SOUTHERN FIRST BANCSHARES INC 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this Annual Report on Form 10-K. OVERVIEW Our business model continues to be client-focused, utilizing relationship teams to provide our clients with a specific banker contact and support team responsible for all of their banking needs. The purpose of this structure is to provide a consistent and superior level of professional service, and we believe it provides us with a distinct competitive advantage. We consider exceptional client service to be a critical part of our culture, which we refer to as “ClientFIRST.” At December 31, 2023, we had total assets of $4.06 billion, a 9.9% increase from total assets of $3.69 billion at December 31, 2022. The largest components of our total assets are loans which were $3.60 billion and $3.27 billion at December 31, 2023 and 2022, respectively. Our liabilities and shareholders’ equity at December 31, 2023 totaled $3.74 billion and $312.5 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 $3.38 billion and $3.13 billion at December 31, 2023 and 2022, respectively. Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the difference between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread. In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients. Our net income available to common shareholders for the years ended December 31, 2023 and 2022 was $13.4 million and $29.1 million, or diluted earnings per share (“EPS”) of $1.66 and $3.61 for the years ended December 31, 2023 and 2022, respectively. The decrease in net income resulted primarily from a decrease in net interest income and an increase in noninterest expenses, partially offset by a decrease in the provision for credit losses. In addition, our net income available to shareholders was $46.7 million, or EPS of $5.85 for the year ended December 31, 2021. 47 Table of Contents SELECTED FINANCIAL DATA The following table sets forth our selected historical consolidated financial information for the periods and as of the dates indicated. We derived our balance sheet and income statement data for the years ended December 31, 2023, 2022, and 2021 from our audited consolidated financial statements. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes thereto, which are included elsewhere in this Annual Report on Form 10-K. Years Ended December 31, (dollars in thousands, except per share data) 2023 2022 2021 BALANCE SHEET DATA Total assets $ 4,055,789 3,691,981 2,925,548 Investment securities 154,641 104,180 124,302 Loans (1) 3,602,627 3,273,363 2,489,877 Allowance for credit losses 40,682 38,639 30,408 Deposits 3,379,564 3,133,864 2,563,826 FHLB advances and other borrowings 275,000 175,000 - Subordinated debentures 36,322 36,214 36,106 Common equity 312,467 294,512 277,901 Preferred stock - - - Shareholders’ equity 312,467 294,512 277,901 SELECTED RESULTS OF OPERATIONS DATA Interest income $ 177,598 117,662 93,167 Interest expense 99,944 20,041 5,435 Net interest income 77,654 97,621 87,732 Provision for credit losses 1,260 6,155 (12,400 ) Net interest income after provision for credit losses 76,394 91,466 100,132 Noninterest income 9,860 9,580 17,101 Noninterest expenses 68,827 62,933 56,430 Income before income tax expense 17,427 38,113 60,803 Income tax expense 4,001 8,998 14,092 Net income 13,426 29,115 46,711 Preferred stock dividends - - - Net income available to common shareholders $ 13,426 29,115 46,711 PER COMMON SHARE DATA Basic $ 1.67 3.66 5.96 Diluted 1.66 3.61 5.85 Book value 38.63 36.76 35.07 Weighted average number of common shares outstanding: Basic, in thousands 8,047 7,958 7,844 Diluted, in thousands 8,078 8,072 7,989 SELECTED FINANCIAL RATIOS Performance Ratios: Return on average assets 0.34 % 0.90 % 1.75 % Return on average equity 4.44 % 10.20 % 18.64 % Return on average common equity 4.44 % 10.20 % 18.64 % Net interest margin, tax equivalent (2) 2.07 % 3.19 % 3.45 % Efficiency ratio (3) 78.65 % 58.71 % 53.83 % Asset Quality Ratios: Nonperforming assets to total loans (1) 0.11 % 0.08 % 0.20 % Nonperforming assets to total assets 0.10 % 0.07 % 0.17 % Net charge-offs to average total loans 0.00 % (0.05 %) 0.06 % Allowance for credit losses to nonperforming loans 1,026.58 % 1,470.74 % 625.16 % Allowance for credit losses to total loans 1.13 % 1.18 % 1.22 % Holding Company Capital Ratios: Total risk-based capital ratio 12.57 % 12.91 % 14.90 % Tier 1 risk-based capital ratio 10.60 % 10.88 % 12.65 % Leverage ratio 8.14 % 9.17 % 10.19 % Common equity tier 1 ratio (4) 10.19 % 10.44 % 12.09 % Tangible common equity (5) 7.70 % 7.98 % 9.50 % Growth Ratios: Change in assets 9.85 % 26.20 % 17.84 % Change in loans 10.06 % 31.47 % 16.19 % Change in deposits 7.84 % 22.23 % 19.65 % Change in net income to common shareholders -53.89 % -37.67 % 154.86 % Change in earnings per common share - diluted -54.02 % -38.29 % 150.00 % 48 Table of Contents Footnotes to table: (1) Excludes loans held for sale. (2) The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. (3) Noninterest expense divided by the sum of net interest income and noninterest income. (4) The common equity tier 1 ratio is calculated as the sum of common equity divided by risk-weighted assets. (5) The common equity ratio is calculated as total equity less preferred stock divided by total assets. CRITICAL ACCOUNTING ESTIMATES We have adopted various accounting policies that govern the application of accounting principles generally accepted in the U.S. and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our Consolidated Financial Statements as of December 31, 2023. Certain accounting policies inherently involve a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. We consider these accounting policies and estimates to be critical accounting policies. We have identified the determination of the allowance for credit losses, the fair valuation of financial instruments and income taxes to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Therefore, management has reviewed and approved these critical accounting policies and estimates and has discussed these policies with the Company’s Audit Committee. Allowance for Credit Losses The allowance for credit losses (“ACL”) is management’s current estimate of expected credit losses that will result from the inability of our borrowers to make required loan payments, with particular applicability on our balance sheet to loans and unfunded loan commitments. Estimating the amount of the ACL requires significant judgment and the use of estimates related to historical experience, current conditions, reasonable and supportable forecasts, and the value of collateral on collateral-dependent loans. Credit losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. There are many factors affecting the ACL; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and is susceptible to significant change. To the extent actual outcomes are worse than management estimates, additional provision for credit losses could be required that could adversely affect our earnings or financial position in future periods. See Note 1 – Summary of Significant Accounting Policies and Activities for further detailed descriptions of our estimation process and methodology related to the ACL. See also Note 4 – Loans and Allowance for Credit Losses and “Provision for Credit Losses” in this MD&A. Fair Valuation of Financial Instruments Certain assets and liabilities are measured at fair value on a recurring basis, including securities and derivative instruments. Assets and liabilities carried at fair value inherently include subjectivity and may require the use of significant assumptions, adjustments and judgment including, among others, discount rates, rates of return on assets, cash flows, default rates, loss rates, terminal values and liquidation values. A significant change in assumptions may result in a significant change in fair value, which in turn, may result in a higher degree of financial statement volatility and could result in significant impact on our results of operations, financial condition or disclosures of fair value information. The fair value hierarchy requires use of observable inputs first and subsequently unobservable inputs when observable inputs are not available. Our fair value measurements involve various valuation techniques and models, which involve inputs that are observable (Level 1 or Level 2 in fair value hierarchy), when available. The level of judgment required to determine fair value is dependent on the methods or techniques used in the process. Assets and liabilities that are measured at fair value using quoted prices in active markets (Level 1) do not require significant judgment while the valuation of assets and liabilities when quoted market prices are not available (Levels 2 and 3) may require significant 49 Table of Contents judgment to assess whether observable or unobservable inputs for those assets and liabilities provide reasonable determination of fair value. See Note 12 to the Consolidated Financial Statements for additional information regarding the fair values measured at each level of the fair value hierarchy, additional discussion regarding fair value measurements, and a brief description of how fair value is determined for categories that have unobservable inputs. Income Taxes The financial statements have been prepared on the accrual basis. When income and expenses are recognized in different periods for financial reporting purposes versus for the purposes of computing income taxes currently payable, deferred taxes are provided on such temporary differences. Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. RESULTS OF OPERATIONS Net Interest Income and Margin Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. For the years ended December 31, 2023, 2022, and 2021, our net interest income was $77.7 million, $97.6 million, and $87.7 million, respectively. The $20.0 million, or 20.5%, decrease in net interest income during 2023, compared to 2022, was driven by a $79.9 million increase in interest expense, primarily related to our interest-bearing deposits, partially offset by a $59.9 million increase in interest income. During 2022, our net interest income increased $9.9 million, or 11.3%, compared to 2021, while average interest-earning assets increased $525.0 million and average interest-bearing liabilities increased $401.0 million. Interest income for the years ended December 31, 2023, 2022, and 2021 was $177.6 million, $117.7 million, and $93.2 million, respectively. A significant portion of our interest income relates to our strategy to maintain a large portion of our assets in higher earning loans compared to lower yielding investments and federal funds sold. As such, 93.5% of our interest income related to interest on loans during 2023, compared to 97.1% during 2022 and 98.3% during 2021. Also, included in interest income on loans was $1.7 million related to the net amortization of loan fees and capitalized loan origination costs for the year ended December 31, 2023, compared to $1.7 million and $1.4 million for the years ended December 31, 2022 and 2021, respectively. The increase in interest income during 2023 was driven by an increase in average interest-earning assets, combined with higher yields on those assets. Interest expense was $99.9 million, $20.0 million, and $5.4 million for the years ended December 31, 2023, 2022, and 2021, respectively. Interest expense on deposits for 2023 represented 91.4% of total interest expense, compared to 90.3% for 2022, and 71.9% for 2021, while interest expense on borrowings represented 8.6% of total interest expense for 2023, compared to 9.7% for 2022, and 28.1% for 2021. The increase in interest expense on deposits during 2023 resulted primarily from an increase in the rate paid on deposit balances which relates to the Federal Reserve’s 525 basis point increase in the federal funds rate over the past two years. We have included a number of tables to assist in our description of various measures of our financial performance. For example, the “Average Balances, Income and Expenses, Yields and Rates” table shows the average balance of each category of our assets and liabilities as well as the yield we earned or the rate we paid with respect to each category during 2023, 2022, and 2021. Similarly, the “Rate/Volume Analysis” table demonstrates the effect of changing interest rates and changing volume of assets and liabilities on our financial condition during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included tables to illustrate our interest rate sensitivity with respect to interest-earning and interest-bearing accounts. The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities at December 31, 2023, 2022 and 2021. We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments were owned at an original maturity of over one year. Nonaccrual loans are included in earning assets in the following tables. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. The net of capitalized loan costs and fees are amortized into interest income on loans. 50 Table of Contents Average Balances, Income and Expenses, Yields and Rates For the Year Ended December 31, 2023 2022 2021 (dollars in thousands) Average Balance Income/ Expense Yield/ Rate Average Balance Income/ Expense Yield/ Rate Average Balance Income/ Expense Yield/ Rate Interest-earning assets Federal funds sold and interest-bearing deposits with banks $ 134,495 $ 6,998 5.20 % $ 88,077 $ 1,439 1.63 % $ 123,379 $ 233 0.19 % Investment securities, taxable 121,739 4,296 3.53 % 97,328 1,793 1.84 % 92,812 1,110 1.20 % Investment securities, nontaxable (1) 7,941 217 2.73 % 10,604 256 2.41 % 11,331 292 2.58 % Loans (2) 3,497,623 166,137 4.75 % 2,870,733 114,233 3.98 % 2,314,257 91,599 3.96 % Total interest-earning assets 3,761,798 177,648 4.72 % 3,066,742 117,721 3.84 % 2,541,779 93,234 3.67 % Noninterest-earning assets 162,771 157,380 126,654 Total assets $ 3,924,569 $ 3,224,122 $ 2,668,433 Interest-bearing liabilities NOW accounts $ 299,703 2,254 0.75 % $ 374,956 816 0.22 % $ 306,669 204 0.07 % Savings & money market 1,708,874 61,241 3.58 % 1,364,961 13,138 0.96 % 1,176,820 2,454 0.21 % Time deposits 631,967 27,878 4.41 % 301,793 4,148 1.37 % 176,301 1,251 0.71 % Total interest-bearing deposits 2,640,544 91,373 3.46 % 2,041,710 18,102 0.89 % 1,659,790 3,909 0.24 % FHLB advances and other borrowings 169,963 6,382 3.75 % 19,614 209 1.07 % 704 11 1.56 % Subordinated debt 36,265 2,189 6.04 % 36,156 1,730 4.78 % 36,049 1,515 4.20 % Total interest-bearing liabilities 2,846,772 99,944 3.51 % 2,097,498 20,041 0.96 % 1,696,543 5,435 0.32 % Noninterest-bearing liabilities 775,116 841,233 721,267 Shareholders’ equity 302,681 285,409 250,623 Total liabilities and shareholders’ equity $ 3,924,569 $ 3,224,122 $ 2,668,433 Net interest spread 1.21 % 2.88 % 3.35 % Net interest income(tax equivalent)/margin $ 77,704 2.07 % $ 97,680 3.19 % $ 87,799 3.45 % Less: tax-equivalent adjustment (1) (50 ) (59 ) (67 ) Net interest income $ 77,654 $ 97,621 $ 87,732 (1) The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. (2) Includes loans held for sale and nonaccrual loans. Our net interest margin, on a tax-equivalent basis (TE), was 2.07%, 3.19% and 3.45% for the years ended December 31, 2023, 2022 and 2021, respectively. Our net interest margin (TE) decreased 112 basis points in 2023, compared to 2022, driven by higher costs on our interest-bearing liabilities, partially offset by an increase in yield on our interest-earning assets. During 2022, our net interest margin decreased 26 basis points, compared to 2021, due to higher costs on our interest-bearing liabilities, partially offset by an increase in yield on our interest-earning assets. Our average interest-earning assets increased by $695.1 million during the year ended December 31, 2023, compared to 2022, while the related yield on our interest-earning assets increased by 88 basis points. The increase in average interest-earning assets was driven by a $626.9 million increase in average loan balances and a $46.4 million increase in federal funds sold and interest-bearing deposits with banks. In addition, the increase in yield on our interest earning assets was driven by a 357 basis point increase in the yield on our federal funds sold and other interest-bearing deposits which repriced as the Federal Reserve increased the federal funds rate by 100 basis points during 2023. Our average interest-bearing liabilities increased by $749.3 million during 2023 while the cost of our interest-bearing liabilities increased by 255 basis points. The increase in average interest-bearing liabilities was driven primarily by a $598.8 million increase in average interest-bearing deposits at an average rate of 3.46%. During 2022, our average interest-bearing liabilities increased by $401.0 million, compared to 2021, while the cost of our interest-bearing liabilities increased by 64 basis points. During the year ended December 31, 2022, our average interest-earning assets increased by $525.0 million, compared to 2021, while the yield on our interest-earning assets increased by 17 basis points. The increase in average interest-earning assets was driven primarily by a $556.5 million increase in average loan balances combined with an $35.3 million decrease in federal funds sold and interest-bearing deposits with banks. In addition, the increase in yield on our interest earning assets was driven by a 144 basis point increase in the yield on our federal funds sold and other interest-bearing deposits which repriced as the Federal Reserve increased the federal funds rate by 425 basis points during 2022. Our net interest spread was 1.21% for the year ended December 31, 2023, compared to 2.88% for the same period in 2022 and 3.35% for 2021. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 255 basis point increase in the cost of our interest- 51 Table of Contents bearing liabilities, partially offset by an 88 basis point increase in yield on our interest-earning assets resulted in a 167 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 our deposits continue to reprice immediately with increases in the fed funds rate, compared to our loan portfolio which reprices as loans are originated or renewed. Rate/Volume Analysis Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented. Years Ended December 31, 2023 vs. 2022 December 31, 2022 vs. 2021 Increase (Decrease) Due to Change in Increase (Decrease) Due to Change in (dollars in thousands) Volume Rate Rate/ Volume Total Volume Rate Rate/ Volume Total Interest income Loans $ 24,945 22,127 4,832 51,904 $ 22,025 491 118 22,634 Investment securities 401 1,725 347 2,473 49 585 21 655 Federal funds sold 758 3,144 1,657 5,559 (67 ) 1,782 (509 ) 1,206 Total interest income 26,104 26,996 6,836 59,936 22,007 2,858 (370 ) 24,495 Interest expense Deposits 3,371 58,928 10,972 73,271 838 10,997 2,358 14,193 FHLB advances and other borrowings 1,602 528 4,044 6,174 294 (3 ) (94 ) 197 Subordinated debt 5 452 1 458 4 211 1 216 Total interest expense 4,978 59,908 15,017 79,903 1,136 11,205 2,265 14,606 Net interest income $ 21,126 (32,912 ) (8,181 ) (19,967 ) $ 20,871 (8,347 ) (2,635 ) 9,889 Net interest income, the largest component of our income, was $77.7 million for the year ended December 31, 2023, a $20.0 million decrease from net interest income of $97.6 million for the year ended December 31, 2022. The decrease in net interest income was driven by a $79.9 million increase in interest expense, partially offset by a $59.9 million increase in interest income. The 257 basis point increase in deposit costs drove the increase in interest expense while the $626.9 million increase in average loan balances combined with the 77 basis point increase in loan yield drove the increase in interest income. Net interest income was $97.6 million for the year ended December 31, 2022, a $9.9 million increase from net interest income of $87.7 million for the year ended December 31, 2021. The increase in net interest income was driven by a $24.5 million increase in interest income, partially offset by a $14.6 million increase in interest expense. The $556.5 million increase in average loan balances was the primary driver of the increase in interest income, while the 65 basis point increase in deposit costs drove the increase in interest expense. 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. On January 1, 2022, we adopted the Current Expected Credit Loss (CECL) methodology for estimating credit losses, which resulted in an increase of $1.5 million in our allowance for credit losses and an increase of $2.0 million in our reserve for unfunded commitments. The tax-effected impact of these two items amounted to $2.8 million and was recorded as an adjustment to our retained earnings as of January 1, 2022. We review the adequacy of the allowance for credit losses on a quarterly basis. Please see the discussion below under “Results of Operations – 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. There was a $1.3 million provision for credit losses for the year ended December 31, 2023, compared to a provision of $6.2 million and a reversal of $12.4 million for the years ended December 31, 2022 and 2021, respectively. The $1.3 million provision during 2023 included a $2.2 million provision for credit losses and a reversal of $949,000 for unfunded commitments. The $2.2 million provision was driven primarily by $329.3 million in loan growth during the year, while the $949,000 reversal was driven by a $153.7 million decrease in unfunded commitments. The $6.2 million provision during 2022, which included a $780,000 provision for unfunded commitments, was driven primarily by $783.5 million in loan growth during the year, combined with a $259.6 million increase in unfunded commitments. In addition, to loan growth, 52 Table of Contents the provision for credit losses was impacted by slightly lower expected loss rates due to historically low charge-offs during the 12 months ended December 31, 2022 while minor adjustments to two internal qualitative factors increased the qualitative component of the allowance and related provision expense. The $12.4 million reversal of provision during 2021 related to a reduction in qualitative adjustment factors driven by the overall improvement in economic conditions as well as improvement in the credit quality of our portfolio following the pandemic. Following is a summary of the activity in the allowance for credit losses. December 31, (dollars in thousands) 2023 2022 2021 Balance, beginning of period $ 38,639 30,408 44,149 Adjustment for CECL - 1,500 - Provision for (reversal of) credit losses 2,209 5,375 (12,400 ) Loan charge-offs (761 ) (485 ) (2,166 ) Loan recoveries 595 1,841 825 Net loan (charge-offs) recoveries (166 ) 1,356 (1,341 ) Balance, end of period $ 40,682 38,639 30,408 As of December 31, 2023, the allowance for credit losses totaled $40.7 million, or 1.13% of gross loans. In comparison, the allowance for credit losses totaled $38.6 million as of December 31, 2022, or 1.18% of gross loans, and $30.4 million as of December 31, 2021, or 1.22% of gross loans. During the year ended December 31, 2023, we had net charge-offs of $166,000, consisting of $761,000 of loans charged-off in the current year, partially offset by $595,000 of recoveries on loans previously charged-off. Net charge-offs were 0.00% of the average outstanding loan portfolio for 2023. In addition, nonperforming assets increased to 0.10% of total assets while our level of classified assets decreased to 4.25% at December 31, 2023. We reported net recoveries of $1.4 million and net charge-offs of $1.3 million for the years ended December 31, 2022 and 2021, respectively, including charge-offs of $485,000 and recoveries of $825,000 in 2022 and 2021, respectively. The net recoveries of $1.4 million and charge-offs of $1.3 million during 2022 and 2021, respectively, represented 0.05% and 0.06% of the average outstanding loan portfolios for 2022 and 2021, respectively. In addition, nonperforming assets were 0.07% and 0.17% of total assets for 2022 and 2021, respectively, and classified assets were 4.72% and 12.61% at December 31, 2022 and 2021, respectively. Noninterest Income The following table sets forth information related to our noninterest income. Year ended December 31, (dollars in thousands) 2023 2022 2021 Mortgage banking income $ 4,036 4,198 11,376 Service fees on deposit accounts 1,382 1,265 1,174 ATM and debit card income 2,245 2,163 2,037 Income from bank owned life insurance 1,379 1,289 1,231 Net lender fees on PPP loan sale - - 268 Gain (loss) on disposal of fixed assets - (394 ) 10 Gain on sale of securities - 12 (3 ) Other income 818 1,047 1,008 Total noninterest income $ 9,860 9,580 17,101 Noninterest income was $9.9 million for the year ended December 31, 2023, a $280,000, or 2.9%, increase compared to noninterest income of $9.6 million for the year ended December 31, 2022. The increase in noninterest income during 2023, compared to 2022, resulted primarily from a loss on disposal of assets during the prior year. Offsetting the increases in noninterest income were decreases in mortgage banking income and other income. Other income decreased due to a decrease in loan fee income during 2023 as compared to 2022 due to fewer loan originations. Noninterest income was $9.6 million for the year ended December 31, 2022, a $7.5 million, or 44.0%, decrease compared to noninterest income of $17.1 million for the year ended December 31, 2021. The decrease in noninterest income during 2022, compared to 2021, resulted primarily from the following: 53 Table of Contents ● Mortgage banking income decreased $7.2 million, or 63.1%, driven by low inventory in the housing market, lower refinance volumes, and a decrease in margin on loan sales. During 2022, purchase transactions accounted for approximately 84% of our mortgage volume compared to 40% in 2021 as refinance transactions diminished due to the higher mortgage rates in 2022. Offsetting these decreases in noninterest income were increases in service fees on deposit accounts and ATM and debit card income due to growth in our client base and transaction volume. Noninterest Expenses The following table sets forth information related to our noninterest expenses. Years ended December 31, (dollars in thousands) 2023 2022 2021 Compensation and benefits $ 40,275 38,790 36,103 Occupancy 10,255 9,105 6,956 Other real estate owned expenses, net - - 385 Outside service and data processing costs 7,078 6,112 5,468 Insurance 3,766 1,686 1,149 Professional fees 2,496 2,635 2,589 Marketing 1,357 1,216 905 Other 3,600 3,389 2,875 Total noninterest expenses $ 68,827 62,933 56,430 Noninterest expenses were $68.8 million for the year ended December 31, 2023, a $5.9 million, or 9.4%, increase from noninterest expense of $62.9 million for 2022. The increase in total noninterest expenses during 2023, compared to 2022, resulted primarily from the following: ● Compensation and benefits expense increased $1.5 million, or 3.8%, during 2023 relating primarily to an increase in salaries and incentive compensation. ● Occupancy expenses increased $1.2 million, or 12.6%, driven by increased depreciation, insurance, property taxes and maintenance expenses primarily related to our new headquarters building. ● Outside service and data processing costs increased $966,000, or 15.8%, primarily due to increased electronic banking, software licensing costs and debit card related expenses. ● Insurance expenses increased $2.1 million, or 123.4%, related to higher FDIC insurance premiums. ● Marketing expenses increased $141,000, or 11.6%, driven by an increase in community sponsorships and business development. ● Other noninterest expenses increased $211,000, or 6.2%, due primarily to an increase in telephone expense and deposit account and fraud losses. Partially offsetting the above increases was a decrease in professional of $139,000, or 5.3% due to less legal fees and consulting expenses. Noninterest expenses were $62.9 million for the year ended December 31, 2022, a $6.5 million, or 11.5%, increase from noninterest expense of $56.4 million for 2021. The increase in total noninterest expenses during 2022, compared to 2021, resulted primarily from the following: ● Compensation and benefits expense increased $2.7 million, or 7.4%, during 2022 relating primarily to a $5.2 million increase in salaries and incentive compensation, partially offset by a $2.4 million decrease in mortgage commissions paid on sales activity. During 2022, we grew by 15 employees who were hired primarily to grow our footprint in each of our South Carolina, North Carolina, and Georgia markets. ● Occupancy expenses increased $2.1 million, or 30.9%, driven by increased depreciation, insurance, property taxes and maintenance expenses primarily related to our new headquarters building. ● Outside service and data processing costs increased $644,000, or 11.8%, primarily due to increased electronic banking, software licensing costs and ATM card related expenses. ● Insurance expenses increased $537,000, or 46.7%, related to higher FDIC insurance premiums. 54 Table of Contents ● Marketing expenses increased $311,000, or 34.4%, driven by an increase in community sponsorships and business development. ● Other noninterest expenses increased $514,000, or 17.9%, due primarily to an increase in travel expenses between our eight markets, deposit account losses, and staff related expenses. Partially offsetting the above increases was a decrease in other real estate owned expenses of $385,000 due to the sale of one commercial property in 2021. Our efficiency ratio was 78.7% for 2023 compared to 58.7% for 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 increase during the 2023 period relates primarily to the decrease in net interest income compared to the prior year. Income Taxes Income tax expense was $4.0 million, $9.0 million and $14.1 million for the years ended December 31, 2023, 2022 and 2021, respectively. Our effective tax rate was 23.0% for the year ended December 31, 2023, compared to 23.6% for 2022, and 23.2% for 2021. The fluctuation in the effective rate for each of the periods is driven by to the impact of tax-exempt income and equity compensation transactions that occurred during the respective periods in relation to pre-tax income. Investment Securities At December 31, 2023 and 2022, our investment securities portfolio was $154.6 million and $104.2 million, respectively, and represented approximately 3.8% and 2.8% of our total assets, respectively. Our available for sale investment portfolio included corporate bonds, US treasuries, US agency securities, SBA securities, state and political subdivisions, asset-backed securities, and mortgage-backed securities with a fair value of $134.7 million and amortized cost of $149.1 million for an unrealized loss of $14.4 million at December 31, 2023 compared to a fair value of $93.3 million and amortized cost of $110.3 million for an unrealized loss of $17.0 million at December 31, 2022. The amortized costs and the fair value of our investments are as follows. December 31, 2023 2022 2021 (dollars in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Available for Sale Corporate bonds $ 2,147 1,910 2,172 1,883 2,198 2,188 US treasuries 9,495 9,394 999 871 999 992 US government agencies 20,594 18,656 13,007 10,617 14,504 14,169 SBA securities - - - - 429 438 State and political subdivisions 22,642 19,741 22,910 18,906 24,887 25,176 Asset-backed securities 33,450 33,236 6,435 6,229 10,136 10,164 Mortgage-backed securities 60,730 51,765 64,800 54,841 68,065 67,154 Total $ 149,058 134,702 110,323 93,347 121,218 120,281 Contractual maturities and yields on our investments are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. 55 Table of Contents December 31, 2023 Less Than One Year One to Five Years Five to Ten Years Over Ten Years Total (dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Available for Sale Corporate bonds $ - - $ - - $ 1,910 2.01 % $ - - $ 1,910 2.01 % US treasuries 8,497 5.42 % 897 1.27 % - - - - 9,394 5.02 % US government agencies 970 0.45 % 2,385 1.00 % 15,301 4.41 % - - 18,656 3.77 % State and political subdivisions - - 906 1.94 % 5,769 1.89 % 13,066 2.15 % 19,741 2.06 % Asset-backed securities - - 296 (6.13 %) - - 32,940 6.63 % 33,236 6.57 % Mortgage-backed securities - - 4,795 1.15 % 5,400 1.59 % 41,570 2.00 % 51,765 1.87 % Total $ 9,467 4.91 % $ 9,279 0.98 % $ 28,380 3.20 % $ 87,576 3.76 % $ 134,702 3.55 % Other investments are comprised of the following and are recorded at cost which approximates fair value. December 31, (dollars in thousands) 2023 2022 Federal Home Loan Bank stock $ 16,063 9,250 Other investments 3,473 1,180 Investment in Trust Preferred subsidiaries 403 403 Total $ 19,939 10,833 Loans Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Average loans for the years ended December 31, 2023 and 2022 were $3.50 billion and $2.87 billion, respectively. Before allowance for credit losses, total loans outstanding at December 31, 2023 and 2022 were $3.60 billion and $3.27 billion, respectively. The principal component of our loan portfolio is loans secured by real estate mortgages. As of December 31, 2023, our loan portfolio included $3.05 billion, or 84.8%, of real estate loans, compared to $2.78 billion, or 84.8%, as of 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. In addition to traditional residential mortgage loans, we issue second mortgage residential real estate loans and home equity lines of credit. Home equity lines of credit totaled $183.0 million as of December 31, 2023, of which approximately 46% were in a first lien position, while the remaining balance was second liens, compared to $179.3 million as of December 31, 2022, of which approximately 48% were in first lien positions and the remaining balance was in second liens. The average home equity loan had a balance of approximately $85,000 and a loan to value of approximately 73% as of December 31, 2023, compared to an average loan balance of $84,000 and a loan to value of approximately 73% as of December 31, 2022. Further, 0.8% and 0.6% of our total home equity lines of credit were over 30 days past due as of December 31, 2023 and 2022, respectively. Following is a summary of our loan composition for each of the last three years ended December 31, 2023. Of the $329.3 million in loan growth in 2023, $171.7 million of growth was in commercial related loans, while $157.6 million of growth was in consumer related loans, specifically consumer real estate mortgages which grew by $151.2 million during 2023. The increase in consumer real estate loans is related to our focus to continue to originate high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $469,000, a term of 23 years, and an average rate of 4.10%. 56 Table of Contents December 31, 2023 2022 2021 (dollars in thousands) Amount %of Total Amount %of Total Amount %of Total Commercial Owner occupied RE $ 631,657 17.5 % $ 612,901 18.7 % $ 488,965 19.6 % Non-owner occupied RE 942,529 26.2 % 862,579 26.3 % 666,833 26.8 % Construction 150,680 4.2 % 109,726 3.4 % 64,425 2.6 % Business 500,161 13.9 % 468,112 14.3 % 333,049 13.4 % Total commercial loans 2,225,027 61.8 % 2,053,318 62.7 % 1,553,272 62.4 % Consumer Real estate 1,082,429 30.0 % 931,278 28.4 % 694,401 27.9 % Home equity 183,004 5.1 % 179,300 5.5 % 154,839 6.2 % Construction 63,348 1.7 % 80,415 2.5 % 59,846 2.4 % Other 48,819 1.4 % 29,052 0.9 % 27,519 1.1 % Total consumer loans 1,377,600 38.2 % 1,220,045 37.3 % 936,605 37.6 % Total gross loans, net of deferred fees 3,602,627 100.0 % 3,273,363 100.0 % 2,489,877 100.0 % Less – allowance for credit losses (40,682 ) (38,639 ) (30,408 ) Total loans, net $ 3,561,945 $ 3,234,724 $ 2,459,469 Maturities and Sensitivity of Loans to Changes in Interest Rates The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties. The following table summarizes the composition and maturities of the loan portfolio. December 31, 2023 (dollars in thousands) One year or less After one but within five years After five but within fifteen years After fifteen years Total Commercial Owner occupied RE $ 17,358 177,203 395,130 41,966 631,657 Non-owner occupied RE 68,601 517,622 331,727 24,579 942,529 Construction 26,762 64,432 59,486 - 150,680 Business 114,432 194,416 186,927 4,386 500,161 Total commercial loans 227,153 953,673 973,270 70,931 2,225,027 Consumer Real estate 10,593 51,956 301,095 718,785 1,082,429 Home equity 2,716 27,578 147,855 4,855 183,004 Construction - 252 39,459 23,637 63,348 Other 11,157 33,592 3,265 805 48,819 Total consumer loans 24,466 113,378 491,674 748,082 1,377,600 Total gross loan, net of deferred fees $ 251,619 1,067,051 1,464,944 819,013 3,602,627 57 Table of Contents The following table summarizes the loans due after one year by category. Interest Rate (dollars in thousands) Fixed Floating or Adjustable Commercial Owner occupied RE $ 605,199 9,100 Non-owner occupied RE 768,048 105,880 Construction 81,326 42,592 Business 293,920 91,809 Total commercial loans 1,748,493 249,381 Consumer Real estate 1,071,836 - Home equity 11,441 168,847 Construction 63,348 - Other 11,525 26,137 Total consumer loans 1,158,150 194,984 Total gross loan, net of deferred fees $ 2,906,643 444,365 Nonperforming Assets Nonperforming assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans for the five years ended December 31, 2023. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. December 31, (dollars in thousands) 2023 2022 2021 Commercial Non-owner occupied RE $ 1,423 247 270 Business 319 182 - Consumer Real estate 985 207 989 Home equity 1,236 195 653 Nonaccruing troubled debt restructurings (TDRs) - 1,796 2,952 Total nonaccrual loans, including nonaccruing TDRs 3,963 2,627 4,864 Total nonperforming assets $ 3,963 2,627 4,864 Asset Quality Ratios: Nonperforming assets/total assets 0.10 % 0.07 % 0.17 % Nonaccrual loans/gross loans 0.11 % 0.08 % 0.20 % Total loans over 90 days past due (1) $ 1,300 402 554 Loans over 90 days past due and still accruing - - - Accruing troubled debt restructurings - 4,503 3,299 (1) Loans over 90 days are included in nonaccrual loans At December 31, 2023, nonperforming assets were $4.0 million, or 0.10% of total assets and 0.11% of gross loans, compared to $2.6 million, or 0.07% of total assets and 0.08% of gross loans at December 31, 2022. Nonaccrual loans increased $1.3 million to $4.0 million at December 31, 2023 from $2.6 million at December 31, 2022. During 2023, we added eight new loans totaling $2.0 million to nonaccrual, two loans totaling $283,000 were returned to accruing status, one loan totaling $30,000 was charged off, while paydowns on nonaccrual loans totaled $388,000. The amount of foregone interest income on the nonaccrual loans as of December 31, 2023 and 2022 was approximately $73,000 and $28,000, respectively, for the twelve-month periods. 58 Table of Contents A significant portion, or 95.1%, of nonaccrual loans at December 31, 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 result of this level of coverage on nonaccrual loans, we believe the allowance for credit losses of $40.7 million for the year ended December 31, 2023 is adequate. As a general practice, most of our commercial loans and a portion of our consumer loans are originated with relatively short maturities of less than ten years. As a result, when a loan reaches its maturity, we frequently renew the loan and thus extend its maturity using similar credit standards as those used when the loan was first originated. Due to these loan practices, we may, at times, renew loans which are classified as nonaccrual after evaluating the loan’s collateral value and financial strength of its guarantors. Nonaccrual loans are renewed at terms generally consistent with the ultimate source of repayment and rarely at reduced rates. In these cases, we will generally seek additional credit enhancements, such as additional collateral or additional guarantees to further protect the loan. When a loan is no longer performing in accordance with its stated terms, we will typically seek performance under the guarantee. In addition, approximately 85% of our loans are collateralized by real estate and approximately 96% of our individually evaluated loans are secured by real estate. Individual loan evaluations are generally performed for individually evaluated loans, which includes nonaccrual loans and certain loans not meeting the risk characteristics of the pool, whether on accrual or nonaccrual status. We use third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require us to review individually evaluated loans at least annually and determine whether it is necessary to obtain an updated appraisal, either through a new external appraisal or an internal appraisal evaluation. We review each of our individually evaluated loans on a quarterly basis to determine the level of impairment. As of December 31, 2023, we do not have any individually evaluated 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 December 31, 2023, individually evaluated loans totaled approximately $4.8 million for which $3.7 million of these loans have a reserve of approximately $688,000 allocated in the allowance. At December 31, 2022, individually evaluated loans totaled approximately $7.1 million for which $6.8 million of these loans had a reserve of approximately $1.3 million allocated in the allowance. We 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 measurement of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty. During the 12 months ended December 31, 2023, we had two commercial business loans that were modified due to the borrowers experiencing financial difficulty. The amortized cost basis of the two loans was $319,000 at December 31, 2023. Prior to adopting ASU 2022-02, we considered a loan to be a TDR when the debtor experienced financial difficulty and we provided concessions such that we would not collect all principal and interest in accordance with the original terms of the loan agreement. Concessions related to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we restructured loan terms to assist borrowers facing challenges in the economic environment. As of December 31, 2022, we had $6.3 million in loans that we considered TDRs. As permitted by the CARES Act, we did not consider loan modifications to borrowers affected by COVID-19 to be TDRs unless the borrower was 30 days or more past due as of December 31, 2019, (ii) the modifications were related to COVID-19, and (iii) the modification occurred between March 1, 2020 and January 1, 2022. See Notes 1 and 4 to the Consolidated Financial Statements for additional information on loan modifications and TDRs. Allowance for Credit Losses At December 31, 2023 and December 31, 2022, the allowance for credit losses was $40.7 million and $38.6 million, respectively, or 1.13% and 1.18% of outstanding loans, respectively. The allowance for credit losses as a percentage of our outstanding loan portfolio decreased from the prior year primarily due to historically low loan charge-offs which factors into the expected loss rate on our current loan portfolio. In addition, our nonperforming assets increased to 0.10% compared to 0.07%, as a percentage of total assets, at December 31, 2023 and 2022, respectively. Our classified assets decreased to 4.25% of capital as of December 31, 2023, compared to 4.72% of capital as of December 31, 2022. See Note 4 to the Consolidated Financial Statements for more information on our allowance for credit losses. 59 Table of Contents The following table summarizes the net charge-off detail as a percentage of average loans by loan composition for the three years ended December 31, 2023. Year ended December 31, 2023 2022 2021 (dollars in thousands) Amount % Amount % Amount % Net charge-offs: Commercial Owner occupied RE $ - - $ - - $ 94 0.00 % Non-owner occupied RE (57 ) 0.00 % 1,540 0.05 % (573 ) 0.03 % Business 279 0.01 % 153 0.01 % (943 ) 0.04 % Total commercial 222 0.01 % 1,693 0.06 % (1,422 ) 0.06 % Consumer Real estate - 0.00 % - 0.00 % 18 0.00 % Home equity (373 ) (0.01 %) (247 ) 0.01 % 62 0.00 % Other (15 ) 0.00 % (90 ) 0.00 % 1 0.00 % Total consumer (388 ) (0.01 %) (337 ) 0.00 % 81 0.00 % Net loan (charge-offs) recoveries $ (166 ) $ 1,356 $ (1,341 ) Net loan (charge-offs) recoveries as a % of average loans 0.00 % (0.05 %) 0.06 % The following table summarizes the allocation of the allowance for credit losses among the various loan categories. Year ended December 31, 2023 2022 (dollars in thousands) Amount % (1) Amount % (1) Commercial Owner occupied RE $ 6,118 17.5 % $ 5,867 18.7 % Non-owner occupied RE 11,167 26.2 % 10,376 26.3 % Construction 1,594 4.2 % 1,292 3.4 % Business 7,385 13.9 % 7,861 14.3 % Total commercial 26,264 61.8 % 25,396 62.7 % Consumer Real estate 10,647 30.0 % 9,487 28.4 % Home equity 2,600 5.1 % 2,551 5.5 % Construction 677 1.7 % 893 2.5 % Other 494 1.4 % 312 0.9 % Total consumer 14,418 38.2 % 13,243 37.3 % Total allowance for credit losses $ 40,682 100.0 % $ 38,639 100.0 % (1) Percentage of loans in each category to total 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 30% of total deposits. These guidelines allow us to take advantage of the attractive terms that wholesale funding can offer while mitigating the related inherent risk. Our retail deposits represented $3.00 billion, or 88.8% of total deposits at December 31, 2023. At December 31, 2022, retail deposits represented $2.90 billion, or 92.5% of our total deposits. Brokered deposits were $379.4 million, representing 11.2% of our total deposits at December 31, 2023 and are included in time deposits greater than $250,000 in the following table. Our loan-to-deposit ratio was 107%, 104%, and 97% at December 31, 2023, 2022, and 2021, respectively. 60 Table of Contents The following table shows the average balance amounts and the average rates paid on deposits held by us. December 31, 2023 2022 2021 (dollars in thousands) Amount Rate Amount Rate Amount Rate Noninterest bearing demand deposits $ 717,275 -% $ 788,960 -% $ 671,223 - % Interest bearing demand deposits 299,703 0.75 % 374,956 0.22 % 306,669 0.07 % Money market accounts 1,672,550 3.66 % 1,323,487 0.99 % 1,143,904 0.21 % Savings accounts 36,324 0.11 % 41,474 0.05 % 32,916 0.05 % Time deposits less than $250,000 106,169 3.88 % 81,664 1.17 % 78,487 0.80 % Time deposits greater than $250,000 525,798 4.52 % 220,192 1.45 % 97,814 0.59 % Total deposits $ 3,357,819 2.72 % $ 2,830,733 0.64 % $ 2,331,013 0.17 % During the 12 months ended December 31, 2023, our average transaction account balances increased by $197.0 million, or 7.8%, while our average time deposit balances increased by $330.1 million, or 109.4%. Core deposits exclude out-of-market deposits and time deposits of $250,000 or more and provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $2.81 billion, $2.76 billion, and $2.48 billion at December 31, 2023, 2022 and 2021, respectively. All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $250,000 or more is as follows: December 31, (dollars in thousands) 2023 2022 Three months or less $ 169,419 235,216 Over three through six months 86,342 76,778 Over six through twelve months 58,293 35,681 Over twelve months 254,011 27,076 Total $ 568,065 374,751 Time deposits that meet or exceed the FDIC insurance limit of $250,000 at December 31, 2023 and December 31, 2022 were $568.1 million and $374.8 million, respectively, including wholesale deposits. At December 31, 2023 and 2022, the Company estimates that it has approximately $1.3 billion and $1.4 billion, 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 for the bank’s regulatory reporting requirements by the FDIC for the Call Report. 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 December 31, 2023 and 2022, our cash and cash equivalents amounted to $156.2 million and $170.9 million, or 3.9% and 4.6% of total assets, respectively. Our investment securities at December 31, 2023 and 2022 amounted to $154.6 million and $104.2 million, or 3.8% 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. 61 Table of Contents Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain five federal funds purchased lines of credit with correspondent banks totaling $108.5 million to meet short-term liquidity needs. There were no borrowings against the lines at December 31, 2023.Further, in July 2023, we enrolled in the Federal Reserve’s Bank Term Funding Program which offers 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 December 31, 2023, we had $13.0 million of marketable investment securities pledged in the Federal Reserve’s Bank Term Funding Program. At December 31, 2023, we had $227.1 million pledged and available with the Federal Reserve Discount Window. We are also a member of the FHLB of Atlanta, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at December 31, 2023 was $542.8 million, based on the Bank’s $16.1 million investment in FHLB stock, as well as qualifying mortgages available to secure any future borrowings. However, we are able to pledge additional securities to the FHLB in order to increase our available borrowing capacity. In addition, at December 31, 2023 we had $388.3 million of letters of credit outstanding with the FHLB to secure client deposits. 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 December 31, 2023. The line of credit was issued on December 28, 2023 at an interest rate of the U.S. Prime Rate plus 0.25% and a maturity date of February 28, 2025. We believe that our existing stable base of core deposits, federal funds purchased lines of credit with correspondent banks, availability with the Federal Reserve’s Bank Term Funding Program and Discount Window, 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 should we be required to meet those needs. Total shareholders’ equity was $312.5 million at December 31, 2023 and $294.5 million at December 31, 2022. The $18.0 million increase during 2023 is due primarily to net income to common shareholders of $13.4 million, stock option exercises and expenses of $2.5 million and $2.1 million gain in other comprehensive income. The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), equity to assets ratio (average equity divided by average assets), and tangible common equity ratio (total equity less preferred stock divided by total assets) for the three years ended December 31, 2023. Since our inception, we have not paid cash dividends. December 31, (dollars in thousands) 2023 2022 2021 Return on average assets 0.34 % 0.90 % 1.75 % Return on average equity 4.44 % 10.20 % 18.64 % Return on average common equity 4.44 % 10.20 % 18.64 % Average equity to average assets ratio 7.71 % 8.85 % 9.39 % Tangible common equity to assets ratio 7.70 % 7.98 % 9.50 % Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied 62 Table of Contents 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 as 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 December 31, 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. See Note 21 to the Consolidated Financial Statements for ratios of the Company. Actual For capital adequacy purposes minimum (1) To be well capitalized under prompt corrective action provisions minimum (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio As of December 31, 2023 Total Capital (to risk weighted assets) $ 390,197 12.28 % $ 254,278 8.00 % $ 317,847 10.00 % Tier 1 Capital (to risk weighted assets) 350,455 11.03 % 190,708 6.00 % 254,278 8.00 % Common Equity Tier 1 (to risk weighted assets) 350,455 11.03 % 143,031 4.50 % 206,601 6.50 % Tier 1 Capital (to average assets) 350,455 8.47 % 165,414 4.00 % 206,767 5.00 % As of December 31, 2022 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 (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 % As of December 31, 2021 Total Capital (to risk weighted assets) $ 331,052 14.36 % $ 184,418 8.00 % $ 230,522 10.00 % Tier 1 Capital (to risk weighted assets) 302,217 13.11 % 138,313 6.00 % 184,418 8.00 % Common Equity Tier 1 (to risk weighted assets) 302,217 13.11 % 103,735 4.50 % 149,839 6.50 % Tier 1 Capital (to average assets) 302,217 10.55 % 114,537 4.00 % 143,172 5.00 % (1) Ratios do not include the capital conservation buffer of 2.5%. On September 30, 2019, the Company sold and issued $23.0 million in aggregate principal amount of its 4.75% Fixed-to-Floating Rate Subordinated Notes due 2029 to eligible purchasers in a private offering. The Company used the proceeds from the offering, which were approximately $22.5 million, for general corporate purposes, including providing capital to the Bank and supporting organic growth. The Notes rank junior in right to payment to the Company’s current and future senior indebtedness. The Notes are intended to qualify as Tier 2 capital for regulatory capital purposes for the Company and are subject to certain limitations. See Note 9 to the Consolidated Financial Statements for more information on our subordinated debentures. The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. 63 Table of Contents Effect of Inflation and Changing Prices The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles. Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation. Off-Balance Sheet Risk Commitments to extend credit are agreements to lend to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2023, unfunded commitments to extend credit were approximately $724.6 million, of which $145.6 million were at fixed rates and $579.0 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 majority of the unfunded commitments related to commercial business lines of credit and home equity lines of credit. Based on historical experience, we anticipate that a significant portion of these lines of credit will not be funded. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. At December 31, 2023 and 2022, there were $16.1 million and $14.3 million of commitments under letters of credit, respectively. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements. Except as disclosed in this Annual Report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings. Market Risk and Interest Rate Sensitivity Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business. We actively monitor and manage our interest rate risk exposure to seek 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 no less than quarterly and a board risk committee that meets quarterly. These committees are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits. As of December 31, 2023, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and downward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market conditions. 64 Table of Contents Interest rate scenario Change in net interest income from base Up 300 basis points (12.68 )% Up 200 basis points (8.45 )% Up 100 basis points (4.26 )% Base - Down 100 basis points 5.85 % Down 200 basis points 10.64 % Down 300 basis points 15.29 % Contractual Obligations We have commitments with various investment partners under the Small Business Investment Company (“SBIC”) and the Rural Business Investment Company (“RBIC”) programs for which we have committed to make capital contributions from time to time. As of December 31, 2023, $1.4 million remained outstanding under these commitments. We utilize a variety of short-term and long-term borrowings to supplement our supply of lendable funds, to assist in meeting deposit withdrawal requirements, and to fund growth of interest-earning assets in excess of traditional deposit growth. Certificates of deposit, structured repurchase agreements, FHLB advances, and subordinated debentures serve as our primary sources of such funds. Obligations under noncancelable operating lease agreements are payable over several years with the longest obligation expiring in 2032. We do not feel that any existing noncancelable operating lease agreements are likely to materially impact our financial condition or results of operations in an adverse way. Contractual obligations relative to these agreements are noted in the table below. Option periods that we have not yet exercised are not included in this analysis as they do not represent contractual obligations until exercised. The following table provides payments due by period for obligations under long-term borrowings and operating lease obligations as of December 31, 2023. December 31, 2023 Payments Due by Period (dollars in thousands) Within One Year Over One to Two Years Over Two to Three Years Over Three to Four Years After Five Years Total Certificates of deposit $ 494,392 45,190 100,308 60 118,282 758,232 Subordinated debentures - - - - 36,322 36,322 Operating lease obligations 2,099 2,157 2,210 2,267 22,202 30,935 Total $ 496,490 47,347 102,518 2,327 176,807 825,489 Accounting, Reporting, and Regulatory Matters See Note 1 – Summary of Significant Accounting Policies and Activities in our “Notes to Consolidated Financial Statements” for a discussion on the effects of recently issued accounting pronouncements. Item 7A. Quantitative and Qualitative Disclosures about Market Risk See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk and Interest Rate Sensitivity and – Liquidity and Capital Resources. 65 Table of Contents