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, 2023 OR ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission file number 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.) 6 Verdae Boulevard 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: 8,047,975 shares of common stock, par value $0.01 per share, were issued and outstanding as of April 27, 2023. Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY March 31, 2023 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 23 Item 3. Quantitative and Qualitative Disclosures about Market Risk 37 Item 4. Controls and Procedures 37 PART II – OTHER INFORMATION 38 Item 1. Legal Proceedings 38 Item 1A. Risk Factors 38 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 39 Item 3. Defaults upon Senior Securities 39 Item 4. Mine Safety Disclosures 39 Item 5. Other Information 39 Item 6. Exhibits 40 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) 2023 2022 (Unaudited) (Audited) ASSETS Cash and cash equivalents: Cash and due from banks $ 22,213 18,788 Federal funds sold 242,642 101,277 Interest-bearing deposits with banks 7,350 50,809 Total cash and cash equivalents 272,205 170,874 Investment securities: Investment securities available for sale 94,036 93,347 Other investments 10,097 10,833 Total investment securities 104,133 104,180 Mortgage loans held for sale 6,979 3,917 Loans 3,417,945 3,273,363 Less allowance for credit losses ( 40,435 ) ( 38,639 ) Loans, net 3,377,510 3,234,724 Bank owned life insurance 51,453 51,122 Property and equipment, net 97,806 99,183 Deferred income taxes, net 12,087 12,522 Other assets 15,967 15,459 Total assets $ 3,938,140 3,691,981 LIABILITIES Deposits $ 3,426,774 3,133,864 FHLB advances and related debt 125,000 175,000 Subordinated debentures 36,241 36,214 Other liabilities 50,775 52,391 Total liabilities 3,638,790 3,397,469 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, 8,047,975 and 8,011,045 shares issued and outstanding at March 31, 2023 and December 31, 2022, respectively 80 80 Nonvested restricted stock ( 4,462 ) ( 3,306 ) Additional paid-in capital 120,683 119,027 Accumulated other comprehensive loss ( 11,775 ) ( 13,410 ) Retained earnings 194,824 192,121 Total shareholders’ equity 299,350 294,512 Total liabilities and shareholders’ equity $ 3,938,140 3,691,981 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) 2023 2022 Interest income Loans $ 36,748 23,931 Investment securities 613 474 Federal funds sold and interest-bearing deposits with banks 969 59 Total interest income 38,330 24,464 Interest expense Deposits 17,179 908 Borrowings 727 392 Total interest expense 17,906 1,300 Net interest income 20,424 23,164 Provision for credit losses 1,825 1,105 Net interest income after provision for credit losses 18,599 22,059 Noninterest income Mortgage banking income 622 1,494 Service fees on deposit accounts 325 303 ATM and debit card income 555 514 Income from bank owned life insurance 332 315 Other income 210 301 Total noninterest income 2,044 2,927 Noninterest expenses Compensation and benefits 10,356 9,455 Occupancy 2,457 1,779 Outside service and data processing costs 1,629 1,534 Insurance 689 261 Professional fees 660 599 Marketing 366 266 Other 947 791 Total noninterest expenses 17,104 14,685 Income before income tax expense 3,539 10,301 Income tax expense 836 2,331 Net income $ 2,703 7,970 Earnings per common share Basic $ 0.34 1.00 Diluted 0.33 0.98 Weighted average common shares outstanding Basic 8,025,876 7,931,855 Diluted 8,092,270 8,096,310 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) 2023 2022 Net income $ 2,703 7,970 Other comprehensive income (loss): Unrealized gain (loss) on securities available for sale: Unrealized holding gain (loss) arising during the period, pretax 2,070 ( 7,141 ) Tax benefit (expense) ( 435 ) 1,500 Reclassification of realized gain - ( 15 ) Tax expense - 3 Other comprehensive income (loss) 1,635 ( 5,653 ) Comprehensive income $ 4,338 2,317 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, 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 December 31, 2022 8,011,045 $ 80 - $ - $ ( 3,306 ) $ 119,027 $ ( 13,410 ) $ 192,121 $ 294,512 Net income - - - - - - - 2,703 2,703 Proceeds from exercise of stock options 1,000 - - - - 17 - - 17 Issuance of restricted stock 35,930 - - - ( 1,521 ) 1,521 - - - Compensation expense related to restricted stock, net of tax - - - - 365 - - - 365 Compensation expense related to stock options, net of tax - - - - - 118 - - 118 Other comprehensive income - - - - - - 1,635 - 1,635 March 31, 2023 8,047,975 $ 80 - $ - $ ( 4,462 ) $ 120,683 $ ( 11,775 ) $ 194,824 $ 299,350 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) 2023 2022 Operating activities Net income $ 2,703 7,970 Adjustments to reconcile net income to cash provided by operating activities: Provision for credit losses 1,825 1,105 Depreciation and other amortization 1,203 583 Accretion and amortization of securities discounts and premium, net 129 210 Gain on sale of securities - ( 15 ) Net change in operating leases 53 108 Compensation expense related to stock options and restricted stock grants 483 492 Gain on sale of loans held for sale ( 530 ) ( 899 ) Loans originated and held for sale ( 17,892 ) ( 75,729 ) Proceeds from sale of loans held for sale 15,360 72,344 Increase in cash surrender value of bank owned life insurance ( 331 ) ( 315 ) Increase in other assets ( 508 ) ( 447 ) Increase (decrease) in other liabilities ( 1,258 ) 2,460 Net cash provided by operating activities 1,237 7,867 Investing activities Increase (decrease) in cash realized from: Increase in loans, net ( 144,641 ) ( 170,787 ) Purchase of property and equipment ( 180 ) ( 5,869 ) Purchase of investment securities: Available for sale - ( 10,094 ) Other investments ( 18,264 ) ( 2,265 ) Payments and maturities, calls and repayments of investment securities: Available for sale 1,252 16,046 Other investments 19,000 2,182 Net cash used for investing activities ( 142,833 ) ( 170,787 ) Financing activities Increase (decrease) in cash realized from: Increase in deposits, net 292,910 144,348 Decrease in Federal Home Loan Bank advances and other borrowings, net ( 50,000 ) - Proceeds from the exercise of stock options 17 579 Net cash provided by financing activities 242,927 144,927 Net increase (decrease) in cash and cash equivalents 101,331 ( 17,993 ) Cash and cash equivalents at beginning of the period 170,874 167,209 Cash and cash equivalents at end of the period $ 272,205 149,216 Supplemental information Cash paid for Interest $ 16,801 1,789 Income taxes - - Schedule of non-cash transactions Unrealized gain (loss) on securities, net of income taxes 1,635 ( 5,641 ) 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, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023. 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, 2022 as filed with the U.S. Securities and Exchange Commission (“SEC”) on February 13, 2023. 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 The Company, through the Bank, provides a broad range of financial services to individuals and companies in South Carolina, North Carolina, and Georgia. These services include demand, time and savings deposits; lending services; ATM processing and mortgage banking services. While the Company’s management periodically reviews limited production information for these revenue streams, that information is not complete as it does not include a full allocation of revenue, costs and capital from key corporate functions. Management will continue to evaluate these lines of business for separate reporting as facts and circumstances change. Accordingly, the Company’s various banking operations are not considered by management to constitute more than one reportable operating segment. Risk and Uncertainties There were two significant bank failures in the first part of March 2023, primarily due to the failed banks’ lack of liquidity as depositors sought to withdraw their deposits. Due to rising interest rates, the failed banks were unable to sell investment securities held to meet liquidity needs without realizing substantial losses. As a result of the March 2023 bank closures and in an effort to strengthen public confidence in the banking system and protect depositors, regulators have announced that any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law, which could increase the cost of our FDIC insurance assessments. Additionally, the Federal Reserve announced the creation of a new Bank Term Funding Program in an effort to minimize the need for banks to sell securities at a loss in times of stress. The future impact of these failures on the economy, financial institutions and their depositors, as well as any governmental regulatory responses or actions resulting from the same, is difficult to predict at this time. 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, and valuation of deferred tax assets. 6 Table of Contents 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 January 2023, the Company adopted ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”), which eliminated the accounting guidance for troubled debt restructurings (“TDRs”) while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty. In addition, for public business entities, the guidance requires 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 Company adopted the guidance using the modified retrospective method. Upon adoption of this guidance, the Company no longer establishes a specific reserve for modifications to borrowers experiencing financial difficulty. Instead, these modifications are included in their respective cohort and a historical loss rate is applied to the current loan balance to arrive at the quantitative baseline portion of the allowance. The difference between the allowance previously determined and the current allowance was not material to the Company’s financial statements. Newly Issued, But Not Yet Effective Accounting Standards In December 2022, the FASB issued amendments to defer the sunset date of the Reference Rate Reform Topic of the Accounting Standards Codification from December 31, 2022 to December 31, 2024, because the current relief in Reference Rate Reform Topic may not cover a period of time during which a significant number of modifications may take place. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements. NOTE 2 – Investment Securities The amortized costs and fair value of investment securities are as follows: March 31, 2023 Amortized Gross Unrealized Fair (dollars in thousands) Cost Gains Losses Value Available for sale Corporate bonds $ 2,166 - 250 1,916 US treasuries 999 - 107 892 US government agencies 13,008 - 2,024 10,984 State and political subdivisions 22,844 8 3,203 19,649 Asset-backed securities 5,966 - 147 5,819 Mortgage-backed securities FHLMC 23,876 1 3,467 20,410 FNMA 34,612 - 5,029 29,583 GNMA 5,471 - 688 4,783 Total mortgage-backed securities 63,959 1 9,184 54,776 Total investment securities available for sale $ 108,942 9 14,915 94,036 7 Table of Contents December 31, 2022 Amortized Gross Unrealized Fair Cost Gains Losses Value Available for sale Corporate bonds $ 2,172 - 289 1,883 US treasuries 999 - 128 871 US government agencies 13,007 - 2,390 10,617 State and political subdivisions 22,910 - 4,004 18,906 Asset-backed securities 6,435 - 206 6,229 Mortgage-backed securities FHLMC 24,086 - 3,745 20,341 FNMA 35,141 - 5,520 29,621 GNMA 5,573 - 694 4,879 Total mortgage-backed securities 64,800 - 9,959 54,841 Total investment securities available for sale $ 110,323 - 16,976 93,347 Contractual maturities and yields on the Company’s investment securities at March 31, 2023 and December 31, 2022 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. March 31, 2023 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 $ - - $ - - $ 1,916 2.00 % $ - - $ 1,916 2.00 % US treasuries - - - - 892 1.27 % - - 892 1.27 % US government agencies - - 3,291 0.85 % 7,693 1.55 % - - 10,984 1.34 % State and political subdivisions - - 465 2.13 % 5,598 1.80 % 13,586 2.16 % 19,649 2.06 % Asset-backed securities - - - - 452 4.43 % 5,367 5.62 % 5,819 5.53 % Mortgage-backed securities - - 4,902 1.17 % 3,712 1.57 % 46,162 1.95 % 54,776 1.85 % Total investment securities $ - - $ 8,658 1.10 % $ 20,263 1.72 % $ 65,115 2.30 % $ 94,036 2.06 % December 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 $ - - $ - - $ 1,883 2.00 % $ - - $ 1,883 2.00 % US treasuries - - - - 871 1.27 % - - 871 1.27 % US government agencies - - 3,223 0.85 % 7,394 1.55 % - - 10,617 1.34 % State and political subdivisions - - 460 2.13 % 5,382 1.80 % 13,064 2.16 % 18,906 2.05 % Asset-backed securities - - - - 554 4.77 % 5,675 5.14 % 6,229 5.10 % Mortgage-backed securities - - 4,594 1.13 % 3,959 1.60 % 46,288 1.90 % 54,841 1.82 % Total investment securities $ - - $ 8,277 1.08 % $ 20,043 1.75 % $ 65,027 2.24 % $ 93,347 2.03 % The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at March 31, 2023 and December 31, 2022, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. 8 Table of Contents March 31, 2023 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 $ 1,916 $ 250 1 $ 1,916 $ 250 US treasuries - - - 1 892 107 1 892 107 US government agencies - - - 10 10,984 2,024 10 10,984 2,024 State and political subdivisions 1 465 5 29 18,404 3,198 30 18,869 3,203 Asset-backed 2 1,228 16 6 4,591 131 8 5,819 147 Mortgage-backed securities FHLMC 1 1,504 12 19 17,486 3,455 20 18,990 3,467 FNMA 1 5 - 36 29,578 5,029 37 29,583 5,029 GNMA - - - 7 4,783 688 7 4,783 688 Total investment securities 5 $ 3,202 $ 33 109 $ 88,634 $ 14,882 114 $ 91,836 $ 14,915 December 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 $ 1,883 $ 289 1 $ 1,883 $ 289 US treasuries - - - 1 871 128 1 871 128 US government agencies - - - 10 10,617 2,390 10 10,617 2,390 State and political subdivisions 10 5,101 763 22 13,805 3,241 32 18,906 4,004 Asset-backed 5 4,291 135 3 1,938 71 8 6,229 206 Mortgage-backed securities FHLMC 4 3,712 155 17 16,629 3,590 21 20,341 3,745 FNMA 9 2,208 201 28 27,413 5,319 37 29,621 5,520 GNMA 1 103 7 6 4,776 687 7 4,879 694 Total investment securities 29 $ 15,415 $ 1,261 88 $ 77,932 $ 15,715 117 $ 93,347 $ 16,976 At March 31, 2023 the Company had 114 individual investments that were in an unrealized loss position. 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. The issuers of these securities continue to make timely principal and interest payments under the contractual terms of the securities. As such, there is no allowance for credit losses on available for sale securities recognized as of March 31, 2023. Other investments are comprised of the following and are recorded at cost which approximates fair value. (dollars in thousands) March 31, 2023 December 31, 2022 Federal Home Loan Bank stock $ 7,534 9,250 Other nonmarketable investments 2,160 1,180 Investment in Trust Preferred subsidiaries 403 403 Total other investments $ 10,097 10,833 The Company has evaluated other investments for impairment and determined that the other investments are not impaired as of March 31, 2023 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. 9 Table of Contents 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 2023, mortgage loans held for sale totaled $ 7.0 million compared to $ 3.9 million at December 31, 2022. 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 $ 7.4 million as of March 31, 2023 and $ 7.3 million as of December 31, 2022.   March 31, 2023 December 31, 2022 (dollars in thousands) Amount % of Total Amount % of Total Commercial Owner occupied RE $ 615,094 18.0 % $ 612,901 18.7 % Non-owner occupied RE 928,059 27.2 % 862,579 26.3 % Construction 94,641 2.8 % 109,726 3.4 % Business 495,161 14.5 % 468,112 14.3 % Total commercial loans 2,132,955 62.5 % 2,053,318 62.7 % Consumer Real estate 993,258 29.1 % 931,278 28.4 % Home equity 180,974 5.3 % 179,300 5.5 % Construction 71,137 2.1 % 80,415 2.5 % Other 39,621 1.0 % 29,052 0.9 % Total consumer loans 1,284,990 37.5 % 1,220,045 37.3 % Total gross loans, net of deferred fees 3,417,945 100.0 % 3,273,363 100.0 % Less—allowance for credit losses ( 40,435 ) ( 38,639 ) Total loans, net $ 3,377,510 $ 3,234,724 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, 2023 (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 $ 9,295 144,602 418,450 42,747 615,094 Non-owner occupied RE 57,909 449,859 394,421 25,870 928,059 Construction 2,742 30,409 59,103 2,387 94,641 Business 92,502 211,145 187,033 4,481 495,161 Total commercial loans 162,448 836,015 1,059,007 75,485 2,132,955 Consumer Real estate 9,871 46,324 280,204 656,859 993,258 Home equity 1,028 20,452 154,189 5,305 180,974 Construction 1,014 227 32,358 37,538 71,137 Other 3,569 21,975 13,272 805 39,621 Total consumer loans 15,482 88,978 480,023 700,507 1,284,990 Total gross loans, net of deferred fees $ 177,930 924,993 1,539,030 775,992 3,417,945 10 Table of Contents December 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 $ 10,574 133,017 420,881 48,429 612,901 Non-owner occupied RE 44,570 419,976 371,208 26,825 862,579 Construction 5,509 36,537 61,009 6,671 109,726 Business 96,157 194,489 173,259 4,207 468,112 Total commercial loans 156,810 784,019 1,026,357 86,132 2,053,318 Consumer Real estate 12,137 38,948 260,005 620,188 931,278 Home equity 1,336 20,933 151,696 5,335 179,300 Construction 665 182 23,788 55,780 80,415 Other 3,926 21,890 2,458 778 29,052 Total consumer loans 18,064 81,953 437,947 682,081 1,220,045 Total gross loans, net of deferred fees $ 174,874 865,972 1,464,304 768,213 3,273,363 The following table summarizes the loans due after one year by category. March 31, 2023 December 31, 2022 Interest Rate Interest Rate (dollars in thousands) Fixed Floating or Adjustable Fixed Floating or Adjustable Commercial Owner occupied RE $ 602,302 3,497 598,513 3,814 Non-owner occupied RE 784,868 85,282 742,763 75,246 Construction 75,041 16,858 90,246 13,971 Business 310,976 91,683 298,866 73,089 Total commercial loans 1,773,187 197,320 1,730,388 166,120 Consumer Real estate 983,376 11 919,130 11 Home equity 13,508 166,438 14,173 163,791 Construction 70,123 - 79,750 - Other 19,173 16,879 19,113 6,013 Total consumer loans 1,086,180 183,328 1,032,166 169,815 Total gross loans, net of deferred fees $ 2,859,367 380,648 2,762,554 335,935 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— A pass loan ranges from minimal to average credit risk; however, still has acceptable credit risk. ● Watch—A watch loan exhibits above average credit risk due to minor weaknesses and warrants closer scrutiny by management. ● 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. 11 Table of Contents The following table presents loan balances classified by credit quality indicators by year of origination as of March 31, 2023. March 31, 2023 (dollars in thousands) 2023 2022 2021 2020 2019 Prior Revolving Revolving Converted to Term Total Commercial Owner occupied RE Pass $ 19,874 160,403 143,384 76,171 65,408 121,520 - 169 586,929 Watch - 3,548 475 9,281 3,628 6,716 - - 23,648 Special Mention - 196 - - - 3,133 - - 3,329 Substandard - - - - - 1,188 - - 1,188 Total Owner occupied RE 19,874 164,147 143,859 85,452 69,036 132,557 - 169 615,094 Non-owner occupied RE Pass 47,280 298,161 177,421 112,850 59,025 181,699 623 - 877,059 Watch 200 972 9,496 - 7,555 13,070 - - 31,293 Special Mention - - 201 - 8,893 906 - - 10,000 Substandard - 615 - - 7,996 1,096 - - 9,707 Total Non-owner occupied RE 47,480 299,748 187,118 112,850 83,469 196,771 623 - 928,059 Construction Pass 942 62,604 22,778 6,737 246 - - - 93,307 Watch - 1,334 - - - - - - 1,334 Special Mention - - - - - - - - - Substandard - - - - - - - - - Total Construction 942 63,938 22,778 6,737 246 - - - 94,641 Business Pass 17,705 140,684 54,235 21,675 20,611 58,086 147,734 442 461,172 Watch 145 14,571 2,031 1,627 1,061 3,607 5,420 - 28,462 Special Mention - 1,259 236 463 279 424 15 99 2,775 Substandard - 495 - 28 202 1,344 683 - 2,752 Total Business 17,850 157,009 56,502 23,793 22,153 63,461 153,852 541 495,161 Total Commercial loans 86,146 684,842 410,257 228,832 174,904 392,789 154,475 710 2,132,955 Consumer Real estate Pass 49,330 253,611 284,238 183,939 69,806 112,705 - - 953,629 Watch 494 5,765 8,023 4,016 2,086 4,582 - - 24,966 Special Mention - 2,346 1,687 2,152 2,444 3,127 - - 11,756 Substandard - - 646 224 330 1,707 - - 2,907 Total Real estate 49,824 261,722 294,594 190,331 74,666 122,121 - - 993,258 Home equity Pass - - - - - - 167,694 - 167,694 Watch - - - - - - 6,701 - 6,701 Special Mention - - - - - - 3,861 - 3,861 Substandard - - - - - - 2,718 - 2,718 Total Home equity - - - - - - 180,974 - 180,974 Construction Pass 2,656 47,570 20,066 845 - - - - 71,137 Watch - - - - - - - - - Special Mention - - - - - - - - - Substandard - - - - - - - - - Total Construction 2,656 47,570 20,066 845 - - - - 71,137 Other Pass 390 3,375 2,829 1,645 1,433 3,205 25,359 - 38,236 Watch 10 42 363 11 4 183 118 - 731 Special Mention - 11 - - 37 90 93 - 231 Substandard - 327 88 - 3 - 5 - 423 Total Other 400 3,755 3,280 1,656 1,477 3,478 25,575 - 39,621 Total Consumer loans 52,880 313,047 317,940 192,832 76,143 125,599 206,549 - 1,284,990 Total loans $ 139,026 997,889 728,197 421,664 251,047 518,388 361,024 710 3,417,945 Current period gross write-offs ( 160 ) ( 1 ) ( 161 ) 12 Table of Contents The following table presents loan balances classified by credit quality indicators by year of origination as of December 31, 2022. December 31, 2022 (dollars in thousands) 2022 2021 2020 2019 2018 Prior Revolving Revolving Converted to Term Total Commercial Owner occupied RE Pass $ 169,083 122,654 85,867 66,299 36,718 93,915 - - 574,536 Watch 14,648 479 9,339 3,658 - 6,792 - - 34,916 Special Mention 200 - - - - 2,960 - - 3,160 Substandard - - - - 289 - - - 289 Total Owner occupied RE 183,931 123,133 95,206 69,957 37,007 103,667 - - 612,901 Non-owner occupied RE Pass 281,890 169,599 113,264 59,550 79,722 106,967 604 137 811,733 Watch 1,061 9,491 - 10,683 1,408 11,660 - - 34,303 Special Mention - 202 - 6,087 - 930 - - 7,219 Substandard - 134 - 7,992 327 871 - - 9,324 Total Non-owner occupied RE 282,951 179,426 113,264 84,312 81,457 120,428 604 137 862,579 Construction Pass 48,420 55,129 4,811 247 - - - - 108,607 Watch 1,119 - - - - - - - 1,119 Special Mention - - - - - - - - - Substandard - - - - - - - - - Total Construction 49,539 55,129 4,811 247 - - - - 109,726 Business Pass 136,489 57,804 29,864 21,808 35,249 28,914 136,337 709 447,174 Watch 3,186 2,058 1,318 1,282 179 3,074 3,783 439 15,319 Special Mention 1,137 260 386 210 - 252 115 642 3,002 Substandard 498 - 188 233 315 911 472 - 2,617 Total Business 141,310 60,122 31,756 23,533 35,743 33,151 140,707 1,790 468,112 Total Commercial loans 657,731 417,810 245,037 178,049 154,207 257,246 141,311 1,927 2,053,318 Consumer Real estate Pass 243,589 269,565 189,075 72,499 39,042 76,172 - - 889,942 Watch 6,196 8,256 3,847 2,278 494 3,671 - - 24,742 Special Mention 3,114 1,938 2,644 2,258 955 2,639 - - 13,548 Substandard - 648 227 341 408 1,422 - - 3,046 Total Real estate 252,899 280,407 195,793 77,376 40,899 83,904 - - 931,278 Home equity Pass - - - - - - 165,847 - 165,847 Watch - - - - - - 7,226 - 7,226 Special Mention - - - - - - 4,055 - 4,055 Substandard - - - - - - 2,172 - 2,172 Total Home equity - - - - - - 179,300 - 179,300 Construction Pass 41,138 34,039 4,923 - - - - - 80,100 Watch - - - - - - - - - Special Mention - - - 315 - - - - 315 Substandard - - - - - - - - - Total Construction 41,138 34,039 4,923 315 - - - - 80,415 Other Pass 3,894 3,038 1,702 1,534 341 3,015 14,465 - 27,989 Watch 46 367 15 5 16 175 93 - 717 Special Mention 94 - - 44 75 23 97 - 332 Substandard - - - 5 - - 9 - 14 Total Other 4,034 3,405 1,717 1,588 432 3,213 14,663 - 29,052 Total Consumer loans 298,071 317,851 202,433 79,279 41,331 87,117 193,963 - 1,220,045 Total loans $ 955,802 735,661 447,470 257,328 195,538 344,363 335,274 1,927 3,273,363 13 Table of Contents The following tables present loan balances by age and payment status. March 31, 2023 (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 $ - - - - 615,094 615,094 Non-owner occupied RE 151 - - 1,384 926,524 928,059 Construction - - - - 94,641 94,641 Business 135 235 - 1,196 493,595 495,161 Consumer Real estate 886 - - 1,075 991,297 993,258 Home equity 587 - - 1,078 179,309 180,974 Construction - - - - 71,137 71,137 Other 1 88 - - 39,532 39,621 Total loans $ 1,760 323 - 4,733 3,411,129 3,417,945 Total loans over 90 days past due - - - - - 192 December 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 $ - - - - 612,901 612,901 Non-owner occupied RE 119 757 - 247 861,456 862,579 Construction - - - - 109,726 109,726 Business 24 1 - 182 467,905 468,112 Consumer Real estate 330 - - 1,099 929,849 931,278 Home equity 50 - - 1,099 178,151 179,300 Construction - - - - 80,415 80,415 Other 88 - - - 28,964 29,052 Total loans $ 611 758 - 2,627 3,269,367 3,273,363 Total loans over 90 days past due - - - - - 402 As of March 31, 2023 and December 31, 2022, loans 30 days or more past due represented 0.11 % of the Company’s total loan portfolio. Commercial loans 30 days or more past due were 0.03 % of the Company’s total loan portfolio as of March 31, 2023 and December 31, 2022. Consumer loans 30 days or more past due were 0.08 % of total loans as of March 31, 2023 and December 31, 2022. 14 Table of Contents The table below summarizes nonaccrual loans by major categories for the periods presented. March 31, 2023 December 31, 2022 Nonaccrual Nonaccrual Nonaccrual Nonaccrual loans loans Total loans loans Total with no with an nonaccrual with no with an nonaccrual (dollars in thousands) allowance allowance loans allowance allowance loans Commercial Owner occupied RE - - - - - - Non-owner occupied RE $ 615 769 1,384 114 133 247 Construction - - - - - - Business 1,045 151 1,196 - 182 182 Total commercial 1,660 920 2,580 114 315 429 Consumer Real estate - 1,075 1,075 - 1,099 1,099 Home equity 192 886 1,078 194 905 1,099 Construction - - - - - - Other - - - - - - Total consumer 192 1,961 2,153 194 2,004 2,198 Total nonaccrual loans 1,852 2,881 4,733 308 2,319 2,627 We did not recognize interest income on nonaccrual loans for the three months ended March 31, 2023 and March 31, 2022. Accrued interest of $ 23,000 was reversed during the three months ended March 31, 2023. Accrued interest of $ 3,000 was reversed during the three months ended March 31, 2022. The table below summarizes information regarding nonperforming assets. (dollars in thousands) March 31, 2023 December 31, 2022 Nonaccrual loans $ 4,733 2,627 Other real estate owned - - Total nonperforming assets $ 4,733 2,627 Nonperforming assets as a percentage of: Total assets 0.12 % 0.07 % Gross loans 0.14 % 0.08 % Total loans over 90 days past due $ 192 402 Loans over 90 days past due and still accruing - - Accruing troubled debt restructurings - 4,503 Modifications to Borrowers Experiencing Financial Difficulty The Company adopted Accounting Standards Update (“ASU”) 2022-02, Financial Instruments - Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”) effective January 1, 2023. The amendments in ASU 2022-02 eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty. There were no loan modifications to borrowers experiencing financial difficulty during the three months ended March 31, 2023. Allowance for Credit Losses The Company maintains an allowance for credit losses to provide for expected credit losses. Losses are charged against the allowance when management believes that the principal is uncollectable. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance are made for specific loans and for pools of similar types of loans, although the entire allowance is available for any loan that, in management’s judgment, should be charged against the allowance. A provision for credit losses is taken based on management’s ongoing evaluation of the appropriate allowance balance. 15 Table of Contents A formal evaluation of the adequacy of the credit loss allowance is conducted quarterly. 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 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. Loans that do not share risk characteristics are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. 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 Company generally utilizes a four-quarter forecast period in evaluating the appropriateness of the reasonable and supportable forecast scenarios which are incorporated through qualitative adjustments. There is immediate reversion to historical loss rates. 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 such as labor, inflation, consumer sentiment and real disposable income, 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. The following table summarizes the activity related to the allowance for credit losses for the three months ended March 31, 2023 under the CECL methodology. Three months ended March 31, 2023 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 $ 5,867 10,376 1,292 7,861 9,487 2,551 893 312 38,639 Provision for credit losses 117 1,038 ( 182 ) 150 592 53 ( 83 ) 170 1,855 Loan charge-offs - ( 160 ) - ( 1 ) - - - - ( 161 ) Loan recoveries - 31 - 12 - 59 - - 102 Net loan recoveries (charge-offs) - ( 129 ) - 11 - 59 - - ( 59 ) Balance, end of period $ 5,984 11,285 1,110 8,022 10,079 2,663 810 482 40,435 Net charge-offs to average loans (annualized) 0.01 % Allowance for credit losses to gross loans 1.18 % Allowance for credit losses to nonperforming loans 854.33 % 16 Table of Contents 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 % The $ 1.9 million provision for credit losses for the three months ended March 31, 2023 was driven by $ 144.6 million in loan growth for the quarter. In addition to loan growth, the provision for credit losses was impacted by slightly lower expected loss rates due to continued low charge-offs during the first quarter of 2023, while minor adjustments to an internal qualitative factor increased the qualitative component of the allowance and related provision expense. 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 tables present an analysis of collateral-dependent loans of the Company. March 31, 2023 (dollars in thousands) Real estate Business assets Other Total Commercial Owner occupied RE $ - - - - Non-owner occupied RE 651 - - 651 Construction - - - - Business 28 - 1,045 1,073 Total commercial 679 - 1,045 1,724 Consumer Real estate 197 - - 197 Home equity 192 - - 192 Construction - - - - Other - - - - Total consumer 389 - - 389 Total $ 1,068 - 1,045 2,113 17 Table of Contents December 31, 2022 Real Business (dollars in thousands) estate assets Other Total Commercial Owner occupied RE $ - - - - Non-owner occupied RE 114 - - 114 Construction - - - - Business 30 - - 30 Total commercial 144 - - 144 Consumer Real estate 207 - - 207 Home equity 194 - - 194 Construction - - - - Other - - - - Total consumer 401 - - 401 Total $ 545 - - 545 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 $ 2.8 million at March 31, 2023 and is separately classified on the balance sheet within other liabilities. 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, 2023 and for the twelve months ended December 31, 2022. Three months ended Twelve months ended (dollars in thousands) March 31, 2023 December 31, 2022 Balance, beginning of period $ 2,780 - Adjustment for adoption of CECL - 2,000 Provision (reversal of) for credit losses ( 30 ) 780 Balance, end of period $ 2,750 2,780 Unfunded Loan Commitments $ 882,489 878,324 Reserve for Unfunded Commitments to Unfunded Loan Commitments 0.31 % 0.32 % NOTE 5 – 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. 18 Table of Contents 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, 2023 and December 31, 2022. March 31, 2023 Fair Value (dollars in thousands) Notional Balance Sheet Location Asset/(Liability) Mortgage loan interest rate lock commitments $ 13,384 Other assets $ 187 MBS forward sales commitments 10,000 Other liabilities ( 86 ) Total derivative financial instruments $ 23,384 $ 101 December 31, 2022 Fair Value (dollars in thousands) Notional Balance Sheet Location Asset/(Liability) Mortgage loan interest rate lock commitments $ 6,793 Other assets $ 49 MBS forward sales commitments 5,750 Other assets 27 Total derivative financial instruments $ 12,543 $ 76 NOTE 6 – 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. 19 Table of Contents 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 2022 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, 2023 and December 31, 2022. March 31, 2023 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Securities available for sale Corporate bonds $ - 1,916 - 1,916 US treasuries - 892 - 892 US government agencies - 10,984 - 10,984 State and political subdivisions - 19,649 - 19,649 Asset-backed securities - 5,819 - 5,819 Mortgage-backed securities - 54,776 - 54,776 Mortgage loans held for sale - 6,979 - 6,979 Mortgage loan interest rate lock commitments - 187 - 187 Total assets measured at fair value on a recurring basis $ - 101,202 - 101,202 Liabilities MBS forward sales commitments $ - 86 - 86 Total liabilities measured at fair value on a recurring basis $ - 86 - 86 December 31, 2022 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Securities available for sale: Corporate bonds $ - 1,883 - 1,883 US treasuries - 871 - 871 US government agencies - 10,617 - 10,617 State and political subdivisions - 18,906 - 18,906 Asset-backed securities - 6,229 - 6,229 Mortgage-backed securities - 54,841 - 54,841 Mortgage loans held for sale - 3,917 - 3,917 Mortgage loan interest rate lock commitments - 49 - 49 MBS forward sales commitments - 27 - 27 Total assets measured at fair value on a recurring basis $ - 97,340 - 97,340 The Company had no liabilities recorded for fair value on a recurring basis as of December 31, 2022. 20 Table of Contents 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, 2023 and December 31, 2022. As of March 31, 2023 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Individually evaluated $ - 1,972 3,695 5,667 Total assets measured at fair value on a nonrecurring basis $ - 1,972 3,695 5,667 As of December 31, 2022 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Individually evaluated $ - 429 4,071 4,500 Total assets measured at fair value on a nonrecurring basis $ - 429 4,071 4,500 The Company had no liabilities carried at fair value or measured at fair value on a nonrecurring basis. For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of March 31, 2023 and December 31, 2022, the significant unobservable inputs used in the fair value measurements were as follows: Valuation Technique Significant Unobservable Inputs Range of Inputs Individually evaluated loans Appraised Value/ Discounted Cash Flows Discounts to appraisals or cash flows for estimated holding and/or selling costs or age of appraisal 0 - 25 % 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. The estimated fair values of the Company’s financial instruments at March 31, 2023 and December 31, 2022 are as follows: March 31, 2023 (dollars in thousands) Carrying Amount Fair Value Level 1 Level 2 Level 3 Financial Assets: Other investments, at cost $ 10,097 10,097 - - 10,097 Loans 1 3,368,332 3,176,788 - - 3,176,788 Financial Liabilities: Deposits 3,426,774 3,065,819 - 3,065,819 - Subordinated debentures 36,241 40,369 - 40,369 - December 31, 2022 (dollars in thousands) Carrying Amount Fair Value Level 1 Level 2 Level 3 Financial Assets: Other investments, at cost $ 10,833 10,833 - - 10,833 Loans 1 3,227,455 3,057,891 - - 3,057,891 Financial Liabilities: Deposits 3,133,864 2,717,900 - 2,717,900 - Subordinated debentures 36,214 39,885 - 39,885 - 1 Carrying amount is net of the allowance for credit losses and individually evaluated loans. 21 Table of Contents NOTE 7 – Leases The Company had operating right-of-use assets, included in property and equipment, of $ 23.2 million and $ 23.6 million as of March 31, 2023 and December 31, 2022, respectively. The Company had lease liabilities, included in other liabilities, of $ 25.5 million and $ 25.8 million as of March 31, 2023 and December 31, 2022, respectively. We maintain operating leases on land and buildings for various office spaces. The lease agreements have maturity dates ranging from April 2025 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 6.74 years as of March 31, 2023. The ROU asset and lease liability are recognized at lease commencement by calculating the present value of lease payments over the lease term. 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 at implementation of the accounting standard and as of the lease commencement date for leases subsequently entered into. The weighted average discount rate for leases was 2.32 % as of March 31, 2023. The total operating lease costs were $ 595,000 and $ 778,000 for the three months ended March 31, 2023 and 2022, respectively. Maturities of lease liabilities as of March 31, 2023 were as follows: Operating (dollars in thousands) Leases 2023 $ 1,513 2024 2,067 2025 2,124 2026 2,176 2027 2,232 Thereafter 22,200 Total undiscounted lease payments 32,312 Discount effect of cash flows 6,813 Total lease liability $ 25,499 NOTE 8 – 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, 2023 and 2022. Dilutive common shares arise from the potentially dilutive effect of the Company’s stock options that were outstanding at March 31, 2023. The assumed conversion of stock options can create a difference between basic and dilutive net income per common share. At March 31, 2023 and 2022, there were 205,689 and 9,000 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) 2023 2022 Numerator: Net income available to common shareholders $ 2,703 7,970 Denominator: Weighted-average common shares outstanding – basic 8,025,876 7,931,855 Common stock equivalents 66,394 164,455 Weighted-average common shares outstanding – diluted 8,092,270 8,096,310 Earnings per common share: Basic $ 0.34 1.00 Diluted 0.33 0.98 22 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, 2023 as compared to the three month period ended March 31, 2022 and assesses our financial condition as of March 31, 2023 as compared to December 31, 2022. 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, 2022 included in our Annual Report on Form 10-K for that period. Results for the three month period ended March 31, 2023 are not necessarily indicative of the results for the year ending December 31, 2023 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: ● 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, which could impair our liquidity; ● Changes in deposit flows, which may be negatively affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to clients on alternative investments and general economic or industry conditions; ● 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; 23 Table of Contents ● 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; ● 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 U.S. monetary policy, the level and volatility of interest rates, the capital markets and other market conditions that may affect, among other things, our liquidity and the value of our assets and liabilities; ● Any increase in FDIC assessments which will increase our cost of doing business; ● 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; ● 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, 2022, 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. 24 Table of Contents 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, 2023, we had total assets of $3.94 billion, a 6.7% increase from total assets of $3.69 billion at December 31, 2022. The largest component of our total assets is loans which were $3.42 billion and $3.27 billion at March 31, 2023 and December 31, 2022, respectively. Our liabilities and shareholders’ equity at March 31, 2023 totaled $3.64 billion and $299.4 million, respectively, compared to liabilities of $3.40 billion and shareholders’ equity of $294.5 million at December 31, 2022. The principal component of our liabilities is deposits which were $3.43 billion and $3.13 billion at March 31, 2023 and December 31, 2022, respectively. Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the 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 $2.7 million and $8.0 million for the three months ended March 31, 2023 and 2022, respectively. Diluted earnings per share (“EPS”) was $0.33 for the first quarter of 2023 as compared to $0.98 for the same period in 2022. The decrease in net income was primarily driven by a decrease in net interest income resulting from higher costs on our deposit accounts related to the Federal Reserve’s cumulative 475 basis point interest rate increase during the past 14 months, combined with an increase in non-interest expenses. 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 $20.4 million for the first quarter of 2023, an 11.8% decrease over net interest income of $23.2 million for the first quarter of 2022, driven primarily by the increase in interest expense on our deposit accounts. In addition, our net interest margin, on a tax-equivalent basis (TE), was 2.36% for the first quarter of 2023 compared to 3.37% for the same period in 2022. 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, 2023 and 2022. 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” tables demonstrate 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. 25 Table of Contents The following tables entitled “Average Balances, Income and Expenses, Yield and Rates” set 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, 2023 2022 (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 $ 85,966 $ 969 4.57 % $ 89,096 $ 59 0.27 % Investment securities, taxable 87,521 530 2.46 % 113,101 425 1.52 % Investment securities, nontaxable (2) 10,266 106 4.21 % 11,899 64 2.17 % Loans (3) 3,334,530 36,748 4.47 % 2,573,978 23,931 3.77 % Total interest-earning assets 3,518,283 38,353 4.42 % 2,788,074 24,479 3.56 % Noninterest-earning assets 161,310 152,565 Total assets $ 3,679,593 $ 2,940,639 Interest-bearing liabilities NOW accounts $ 303,176 440 0.59 % $ 406,054 115 0.11 % Savings & money market 1,661,878 11,992 2.93 % 1,242,225 618 0.20 % Time deposits 543,425 4,747 3.54 % 158,720 175 0.45 % Total interest-bearing deposits 2,508,479 17,179 2.78 % 1,806,999 908 0.20 % FHLB advances and other borrowings 18,243 200 4.45 % 16,626 12 0.29 % Subordinated debentures 36,224 527 5.90 % 36,116 380 4.27 % Total interest-bearing liabilities 2,562,946 17,906 2.83 % 1,859,741 1,300 0.28 % Noninterest-bearing liabilities 818,123 802,298 Shareholders’ equity 298,524 278,600 Total liabilities and shareholders’ equity $ 3,679,593 $ 2,940,639 Net interest spread 1.59 % 3.28 % Net interest income (tax equivalent) / margin $ 20,447 2.36 % $ 23,179 3.37 % Less: tax-equivalent adjustment (2) 23 15 Net interest income $ 20,424 $ 23,164 (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. 26 Table of Contents Our net interest margin (TE) decreased 101 basis points to 2.36% during the first quarter of 2023, compared to the first quarter of 2022, primarily due to higher costs on our interest-bearing liabilities. Our average interest-bearing liabilities grew by $703.2 million during the first quarter of 2023, while the rate on these liabilities increased 255 basis points to 2.83%. In contrast, our average interest-earning assets grew by $730.2 million during the first quarter of 2023 while the average yield on these assets increased by 86 basis points to 4.42% during the same period. The increase in average interest-earning assets for the first quarter of 2023 related primarily to an increase of $760.6 million in our average loan balances. The 86 basis point increase in yield on our interest-earning assets was driven by a 70 basis point increase in loan yield as our loan portfolio has repriced at rates higher than historical rates for the majority of the past 12 months. The increase in our average interest-bearing liabilities during the first quarter of 2023 resulted primarily from a $701.5 million increase in our interest-bearing deposits, while the 255-basis point increase in rate on our interest-bearing liabilities resulted primarily from a 258 basis point increase in deposit rates. Our net interest spread was 1.59% for the first quarter of 2023 compared to 3.28% for the same period in 2022. 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 255 basis point increase in the rate on our interest-bearing liabilities was partially offset by an 86 basis point increase in yield on our interest-bearing assets, resulting in a 169 basis point decrease in our net interest spread for the 2023 period. We anticipate continued pressure on our net interest spread and net interest margin in future periods as a significant portion of our loan portfolio is at fixed rates which do not move with the Federal Reserve’s interest rate increases, while our deposit accounts reprice much more quickly. Rate/Volume Analysis Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented. Three Months Ended March 31, 2023 vs. 2022 March 31, 2022 vs. 2021 Increase (Decrease) Due to Increase (Decrease) Due to (dollars in thousands) Volume Rate Rate/ Volume Total Volume Rate Rate/ Volume Total Interest income Loans $ 7,189 4,328 1,300 12,817 $ 3,571 (1,816 ) (289) 1,466 Investment securities (103 ) 309 (67 ) 139 90 64 19 173 Federal funds sold and interest-bearing deposits with banks (2 ) 945 (33 ) 910 - 12 - 12 Total interest income 7,084 5,582 1,200 13,866 3,661 (1,740 ) (270 ) 1,651 Interest expense Deposits 253 12,521 3,497 16,271 721 (596 ) (372 ) (247 ) FHLB advances and other borrowings 1 170 17 188 14 (1 ) (4 ) 9 Subordinated debentures 1 146 - 147 1 (3 ) - (2 ) Total interest expense 255 12,837 3,514 16,606 736 (600 ) (376 ) (240 ) Net interest income $ 6,829 (7,255 ) (2,314 ) (2,740 ) $ 2,925 (1,140 ) 106 1,891 Net interest income, the largest component of our income, was $20.4 million for the first quarter of 2023 and $23.2 million for the first quarter of 2022, a $2.7 million, or 11.8%, decrease year over year. The decrease during 2023 was driven by a $16.6 million increase in interest expense primarily due to higher rates on our interest-bearing deposits. In addition, interest income increased by $13.9 million primarily due to an increase in volume of loans and the rates on loans. 27 Table of Contents 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 and reserve for unfunded commitments at levels consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. We review the adequacy of the allowance for credit losses on a quarterly basis. Please see the discussion included in 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 $1.8 million provision for credit losses in the first quarter of 2023, compared to a $1.1 million provision for credit losses in the first quarter of 2022. The $1.8 million provision in 2023, which included a $1.9 million provision for credit losses and a $30,000 reversal for unfunded commitments, was driven by $144.6 million in loan growth during the first quarter. Noninterest Income The following table sets forth information related to our noninterest income. Three months ended March 31, (dollars in thousands) 2023 2022 Mortgage banking income $ 622 1,494 Service fees on deposit accounts 325 303 ATM and debit card income 555 514 Income from bank owned life insurance 332 315 Other income 210 301 Total noninterest income $ 2,044 2,927 Noninterest income decreased $883,000, or 30.2%, for the first quarter of 2023 as compared to the same period in 2022. The decrease in total noninterest income resulted primarily from the following: ● Mortgage banking income has typically been the largest component of our noninterest income; however, lower mortgage origination volume during the past 12 months, combined with our strategy to keep a larger percentage of these loans in our portfolio, has impacted our profitability. Consequently, mortgage banking income decreased by $872,000, or 58.4%, from the first quarter of 2022. ● Other income decreased $91,000, or 30.2% primarily due to a decrease in loan fee income. Noninterest expenses The following table sets forth information related to our noninterest expenses. Three months ended March 31, (dollars in thousands) 2023 2022 Compensation and benefits $ 10,356 9,455 Occupancy 2,457 1,779 Outside service and data processing costs 1,629 1,534 Insurance 689 261 Professional fees 660 599 Marketing 366 266 Other 947 791 Total noninterest expense $ 17,104 14,685 28 Table of Contents Noninterest expense was $17.1 million for the first quarter of 2023, a $2.4 million, or 16.5%, increase from noninterest expense of $14.7 million for the first quarter of 2022. The increase in noninterest expense was driven primarily by the following: ● Compensation and benefits expense increased $901,000, or 9.5%, relating primarily to annual salary increases, hiring of new team members, and higher benefits expense. ● Occupancy costs increased $678,000, or 38.1%, driven by costs associated with higher depreciation, property taxes and maintenance costs of our new headquarters. ● Insurance costs increased $428,000, or 164.0%, driven by higher FDIC insurance premiums. Our efficiency ratio was 76.1% for the first quarter of 2023, compared to 56.3% for the first quarter of 2022. 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 2023, compared to the first quarter of 2022, relates primarily to the decrease in net interest income and mortgage banking income, combined with higher noninterest expenses. We incurred income tax expense of $836,000 and $2.3 million for the three months ended March 31, 2023 and 2022, respectively. Our effective tax rate was 23.6% and 22.6% for the three months ended March 31, 2023 and 2022, respectively. The higher tax rate during the first three months of 2023 relates to the lesser impact of equity compensation transactions during the period. Balance Sheet Review Investment Securities At March 31, 2023, the $104.1 million in our investment securities portfolio represented approximately 2.6% 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 $94.0 million and an amortized cost of $108.9 million, resulting in an unrealized loss of $14.9 million. At December 31, 2022, the $104.2 million in our investment securities portfolio represented approximately 2.8% of our total assets, including investment securities with a fair value of $93.3 million and an amortized cost of $110.3 million for an unrealized loss of $17.0 million. 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, 2023 and 2022 were $3.33 billion and $2.56 billion, respectively. Before the allowance for credit losses, total loans outstanding at March 31, 2023 and December 31, 2022 were $3.42 billion and $3.27 billion, respectively. The principal component of our loan portfolio is loans secured by real estate mortgages. As of March 31, 2023, our loan portfolio included $2.88 billion, or 84.4%, of real estate loans, compared to $2.78 billion, or 84.8%, at December 31, 2022. 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 $181.0 million as of March 31, 2023, of which approximately 49% were in a first lien position, while the remaining balance was second liens. At December 31, 2022, our home equity lines of credit totaled $179.3 million, of which approximately 48% were in first lien positions, while the remaining balance was in second liens. The average home equity loan had a balance of approximately $83,000 and a loan to value of 74% as of March 31, 2023, compared to an average loan balance of $84,000 and a loan to value of approximately 73% as of December 31, 2022. Further, 0.7% and 0.6% of our total home equity lines of credit were over 30 days past due as of March 31, 2023 and December 31, 2022, respectively. 29 Table of Contents Following is a summary of our loan composition at March 31, 2023 and December 31, 2022. During the first three months of 2023, our loan portfolio increased by $144.6 million, or 4.4%, with a 3.9% increase in commercial loans while consumer loans increased by 5.3% during the period. The majority of the increase was in loans secured by real estate. Our consumer real estate portfolio grew by $62.0 million and includes high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $470,000, a term of 22 years, and an average rate of 3.84% as of March 31, 2023, compared to a principal balance of $468,000, a term of 22 years, and an average rate of 3.71% as of December 31, 2022. March 31, 2023 December 31, 2022 (dollars in thousands) Amount % of Total Amount % of Total Commercial Owner occupied RE $ 615,094 18.0 % $ 612,901 18.7 % Non-owner occupied RE 928,059 27.2 % 862,579 26.3 % Construction 94,641 2.8 % 109,726 3.4 % Business 495,161 14.5 % 468,112 14.3 % Total commercial loans 2,132,955 62.5 % 2,053,318 62.7 % Consumer Real estate 993,258 29.1 % 931,278 28.4 % Home equity 180,974 5.3 % 179,300 5.5 % Construction 71,137 2.1 % 80,415 2.5 % Other 39,621 1.0 % 29,052 0.9 % Total consumer loans 1,284,990 37.5 % 1,220,045 37.3 % Total gross loans, net of deferred fees 3,417,945 100.0 % 3,273,363 100.0 % Less—allowance for credit losses (40,435 ) (38,639 ) Total loans, net $ 3,377,510 $ 3,234,724 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, 2023 and December 31, 2022, we had no loans 90 days past due and still accruing. Following is a summary of our nonperforming assets. (dollars in thousands) March 31, 2023 December 31, 2022 Commercial $ 2,580 429 Consumer 2,153 2,198 Total nonaccrual loans 4,733 2,627 Other real estate owned - - Total nonperforming assets $ 4,733 2,627 At March 31, 2023, nonperforming assets were $4.7 million, or 0.12% of total assets and 0.14% of gross loans. Comparatively, nonperforming assets were $2.6 million, or 0.07% of total assets and 0.08% of gross loans at December 31, 2022. Nonaccrual loans increased $2.1 million during the first three months of 2023 due primarily to three commercial relationships totaling $2.4 million that were added to nonaccrual status, all of which are secured by real estate or liquid assets. 30 Table of Contents The amount of foregone interest income on nonaccrual loans in the first three months of 2023 and 2022 was not material. At March 31, 2023 and December 31, 2022, the allowance for credit losses represented 854.3% and 1470.7% of the total amount of nonperforming loans, respectively. The majority of the nonperforming loans at March 31, 2023 were secured by real estate, while one nonperforming loan was secured by a brokerage account. We have evaluated the underlying collateral on these loans and believe that the collateral on these loans is sufficient to minimize future losses. As a 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, 2023, 84.4% of our loans were collateralized by real estate and 83.1% of our individually evaluated 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. Individually evaluated loans are reviewed on a quarterly basis to determine the level of impairment. As of March 31, 2023, we did not have any individually evaluated 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, 2023, individually evaluated loans totaled $6.6 million, for which $5.5 million of these loans had a reserve of approximately $959,000 allocated in the allowance for credit losses. During the first three months of 2023, the average recorded investment in individually evaluated loans was approximately $7.5 million. Comparatively, individually evaluated loans totaled $7.1 million at December 31, 2022 for which $6.8 million of these loans had a reserve of approximately $1.3 million allocated in the allowance for credit losses. During 2022, the average recorded investment in individually evaluated loans was approximately $7.6 million. Allowance for Credit Losses The allowance for credit losses was $40.4 million, representing 1.18% of outstanding loans and providing coverage of 854.33%, of nonperforming loans at March 31, 2023 compared to $38.6 million, or 1.18% of outstanding loans and 1470.84% of nonperforming loans at December 31, 2022. At March 31, 2022, the allowance for credit losses was $32.9 million, or 1.24% of outstanding loans and 726.88% of nonperforming loans. 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, which allows us to take advantage of the attractive terms that wholesale funding can offer while mitigating the related inherent risk. Our retail deposits represented $3.08 billion, or 89.9% of total deposits, while our wholesale deposits represented $347.7 million, or 10.1%, of total deposits at March 31, 2023. At December 31, 2022, retail deposits represented $2.90 billion, or 92.5%, of our total deposits. Wholesale deposits were $236.2 million, representing 7.5% of our total deposits, at December 31, 2022. Our loan-to-deposit ratio was 100% at March 31, 2023 and 104% at December 31, 2022. 31 Table of Contents The following is a detail of our deposit accounts: March 31, December 31, (dollars in thousands) 2023 2022 Non-interest bearing $ 740,534 804,115 Interest bearing: NOW accounts 303,743 318,030 Money market accounts 1,748,562 1,506,418 Savings 39,706 40,673 Time, less than $250,000 106,679 89,876 Time and out-of-market deposits, $250,000 and over 487,550 374,752 Total deposits $ 3,426,774 3,133,864 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 $2.95 billion and $2.76 billion at March 31, 2023, and December 31, 2022, respectively. In addition, at March 31, 2023 and December 31, 2022, we estimate that we have approximately $1.1 billion, or 32.1% and 36.6% of total deposits, respectively, in uninsured deposits including related interest accrued and unpaid. Since it is not reasonably practicable to provide a precise measure of uninsured deposits, the amounts above are estimates and are based on the same methodologies and assumptions used by the FDIC for the Bank’s regulatory reporting requirements. The following table shows the average balance amounts and the average rates paid on deposits. Three months ended March 31, 2023 2022 (dollars in thousands) Amount Rate Amount Rate Noninterest-bearing demand deposits $ 766,916 0.00 % $ 753,546 0.00 % Interest-bearing demand deposits 303,176 0.59 % 406,054 0.12 % Money market accounts 1,621,885 3.00 % 1,201,816 0.21 % Savings accounts 39,993 0.06 % 40,409 0.05 % Time deposits less than $250,000 59,469 4.55 % 56,648 0.32 % Time deposits greater than $250,000 483,956 0.94 % 102,073 0.50 % Total deposits $ 3,275,395 1.76 % $ 2,560,546 0.14 % During the first three months of 2023, our average transaction account balances increased by $330.1 million, or 13.7%, from the prior year, while our average time deposit balances increased by $385,000, or 242.4%. We have experienced record growth in new account openings throughout our footprint during the first quarter of 2023. In addition, we have added $245.9 million in wholesale time deposits. All of our time deposits are certificates of deposits. The maturity distribution of our time deposits $250,000 or more at March 31, 2023 was as follows: (dollars in thousands) March 31, 2023 Three months or less $ 180,209 Over three through six months 155,187 Over six through twelve months 137,563 Over twelve months 14,591 Total $ 487,550 Time deposits that meet or exceed the FDIC insurance limit of $250,000 at March 31, 2023 and December 31, 2022 were $487.6 million and $374.8 million, respectively. 32 Table of Contents Liquidity and Capital Resources Liquidity is our ability to fund operations, to meet depositor withdrawals, to provide for customers’ credit needs, and to meet maturing obligations and existing commitments. Our liquidity principally depends on our cash flows from operating activities, investment in and maturity of assets, changes in balances of deposits and borrowings, and our ability to borrow funds. The bank failures in March 2023 exemplify the potential serious results of the unexpected inability of insured depository institutions to obtain needed liquidity to satisfy deposit withdrawal requests, including how quickly such requests can accelerate once uninsured depositors lose confidence in an institutions ability to satisfy its obligations to depositors. We seek to ensure our funding needs are met by maintaining a level of liquidity through asset and liability management. 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, 2023 and December 31, 2022 our cash and cash equivalents totaled $272.2 million and $170.9 million, respectively, or 6.9% and 4.6% of total assets, respectively. Our investment securities at March 31, 2023 and December 31, 2022 amounted to $104.1 million and $104.2 million, respectively, or 2.6% and 2.8% 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, 2023. 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, 2023 was $609.9 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, 2023 and December 31, 2022 we had $373.3 million and $341.5 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, 2023. 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. 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 $299.4 million at March 31, 2023 and $294.5 million at December 31, 2022. The $4.9 million increase from December 31, 2022 is primarily related to net income of $2.7 million during the first three months of 2023 and a decrease in the unrealized loss on securities available for sale of $1.6 million. 33 Table of Contents 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, 2023 and the year ended December 31, 2022. Since our inception, we have not paid cash dividends. March 31, 2023 December 31, 2022 Return on average assets 0.30 % 0.90 % Return on average equity 3.67 % 10.20 % Return on average common equity 3.67 % 10.20 % Average equity to average assets ratio 8.11 % 8.85 % Tangible common equity to assets ratio 7.60 % 7.98 % 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 credit 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. 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, 2023, our capital ratios exceed these ratios and we remain “well capitalized.” 34 Table of Contents The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements. March 31, 2023 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) $ 376,311 12.38 % $ 243,212 8.00 % $ 304,016 10.00 % Tier 1 Capital (to risk weighted assets) 338,279 11.13 % 182,409 6.00 % 243,212 8.00 % Common Equity Tier 1 Capital (to risk weighted assets) 338,279 11.13 % 136,807 4.50 % 197,610 6.50 % Tier 1 Capital (to average assets) 338,279 9.16 % 147,775 4.00 % 184,719 5.00 % December 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) $ 366,988 12.45 % $ 235,892 8.00 % $ 294,865 10.00 % Tier 1 Capital (to risk weighted assets) 330,108 11.20 % 176,919 6.00 % 235,892 8.00 % Common Equity Tier 1 Capital (to risk weighted assets) 330,108 11.20 % 132,689 4.50 % 191,662 6.50 % Tier 1 Capital (to average assets) 330,108 9.43 % 140,040 4.00 % 175,050 5.00 % The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements. March 31, 2023 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) $ 385,157 12.67 % $ 243,211 8.00 % N/A N/A Tier 1 Capital (to risk weighted assets) 324,125 10.66 % 182,409 6.00 % N/A N/A Common Equity Tier 1 Capital (to risk weighted assets) 311,125 10.23 % 136,806 4.50 % N/A N/A Tier 1 Capital (to average assets) 324,125 8.80 % 147,285 4.00 % N/A N/A December 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) $ 380,802 12.91 % $ 235,892 8.00 % N/A N/A Tier 1 Capital (to risk weighted assets) 320,922 10.88 % 176,919 6.00 % N/A N/A Common Equity Tier 1 Capital (to risk weighted assets) 307,922 10.44 % 132,689 4.50 % N/A N/A Tier 1 Capital (to average assets) 320,922 9.17 % 140,057 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 to shareholders 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 to shareholders. 35 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, 2023 unfunded commitments to extend credit were $882.5 million, of which $286.3 million were at fixed rates and $596.2 million were at variable rates. At December 31, 2022, unfunded commitments to extend credit were $878.3 million, of which approximately $318.9 million were at fixed rates and $559.4 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. As of March 31, 2023, the reserve for unfunded commitments was $2.8 million or 0.31% of total unfunded commitments. As of December 31, 2022, the reserve for unfunded commitments was $2.8 million or 0.32% of total unfunded commitments. At March 31, 2023 and December 31, 2022, there were commitments under letters of credit for $15.6 million and $14.3 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, 2022, for a description our significant accounting policies that use critical accounting estimates. 36 Table of Contents 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. As of March 31, 2023, 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 (16.34 )% Up 200 basis points (10.86 )% Up 100 basis points (5.43 )% Base — Down 100 basis points 10.80 % Down 200 basis points 21.01 % Down 300 basis points 30.48 % 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, 2023, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. 37 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, 2022, 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. We are providing these additional risk factors to supplement the risk factors contained in Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2022. Our deposit insurance premiums could be higher in the future, which could have an adverse effect on our future earnings. The FDIC insures deposits at FDIC-insured depository institutions, such as Southern First Bank, up to the maximum federal deposit insurance level per account. Our regular assessments are based on its average consolidated total assets minus average tangible equity as well as by risk classification, which includes regulatory capital levels and the level of supervisory concern. In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums. For example, in response to March 2023 bank closures and in an effort to strengthen public confidence in the banking system and protect depositors, regulators announced that any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law, which could increase the cost of our FDIC insurance assessments and affect our profitability. If our financial condition deteriorates or if the bank regulators otherwise have supervisory concerns about us, then our assessments could rise. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could reduce our profitability, may limit our ability to pursue certain business opportunities, or otherwise negatively impact our operations. The Federal Reserve has implemented significant economic strategies that have affected interest rates, inflation, asset values, and the shape of the yield curve. In 2020, in response to economic disruption associated with the COVID-19 pandemic, the Federal Reserve quickly reduced short-term rates to extremely low levels and acted to influence the markets to reduce long-term rates as well. During 2021, the Federal Reserve significantly reduced such “easing” actions that held down long-term rates. During 2022, the Federal Reserve switched to a tightening policy. It raised short term rates significantly and rapidly throughout the year. Those actions triggered a significant decline in the values of most categories of U.S. stocks and bonds; significantly raised recessionary expectations for the U.S.; and inverted the yield curve in the U.S. for much of the last two quarters of 2022. Effects on the yield curve often are most pronounced at the short end of the curve, which is of particular importance to us and other banks. Among other things, easing strategies are intended to lower interest rates, expand the money supply, and stimulate economic activity, while tightening strategies are intended to increase interest rates, discourage borrowing, tighten the money supply, and restrain economic activity. However, in 2022, short term rates rose faster than long term rates to the point that the yield curve inverted for much of the final two quarters of 2022. This sort of phenomenon—where short term rates rise more strongly and rapidly than long-term rates can follow—is relatively uncommon. It is unclear when long term rates are likely to catch up. Many external factors may interfere with the effects of these plans or cause them to be changed, sometimes quickly. Such factors include significant economic trends or events as well as significant international monetary policies and events. For 2023, the Federal Reserve has not yet indicated when it will stop, or at least pause, raising short term rates, although the rate of increases has slowed. These economic strategies have had, and will continue to have, a significant impact on our business and on many of our clients. As exemplified by the March 2023 bank failures in the U.S., such strategies also can affect the U.S. and world-wide financial systems in ways that may be difficult to predict. 38 Table of Contents Adverse developments affecting the financial services industry, such as recent bank failures or concerns involving liquidity, may have a material adverse effect on the Company’s operations. The recent high-profile bank failures involving Silicon Valley Bank and Signature Bank have caused general uncertainty and concern regarding the liquidity adequacy of the banking sector. Although we were not directly affected by these bank failures, the resulting speed and ease in which news, including social media commentary, led depositors to withdraw or attempt to withdraw their funds from these and other financial institutions caused the stock prices of many financial institutions to become volatile. Additional bank failures could have an adverse effect on our financial condition and results of operations, either directly or through an adverse impact on certain of our customers. In response to these bank failures and the resulting market reaction, the Secretary of the Treasury approved actions enabling the FDIC to complete its resolutions of the failed banks in a manner that fully protects depositors by utilizing the Deposit Insurance Fund, including the use of Bridge Banks to assume all of the deposit obligations of the failed banks, while leaving unsecured lenders and equity holders of such institutions exposed to losses. In addition, the Federal Reserve announced it would make available additional funding to eligible depository institutions under a Bank Term Funding Program to help assure banks have the ability to meet the needs of all their depositors. In an effort to strengthen public confidence in the banking system and protect depositors, regulators announced that any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law, which will increase our FDIC insurance assessment and will increase our costs of doing business. However, it is uncertain whether these steps by the government will be sufficient to calm the financial markets, reduce the risk of significant depositor withdrawals at other institutions and thereby reduce the risk of additional bank failures. As a result of this uncertainty, we face the potential for reputational risk, deposit outflows, increased costs and competition for liquidity, and increased credit risk which, individually or in the aggregate, could have a material adverse effect on our business, financial condition and results of operations. Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. (a) Not applicable. (b) Not applicable. (c) Not applicable. Item 3. DEFAULTS UPON SENIOR SECURITIES. None. Item 4. MINE SAFETY DISCLOSURES. Not applicable. Item 5. OTHER INFORMATION. None. 39 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 10.1 Employment Agreement by and between Southern First Bank and William M. Aiken, III, dated December 1, 2021. 10.2 Employment Agreement by and between Southern First Bank and D. Andrew Borrmann, dated March 29, 2023 (incorporated by reference to Exhibit 10.1 of the Company’s Form 8-K filed April 3, 2023).* 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, 2023, 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) ______ ________________________________________________ * Management contract or compensatory plan or arrangement. 40 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 2, 2023 /s/ R. Arthur Seaver, Jr. R. Arthur Seaver, Jr. Chief Executive Officer (Principal Executive Officer) Date: May 2, 2023 /s/ D. Andrew Borrmann D. Andrew Borrmann Chief Financial Officer (Principal Financial and Accounting Officer) 41