SOUTHERN FIRST BANCSHARES INC 10-Q

Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2023 OR ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to Commission file number 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 x 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 x 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 x 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 x Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 8,088,638 shares of common stock, par value $0.01 per share, were issued and outstanding as of October 31, 2023. Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY September 30, 2023 Form 10-Q INDEX Page PART I – CONSOLIDATED FINANCIAL INFORMATION Item 1. Consolidated Financial Statements Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Comprehensive Income 5 Consolidated Statements of Shareholders’ Equity 6 Consolidated Statements of Cash Flows 7 Notes to Unaudited Consolidated Financial Statements 8 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 29 Item 3. Quantitative and Qualitative Disclosures about Market Risk 45 Item 4. Controls and Procedures 46 PART II – OTHER INFORMATION Item 1. Legal Proceedings 46 Item 1A. Risk Factors 46 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 46 Item 3. Defaults upon Senior Securities 47 Item 4. Mine Safety Disclosures 47 Item 5. Other Information 47 Item 6. Exhibits 47 2 Table of Contents PART I. CONSOLIDATED FINANCIAL INFORMATION Item 1. CONSOLIDATED FINANCIAL STATEMENTS SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS September 30, December 31, (dollars in thousands, except share data) 2023 2022 (Unaudited) (Audited) ASSETS Cash and cash equivalents: Cash and due from banks $ 17,395 18,788 Federal funds sold 127,714 101,277 Interest-bearing deposits with banks 7,283 50,809 Total cash and cash equivalents 152,392 170,874 Investment securities: Investment securities available for sale 144,035 93,347 Other investments 19,600 10,833 Total investment securities 163,635 104,180 Mortgage loans held for sale 7,117 3,917 Loans 3,553,632 3,273,363 Less allowance for credit losses ( 41,131 ) ( 38,639 ) Loans, net 3,512,501 3,234,724 Bank owned life insurance 52,140 51,122 Property and equipment, net 95,743 99,183 Deferred income taxes, net 13,078 12,522 Other assets 23,351 15,459 Total assets $ 4,019,957 3,691,981 LIABILITIES Deposits $ 3,347,771 3,133,864 FHLB advances and related debt 275,000 175,000 Subordinated debentures 36,295 36,214 Other liabilities 56,993 52,391 Total liabilities 3,716,059 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, 8,088,638 and 8,011,045 shares issued and outstanding at September 30, 2023 and December 31, 2022, respectively 81 80 Nonvested restricted stock ( 4,065 ) ( 3,306 ) Additional paid-in capital 121,757 119,027 Accumulated other comprehensive loss ( 15,255 ) ( 13,410 ) Retained earnings 201,380 192,121 Total shareholders’ equity 303,898 294,512 Total liabilities and shareholders’ equity $ 4,019,957 3,691,981 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 INCOME (Unaudited) For the three months For the nine months ended September 30, ended September 30, (dollars in thousands, except share data) 2023 2022 2023 2022 Interest income Loans $ 43,542 29,752 121,380 80,294 Investment securities 1,470 506 2,788 1,428 Federal funds sold and interest-bearing deposits with banks 2,435 676 4,295 915 Total interest income 47,447 30,934 128,463 82,637 Interest expense Deposits 25,130 5,021 64,245 7,773 Borrowings 2,972 459 5,623 1,362 Total interest expense 28,102 5,480 69,868 9,135 Net interest income 19,345 25,454 58,595 73,502 Provision for credit losses ( 500 ) 950 2,235 3,830 Net interest income after provision for credit losses 19,845 24,504 56,360 69,672 Noninterest income Mortgage banking income 1,208 1,230 3,167 3,907 Service fees on deposit accounts 356 318 1,011 949 ATM and debit card income 588 542 1,680 1,604 Income from bank owned life insurance 349 315 1,018 945 Loss on disposal of fixed assets - - - ( 394 ) Gain on sale of securities - - - 12 Other income 249 275 653 850 Total noninterest income 2,750 2,680 7,529 7,873 Noninterest expenses Compensation and benefits 10,231 9,843 30,874 29,214 Occupancy 2,562 2,442 7,537 6,439 Outside service and data processing costs 1,744 1,529 5,078 4,591 Insurance 1,243 507 2,829 1,134 Professional fees 504 555 1,914 1,848 Marketing 293 338 994 934 Other 725 832 2,573 2,360 Total noninterest expenses 17,302 16,046 51,799 46,520 Income before income tax expense 5,293 11,138 12,090 31,025 Income tax expense 1,195 2,725 2,831 7,402 Net income $ 4,098 8,413 9,259 23,623 Earnings per common share Basic $ 0.51 1.06 1.15 2.97 Diluted 0.51 1.04 1.15 2.93 Weighted average common shares outstanding Basic 8,052,926 7,972,146 8,043,410 7,954,025 Diluted 8,072,408 8,065,087 8,077,830 8,071,988 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 COMPREHENSIVE INCOME (Unaudited) For the three months ended September 30, For the nine months ended September 30, (dollars in thousands) 2023 2022 2023 2022 Net income $ 4,098 8,413 9,259 23,623 Other comprehensive loss: Unrealized loss on securities available for sale: Unrealized holding loss arising during the period, pretax ( 3,221 ) ( 4,894 ) ( 2,333 ) ( 16,783 ) Tax expense 676 1,028 488 3,524 Reclassification of realized gain - - - ( 12 ) Tax benefit - - - 2 Other comprehensive loss ( 2,545 ) ( 3,866 ) ( 1,845 ) ( 13,269 ) Comprehensive income $ 1,553 4,547 7,414 10,354 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 CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited) For the three months ended September 30, 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 June 30, 2022 7,985,644 $ 80 - - $ ( 3,230 ) $ 117,714 $ ( 10,143 ) $ 178,216 $ 282,637 Net income Retained earnings - - - - - - - 8,413 8,413 Proceeds from exercise of stock options 3,000 - - - - 87 - - 87 Issuance of restricted stock 8,700 - - - ( 405 ) 405 - - - Compensation expense related to restricted stock, net of tax - - - - 287 - - - 287 Compensation expense related to stock options, net of tax - - - - - 227 - - 227 Other comprehensive loss - - - - - - ( 3,866 ) - ( 3,866 ) Additional paid-in capital September 30, 2022 7,997,344 $ 80 - $ - $ ( 3,348 ) $ 118,433 $ ( 14,009 ) $ 186,629 $ 287,785 June 30, 2023 8,058,438 $ 81 - $ - $ ( 4,051 ) $ 120,912 $ ( 12,710 ) $ 197,282 $ 301,514 Net income - - - - - - - 4,098 4,098 Proceeds from exercise of stock options 14,250 - - - - 312 - - 312 Issuance of restricted stock, net of forfeitures 15,950 - - - ( 388 ) 388 - - - Compensation expense related to restricted stock, net of tax - - - - 374 - - - 374 Compensation expense related to stock options, net of tax - - - - - 145 - - 145 Other comprehensive loss - - - - - - ( 2,545 ) - ( 2,545 ) September 30, 2023 8,088,638 $ 81 - $ - $ ( 4,065 ) $ 121,757 $ ( 15,255 ) $ 201,380 $ 303,898 For the nine months ended September 30, 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 Preferred stock 7,925,819 $ 79 - - $ ( 1,435 ) $ 114,226 $ ( 740 ) $ 165,771 $ 277,901 Net income Common stock - - - - - - - 23,623 23,623 Proceeds from exercise of stock options 24,750 1 - - - 793 - - 794 Issuance of restricted stock 46,775 - - - ( 2,710 ) 2,710 - - - Adoption of ASU 2016-13 - - - - - - - ( 2,765 ) ( 2,765 ) Compensation expense related to restricted stock, net of tax - - - - 797 - - - 797 Compensation expense related to stock options, net of tax - - - - - 704 - - 704 Other comprehensive loss - - - - - - ( 13,269 ) - ( 13,269 ) September 30, 2022 7,997,344 $ 80 - $ - $ ( 3,348 ) $ 118,433 $ ( 14,009 ) $ 186,629 $ 287,785 December 31, 2022 8,011,045 $ 80 - $ - $ ( 3,306 ) $ 119,027 $ ( 13,410 ) $ 192,121 $ 294,512 Net income - - - - - - - 9,259 9,259 Proceeds from exercise of stock options 25,250 - - - - 497 - - 497 Issuance of restricted stock 52,343 1 - - ( 1,824 ) 1,823 - - - Compensation expense related to restricted stock, net of tax - - - - 1,065 - - - 1,065 Compensation expense related to stock options, net of tax - - - - - 410 - - 410 Other comprehensive loss - - - - - - ( 1,845 ) - ( 1,845 ) Accumulated other comprehensive income (loss) September 30, 2023 8,088,638 $ 81 - $ - $ ( 4,065 ) $ 121,757 $ ( 15,255 ) $ 201,380 $ 303,898 See notes to consolidated financial statements that are an integral part of these consolidated statements. 6 Table of Contents SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) For the nine months ended September 30, (dollars in thousands) 2023 2022 Operating activities Net income $ 9,259 23,623 Adjustments to reconcile net income to cash provided by operating activities: Provision for credit losses 2,235 3,830 Depreciation and other amortization 3,611 2,521 Accretion and amortization of securities discounts and premium, net 142 554 Loss on sale of fixed assets - 394 Gain on sale of securities - ( 12 ) Net change in operating leases 188 814 Compensation expense related to stock options and restricted stock grants 1,475 1,501 Gain on sale of loans held for sale ( 2,793 ) ( 2,700 ) Loans originated and held for sale ( 112,930 ) ( 191,448 ) Proceeds from sale of loans held for sale 112,523 198,461 Increase in cash surrender value of bank owned life insurance ( 1,018 ) ( 945 ) Increase in deferred tax asset ( 66 ) ( 5,766 ) (Increase) decrease in other assets ( 7,892 ) 5 Increase in other liabilities 6,059 6,006 Net cash provided by operating activities 10,793 36,838 Investing activities Increase (decrease) in cash realized from: Increase in loans, net ( 280,627 ) ( 538,816 ) Purchase of property and equipment ( 1,120 ) ( 13,134 ) Purchase of investment securities: Available for sale ( 58,204 ) ( 10,094 ) Other investments ( 49,949 ) ( 15,235 ) Payments and maturities, calls and repayments of investment securities: Available for sale 5,039 21,517 Other investments 41,182 13,806 Proceeds from sale of fixed assets - 95 Net cash used for investing activities ( 343,679 ) ( 541,861 ) Financing activities Increase in cash realized from: Increase in deposits, net 213,907 437,626 Increase in Federal Home Loan Bank advances and other borrowings, net 100,000 60,000 Proceeds from the exercise of stock options 497 794 Net cash provided by financing activities 314,404 498,420 Net decrease in cash and cash equivalents ( 18,482 ) ( 6,603 ) Cash and cash equivalents at beginning of the period 170,874 167,209 Cash and cash equivalents at end of the period $ 152,392 160,606 Supplemental information Cash paid for Interest $ 64,390 9,155 Income taxes 586 8,270 Schedule of non-cash transactions Unrealized gain (loss) on securities, net of income taxes ( 1,845 ) ( 13,259 ) Right-of-use assets obtained in exchange for lease obligations: Operating leases 147 237 See notes to consolidated financial statements that are an integral part of these consolidated statements. 7 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 and nine-month periods ended September 30, 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 and 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 three significant bank failures in the first five months of 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 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 has and could continue to 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 continued impact of these bank 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 8 Table of Contents 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. 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. In January 2023, the Company adopted ASU 2022-01, “Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method”, which intended to better align hedge accounting with an organization’s risk management strategies. The ASU became applicable to the Company in the second quarter of 2023 when we entered into a fair value hedge using the portfolio layer method. 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. 9 Table of Contents NOTE 2 – Investment Securities The amortized costs and fair value of investment securities are as follows: Schedule of amortized costs and fair value of investment securities September 30, 2023 Amortized Gross Unrealized Fair (dollars in thousands) Cost Gains Losses Value Available for sale Corporate bonds $ 2,153 - 303 1,850 US treasuries 25,737 2 136 25,603 US government agencies 21,225 - 2,501 18,724 State and political subdivisions 22,708 - 4,398 18,310 Asset-backed securities 29,780 25 164 29,641 Mortgage-backed securities FHLMC 23,379 - 4,639 18,740 FNMA 33,251 - 6,285 26,966 GNMA 5,111 - 910 4,201 Total mortgage-backed securities 61,741 - 11,834 49,907 Total investment securities available for sale $ 163,344 27 19,336 144,035 December 31, 2022 Amortized Gross Unrealized Fair Cost Gains Losses Value Available for sale Corporate bonds $ 2,172 - 289 1,883 US treasuries US treasuries [Member] 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 FHLMC [Member] 24,086 - 3,745 20,341 FNMA FNMA [Member] 35,141 - 5,520 29,621 GNMA GNMA [Member] 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 September 30, 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. 10 Table of Contents Schedule of maturities and yields on the company’s investment securities September 30, 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 Corporate bonds [Member] $ - - $ - - $ 1,850 2.01 % $ - - $ 1,850 2.01 % US treasuries 24,739 5.39 % 864 1.27 % - - - - 25,603 5.25 % US government agencies US government agencies [Member] 956 0.45 % 2,293 1.00 % 15,475 4.45 % - - 18,724 3.82 % State and political subdivisions State and political subdivisions [Member] - - 872 1.94 % 4,919 1.80 % 12,519 2.17 % 18,310 2.06 % Asset-backed securities Asset-backed securities [Member] - - - - 340 6.24 % 29,301 6.61 % 29,641 6.60 % Mortgage-backed securities Mortgage-backed securities [Member] - - 4,680 1.16 % 5,140 1.59 % 40,087 1.94 % 49,907 1.83 % Total investment securities Total investment securities [Member] $ 25,695 5.21 % $ 8,709 1.20 % $ 27,724 3.31 % $ 81,907 3.64 % $ 144,035 3.71 % 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 September 30, 2023 and December 31, 2022, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. Schedule of gross unrealized losses on investment securities and fair market value of related securities September 30, 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 $ 1,850 $ 303 1 $ 1,850 $ 303 US treasuries - - - 1 863 136 1 863 136 US government agencies 2 8,156 60 10 10,568 2,441 12 18,724 2,501 State and political subdivisions 2 734 33 30 17,576 4,365 32 18,310 4,398 Asset-backed 5 15,631 83 7 5,039 81 12 20,670 164 Mortgage-backed securities Mortgage-backed securities [Member] FHLMC FHLMC [Member] 2 2,726 189 19 16,014 4,450 21 18,740 4,639 FNMA - - - 37 26,966 6,285 37 26,966 6,285 GNMA - - - 6 4,201 910 6 4,201 910 Total investment securities 11 $ 27,247 $ 365 111 $ 83,077 $ 18,971 122 $ 110,324 $ 19,336 11 Table of Contents 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 September 30, 2023 the Company had 122 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 September 30, 2023 . Other investments are comprised of the following and are recorded at cost which approximates fair value. Schedule of other investments (dollars in thousands) September 30, 2023 December 31, 2022 Federal Home Loan Bank stock $ 16,046 9,250 Other nonmarketable investments 3,151 1,180 Investment in Trust Preferred subsidiaries 403 403 Total other investments $ 19,600 10,833 The Company has evaluated other investments for impairment and determined that the other investments are not impaired as of September 30, 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. 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 September 30 2023, mortgage loans held for sale totaled $ 7.1 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 $ 7.1 million as of September 30, 2023 and $ 7.3 million as of December 31, 2022. 12 Table of Contents   Schedule of composition of our loan portfolio September 30, 2023 December 31, 2022 (dollars in thousands) Commercial [Member] Amount % of Total Amount % of Total Commercial Owner occupied RE Owner occupied RE [Member] $ 637,038 17.9 % $ 612,901 18.7 % Non-owner occupied RE Non-owner occupied RE [Member] 937,749 26.4 % 862,579 26.3 % Construction Construction [Member] 119,629 3.4 % 109,726 3.4 % Business Business [Member] 500,253 14.1 % 468,112 14.3 % Total commercial loans Consumer [Member] 2,194,669 61.8 % 2,053,318 62.7 % Consumer Real estate Real estate [Member] 1,074,679 30.2 % 931,278 28.4 % Home equity Home equity [Member] 180,856 5.1 % 179,300 5.5 % Construction Construction [Member] 54,210 1.5 % 80,415 2.5 % Other Other [Member] 49,218 1.4 % 29,052 0.9 % Total consumer loans 1,358,963 38.2 % 1,220,045 37.3 % Total gross loans, net of deferred fees 3,553,632 100.0 % 3,273,363 100.0 % Less—allowance for credit losses ( 41,131 ) ( 38,639 ) Total loans, net $ 3,512,501 $ 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. Schedule of loan maturity distribution by type and related interest rate September 30, 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 $ 13,679 177,138 404,693 41,528 637,038 Non-owner occupied RE 66,746 501,700 343,953 25,350 937,749 Construction 23,899 44,452 51,278 - 119,629 Business 106,126 198,150 191,559 4,418 500,253 Total commercial loans 210,450 921,440 991,483 71,296 2,194,669 Consumer Real estate 8,646 50,898 304,890 710,245 1,074,679 Home equity 1,996 24,720 149,252 4,888 180,856 Construction - 259 31,796 22,155 54,210 Other 12,945 33,082 2,376 815 49,218 Total consumer loans 23,587 108,959 488,314 738,103 1,358,963 Total gross loans, net of deferred fees $ 234,037 1,030,399 1,479,797 809,399 3,553,632 13 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. Schedule of composition of gross loans by rate type September 30, 2023 December 31, 2022 Interest Rate Interest Rate (dollars in thousands) Fixed Floating or Adjustable Fixed Floating or Adjustable Commercial Commercial [Member] Owner occupied RE Owner occupied RE [Member] $ 614,563 8,796 598,513 3,814 Non-owner occupied RE Non-owner occupied RE [Member] 787,479 83,524 742,763 75,246 Construction Construction [Member] 65,517 30,213 90,246 13,971 Business Business [Member] 300,464 93,663 298,866 73,089 Total commercial loans 1,768,023 216,196 1,730,388 166,120 Consumer Consumer [Member] Real estate Real estate [Member] 1,066,033 - 919,130 11 Home equity Home equity [Member] 12,403 166,457 14,173 163,791 Construction Construction [Member] 54,210 - 79,750 - Other Other [Member] 11,916 24,357 19,113 6,013 Total consumer loans 1,144,562 190,814 1,032,166 169,815 Total gross loans, net of deferred fees $ 2,912,585 407,010 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. 14 Table of Contents · 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, which may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. · Doubtful—A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable. 15 Table of Contents The following table presents loan balances classified by credit quality indicators by year of origination as of September 30, 2023. Schedule of breakdown of outstanding loans by risk category September 30, 2023 (dollars in thousands) 2023 2022 2021 2020 2019 Prior Revolving Revolving Converted to Term Total Commercial Owner occupied RE Pass $ 38,310 178,722 143,057 67,509 62,216 112,528 - 167 602,509 Watch - 3,482 464 16,074 3,551 6,821 - - 30,392 Special Mention - 186 - - - 3,074 - - 3,260 Substandard - - - - - 877 - - 877 Total Owner occupied RE 38,310 182,390 143,521 83,583 65,767 123,300 - 167 637,038 Non-owner occupied RE Pass 79,567 302,942 169,567 109,566 59,595 173,400 257 - 894,894 Watch 772 828 10,221 - 5,393 6,610 - - 23,824 Special Mention - - 199 - 8,267 878 - - 9,344 Substandard - - - - 8,073 1,614 - - 9,687 Total Non-owner occupied RE 80,339 303,770 179,987 109,566 81,328 182,502 257 - 937,749 Construction Pass 13,921 72,528 22,179 9,897 - - - - 118,525 Watch - 1,104 - - - - - - 1,104 Special Mention - - - - - - - - - Substandard - - - - - - - - - Total Construction 13,921 73,632 22,179 9,897 - - - - 119,629 Business Pass 41,808 136,635 50,098 19,637 18,214 53,775 144,671 1,099 465,937 Watch 282 14,431 1,955 1,114 913 3,958 6,697 - 29,350 Special Mention 101 977 77 793 211 234 - 98 2,491 Substandard - 490 164 - 153 1,199 447 22 2,475 Total Business 42,191 152,533 52,294 21,544 19,491 59,166 151,815 1,219 500,253 Total Commercial loans 174,761 712,325 397,981 224,590 166,586 364,968 152,072 1,386 2,194,669 Consumer Real estate Pass 126,174 273,593 283,538 178,459 66,468 108,094 - - 1,036,326 Watch 490 5,684 7,877 3,941 2,058 4,098 - - 24,148 Special Mention - 2,319 1,663 1,301 2,407 2,799 - - 10,489 Substandard - 186 637 820 323 1,750 - - 3,716 Total Real estate 126,664 281,782 293,715 184,521 71,256 116,741 - - 1,074,679 Home equity Pass - - - - - - 168,399 - 168,399 Watch - - - - - - 6,870 - 6,870 Special Mention - - - - - - 4,150 - 4,150 Substandard - - - - - - 1,437 - 1,437 Total Home equity - - - - - - 180,856 - 180,856 Construction Pass 9,798 35,606 8,806 - - - - - 54,210 Watch - - - - - - - - - Special Mention - - - - - - - - - Substandard - - - - - - - - - Total Construction 9,798 35,606 8,806 - - - - - 54,210 Other Pass 923 2,643 2,578 1,505 846 2,726 36,718 - 47,939 Watch 44 33 352 4 1 167 94 - 695 Special Mention - 334 - - 27 84 51 - 496 Substandard - - 80 - 1 - 7 - 88 Total Other 967 3,010 3,010 1,509 875 2,977 36,870 - 49,218 Total Consumer loans 137,429 320,398 305,531 186,030 72,131 119,718 217,726 - 1,358,963 Total loans $ 312,190 1,032,723 703,512 410,620 238,717 484,686 369,798 1,386 3,553,632 Current period gross write-offs - ( 200 ) - ( 28 ) - ( 10 ) ( 405 ) - ( 643 ) 16 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 96 - 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 Current period gross write-offs - ( 91 ) - ( 23 ) - ( 32 ) ( 339 ) - ( 485 ) 17 Table of Contents The following tables present loan balances by age and payment status. Schedule of loan balances by payment status September 30, 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 $ - - - - 637,038 637,038 Non-owner occupied RE 440 - - 1,615 935,694 937,749 Construction - - - - 119,629 119,629 Business 347 27 - 404 499,475 500,253 Consumer Real estate 1,210 - - 1,228 1,072,241 1,074,679 Home equity 226 182 - 1,068 179,380 180,856 Construction - - - - 54,210 54,210 Other - - - - 49,218 49,218 Total loans $ 2,223 209 - 4,315 3,546,885 3,553,632 Total loans over 90 days past due - - - - - 1,572 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 September 30, 2023 and December 31, 2022, loans 30 days or more past due represented 0.13 % and 0.11 % of the Company’s total loan portfolio, respectively. Commercial loans 30 days or more past due were 0.05 % and 0.03 % of the Company’s total loan portfolio as of September 30, 2023 and December 31, 2022, respectively. Consumer loans 30 days or more past due were 0.08 % and 0.08 % of total loans as of September 30, 2023 and December 31, 2022, respectively. 18 Table of Contents The table below summarizes nonaccrual loans by major categories for the periods presented. Schedule nonaccrual loans by major categories September 30, 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 379 1,236 1,615 114 133 247 Construction - - - - - - Business 170 234 404 - 182 182 Total commercial 549 1,470 2,019 114 315 429 Consumer Real estate 227 1,001 1,228 - 1,099 1,099 Home equity 181 887 1,068 194 905 1,099 Construction - - - - - - Other - - - - - - Total consumer 408 1,888 2,296 194 2,004 2,198 Total nonaccrual loans 957 3,358 4,315 308 2,319 2,627 We did not recognize interest income on nonaccrual loans for the three months ended September 30, 2023 and September 30, 2022. The accrued interest reversed during the three months ended September 30, 2023 and September 30, 2022 was not material. We did not recognize interest income on nonaccrual loans for the nine months ended September 30, 2023 and September 30, 2022. Accrued interest of $ 35,000 was reversed during the nine months ended September 30, 2023 and $ 16,000 was reversed during the nine months ended September 30, 2022. The table below summarizes information regarding nonperforming assets. Schedule of nonperforming assets, including nonaccruing TDRs (dollars in thousands) September 30, 2023 December 31, 2022 Nonaccrual loans $ 4,315 2,627 Other real estate owned - - Total nonperforming assets $ 4,315 2,627 Nonperforming assets as a percentage of: Total assets 0.11 % 0.07 % Gross loans 0.12 % 0.08 % Total loans over 90 days past due $ 1,572 402 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. The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. The Company uses a probability of default/loss given default model to determine the allowance for credit losses. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification. 19 Table of Contents Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. The following table shows the amortized cost basis of the loans modified to borrowers experiencing financial difficulty during the three and nine months ended September 30, 2023, disaggregated by class of loans and type of concession granted and describes the financial effect of the modifications made to borrowers experiencing financial difficulty. Schedule of amortized cost basis of loans Term Extension (dollars in thousands) Amortized Cost Basis % of Total Loan Type Financial Effect Commercial Business $ 329 0.07 % Added a 1-year term to both of the loans modified. One loan was granted an extended amortization due to the inability to pay on a 3-year amortization. The other loan was given an interest only period due to the ability to pay only interest to get the loan renewed. Neither of the two loans modified had a payment default during the period. The Company closely monitors the performance of the loans that are modified for borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. Both loans are in current payment status since the loan modification occurred in the third quarter of 2023. There have been no commitments to lend additional funds to the borrowers experiencing financial difficulty as of September 30, 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. 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 20 Table of Contents 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 tables summarize the activity related to the allowance for credit losses for the three and nine months ended September 30, 2023 and September 30, 2022 under the CECL methodology. Schedule of activity related to the allowance for credit losses Three months ended September 30, 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 $ 5,896 11,584 1,331 8,152 10,395 2,521 684 542 41,105 Provision for credit losses 300 ( 247 ) ( 34 ) ( 148 ) 191 ( 20 ) ( 102 ) ( 40 ) ( 100 ) Loan charge-offs - ( 1 ) - ( 42 ) - - - - ( 43 ) Loan recoveries - 154 - 13 - 2 - - 169 Net loan recoveries (charge-offs) - 153 - ( 29 ) - 2 - - 126 Balance, end of period $ 6,196 11,490 1,297 7,975 10,586 2,503 582 502 41,131 Net recoveries to average loans (annualized) ( 0.01 )% Allowance for credit losses to gross loans 1.16 % Allowance for credit losses to nonperforming loans 953.25 % Three months ended September 30, 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 $ 4,829 10,010 1,060 6,717 7,992 2,442 851 291 34,192 Provision for credit losses 476 ( 1,595 ) ( 82 ) 875 782 3 41 25 525 Loan charge-offs - - - - - - - - - Loan recoveries - 1,540 - 51 - 8 - 1 1,600 Net loan recoveries (charge-offs) - 1,540 - 51 - 8 - 1 1,600 Balance, end of period $ 5,305 9,955 978 7,643 8,774 2,453 892 317 36,317 Net recoveries to average loans (annualized) ( 0.22 )% Allowance for credit losses to gross loans 1.20 % Allowance for credit losses to nonperforming loans 1,388.87 % 21 Table of Contents Nine months ended September 30, 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 329 1,138 5 120 1,099 278 ( 311 ) 192 2,850 Loan charge-offs - ( 209 ) - ( 43 ) - ( 389 ) - ( 2 ) ( 643 ) Loan recoveries - 185 - 37 - 63 - - 285 Net loan recoveries (charge-offs) - ( 24 ) - ( 6 ) - ( 326 ) - ( 2 ) ( 358 ) Balance, end of period $ 6,196 11,490 1,297 7,975 10,586 2,503 582 502 41,131 Net charge-offs to average loans (annualized) 0.01 % Allowance for credit losses to gross loans 1.16 % Allowance for credit losses to nonperforming loans 953.25 % Nine months ended September 30, 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 918 ( 2,436 ) 199 1,558 1,985 575 184 92 3,075 Loan charge-offs - - - ( 55 ) - ( 339 ) - ( 91 ) ( 485 ) Loan recoveries - 1,540 - 196 - 82 - 1 1,819 Net loan recoveries (charge-offs) - 1,540 - 141 - ( 257 ) - ( 90 ) 1,334 Balance, end of period $ 5,305 9,955 978 7,643 8,774 2,453 892 317 36,317 Net recoveries to average loans (annualized) ( 0.06 )% Allowance for credit losses to gross loans 1.20 % Allowance for credit losses to nonperforming loans 1,388.87 % The $ 100,000 reversal of the provision for credit losses for the three months ended September 30, 2023 was driven by net recoveries of $ 126,000 for the quarter combined with lower expected loss rates. The $ 2.9 million provision for credit losses for the nine months ended September 30, 2023 was driven by $ 280.3 million in loan growth for the period. In addition to loan growth, the provision for credit losses was impacted by lower expected loss rates due to continued low charge-offs during the first nine months 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. 22 Table of Contents The following tables present an analysis of collateral-dependent loans of the Company as of September 30, 2023 and December 31, 2022. Schedule of analysis of collateral-dependent loans of the company September 30, 2023 Real Business (dollars in thousands) estate assets Other Total Commercial Owner occupied RE $ - - - - Non-owner occupied RE 908 - - 908 Construction - - - - Business 244 - - 244 Total commercial 1,152 - - 1,152 Consumer Real estate 386 - - 386 Home equity 182 - - 182 Construction - - - - Other - - - - Total consumer 568 - - 568 Total $ 1,720 - - 1,720 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 $ 2.2 million and $ 2.8 million at September 30, 2023 and December 31, 2022, respectively, 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 and nine months ended September 30, 2023 and September 30, 2022. 23 Table of Contents Schedule of allowance for credit losses for unfunded loan commitments Three months ended Three months ended (dollars in thousands) September 30, 2023 September 30, 2022 Balance, beginning of period $ 2,565 2,330 Adjustment for adoption of CECL - - Provision for (reversal of) credit losses ( 400 ) 425 Balance, end of period $ 2,165 2,755 Unfunded Loan Commitments $ 780,581 840,912 Reserve for Unfunded Commitments to Unfunded Loan Commitments 0.28 % 0.33 % Nine months ended Nine months ended (dollars in thousands) September 30, 2023 September 30, 2022 Balance, beginning of period $ 2,780 - Adjustment for adoption of CECL - 2,000 Provision for (reversal of) credit losses ( 615 ) 755 Balance, end of period $ 2,165 2,755 Unfunded Loan Commitments $ 780,581 840,912 Reserve for Unfunded Commitments to Unfunded Loan Commitments 0.28 % 0.33 % NOTE 5 – Derivative Financial Instruments The Company utilizes derivative financial instruments primarily to manage 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 enters into commitments to originate residential mortgage loans held for sale, at specified interest rates and within a specified period of time, with clients who have applied for a loan and meet certain credit and underwriting criteria (interest rate lock commitments). These interest rate lock commitments (“IRLCs”) meet the definition of a derivative financial instrument and are reflected in the balance sheet at fair value with changes in fair value recognized in current period earnings. Unrealized gains and losses on the IRLCs are recorded as derivative assets and derivative liabilities, respectively, and are measured based on the value of the underlying mortgage loan, quoted mortgage-backed securities (“MBS”) prices and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of estimated commission expenses. The Company manages the interest rate and price risk associated with its outstanding IRLCs and mortgage loans held for sale by entering into derivative instruments such as forward sales of MBS. These derivatives are free- standing derivatives and are not designated as instruments for hedge accounting. 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 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 entered into a pay-fixed portfolio layer method fair value swap, designated as a hedging instrument, with a total notional amount of $ 200.0 million in the second quarter of 2023. The Company is designating the fair value swap under the portfolio layer method (“PLM”). Under this method, the hedged item is designated as a hedged layer of a closed portfolio of financial loans that is anticipated to remain outstanding for the designated hedged period. Adjustments are made to record the swap at fair value on the consolidated balance sheets, with changes in fair value recognized in interest income. The carrying value of the fair value swap on the consolidated balance sheets will also be adjusted through interest income, based on changes in fair value attributable to changes in the hedged risk. The following table represents the carrying value of the portfolio layer method hedged asset and the cumulative fair value hedging adjustment included in the carrying value of the hedged asset as of September 30, 2023 and December 31, 2022. 24 Table of Contents Schedule of carrying value of hedged asset and cumulative fair value hedging adjustment September 30, 2023 December 31, 2022 (dollars in thousands) Carrying Amount Hedged Asset Carrying Amount Hedged Asset Fixed Rate Asset 1 $ 206,250 $ 6,250 $ - $ - 1 These amounts included the amortized cost basis of closed portfolios of fixed rate loans used to designate hedging relationships in which the hedged item is the stated amount of the assets in the closed portfolio anticipated to be outstanding for the designated hedged period. As of September 30, 2023, the amortized cost basis of the closed portfolio used in this hedging relationship was $ 729.5 million, the cumulative basis adjustment associated with this hedging relationship was $ 6.3 million, and the amount of the designated hedged item was $ 200.0 million. The following table summarizes the Company’s outstanding financial derivative instruments at September 30, 2023 and December 31, 2022. Schedule of outstanding financial derivative instruments September 30, 2023 Fair Value (dollars in thousands) Notional Balance Sheet Location Asset/(Liability) Derivatives designated as hedging instruments: Fair value swap Fair value swap [Member] $ 200,000 Other assets $ 6,250 Derivatives not designated as hedging instruments: Mortgage loan interest rate lock commitments Mortgage loan interest rate lock commitments [Member] 16,401 Other assets 160 MBS forward sales commitments MBS forward sales commitments [Member] 10,000 Other assets 38 Total derivative financial instruments Total derivative financial instruments [Member] $ 226,401 $ 6,448 December 31, 2022 Fair Value (dollars in thousands) Notional Balance Sheet Location Asset/(Liability) Derivatives not designated as hedging instruments: 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 Accrued interest receivable related to the interest rate swap as of September 30, 2023 totaled $ 280 ,000 and is excluded from the fair value presented in the table above. The Company assesses the effectiveness of the fair value swap hedge with a regression analysis that compares the changes in forward curves to determine the value. The effective portion of changes in fair value of derivatives designated as fair value hedges is recorded through interest income. The Company does not offset derivative assets and derivative liabilities for financial statement presentation purposes. The following table summarizes the effect of the fair value hedging relationship recognized in the consolidated statements of income for the three and nine months ended September 30, 2023 and September 30, 2022. Schedule of summarize the effect of fair value hedging relationship recognized in consolidated statement of income Three months ended September 30, Nine months ended September 30, (dollars in thousands) 2023 2022 2023 2022 Gain (loss) on fair value hedging relationship: Hedged asset $ 3,500 - 6,250 - Fair value derivative designated as hedging instrument ( 3,501 ) - ( 6,285 ) - Total gain (loss) recognized in interest income on loans $ ( 1 ) - ( 35 ) - 25 Table of Contents 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. 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. See Note 5 for how the derivative asset fair value is determined. 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 September 30, 2023 and December 31, 2022. 26 Table of Contents Schedule of assets and liabilities measured at fair value on a recurring basis September 30, 2023 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Securities available for sale Level 1 [Member] Corporate bonds Level 2 [Member] $ - 1,850 - 1,850 US treasuries Level 3 [Member] - 25,603 - 25,603 US government agencies - 18,724 - 18,724 State and political subdivisions - 18,310 - 18,310 Asset-backed securities - 29,641 - 29,641 Mortgage-backed securities - 49,907 - 49,907 Mortgage loans held for sale - 7,117 - 7,117 Mortgage loan interest rate lock commitments - 160 - 160 MBS forward sales commitments - 38 - 38 Derivative asset - 6,250 - 6,250 Total assets measured at fair value on a recurring basis $ - 157,600 - 157,600 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 at fair value on a recurring basis as of September 30, 2023 and December 31, 2022. 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 September 30, 2023 and December 31, 2022. Schedule of assets and liabilities measured at fair value on a nonrecurring basis As of September 30, 2023 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Individually evaluated loans $ - 957 3,624 4,581 Total assets measured at fair value on a nonrecurring basis $ - 957 3,624 4,581 As of December 31, 2022 (dollars in thousands) Level 1 Level 2 Level 3 Total Assets Individually evaluated loans $ - 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. 27 Table of Contents For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2023 and December 31, 2022, the significant unobservable inputs used in the fair value measurements were as follows: Schedule of unobservable inputs used in the fair value measurements 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 September 30, 2023 and December 31, 2022 are as follows: Schedule of estimated fair values of the company's financial instruments September 30, 2023 (dollars in thousands) Carrying Amount Fair Value Level 1 Level 2 Level 3 Financial Assets: Other investments, at cost $ 19,600 19,600 - - 19,600 Loans 1 3,506,372 3,221,087 - - 3,221,087 Financial Liabilities: Deposits 3,347,771 2,957,882 - 2,957,882 - Subordinated debentures 36,295 40,820 - 40,820 - 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. NOTE 7 – Leases The Company had operating right-of-use assets, included in property and equipment, of $ 22.6 million and $ 23.6 million as of September 30, 2023 and December 31, 2022, respectively. The Company had lease liabilities, included in other liabilities, of $ 25 .0 million and $ 25.8 million as of September 30, 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 6.16 years as of September 30, 2023. The ROU asset and lease liability are recognized at lease commencement by calculating the present value of lease payments over the lease term. 28 Table of Contents 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 2.29 % as of September 30, 2023. The total operating lease costs were $ 597,000 and $ 582,000 for the three months ended September 30, 2023 and 2022, respectively, and $ 1.8 million and $ 2.1 million for the nine months ended September 30, 2023 and 2022, respectively. Operating lease payments due as of September 30, 2023 were as follows: Schedule of maturities of lease liabilities Operating (dollars in thousands) Leases 2023 $ 516 2024 2,099 2025 2,157 2026 2,210 2027 2,268 Thereafter 22,202 Total undiscounted lease payments 31,452 Discount effect of cash flows 6,468 Total lease liability $ 24,984 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 and nine-month periods ended September 30, 2023 and 2022. Dilutive common shares arise from the potentially dilutive effect of the Company’s stock options that were outstanding at September 30, 2023. The assumed conversion of stock options can create a difference between basic and dilutive net income per common share. At September 30, 2023 and 2022, there were 351,746 and 162,060 options, respectively, that were not considered in computing diluted earnings per common share because they were anti-dilutive. Schedule of earnings per share computations Three months ended September 30, Nine months ended September 30, (dollars in thousands, except share data) 2023 2022 2023 2022 Numerator: Net income available to common shareholders $ 4,098 8,413 9,259 23,623 Denominator: Weighted-average common shares outstanding – basic 8,052,926 7,972,146 8,043,410 7,954,025 Common stock equivalents 19,482 92,941 34,420 117,963 Weighted-average common shares outstanding – diluted 8,072,408 8,065,087 8,077,830 8,071,988 Earnings per common share: Basic $ 0.51 1.06 1.15 2.97 Diluted $ 0.51 1.04 1.15 2.93 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 and nine month periods ended September 30, 2023 as compared to the three and nine month periods ended September 30, 2022 and assesses our financial condition as of September 30, 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 29 Table of Contents Annual Report on Form 10-K for that period. Results for the three and nine month periods ended September 30, 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; · 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; 30 Table of Contents ● 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; ● Risks associated with complex and changing regulatory environments, including, among others, with respect to data privacy, artificial intelligence, information security, climate change or other environmental, social and governance matters, and labor matters, relating to our operations; ● 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, 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. 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 September 30, 2023, we had total assets of $4.02 billion, an 8.9% increase from total assets of $3.69 billion at December 31, 2022. The largest component of our total assets is loans which were $3.55 billion and $3.27 billion at September 30, 2023 and December 31, 2022, respectively. Our liabilities and shareholders’ equity at September 30, 2023 totaled $3.72 billion and $303.9 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 $3.35 billion and $3.13 billion at September 30, 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 31 Table of Contents 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 $4.1 million and $8.4 million for the three months ended September 30, 2023 and 2022, respectively. Diluted earnings per share (“EPS”) was $0.51 for the third quarter of 2023 as compared to $1.04 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 525 basis point interest rate increase during the past 19 months. Our net income to common shareholders was $9.3 million and $23.6 million for the nine months ended September 30, 2023 and 2022, respectively. Diluted EPS was $1.15 for the nine months ended September 30, 2023 as compared to $2.93 for the same period in 2022. The decrease in net income was primarily driven by the increase in interest expense on our deposit accounts. 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 $19.3 million for the third quarter of 2023, a 24.0% decrease over net interest income of $25.5 million for the third 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 1.97% for the third quarter of 2023 compared to 3.19% 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 and nine month periods ended September 30, 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. 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. 32 Table of Contents Average Balances, Income and Expenses, Yields and Rates For the Three Months Ended September 30, 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 $ 181,784 $ 2,435 5.31 % $ 122,071 $ 676 2.20 % Investment securities, taxable 148,239 1,429 3.82 % 91,462 449 1.95 % Investment securities, nontaxable (2) 7,799 55 2.77 % 10,160 74 2.89 % Loans (3) 3,554,478 43,542 4.86 % 2,941,350 29,752 4.01 % Total interest-earning assets 3,892,300 47,461 4.84 % 3,165,043 30,951 3.88 % Noninterest-earning assets 159,103 159,233 Total assets $ 4,051,403 $ 3,324,726 Interest-bearing liabilities NOW accounts $ 297,028 620 0.83 % $ 361,500 178 0.20 % Savings & money market 1,748,638 16,908 3.84 % 1,417,181 3,663 1.03 % Time deposits 648,949 7,602 4.65 % 361,325 1,180 1.30 % Total interest-bearing deposits 2,694,615 25,130 3.70 % 2,140,006 5,021 0.93 % FHLB advances and other borrowings 264,141 2,414 3.63 % 1,357 10 2.92 % Subordinated debentures 36,278 558 6.10 % 36,169 449 4.93 % Total interest-bearing liabilities 2,995,034 28,102 3.72 % 2,177,532 5,480 1.00 % Noninterest-bearing liabilities 752,433 858,202 Shareholders’ equity 303,936 288,542 Total liabilities and shareholders’ equity $ 4,051,403 $ 3,324,276 Net interest spread 1.12 % 2.88 % Net interest income (tax equivalent) / margin $ 19,359 1.97 % $ 25,471 3.19 % Less: tax-equivalent adjustment (2) 14 17 Net interest income $ 19,345 $ 25,454 (1) Annualized for the three month period. (2) The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. (3) Includes mortgage loans held for sale. Our net interest margin (TE) decreased 122 basis points to 1.97% during the third quarter of 2023, compared to the third quarter of 2022, primarily due to higher costs on our interest-bearing liabilities. Our average interest-bearing liabilities grew by $817.5 million during the third quarter of 2023 from the prior year, while the rate on these liabilities increased 272 basis points to 3.72%. In contrast, our average interest-earning assets grew by $727.3 million during the third quarter of 2023 from the prior year, while the average yield on these assets increased by only 96 basis points to 4.84% during the same period. The increase in our average interest-bearing liabilities during the third quarter of 2023 resulted primarily from a $554.6 million increase in our interest-bearing deposits from the prior year, while the 272 basis point increase in rate on our interest-bearing liabilities was driven by a 277 basis point increase in deposit rates. The increase in average interest-earning assets for the third quarter of 2023 related primarily to an increase of $613.1 million in our average loan balances from the prior year. The 96 basis point increase in yield on our interest-earning assets was driven by an 85 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. Our net interest spread was 1.12% for the third quarter of 2023 compared to 2.88% 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 272 basis point increase in the rate on our interest-bearing liabilities was partially offset by a 96 basis point increase in yield on our interest-earning assets, resulting in a 176 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. To 33 Table of Contents partially address this continued pressure, we entered into a pay-fixed portfolio layer method fair value swap, designated as a hedging instrument, with a total notional amount of $200.0 million in the second quarter of 2023. The financial implication of this swap is described in further detail in “NOTE 5 – Derivative Financial Instruments” above. Average Balances, Income and Expenses, Yields and Rates For the Nine Months Ended September 30, 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 $ 113,269 $ 4,295 5.07 % $ 97,479 $ 915 1.25 % Investment securities, taxable 111,551 2,663 3.19 % 100,947 1,278 1.69 % Investment securities, nontaxable (2) 7,978 162 2.72 % 10,811 195 2.41 % Loans (3) 3,467,550 121,380 4.68 % 2,771,546 80,294 3.87 % Total interest-earning assets 3,700,348 128,500 4.64 % 2,980,783 82,682 3.71 % Noninterest-earning assets 158,746 155,511 Total assets $ 3,859,094 $ 3,136,294 Interest-bearing liabilities NOW accounts $ 299,123 1,598 0.71 % $ 385,543 437 0.15 % Savings & money market 1,712,827 44,197 3.45 % 1,309,502 5,481 0.56 % Time deposits 588,876 18,450 4.19 % 266,791 1,855 0.93 % Total interest-bearing deposits 2,600,826 64,245 3.30 % 1,961,836 7,773 0.53 % FHLB advances and other borrowings 140,336 3,996 3.81 % 23,665 129 0.73 % Subordinated debentures 36,251 1,627 6.00 % 36,143 1,233 4.56 % Total interest-bearing liabilities 2,777,413 69,868 3.36 % 2,021,644 9,135 0.60 % Noninterest-bearing liabilities 780,408 831,684 Shareholders’ equity 301,273 282,966 Total liabilities and shareholders’ equity $ 3,859,094 $ 3,136,294 Net interest spread 1.28 % 3.11 % Net interest income (tax equivalent) / margin $ 58,632 2.12 % $ 73,547 3.30 % Less: tax-equivalent adjustment (2) 37 45 Net interest income $ 58,595 $ 73,502 (1) Annualized for the nine 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. During the first nine months of 2023, our net interest margin (TE) decreased by 118 basis points to 2.12%, compared to 3.30% for the first nine months of 2022, driven by the increase in yield on our interest-bearing liabilities. Our average interest-bearing liabilities grew by $755.8 million from the prior year, with the average yield increasing by 276 basis points to 3.36%. In contrast, our average interest-earning assets grew by $719.6 million, while the rate on these assets increased by only 93 basis points to 4.64%. The increase in average interest-bearing liabilities for the first nine months of 2023 was driven by an increase in interest-bearing deposits of $639.0 million and a $116.7 million increase in FHLB advances and other borrowings, while the increase in cost was driven by a 277 basis point increase on our interest-bearing deposits and a 308 basis point increase on FHLB advances and other borrowings. The increase in average interest-earning assets for the first nine months of 2023 related primarily to a $696.0 million increase in our average loan balances. The increase in yield on our interest-earning assets was driven by an 81 basis point increase in our loan yield. 34 Table of Contents Our net interest spread was 1.28% for the first nine months of 2023 compared to 3.11% for the same period in 2022. The 183 basis point decrease in our net interest spread was driven by the 276 basis point increase in yield on our interest-bearing liabilities. 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 September 30, 2023 vs. 2022 September 30, 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 $ 6,233 6,248 1,309 13,790 $ 5,674 815 200 6,689 Investment securities 271 451 242 964 (9 ) 164 (4 ) 151 Federal funds sold and interest-bearing deposits with banks 331 959 469 1,759 (11 ) 740 (121 ) 608 Total interest income 6,835 7,658 2,020 16,513 5,654 1,719 75 7,448 Interest expense Deposits 762 16,798 2,549 20,109 217 3,142 728 4,087 FHLB advances and other borrowings 1,938 2 466 2,406 - - 10 10 Subordinated debentures 1 106 - 107 1 68 - 69 Total interest expense 2,701 16,906 3,015 22,622 218 3,210 738 4,166 Net interest income $ 4,134 (9,248 ) (995 ) (6,109 ) $ 5,436 (1,491 ) (663 ) 3,282 Net interest income, the largest component of our income, was $19.3 million for the third quarter of 2023 and $25.5 million for the third quarter of 2022, a $6.1 million, or 24.0%, decrease year over year. The decrease during 2023 was driven by a $22.6 million increase in interest expense primarily due to higher rates on our interest-bearing deposits. Partially offsetting the increase in interest expense was a $16.5 million increase in interest income primarily due to an increase in volume of loans and the rates on loans. Nine Months Ended September 30, 2023 vs. 2022 September 30, 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 $ 20,388 16,507 4,191 41,086 $ 16,300 (3,180 ) (764 ) 12,356 Investment securities 99 1,179 82 1,360 146 307 49 502 Federal funds sold and interest-bearing deposits with banks 148 2,781 451 3,380 (11 ) 813 (54 ) 748 Total interest income 20,635 20,467 4,724 45,826 16,435 (2,060 ) (769 ) 13,606 Interest expense Deposits 1,656 45,190 9,626 56,472 719 3,265 780 4,764 FHLB advances and other borrowings 636 545 2,686 3,867 63 3 59 125 Subordinated debentures 4 389 1 394 4 86 - 90 Total interest expense 2,296 46,124 12,313 60,733 786 3,354 839 4,979 Net interest income $ 18,339 (25,657 ) (7,589 ) (14,907 ) $ 15,649 (5,414 ) (1,608 ) 8,627 Net interest income for the first nine months of 2023 was $58.6 million compared to $73.5 million for 2022, a $14.9 million, or 20.3%, decrease. The decrease in net interest income during 2023 was driven by a $60.7 million increase in interest expense, related primarily to higher rates on our interest-bearing deposits, partially offset by a $45.8 million increase in interest income related to an increase in volume of loans and the rates on loans. 35 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 reversal of $500,000 to the provision for credit losses in the third quarter of 2023, compared to a $950,000 provision for credit losses in the third quarter of 2022. We recorded a provision expense of $2.2 million and $3.8 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. The provision reversal during the third quarter of 2023 includes a $100,000 reversal of the provision for credit losses and a $400,000 reversal of the reserve for unfunded commitments. The reversal of the provision for credit losses was driven by lower expected loss rates, while the reversal of the reserve for unfunded commitments was driven by a decrease in the balance of unfunded commitments at September 30, 2023, compared to the previous quarter and year. The $2.2 million provision expense for the first nine months of 2023 included a $2.9 million provision for credit losses and a $615,000 reversal for unfunded commitments. Noninterest Income The following table sets forth information related to our noninterest income. Three months ended September 30, Nine months ended September 30, (dollars in thousands) 2023 2022 2023 2022 Mortgage banking income $ 1,208 1,230 3,167 3,907 Service fees on deposit accounts 356 318 1,011 949 ATM and debit card income 588 542 1,680 1,604 Income from bank owned life insurance 349 315 1,018 945 Loss on disposal of fixed assets - - - (394 ) Gain on sale of securities - - - 12 Other income 249 275 653 850 Total noninterest income $ 2,750 2,680 7,529 7,873 Noninterest income was $2.7 million for the third quarter of 2023 and 2022. Mortgage banking income continues to be the largest component of our noninterest income at $1.2 million for both the third quarter of 2023 and 2022. Noninterest income decreased $344,000, or 4.4%, during the first nine months of 2023 as compared to 2022. The decrease in total noninterest income resulted primarily from the following: ● Mortgage banking income decreased $740,000, or 18.9%, from the first nine months of 2022 driven by lower mortgage volume and less income recorded on the related derivative. ● Other income decreased $197,000, or 23.2%, primarily due to a decrease in loan and appraisal fee income. 36 Table of Contents Noninterest expenses The following table sets forth information related to our noninterest expenses. Three months ended September 30, Nine months ended September 30, (dollars in thousands) 2023 2022 2023 2022 Compensation and benefits $ 10,231 9,843 30,874 29,214 Occupancy 2,562 2,442 7,537 6,439 Outside service and data processing costs 1,744 1,529 5,078 4,591 Insurance 1,243 507 2,829 1,134 Professional fees 504 555 1,914 1,848 Marketing 293 338 994 934 Other 725 832 2,573 2,360 Total noninterest expense $ 17,302 16,046 51,799 46,520 Noninterest expense was $17.3 million for the third quarter of 2023, a $1.3 million, or 7.8%, increase from noninterest expense of $16.0 million for the third quarter of 2022. The increase in noninterest expense was driven primarily by the following: ● Compensation and benefits expense increased $388,000, or 3.9%, relating primarily to annual salary increases and hiring of new team members as well as higher benefit related expenses. ● Outside service and data processing costs increased $215,000, or 14.1%, relating primarily to an increase in software licensing and maintenance costs. ● Insurance costs increased $736,000, or 145.2%, as a result of higher FDIC insurance premiums. Noninterest expense was $51.8 million for the first nine months of 2023, a $5.3 million, or 11.3%, increase from noninterest expense of $46.5 million for the first nine months of 2022. The increase in noninterest expense was driven primarily by increases in compensation and benefits and insurance expense as discussed above. Occupancy costs also increased over the prior year primarily related to increased depreciation, maintenance and property tax expense on our new headquarters building. Our efficiency ratio was 78.3% for the third quarter of 2023, compared to 57.0% for the third 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 third quarter of 2023, compared to the third quarter of 2022, relates primarily to the decrease in net interest income combined with higher noninterest expenses. We incurred income tax expense of $1.2 million and $2.7 million for the three months ended September 30, 2023 and 2022, respectively, and $2.8 million and $7.4 million for the nine months ended September 30, 2023 and 2022, respectively. Our effective tax rate was 23.4% and 23.9% for the nine months ended September 30, 2023 and 2022, respectively. Balance Sheet Review Investment Securities At September 30, 2023, the $163.6 million in our investment securities portfolio represented approximately 4.1% 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 $144.0 million and an amortized cost of $163.3 million, resulting in an unrealized loss of $19.3 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. In addition, other investments, which includes FHLB Stock, increased $8.8 million from December 31, 2022 to $19.6 million at September 30, 2023. 37 Table of Contents 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 nine months ended September 30, 2023 and 2022 were $3.46 billion and $2.76 billion, respectively. Before the allowance for credit losses, total loans outstanding at September 30, 2023 and December 31, 2022 were $3.55 billion and $3.27 billion, respectively. The principal component of our loan portfolio is loans secured by real estate mortgages. As of September 30, 2023, our loan portfolio included $3.0 billion, or 84.5%, 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 $180.9 million as of September 30, 2023, of which approximately 45% 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 $84,000 and a loan to value of 73% as of both September 30, 2023 and December 31, 2022. Further, 0.8% and 0.6% of our total home equity lines of credit were over 30 days past due as of September 30, 2023 and December 31, 2022, respectively. Following is a summary of our loan composition at September 30, 2023 and December 31, 2022. During the first nine months of 2023, our loan portfolio increased by $280.3 million, or 8.6%, with a 6.9% increase in commercial loans while consumer loans increased by 11.4% during the period. The majority of the increase was in loans secured by real estate. Our level of non-owner occupied commercial real estate and multi-family loans represents 266.3% of the Bank’s total risk-based capital at September 30, 2023. Our consumer real estate portfolio grew by $143.4 million and includes high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $475,000, a term of 25 years, and an average rate of 4.05% as of September 30, 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. September 30, 2023 December 31, 2022 (dollars in thousands) Amount % of Total Amount % of Total Commercial Owner occupied RE $ 637,038 17.9 % $ 612,901 18.7 % Non-owner occupied RE 937,749 26.4 % 862,579 26.3 % Construction 119,629 3.4 % 109,726 3.4 % Business 500,253 14.1 % 468,112 14.3 % Total commercial loans 2,194,669 61.8 % 2,053,318 62.7 % Consumer Real estate 1,074,679 30.2 % 931,278 28.4 % Home equity 180,856 5.1 % 179,300 5.5 % Construction 54,210 1.5 % 80,415 2.5 % Other 49,218 1.4 % 29,052 0.9 % Total consumer loans 1,358,963 38.2 % 1,220,045 37.3 % Total gross loans, net of deferred fees 3,553,632 100.0 % 3,273,363 100.0 % Less—allowance for credit losses (41,131 ) (38,639 ) Total loans, net $ 3,512,501 $ 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 38 Table of Contents 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 September 30, 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) September 30, 2023 December 31, 2022 Commercial $ 2,019 429 Consumer 2,296 2,198 Total nonaccrual loans 4,315 2,627 Other real estate owned - - Total nonperforming assets $ 4,315 2,627 At September 30, 2023, nonperforming assets were $4.3 million, or 0.11% of total assets and 0.12% 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 $1.7 million during the first nine months of 2023 due primarily to four commercial relationships and two consumer loans that were added to nonaccrual status. The amount of foregone interest income on nonaccrual loans in the first nine months of 2023 and 2022 was not material. At September 30, 2023 and December 31, 2022, the allowance for credit losses represented 953.25% and 1,470.74% of the total amount of nonperforming loans, respectively. A significant portion of the nonperforming loans at September 30, 2023 were secured by real estate. We have evaluated the underlying collateral on these loans and believe that the collateral on these loans is sufficient to minimize future losses. As a 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 September 30, 2023, 84.5% of our loans were collateralized by real estate and 82.1% 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 September 30, 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 individually evaluated loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. At September 30, 2023, individually evaluated loans totaled $6.1 million with a reserve of approximately $1.5 million allocated in the allowance for credit losses. During the first nine months of 2023, the average recorded investment in individually evaluated loans was approximately $5.5 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 $41.1 million, representing 1.16% of outstanding loans and providing coverage of 953.25%, of nonperforming loans at September 30, 2023 compared to $38.6 million, or 1.18% of outstanding 39 Table of Contents loans and 1,470.84% of nonperforming loans at December 31, 2022. At September 30, 2022, the allowance for credit losses was $36.3 million, or 1.20% of outstanding loans and 1,388.87% 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 $3.01 billion, or 89.8% of total deposits, while our wholesale deposits represented $342.4 million, or 10.2%, of total deposits at September 30, 2023. At December 31, 2022, retail deposits represented $2.90 billion, or 92.5%, of our total deposits and wholesale deposits were $236.2 million, representing 7.5% of our total deposits. Our loan-to-deposit ratio was 106% at September 30, 2023 and 104% at December 31, 2022. The following is a detail of our deposit accounts: September 30, December 31, (dollars in thousands) 2023 2022 Non-interest bearing $ 675,409 804,115 Interest bearing: NOW accounts 306,667 318,030 Money market accounts 1,685,736 1,506,418 Savings 34,737 40,673 Time, less than $250,000 125,506 89,876 Time and out-of-market deposits, $250,000 and over 519,716 374,752 Total deposits $ 3,347,771 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 $2.87 billion and $2.76 billion at September 30, 2023, and December 31, 2022, respectively. In addition, at September 30, 2023 and December 31, 2022, we estimate that we have approximately $1.4 billion and $1.5 billion, or 40.4% and 47.8% 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. Nine months ended September 30, 2023 2022 (dollars in thousands) Amount Rate Amount Rate Noninterest-bearing demand deposits $ 726,660 0.00 % $ 781,303 0.00 % Interest-bearing demand deposits 299,123 0.71 % 385,543 0.15 % Money market accounts 1,675,181 3.53 % 1,268,039 0.58 % Savings accounts 37,646 0.10 % 41,463 0.05 % Time deposits less than $250,000 96,506 3.75 % 24,519 0.45 % Time deposits greater than $250,000 492,371 4.27 % 242,272 0.98 % Total deposits $ 3,327,487 2.58 % $ 2,743,139 0.38 % During the first nine months of 2023, our average transaction account balances increased by $262.3 million, or 10.6%, from the prior year, while our average time deposit balances increased by $322,000, or 120.7%. We have 40 Table of Contents experienced record growth in new account openings throughout our footprint during the first nine months of 2023. In addition, we have added $167.3 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 September 30, 2023 was as follows: (dollars in thousands) September 30, 2023 Three months or less $ 148,458 Over three through six months 180,510 Over six through twelve months 110,657 Over twelve months 80,091 Total $ 519,716 Time deposits that meet or exceed the FDIC insurance limit of $250,000 at September 30, 2023 and December 31, 2022 were $519.7 million and $374.8 million, respectively. We have a relationship with IntraFi Promontory Network, allowing us to provide deposit customers with access to aggregate FDIC insurance in amounts exceeding $250,000. This gives us the ability, as and when needed, to attract and retain large deposits from insurance conscious customers. With IntraFi, we have the option to keep deposits on balance sheet or sell them to other members of the network. At September 30, 2023, the Company had $275.0 million of convertible fixed rate FHLB advances with a weighted average rate of 3.58%, while at December 31, 2022, the Company had a $175.0 million FHLB advance at a variable rate of 4.57%. 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 the first five months of 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 September 30, 2023 and December 31, 2022, our cash and cash equivalents totaled $152.4 million and $170.9 million, respectively, or 3.8% and 4.6% of total assets, respectively. Our investment securities at September 30, 2023 and December 31, 2022 amounted to $163.6 million and $104.2 million, respectively, or 4.1% 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 September 30, 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 41 Table of Contents from the FHLB. The unused borrowing capacity currently available from the FHLB at September 30, 2023 was $528.4 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 September 30, 2023 and December 31, 2022 we had $397.7 million and $341.5 million, respectively, of letters of credit outstanding with the FHLB to secure client deposits. Further, in July 2023, we enrolled in the Federal Reserve’s Bank Term Funding Program which offer loans of up to one year in length if we pledge collateral eligible for purchase by the Federal Reserve Banks in open market operations, such as U.S. Treasuries, U.S. agency securities, and U.S. agency mortgage-backed securities. At September 30, 2023, we had $13.0 million of marketable investment securities pledged in the Federal Reserve’s Bank Term Funding Program. At September 30, 2023, we had $219.9 million pledged and available with the Federal Reserve Discount Window. We have a relationship with IntraFi Promontory Network, allowing us to provide deposit customers with access to aggregate FDIC insurance in amounts exceeding $250,000. This gives us the ability, as and when needed, to attract and retain large deposits from insurance conscious customers. With IntraFi, we have the option to keep deposits on balance sheet or sell them to other members of the network. Additionally, subject to certain limits, the Bank can use IntraFi to purchase cost-effective funding without collateralization and in lieu of generating funds through traditional brokered CDs or the FHLB. In this manner, IntraFi can provide us with another funding option. Thus, it serves as a deposit-gathering tool and an additional liquidity management tool. Under the Economic Growth, Regulatory Relief, and Consumer Protection Act, a well capitalized bank with a CAMELS rating of 1 or 2 may hold reciprocal deposits up to the lesser of 20% of its total liabilities or $5 billion without those deposits being treated as brokered deposits. We also have a line of credit with another financial institution for $15.0 million, which was unused at September 30, 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. As of September 30, 2023, we were in violation of one particular loan covenant and have subsequently received a waiver from the lender regarding this violation. 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 $303.9 million at September 30, 2023 and $294.5 million at December 31, 2022. The $9.4 million increase from December 31, 2022 is primarily related to net income of $9.3 million during the first nine months of 2023, stock option exercises and equity compensation expenses of $1.5 million, partially offset by a $1.8 million increase in the unrealized loss on securities available for sale. 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 nine months ended September 30, 2023 and the year ended December 31, 2022. Since our inception, we have not paid cash dividends. September 30, 2023 December 31, 2022 Return on average assets 0.32 % 0.90 % Return on average equity 4.11 % 10.20 % Return on average common equity 4.11 % 10.20 % Average equity to average assets ratio 7.81 % 8.85 % Tangible common equity to assets ratio 7.56 % 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 42 Table of Contents 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 September 30, 2023, our capital ratios exceed these ratios and we remain “well capitalized.” The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements. September 30, 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) $ 385,063 12.27 % $ 251,151 8.00 % $ 313,939 10.00 % Tier 1 Capital (to risk weighted assets) 345,798 11.01 % 188,363 6.00 % 251,151 8.00 % Common Equity Tier 1 Capital (to risk weighted assets) 345,798 11.01 % 141,272 4.50 % 204,060 6.50 % Tier 1 Capital (to average assets) 345,798 8.50 % 162,633 4.00 % 203,291 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 % 43 Table of Contents The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements. September 30, 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) $ 394,419 12.56 % $ 251,162 8.00 % N/A N/A Tier 1 Capital (to risk weighted assets) 332,154 10.58 % 188,372 6.00 % N/A N/A Common Equity Tier 1 Capital (to risk weighted assets) 319,154 10.17 % 141,279 4.50 % N/A N/A Tier 1 Capital (to average assets) 332,154 8.17 % 162,654 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) The prompt corrective action provisions are only applicable at the Bank level. The Bank exceeded the general minimum regulatory requirements to be considered “well capitalized.” 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. 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 September 30, 2023 unfunded commitments to extend credit were $780.6 million, of which $178.2 million were at fixed rates and $602.4 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 September 30, 2023, the reserve for unfunded commitments was $2.2 million or 0.28% of total unfunded 44 Table of Contents commitments. As of December 31, 2022, the reserve for unfunded commitments was $2.8 million or 0.32% of total unfunded commitments. At September 30, 2023 and December 31, 2022, there were commitments under letters of credit for $15.0 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. 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 September 30, 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 45 Table of Contents 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 (19.19 )% Up 200 basis points (12.76 )% Up 100 basis points (6.43 )% Base - Down 100 basis points 8.33 % Down 200 basis points 15.59 % Down 300 basis points 21.89 % 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 nine months ended September 30, 2023, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. 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. There have been no material changes to the risk factors previously disclosed in the Company’s (i) Annual Report on Form 10-K for fiscal year ended December 31, 2022 and (ii) Quarterly Reports on Form 10-Q for fiscal quarters ended March 31, 2023 and June 30, 2023. Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. (a) Not applicable. (b) Not applicable. (c) Not applicable. 46 Table of Contents Item 3. DEFAULTS UPON SENIOR SECURITIES. None. Item 4. MINE SAFETY DISCLOSURES. Not applicable. Item 5. OTHER INFORMATION. None. 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. 47 Table of Contents INDEX TO EXHIBITS Exhibit Number Description 31.1 Rule 13a-14(a) Certification of the Principal Executive Officer. 31.2 Rule 13a-14(a) Certification of the Principal Financial Officer. 32 Section 1350 Certifications. 101 The following materials from the Quarterly Report on Form 10-Q of Southern First Bancshares, Inc. for the quarter ended September 30, 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) 48 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: October 31, 2023 /s/R. Arthur Seaver, Jr. R. Arthur Seaver, Jr. Chief Executive Officer (Principal Executive Officer) Date: October 31, 2023 /s/D. Andrew Borrmann D. Andrew Borrmann Chief Financial Officer (Principal Financial and Accounting Officer) 49