SOUTHERN FIRST BANCSHARES INC 10-Q

Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2022 OR ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission file number 000-27719 Southern First Bancshares, Inc. (Exact name of registrant as specified in its charter) South Carolina 58-2459561 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 100 Verdae Boulevard , Suite 100 Greenville , S.C. 29607 (Address of principal executive offices) (Zip Code) 864-679-9000 (Registrant’s telephone number, including area code) Not Applicable (Former name, former address, and former fiscal year, if changed since last report) Securities registered pursuant to Section 12(b) of the Act: Title of each class Trading Symbol(s) Name of each exchange on which registered Common Stock SFST The Nasdaq Global Market Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ☐ Accelerated filer ☒ Non-accelerated filer ☐ Smaller Reporting Company ☐ Emerging growth company ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,983,269 shares of common stock, par value $0.01 per share, were issued and outstanding as of April 28, 2022. Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY March 31, 2022 Form 10-Q INDEX Page PART I – CONSOLIDATED FINANCIAL INFORMATION 1 Item 1. Consolidated Financial Statements 1 Consolidated Balance Sheets 1 Consolidated Statements of Income 2 Consolidated Statements of Comprehensive Income 3 Consolidated Statements of Shareholders’ Equity 4 Consolidated Statements of Cash Flows 5 Notes to Unaudited Consolidated Financial Statements 6 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27 Item 3. Quantitative and Qualitative Disclosures about Market Risk 41 Item 4. Controls and Procedures 42 PART II – OTHER INFORMATION 43 Item 1. Legal Proceedings 43 Item 1A. Risk Factors 43 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 43 Item 3. Defaults upon Senior Securities 43 Item 4. Mine Safety Disclosures 43 Item 5. Other Information 43 Item 6. Exhibits 44 i Table of Contents PART I. CONSOLIDATED FINANCIAL INFORMATION Item 1. CONSOLIDATED FINANCIAL STATEMENTS SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS March 31, December 31, (dollars in thousands, except share data) 2022 2021 (Unaudited) (Audited) ASSETS Cash and cash equivalents: Cash and due from banks $ 20,992 21,770 Federal funds sold 95,093 86,882 Interest-bearing deposits with banks 33,131 58,557 Total cash and cash equivalents 149,216 167,209 Investment securities: Investment securities available for sale 106,978 120,281 Other investments 4,104 4,021 Total investment securities 111,082 124,302 Mortgage loans held for sale 17,840 13,556 Loans 2,660,675 2,489,877 Less allowance for credit losses ( 32,944 ) ( 30,408 ) Loans, net 2,627,731 2,459,469 Bank owned life insurance 50,148 49,833 Property and equipment, net 95,129 92,370 Deferred income taxes, net 10,635 8,397 Accrued interest receivable 7,627 7,624 Other assets 3,232 2,788 Total assets $ 3,072,640 2,925,548 LIABILITIES Deposits $ 2,708,174 2,563,826 Subordinated debentures 36,133 36,106 Other liabilities 49,809 47,715 Total liabilities 2,794,116 2,647,647 SHAREHOLDERS’ EQUITY Preferred stock, par value $ .01 per share, 10,000,000 shares authorized - - Common stock, par value $ .01 per share, 10,000,000 shares authorized, 7,980,519 and 7,925,819 shares issued and outstanding at March 31, 2022 and December 31, 2021, respectively 80 79 Nonvested restricted stock ( 3,425 ) ( 1,435 ) Additional paid-in capital 117,286 114,226 Accumulated other comprehensive loss ( 6,393 ) ( 740 ) Retained earnings 170,976 165,771 Total shareholders’ equity 278,524 277,901 Total liabilities and shareholders’ equity $ 3,072,640 2,925,548 See notes to consolidated financial statements that are an integral part of these consolidated statements. 1 Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (Unaudited) For the three months ended March 31, (dollars in thousands, except share data) 2022 2021 Interest income Loans $ 23,931 22,465 Investment securities 474 301 Federal funds sold and interest-bearing deposits with banks 59 47 Total interest income 24,464 22,813 Interest expense Deposits 908 1,155 Borrowings 392 385 Total interest expense 1,300 1,540 Net interest income 23,164 21,273 Provision for (reversal of) credit losses 1,105 ( 300 ) Net interest income after provision for credit losses 22,059 21,573 Noninterest income Mortgage banking income 1,494 4,633 Service fees on deposit accounts 191 185 ATM and debit card income 528 470 Income from bank owned life insurance 315 267 Other income 399 349 Total noninterest income 2,927 5,904 Noninterest expenses Compensation and benefits 8,144 6,683 Mortgage production costs 1,649 2,867 Occupancy 1,777 1,637 Other real estate owned expenses - 387 Outside service and data processing costs 1,411 1,142 Insurance 261 301 Professional fees 496 421 Marketing 256 182 Other 691 542 Total noninterest expenses 14,685 14,162 Income before income tax expense 10,301 13,315 Income tax expense 2,331 2,949 Net income $ 7,970 10,366 Earnings per common share Basic $ 1.00 1.33 Diluted 0.98 1.31 Weighted average common shares outstanding Basic 7,931,855 7,774,515 Diluted 8,096,310 7,908,537 See notes to consolidated financial statements that are an integral part of these consolidated statements. 2 Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) For the three months ended March 31, (dollars in thousands) 2022 2021 Net income $ 7,970 10,366 Other comprehensive income: Unrealized gain (loss) on securities available for sale: Unrealized holding loss arising during the period, pretax ( 7,141 ) ( 1,409 ) Tax benefit 1,500 296 Reclassification of realized gain ( 15 ) - Tax benefit 3 - Other comprehensive loss ( 5,653 ) ( 1,113 ) Comprehensive income $ 2,317 9,253 See notes to consolidated financial statements that are an integral part of these consolidated statements. 3 Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited) For the three months ended March 31, Common stock Preferred stock Nonvested restricted Additional paid-in Accumulated other comprehensive Retained (dollars in thousands, except share data) Shares Amount Shares Amount stock capital income (loss) earnings Total December 31, 2020 7,772,748 $ 78 - $ - $ ( 698 ) $ 108,831 $ 1,023 $ 119,060 $ 228,294 Net income - - - - - - - 10,366 10,366 Proceeds from exercise of stock options 69,598 1 - - - 1,577 - - 1,578 Issuance of restricted stock 10,750 - - - ( 477 ) 477 - - - Compensation expense related to restricted stock, net of tax - - - - 100 - - - 100 Compensation expense related to stock options, net of tax - - - - - 296 - - 296 Other comprehensive loss - - - - - - ( 1,113 ) - ( 1,113 ) March 31, 2021 7,853,096 $ 79 - $ - $ ( 1,075 ) $ 111,181 $ ( 90 ) $ 129,426 $ 239,521 December 31, 2021 7,925,819 $ 79 - $ - $ ( 1,435 ) $ 114,226 $ ( 740 ) $ 165,771 $ 277,901 Net income - - - - - - - 7,970 7,970 Proceeds from exercise of stock options 18,125 - - - - 579 - - 579 Issuance of restricted stock 36,575 1 - - ( 2,235 ) 2,234 - - - Adoption of ASU 2016-13 - - - - - - - ( 2,765 ) ( 2,765 ) Compensation expense related to restricted stock, net of tax - - - - 245 - - - 245 Compensation expense related to stock options, net of tax - - - - - 247 - - 247 Other comprehensive loss - - - - - - ( 5,653 ) - ( 5,653 ) March 31, 2022 7,980,519 $ 80 - $ - $ ( 3,425 ) $ 117,286 $ ( 6,393 ) $ 170,976 $ 278,524 See notes to consolidated financial statements that are an integral part of these consolidated statements. 4 Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the three months ended March 31, (dollars in thousands) 2022 2021 Operating activities Net income $ 7,970 10,366 Adjustments to reconcile net income to cash provided by operating activities: Provision for (reversal of) credit losses 1,105 ( 300 ) Depreciation and other amortization 583 551 Accretion and amortization of securities discounts and premium, net 210 232 Loss on sale of real estate owned - 380 Gain on sale of fixed assets - ( 10 ) Gain on sale of securities ( 15 ) - Net change in operating leases 108 121 Compensation expense related to stock options and restricted stock grants 492 396 Gain on sale of loans held for sale ( 899 ) ( 4,813 ) Loans originated and held for sale ( 75,729 ) ( 173,380 ) Proceeds from sale of loans held for sale 72,344 181,377 Increase in cash surrender value of bank owned life insurance ( 315 ) ( 267 ) Decrease in deferred tax asset - 1 Decrease (increase) in accrued interest receivable ( 3 ) 499 Decrease (increase) in other assets ( 444 ) ( 123 ) Increase (decrease) in other liabilities 2,460 ( 4,461 ) Net cash provided by operating activities 7,867 10,569 Investing activities Increase (decrease) in cash realized from: Increase in loans, net ( 170,787 ) ( 41,165 ) Purchase of property and equipment ( 5,869 ) ( 2,609 ) Purchase of investment securities: Available for sale ( 10,094 ) ( 5,366 ) Other investments ( 2,265 ) - Payments and maturities, calls and repayments of investment securities: Available for sale 16,046 5,458 Other investments 2,182 1,862 Purchase of bank owned life insurance - ( 7,500 ) Proceeds from sale of fixed assets - 50 Proceeds from sale of other real estate owned - 788 Net cash used for investing activities ( 170,787 ) ( 48,482 ) Financing activities Increase (decrease) in cash realized from: Increase in deposits, net 144,348 115,993 Decrease in Federal Home Loan Bank advances and other borrowings, net - ( 25,000 ) Proceeds from the exercise of stock options 579 1,578 Net cash provided by financing activities 144,927 92,571 Net increase (decrease) in cash and cash equivalents ( 17,993 ) 54,658 Cash and cash equivalents at beginning of the period 167,209 100,687 Cash and cash equivalents at end of the period $ 149,216 155,345 Supplemental information Cash paid for Interest $ 1,789 2,767 Income taxes - - Schedule of non-cash transactions Unrealized loss on securities, net of income taxes ( 5,653 ) ( 1,113 ) See notes to consolidated financial statements that are an integral part of these consolidated statements. 5 Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 – Summary of Significant Accounting Policies Nature of Business Southern First Bancshares, Inc. (the “Company”) is a South Carolina corporation that owns all of the capital stock of Southern First Bank (the “Bank”) and all of the stock of Greenville First Statutory Trusts I and II (collectively, the “Trusts”). The Trusts are special purpose non-consolidated entities organized for the sole purpose of issuing trust preferred securities. The Bank’s primary federal regulator is the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is also regulated and examined by the South Carolina Board of Financial Institutions. The Bank is primarily engaged in the business of accepting demand deposits and savings deposits insured by the FDIC, and providing commercial, consumer and mortgage loans to the general public. Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 4, 2022. The consolidated financial statements include the accounts of the Company and the Bank. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation,” the financial statements related to the Trusts have not been consolidated. Business Segments In determining proper segment definition, the Company considers the materiality of a potential segment and components of the business about which financial information is available and regularly evaluated, relative to a resource allocation and performance assessment. The Company accounts for intersegment revenues and expenses as if the revenue/expense transactions were generated to third parties, that is, at current market prices. Please refer to “Note 10 – Reportable Segments” for further information on the reporting for the Company’s three business segments. Use of Estimates The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, real estate acquired in the settlement of loans, fair value of financial instruments, evaluating other-than-temporary-impairment of investment securities and valuation of deferred tax assets. Risks and Uncertainties The impact of the coronavirus (COVID-19) pandemic is fluid and continues to evolve, adversely affecting many of the Bank’s clients. While vaccine availability and uptake has increased, the longer-term macro-economic effects on global supply chains, inflation, labor shortages and wage increases continue to impact many industries. 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 increases in new COVID-19 cases, hospitalizations and deaths leading to additional government imposed restrictions; refusals to receive the vaccines along with concerns related to new strains of the virus; supply chain issues remaining unresolved longer than anticipated; labor shortages; decreases in consumer confidence and spending; and rising geopolitical tensions. 6 Table of Contents The Company’s business, financial condition and results of operations generally rely upon the ability of the Bank’s borrowers to repay their loans, the value of collateral underlying the Bank’s secured loans, and demand for loans and other products and services the Bank offers, which are highly dependent on the business environment in the Bank’s primary markets where it operates and in the United States as a whole. As of March 31, 2022, the Company’s and the Bank’s capital ratios were in excess of all regulatory requirements. While management believes 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. The Company maintains 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 subsidiary bank. As of March 31, 2022, the $ 15.0 million line was unused. Reclassifications Certain amounts, previously reported, have been reclassified to state all periods on a comparable basis and had no effect on shareholders’ equity or net income. Subsequent Events Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Adoption of New Accounting Standard In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326). The ASU introduces a new credit loss methodology, the Current Expected Credit Loss (“CECL”) methodology, which requires earlier recognition of credit losses, while also providing additional transparency about credit risk. Since its original issuance in 2016, the FASB has issued several updates to the original ASU. The CECL methodology utilizes a lifetime “expected credit loss” measurement objective for the recognition of credit losses for loans, held-to-maturity securities and other receivables at the time the financial asset is originated or acquired. It also applies to off-balance sheet credit exposures, such as unfunded commitments to extend credit. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The methodology replaces the multiple existing impairment methods in current GAAP, which generally require that a loss be incurred before it is recognized. For available-for-sale securities where fair value is less than cost, credit-related impairment, if any, is recognized through an allowance for credit losses and adjusted each period for changes in credit risk. On January 1, 2022, the Company adopted the guidance prospectively with a cumulative adjustment to retained earnings. Results for reporting periods beginning after January 1, 2022 are presented under CECL while prior period amounts continue to be reported in accordance with the previously applicable incurred loss accounting methodology. The transition adjustment for the adoption of CECL included an increase in the allowance for credit losses on loans of $ 1.5 million and an increase in the reserve for unfunded loan commitments of $ 2.0 million, which is recorded within other liabilities. The adoption of CECL had an insignificant impact on the Company’s investment securities portfolio. The Company recorded a net decrease to retained earnings of $ 2.8 million as of January 1, 2022 for the cumulative effect of adopting CECL, which reflects the transition adjustments noted above, net of the applicable deferred tax assets recorded. Federal banking regulatory agencies provided optional relief to delay the adverse regulatory capital impact of CECL at adoption. The Company did not elect to use this optional relief. Significant Accounting Policy Changes Upon adoption of ASC 326, the Company revised the accounting policy for the Allowance for Credit Losses as detailed below. 7 Table of Contents Allowance for Credit Losses - Securities Available for Sale For available for sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or if it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance under CECL compared to a direct write down of the security under Incurred Loss. For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether any decline in fair value is due to credit loss factors. In making this assessment, management considers any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Changes in the allowance for credit losses under CECL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At March 31, 2022, there was no allowance for credit losses related to the available-for-sale portfolio. Accrued interest receivable on available for sale debt securities totaled $ 436,000 at March 31, 2022 and was excluded from the estimate of credit losses. Allowance for Credit Losses - Loans Under the current expected credit loss model, the allowance for credit losses on loans is a valuation allowance estimated at each balance sheet date in accordance with GAAP that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Management assesses the adequacy of the allowance on a quarterly basis. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay a loan, the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. Management believes the level of the allowance for credit losses is adequate to absorb all expected future losses inherent in the loan portfolio at the balance sheet date. The allowance is increased through provision for credit losses and decreased by charge-offs, net of recoveries of amounts previously charged-off. The allowance for credit losses is measured on a collective basis for pools of loans with similar risk characteristics. The Company has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses: Commercial loans ● Owner occupied real estate - Owner occupied commercial mortgages consist of loans to purchase or re-finance owner occupied nonresidential properties. This includes office buildings, other commercial facilities, and farmland. Commercial mortgages secured by owner occupied properties are primarily dependent on the ability of borrowers to achieve business results consistent with those projected at loan origination. While these loans and leases are collateralized by real property in an effort to mitigate risk, it is possible the liquidation of collateral will not fully satisfy the obligation. ● Non-owner occupied real estate - Non-owner occupied commercial mortgages consist of loans to purchase or refinance investment nonresidential properties. This includes office buildings and other facilities rented or leased to unrelated parties, as well as farmland and multifamily properties. The primary risk associated with income producing commercial mortgage loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. While these loans and leases are collateralized by real property in an effort to mitigate risk, it is possible the liquidation of collateral will not fully satisfy the obligation. 8 Table of Contents ● Construction - Construction loans consist of loans to finance land for development of commercial or residential real property and construction of multifamily apartments or other commercial properties. These loans are highly dependent on the supply and demand for commercial real estate as well as the demand for newly constructed residential homes and lots acquired for development. Deterioration in demand could result in decreased collateral values, which could make repayments of outstanding loans difficult for customers. ● Commercial business - Commercial business loans consist of loans or lines of credit to finance accounts receivable, inventory or other general business needs, business credit cards, and lease financing agreements for equipment, vehicles, or other assets. The primary risk associated with commercial and industrial and lease financing loans is the ability of borrowers to achieve business results consistent with those projected at origination. Failure to achieve these projections presents risk the borrower will be unable to service the debt consistent with the contractual terms of the loan or lease. Consumer loans ● Real estate - Residential mortgages consist of loans to purchase or refinance the borrower’s primary dwelling, second residence or vacation home and are often secured by 1-4 family residential property. Significant and rapid declines in real estate values can result in borrowers having debt levels in excess of the current market value of the collateral. ● Home equity – Home equity loans consist of home equity lines of credit and other lines of credit secured by first or second liens on the borrower’s primary residence. These loans are secured by both senior and junior liens on the residential real estate and are particularly susceptible to declining collateral values. This risk is elevated for loans secured by junior lines as a substantial decline in value could render the junior lien position effectively unsecured. ● Construction - Construction loans consist of loans to construct a borrower’s primary or secondary residence or vacant land upon which the owner intends to construct a dwelling at a future date. These loans are typically secured by undeveloped or partially developed land in anticipation of completing construction of a 1-4 family residential property. There is risk these construction and development projects can experience delays and cost overruns exceeding the borrower’s financial ability to complete the project. Such cost overruns can result in foreclosure of partially completed and unmarketable collateral. ● Other - Consumer loans consist of loans to finance unsecured home improvements, student loans, automobiles and revolving lines of credit that can be secured or unsecured. The value of the underlying collateral within this class is at risk of potential rapid depreciation which could result in unpaid balances in excess of the collateral. For all loan pools, the Company uses a lifetime probability of default and loss given default modeling approach to estimate the allowance for credit losses on loans. This method uses historical correlations between default experience and the age of loans to forecast defaults and losses, assuming that a loan in a pool shares similar risk characteristics such as loan product type, risk rating and loan age, and demonstrates similar default characteristics as other loans in that pool, as the loan progresses through its lifecycle. The Company calculates lifetime probability of default and loss given default rates based on historical loss experience, which is used to calculate expected losses based on the pool’s loss rate and the age of loans in the pool. Management believes that the Company’s historical loss experience provides the best basis for its assessment of expected credit losses to determine the allowance for credit losses. The Company uses its own internal data to measure historical credit loss experience within the pools with similar risk characteristics over an economic cycle. The probability of default and loss given default method also includes assumptions of observed migration over the lifetime of the underlying loan data. 9 Table of Contents Management also considers further adjustments to historical loss information for current conditions and reasonable and supportable forecasts that differ from the conditions that exist for the period over which historical information is evaluated as well as other changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative categories and the measurements used to quantify the risks within each of these categories are subjectively selected by management, but measured by objective measurements period over period. The data for each measurement may be obtained from internal or external sources. The current period measurements are evaluated and assigned a factor commensurate with the current level of risk relative to past measurements over time. The resulting qualitative adjustments are applied to the relevant collectively evaluated loan pools. These adjustments are based upon quarterly trend assessments in certain economic factors as well as associate retention and turnover, portfolio concentrations, and growth characteristics. The qualitative analysis increases or decreases the allowance allocation for each loan pool based on the assessment of factors described above. Loans that do not share similar risk characteristics with the collectively evaluated pools are evaluated on an individual basis and are excluded from the collectively evaluated loan pools. Individual loan evaluations are generally performed for impaired loans, which includes nonaccrual loans and loans modified in a troubled debt restructuring (“TDR”). Such loans are evaluated for credit losses based on either discounted cash flows or the fair value of collateral. The Company has elected the practical expedient under ASC 326 to estimate expected credit losses based on the fair value of collateral, which considers selling costs in the event sale of the collateral is expected. Loans for which terms have been modified in a TDR are evaluated using these same individual evaluation methods. In the event the discounted cash flow method is used for a TDR, the original interest rate is used to discount expected cash flows. While the Company’s policies and procedures used to estimate the allowance for credit losses, as well as the resultant provision for credit losses charged to income, are considered adequate by management and are reviewed periodically by regulators, model validators and internal audit, they are necessarily approximate and imprecise. There are factors beyond the Company’s control, such as changes in projected economic conditions, real estate markets or particular industry conditions which may materially impact asset quality and the adequacy of the allowance for credit losses and thus the resulting provision for credit losses. Accrued Interest Receivable Accrued interest receivable related to loans totaled $ 7.2 million at March 31, 2022 and was reported in accrued interest receivable on the consolidated balance sheets. The Company elected not to measure an allowance for credit losses for accrued interest receivable and instead elected to reverse interest income on loans or securities that are placed on nonaccrual status, which is generally when the instrument is 90 days past due, or earlier if the Company believes the collection of interest is doubtful. The Company has concluded that this policy results in the timely reversal of uncollectable interest. Unfunded Commitments Effective with the adoption of CECL, the Company estimates expected credit losses on commitments to extend credit over the contractual period in which the Company is exposed to credit risk on the underlying commitments, unless the obligation is unconditionally cancelable by the Company. The allowance for off-balance sheet credit exposures, which is reflected within other liabilities on the consolidated balance sheet, is adjusted for as an increase or decrease to the provision for credit losses. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to fund. The Company’s CECL allowances will fluctuate over time due to macroeconomic conditions and forecasts as well as the size and composition of the loan portfolios. Newly Issued, But Not Yet Effective Accounting Standards In March 2022, the FASB amended the Receivables–Troubled Debt Restructuring by Creditors subtopic and Financial Instruments–Credit Losses subtopic to the Accounting Standards Codification. The amendments eliminate the accounting guidance for TDRs by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. In addition, for public business entities, the amendments require disclosure of current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption of the amendments is permitted if ASU 2016-13 has been adopted, including adoption in an interim period. The Company does not expect these amendments to have a material effect on its financial statements. 10 Table of Contents NOTE 2 – Investment Securities The amortized costs and fair value of investment securities are as follows: March 31, 2022 Amortized Gross Unrealized Fair (dollars in thousands) Cost Gains Losses Value Available for sale Corporate bonds $ 2,191 - 125 2,066 US treasuries 999 - 65 934 US government agencies 13,005 - 1,187 11,818 State and political subdivisions 23,202 26 1,587 21,641 Asset-backed securities 8,423 4 76 8,351 Mortgage-backed securities FHLMC 22,138 - 1,846 20,292 FNMA 37,907 - 2,816 35,091 GNMA 7,206 - 421 6,785 Total mortgage-backed securities 67,251 - 5,083 62,168 Total investment securities available for sale $ 115,071 30 8,123 106,978 December 31, 2021 Amortized Gross Unrealized Fair Cost Gains Losses Value Available for sale Corporate bonds $ 2,198 - 10 2,188 US treasuries 999 - 7 992 US government agencies 14,504 1 336 14,169 SBA securities 429 9 - 438 State and political subdivisions 24,887 549 260 25,176 Asset-backed securities 10,136 45 17 10,164 Mortgage-backed securities FHLMC 23,057 102 494 22,665 FNMA 40,924 235 660 40,499 GNMA 4,084 3 97 3,990 Total mortgage-backed securities 68,065 340 1,251 67,154 Total investment securities available for sale $ 121,218 944 1,881 120,281 Contractual maturities and yields on the Company’s investment securities at March 31, 2022 and December 31, 2021 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. 11 Table of Contents March 31, 2022 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 Corporate bonds $ - - $ - - $ 2,066 1.99 % $ - - $ 2,066 1.99 % US treasuries - - - - 934 1.27 % - - 934 1.27 % US government agencies - - 954 0.45 % 8,176 1.31 % 2,688 1.79 % 11,818 1.35 % State and political subdivisions - - 470 2.13 % 4,859 1.62 % 16,312 2.19 % 21,641 2.06 % Asset-backed securities - - - - 1,412 2.22 % 6,939 1.08 % 8,351 1.27 % Mortgage-backed securities - - 3,422 1.22 % 5,196 1.43 % 53,550 1.50 % 62,168 1.47 % Total $ - - $ 4,846 1.16 % $ 22,643 1.52 % $ 79,489 1.61 % $ 106,978 1.57 % December 31, 2021 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 Corporate bonds $ - - $ - - $ 2,188 1.98 % $ - - $ 2,188 1.98 % US treasuries - - - - 992 1.27 % - - 992 1.27 % US government agencies - - 2,481 0.36 % 8,756 1.31 % 2,932 1.79 % 14,169 1.24 % SBA securities - - - - - - 438 1.01 % 438 1.01 % State and political subdivisions - - 471 2.13 % 4,282 1.61 % 20,423 2.21 % 25,176 2.11 % Asset-backed securities - - - - 1,614 1.79 % 8,550 0.97 % 10,164 1.10 % Mortgage-backed securities 387 2.10 % 4,411 1.29 % 9,121 1.59 % 53,235 1.38 % 67,154 1.40 % Total $ 387 2.10 % $ 7,363 1.03 % $ 26,953 1.53 % $ 85,578 1.55 % $ 120,281 1.52 % The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at March 31, 2022 and December 31, 2021, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. March 31, 2022 Less than 12 months 12 months or longer Total (dollars in thousands) # Fair value Unrealized losses # Fair value Unrealized losses # Fair value Unrealized losses Available for sale Corporate bonds 1 $ 2,066 $ 125 - $ - $ - 1 $ 2,066 $ 125 US treasures 1 934 65 - - - 1 934 65 US government agencies 4 6,399 612 6 5,420 575 10 11,819 1,187 State and political subdivisions 20 15,206 1,033 8 4,461 554 28 19,667 1,587 Asset-backed 6 5,861 55 2 1,612 21 8 7,473 76 Mortgage-backed securities FHLMC 14 15,318 1,286 5 4,974 560 19 20,292 1,846 FNMA 26 23,751 1,692 10 11,329 1,124 36 35,080 2,816 GNMA 4 4,107 212 3 2,678 209 7 6,785 421 Total 76 $ 73,642 $ 5,080 34 $ 30,474 $ 3,043 110 $ 104,116 $ 8,123 12 Table of Contents December 31, 2021 Less than 12 months 12 months or longer Total (dollars in thousands) # Fair value Unrealized losses # Fair value Unrealized losses # Fair value Unrealized losses Available for sale Corporate bonds 1 $ 2,188 $ 10 - $ - $ - 1 $ 2,188 $ 10 US treasures 1 992 7 - - - 1 992 7 US government agencies 7 9,831 173 4 3,837 163 11 13,668 336 State and political subdivisions 9 7,821 193 6 2,909 67 15 10,730 260 Asset-backed 2 1,751 9 2 1,717 7 4 3,468 16 Mortgage-backed securities FHLMC 10 13,705 303 4 4,644 192 14 18,349 495 FNMA 11 16,098 296 9 11,264 364 20 27,362 660 GNMA 2 655 4 3 3,215 93 5 3,870 97 Total 43 $ 53,041 $ 995 28 $ 27,586 $ 886 71 $ 80,627 $ 1,881 At March 31, 2022 the Company had 76 individual investments with a fair market value of $ 73.6 million that were in an unrealized loss position for less than 12 months and 34 individual investments with a fair market value of $ 30.5 million that were in an unrealized loss position for 12 months or longer. The unrealized losses were primarily attributable to changes in interest rates, rather than deterioration in credit quality. The individual securities are each investment grade securities. The Company considers factors such as the financial condition of the issuer including credit ratings and specific events affecting the operations of the issuer, volatility of the security, underlying assets that collateralize the debt security, and other industry and macroeconomic conditions. The Company does not intend to sell these securities, and it is more likely than not that the Company will not be required to sell these securities before recovery of the amortized cost. Other investments are comprised of the following and are recorded at cost which approximates fair value. (dollars in thousands) March 31, 2022 December 31, 2021 Federal Home Loan Bank stock $ 1,256 1,241 Other nonmarketable investments 2,445 2,377 Investment in Trust Preferred subsidiaries 403 403 Total other investments $ 4,104 4,021 The Company has evaluated other investments for impairment and determined that the other investments are not impaired as of March 31, 2022 and that ultimate recoverability of the par value of the investments is probable. All of the FHLB stock is used to collateralize advances with the FHLB. NOTE 3 – Mortgage Loans Held for Sale Mortgage loans originated and intended for sale in the secondary market are reported as loans held for sale and carried at fair value under the fair value option with changes in fair value recognized in current period earnings. At the date of funding of the mortgage loan held for sale, the funded amount of the loan, the related derivative asset or liability of the associated interest rate lock commitment, less direct loan costs becomes the initial recorded investment in the loan held for sale. Such amount approximates the fair value of the loan. At March 31, 2022, mortgage loans held for sale totaled $ 17.8 million compared to $ 13.6 million at December 31, 2021. 13 Table of Contents NOTE 4 – Loans and Allowance for Credit Losses The following table summarizes the composition of our loan portfolio. Total gross loans are recorded net of deferred loan fees and costs, which totaled $ 5.5 million as of March 31, 2022 and $ 5.0 million as of December 31, 2021. March 31, 2022 December 31, 2021 (dollars in thousands) Amount % of Total Amount % of Total Commercial Owner occupied RE $ 527,776 19.8 % $ 488,965 19.6 % Non-owner occupied RE 705,811 26.5 % 666,833 26.8 % Construction 75,015 2.8 % 64,425 2.6 % Business 352,932 13.3 % 333,049 13.4 % Total commercial loans 1,661,534 62.4 % 1,553,272 62.4 % Consumer Real estate 745,667 28.0 % 694,401 27.9 % Home equity 155,678 5.9 % 154,839 6.2 % Construction 72,627 2.7 % 59,846 2.4 % Other 25,169 1.0 % 27,519 1.1 % Total consumer loans 999,141 37.6 % 936,605 37.6 % Total gross loans, net of deferred fees 2,660,675 100.0 % 2,489,877 100.0 % Less—allowance for credit losses ( 32,944 ) ( 30,408 ) Total loans, net $ 2,627,731 $ 2,459,469 Maturities and Sensitivity of Loans to Changes in Interest Rates The information in the following tables summarizes the loan maturity distribution by type and related interest rate characteristics 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. March 31, 2022 (dollars in thousands) One year or less After one but within five years After five but within fifteen years After fifteen years Total Commercial Owner occupied RE $ 15,677 116,156 353,233 42,710 527,776 Non-owner occupied RE 48,491 338,553 290,547 28,220 705,811 Construction 4,668 24,360 36,711 9,276 75,015 Business 71,844 155,045 122,820 3,223 352,932 Total commercial loans 140,680 634,114 803,311 83,429 1,661,534 Consumer Real estate 9,839 45,057 182,195 508,576 745,667 Home equity 2,309 20,411 127,604 5,354 155,678 Construction 932 1,651 8,858 61,186 72,627 Other 5,160 16,368 3,219 422 25,169 Total consumer loans 18,240 83,487 321,876 575,538 999,141 Total gross loans, net of deferred fees $ 158,920 717,601 1,125,187 658,967 2,660,675 14 Table of Contents December 31, 2021 (dollars in thousands) One year or less After one but within five years After five but within fifteen years After fifteen years Total Commercial Owner occupied RE $ 16,858 120,480 316,261 35,366 488,965 Non-owner occupied RE 47,453 329,085 263,317 26,978 666,833 Construction 4,882 16,393 29,310 13,840 64,425 Business 66,833 152,732 109,008 4,476 333,049 Total commercial loans 136,026 618,690 717,896 80,660 1,553,272 Consumer Real estate 14,632 45,219 162,655 471,895 694,401 Home equity 2,178 21,280 125,427 5,954 154,839 Construction 961 594 8,956 49,335 59,846 Other 8,071 15,711 3,341 396 27,519 Total consumer 25,842 82,804 300,379 527,580 936,605 Total gross loans, net of deferred fees $ 161,868 701,494 1,018,275 608,240 2,489,877 The following table summarizes the loans due after one year by category as of March 31, 2022. Interest Rate (dollars in thousands) Fixed Floating or Adjustable Commercial Owner occupied RE $ 507,622 4,477 Non-owner occupied RE 578,786 78,534 Construction 66,873 3,474 Business 212,419 68,669 Total commercial loans 1,365,700 155,154 Consumer Real estate 735,758 70 Home equity 11,634 141,735 Construction 71,695 - Other 13,208 6,801 Total consumer loans 832,295 148,606 Total gross loans, net of deferred fees $ 2,197,995 303,760 Credit Quality Indicators The Company tracks credit quality based on its internal risk ratings. Upon origination, a loan is assigned an initial risk grade, which is generally based on several factors such as the borrower’s credit score, the loan-to-value ratio, the debt-to-income ratio, etc. After loans are initially graded, they are monitored regularly for credit quality based on many factors, such as payment history, the borrower’s financial status, and changes in collateral value. Loans can be downgraded or upgraded depending on management’s evaluation of these factors. Internal risk-grading policies are consistent throughout each loan type. A description of the general characteristics of the risk grades is as follows: ● Pass—These loans range from minimal to average credit risk however still have acceptable credit risk. ● Special mention—A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date. ● Substandard—A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. ● Doubtful—A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable. 15 Table of Contents The following table presents loan balances classified by credit quality indicators by year of origination as of March 31, 2022. March 31, 2022 (dollars in thousands) 2022 2021 2020 2019 2018 Prior Revolving Total Commercial Owner occupied RE Pass $ 48,943 136,043 91,485 76,409 42,537 130,973 - 526,390 Special Mention - 163 - - - 159 - 322 Substandard - - 653 - 298 113 - 1,064 Total Owner occupied RE 48,943 136,206 92,138 76,409 42,835 131,245 - 527,776 Non-owner occupied RE Pass 61,668 186,526 118,651 82,442 84,310 145,200 - 678,797 Special Mention - 205 - 313 5,544 5,614 - 11,676 Substandard - 141 - 13,237 309 1,651 - 15,338 Total Non-owner occupied RE 61,668 186,872 118,651 95,992 90,163 152,465 - 705,811 Construction Pass 6,472 53,371 9,073 4,498 1,601 - - 75,015 Special Mention - - - - - - - - Substandard - - - - - - - - Total Construction 6,472 53,371 9,073 4,498 1,601 - - 75,015 Business Pass 30,305 62,583 36,345 27,908 38,361 36,286 117,232 349,020 Special Mention 224 53 398 - - 168 101 944 Substandard - - 1,294 204 362 1,083 25 2,968 Total Business 30,529 62,636 38,037 28,112 38,723 37,537 117,358 352,932 Total Commercial loans 147,612 439,085 257,899 205,011 173,322 321,247 117,358 1,661,534 Consumer Real estate Pass 69,226 255,662 197,008 80,005 42,490 91,948 - 736,339 Special Mention 1,113 1,387 1,068 568 848 - 4,984 Substandard - 902 230 419 963 1,830 - 4,344 Total Real estate 69,226 257,677 198,625 81,492 44,021 94,626 - 745,667 Home equity Pass - - - - - - 150,767 150,767 Special Mention - - - - - - 2,186 2,186 Substandard - - - - - - 2,725 2,725 Total Home equity - - - - - - 155,678 155,678 Construction Pass 10,078 42,845 19,420 - - - - 72,343 Special Mention - - - 284 - - - 284 Substandard - - - - - - - - Total Construction 10,078 42,845 19,420 284 - - - 72,627 Other Pass 1,177 2,700 1,250 2,001 711 3,916 13,227 24,982 Special Mention - - 8 38 76 10 33 165 Substandard - - - 12 - - 10 22 Total Other 1,177 2,700 1,258 2,051 787 3,926 13,270 25,169 Total Consumer loans 80,481 303,222 219,303 83,827 44,808 98,552 168,948 999,141 Total loans $ 228,093 742,307 477,202 288,838 218,130 419,799 286,306 2,660,675 16 Table of Contents The following table presents loan balances classified by credit quality indicators and loan categories as of December 31, 2021. December 31, 2021 Commercial Consumer (dollars in thousands) Owner occupied RE Non-owner occupied RE Construction Business Real Estate Home Equity Construction Other Total Pass $ 487,422 589,280 64,425 328,371 684,923 148,933 59,846 27,365 2,390,565 Special mention 327 48,310 - 1,530 4,294 2,986 - 129 57,576 Substandard 1,216 29,243 - 3,148 5,184 2,920 - 25 41,736 Total $ 488,965 666,833 64,425 333,049 694,401 154,839 59,846 27,519 2,489,877 The following tables loan balances by payment status. March 31, 2022 (dollars in thousands) Accruing 30-59 days past due Accruing 60-89 days past due Accruing 90 days or more past due Nonaccrual loans Accruing current Total Commercial Owner occupied RE $ - - - - 527,776 527,776 Non-owner occupied RE 75 - - 1,026 704,710 705,811 Construction - - - - 75,015 75,015 Business 124 - - - 352,808 352,932 Consumer Real estate 757 695 - 1,482 742,733 745,667 Home equity - 1 - 2,024 153,653 155,678 Construction - - - - 72,627 72,627 Other 3 - - - 25,166 25,169 Total $ 959 696 - 4,532 2,654,488 2,660,675 December 31, 2021 (dollars in thousands) Accruing 30-59 days past due Accruing 60-89 days past due Accruing 90 days or more past due Nonaccrual loans Accruing current Total Commercial Owner occupied RE $ - - - - 488,965 488,965 Non-owner occupied RE - - - 1,069 665,764 666,833 Construction - - - - 64,425 64,425 Business - - - - 333,049 333,049 Consumer Real estate 136 - - 1,750 692,515 694,401 Home equity 417 174 - 2,045 152,203 154,839 Construction - - - - 59,846 59,846 Other 5 - - - 27,514 27,519 Total $ 558 174 - 4,864 2,484,281 2,489,877 As of March 31, 2022 and December 31, 2021, loans 30 days or more past due represented 0.13 % and 0.09 % of the Company’s total loan portfolio, respectively. Commercial loans 30 days or more past due were 0.01 % and 0.00 % of the Company’s total loan portfolio as of March 31, 2022 and December 31, 2021, respectively. Consumer loans 30 days or more past due were 0.12 % and 0.09 % of total loans as of March 31, 2022 and December 31, 2021, respectively. 17 Table of Contents Nonperforming assets Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when the Company believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on 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. The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans. (dollars in thousands) March 31, 2022 December 31, 2021 Nonaccrual loans $ 1,819 - Nonaccruing TDRs 2,713 2,952 Total nonaccrual loans, including nonaccruing TDRs 4,532 4,864 Other real estate owned - - Total nonperforming assets $ 4,532 4,864 Nonperforming assets as a percentage of: Total assets 0.15 % 0.17 % Gross loans 0.17 % 0.20 % Total loans over 90 days past due $ 554 554 Loans over 90 days past due and still accruing - - Accruing troubled debt restructurings 3,241 3,299 The table below summarizes nonaccrual loans by major categories for the periods presented. CECL Incurred loss March 31, 2022 December 31, 2021 Nonaccrual Nonaccrual loans loans Total Total with no with an nonaccrual nonaccrual (dollars in thousands) allowance allowance loans loans Commercial Owner occupied RE $ - - - - Non-owner occupied RE 265 761 1,026 1,070 Construction - - - - Business - - - - Total commercial 265 761 1,026 1,070 Consumer Real estate 987 495 1,482 1,750 Home equity 1,971 53 2,024 2,044 Construction - - - - Other - - - - Total consumer 2,958 548 3,506 3,794 Total $ 3,224 1,309 4,532 4,864 18 Table of Contents The table below summarizes key information for loans individually evaluated for impairment loans under the incurred loss methodology. These loans include loans on nonaccrual status and loans modified in a TDR, whether on accrual or nonaccrual status. These loans may have estimated impairment which is included in the allowance for credit losses. December 31, 2021 Recorded investment Impaired loans Impaired loans Unpaid with no related with related Related (dollars in thousands) Principal Balance Impaired loans allowance for credit losses allowance for credit losses allowance for credit losses Commercial Owner occupied RE $ 1,261 1,261 1,261 - - Non-owner occupied RE 2,012 1,070 270 800 171 Construction - - - - - Business 1,104 1,104 - 1,104 452 Total commercial 4,377 3,435 1,531 1,904 623 Consumer Real estate 2,638 2,561 1,743 818 144 Home equity 2,206 2,044 1,989 55 55 Construction - - - - - Other 123 123 - 123 14 Total consumer 4,967 4,728 3,732 996 213 Total $ 9,344 8,163 5,263 2,900 836 The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class. Three months ended March 31, 2021 Year ended December 31, 2021 (dollars in thousands) Average recorded investment Recognized interest income Average recorded investment Recognized interest income Commercial Owner occupied RE $ 1,569 16 1,387 65 Non-owner occupied RE 2,161 62 3,128 182 Construction 137 2 55 - Business 2,329 34 2,218 62 Total commercial 6,196 114 6,788 309 Consumer Real estate 4,212 43 3,641 98 Home equity 2,030 16 1,964 85 Construction - - - - Other 134 1 129 4 Total consumer 6,376 60 5,734 187 Total $ 12,572 174 12,522 496 19 Table of Contents Allowance for Credit Losses The following table summarizes the activity related to the allowance for credit losses for the three months ended March 31, 2022 under the CECL methodology. Three months ended March 31, 2022 Commercial Consumer (dollars in thousands) Owner occupied RE Non- owner occupied RE Construction Business Real Estate Home Equity Construction Other Total Balance, beginning of period $ 4,700 10,518 625 4,887 7,083 1,697 578 320 30,408 Adjustment for CECL ( 313 ) 333 154 1,057 ( 294 ) 438 130 ( 5 ) 1,500 Provision for credit losses 511 ( 878 ) 150 159 813 165 136 ( 31 ) 1,025 Loan charge-offs - - - - - ( 169 ) - - ( 169 ) Loan recoveries - - - 114 - 66 - - 180 Net loan recoveries (charge-offs) - - - 114 - ( 103 ) - - 11 Balance, end of period $ 4,898 9,973 929 6,217 7,602 2,197 844 284 32,944 Net charge-offs (recoveries) to average loans (annualized) 0.00 % Allowance for credit losses to gross loans 1.24 % Allowance for credit losses to nonperforming loans 726.88 % Prior to the adoption of ASC 326 on January 1, 2022, the Company calculated the allowance for loan losses under the incurred loss methodology. The following two tables are disclosures related to the allowance for loan losses in prior periods under this methodology. Three months ended March 31, 2021 Commercial Consumer (dollars in thousands) Owner occupied RE Non- owner occupied RE Construction Business Real Estate Home Equity Construction Other Total Balance, beginning of period $ 8,145 12,049 1,154 7,845 10,453 3,249 747 507 44,149 Provision for loan losses ( 991 ) 3,146 ( 327 ) ( 785 ) ( 787 ) ( 423 ) ( 62 ) ( 71 ) ( 300 ) Loan charge-offs - - - ( 267 ) - ( 139 ) - - ( 406 ) Loan recoveries - - - 55 - 1 - - 56 Net loan recoveries (charge-offs) - - - ( 212 ) - ( 138 ) - - ( 350 ) Balance, end of period $ 7,154 15,195 827 6,848 9,666 2,688 685 436 43,499 Net charge-offs to average loans (annualized) 0.07 % Allowance for loan losses to gross loans 1.99 % Allowance for loan losses to nonperforming loans 557.47 % The following table disaggregates the allowance for loan losses and recorded investment in loans by impairment methodology under the incurred loss methodology. December 31, 2021 Allowance for loan losses Recorded investment in loans (dollars in thousands) Commercial Consumer Total Commercial Consumer Total Individually evaluated $ 623 213 836 3,435 4,728 8,163 Collectively evaluated 20,107 9,465 29,572 1,549,837 931,877 2,481,714 Total $ 20,730 9,678 30,408 1,553,272 936,605 2,489,877 March 31, 2021 Allowance for loan losses Recorded investment in loans (dollars in thousands) Commercial Consumer Total Commercial Consumer Total Individually evaluated $ 1,171 464 1,635 5,967 6,215 12,182 Collectively evaluated 28,853 13,011 41,864 1,382,616 788,884 2,171,500 Total $ 30,024 13,475 43,499 1,388,583 795,099 2,183,682 20 Table of Contents Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. The Company reviews individually evaluated loans for designation as collateral dependent loans, as well as other loans that management of the Company designates as having higher risk. These loans do not share common risk characteristics and are not included within the collectively evaluated loans for determining the allowance for credit losses. The following table presents an analysis of collateral-dependent loans of the Company as of March 31, 2022. March 31, 2022 Real Business (dollars in thousands) estate assets Other Total Commercial Owner occupied RE $ 1,250 - - 1,250 Non-owner occupied RE 265 - - 265 Construction - - - - Business - - - - Total commercial 1,515 - - 1,515 Consumer Real estate 1,484 - - 1,484 Home equity 2,024 - - 2,024 Construction - - - - Other - - - - Total consumer 3,508 - - 3,508 Total $ 5,023 - - 5,023 Under CECL, for collateral dependent loans, the Company has adopted the practical expedient to measure the allowance for credit losses based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required. Allowance for Credit Losses - Unfunded Loan Commitments The allowance for credit losses for unfunded loan commitments was $ 2.1 million at March 31, 2022 and is separately classified on the balance sheet within other liabilities. Prior to the adoption of CECL, the Company’s reserve for unfunded commitments was not material. The following table presents the balance and activity in the allowance for credit losses for unfunded loan commitments for the three months ended March 31, 2022. Three months ended (dollars in thousands) March 31, 2022 Balance, beginning of period - Adjustment for adoption of CECL $ 2,000 Provision for (reversal of) loan losses 80 Loan charge-offs - Loan recoveries - Net loan (charge-offs) recoveries - Balance, end of period $ 2,080 NOTE 5 – Troubled Debt Restructurings At March 31, 2022, the Company had 13 loans totaling $ 6.0 million compared to 14 loans totaling $ 6.3 million at December 31, 2021, which were considered as TDRs. The Company considers a loan to be a TDR when the debtor experiences financial difficulties and the Company grants a concession to the debtor that it would not normally consider. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of the workout plan for individual loan relationships, the Company may restructure loan terms to assist borrowers facing financial challenges in the current economic environment. 21 Table of Contents The were no renewals or modifications to any loans considered TDRs during the three months ended March 31, 2022. For the three months ended March 31, 2021, renewals and modifications were not material. As of March 31, 2022 and 2021, there were no loans modified as a TDR for which there was a payment default ( 60 days past due) within 12 months of the restructuring date. NOTE 6 – Derivative Financial Instruments The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recognized as either assets or liabilities and measured at fair value. The Company accounts for all of its derivatives as free-standing derivatives and does not designate any of these instruments for hedge accounting. Therefore, the gain or loss resulting from the change in the fair value of the derivative is recognized in the Company’s statement of income during the period of change. The Company enters into commitments to originate residential mortgage loans held for sale, at specified interest rates and within a specified period of time, with clients who have applied for a loan and meet certain credit and underwriting criteria (interest rate lock commitments). These interest rate lock commitments (“IRLCs”) meet the definition of a derivative financial instrument and are reflected in the balance sheet at fair value with changes in fair value recognized in current period earnings. Unrealized gains and losses on the IRLCs are recorded as derivative assets and derivative liabilities, respectively, and are measured based on the value of the underlying mortgage loan, quoted mortgage-backed securities (“MBS”) prices and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of estimated commission expenses. The Company manages the interest rate and price risk associated with its outstanding IRLCs and mortgage loans held for sale by entering into derivative instruments such as forward sales of MBS. Management expects these derivatives will experience changes in fair value opposite to changes in fair value of the IRLCs and mortgage loans held for sale, thereby reducing earnings volatility. The Company takes into account various factors and strategies in determining the portion of the mortgage pipeline (IRLCs and mortgage loans held for sale) it wants to economically hedge. The following table summarizes the Company’s outstanding financial derivative instruments at March 31, 2022 and December 31, 2021. March 31, 2022 Fair Value (dollars in thousands) Notional Balance Sheet Location Asset/(Liability) Mortgage loan interest rate lock commitments $ 33,011 Other assets $ 77 MBS forward sales commitments 24,500 Other assets 436 Total derivative financial instruments $ 57,511 $ 513 December 31, 2021 Fair Value (dollars in thousands) Notional Balance Sheet Location Asset/(Liability) Mortgage loan interest rate lock commitments $ 32,478 Other assets $ 425 MBS forward sales commitments 21,000 Other liabilities ( 41 ) Total derivative financial instruments $ 53,478 $ 384 22 Table of Contents NOTE 7 – Fair Value Accounting FASB ASC 820, “Fair Value Measurement and Disclosures,” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1 – Quoted market price in active markets Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include certain debt and equity securities that are traded in an active exchange market. Level 2 – Significant other observable inputs Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include fixed income securities and mortgage-backed securities that are held in the Company’s available-for-sale portfolio and valued by a third-party pricing service, as well as certain impaired loans. Level 3 – Significant unobservable inputs Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. These methodologies may result in a significant portion of the fair value being derived from unobservable data. The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in Note 14 of the Company’s 2021 Annual Report on Form 10-K. The Company’s loan portfolio is initially fair valued using a segmented approach, using the eight categories of loans as disclosed in Note 4 – Loans and Allowance for Credit Losses. Loans are considered a Level 3 classification. Assets and Liabilities Recorded at Fair Value on a Recurring Basis The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of March 31, 2022 and December 31, 2021. March 31, 2022 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Securities available for sale Corporate bonds $ - 2,066 - 2,066 US treasuries - 934 - 934 US government agencies - 11,818 - 11,818 State and political subdivisions - 21,641 - 21,641 Asset-backed securities - 8,351 - 8,351 Mortgage-backed securities - 62,168 - 62,168 Mortgage loans held for sale - 17,840 - 17,840 Mortgage loan interest rate lock commitments - 77 - 77 MBS forward sales commitments - 436 - 436 Total assets measured at fair value on a recurring basis $ - 125,331 - 125,331 23 Table of Contents December 31, 2021 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Securities available for sale: Corporate bonds $ - 2,188 - 2,188 US treasuries - 992 - 992 US government agencies - 14,169 - 14,169 SBA securities - 438 - 438 State and political subdivisions - 25,176 - 25,176 Asset-backed securities - 10,164 - 10,164 Mortgage-backed securities - 67,154 - 67,154 Mortgage loans held for sale - 13,556 - 13,556 Mortgage loan interest rate lock commitments - 425 - 425 Total assets measured at fair value on a recurring basis $ - 134,262 - 134,262 Liabilities MBS forward sales commitments $ - 41 - 41 Total liabilities measured at fair value on a recurring basis $ - 41 - 41 Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2022 and December 31, 2021. As of March 31, 2022 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Impaired loans $ - 4,970 1,984 6,954 Total assets measured at fair value on a nonrecurring basis $ - 4,970 1,984 6,954 As of December 31, 2021 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Impaired loans $ - 5,262 2,065 7,327 Total assets measured at fair value on a nonrecurring basis $ - 5,262 2,065 7,327 The Company had no liabilities carried at fair value or measured at fair value on a nonrecurring basis. Fair Value of Financial Instruments Financial instruments require disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contractual obligation which requires the exchange of cash. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment and other assets and liabilities. 24 Table of Contents The estimated fair values of the Company’s financial instruments at March 31, 2022 and December 31, 2021 are as follows: March 31, 2022 (dollars in thousands) Carrying Amount Fair Value Level 1 Level 2 Level 3 Financial Assets: Other investments, at cost $ 4,104 4,104 - - 4,104 Loans 1 2,619,957 2,531,268 - - 2,531,268 Financial Liabilities: Deposits 2,623,174 2,273,251 - 2,273,251 - Subordinated debentures 36,133 34,978 - 34,978 - December 31, 2021 (dollars in thousands) Carrying Amount Fair Value Level 1 Level 2 Level 3 Financial Assets: Other investments, at cost $ 4,021 4,021 - - 4,021 Loans 1 2,451,306 2,422,621 - - 2,422,621 Financial Liabilities: Deposits 2,563,826 2,327,055 - 2,327,055 - Subordinated debentures 36,106 33,936 - 33,936 - 1 Carrying amount is net of the allowance for credit losses or loan losses, as applicable, and previously presented impaired loans. NOTE 8 – Leases Effective January 1, 2019, the Company adopted ASU 2016-02, “Leases (Topic 842)”. As of March 31, 2022, we leased seven of our offices under various operating lease agreements. The lease agreements have maturity dates ranging from August 2028 to February 2032, some of which include options for multiple five-year extensions. The weighted average remaining life of the lease term for these leases was 7.63 years as of March 31, 2022. The discount rate used in determining the lease liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease term as of January 1, 2019 for leases that existed at adoption and as of the lease commencement date for leases subsequently entered into. The weighted average discount rate for leases was 2.28 % as of March 31, 2022. The total operating lease costs were $ 778,000 and $ 714,000 for the three months ended March 31, 2022 and 2021, respectively. The right-of-use (ROU) asset, included in property and equipment, and lease liability, included in other liabilities, was $ 24.1 million and $ 25.6 million as of March 31, 2022, respectively, compared to $ 26.6 million and $ 28.0 million as of December 31, 2021, respectively. The ROU asset and lease liability are recognized at lease commencement by calculating the present value of lease payments over the lease term. Maturities of lease liabilities as of March 31, 2022 were as follows: Operating (dollars in thousands) Leases 2022 $ 848 2023 1,938 2024 1,990 2025 2,045 2026 2,096 Thereafter 24,093 Total undiscounted lease payments 33,010 Discount effect of cash flows 7,443 Total lease liability $ 25,567 25 Table of Contents NOTE 9 – Earnings Per Common Share The following schedule reconciles the numerators and denominators of the basic and diluted earnings per share computations for the three-month periods ended March 31, 2022 and 2021. Dilutive common shares arise from the potentially dilutive effect of the Company’s stock options that were outstanding at March 31, 2022. The assumed conversion of stock options can create a difference between basic and dilutive net income per common share. At March 31, 2022 and 2021, there were 9,000 and 210,899 options, respectively, that were not considered in computing diluted earnings per common share because they were anti-dilutive. Three months ended March 31, (dollars in thousands, except share data) 2022 2021 Numerator: Net income available to common shareholders $ 7,970 $ 10,366 Denominator: Weighted-average common shares outstanding – basic 7,931,855 7,774,515 Common stock equivalents 164,455 134,022 Weighted-average common shares outstanding – diluted 8,096,310 7,908,537 Earnings per common share: Basic $ 1.00 $ 1.33 Diluted $ 0.98 $ 1.31 NOTE 10 – Reportable Segments The Company’s reportable segments represent the distinct product lines the Company offers and are viewed separately for strategic planning purposes by management. The three segments include Commercial and Retail Banking, Mortgage Banking, and Corporate. The following schedule presents financial information for each reportable segment. Three months ended March 31, 2022 Three months ended March 31, 2021 (dollars in thousands) Commercial and Retail Banking Mortgage Banking Corporate Elimin- ations Consol- idated Commercial and Retail Banking Mortgage Banking Corporate Elimin- ation Consol- idated Interest income $ 24,234 230 5 ( 5 ) 24,464 22,414 399 3 ( 3 ) 22,813 Interest expense 925 - 380 ( 5 ) 1,300 1,161 - 382 ( 3 ) 1,540 Net interest income (loss) 23,309 230 ( 375 ) - 23,164 21,253 399 ( 379 ) - 21,273 Provision (benefit) for credit losses 905 200 - - 1,105 ( 300 ) - - - ( 300 ) Noninterest income 1,433 1,494 - - 2,927 1,271 4,633 - - 5,904 Noninterest expense 12,976 1,649 60 - 14,685 11,233 2,867 62 - 14,162 Net income (loss) before taxes 10,861 ( 125 ) ( 435 ) - 10,301 11,591 2,165 ( 441 ) - 13,315 Income tax provision (benefit) 2,450 ( 28 ) ( 91 ) - 2,331 2,564 478 ( 93 ) - 2,949 Net income (loss) $ 8,411 ( 97 ) ( 344 ) - 7,970 9,027 1,687 ( 348 ) - 10,366 Total assets $ 3,033,122 39,003 314,658 ( 314,143 ) 3,072,640 2,516,869 62,530 275,941 ( 275,418 ) 2,579,922 Commercial and retail banking. The Company’s primary business is to provide traditional deposit and lending products and services to its commercial and retail banking clients. Mortgage banking. The mortgage banking segment provides mortgage loan origination services for loans that will be sold in the secondary market to investors. Corporate. Corporate is comprised primarily of compensation and benefits for certain members of management and interest on parent company debt. 26 Table of Contents Item 2. MANAGEMENT’S DISCUSSION AND Analysis of Financial Condition and Results of Operations. The following discussion reviews our results of operations for the three month period ended March 31, 2022 as compared to the three month period ended March 31, 2021 and assesses our financial condition as of March 31, 2022 as compared to December 31, 2021. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and the related notes and the consolidated financial statements and the related notes for the year ended December 31, 2021 included in our Annual Report on Form 10-K for that period. Results for the three month period ended March 31, 2022 are not necessarily indicative of the results for the year ending December 31, 2022 or any future period. Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” or similar references mean Southern First Bancshares, Inc. and its consolidated subsidiary. References to the “Bank” refer to Southern First Bank. Cautionary Warning Regarding forward-looking statements This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements may relate to our financial condition, results of operations, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “seek to,” “strive,” “focus,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to: ● The continuing impact of COVID-19 and its variants on our business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the United States economy (including, without limitation, the Coronavirus Aid, Relief and Economic Security Act, or the CARES Act), and the resulting effect of these items on our operations, liquidity and capital position, and on the financial condition of our borrowers and other customers; ● Restrictions or conditions imposed by our regulators on our operations; ● Increases in competitive pressure in the banking and financial services industries; ● Changes in access to funding or increased regulatory requirements with regard to funding; ● Changes in deposit flows; ● Credit losses as a result of declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior or other factors; ● Credit losses due to loan concentration; ● Changes in the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market; ● Our ability to successfully execute our business strategy; ● Our ability to attract and retain key personnel; ● The success and costs of our expansion into the Charlotte, North Carolina, Greensboro, North Carolina and Atlanta, Georgia markets and into potential new markets; ● Risks with respect to future mergers or acquisitions, including our ability to successfully expand and integrate the businesses and operations that we acquire and realize the anticipated benefits of the mergers or acquisitions; ● Changes in the interest rate environment which could reduce anticipated or actual margins; 27 Table of Contents ● Changes in political conditions or the legislative or regulatory environment, including new governmental initiatives affecting the financial services industry; ● Changes in economic conditions resulting in, among other things, a deterioration in credit quality; ● Changes occurring in business conditions and inflation; ● Increased cybersecurity risk, including potential business disruptions or financial losses; ● Changes in technology; ● The adequacy of the level of our allowance for credit losses and the amount of loan loss provisions required in future periods; ● Examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for credit losses or write-down assets; ● Changes in monetary and tax policies; ● The rate of delinquencies and amounts of loans charged-off; ● The rate of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio; ● Our ability to maintain appropriate levels of capital and to comply with our capital ratio requirements; ● Adverse changes in asset quality and resulting credit risk-related losses and expenses; ● Changes in accounting standards, rules and interpretations and the related impact on our financial statements, including the effects from our adoption of the current expected credit losses (“CECL”) model on January 1, 2022; ● Risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others; ● Adverse effects of failures by our vendors to provide agreed upon services in the manner and at the cost agreed; ● The potential effects of events beyond our control that may have a destabilizing effect on financial markets and the economy, such as epidemics and pandemics (including COVID-19), war or terrorist activities, disruptions in our customers’ supply chains, disruptions in transportation, essential utility outages or trade disputes and related tariffs; and ● Other risks and uncertainties detailed in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2021, in Part II, Item 1A, “Risk Factors” of our Quarterly Reports on Form 10-Q, and in our other filings with the SEC. If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements, except as required by law. 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 March 31, 2022, we had total assets of $3.07 billion, a 5.0% increase from total assets of $2.93 billion at December 31, 2021. The largest component of our total assets is loans which were $2.66 billion and $2.49 billion at March 31, 2022 and December 31, 2021, respectively. Our liabilities and shareholders’ equity at March 31, 2022 totaled $2.79 billion and $278.5 million, respectively, compared to liabilities of $2.65 billion and shareholders’ equity of $277.9 million at December 31, 2021. The principal component of our liabilities is deposits which were $2.71 billion and $2.56 billion at March 31, 2022 and December 31, 2021, respectively. 28 Table of Contents 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 spread 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 to common shareholders was $8.0 million and $10.4 million for the three months ended March 31, 2022 and 2021, respectively. Diluted earnings per share (“EPS”) was $0.98 for the first quarter of 2022, compared to $1.31 for the same period in 2021. The decrease in net income was driven primarily by an increased provision for credit losses during the first quarter of 2022 as compared to 2021. Our mortgage banking segment reported a pre-tax loss of $125,000 for the three-month period ended March 31, 2022, compared to pre-tax net income of $2.2 million for the three-month period ended March 31, 2021. Noninterest income for our mortgage banking segment, which consists mainly of realized and unrealized gains associated with the fair value of commitments and loans held for sale, was $1.5 million for the first quarter of 2022, compared to $4.6 million for the first quarter of 2021. The $3.1 million decrease during the period was driven by a decline in sales activity combined with a decrease in the fair value of derivatives associated with mortgage loan commitments. Noninterest expense for our mortgage banking segment consists mainly of salaries, commissions and benefits of mortgage employees, professional fees and outside services and data processing costs. Noninterest expense was $1.6 million for the first quarter of 2022, compared to $2.9 million for the first quarter of 2021. The $1.2 million decrease during the first quarter of 2022 was driven by a decrease in salaries and benefits expense primarily related to commissions paid on sales activity. We are currently constructing a new bank headquarters on a piece of property that we own in Greenville, South Carolina. The new headquarters which includes a retail office will open in the second quarter of 2022. 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. Our net interest income was $23.2 million for the first quarter of 2022, an 8.9% increase over net interest income of $21.3 million for the first quarter of 2021, resulting primarily from a $364.4 million increase in average loan balances. In addition, our net interest margin, on a tax-equivalent basis (TE), was 3.37% for the first quarter of 2022 compared to 3.60% for the same period in 2021. 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 reflects 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 the three-month periods ended March 31, 2022 and 2021. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio. 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 accounts and interest-bearing accounts. 29 Table of Contents The following table entitled “Average Balances, Income and Expenses, Yield and Rates” sets forth information related to our average balance sheets, average yields on assets, and average costs of liabilities. We derived these yields 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 owned have an original maturity of over one year. Nonaccrual loans are included 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. Average Balances, Income and Expenses, Yields and Rates For the Three Months Ended March 31, 2022 2021 (dollars in thousands) Average Balance Income/ Expense Yield/ Rate (1) Average Balance Income/ Expense Yield/ Rate (1) Interest-earning assets Federal funds sold and interest-bearing deposits with banks $ 89,096 $ 59 0.27 % $ 89,522 $ 47 0.21 % Investment securities, taxable 113,101 425 1.52 % 85,136 245 1.17 % Investment securities, nontaxable (2) 11,899 64 2.17 % 11,000 73 2.68 % Loans (3) 2,573,978 23,931 3.77 % 2,209,569 22,465 4.12 % Total interest-earning assets 2,788,074 24,479 3.56 % 2,395,227 22,830 3.87 % Noninterest-earning assets 152,565 101,932 Total assets $ 2,940,639 $ 2,497,159 Interest-bearing liabilities NOW accounts $ 406,054 115 0.11 % $ 280,737 46 0.07 % Savings & money market 1,242,225 618 0.20 % 1,084,467 586 0.22 % Time deposits 158,720 175 0.45 % 213,378 523 0.99 % Total interest-bearing deposits 1,806,999 908 0.20 % 1,578,582 1,155 0.30 % FHLB advances and other borrowings 16,626 12 0.29 % 2,809 5 0.72 % Subordinated debentures 36,116 380 4.27 % 36,008 380 4.28 % Total interest-bearing liabilities 1,859,741 1,300 0.28 % 1,617,399 1,540 0.39 % Noninterest-bearing liabilities 802,298 648,969 Shareholders’ equity 278,600 230,791 Total liabilities and shareholders’ equity $ 2,940,639 $ 2,497,159 Net interest spread 3.28 % 3.48 % Net interest income (tax equivalent) / margin $ 23,179 3.37 % $ 21,290 3.60 % Less: tax-equivalent adjustment (2) 15 17 Net interest income $ 23,164 $ 21,273 (1) Annualized for the three month period. (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) Includes mortgage loans held for sale. Our net interest margin (TE) decreased 23 basis points to 3.37% during the first quarter of 2022, compared to the first quarter of 2021, primarily due to a reduction in yield on our interest-earning assets, partially offset by the decreased cost of our interest-bearing liabilities. Our average interest-earning assets grew by $392.8 million during the first quarter of 2022, while the average yield on these assets decreased by 31 basis points to 3.56% during the same period. In addition, our average interest-bearing liabilities grew by $242.3 million during the first quarter of 2022, while the rate on these liabilities decreased 11 basis points to 0.28%. The increase in average interest-earning assets for the first quarter of 2022 related primarily to an increase of $364.4 million in our average loan balances and a $28.9 million increase in investment securities. The decrease in yield on our interest earning assets was driven by a 35 basis point decrease in loan yield as our loan portfolio continues to reprice at rates lower than those in the past following the Federal Reserve’s interest rate reductions beginning in 2019. The increase in our average interest-bearing liabilities during the first quarter of 2022 resulted primarily from a $228.4 million increase in our interest-bearing deposits, while the 11 basis point decrease in rate on our interest-bearing liabilities resulted primarily from a ten basis point decrease in deposit rates. 30 Table of Contents Our net interest spread was 3.28% for the first quarter of 2022 compared to 3.48% for the same period in 2021. 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 decrease in both the yield on our interest-earning assets and the rate on our interest-bearing liabilities resulted in a twenty basis point decrease in our net interest spread for the 2022 period. We anticipate continued 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. Rate/Volume Analysis Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following table sets 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. Three Months Ended March 31, 2022 vs. 2021 March 31, 2021 vs. 2020 Increase (Decrease) Due to Increase (Decrease) Due to (dollars in thousands) Volume Rate Rate/ Volume Total Volume Rate Rate/ Volume Total Interest income Loans $ 3,571 (1,816 ) (289 ) 1,466 $ 2,403 (2,996 ) (309 ) (902 ) Investment securities 90 64 19 173 144 (175 ) (64 ) (95 ) Federal funds sold and interest-bearing deposits with banks - 12 - 12 97 (79 ) (74 ) (56 ) Total interest income 3,661 (1,740 ) (270 ) 1,651 2,644 (3,250 ) (447 ) (1,053 ) Interest expense Deposits 721 (596 ) (372 ) (247 ) (889 ) (4,778 ) 648 (4,019 ) FHLB advances and other borrowings 14 (1 ) (4 ) 9 (148 ) (112 ) 105 (155 ) Subordinated debentures 1 (3 ) - (2 ) 1 (55 ) - (54 ) Total interest expense 736 (600 ) (376 ) (240 ) (1,036 ) (3,945 ) 753 (4,228 ) Net interest income $ 2,925 (1,140 ) (106 ) 1,891 $ 3,680 695 (1,200 ) 3,175 Net interest income, the largest component of our income, was $23.2 million for the first quarter of 2022 and $21.3 million for the first quarter of 2021, a $1.9 million, or 8.9%, increase. The increase during 2022 was driven by a $3.6 million increase due to higher loan volume, partially offset by higher volume in our interest-bearing liabilities. Provision for Credit Losses The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for credit losses at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. On January 1, 2022, we adopted the Current Expected Credit Loss (CECL) methodology for estimating credit losses, which resulted in an increase of $1.5 million in our allowance for credit losses and an increase of $2.0 million in our reserve for unfunded commitments. The tax-effected impact of these two items amounted to $2.8 million and was recorded as an adjustment to our retained earnings as of January 1, 2022. We review the adequacy of the allowance for credit losses on a quarterly basis. Please see the discussion included in Note 1 – Summary of Significant Accounting Policies and Note 4 – Loans and Allowance for Credit Losses for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance. We recorded a $1.0 million provision for credit losses in the first quarter of 2022, compared to a $300,000 reversal of provision expense in the first quarter of 2020. The $1.0 million provision in 2022 was driven by the $170.1 million growth in our loan portfolio during the first quarter. In addition, we upgraded $86.4 million of hotel loans during the first quarter of 2022 after observing 12 months of positive financial performance. See additional discussion below in the section “Allowance for Credit Losses.” 31 Table of Contents Noninterest Income The following table sets forth information related to our noninterest income. Three months ended March 31, (dollars in thousands) 2022 2021 Mortgage banking income $ 1,494 4,633 Service fees on deposit accounts 191 185 ATM and debit card income 528 470 Income from bank owned life insurance 315 267 Other income 399 349 Total noninterest income $ 2,927 5,904 Noninterest income decreased $3.0 million, or 50.4%, for the first quarter of 2022 as compared to the same period in 2021. The decrease in total noninterest income resulted primarily from the following: ● Mortgage banking income decreased by $3.1 million, or 67.8%, driven by low inventory in the housing market, lower refinance volumes, and a decrease in margin on loan sales. We do not expect mortgage origination volume to continue at levels seen in the prior year which will reduce the amount of mortgage banking income recorded in future periods in comparison to prior periods. Partially offsetting the above decrease was an increase in ATM and debit card income of $58,000, or 12.3%, due to an increase in debit card transactions. Noninterest expenses The following table sets forth information related to our noninterest expenses. Three months ended March 31, (dollars in thousands) 2022 2021 Compensation and benefits $ 8,144 6,683 Mortgage production costs 1,649 2,867 Occupancy 1,777 1,637 Real estate owned expenses - 387 Outside service and data processing costs 1,411 1,142 Insurance 261 301 Professional fees 496 421 Marketing 256 182 Other 691 542 Total noninterest expense $ 14,685 14,162 Noninterest expense was $14.7 million for the first quarter of 2022, a $523,000, or 3.7%, increase from noninterest expense of $14.2 million for the first quarter of 2021. The increase in noninterest expense was driven primarily by the following: ● Compensation and benefits expense increased $1.5 million, or 21.9%, relating primarily to an increase in salaries and incentive compensation. We hired 17 new team members during the first quarter of 2022 and 24 new team members during 2021. ● Occupancy costs increased $140,000, or 8.6%, driven by increased rent expense and depreciation on our new office in Charlotte, North Carolina. ● Outside service and data processing costs increased $269,000, or 23.6%, primarily due to increased software licensing costs and ATM/debit card related expenses. Partially offsetting the above increases were the following: ● Mortgage production costs decreased by $1.2 million, or 42.5%, due primarily to less mortgage volume in the first quarter of 2022. ● Real estate owned expenses decreased by $387,000 due to a large write-down on a piece of property during 2021. 32 Table of Contents Our efficiency ratio was 56.3% for the first quarter of 2022, compared to 52.1% for the first quarter of 2021. 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 higher ratio during the first quarter of 2022, compared to the first quarter of 2021, relates primarily to the decrease in mortgage banking income. We incurred income tax expense of $2.3 million and $2.9 million for the three months ended March 31, 2022 and 2021, respectively. Our effective tax rate was 22.6% and 22.1% for the three months ended March 31, 2022 and 2021, respectively. Balance Sheet Review Investment Securities At March 31, 2022, the $111.1 million in our investment securities portfolio represented approximately 3.6% of our total assets. Our available for sale investment portfolio included corporate bonds, US treasuries, US government agency securities, state and political subdivisions, asset-backed securities and mortgage-backed securities with a fair value of $107.0 million and an amortized cost of $115.1 million, resulting in an unrealized loss of $8.1 million. At December 31, 2021, the $124.3 million in our investment securities portfolio represented approximately 4.2% of our total assets, including investment securities with a fair value of $120.3 million and an amortized cost of $121.2 million for an unrealized loss of $937,000. 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, excluding mortgage loans held for sale, for the three months ended March 31, 2022 and 2021 were $2.56 billion and $2.21 billion, respectively. Before the allowance for credit losses, total loans outstanding at March 31, 2022 and December 31, 2021 were $2.66 billion and $2.49 billion, respectively. The principal component of our loan portfolio is loans secured by real estate mortgages. As of March 31, 2022, our loan portfolio included $2.28 billion, or 85.8%, of real estate loans, compared to $2.13 billion, or 85.5%, at December 31, 2021. 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. Home equity lines of credit totaled $155.7 million as of March 31, 2022, of which approximately 53% were in a first lien position, while the remaining balance was second liens. At December 31, 2021, our home equity lines of credit totaled $154.8 million, of which approximately 49% were in first lien positions, while the remaining balance was in second liens. The average home equity loan had a balance of approximately $80,000 and a loan to value of 61% as of March 31, 2022, compared to an average loan balance of $81,000 and a loan to value of approximately 62% as of December 31, 2021. Further, 0.7% and 1.0% of our total home equity lines of credit were over 30 days past due as of March 31, 2022 and December 31, 2021, respectively. 33 Table of Contents Following is a summary of our loan composition at March 31, 2022 and December 31, 2021. During the first three months of 2022, our loan portfolio increased by $170.8 million, or 6.86%, with a 6.97% increase in commercial loans while consumer loans increased by 6.68% during the period. The majority of the increase was in loans secured by real estate. Our consumer real estate portfolio grew by $51.3 million and includes high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $463,000, a term of 22 years, and an average rate of 3.45% as of March 31, 2022, compared to a principal balance of $454,000, a term of 21 years, and an average rate of 3.47% as of December 31, 2021. March 31, 2022 December 31, 2021 (dollars in thousands) Amount % of Total Amount % of Total Commercial Owner occupied RE $ 527,776 19.8 % $ 488,965 19.6 % Non-owner occupied RE 705,811 26.5 % 666,833 26.8 % Construction 75,015 2.8 % 64,425 2.6 % Business 352,932 13.3 % 333,049 13.4 % Total commercial loans 1,661,534 62.4 % 1,553,272 62.4 % Consumer Real estate 745,667 28.0 % 694,401 27.9 % Home equity 155,678 5.9 % 154,839 6.2 % Construction 72,627 2.7 % 59,846 2.4 % Other 25,169 1.0 % 27,519 1.1 % Total consumer loans 999,141 37.6 % 936,605 37.6 % Total gross loans, net of deferred fees 2,660,675 100.0 % 2,489,877 100.0 % Less—allowance for credit losses (32,944 ) (30,408 ) Total loans, net $ 2,627,731 $ 2,459,469 Nonperforming assets Nonperforming assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. 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 contractual principal or interest on 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 and to show capacity to continue performing into the future before that loan can be placed back on accrual status. As of March 31, 2022 and December 31, 2021, we had no loans 90 days past due and still accruing. Following is a summary of our nonperforming assets, including nonaccruing TDRs. (dollars in thousands) March 31, 2022 December 31, 2021 Commercial $ 265 270 Consumer 1,554 1,642 Nonaccruing troubled debt restructurings 2,713 2,952 Total nonaccrual loans 4,532 4,864 Other real estate owned - - Total nonperforming assets $ 4,532 4,864 At March 31, 2022, nonperforming assets were $4.5 million, or 0.15% of total assets and 0.17% of gross loans. Comparatively, nonperforming assets were $4.9 million, or 0.17% of total assets and 0.20% of gross loans at December 31, 2021. Nonaccrual loans decreased $332,000 during the first three months of 2022 due primarily to $418,000 of loans paid or charged off, and partially offset by a $170,000 addition to nonaccrual loans. The amount of foregone interest income on nonaccrual loans in the first three months of 2022 and 2021 was not material. At March 31, 2022 and 2021, the allowance for credit losses represented 726.9% and 557.5% of the total amount of nonperforming loans, respectively. A significant portion, or approximately 95%, of nonperforming loans at March 31, 2022, was 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. 34 Table of Contents 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. In addition, at March 31, 2022, 85.8% of our loans were collateralized by real estate and 95% of our impaired loans were secured by real estate. We utilize third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require us to obtain updated appraisals on an annual basis, either through a new external appraisal or an appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. As of March 31, 2022, we did not have any impaired real estate 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 March 31, 2022, impaired loans totaled $7.8 million, for which $2.8 million of these loans had a reserve of approximately $820,000 allocated in the allowance. During the first three months of 2022, the average recorded investment in impaired loans was approximately $7.8 million. Comparatively, impaired loans totaled $8.2 million at December 31, 2021 for which $2.9 million of these loans had a reserve of approximately $836,000 allocated in the allowance. During 2021, the average recorded investment in impaired loans was approximately $12.5 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 March 31, 2022, we determined that we had loans totaling $6.0 million that we considered TDRs compared to $6.3 million as of December 31, 2021. Allowance for Credit Losses On January 1, 2022, we adopted CECL for estimating credit losses, which resulted in an increase of $1.5 million in our allowance for credit losses and an increase of $2.0 million in our reserve for unfunded commitments, which is recorded within other liabilities. The tax-effected impact of those two items amounted to $2.8 million and was recorded as an adjustment to our retained earnings as of January 1, 2022. The allowance for loan loss accounting in effect at December 31, 2021 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date. The allowance for credit losses was $32.9 million, representing 1.24% of outstanding loans and providing coverage of 726.88%, of nonperforming loans compared to $30.4 million, or 1.22% of outstanding loans and 625.22% of nonperforming loans at December 31, 2021. At March 31, 2021, the allowance for loan losses was $43.5 million, or 1.99% of outstanding loans and 557.48% of nonperforming loans. The adoption of CECL on January 1, 2022 increased the allowance for credit losses by $1.5 million. In addition, we recorded a provision for credit losses of $1.0 million during the first quarter of 2022 driven by the growth in our loan portfolio. 35 Table of Contents Following is a summary of the activity in the allowance for credit losses. Three months ended March 31, Year ended (dollars in thousands) 2022 2021 December 31, 2021 Balance, beginning of period $ 30,408 44,149 44,149 Adjustment for adoption of CECL 1,500 - - Provision for (reversal of) credit losses 1,025 (300 ) (12,400 ) Loan charge-offs (169 ) (406 ) (2,166 ) Loan recoveries 180 57 825 Net loan (charge-offs) recoveries 11 (349 ) (1,341 ) Balance, end of period $ 32,944 43,500 30,408 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 $2.62 billion, or 96.9% of total deposits, while our wholesale deposits represented $85.0 million, or 3.1%, of total deposits at March 31, 2022. At December 31, 2021, retail deposits represented $2.56 billion, or 100%, of our total deposits. Our loan-to-deposit ratio was 98% at March 31, 2022 and 97% at December 31, 2021. The following is a detail of our deposit accounts: March 31, December 31, (dollars in thousands) 2022 2021 Non-interest bearing $ 779,262 $ 768,650 Interest bearing: NOW accounts 416,322 401,788 Money market accounts 1,238,866 1,201,099 Savings 41,630 39,696 Time, less than $250,000 150,032 68,179 Time and out-of-market deposits, $250,000 and over 82,062 84,414 Total deposits $ 2,708,174 $ 2,563,826 During the past 12 months, we continued our focus on increasing core deposits, which exclude out-of-market deposits and time deposits of $250,000 or more, in order to provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $2.54 billion and $2.48 billion at March 31, 2022, and December 31, 2021, respectively. The following table shows the average balance amounts and the average rates paid on deposits. Three months ended March 31, 2022 2021 (dollars in thousands) Amount Rate Amount Rate Noninterest-bearing demand deposits $ 753,546 - % $ 603,292 - % Interest-bearing demand deposits 406,054 0.03 % 280,737 0.07 % Money market accounts 1,201,816 0.05 % 1,055,678 0.22 % Savings accounts 40,409 0.01 % 28,789 0.05 % Time deposits less than $100,000 25,392 0.05 % 34,416 0.80 % Time deposits greater than $100,000 133,329 0.12 % 178,962 1.03 % Total deposits $ 2,560,546 0.04 % $ 2,181,874 0.21 % 36 Table of Contents During the first three months of 2022, our average transaction account balances increased by $433.3 million, or 22.0%, from the prior year, while our average time deposit balances decreased by $55,000, or 25.62%. All of our time deposits are certificates of deposits. The maturity distribution of our time deposits $250,000 or more at March 31, 2022 was as follows: (dollars in thousands) March 31, 2022 Three months or less $ 13,510 Over three through six months 20,935 Over six through twelve months 35,520 Over twelve months 12,097 Total $ 82,062 Time deposits that meet or exceed the FDIC insurance limit of $250,000 at March 31, 2022 and December 31, 2021 were $82.1 million and $84.4 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 March 31, 2022 and December 31, 2021 cash and cash equivalents totaled $149.2 million and $167.2 million, respectively, or 4.9% and 5.7% of total assets, respectively. Our investment securities at March 31, 2022 and December 31, 2021 amounted to $111.1 million and $124.3 million, respectively, or 3.6% and 4.2% 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, loan payoffs, 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 of credit at March 31, 2022. We are also a member of the FHLB, 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 March 31, 2022 was $591.8 million, based primarily on the Bank’s 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 March 31, 2022 and December 31, 2021 we had $286.0 million and $259.5 million, respectively, of letters of credit outstanding with the FHLB to secure client deposits. We also have a line of credit with another financial institution for $15.0 million, which was unused at March 31, 2022. The line of credit was renewed on December 21, 2021 at an interest rate of One Month CME Term SOFR plus 3.5% and a maturity date of December 20, 2023. 37 Table of Contents 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 $278.5 million at March 31, 2022 and $277.9 million at December 31, 2021. The $623,000 increase from December 31, 2021 is primarily related to net income of $8.0 million during the first three months of 2022, stock option exercises and equity compensation expenses of $1.1 million, partially offset by a $5.7 million decrease in other comprehensive loss and the tax-effected impact of $2.8 million of expense related to the adoption of CECL recorded as an adjustment to retained earnings. 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) annualized for the three months ended March 31, 2022 and the year ended December 31, 2021. Since our inception, we have not paid cash dividends. March 31, 2022 December 31, 2021 Return on average assets 1.10 % 1.75 % Return on average equity 11.60 % 18.64 % Return on average common equity 11.60 % 18.64 % Average equity to average assets ratio 9.47 % 9.39 % Tangible common equity to assets ratio 9.06 % 9.50 % 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, 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). Although we had over $3 billion in assets at March 31, 2022, under Federal Reserve guidance, the Company still maintains its status as a “small bank holding company.” If our consolidated total assets exceed $3 billion at June 30, 2022, we will lose our status as a “small bank holding company” in March 2023. 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 March 31, 2022, our capital ratios exceed these ratios and we remain “well capitalized.” 38 Table of Contents The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements. March 31, 2022 Actual For capital adequacy purposes minimum plus the capital conservation buffer To be well capitalized under prompt corrective action provisions minimum (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk weighted assets) $ 338,371 13.83 % $ 256,832 10.50 % $ 244,602 10.00 % Tier 1 Capital (to risk weighted assets) 307,767 12.58 % 207,912 8.50 % 195,681 8.00 % Common Equity Tier 1 Capital (to risk weighted assets) 307,767 12.58 % 171,221 7.00 % 158,992 6.50 % Tier 1 Capital (to average assets) 307,767 10.46 % 117,718 4.00 % 147,147 5.00 % December 31, 2021 Actual For capital adequacy purposes minimum plus the capital conservation buffer To be well capitalized under prompt corrective action provisions minimum (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk weighted assets) $ 331,052 14.36 % $ 242,048 10.50 % $ 230,522 10.00 % Tier 1 Capital (to risk weighted assets) 302,217 13.11 % 195,944 8.50 % 184,418 8.00 % Common Equity Tier 1 Capital (to risk weighted assets) 302,217 13.11 % 161,365 7.00 % 149,839 6.50 % Tier 1 Capital (to average assets) 302,217 10.55 % 114,537 4.00 % 143,172 5.00 % The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements. March 31, 2022 Actual For capital adequacy purposes minimum plus the capital conservation buffer (1) To be well capitalized under prompt corrective action provisions minimum (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk weighted assets) $ 351,522 14.37 % $ 256,832 10.50 % N/A N/A Tier 1 Capital (to risk weighted assets) 297,918 12.18 % 207,911 8.50 % N/A N/A Common Equity Tier 1 Capital (to risk weighted assets) 284,918 11.65 % 171,221 7.00 % N/A N/A Tier 1 Capital (to average assets) 297,918 10.12 % 117,736 4.00 % N/A N/A December 31, 2021 Actual For capital adequacy purposes minimum plus the capital conservation buffer (1) To be well capitalized under prompt corrective action provisions minimum (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Total Capital (to risk weighted assets) $ 343,476 14.90 % $ 242,048 10.50 % N/A N/A Tier 1 Capital (to risk weighted assets) 291,641 12.65 % 195,944 8.50 % N/A N/A Common Equity Tier 1 Capital (to risk weighted assets) 278,641 12.09 % 161,365 7.00 % N/A N/A Tier 1 Capital (to average assets) 291,641 10.18 % 114,555 4.00 % N/A N/A (1) Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes. 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. Since our inception, we have not paid cash dividends. 39 Table of Contents 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 money 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 March 31, 2022, unfunded commitments to extend credit were $686.5 million, of which $234.7 million were at fixed rates and $451.8 million were at variable rates. At December 31, 2021, unfunded commitments to extend credit were $618.7 million, of which approximately $205.4 million were at fixed rates and $413.3 million were at variable rates. A significant portion of the unfunded commitments related to commercial business loans and consumer home equity lines of credit. 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. Following the adoption of CECL on January 1, 2022, we recorded a reserve for unfunded commitments of $2.0 million, or 0.31% of total unfunded commitments. As of March 31, 2022, the reserve for unfunded commitments was $2.1 million or 0.30% of total unfunded commitments. At March 31, 2022 and December 31, 2021, there were commitments under letters of credit for $10.5 million and $10.2 million, respectively. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. 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 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. Critical Accounting Estimates We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. 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. Of the significant accounting policies used in the preparation of our consolidated financial statements, we have identified certain items as critical accounting policies based on the associated estimates, assumptions, judgments and complexity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2021, for a description our significant accounting policies that use critical accounting estimates. 40 Table of Contents We have historically identified the determination of the allowance for loan losses as a significant accounting policy that uses critical accounting estimates. On January 1, 2022, we adopted the new CECL accounting methodology that requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans and other financial assets measured at amortized cost. In prior periods, our allowance was based on the incurred loss methodology where we recognized an allowance for loan losses based on probable incurred losses. We believe that the accounting estimates relating to the allowance for credit losses is also a “critical accounting policy” as: ● changes in the provision for credit losses can materially affect our financial results; ● estimates relating to the allowance for credit losses require us to project future borrower performance, including cash flows, delinquencies and charge-offs, along with, when applicable, collateral values, based on a reasonable and supportable forecast period utilizing forward-looking economic scenarios in order to estimate lifetime probability of default and loss given default; ● the allowance for credit losses is influenced by factors outside of our control such as changes in projected economic conditions, real estate markets or particular industry conditions which may materially impact asset quality and the adequacy of the allowance for credit losses; and ● considerable judgment is required to determine whether the models used to generate the allowance for credit losses produce an estimate that is sufficient to encompass the current view of lifetime expected credit losses. Because our estimates of the allowance for credit losses involve judgment and are influenced by factors outside our control, there is uncertainty inherent in these estimates . Our estimate of lifetime expected credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions and other factors outside of our control. Changes in such estimates could significantly impact our allowance and provision for credit losses. See Note 1 – Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report for a discussion of our Allowance for Credit Losses. Accounting, Reporting, and Regulatory Matters See Note 1 – Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on our consolidated financial statements. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 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 seek 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. 41 Table of Contents As of March 31, 2022, 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. Interest rate scenario Change in net interest income from base Up 300 basis points (15.53 )% Up 200 basis points (9.85 )% Up 100 basis points (4.61 )% Base - Down 100 basis points (2.24 )% Down 200 basis points (3.04 )% Down 300 basis points (3.82 )% Item 4. CONTROLS AND PROCEDURES. Evaluation of Disclosure Controls and Procedures Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Control over Financial Reporting There has been no change in the Company’s internal control over financial reporting during the three months ended March 31, 2022, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. 42 Table of Contents PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS. We are a party to claims and lawsuits arising in the course of normal business activities. Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, would have a material adverse impact on the company’s financial position, results of operations or cash flows. Item 1A. RISK FACTORS. Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Warning Regarding Forward-Looking Statements” set forth in Part I, Item 2 of this Form 10-Q, risks and matters described elsewhere in this Form 10-Q, and in our other filings with the SEC. There have been no material changes to the risk factors disclosed in Item 1A. of Part I in our Annual Report on Form 10-K for the year ended December 31, 2021. Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. None Item 3. DEFAULTS UPON SENIOR SECURITIES. None. Item 4. MINE SAFETY DISCLOSURES. Not applicable. Item 5. OTHER INFORMATION. None. 43 Table of Contents Item 6. EXHIBITS. The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Index to Exhibits attached hereto and are incorporated herein by reference. INDEX TO EXHIBITS Exhibit Number Description 31.1 Rule 13a-14(a) Certification of the Principal Executive Officer. 31.2 Rule 13a-14(a) Certification of the Principal Financial Officer. 32 Section 1350 Certifications. 101 The following materials from the Quarterly Report on Form 10-Q of Southern First Bancshares, Inc. for the quarter ended March 31, 2022, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements. 104 Cover Page Interactive Data File (embedded within the Inline XBRL document) _______ _______________________________________________ 44 Table of Contents SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHERN FIRST BANCSHARES, INC. Registrant Date: May 6, 2022 /s/ R. Arthur Seaver, Jr. R. Arthur Seaver, Jr. Chief Executive Officer (Principal Executive Officer) Date: May 6, 2022 /s/ Michael D. Dowling Michael D. Dowling Chief Financial Officer (Principal Financial and Accounting Officer) 45