SOUTHERN FIRST BANCSHARES INC MANAGEMENT’S DISCUSSION AND Analysis of Financial Condition and Results of Operations. (form 10-Q)

The following discussion reviews our results of operations for the three month
period ended March 31, 2022 as compared to the three month period ended March
31, 2021 and assesses our financial condition as of March 31, 2022 as compared
to December 31, 2021. You should read the following discussion and analysis in
conjunction with the accompanying consolidated financial statements and the
related notes and the consolidated financial statements and the related notes
for the year ended December 31, 2021 included in our Annual Report on Form 10-K
for that period. Results for the three month period ended March 31, 2022 are not
necessarily indicative of the results for the year ending December 31, 2022
or
any future period.


Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” or similar references mean Southern First Bancshares, Inc. and its consolidated subsidiary. References to the “Bank” refer to Southern First Bank.

Cautionary Warning Regarding forward-looking statements

This report contains statements which constitute forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 (the "Exchange Act"). Forward-looking
statements may relate to our financial condition, results of operations, plans,
objectives, or future performance. These statements are based on many
assumptions and estimates and are not guarantees of future performance. Our
actual results may differ materially from those anticipated in any
forward-looking statements, as they will depend on many factors about which we
are unsure, including many factors which are beyond our control. The words
"may," "would," "could," "should," "will," "seek to," "strive," "focus,"
"expect," "anticipate," "predict," "project," "potential," "believe,"
"continue," "assume," "intend," "plan," and "estimate," as well as similar
expressions, are meant to identify such forward-looking statements. Potential
risks and uncertainties that could cause our actual results to differ from those
anticipated in any forward-looking statements include, but are not limited to:



? The continuing impact of COVID-19 and its variants on our business, including

the impact of the actions taken by governmental authorities to try and contain

the virus or address the impact of the virus on the United States economy

(including, without limitation, the Coronavirus Aid, Relief and Economic

Security Act, or the CARES Act), and the resulting effect of these items on our

operations, liquidity and capital position, and on the financial condition of

our borrowers and other customers;

 ? Restrictions or conditions imposed by our regulators on our operations;

? Increases in competitive pressure in the banking and financial services

   industries;



? Changes in access to funding or increased regulatory requirements with regard

   to funding;




 ? Changes in deposit flows;




? Credit losses as a result of declining real estate values, increasing interest

rates, increasing unemployment, changes in payment behavior or other factors;

? Credit losses due to loan concentration;

? Changes in the amount of our loan portfolio collateralized by real estate and

weaknesses in the real estate market;

? Our ability to successfully execute our business strategy;

? Our ability to attract and retain key personnel;

? The success and costs of our expansion into the Charlotte, North Carolina,

Greensboro, North Carolina and Atlanta, Georgia markets and into potential new

   markets;



? Risks with respect to future mergers or acquisitions, including our ability to

successfully expand and integrate the businesses and operations that we acquire

and realize the anticipated benefits of the mergers or acquisitions;





 ? Changes in the interest rate environment which could reduce anticipated or
   actual margins;




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? Changes in political conditions or the legislative or regulatory environment,

including new governmental initiatives affecting the financial services

   industry;



? Changes in economic conditions resulting in, among other things, a

deterioration in credit quality;

? Changes occurring in business conditions and inflation;

? Increased cybersecurity risk, including potential business disruptions or

   financial losses;




 ? Changes in technology;




? The adequacy of the level of our allowance for credit losses and the amount of

loan loss provisions required in future periods;

? Examinations by our regulatory authorities, including the possibility that the

regulatory authorities may, among other things, require us to increase our

allowance for credit losses or write-down assets;

? Changes in monetary and tax policies;

? The rate of delinquencies and amounts of loans charged-off;

? The rate of loan growth in recent years and the lack of seasoning of a portion

   of our loan portfolio;




? Our ability to maintain appropriate levels of capital and to comply with our

capital ratio requirements;

? Adverse changes in asset quality and resulting credit risk-related losses and

   expenses;




? Changes in accounting standards, rules and interpretations and the related

impact on our financial statements, including the effects from our adoption of

the current expected credit losses (“CECL”) model on January 1, 2022;

? Risks associated with actual or potential litigation or investigations by

customers, regulatory agencies or others;

? Adverse effects of failures by our vendors to provide agreed upon services in

the manner and at the cost agreed;

? The potential effects of events beyond our control that may have a

destabilizing effect on financial markets and the economy, such as epidemics

and pandemics (including COVID-19), war or terrorist activities, disruptions in

our customers’ supply chains, disruptions in transportation, essential utility

outages or trade disputes and related tariffs; and

? Other risks and uncertainties detailed in Part I, Item 1A, “Risk Factors” of

our Annual Report on Form 10-K for the year ended December 31, 2021in Part

II, Item 1A, “Risk Factors” of our Quarterly Reports on Form 10-Q, and in our

   other filings with the SEC.




If any of these risks or uncertainties materialize, or if any of the assumptions
underlying such forward-looking statements proves to be incorrect, our results
could differ materially from those expressed in, implied or projected by, such
forward-looking statements. We urge investors to consider all of these factors
carefully in evaluating the forward-looking statements contained in this
Quarterly Report on Form 10-Q. We make these forward-looking statements as of
the date of this document and we do not intend, and assume no obligation, to
update the forward-looking statements or to update the reasons why actual
results could differ from those expressed in, or implied or projected by, the
forward-looking statements, except as required by law.



OVERVIEW



Our business model continues to be client-focused, utilizing relationship teams
to provide our clients with a specific banker contact and support team
responsible for all of their banking needs. The purpose of this structure is to
provide a consistent and superior level of professional service, and we believe
it provides us with a distinct competitive advantage. We consider exceptional
client service to be a critical part of our culture, which we refer to as
"ClientFIRST."



At March 31, 2022, we had total assets of $3.07 billion, a 5.0% increase from
total assets of $2.93 billion at December 31, 2021. The largest component of our
total assets is loans which were $2.66 billion and $2.49 billion at March 31,
2022 and December 31, 2021, respectively. Our liabilities and shareholders'
equity at March 31, 2022 totaled $2.79 billion and $278.5 million, respectively,
compared to liabilities of $2.65 billion and shareholders' equity of $277.9
million at December 31, 2021. The principal component of our liabilities is
deposits which were $2.71 billion and $2.56 billion at March 31, 2022 and
December 31, 2021, respectively.



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Like most community banks, we derive the majority of our income from interest
received on our loans and investments. Our primary source of funds for making
these loans and investments is our deposits, on which we pay interest.
Consequently, one of the key measures of our success is our amount of net
interest income, or the difference between the income on our interest-earning
assets, such as loans and investments, and the expense on our interest-bearing
liabilities, such as deposits and borrowings. Another key measure is the spread
between the yield we earn on these interest-earning assets and the rate we pay
on our interest-bearing liabilities, which is called our net interest spread. In
addition to earning interest on our loans and investments, we earn income
through fees and other charges to our clients.



Our net income to common shareholders was $8.0 million and $10.4 million for the
three months ended March 31, 2022 and 2021, respectively. Diluted earnings per
share ("EPS") was $0.98 for the first quarter of 2022, compared to $1.31 for the
same period in 2021. The decrease in net income was driven primarily by an
increased provision for credit losses during the first quarter of 2022 as
compared to 2021.



Our mortgage banking segment reported a pre-tax loss of $125,000 for the
three-month period ended March 31, 2022, compared to pre-tax net income of $2.2
million for the three-month period ended March 31, 2021. Noninterest income for
our mortgage banking segment, which consists mainly of realized and unrealized
gains associated with the fair value of commitments and loans held for sale, was
$1.5 million for the first quarter of 2022, compared to $4.6 million for the
first quarter of 2021. The $3.1 million decrease during the period was driven by
a decline in sales activity combined with a decrease in the fair value of
derivatives associated with mortgage loan commitments. Noninterest expense for
our mortgage banking segment consists mainly of salaries, commissions and
benefits of mortgage employees, professional fees and outside services and data
processing costs. Noninterest expense was $1.6 million for the first quarter of
2022, compared to $2.9 million for the first quarter of 2021. The $1.2 million
decrease during the first quarter of 2022 was driven by a decrease in salaries
and benefits expense primarily related to commissions paid on sales activity.



We are currently constructing a new bank headquarters on a piece of property
that we own in Greenville, South Carolina. The new headquarters which includes a
retail office will open in the second quarter of 2022.



results of operations


Net Interest Income and Margin




Our level of net interest income is determined by the level of earning assets
and the management of our net interest margin. Our net interest income was $23.2
million for the first quarter of 2022, an 8.9% increase over net interest income
of $21.3 million for the first quarter of 2021, resulting primarily from a
$364.4 million increase in average loan balances. In addition, our net interest
margin, on a tax-equivalent basis (TE), was 3.37% for the first quarter of 2022
compared to 3.60% for the same period in 2021.



We have included a number of tables to assist in our description of various
measures of our financial performance. For example, the "Average Balances,
Income and Expenses, Yields and Rates" table reflects the average balance of
each category of our assets and liabilities as well as the yield we earned or
the rate we paid with respect to each category during the three-month periods
ended March 31, 2022 and 2021. A review of this table shows that our loans
typically provide higher interest yields than do other types of interest-earning
assets, which is why we direct a substantial percentage of our earning assets
into our loan portfolio. Similarly, the "Rate/Volume Analysis" table
demonstrates the effect of changing interest rates and changing volume of assets
and liabilities on our financial condition during the periods shown. We also
track the sensitivity of our various categories of assets and liabilities to
changes in interest rates, and we have included tables to illustrate our
interest rate sensitivity with respect to interest-earning accounts and
interest-bearing accounts.



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The following table entitled "Average Balances, Income and Expenses, Yield and
Rates" sets forth information related to our average balance sheets, average
yields on assets, and average costs of liabilities. We derived these yields by
dividing income or expense by the average balance of the corresponding assets or
liabilities. We derived average balances from the daily balances throughout the
periods indicated. During the same periods, we had no securities purchased with
agreements to resell. All investments owned have an original maturity of over
one year. Nonaccrual loans are included in the following tables. Loan yields
have been reduced to reflect the negative impact on our earnings of loans on
nonaccrual status. The net of capitalized loan costs and fees are amortized into
interest income on loans.



Average Balances, Income and Expenses, Yields and Rates

For the Three Months Ended March 31,

                                                             2022                                         2021
                             Average       Income/         Yield/         Average       Income/         Yield/
(dollars in thousands)       Balance       Expense        Rate(1)         Balance       Expense        Rate(1)
Interest-earning
assets
Federal funds sold and
interest-bearing
deposits with banks      $    89,096     $      59           0.27 %   $    89,522     $      47           0.21 %
Investment securities,
taxable                      113,101           425           1.52 %        85,136           245           1.17 %
Investment securities,
nontaxable(2)                 11,899            64           2.17 %        11,000            73           2.68 %
Loans(3)                   2,573,978        23,931           3.77 %     2,209,569        22,465           4.12 %
Total interest-earning
assets                     2,788,074        24,479           3.56 %     2,395,227        22,830           3.87 %
Noninterest-earning
assets                       152,565                                      101,932
Total assets             $ 2,940,639                                  $ 2,497,159
Interest-bearing
liabilities
NOW accounts             $   406,054           115           0.11 %   $   280,737            46           0.07 %
Savings & money market     1,242,225           618           0.20 %     1,084,467           586           0.22 %
Time deposits                158,720           175           0.45 %       213,378           523           0.99 %
Total interest-bearing
deposits                   1,806,999           908           0.20 %     1,578,582         1,155           0.30 %
FHLB advances and
other borrowings              16,626            12           0.29 %         2,809             5           0.72 %
Subordinated
debentures                    36,116           380           4.27 %        36,008           380           4.28 %
Total interest-bearing
liabilities                1,859,741         1,300           0.28 %     1,617,399         1,540           0.39 %
Noninterest-bearing
liabilities                  802,298                                      648,969
Shareholders' equity         278,600                                      230,791
Total liabilities and
shareholders' equity     $ 2,940,639                                  $ 2,497,159
Net interest spread                                          3.28 %                                       3.48 %
Net interest income
(tax equivalent) /
margin                                   $  23,179           3.37 %                   $  21,290           3.60 %
Less: tax-equivalent
adjustment(2)                                   15                                           17
Net interest income                      $  23,164                                    $  21,273



(1) Annualized for the three month period.

(2) The tax-equivalent adjustment to net interest income adjusts the yield for

assets earning tax-exempt income to a comparable yield on a taxable basis.

(3) Includes mortgage loans held for sale.

Our net interest margin (TE) decreased 23 basis points to 3.37% during the first
quarter of 2022, compared to the first quarter of 2021, primarily due to a
reduction in yield on our interest-earning assets, partially offset by the
decreased cost of our interest-bearing liabilities. Our average interest-earning
assets grew by $392.8 million during the first quarter of 2022, while the
average yield on these assets decreased by 31 basis points to 3.56% during the
same period. In addition, our average interest-bearing liabilities grew by
$242.3 million during the first quarter of 2022, while the rate on these
liabilities decreased 11 basis points to 0.28%.



The increase in average interest-earning assets for the first quarter of 2022
related primarily to an increase of $364.4 million in our average loan balances
and a $28.9 million increase in investment securities. The decrease in yield on
our interest earning assets was driven by a 35 basis point decrease in loan
yield as our loan portfolio continues to reprice at rates lower than those in
the past following the Federal Reserve's interest rate reductions beginning
in
2019.


The increase in our average interest-bearing liabilities during the first quarter of 2022 resulted primarily from a $ 228.4 million increase in our interest-bearing deposits, while the 11 basis point decrease in rate on our interest-bearing liabilities resulted primarily from a ten basis point decrease in deposit rates.



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Our net interest spread was 3.28% for the first quarter of 2022 compared to
3.48% for the same period in 2021. The net interest spread is the difference
between the yield we earn on our interest-earning assets and the rate we pay on
our interest-bearing liabilities. The decrease in both the yield on our
interest-earning assets and the rate on our interest-bearing liabilities
resulted in a twenty basis point decrease in our net interest spread for the
2022 period. We anticipate continued pressure on our net interest spread and net
interest margin in future periods as our loan yield continues to decline due to
new and renewed loans pricing at rates lower than our current portfolio rate.



Rate/Volume Analysis



Net interest income can be analyzed in terms of the impact of changing interest
rates and changing volume. The following table sets forth the effect which the
varying levels of interest-earning assets and interest-bearing liabilities and
the applicable rates have had on changes in net interest income for the periods
presented.




                                                                                                           Three Months Ended
                                                  March 31, 2022 vs. 2021                             March 31, 2021 vs. 2020
                                               Increase (Decrease) Due to                          Increase (Decrease) Due to
                                                        Rate/                                              Rate/
(dollars in thousands)       Volume         Rate       Volume       Total       Volume         Rate       Volume        Total
Interest income
Loans                       $ 3,571       (1,816 )       (289 )     1,466     $  2,403       (2,996 )       (309 )       (902 )
Investment securities            90           64           19         173          144         (175 )        (64 )        (95 )
Federal funds sold and
interest-bearing deposits
with banks                        -           12            -          12           97          (79 )        (74 )        (56 )
Total interest income         3,661       (1,740 )       (270 )     1,651        2,644       (3,250 )       (447 )     (1,053 )
Interest expense
Deposits                        721         (596 )       (372 )      (247 )       (889 )     (4,778 )        648       (4,019 )
FHLB advances and other
borrowings                       14           (1 )         (4 )         9         (148 )       (112 )        105         (155 )
Subordinated debentures           1           (3 )          -          (2 )          1          (55 )          -          (54 )
Total interest expense          736         (600 )       (376 )      (240 )     (1,036 )     (3,945 )        753       (4,228 )
Net interest income         $ 2,925       (1,140 )       (106 )     1,891     $  3,680          695       (1,200 )      3,175



Net interest income, the largest component of our income, was $23.2 million for
the first quarter of 2022 and $21.3 million for the first quarter of 2021, a
$1.9 million, or 8.9%, increase. The increase during 2022 was driven by a $3.6
million increase due to higher loan volume, partially offset by higher volume in
our interest-bearing liabilities.



Provision for Credit Losses



The provision for credit losses, which includes a provision for losses on
unfunded commitments, is a charge to earnings to maintain the allowance for
credit losses at a level consistent with management's assessment of expected
losses in the loan portfolio at the balance sheet date. On January 1, 2022, we
adopted the Current Expected Credit Loss (CECL) methodology for estimating
credit losses, which resulted in an increase of $1.5 million in our allowance
for credit losses and an increase of $2.0 million in our reserve for unfunded
commitments. The tax-effected impact of these two items amounted to $2.8 million
and was recorded as an adjustment to our retained earnings as of January 1,
2022. We review the adequacy of the allowance for credit losses on a quarterly
basis. Please see the discussion included in Note 1 - Summary of Significant
Accounting Policies and Note 4 - Loans and Allowance for Credit Losses for a
description of the factors we consider in determining the amount of the
provision we expense each period to maintain this allowance.



We recorded a $1.0 million provision for credit losses in the first quarter of
2022, compared to a $300,000 reversal of provision expense in the first quarter
of 2020. The $1.0 million provision in 2022 was driven by the $170.1 million
growth in our loan portfolio during the first quarter. In addition, we upgraded
$86.4 million of hotel loans during the first quarter of 2022 after observing 12
months of positive financial performance. See additional discussion below in the
section "Allowance for Credit Losses."



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Noninterest Income



The following table sets forth information related to our noninterest income.




                                             Three months ended
                                                      March 31,
(dollars in thousands)                        2022         2021
Mortgage banking income                 $    1,494        4,633
Service fees on deposit accounts               191          185
ATM and debit card income                      528          470
Income from bank owned life insurance          315          267
Other income                                   399          349
Total noninterest income                $    2,927        5,904



Noninterest income decreased $3.0 million, or 50.4%, for the first quarter of
2022 as compared to the same period in 2021. The decrease in total noninterest
income resulted primarily from the following:



? Mortgage banking income decreased by $ 3.1 millionor 67.8%, driven by low

inventory in the housing market, lower refinance volumes, and a decrease in

margin on loan sales. We do not expect mortgage origination volume to continue

at levels seen in the prior year which will reduce the amount of mortgage

banking income recorded in future periods in comparison to prior periods.

Partially offsetting the above decrease was an increase in ATM and debit card income of $ 58,000or 12.3%, due to an increase in debit card transactions.



Noninterest expenses



The following table sets forth information related to our noninterest expenses.




                                                 Three months ended
                                                          March 31,
(dollars in thousands)                            2022         2021
Compensation and benefits                   $    8,144        6,683
Mortgage production costs                        1,649        2,867
Occupancy                                        1,777        1,637
Real estate owned expenses                           -          387
Outside service and data processing costs        1,411        1,142
Insurance                                          261          301
Professional fees                                  496          421
Marketing                                          256          182
Other                                              691          542
Total noninterest expense                   $   14,685       14,162




Noninterest expense was $14.7 million for the first quarter of 2022, a $523,000,
or 3.7%, increase from noninterest expense of $14.2 million for the first
quarter of 2021. The increase in noninterest expense was driven primarily by the
following:


? Compensation and benefits expense increased $ 1.5 millionor 21.9%, relating

primarily to an increase in salaries and incentive compensation. We hired 17

new team members during the first quarter of 2022 and 24 new team members

    during 2021.


? Occupancy costs increased $ 140,000or 8.6%, driven by increased rent expense

and depreciation on our new office in Charlotte, North Carolina.

? Outside service and data processing costs increased $ 269,000or 23.6%,

primarily due to increased software licensing costs and ATM / debit card related

   expenses.



Partially offsetting the above increases were the following:

? Mortgage production costs decreased by $ 1.2 millionor 42.5%, due primarily

to less mortgage volume in the first quarter of 2022.

? Real estate owned expenses decreased by $ 387,000 due to a large write-down on a

   piece of property during 2021.




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Our efficiency ratio was 56.3% for the first quarter of 2022, compared to 52.1%
for the first quarter of 2021. The efficiency ratio represents the percentage of
one dollar of expense required to be incurred to earn a full dollar of revenue
and is computed by dividing noninterest expense by the sum of net interest
income and noninterest income. The higher ratio during the first quarter of
2022, compared to the first quarter of 2021, relates primarily to the decrease
in mortgage banking income.



We incurred income tax expense of $2.3 million and $2.9 million for the three
months ended March 31, 2022 and 2021, respectively. Our effective tax rate was
22.6% and 22.1% for the three months ended March 31, 2022 and 2021,
respectively.



Balance Sheet Review



Investment Securities



At March 31, 2022, the $111.1 million in our investment securities portfolio
represented approximately 3.6% of our total assets. Our available for sale
investment portfolio included corporate bonds, US treasuries, US government
agency securities, state and political subdivisions, asset-backed securities and
mortgage-backed securities with a fair value of $107.0 million and an amortized
cost of $115.1 million, resulting in an unrealized loss of $8.1 million. At
December 31, 2021, the $124.3 million in our investment securities portfolio
represented approximately 4.2% of our total assets, including investment
securities with a fair value of $120.3 million and an amortized cost of $121.2
million for an unrealized loss of $937,000.



Loans



Since loans typically provide higher interest yields than other types of
interest earning assets, a substantial percentage of our earning assets are
invested in our loan portfolio. Average loans, excluding mortgage loans held for
sale, for the three months ended March 31, 2022 and 2021 were $2.56 billion and
$2.21 billion, respectively. Before the allowance for credit losses, total loans
outstanding at March 31, 2022 and December 31, 2021 were $2.66 billion and
$2.49
billion, respectively.



The principal component of our loan portfolio is loans secured by real estate
mortgages. As of March 31, 2022, our loan portfolio included $2.28 billion, or
85.8%, of real estate loans, compared to $2.13 billion, or 85.5%, at December
31, 2021. Most of our real estate loans are secured by residential or commercial
property. We obtain a security interest in real estate, in addition to any other
available collateral, in order to increase the likelihood of the ultimate
repayment of the loan. Generally, we limit the loan-to-value ratio on loans to
coincide with the appropriate regulatory guidelines. We attempt to maintain a
relatively diversified loan portfolio to help reduce the risk inherent in
concentration in certain types of collateral and business types. Home equity
lines of credit totaled $155.7 million as of March 31, 2022, of which
approximately 53% were in a first lien position, while the remaining balance was
second liens. At December 31, 2021, our home equity lines of credit totaled
$154.8 million, of which approximately 49% were in first lien positions, while
the remaining balance was in second liens. The average home equity loan had a
balance of approximately $80,000 and a loan to value of 61% as of March 31,
2022, compared to an average loan balance of $81,000 and a loan to value of
approximately 62% as of December 31, 2021. Further, 0.7% and 1.0% of our total
home equity lines of credit were over 30 days past due as of March 31, 2022 and
December 31, 2021, respectively.



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Following is a summary of our loan composition at March 31, 2022 and December
31, 2021. During the first three months of 2022, our loan portfolio increased by
$170.8 million, or 6.86%, with a 6.97% increase in commercial loans while
consumer loans increased by 6.68% during the period. The majority of the
increase was in loans secured by real estate. Our consumer real estate portfolio
grew by $51.3 million and includes high quality 1-4 family consumer real estate
loans. Our average consumer real estate loan currently has a principal balance
of $463,000, a term of 22 years, and an average rate of 3.45% as of March 31,
2022, compared to a principal balance of $454,000, a term of 21 years, and an
average rate of 3.47% as of December 31, 2021.




                                                         March 31, 2022                December 31, 2021
(dollars in thousands)                          Amount       % of Total          Amount       % of Total
Commercial
Owner occupied RE                          $   527,776             19.8 %   $   488,965             19.6 %
Non-owner occupied RE                          705,811             26.5 %  
    666,833             26.8 %
Construction                                    75,015              2.8 %        64,425              2.6 %
Business                                       352,932             13.3 %       333,049             13.4 %
Total commercial loans                       1,661,534             62.4 %  
  1,553,272             62.4 %

Consumer
Real estate                                    745,667             28.0 %       694,401             27.9 %
Home equity                                    155,678              5.9 %       154,839              6.2 %
Construction                                    72,627              2.7 %        59,846              2.4 %
Other                                           25,169              1.0 %        27,519              1.1 %
Total consumer loans                           999,141             37.6 %       936,605             37.6 %
Total gross loans, net of deferred fees      2,660,675            100.0 %     2,489,877            100.0 %
Less-allowance for credit losses               (32,944 )                   
    (30,408 )
Total loans, net                           $ 2,627,731                      $ 2,459,469




Nonperforming assets



Nonperforming assets include real estate acquired through foreclosure or deed
taken in lieu of foreclosure and loans on nonaccrual status. Generally, a loan
is placed on nonaccrual status when it becomes 90 days past due as to principal
or interest, or when we believe, after considering economic and business
conditions and collection efforts, that the borrower's financial condition is
such that collection of the contractual principal or interest on the loan is
doubtful. A payment of interest on a loan that is classified as nonaccrual is
recognized as a reduction in principal when received. Our policy with respect to
nonperforming loans requires the borrower to make a minimum of six consecutive
payments in accordance with the loan terms and to show capacity to continue
performing into the future before that loan can be placed back on accrual
status. As of March 31, 2022 and December 31, 2021, we had no loans 90 days
past
due and still accruing.



Following is a summary of our nonperforming assets, including nonaccruing TDRs.




                                             March 31,      December 31,
(dollars in thousands)                            2022              2021
Commercial                                 $       265               270
Consumer                                         1,554             1,642
Nonaccruing troubled debt restructurings         2,713             2,952
Total nonaccrual loans                           4,532             4,864
Other real estate owned                              -                 -
Total nonperforming assets                 $     4,532             4,864




At March 31, 2022, nonperforming assets were $4.5 million, or 0.15% of total
assets and 0.17% of gross loans. Comparatively, nonperforming assets were $4.9
million, or 0.17% of total assets and 0.20% of gross loans at December 31, 2021.
Nonaccrual loans decreased $332,000 during the first three months of 2022 due
primarily to $418,000 of loans paid or charged off, and partially offset by a
$170,000 addition to nonaccrual loans.



The amount of foregone interest income on nonaccrual loans in the first three
months of 2022 and 2021 was not material. At March 31, 2022 and 2021, the
allowance for credit losses represented 726.9% and 557.5% of the total amount of
nonperforming loans, respectively. A significant portion, or approximately 95%,
of nonperforming loans at March 31, 2022, was secured by real estate. We have
evaluated the underlying collateral on these loans and believe that the
collateral on these loans is sufficient to minimize future losses.



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As a general practice, most of our commercial loans and a portion of our
consumer loans are originated with relatively short maturities of less than ten
years. As a result, when a loan reaches its maturity we frequently renew the
loan and thus extend its maturity using similar credit standards as those used
when the loan was first originated. Due to these loan practices, we may, at
times, renew loans which are classified as nonaccrual after evaluating the
loan's collateral value and financial strength of its guarantors. Nonaccrual
loans are renewed at terms generally consistent with the ultimate source of
repayment and rarely at reduced rates. In these cases, we will generally seek
additional credit enhancements, such as additional collateral or additional
guarantees to further protect the loan. When a loan is no longer performing in
accordance with its stated terms, we will typically seek performance under
the
guarantee.



In addition, at March 31, 2022, 85.8% of our loans were collateralized by real
estate and 95% of our impaired loans were secured by real estate. We utilize
third party appraisers to determine the fair value of collateral dependent
loans. Our current loan and appraisal policies require us to obtain updated
appraisals on an annual basis, either through a new external appraisal or an
appraisal evaluation. Impaired loans are individually reviewed on a quarterly
basis to determine the level of impairment. As of March 31, 2022, we did not
have any impaired real estate loans carried at a value in excess of the
appraised value. We typically charge-off a portion or create a specific reserve
for impaired loans when we do not expect repayment to occur as agreed upon under
the original terms of the loan agreement.



At March 31, 2022, impaired loans totaled $7.8 million, for which $2.8 million
of these loans had a reserve of approximately $820,000 allocated in the
allowance. During the first three months of 2022, the average recorded
investment in impaired loans was approximately $7.8 million. Comparatively,
impaired loans totaled $8.2 million at December 31, 2021 for which $2.9 million
of these loans had a reserve of approximately $836,000 allocated in the
allowance. During 2021, the average recorded investment in impaired loans was
approximately $12.5 million.



We consider a loan to be a TDR when the debtor experiences financial
difficulties and we provide concessions such that we will not collect all
principal and interest in accordance with the original terms of the loan
agreement. Concessions can relate to the contractual interest rate, maturity
date, or payment structure of the note. As part of our workout plan for
individual loan relationships, we may restructure loan terms to assist borrowers
facing challenges in the current economic environment. As of March 31, 2022, we
determined that we had loans totaling $6.0 million that we considered TDRs
compared to $6.3 million as of December 31, 2021.



Allowance for Credit Losses



On January 1, 2022, we adopted CECL for estimating credit losses, which resulted
in an increase of $1.5 million in our allowance for credit losses and an
increase of $2.0 million in our reserve for unfunded commitments, which is
recorded within other liabilities. The tax-effected impact of those two items
amounted to $2.8 million and was recorded as an adjustment to our retained
earnings as of January 1, 2022. The allowance for loan loss accounting in effect
at December 31, 2021 and all prior periods was based on our estimate of probable
incurred loan losses as of the reporting date.



The allowance for credit losses was $32.9 million, representing 1.24% of
outstanding loans and providing coverage of 726.88%, of nonperforming loans
compared to $30.4 million, or 1.22% of outstanding loans and 625.22% of
nonperforming loans at December 31, 2021. At March 31, 2021, the allowance for
loan losses was $43.5 million, or 1.99% of outstanding loans and 557.48% of
nonperforming loans. The adoption of CECL on January 1, 2022 increased the
allowance for credit losses by $1.5 million. In addition, we recorded a
provision for credit losses of $1.0 million during the first quarter of 2022
driven by the growth in our loan portfolio.



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Following is a summary of the activity in the allowance for credit losses.




                                                           Three months ended
                                                                    March 31,             Year ended
(dollars in thousands)                                     2022          2021       December 31, 2021
Balance, beginning of period                         $   30,408        44,149                  44,149
Adjustment for adoption of CECL                           1,500             -                       -
Provision for (reversal of) credit losses                 1,025          (300 )               (12,400 )
Loan charge-offs                                           (169 )        (406 )                (2,166 )
Loan recoveries                                             180            57                     825
Net loan (charge-offs) recoveries                            11          (349 )                (1,341 )
Balance, end of period                               $   32,944        43,500                  30,408



Deposits and Other Interest-Bearing Liabilities




Our primary source of funds for loans and investments is our deposits and
advances from the FHLB. In the past, we have chosen to obtain a portion of our
certificates of deposits from areas outside of our market in order to obtain
longer term deposits than are readily available in our local market. Our
internal guidelines regarding the use of brokered CDs limit our brokered CDs to
20% of total deposits. In addition, we do not obtain time deposits of $100,000
or more through the Internet. These guidelines allow us to take advantage of the
attractive terms that wholesale funding can offer while mitigating the related
inherent risk.


Our retail deposits represented $2.62 billion, or 96.9% of total deposits, while
our wholesale deposits represented $85.0 million, or 3.1%, of total deposits at
March 31, 2022. At December 31, 2021, retail deposits represented $2.56 billion,
or 100%, of our total deposits. Our loan-to-deposit ratio was 98% at March 31,
2022 and 97% at December 31, 2021.



The following is a detail of our deposit accounts:




                                                       March 31,       December 31,
(dollars in thousands)                                      2022               2021
Non-interest bearing                                 $   779,262     $      768,650
Interest bearing:
NOW accounts                                             416,322            401,788
Money market accounts                                  1,238,866          1,201,099
Savings                                                   41,630             39,696
Time, less than $250,000                                 150,032             68,179
Time and out-of-market deposits, $250,000 and over        82,062           
 84,414
Total deposits                                       $ 2,708,174     $    2,563,826




During the past 12 months, we continued our focus on increasing core deposits,
which exclude out-of-market deposits and time deposits of $250,000 or more, in
order to provide a relatively stable funding source for our loan portfolio and
other earning assets. Our core deposits were $2.54 billion and $2.48 billion at
March 31, 2022, and December 31, 2021, respectively.



The following table shows the average balance amounts and the average rates paid
on deposits.




                                                                     Three months ended
                                                                              March 31,
                                                        2022                       2021
(dollars in thousands)                     Amount       Rate          Amount       Rate
Noninterest-bearing demand deposits   $   753,546          - %   $   603,292          - %
Interest-bearing demand deposits          406,054       0.03 %       280,737       0.07 %
Money market accounts                   1,201,816       0.05 %     1,055,678       0.22 %
Savings accounts                           40,409       0.01 %        28,789       0.05 %
Time deposits less than $100,000           25,392       0.05 %        34,416       0.80 %
Time deposits greater than $100,000       133,329       0.12 %       178,962       1.03 %
Total deposits                        $ 2,560,546       0.04 %   $ 2,181,874       0.21 %




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During the first three months of 2022, our average transaction account balances
increased by $433.3 million, or 22.0%, from the prior year, while our average
time deposit balances decreased by $55,000, or 25.62%.



All of our time deposits are certificates of deposits. The maturity distribution of our time deposits $ 250,000 or more at March 31, 2022 was as follows:




(dollars in thousands)            March 31, 2022
Three months or less             $        13,510
Over three through six months             20,935
Over six through twelve months            35,520
Over twelve months                        12,097
Total                            $        82,062



Time deposits that meet or exceed the FDIC insurance limit of $ 250,000 at March 31, 2022 and December 31, 2021 were $ 82.1 million and $ 84.4 millionrespectively.

Liquidity and Capital Resources




Liquidity represents the ability of a company to convert assets into cash or
cash equivalents without significant loss, and the ability to raise additional
funds by increasing liabilities. Liquidity management involves monitoring our
sources and uses of funds in order to meet our day-to-day cash flow requirements
while maximizing profits. Liquidity management is made more complicated because
different balance sheet components are subject to varying degrees of management
control. For example, the timing of maturities of our investment portfolio is
fairly predictable and subject to a high degree of control at the time
investment decisions are made. However, net deposit inflows and outflows are far
less predictable and are not subject to the same degree of control.



At March 31, 2022 and December 31, 2021 cash and cash equivalents totaled $149.2
million and $167.2 million, respectively, or 4.9% and 5.7% of total assets,
respectively. Our investment securities at March 31, 2022 and December 31, 2021
amounted to $111.1 million and $124.3 million, respectively, or 3.6% and 4.2% of
total assets, respectively. Investment securities traditionally provide a
secondary source of liquidity since they can be converted into cash in a timely
manner.



Our ability to maintain and expand our deposit base and borrowing capabilities
serves as our primary source of liquidity. We plan to meet our future cash needs
through the liquidation of temporary investments, the generation of deposits,
loan payoffs, and from additional borrowings. In addition, we will receive cash
upon the maturity and sale of loans and the maturity of investment securities.
We maintain five federal funds purchased lines of credit with correspondent
banks totaling $118.5 million for which there were no borrowings against the
lines of credit at March 31, 2022.



We are also a member of the FHLB, from which applications for borrowings can be
made. The FHLB requires that securities, qualifying mortgage loans, and stock of
the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The
unused borrowing capacity currently available from the FHLB at March 31, 2022
was $591.8 million, based primarily on the Bank's qualifying mortgages available
to secure any future borrowings. However, we are able to pledge additional
securities to the FHLB in order to increase our available borrowing capacity. In
addition, at March 31, 2022 and December 31, 2021 we had $286.0 million and
$259.5 million, respectively, of letters of credit outstanding with the FHLB to
secure client deposits.


We also have a line of credit with another financial institution for $15.0
million, which was unused at March 31, 2022. The line of credit was renewed on
December 21, 2021 at an interest rate of One Month CME Term SOFR plus 3.5% and a
maturity date of December 20, 2023.



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We believe that our existing stable base of core deposits, federal funds
purchased lines of credit with correspondent banks, and borrowings from the FHLB
will enable us to successfully meet our long-term liquidity needs. However, as
short-term liquidity needs arise, we have the ability to sell a portion of our
investment securities portfolio to meet those needs.



Total shareholders' equity was $278.5 million at March 31, 2022 and $277.9
million at December 31, 2021. The $623,000 increase from December 31, 2021 is
primarily related to net income of $8.0 million during the first three months of
2022, stock option exercises and equity compensation expenses of $1.1 million,
partially offset by a $5.7 million decrease in other comprehensive loss and the
tax-effected impact of $2.8 million of expense related to the adoption of CECL
recorded as an adjustment to retained earnings.



The following table shows the return on average assets (net income divided by
average total assets), return on average equity (net income divided by average
equity), equity to assets ratio (average equity divided by average assets), and
tangible common equity ratio (total equity less preferred stock divided by total
assets) annualized for the three months ended March 31, 2022 and the year ended
December 31, 2021. Since our inception, we have not paid cash dividends.




                                           March 31, 2022       December 31, 2021
Return on average assets                             1.10 %                  1.75 %
Return on average equity                            11.60 %                 18.64 %
Return on average common equity                     11.60 %                 18.64 %
Average equity to average assets ratio               9.47 %                  9.39 %
Tangible common equity to assets ratio               9.06 %                
 9.50 %




Under the capital adequacy guidelines, regulatory capital is classified into two
tiers. These guidelines require an institution to maintain a certain level of
Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of
common shareholders' equity, excluding the unrealized gain or loss on securities
available for sale, minus certain intangible assets. In determining the amount
of risk-weighted assets, all assets, including certain off-balance sheet assets,
are multiplied by a risk-weight factor of 0% to 100% based on the risks believed
to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital
plus the general reserve for loan losses, subject to certain limitations. We are
also required to maintain capital at a minimum level based on total average
assets, which is known as the Tier 1 leverage ratio.



Regulatory capital rules, which we refer to Basel III, impose minimum capital
requirements for bank holding companies and banks. The Basel III rules apply to
all national and state banks and savings associations regardless of size and
bank holding companies and savings and loan holding companies other than "small
bank holding companies," generally holding companies with consolidated assets of
less than $3 billion (such as the Company). Although we had over $3 billion in
assets at March 31, 2022, under Federal Reserve guidance, the Company still
maintains its status as a "small bank holding company." If our consolidated
total assets exceed $3 billion at June 30, 2022, we will lose our status as a
"small bank holding company" in March 2023. In order to avoid restrictions on
capital distributions or discretionary bonus payments to executives, a covered
banking organization must maintain a "capital conservation buffer" on top of our
minimum risk-based capital requirements. This buffer must consist solely of
common equity Tier 1, but the buffer applies to all three measurements (common
equity Tier 1, Tier 1 capital and total capital). The capital conservation
buffer consists of an additional amount of CET1 equal to 2.5% of risk-weighted
assets.



To be considered "well-capitalized" for purposes of certain rules and prompt
corrective action requirements, the Bank must maintain a minimum total
risked-based capital ratio of at least 10%, a total Tier 1 capital ratio of at
least 8%, a common equity Tier 1 capital ratio of at least 6.5%, and a leverage
ratio of at least 5%. As of March 31, 2022, our capital ratios exceed these
ratios and we remain "well capitalized."



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The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements.




                                                                                                   March 31, 2022
                                                                    For capital            To be well capitalized
                                                              adequacy purposes                      under prompt
                                                               minimum plus the                        corrective
                                                           capital conservation                 action provisions
                                         Actual                          buffer                           minimum
(dollars in
thousands)                 Amount         Ratio           Amount          Ratio            Amount           Ratio

Total Capital (to risk weighted assets) $ 338,371 13.83% $ 256,832 10.50% $ 244,602

           10.00 %

Tier 1 Capital (to risk weighted assets) 307,767 12.58% 207,912 8.50% 195,681

            8.00 %
Common Equity Tier 1
Capital (to risk
weighted assets)          307,767         12.58 %        171,221           7.00 %         158,992            6.50 %
Tier 1 Capital (to
average assets)           307,767         10.46 %        117,718           4.00 %         147,147            5.00 %




                                                                                                December 31, 2021
                                                                    For capital            To be well capitalized
                                                              adequacy purposes                      under prompt
                                                               minimum plus the                        corrective
                                                           capital conservation                 action provisions
                                         Actual                          buffer                           minimum
(dollars in
thousands)                 Amount         Ratio           Amount          Ratio            Amount           Ratio

Total Capital (to risk weighted assets) $ 331,052 14.36% $ 242,048 10.50% $ 230,522

           10.00 %

Tier 1 Capital (to risk weighted assets) 302,217 13.11% 195,944 8.50% 184,418

            8.00 %
Common Equity Tier 1
Capital (to risk
weighted assets)          302,217         13.11 %        161,365           7.00 %         149,839            6.50 %
Tier 1 Capital (to
average assets)           302,217         10.55 %        114,537          
4.00 %         143,172            5.00 %



The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements.



                                                                                                     March 31, 2022
                                                                    For capital              To be well capitalized
                                                              adequacy purposes                        under prompt
                                                               minimum plus the                          corrective
                                                           capital conservation                   action provisions
                                         Actual                      buffer (1)                             minimum
(dollars in
thousands)                 Amount         Ratio           Amount          Ratio          Amount               Ratio

Total Capital (to risk weighted assets) $ 351,522 14.37% $ 256,832 10.50%

           N/A                 N/A

Tier 1 Capital (to risk weighted assets) 297,918 12.18% 207,911 8.50%

           N/A                 N/A
Common Equity Tier 1
Capital (to risk
weighted assets)          284,918         11.65 %        171,221           7.00 %           N/A                 N/A
Tier 1 Capital (to
average assets)           297,918         10.12 %        117,736           4.00 %           N/A                 N/A




                                                                                                  December 31, 2021
                                                                    For capital              To be well capitalized
                                                              adequacy purposes                        under prompt
                                                               minimum plus the                          corrective
                                                           capital conservation                   action provisions
                                         Actual                      buffer (1)                             minimum
(dollars in
thousands)                 Amount         Ratio           Amount          Ratio          Amount               Ratio
Total Capital (to
risk weighted assets)   $ 343,476         14.90 %   $    242,048          10.50 %           N/A                 N/A
Tier 1 Capital (to
risk weighted assets)     291,641         12.65 %        195,944           8.50 %           N/A                 N/A
Common Equity Tier 1
Capital (to risk
weighted assets)          278,641         12.09 %        161,365           7.00 %           N/A                 N/A
Tier 1 Capital (to
average assets)           291,641         10.18 %        114,555           4.00 %           N/A                 N/A



(1) Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the

Company is not subject to the minimum capital adequacy and capital

conservation buffer capital requirements at the holding company level,

unless otherwise advised by the Federal Reserve (such capital requirements

are applicable only at the Bank level). Although the minimum regulatory

capital requirements are not applicable to the Company, we calculate these

      ratios for our own planning and monitoring purposes.




The ability of the Company to pay cash dividends is dependent upon receiving
cash in the form of dividends from the Bank. The dividends that may be paid by
the Bank to the Company are subject to legal limitations and regulatory capital
requirements. Since our inception, we have not paid cash dividends.



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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 a historical cost basis in accordance with generally accepted accounting principles.

Unlike most industrial companies, our assets and liabilities are primarily
monetary in nature. Therefore, the effect of changes in interest rates will have
a more significant impact on our performance than will the effect of changing
prices and inflation in general. In addition, interest rates may generally
increase as the rate of inflation increases, although not necessarily in the
same magnitude. As discussed previously, we seek to manage the relationships
between interest sensitive assets and liabilities in order to protect against
wide rate fluctuations, including those resulting from inflation.



Off-Balance Sheet Risk



Commitments to extend credit are agreements to lend money to a client as long as
the client has not violated any material condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require the payment of a fee. At March 31, 2022, unfunded commitments to
extend credit were $686.5 million, of which $234.7 million were at fixed rates
and $451.8 million were at variable rates. At December 31, 2021, unfunded
commitments to extend credit were $618.7 million, of which approximately $205.4
million were at fixed rates and $413.3 million were at variable rates. A
significant portion of the unfunded commitments related to commercial business
loans and consumer home equity lines of credit. We evaluate each client's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by us upon extension of credit, is based on our credit evaluation of
the borrower. The type of collateral varies but may include accounts receivable,
inventory, property, plant and equipment, and commercial and residential real
estate. Following the adoption of CECL on January 1, 2022, we recorded a reserve
for unfunded commitments of $2.0 million, or 0.31% of total unfunded
commitments. As of March 31, 2022, the reserve for unfunded commitments was $2.1
million or 0.30% of total unfunded commitments.



At March 31, 2022 and December 31, 2021, there were commitments under letters of
credit for $10.5 million and $10.2 million, respectively. The credit risk and
collateral involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. Since most of the letters of
credit are expected to expire without being drawn upon, they do not necessarily
represent future cash requirements.



Except as disclosed in this report, we are not involved in off-balance sheet
contractual relationships, unconsolidated related entities that have off-balance
sheet arrangements or transactions that could result in liquidity needs or other
commitments that significantly impact earnings.



Critical Accounting Estimates

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements.




Certain accounting policies inherently involve a greater reliance on the use of
estimates, assumptions and judgments and, as such, have a greater possibility of
producing results that could be materially different than originally reported,
which could have a material impact on the carrying values of our assets and
liabilities and our results of operations. Of the significant accounting
policies used in the preparation of our consolidated financial statements, we
have identified certain items as critical accounting policies based on the
associated estimates, assumptions, judgments and complexity. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Critical Accounting Estimates" in our Annual Report on Form 10-K for
the year ended December 31, 2021, for a description our significant accounting
policies that use critical accounting estimates.



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We have historically identified the determination of the allowance for loan
losses as a significant accounting policy that uses critical accounting
estimates. On January 1, 2022, we adopted the new CECL accounting methodology
that requires entities to estimate and recognize an allowance for lifetime
expected credit losses for loans and other financial assets measured at
amortized cost. In prior periods, our allowance was based on the incurred loss
methodology where we recognized an allowance for loan losses based on probable
incurred losses. We believe that the accounting estimates relating to the
allowance for credit losses is also a "critical accounting policy" as:



? changes in the provision for credit losses can materially affect our financial

   results;



? estimates relating to the allowance for credit losses require us to project

future borrower performance, including cash flows, delinquencies and

charge-offs, along with, when applicable, collateral values, based on a

reasonable and supportable forecast period utilizing forward-looking economic

scenarios in order to estimate lifetime probability of default and loss given

   default;



? the allowance for credit losses is influenced by factors outside of our control

such as changes in projected economic conditions, real estate markets or

particular industry conditions which may materially impact asset quality and

the adequacy of the allowance for credit losses; and

? considerable judgment is required to determine whether the models used to

generate the allowance for credit losses produce an estimate that is sufficient

   to encompass the current view of lifetime expected credit losses.




Because our estimates of the allowance for credit losses involve judgment and
are influenced by factors outside our control, there is uncertainty inherent in
these estimates. Our estimate of lifetime expected credit losses is inherently
uncertain because it is highly sensitive to changes in economic conditions and
other factors outside of our control. Changes in such estimates could
significantly impact our allowance and provision for credit losses. See Note 1 -
Summary of Significant Accounting Policies in the accompanying notes to the
consolidated financial statements included elsewhere in this report for a
discussion of our Allowance for Credit Losses.



Accounting, Reporting, and Regulatory Matters

See Note 1 - Summary of Significant Accounting Policies in the accompanying
notes to consolidated financial statements included elsewhere in this report for
details of recently issued accounting pronouncements and their expected impact
on our consolidated financial statements.



Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

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