Table of Contents
UNITED STATESSECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2024
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)
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:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 8,155,097 shares of common stock, par value $0.01 per share, were issued and outstanding as of July 25, 2024.
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYJune 30, 2024 Form 10-Q
INDEX
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PART I. CONSOLIDATED FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements that are an integral part of these consolidated statements.
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SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF INCOME(Unaudited)
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SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(Unaudited)
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SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY(Unaudited)
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SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
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SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARYNOTES 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 six-month periods ended June 30, 2024 are not necessarily indicative of the results that may be expected for the year ending December 31, 2024. 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, 2023 as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 5, 2024. 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
In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default within the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company. 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 recent bank failures 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. The ultimate 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, remains difficult to predict at this time.
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The Company is subject to the regulations of various governmental agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject the Company to changes with respect to the valuation of assets, the amount of required credit loss allowance and operating restrictions resulting from the regulators’ judgments based on information available to them at the time of their examinations.
The Bank makes loans to individuals and businesses in the Upstate, Midlands, and Lowcountry regions of South Carolina as well as the Triangle, Triad and Charlotte regions of North Carolina and Atlanta, Georgia for various personal and commercial purposes. The Bank’s loan portfolio has a concentration of real estate loans. As of June 30, 2024 and 2023, real estate loans represented 84.3% and 84.1%, respectively, of total loans. However, borrowers’ ability to repay their loans is not dependent upon any specific economic sector.
As of June 30, 2024, the Company’s and the Bank’s capital ratios were in excess of all regulatory requirements. While management believes that we have sufficient capital to withstand an extended economic recession, our reported and regulatory capital ratios could be adversely impacted by future credit losses.
The Company maintains access to multiple sources of liquidity, including a $15.0 million holding company line of credit with another bank which could be used to support capital ratios at the subsidiary bank. As of June 30, 2024, the $15.0 million line was unused.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, real estate acquired in the settlement of loans, fair value of financial instruments, and valuation of deferred tax assets.
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.
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.
In December 2023, the FASB amended the Income Taxes topic in the Accounting Standards Codification to improve the transparency of income tax disclosures. The amendments are effective for annual periods beginning after December 15, 2024. Early adoption is permitted for annual financial statements that have not yet been issued or made available for issuance. The Company does not expect these amendments to have a material effect on its financial statements.
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NOTE 2 – Investment Securities
The amortized costs and fair value of investment securities are as follows:
Contractual maturities and yields on the Company’s investment securities at June 30, 2024 and December 31, 2023 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.
The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at June 30, 2024 and December 31, 2023, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
At June 30, 2024, the Company had 120 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 June 30, 2024.
Other investments are comprised of the following and are recorded at cost which approximates fair value.
The Company has evaluated other investments for impairment and determined that the other investments are not impaired as of June 30, 2024 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.
At June 30, 2024, there were no securities pledges as collateral for repurchase agreements from brokers.
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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 June 30, 2024, mortgage loans held for sale totaled $14.8million compared to $7.2million at December 31, 2023.
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 $6.8 million as of June 30, 2024 and $7.0 million as of December 31, 2023.
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.
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The following table summarizes the loans due after one year by category.
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:
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The following table presents loan balances classified by credit quality indicators by year of origination as of June 30, 2024.
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The following table presents loan balances classified by credit quality indicators by year of origination as of December 31, 2023.
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The following tables present loan balances by age and payment status.
As of June 30, 2024 and December 31, 2023, loans 30 days or more past due represented 0.30% and 0.37% of the Company’s total loan portfolio, respectively. Commercial loans 30 days or more past due were 0.23% and 0.27% of the Company’s total loan portfolio as of June 30, 2024 and December 31, 2023, respectively. Consumer loans 30 days or more past due were 0.07% and 0.09% of total loans as of June 30, 2024 and December 31, 2023, respectively.
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The table below summarizes nonaccrual loans by major categories for the periods presented.
The Company did not recognize interest income on nonaccrual loans for the three months ended June 30, 2024 and June 30, 2023. The accrued interest reversed during the three months ended June 30, 2024 was $76,000. Accrued interest reversed during the three months ended June 30, 2023 was not material. Foregone interest income on the nonaccrual loans for the three-month period ended June 30, 2024 and June 30, 2023 was not material.
We did not recognize interest income on nonaccrual loans for the six months ended June 30, 2024 and June 30, 2023. Accrued interest of $82,000 was reversed during the six months ended June 30, 2024 and $23,000 was reversed during the six months ended June 30, 2023.
The table below summarizes information regarding nonperforming assets.
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.
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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. Loan modifications to borrowers experiencing financial difficulty were not material for the three and six months ended June 30, 2024 and June 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 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 six months ended June 30, 2024 and June 30, 2023 under the CECL methodology.
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The provision for credit losses was $750,000 and $1.1million for the three months ended June 30, 2024 and June 30, 2023, respectively. In addition, the provision for credit losses was $750,000and $3.0 million for the six months ended June 30, 2024 and June 30, 2023, respectively.
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.
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.
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The following tables present an analysis of collateral-dependent loans of the Company as of June 30, 2024 and December 31, 2023.
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Allowance for Credit Losses - Unfunded Loan Commitments
The allowance for credit losses for unfunded loan commitments was $1.4 million and $1.8 million at June 30, 2024 and December 31, 2023, 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 six months ended June 30, 2024 and June 30, 2023.
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 hedging instrument matures on May 25, 2028. 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.
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The following table represents the carrying value of the portfolio layer method hedged asset and liability and the cumulative fair value hedging adjustment included in the carrying value of the hedged asset as of June 30, 2024 and December 31, 2023.
The following table summarizes the Company’s outstanding financial derivative instruments at June 30, 2024 and December 31, 2023.
Accrued interest receivable related to the interest rate swap as of June 30, 2024 totaled $293,000 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.
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The following table summarizes the effect of the fair value hedging relationship recognized in the consolidated statements of income for the three and six months ended June 30, 2024 and June 30, 2023.
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:
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.
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 individually evaluated loans.
The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in Note 12 of the Company’s 2023 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.
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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 June 30, 2024 and December 31, 2023.
The company had no liabilities recorded at fair value on a recurring basis as of June 30, 2024.
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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 June 30, 2024 and December 31, 2023.
The Company had no liabilities carried at fair value or measured at fair value on a nonrecurring basis.
For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of June 30, 2024 and December 31, 2023, the significant unobservable inputs used in the fair value measurements were as follows:
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.
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The estimated fair values of the Company’s financial instruments at June 30, 2024 and December 31, 2023 are as follows:
NOTE 7 –Leases
The Company had operating right-of-use (“ROU”) assets, included in property and equipment, of $21.4 million and $22.2 million as of June 30, 2024 and December 31, 2023, respectively. The Company had lease liabilities, included in other liabilities, of $23.9million and $24.6 million as of June 30, 2024 and December 31, 2023, 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 5.43 years as of June 30, 2024. The ROU asset and lease liability are recognized at lease commencement by calculating the present value of lease payments over the lease term. The ROU assets also include any initial direct costs incurred and lease payments made at or before commencement date and are reduced by any lease incentives.
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 2.28% as of June 30, 2024.
The total operating lease costs were $604,000 for the three months ended June 30, 2024 and 2023, respectively, and $1.2 million for the six months ended June 30, 2024 and 2023, respectively.
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Operating lease payments due as of June 30, 2024 were as follows:
Operating
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 six month periods ended June 30, 2024 and 2023. Dilutive common shares arise from the potentially dilutive effect of the Company’s stock options that were outstanding at June 30, 2024. The assumed conversion of stock options can create a difference between basic and dilutive net income per common share. At June 30, 2024 and 2023, there were 266,974 and 386,003 options, respectively, that were not considered in computing diluted earnings per common share because they were anti-dilutive.
Three months ended
June 30,
Six months ended
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 six month periods ended June 30, 2024 as compared to the three and six month periods ended June 30, 2023 and assesses our financial condition as of June 30, 2024 as compared to December 31, 2023. 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, 2023 included in our Annual Report on Form 10-K for that period. Results for the three and six month periods ended June 30, 2024 are not necessarily indicative of the results for the year ending December 31, 2024 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-
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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:
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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 June 30, 2024, we had total assets of $4.11 billion, a 1.3% increase from total assets of $4.06 billion at December 31, 2023. The largest component of our total assets is loans which were $3.62 billion and $3.60 billion at June 30, 2024 and December 31, 2023, respectively. Our liabilities and shareholders’ equity at June 30, 2024 totaled $3.79 billion and $318.7 million, respectively, compared to liabilities of $3.74 billion and shareholders’ equity of $312.5 million at December 31, 2023. The principal component of our liabilities is deposits which were $3.46 billion and $3.38 billion at June 30, 2024 and December 31, 2023, respectively.
Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread. In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients.
Our net income to common shareholders was $3.0 million and $2.5 million for the three months ended June 30, 2024 and 2023, respectively. Diluted earnings per share (“EPS”) was $0.37 for the second quarter of 2024 as compared to $0.31 for the same period in 2023. The increase in net income was primarily driven by an increase in
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net interest income resulting from additional interest income on our interest-earning assets combined with an increase in noninterest income, partially offset by an increase in noninterest expenses.
Our net income to common shareholders was $5.5 million and $5.2 million for the six months ended June 30, 2024 and 2023, respectively. Diluted EPS was $0.68 for the six months ended June 30, 2024 as compared to $0.64 for the same period in 2023. The increase in net income was primarily driven by the additional interest income on our interest-earning assets.
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 $19.5 million for the second quarter of 2024, a 3.7% increase over net interest income of $18.8 million for the second quarter of 2023, driven primarily by a $7.9 million increase in interest income on our interest-earning assets, partially offset by a $7.2 million increase in interest expense. In addition, our net interest margin, on a tax-equivalent basis (TE), was 1.98% for the second quarter of 2024 compared to 2.05% for the same period in 2023.
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 six month periods ended June 30, 2024 and 2023. 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.
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Average Balances, Income and Expenses, Yields and Rates
Our net interest margin (TE) decreased seven basis points to 1.98% during the second quarter of 2024, compared to the second quarter of 2023, primarily due to our deposit and borrowing costs increasing faster than our loan yield as our interest-bearing liabilities have been more sensitive to changes in the federal funds rate over the past two years. Our average interest-bearing liabilities grew by $320.6 million during the second quarter of 2024 from the prior year, while the rate on these liabilities increased 58 basis points to 4.04%. In contrast, our average interest-earning assets grew by $287.4 million during the second quarter of 2024 from the prior year, while the average yield on these assets increased by only 47 basis points to 5.12% during the same period.
The increase in our average interest-bearing liabilities during the second quarter of 2024 resulted primarily from a $216.4 million increase in our interest-bearing deposits from the prior year, while the 58 basis point increase in rate on our interest-bearing liabilities was driven by a 64 basis point increase in deposit rates.
The increase in average interest-earning assets for the second quarter of 2024 related primarily to an increase of $134.4 million in our average loan balances from the prior year and a $115.6 million increase in average federal funds sold and interest-bearing deposits with banks. The 47 basis point increase in yield on our interest-earning assets was driven by a 54 basis point increase in yield on federal funds sold and interest-bearing deposits with banks and a 45 basis point increase in loan yield.
Our net interest spread was 1.08% for the second quarter of 2024 compared to 1.19% for the same period in 2023. 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 58 basis point increase in the rate on our interest-bearing liabilities was partially offset by a 47 basis point increase in yield on our interest-earning assets, resulting in a 11 basis point decrease in our net interest spread for the 2024 period. We anticipate continued pressure on our net interest spread
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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.
During the first six months of 2024, our net interest margin (TE) decreased by 24 basis points to 1.96%, compared to 2.20% for the first six months of 2023, driven by the increase in yield on our interest-bearing liabilities. Our average interest-bearing liabilities grew by $376.1 million from the prior year, with the average yield increasing by 85 basis points to 4.01%. In contrast, our average interest-earning assets grew by $315.5 million, while the rate on these assets increased 54 basis points to 5.08%.
The increase in average interest-bearing liabilities for the first half of 2024 was driven by an increase in interest-bearing deposits of $212.7 million and a $163.3 million increase in FHLB advances and other borrowings, while the increase in cost was driven by a 92 basis point increase on our interest-bearing deposits.
The increase in average interest-earning assets for the first half of 2024 related primarily to a $210.9 million increase in our average loan balances and a $62.1 million increase in average federal funds sold and interest-bearing deposits with banks. The increase in yield on our interest-earning assets was driven by a 75 basis point increase in the yield on federal funds sold and interest-bearing deposits with banks and a 51 basis point increase in our loan yield.
Our net interest spread was 1.06% for the first half of 2024 compared to 1.38% for the same period in 2023. The 32 basis point decrease in our net interest spread was driven by the 85 basis point increase in yield on our interest-bearing liabilities.
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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.
Net interest income, the largest component of our income, was $19.5 million for the second quarter of 2024 and $18.8 million for the second quarter of 2023, a $703,000, or 3.7%, increase year over year. The increase during 2024 was driven by a $7.9 million increase in interest income primarily due to higher yields on our loan portfolio and an increase in average loan balances and average federal funds sold and interest-bearing deposits with banks. Partially offsetting the increase in interest income was a $7.2 million increase in interest expense which was primarily driven by higher rates on our interest-bearing deposits.
Net interest income for the first half of 2024 was $38.2 million compared to $39.2 million for 2023, a $1.1 million, or 2.74%, decrease. The decrease in net interest income during 2024 was driven by a $19.0 million increase in interest expense, related primarily to higher rates on our interest-bearing deposits.
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 –
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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 $500,000 provision for credit losses during the second quarter of 2024, compared to a $910,000 provision for credit losses in the second quarter of 2023. We recorded a provision expense of $325,000 and $2.7 million for the six months ended June 30, 2024 and June 30, 2023, respectively. The $500,000 provision in 2024, which included a $750,000 provision for credit losses and a $250,000 reversal for unfunded commitments, was driven by an increase in the level of charge-offs we experienced during the second quarter, combined with an increase in the specific reserve on individually assessed loans. During the second quarter of 2024, we charged-off $1.0 million related to one relationship associated with the assisted living industry. The reversal of the reserve for unfunded commitments was due to a decrease in the balance of unfunded commitments at June 30, 2024. The $325,000 provision expense for the first half of 2024 included $750,000 provision for credit losses and a $425,000 reversal for unfunded commitments. The $910,000 provision in 2023, which included a $1.1 million provision for credit losses and a $185,000 reversal for unfunded commitments, was driven by $119.7 million in loan growth during the second quarter. The $2.7 million provision expense for the first half of 2023 included a $3.0 million provision for credit losses and a $215,000 reversal for unfunded commitments.
Noninterest Income
The following table sets forth information related to our noninterest income.
Noninterest income was $3.5 million for the second quarter of 2024, a $787,000, or 28.8%, increase from noninterest income of $2.7 million for the second quarter of 2023. Mortgage banking income continues to be the largest component of our noninterest income at $1.9 million for the second quarter of 2024 an increase of $586,000, or 43.8%, over the prior year. The increase was driven by higher mortgage volume during the second quarter of 2024.
Noninterest income was $6.2 million for the first half of 2024, a $1.4 million, or 29.4%, increase from noninterest income of $4.8 million for the first half of 2023. Mortgage banking income increased by $1.1 million, or 57.6%, over the prior year while service fees on deposit accounts increased $154,000, or 23.5%, from the first half of 2023.
Noninterest expenses
The following table sets forth information related to our noninterest expenses.
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Noninterest expense was $18.6 million for the second quarter of 2024, a $1.3 million, or 7.2%, increase from noninterest expense of $17.4 million for the second quarter of 2023. The increase in noninterest expense was driven primarily by the following:
Partially offsetting these increases, professional fees decreased $169,000, or 22.5%, relating primarily to decreases in loan appraisal fees and consulting fees.
Noninterest expense was $36.7 million for the first half of 2024, a $2.2 million, or 6.5%, increase from noninterest expense of $34.5 million for the first half of 2023. The increase in noninterest expense was driven primarily by the following:
Partially offsetting these increases, professional fees decreased $210,000, or 14.9%, relating primarily to decreases in loan appraisal fees and consulting fees.
Our efficiency ratio was 80.9% for the second quarter of 2024, compared to 80.7% for the second quarter of 2023. 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.
We incurred income tax expense of $909,000 and $800,000 for the three months ended June 30, 2024 and 2023, respectively, and $1.8 million and $1.6 million for the six months ended June 30, 2024 and 2023, respectively. Our effective tax rate was 24.3% and 24.1% for the six months ended June 30, 2024 and 2023, respectively. The higher tax rate during the first half of 2024 was driven by the effect of equity compensation transactions during the period.
Balance Sheet Review
Investment Securities
At June 30, 2024, the $140.0 million in our investment securities portfolio represented approximately 3.4% 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 $121.4 million and an amortized cost of $136.4 million, resulting in an unrealized loss of $15.0 million. At December 31, 2023, the $154.6 million in our investment securities portfolio represented approximately 3.8% of our total assets, including investment securities with a fair value of $134.7 million and an amortized cost of $149.1 million for an unrealized loss of $14.4 million. In addition, other investments, which include FHLB Stock and other nonmarketable investments, decreased $1.3 million from December 31, 2023 to $18.7 million at June 30, 2024.
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 six months ended June 30, 2024 and 2023 were $3.63 billion and $3.42 billion, respectively. Before the allowance for credit losses, total loans outstanding at June 30, 2024 and December 31, 2023 were $3.62 billion and $3.60 billion, respectively.
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The principal component of our loan portfolio is loans secured by real estate mortgages. As of June 30, 2024, our loan portfolio included $3.05 billion, or 84.3%, of real estate loans, compared to $3.05 billion, or 84.8%, at December 31, 2023. 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 $189.3 million as of June 30, 2024, of which approximately 46% were in a first lien position, while the remaining balance was second liens. At December 31, 2023, our home equity lines of credit totaled $183.0 million, of which approximately 46% were in first lien positions, while the remaining balance was in second liens. The average home equity loan had a balance of approximately $86,000 and a loan to value of 71% as of June 30, 2024, compared to an average loan balance of $85,000 and a loan to value of approximately 73% as of December 31, 2023. Further, 0.4% and 0.8% of our total home equity lines of credit were over 30 days past due as of June 30, 2024 and December 31, 2023, respectively.
Following is a summary of our loan composition at June 30, 2024 and December 31, 2023. During the first six months of 2024, our loan portfolio increased by $19.9 million, or 0.55%, with a $6.0 million increase in commercial loans while consumer loans increased by $13.9 million 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 257.7% of the Bank’s total risk-based capital at June 30, 2024. Our consumer real estate portfolio grew by $43.7 million and includes high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $467,000, a term of 23 years, and an average rate of 4.27% as of June 30, 2024, compared to a principal balance of $469,000, a term of 23 years, and an average rate of 4.10% as of December 31, 2023.
Nonperforming assets
Nonperforming assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms and to show capacity to continue performing into the future before that loan can be placed back on accrual status. As of June 30, 2024 and December 31, 2023, we had no loans 90 days past due and still accruing.
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Following is a summary of our nonperforming assets.
At June 30, 2024, nonperforming assets were $11.2 million, or 0.27% of total assets and 0.31% of gross loans. Comparatively, nonperforming assets were $4.0 million, or 0.10% of total assets and 0.11% of gross loans at December 31, 2023. Nonaccrual loans increased $7.3 million during the first six months of 2024 due primarily to two relationships totaling $6.9 million that went on nonaccrual during the second quarter.
The amount of foregone interest income on nonaccrual loans in the first six months of 2024 and 2023 was not material. At June 30, 2024 and December 31, 2023, the allowance for credit losses represented 357.95% and 1,026.58% of the total amount of nonperforming loans, respectively. A significant portion of the nonperforming loans at June 30, 2024 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 June 30, 2024, 84.3% of our loans were collateralized by real estate and 98.8% of our individually evaluated loans were secured by real estate. Included in our real estate portfolio at June 30, 2024 was $219.7 million of loans, or 6.1% of our total loan portfolio, collateralized by office properties, $172.6 million of loans, or 4.8%, collateralized by retail properties, $131.0 million of loans, or 3.6%, collateralized by hotels, and $109.1 million of loans, or 3.0%, collateralized by multifamily properties. 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 June 30, 2024, 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 June 30, 2024, individually evaluated loans totaled $12.1 million with a reserve of approximately $1.7 million allocated in the allowance for credit losses. Comparatively, individually evaluated loans totaled $4.8 million at December 31, 2023 for which $3.7 million of these loans had a reserve of approximately $688,000 allocated in the allowance for credit losses.
The allowance for credit losses was $40.2 million, representing 1.11% of outstanding loans and providing coverage of 357.95% of nonperforming loans at June 30, 2024 compared to $40.7 million, or 1.13% of outstanding loans and 1,026.55% of nonperforming loans at December 31, 2023. At June 30, 2023, the allowance for credit losses was $41.1 million, or 1.16% of outstanding loans and 1,363.11% of nonperforming loans.
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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, 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 $3.00 billion, or 86.6% of total deposits, while our wholesale deposits represented $463.7 million, or 13.4%, of total deposits at June 30, 2024. At December 31, 2023, retail deposits represented $3.00 billion, or 88.8%, of our total deposits and wholesale deposits were $379.4 million, representing 11.2% of our total deposits. Our loan-to-deposit ratio was 105% at June 30, 2024 and 107% at December 31, 2023.
The following is a detail of our deposit accounts:
Our primary focus is 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. While our non-interest bearing deposits increased by $9.1 million from $674.2 million at December 31, 2023, our core deposits decreased to $2.79 billion from $2.81 billion at December 31, 2023. In addition, at June 30, 2024 and December 31, 2023, we estimate that we have approximately $1.3 billion, or 38.3% and 38.7% 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.
During the first six months of 2024, our average transaction account balances decreased by $158.1 million, or 5.8%, from the prior year, while our average time deposit balances increased by $292.0 million, or 52.3%.
All of our time deposits are certificates of deposits. The maturity distribution of our time deposits $250,000 or more at June 30, 2024 was as follows:
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Time deposits that meet or exceed the FDIC insurance limit of $250,000 at June 30, 2024 and December 31, 2023 were $671.6 million and $568.1 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 June 30, 2024, we had $240.0 million of convertible fixed rate FHLB advances with a weighted average rate of 3.76%, while at December 31, 2023, we had $275.0 million in FHLB Advances. Of the $275.0 million outstanding at December 31, 2023, $35.0 million was at a variable rate and $240.0 million was at fixed rates. The $240.0 million was secured with approximately $1.32 billion of mortgage loans and $14.6 million of stock in the FHLB at June 30, 2024. The $275.0 million was secured with approximately $1.25 billion of mortgage loans and $16.1 million of stock in the FHLB at December 31, 2023.
Listed below is a summary of the terms and maturities of the advances outstanding at June 30, 2024 and December 31, 2023.
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 institution’s 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.
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At June 30, 2024 and December 31, 2023, our cash and cash equivalents totaled $194.8 million and $156.2 million, respectively, or 4.7% and 3.9% of total assets, respectively. Our investment securities at June 30, 2024 and December 31, 2023 amounted to $140.0 million and $154.6 million, respectively, or 3.4% and 3.8% 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 six federal funds purchased lines of credit with correspondent banks totaling $128.5 million for which there were no borrowings against the lines of credit at June 30, 2024. We also had $235.1 million pledged and available with the Federal Reserve Discount Window at June 30, 2024. Comparatively, at December 31, 2023, we had $227.1 million pledged and available with the Federal Reserve Discount Window. At December 31, 2023, we had $13.0 million of marketable investment securities pledged in the Federal Reserve’s Bank Term Funding Program which closed on March 11, 2024.
We are also a member of the FHLB, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at June 30, 2024 was $598.5 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 June 30, 2024 and December 31, 2023 we had $393.4 million and $388.3 million, respectively, 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 June 30, 2024. 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 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 to meet those needs.
Total shareholders’ equity was $318.7 million at June 30, 2024 and $312.5 million at December 31, 2023. The $6.3 million increase from December 31, 2023 is primarily related to net income of $5.5 million during the first six months of 2024 and stock option exercises and equity compensation expenses of $1.3 million, partially offset by a $524,000 increase in other comprehensive loss related to our available for sale securities.
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 six months ended June 30, 2024 and the year ended December 31, 2023. Since our inception, we have not paid cash dividends.
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Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for credit losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.
Regulatory capital rules, which we refer to 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 June 30, 2024 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.
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The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements.
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 June 30, 2024 unfunded commitments to extend credit were $694.5 million, of which $88.2 million were at fixed rates and $606.3 million were at variable rates. At December 31, 2023, unfunded commitments to extend credit were $724.6 million, of which approximately $145.6 million were at fixed rates and $579.0 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.
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As of June 30, 2024, the reserve for unfunded commitments was $1.4 million or 0.20% of total unfunded commitments. As of December 31, 2023, the reserve for unfunded commitments was $1.8 million or 0.25% of total unfunded commitments.
At June 30, 2024 and December 31, 2023, there were commitments under letters of credit for $13.0 million and $16.1 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, 2023, 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 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 June 30, 2024, 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
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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.
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 six months ended June 30, 2024, 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, 2023, 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, 2023.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
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As of June 30, 2024, the Company does not have an authorized share repurchase program.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. MINE SAFETY DISCLOSURES.
Not applicable.
Item 5. OTHER INFORMATION.
Trading Plans
During the six months ended June 30, 2024, no director or “officer” of the Company adopted or terminated a “Rule 10b5-1 trading arrangement” or a “non-Rule 10b5-1 trading arrangement,” as each term is defined in Item 408 of Regulation S-K of the Securities Act of 1933.
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.
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INDEX TO EXHIBITS
Amended and Restated Articles, as amended, of Southern First Bancshares, Inc. (effective May 30, 2024).
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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.
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