1 million during the year ended December 31, 2020, compared to 2019, while the related yield on our interest-earning assets decreased by 58 basis points. The increase in average interest-earning assets was driven primarily by a $293.3 million increase in average loan balances combined with a $33.5 million increase in federal funds sold and interest-bearing deposits with banks. In addition, the reduction in yield on our interest earning assets was driven by a 48 basis point decrease in loan yield as the Federal Reserve reduced interest rates by 225 basis points since August 2019. During the year ended December 31, 2019, our average interest-earning assets increased by $281.1 million, compared to 2018, while the yield on our interest-earning assets increased by 16 basis points. The increase in average interest-earning assets was driven primarily by a $261.9 million increase in average loan balances during 2019, compared to 2018. In addition, our loan yield increased 15 basis points during 2019. Our average interest-bearing liabilities increased by $152.2 million during 2020 while the cost of our interest-bearing liabilities decreased by 80 basis points. The increase in average interest-bearing liabilities was driven primarily by a $126.3 million increase in average interest-bearing deposits at an average rate of 0.84%, an 82 basis point decrease when compared to 2019. During 2019, our average interest-bearing liabilities increased by $190.4 million, compared to 2018, while the cost of our interest-bearing liabilities increased by 43 basis points. Our net interest spread was 3.22% for the year ended December 31, 2020, compared to 3.00% for the same period in 2019 and 3.27% for 2018. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 80 basis point decrease in the cost of our interest-bearing liabilities partially offset by a 58 basis point decrease in yield on our interest-earning assets resulted in a 22 basis point increase in our net interest spread for the 2020 period. We anticipate pressure on our net interest spread and net interest margin in future periods as our loan yield continues to decline due to new and renewed loans pricing at rates lower than our current portfolio rate. 52 Table of Contents Rate/Volume Analysis Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.   Years Ended December 31, 2020 vs. 2019 December 31, 2019 vs. 2018 Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in Rate/ Rate/ (dollars in thousands) Volume Rate Volume Total Volume Rate Volume Total Interest income Loans $ 14,385 (8,763 ) (1,418 ) 4,204 12,445 2,366 400 15,211 Investment securities 33 (708 ) (11 ) (686 ) 236 57 7 300 Federal funds sold 758 (1,438 ) (672 ) (1,352 ) 184 258 42 484 Total interest income 15,176 (10,909 ) (2,101 ) 2,166 12,865 2,681 449 15,995 Interest expense Deposits 2,088 (11,731 ) (1,032 ) (10,675 ) 2,355 5,643 896 8,894 FHLB advances and other borrowings 305 (497 ) (206 ) (398 ) (383 ) 46 (16 ) (353 ) Subordinated debt 805 (57 ) (50 ) 698 248 62 27 337 Total interest expense 3,198 (12,285 ) (1,288 ) (10,375 ) 2,220 5,751 907 8,878 Net interest income $ 11,978 1,376 (813 ) 12,541 10,645 (3,070 ) (458 ) 7,117 Net interest income, the largest component of our income, was $79.8 million for the year ended December 31, 2020, a $12.5 million increase from net interest income of $67.3 million for the year ended December 31, 2019. The increase in net interest income was driven by a $10.4 million decrease in interest expense and a $2.2 million increase in interest income. Reduced rates on our interest-bearing liabilities was the primary driver of the decrease in interest expense which was partially offset by a $152.2 million increase in the average balance of those liabilities. Interest income increased $2.2 million driven by an increase in average loan balances that was partially offset by a decrease in yield across all interest earning assets. During 2019, our average interest-earning assets increased $281.1 million as compared to 2018, resulting in $12.9 million of additional interest income while higher rates on our interest-earning assets also increased interest income by $2.7 million from the prior year. In addition, our average interest-bearing liabilities increased by $190.4 million during 2019 resulting in $2.2 million of additional interest expense. In addition, higher rates on our interest-bearing deposits, subordinated debt, and FHLB advances and other borrowings resulted in an increase of $5.8 million of additional interest expense from the prior year. Provision for Loan Losses We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statements of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Results of Operations – Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance. Following is a summary of the activity in the allowance for loan losses.   December 31, (dollars in thousands) 2020 2019 2018 Balance, beginning of period $ 16,642 15,762 15,523 Provision 29,600 2,300 1,900 Loan charge-offs (3,414 ) (1,515 ) (2,146 ) Loan recoveries 1,321 95 485 Net loan charge-offs (2,093 ) (1,420 ) (1,661 ) Balance, end of period $ 44,149 16,642 15,762 53 Table of Contents For the year ended December 31, 2020, we incurred a noncash expense related to the provision for loan losses of $29.6 million, bringing the allowance for loan losses to $44.1 million, or 2.06% of gross loans. In comparison, we added $2.3 million and $1.9 million to the provision for loan losses during the years ended December 31, 2019 and 2018, respectively, resulting in an allowance for loan losses of $16.6 million, or 0.86% of gross loans, as of December 31, 2019, and an allowance for loan losses of $15.8 million, or 0.94% of gross loans, as of December 31, 2018. The increased provision during 2020 was driven by an increase to our qualitative environmental factors related to the uncertain economic and business conditions at both the national and regional levels at December 31, 2020. Factors such as the continued impact on the tourism and hospitality industries due to the pandemic, an increase in permanent job losses and unemployment rates as well as uncertainty in the political realm have driven this increase. We expect economic uncertainty to continue for at least the next few quarters which may result in a continued increase to the allowance for loan losses during 2021, however, should economic conditions improve, we could determine that the qualitative environmental factors indicate that a release of our provision is appropriate, similar to recent determinations made by a number of other insured depository institutions. During the year ended December 31, 2020, our net charge-offs were $2.1 million, representing 0.10% of average loans, and consisted of $3.4 million in loans charged-off, partially offset by $1.3 million of recoveries on loans previously charged-off. In addition, nonperforming assets increased to 0.37% of total assets while our level of classified assets increased to 8.3% at December 31, 2020. We reported net charge-offs of $1.4 million and $1.7 million for the years ended December 31, 2019 and 2018, respectively, including recoveries of $95,000 and $485,000 in 2019 and 2018, respectively. The net charge-offs of $1.4 million and $1.7 million during 2019 and 2018, respectively, represented 0.08% and 0.11% of the average outstanding loan portfolios for 2019 and 2018, respectively. Noninterest Income The following table sets forth information related to our noninterest income.   Year ended December 31, (dollars in thousands) 2020 2019 2018 Mortgage banking income $ 19,785 9,923 5,544 Service fees on deposit accounts 860 1,061 1,040 ATM and debit card income 1,741 1,728 1,490 Income from bank owned life insurance 1,091 1,001 878 Gain on sale of investment securities 3 727 7 Loss on extinguishment of debt (37 ) (1,496 ) - Net lender fees on PPP loan sale 2,247 - - Other income 1,663 2,039 1,242 Total noninterest income $ 27,353 14,983 10,201 Noninterest income was $27.4 million for the year ended December 31, 2020, a $12.4 million, or 82.6%, increase compared to noninterest income of $15.0 million for the year ended December 31, 2019. The increase in noninterest income during 2020, compared to 2019, resulted primarily from the following: • Mortgage banking income increased $9.9 million, or 99.4%, driven by higher mortgage origination volume during 2020 due to the favorable interest rate environment for mortgage loans.   • Loss on extinguishment of debt decreased as a result of fewer prepayment penalties related to the paydown of FHLB Advances. More detail on these transactions is included in the 2019 discussion below.   • Net lender fees on PPP loan sale totaled $2.2 million and related to the net fee income on the PPP loans we originated and then sold to a third party during the second quarter of 2020.   Offsetting these increases were decreases in service fees on deposit accounts and other income. The decrease in service fees on deposit accounts is directly related to the impact of COVID-19 as we have waived certain fees in an effort to assist our clients during this time. Noninterest income was $15.0 million for the year ended December 31, 2019, a $4.8 million, or 46.9%, increase compared to noninterest income of $10.2 million for the year ended December 31, 2018. The increase in noninterest income during 2019, compared to 2018 resulted primarily from the following: 54 Table of Contents • Mortgage banking income increased $4.4 million, or 79.0%, driven by higher mortgage origination volume during 2019 due in part to the favorable interest rate environment for mortgage loans.   • ATM and debit card income increased $238,000, or 16.0%, driven by higher transaction volume when compared to 2018.   • Gain on sale of investment securities increased $720,000 primarily due to the sale of investments during the fourth quarter. See paragraph immediately below.   • Loss on extinguishment of debt resulted from the prepayment penalty related to the paydown of FHLB advances. See paragraph immediately below.   • Other income increased by $797,000, or 64.2%, due primarily to the sale of our Health Savings Account (“HSA”) deposit accounts during the fourth quarter. See paragraph immediately below.   During the fourth quarter of 2019, the Company sold its Health Savings Account (“HSA”) deposit accounts, which totaled $6.2 million, to a nationwide HSA servicer and recognized a gain of approximately $745,000 from the sale. Also during the fourth quarter, the Company sold $29.5 million of investment securities from its existing investment portfolio, recognizing a gain of approximately $720,000 and paid off $25.0 million of FHLB advances that resulted in a prepayment penalty of $1.5 million. Noninterest Expenses The following table sets forth information related to our noninterest expenses.   Years ended December 31, (dollars in thousands) 2020 2019 2018 Compensation and benefits $ 26,287 23,826 22,328 Mortgage production costs 9,898 6,436 4,152 Occupancy 6,226 5,513 5,035 Other real estate owned (income) expenses, net 1,223 (26 ) 116 Outside service and data processing costs 4,223 3,782 3,022 Insurance 1,380 813 1,284 Professional fees 1,771 1,327 1,345 Marketing 628 791 758 Other 2,108 2,011 1,723 Total noninterest expenses $ 53,744 44,473 39,763 Noninterest expenses were $53.7 million for the year ended December 31, 2020, a $9.3 million, or 20.8%, increase from noninterest expense of $44.5 million for 2019. The increase in total noninterest expenses during 2020, compared to 2019, resulted primarily from the following: • Compensation and benefits expense increased $2.5 million, or 10.3%, during 2020 relating primarily to a $1.3 million increase in benefits expense, which includes insurance, 401k expenses and executive retirement plans. Base and incentive compensation also increased by $1.1 million as we continue to grow our existing markets.   • Mortgage production costs, which primarily includes compensation and benefits, professional fees, software licensing costs and credit bureau fees, increased $3.5 million, or 53.8%, driven by higher mortgage commissions as a result of the increased origination volume during 2020.   • Occupancy expenses increased $713,000, or 12.9%, driven by increased rent expense primarily due to office expansion in Atlanta, Georgia as well as additional depreciation, insurance, property taxes and maintenance expenses related to all of our owned properties.   • Other real estate owned expenses increased $1.2 million due to a valuation adjustment on one commercial property.   • Outside service and data processing costs increased $441,000, or 11.7%, primarily due to increased electronic banking, software licensing costs and ATM card related expenses.   • Insurance expenses increased $567,000, or 69.7%, resulting primarily from higher FDIC assessments during the year.   • Professional fees increased $444,000, or 33.5%, driven by increased audit, legal and various consulting fees.   Noninterest expenses were $44.5 million for the year ended December 31, 2019, a $4.7 million, or 11.8%, increase from noninterest expense of $39.8 million for 2018. 55 Table of Contents The increase in total noninterest expenses during 2019, compared to 2018, resulted primarily from the following: • Compensation and benefits expense increased $3.5 million, or 13.6%, during 2019 relating primarily to an increase in base compensation, partially offset by a decrease in benefits expense. Base compensation expense increased by $4.1 million driven by the addition of 14 new employees - of which 12 were hired to support our new offices in Georgia, North Carolina, and South Carolina. Benefits expense, which includes insurance and 401k expenses, decreased by $485,000 primarily due to lower group insurance costs related to lower claims expense in 2019.   • Occupancy expenses increased $478,000, or 9.5%, driven by increased rent expense primarily due to two new offices in Summerville, South Carolina and Greensboro, North Carolina as well as additional depreciation, insurance, property taxes and maintenance expenses related to all of our owned properties.   • Outside service and data processing costs increased $885,000, or 26.8%, primarily due to increased electronic banking and software licensing costs.   Partially offsetting these increases in noninterest expenses during 2019 was a $471,000 decrease in insurance expenses which was driven by a reduction in FDIC premiums in the fourth quarter. Our efficiency ratio was 50.2% for 2020 compared to 54.1% for 2019. The efficiency ratio represents the percentage of one dollar of expense required to be incurred to earn a full dollar of revenue and is computed by dividing noninterest expense by the sum of net interest income and noninterest income. The improvement during the 2020 period relates primarily to the increase in interest income and noninterest income, partially offset by the increase in noninterest expense compared to the prior year. Income Taxes Income tax expense was $5.5 million, $7.6 million and $6.4 million for the years ended December 31, 2020, 2019 and 2018, respectively. Our effective tax rate was 23.1% for the year ended December 31, 2020, compared to 21.5% for 2019, and 22.3% for 2018. The increase in the effective rate for the 2020 period is related to the greater impact of various employee stock option transactions that occurred during the 2019 period. Investment Securities At December 31, 2020 and 2019, our investment securities portfolio was $98.4 million and $74.6 million, respectively, and represented approximately 4.0% and 3.3% of our total assets, respectively. Our available for sale investment portfolio included U.S. agency securities, SBA securities, state and political subdivisions, mortgage-backed securities, and asset-backed securities with a fair value of $94.7 million and amortized cost of $93.4 million for an unrealized gain of $1.3 million at December 31, 2020 compared to a fair value of $67.7 million and amortized cost of $68.1 million for an unrealized loss of $377,000 at December 31, 2019. The amortized costs and the fair value of our investments are as follows.   December 31, 2020 2019 2018 Amortized Fair Amortized Fair Amortized Fair (dollars in thousands) Cost Value Cost Value Cost Value Available for Sale US government agencies $ 6,500 6,493 $ 500 499 $ 8,975 8,782 SBA securities 504 485 550 531 3,628 3,525 State and political subdivisions 18,614 19,388 4,205 4,184 8,371 8,356 Asset-backed securities 11,587 11,529 13,351 13,167 9,595 9,558 Mortgage-backed securities 56,229 56,834 49,465 49,313 45,496 44,684 Total $ 93,434 94,729 $ 68,071 67,694 $ 76,065 74,905 56 Table of Contents Contractual maturities and yields on our investments are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.   December 31, 2020 Less Than One Year One to Five Years Five to Ten Years Over Ten Years   Total (dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Available for Sale US government agencies $ - - $ 2,501 0.37 % $ 2,995 1.07 % $ 997 1.48 % $ 6,493 0.86 % SBA securities - - - - - - 485 0.98 % 485 0.98 % State and political subdivisions - - 470 2.13 % 3,053 1.98 % 15,865 2.23 % 19,388 2.18 % Asset-backed securities - - - - 1,983 1.17 % 9,546 1.00 % 11,529 1.03 % Mortgage-backed securities - - 2,044 1.77 % 9,544 1.74 % 45,246 1.36 % 56,834 1.44 % Total $ - - $ 5,015 1.10 % $ 17,575 1.60 % $ 72,139 1.50 % $ 94,729 1.50 % Other investments are comprised of the following and are recorded at cost which approximates fair value.   December 31, (dollars in thousands) 2020 2019 Federal Home Loan Bank stock $ 3,103 6,386 Other investments 129 159 Investment in Trust Preferred subsidiaries 403 403 Total $ 3,635 6,948 Loans Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Average loans for the years ended December 31, 2020 and 2019 were $2.11 billion and $1.81 billion, respectively. Before allowance for loan losses, total loans outstanding at December 31, 2020 and 2019 were $2.14 billion and $1.94 billion, respectively. The principal component of our loan portfolio is loans secured by real estate mortgages. As of December 31, 2020, our loan portfolio included $1.81 billion, or 84.6%, of real estate loans, compared to $1.61 billion, or 82.8%, as of December 31, 2019. Most of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types. In addition to traditional residential mortgage loans, we issue second mortgage residential real estate loans and home equity lines of credit. Home equity lines of credit totaled $157.0 million as of December 31, 2020, of which approximately 45% were in a first lien position, while the remaining balance was second liens, compared to $179.7 million as of December 31, 2019, of which approximately 44% were in first lien positions and the remaining balance was in second liens. The average home equity loan had a balance of approximately $83,000 and a loan to value of approximately 62% as of December 31, 2020, compared to an average loan balance of $90,000 and a loan to value of approximately 68% as of December 31, 2019. Further, 0.2% and 0.4% of our total home equity lines of credit were over 30 days past due as of December 31, 2020 and 2019, respectively. Following is a summary of our loan composition for each of the five years ended December 31, 2020. Of the $199.3 million in loan growth in 2020, $89.3 million of growth was in commercial related loans, while $110.0 million of growth was in consumer related loans, specifically consumer real estate mortgages which grew by $138.1 million during 2020. The increase in consumer real estate loans is related to our focus to continue to originate high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $429,000, a term of nineteen years, and an average rate of 3.82%. 57 Table of Contents   December 31, 2020 2019 2018 2017 2016 %of %of %of %of %of (dollars in thousands) Amount Total Amount Total Amount Total Amount Total Amount Total Commercial Owner occupied RE $ 433,320 20.2 % $ 407,851 21.0 % $ 367,018 21.9 % $ 316,818 22.8 % $ 285,938 24.6 % Non-owner occupied RE 585,269 27.3 % 501,878 25.8 % 404,296 24.1 % 312,798 22.6 % 239,574 20.6 % Construction 61,467 2.9 % 80,486 4.1 % 84,411 5.0 % 51,179 3.7 % 33,393 2.9 % Business 307,599 14.4 % 308,123 15.9 % 272,980 16.3 % 226,158 16.3 % 202,552 17.4 % Total commercial loans 1,387,655 64.8 % 1,298,338 66.8 % 1,128,705 67.3 % 906,953 65.4 % 761,457 65.5 % Consumer Real estate 536,311 25.0 % 398,245 20.5 % 320,943 19.1 % 273,050 19.7 % 215,588 18.5 % Home equity 156,957 7.3 % 179,738 9.3 % 165,937 9.9 % 156,141 11.3 % 137,105 11.8 % Construction 40,525 1.9 % 41,471 2.1 % 37,925 2.3 % 28,351 2.0 % 31,922 2.7 % Other 21,419 1.0 % 25,733 1.3 % 23,822 1.4 % 22,575 1.6 % 17,572 1.5 % Total consumer loans 755,212 35.2 % 645,187 33.2 % 548,627 32.7 % 480,117 34.6 % 402,187 34.5 % Total gross loans, net of deferred fees   2,142,867 100.0 % 1,943,525 100.0 % 1,677,332 100.0 % 1,387,070 100.0 % 1,163,644 100.0 % Less – allowance for loan losses (44,149 ) (16,642 ) (15,762 ) (15,523 ) (14,855 ) Total loans, net $ 2,098,718 $ 1,926,883 $ 1,661,570 $ 1,371,547 $ 1,148,789 Maturities and Sensitivity of Loans to Changes in Interest Rates The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties. The following table summarizes the loan maturity distribution by type and related interest rate characteristics.   December 31, 2020 After one One year but within After five (dollars in thousands) or less five years years Total Commercial Owner occupied RE $ 22,232 136,031 275,057 433,320 Non-owner occupied RE 39,359 335,249 210,661 585,269 Construction 21,824 15,785 23,858 61,467 Business 76,662 140,959 89,978 307,599 Total commercial loans 160,077 628,024 599,554 1,387,655 Consumer Real estate 14,205 54,863 467,243 536,311 Home equity 4,824 23,835 128,298 156,957 Construction 1,629 1,234 37,662 40,525 Other 6,438 11,413 3,568 21,419 Total consumer loans 27,096 91,345 636,771 755,212 Total gross loan, net of deferred fees $ 187,173 719,369 1,236,325 2,142,867 Loans maturing – after one year with Fixed interest rates $ 1,590,171 Floating interest rates 365,523 58 Table of Contents Nonperforming Assets Nonperforming assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans for the five years ended December 31, 2020. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. As of December 31, 2020 and 2019, we had no loans 90 days past due and still accruing.   December 31, dollars in thousands) 2020 2019 2018 2017 2016 Commercial Owner occupied RE $ - - - - 276 Non-owner occupied RE 1,143 188 210 1,581 2,711 Construction 139 - - - - Business 195 235 81 910 686 Consumer Real estate 2,536 1,829 1,980 992 550 Home equity 547 431 1,006 1,144 256 Construction - - - - - Other - - 12 1 13 Nonaccruing troubled debt restructurings (TDRs) 3,509 4,111 2,541 2,673 990 Total nonaccrual loans, including nonaccruing TDRs 8,069 6,794 5,830 7,301 5,482 Other real estate owned 1,169 - - 242 639 Total nonperforming assets $ 9,238 6,794 5,830 7,543 6,121 Nonperforming assets as a percentage of: Total assets 0.37% 0.30% 0.31% 0.46% 0.46% Gross loans 0.43% 0.35% 0.35% 0.54% 0.53% Total loans over 90 days past due (1) $ 2,296 2,038 458 2,027 1,984 Loans over 90 days past due and still accruing - - - - - Accruing troubled debt restructurings 4,893 5,219 6,742 5,145 5,675   (1) Loans over 90 days are included in nonaccrual loans At December 31, 2020, nonperforming assets were $9.2 million, or 0.37% of total assets and 0.43% of gross loans, compared to $6.8 million, or 0.30% of total assets and 0.35% of gross loans at December 31, 2019. Nonaccrual loans increased $1.3 million to $8.1 million at December 31, 2020 from $6.8 million at December 31, 2019. During 2020, we added $10.0 million (consisting of 27 new loans) to nonaccrual, removed eight loans totaling $4.8 million that were paid off, transferred 1 loan totaling $2.2 million to other real estate owned and charged off $1.3 million of nonaccrual loans. The amount of foregone interest income on the nonaccrual loans for the years ended December 31, 2020 and 2019 was approximately $61,000 and $23,000, respectively. At December 31, 2020, our allowance for loan losses represented 547.08% of nonaccrual loans, compared to 245.0% at year-end 2019 and 270.4% at year-end 2018. A significant portion, or 97.6%, of nonaccrual loans at December 31, 2020 were secured by real estate. We have evaluated the underlying collateral on these loans and believe that the collateral on these loans is sufficient to minimize future losses. As a result of this level of coverage on nonaccrual loans, we believe the allowance for loan losses of $44.1 million for the year ended December 31, 2020 is adequate. As a general practice, most of our commercial loans and a portion of our consumer loans are originated with relatively short maturities of less than ten years. As a result, when a loan reaches its maturity we frequently renew the loan and thus extend its maturity using similar credit standards as those used when the loan was first originated. Due to these loan practices, we may, at times, renew loans which are classified as nonaccrual after evaluating the loan’s collateral value and financial strength of its guarantors. Nonaccrual loans are renewed at terms generally consistent with the ultimate source of repayment and rarely at reduced rates. In these cases, we will generally seek additional credit enhancements, such as additional collateral or additional guarantees to further protect the loan. When a loan is no longer performing in accordance with its stated terms, we will typically seek performance under the guarantee. 59 Table of Contents In addition, approximately 85% of our loans are collateralized by real estate and approximately 89% of our impaired loans are secured by real estate. We use third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require us to review impaired loans at least annually and determine whether it is necessary to obtain an updated appraisal, either through a new external appraisal or an internal appraisal evaluation. We individually review our impaired loans on a quarterly basis to determine the level of impairment. As of December 31, 2020, we do not have any impaired loans carried at a value in excess of the appraised value. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. At December 31, 2020, impaired loans totaled approximately $13.0 million for which $5.1 million of these loans have a reserve of approximately $1.7 million allocated in the allowance. During 2020, the average recorded investment in impaired loans was approximately $14.6 million. At December 31, 2019, impaired loans totaled approximately $12.0 million for which $4.7 million of these loans had a reserve of approximately $1.4 million allocated in the allowance. During 2019, the average recorded investment in impaired loans was approximately $12.3 million. We consider a loan to be a TDR when the debtor experiences financial difficulties and we provide concessions such that we will not collect all principal and interest in accordance with the original terms of the loan agreement. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. As of December 31, 2020 and 2019, we had $8.4 million and $9.3 million, respectively, in loans that we considered TDRs. As permitted by the CARES Act, we do not consider loan modifications to borrowers affected by COVID-19 to be TDRs unless the borrower was 30 days or more past due before December 31, 2019. See Notes 1 and 5 to the Consolidated Financial Statements for additional information on TDRs. In addition, potential problem loans, which are loans rated substandard and not included in nonperforming loans or TDRs, amounted to approximately $19.6 million, or 0.92% of gross loans at December 31, 2020, compared to $9.0 million, or 0.46% of gross loans at December 31, 2019. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. The increase in potential problem loans since December 31, 2019 is primarily the result of two loans that increased total potential problem loans by approximately $13.5 million, partially offset by one loan partially charged-off and transferred to other real estate owned (“OREO”). Allowance for Loan Losses At December 31, 2020 and December 31, 2019, the allowance for loan losses was $44.1 million and $16.6 million, respectively, or 2.06% and 0.86% of outstanding loans, respectively. The allowance for loan losses as a percentage of our outstanding loan portfolio increased from the prior year primarily due to an increase to our qualitative environmental factors related to the uncertain economic and business conditions at the national, regional and local levels at December 31, 2020. Factors such as the continued impact on the tourism and hospitality industries due to the pandemic, an increase in permanent job losses and unemployment rates as well as uncertainty in the political realm have driven this increase. We expect economic uncertainty to continue for at least the next few quarters which may result in a continued increase to the allowance for loan losses during 2021. Our nonperforming assets as a percentage of total assets increased to 0.37% at December 31, 2020 compared to 0.30% at December 31, 2019 and our classified assets increased to 8.2% of capital as of December 31, 2020, compared to 7.9% of capital as of December 31, 2019. See Note 4 to the Consolidated Financial Statements for more information on our allowance for loan losses. 60 Table of Contents The following table summarizes the activity related to our allowance for loan losses for the five years ended December 31, 2020.   Year ended December 31, (dollars in thousands) 2020 2019 2018 2017 2016 Balance, beginning of period $ 16,642 15,762 15,523 14,855 13,629 Provision for loan losses 29,600 2,300 1,900 2,000 2,300 Loan charge-offs: Commercial Owner occupied RE (94 ) (110 ) - - (5 ) Non-owner occupied RE (1,508 ) (239 ) (432 ) (589 ) (100 ) Construction - - - - (42 ) Business (1,309 ) (910 ) (695 ) (638 ) (1,031 ) Total commercial (2,911 ) (1,259 ) (1,127 ) (1,227 ) (1,178 ) Consumer Real estate (134 ) - (826 ) - (194 ) Home equity (299 ) (174 ) (140 ) (400 ) (66 ) Construction - - - - - Other (70 ) (82 ) (53 ) (11 ) (210 ) Total consumer (503 ) (256 ) (1,019 ) (411 ) (470 ) Total loan charge-offs (3,414 ) (1,515 ) (2,146 ) (1,638 ) (1,648 ) Loan recoveries: Commercial Owner occupied RE 65 - - - - Non-owner occupied RE 670 2 132 119 155 Construction - - - - - Business 470 43 229 86 403 Total commercial 1,205 45 361 205 558 Consumer Real estate 18 37 5 86 10 Home equity 69 2 115 13 1 Construction - - - - - Other 29 11 4 2 5 Total consumer 116 50 124 101 16 Total recoveries 1,321 95 485 306 574 Net loan charge-offs (2,093 ) (1,420 ) (1,661 ) (1,332 ) (1,074 ) Balance, end of period $ 44,149 16,642 15,762 15,523 14,855 Allowance for loan losses to gross loans 2.06% 0.86% 0.94% 1.12% 1.28% Net charge-offs to average loans 0.10% 0.08% 0.11% 0.10% 0.10% Deposits and Other Interest-Bearing Liabilities Our primary source of funds for loans and investments is our deposits and advances from the FHLB. In the past, we have chosen to obtain a portion of our certificates of deposits from areas outside of our market in order to obtain longer term deposits than are readily available in our local market. Our internal guidelines regarding the use of brokered CDs limit our brokered CDs to 20% of total deposits. In addition, we do not obtain time deposits of $100,000 or more through the Internet. These guidelines allow us to take advantage of the attractive terms that wholesale funding can offer while mitigating the related inherent risk. Our retail deposits represented $2.12 billion, or 99.0% of total deposits at December 31, 2020, while our out-of-market, or brokered deposits, represented $22.0 million, or 1.0% of our total deposits at December 31, 2020. At December 31, 2019, retail deposits represented $1.81 billion, or 96.4% of our total deposits, and brokered deposits were $67.4 million, representing 3.6% of our total deposits, at December 31, 2019. Our loan-to-deposit ratio was 100%, 104%, and 102% at December 31, 2020, 2019, and 2018, respectively. 61 Table of Contents The following table shows the average balance amounts and the average rates paid on deposits held by us.   December 31, 2020 2019 2018 (dollars in thousands) Amount Rate Amount Rate Amount Rate Noninterest bearing demand deposits $ 513,576 - % $ 367,674 - % $ 298,709 - % Interest bearing demand deposits 255,514 0.14 % 205,513 0.27 % 235,623 0.17 % Money market accounts 981,226 0.76 % 849,225 1.78 % 653,436 1.34 % Savings accounts 22,113 0.05 % 15,483 0.06 % 15,870 0.05 % Time deposits less than $100,000 41,406 1.40 % 58,043 1.88 % 60,032 1.43 % Time deposits greater than $100,000 259,672 1.27 % 305,388 1.72 % 272,169 1.77 % Total deposits $ 2,073,507 0.57 % $ 1,801,326 1.22 % $ 1,535,839 0.97 % During the 12 months ended December 31, 2020, our average transaction account balances increased by $334.5 million, or 23.3%, while our average time deposit balances decreased by $62.4 million, or 17.2%. Core deposits exclude out-of-market deposits and time deposits of $250,000 or more and provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $2.01 billion, $1.66 billion, and $1.43 billion at December 31, 2020, 2019 and 2018, respectively. All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $100,000 or more is as follows:   December 31, (dollars in thousands) 2020 2019 Three months or less $ 83,606 85,130 Over three through six months 35,565 58,721 Over six through twelve months 48,083 91,867 Over twelve months 23,702 51,273 Total $ 190,956 286,991 Included in time deposits of $100,000 or more at December 31, 2020 is $22.0 million of wholesale CDs scheduled to mature within the next 12 months at a weighted average rate of 2.10%. Time deposits that meet or exceed the FDIC insurance limit of $250,000 at December 31, 2020 and December 31, 2019 were $130.9 million and $220.1 million, respectively. Liquidity and Capital Resources Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control. At December 31, 2020 and 2019, our cash and cash equivalents amounted to $100.7 million and $127.8 million, or 4.1% and 5.6% of total assets, respectively. Our investment securities at December 31, 2020 and 2019 amounted to $98.4 million and $74.6 million, or 4.0% and 3.3% of total assets, respectively. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain five federal funds purchased lines of credit with correspondent banks totaling $118.5 million for which there were no borrowings against the lines at December 31, 2020. We are also a member of the FHLB of Atlanta, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at December 31, 2020 was $512.5 million, based on the Bank’s $3.1 million investment in FHLB stock, as well as qualifying mortgages available to secure any future borrowings. However, we are able to pledge additional securities to the FHLB in order to increase our available borrowing capacity. In addition, at December 31, 2020 we had $206.2 million of letters of credit outstanding with the FHLB to secure client deposits. 62 Table of Contents We also have a line of credit with another financial institution for $15.0 million, which was unused at December 31, 2020. The line of credit bears interest at LIBOR plus 3.50% and matures on December 31, 2021. We believe that our existing stable base of core deposits, federal funds purchased lines of credit with correspondent banks, and borrowings from the FHLB will enable us to successfully meet our long-term liquidity needs. However, as short-term liquidity needs arise, we have the ability to sell a portion of our investment securities portfolio to meet those needs. Total shareholders’ equity was $228.3 million at December 31, 2020 and $205.9 million at December 31, 2019. The $22.4 million increase during 2020 is due primarily to net income to common shareholders of $18.3 million, stock option exercises and expenses of $2.8 million and $1.3 million in other comprehensive income. The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), equity to assets ratio (average equity divided by average assets), and tangible common equity ratio (total equity less preferred stock divided by total assets) for the three years ended December 31, 2020. Since our inception, we have not paid cash dividends.   December 31, (dollars in thousands) 2020 2019 2018 Return on average assets 0.76% 1.35% 1.27% Return on average equity 8.49% 14.72% 13.83% Return on average common equity 8.49% 14.72% 13.83% Average equity to average assets ratio 9.01% 9.16% 9.15% Tangible common equity to assets ratio 9.20% 9.08% 9.15% Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio. Regulatory capital rules adopted in July 2013 and fully-phased in as of January 1, 2019, which we refer to Basel III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies other than “small bank holding companies,” generally holding companies with consolidated assets of less than $3 billion (such as the Company). In order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of our minimum risk-based capital requirements. This buffer must consist solely of common equity Tier 1, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer consists of an additional amount of CET1 equal to 2.5% of risk-weighted assets. To be considered “well-capitalized” for purposes of certain rules and prompt corrective action requirements, the Bank must maintain a minimum total risked-based capital ratio of at least 10%, a total Tier 1 capital ratio of at least 8%, a common equity Tier 1 capital ratio of at least 6.5%, and a leverage ratio of at least 5%. As of December 31, 2020, our capital ratios exceed these ratios and we remain “well capitalized.” 63 Table of Contents The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements. See Note 23 to the Consolidated Financial Statements for ratios of the Company.   To be well capitalized under prompt For capital corrective adequacy purposes action provisions Actual minimum (1) minimum (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio As of December 31, 2020 Total Capital (to risk weighted assets) $ 279,414 13.92 % $ 160,554 8.00 % $ 200,693 10.00 % Tier 1 Capital (to risk weighted assets) 254,092 12.66 % 120,416 6.00 % 160,554 8.00 % Common Equity Tier 1 (to risk weighted assets) 254,092 12.66 % 90,312 4.50 % 130,451 6.50 % Tier 1 Capital (to average assets) 254,092 10.26 % 99,094 4.00 % 123,867 5.00 %   As of December 31, 2019 Total Capital (to risk weighted assets) $ 250,847 13.31 % $ 150,807 8.00 % $ 188,510 10.00 % Tier 1 Capital (to risk weighted assets) 234,205 12.42 % 113,106 6.00 % 150,807 8.00 % Common Equity Tier 1 (to risk weighted assets) 234,205 12.42 % 84,829 4.50 % 122,531 6.50 % Tier 1 Capital (to average assets) 234,205 10.80 % 86,772 4.00 % 108,465 5.00 %   As of December 31, 2018 Total Capital (to risk weighted assets) 198,195 12.16 % 130,368 8.00 % 162,960 10.00 % Tier 1 Capital (to risk weighted assets) 182,433 11.20 % 97,776 6.00 % 130,368 8.00 % Common Equity Tier 1 (to risk weighted assets) 182,433 11.20 % 73,332 4.50 % 105,924 6.50 % Tier 1 Capital (to average assets) 182,433 9.84 % 74,126 4.00 % 92,658 5.00 %   1 Ratios do not include the capital conservation buffer of 2.5% in 2020 and 2019 and 1.875% in 2018. On September 30, 2019, the Company sold and issued $23.0 million in aggregate principal amount of its 4.75% Fixed-to-Floating Rate Subordinated Notes due 2029 to eligible purchasers in a private offering. The Company intends to use the proceeds from the offering, which were approximately $22.5 million, for general corporate purposes, including providing capital to the Bank and supporting organic growth. The Notes rank junior in right to payment to the Company’s current and future senior indebtedness. The Notes are intended to qualify as Tier 2 capital for regulatory capital purposes for the Company. The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. Effect of Inflation and Changing Prices The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles. Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation. Off-Balance Sheet Risk Commitments to extend credit are agreements to lend to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2020, unfunded commitments to extend credit were approximately $480.1 million, of which $114.6 million were at fixed rates and $365.5 million were at variable rates. At December 31, 2019, unfunded commitments to extend credit were $426.6 million, of which approximately $105.0 million were at fixed rates and $321.7 million were at variable rates. A majority of the unfunded commitments related to commercial business lines of credit and home equity lines of credit. Based on historical experience, we anticipate that a significant portion of these lines of credit will not be funded. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. 64 Table of Contents At December 31, 2020 and 2019, there were $8.7 million and $9.9 million of commitments under letters of credit, respectively. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements. Except as disclosed in this Annual Report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings. Market Risk and Interest Rate Sensitivity Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business. We actively monitor and manage our interest rate risk exposure in order to control the mix and maturities of our assets and liabilities utilizing a process we call asset/liability management. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our asset/liability management committee (“ALCO”) monitors and considers methods of managing exposure to interest rate risk. We have both an internal ALCO consisting of senior management that meets at various times during each month and a board ALCO that meets monthly. The ALCOs are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits. As of December 31, 2020, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and downward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market conditions.   Change in net interest Interest rate scenario income from base Up 300 basis points 15.22% Up 200 basis points 10.18% Up 100 basis points 5.12% Base - Down 100 basis points (3.41)% Down 200 basis points (5.30)% Down 300 basis points (6.81)% Contractual Obligations We utilize a variety of short-term and long-term borrowings to supplement our supply of lendable funds, to assist in meeting deposit withdrawal requirements, and to fund growth of interest-earning assets in excess of traditional deposit growth. Certificates of deposit, structured repurchase agreements, FHLB advances, and subordinated debentures serve as our primary sources of such funds. Obligations under noncancelable operating lease agreements are payable over several years with the longest obligation expiring in 2029. We do not feel that any existing noncancelable operating lease agreements are likely to materially impact our financial condition or results of operations in an adverse way. Contractual obligations relative to these agreements 65 Table of Contents are noted in the table below. Option periods that we have not yet exercised are not included in this analysis as they do not represent contractual obligations until exercised. The following table provides payments due by period for obligations under long-term borrowings and operating lease obligations as of December 31, 2020.   December 31, 2020 Payments Due by Period Over One Over Two Over Three After Within to Two to Three to Four Five (dollars in thousands) One Year Years Years Years Years Total Certificates of deposit $ 200,657 13,244 8,373 2,370 2,766 227,410 FHLB advances and other borrowings 25,000 - - - - 25,000 Subordinated debentures - - - - 36,403 36,403 Operating lease obligations 2,335 1,587 1,462 1,501 17,430 24,315 Total $ 227,992 14,831 9,835 3,871 56,599 313,128 Accounting, Reporting, and Regulatory Matters See Note 1 – Summary of Significant Accounting Policies and Activities in our “Notes to Consolidated Financial Statements” for a discussion on the effects of recently issued accounting pronouncements. Item 7A. Quantitative and Qualitative Disclosures about Market Risk See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk and Interest Rate Sensitivity and – Liquidity and Capital Resources. 66 Table of Contents