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CoverageForm 410-K10-Q8-K13D13G13F

Grandsouth Bancorporation

GRRBCIK 0001126961 · Every Form 4 filed by insiders at this issuer. See financials →

Annual report (10-K)

Latest 10-K filed Mar 31, 2022. Sentiment + YoY language diff vs prior year. Read sections →

Signal:No prior 10-K

Risk Factors:tone -0.0343

MD&A:tone -0.0159

Sentiment via Loughran-McDonald lexicon · YoY diff via Jaccard similarity + paragraph set difference.

Top insiders

Most active reporters at Grandsouth Bancorporation

Name	Roles	Filings
Schwiers James B	OfficerDirector	2
Garrett John	OfficerDirector	1
Garrett Mason Y	OfficerDirector	1
Gault Michael L	Director	1
Garrett Harold E	Director	1

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14 Form 4 / 4-A filings, newest first

Filed	Insider	Top transaction	Shares	Price	Value
Jan 4, 2023	Schwiers James B President & COO · Director	DDisposition	90,340	-	-
Jan 4, 2023	Shealy John W Jr Director	DDisposition	3,500	-	-
Jan 4, 2023	Weber Leeann Director	DDisposition	22,768	-	-
Jan 4, 2023	Garrett Harold E Director	DDisposition	157,572	-	-
Jan 4, 2023	Garrett John CFO · Director	DDisposition	145,112	-	-

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YoY shift: Unscored

Year-over-year tone shift - average net-tone change across Risk Factors and MD&A vs the prior 10-K.

Why YoY instead of absolute: the LM lexicon has ~6.6× more negative words than positive (legal/risk-disclosure language is heavy on hedging), so every 10-K reads bearish on raw tone. Year-over-year change strips that bias and surfaces the actual shift in management's framing.

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Sentence-level sentiment highlighting with category and subcategory filters is coming once the snippet-scoring pipeline lands. For now, dig into the actual section text on the Sections tab.

Risk Factors (Item 1A)

15,336 words

Item 1A. Risk Factors

There are risks, many beyond our control, which could cause our results to differ significantly from management’s expectations. Some of these risk factors are described below. Any factor described in Annual Report on Form 10-K could, by itself or together with one or more other factors, adversely affect our business, results of operations and/or financial condition. Additional risks and uncertainties not currently known to us or that we currently consider to not be material also may materially and adversely affect us. In assessing these risks, you should also refer to other information disclosed in our SEC filings, including the financial statements and notes thereto. The risks discussed below also include forward-looking statements, and actual results may differ substantially from those discussed or implied in these forward-looking statements.

Risks Related to Economic Conditions, Including as a Result of the COVID-19 Pandemic

The ongoing COVID-19 pandemic could have an adverse impact on our financial performance and results of operations.

As the COVID-19 pandemic has evolved from its emergence in early 2020, so has its impact. Many states have re-instituted, or strongly encouraged, varying levels of quarantines and restrictions on travel and in some cases have at times limited operations of certain businesses and taken other restrictive measures designed to help slow the spread of COVID-19 and its variants. Governments and businesses have also instituted vaccine mandates and testing requirements for employees. While vaccine availability and uptake has increased, the longer-term macro-economic effects on global supply chains, inflation, labor shortages and wage increases continue to impact many industries, including the collateral underlying certain of our loans. Moreover, with the potential for new strains of COVID-19 to emerge, governments and businesses may re-impose aggressive measures to help slow its spread in the future. For this reason, among others, as the COVID-19 pandemic continues, the potential impacts are uncertain and difficult to assess.

Although financial markets have largely rebounded from the significant declines that occurred earlier in the pandemic and global economic conditions showed signs of improvement during the second half of 2020 and throughout 2021, many of the circumstances that arose or became more pronounced after the onset of the COVID-19 pandemic persist, which may subject us to a number of risks, including, without limitation, the following:

lower loan demand or an increased risk of loan delinquencies, defaults, and foreclosures due to a number of factors, including continuing supply chain issues, decreased consumer and business confidence and economic activity;

collateral for loans, especially real estate, may decline in value, which may reduce our ability to liquidate such collateral and could cause loan losses to increase and impair our ability over the long run to maintain our loan origination volume;

our allowance loan losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;

volatility in financial and capital markets, interest rates, and exchange rates;

increased demands on capital and liquidity;

heightened cybersecurity, information security, and operational risks as cybercriminals attempt to profit from the disruption resulting from the pandemic given increased online and remote activity, including as a result of work-from-home arrangements;

disruptions to business operations experienced by counterparties and service providers;

increased risk of business disruption from the loss of employees due to their inability to work effectively because of illness, quarantines, government actions, failures in systems or technology that disrupt work-from-home arrangements, or other effects of the COVID-19 pandemic, including the increase in employee resignations currently taking place throughout the United States in connection with the COVID-19 pandemic, which is commonly referred to as the “great resignation”; and

decreased demands for our products and services.

We have also experienced and may experience other negative impacts to our business as a result of the pandemic that could exacerbate other risks discussed in this “Risk Factors” section. The ongoing fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions, and, as a result, presents material uncertainty and risk with respect to us.

Our business may be adversely affected by conditions in the financial markets and economic conditions generally.

Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer and whose success we rely on to drive our growth, is highly dependent upon the business environment in the primary markets where we operate and in the U.S. as a whole. Unlike larger banks that are more geographically diversified, we are a regional bank that provides banking and financial services to customers primarily in South Carolina. The economic conditions in these local markets may be different from, and in some instances worse than, the economic conditions in the U.S. as a whole. Some elements of the business environment that affect our financial performance include short-term and long-term interest rates, the prevailing yield curve, inflation and price levels, monetary and trade policy, unemployment and the strength of the domestic economy and the local economy in the markets in which we operate. Unfavorable market conditions can result in a deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions for loan losses, adverse asset values of the collateral securing our loans and an overall material adverse effect on the quality of our loan portfolio. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; epidemics and pandemics (such as COVID-19); or a combination of these or other factors.

The impact of the COVID-19 pandemic is fluid and continues to evolve and there is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the onset of the pandemic. Moreover, as economic conditions relating to the pandemic have improved over time, the Federal Reserve has shifted its focus to limiting inflationary and other potentially adverse effects of the extensive pandemic-related government stimulus, which signals the potential for a continued period of economic uncertainty even if the pandemic subsides. In addition, there are continuing concerns related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to address that debt, a potential resurgence of economic and political tensions with China or futher impacts of the conflict between Russia and Ukraine, all of which may have a destabilizing effect on financial markets and economic activity. Economic pressure on consumers and overall economic uncertainty may result in changes in consumer and business spending, borrowing and saving habits. These economic conditions and/or other negative developments in the domestic or international credit markets or economies may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes and high unemployment or underemployment may also result in higher than expected loan delinquencies, increases in our levels of nonperforming and classified assets and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.

Changes in U.S. trade policies and other factors beyond our control, including the imposition of tariffs and retaliatory tariffs and the impacts of epidemics or pandemics (particularly COVID-19), may adversely impact our business, financial condition and results of operations.

There has been and continues to be substantial debate and controversy concerning changes to U.S. trade policies, legislation, treaties and tariffs, including trade policies and tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by such countries. Such tariffs, retaliatory tariffs or other trade restrictions on products and materials that our customers import or export could cause the prices of our customers’ products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues, financial results and ability to service debt; which, in turn, could adversely affect our financial condition and results of operations. In addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate our business, results of operations and financial condition could be materially and adversely impacted in the future. It remains unclear what the U.S. Administration or foreign governments will or will not do with respect to tariffs already imposed, additional tariffs that may be imposed, or international trade agreements and policies. A trade war or other governmental action related to tariffs or international trade agreements or policies as well as the COVID-19 pandemic or other potential epidemics or pandemics, have the potential to negatively impact ours and/or our customers’ costs, demand for our customers’ products, and/or the U.S. economy or certain sectors thereof and, thus, adversely affect our business, financial condition, and results of operations.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.

A significant portion of our loan portfolio is secured by real estate. As of December 31, 2021, approximately 74.1% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. Deterioration in the real estate market could cause us to adjust our opinion of the level of credit quality in our loan portfolio. Such a determination may lead to an additional increase in our provisions for loan losses, which could also adversely affect our business, financial condition, and results of operations. Natural disasters, including hurricanes, tornados, earthquakes, fires and floods, which could be exacerbated by potential climate change, may cause uninsured damage and other loss of value to real estate that secures these loans and may also negatively impact our financial condition.

We have a concentration of credit exposure in floor plan inventory financing to small automobile dealers which could be more significantly impacted by an economic downturn.

As of December 31, 2021, we had approximately $98.3 million in floor plan inventory loans outstanding to independent automobile dealers located across more than 20 states through our CarBucks division. These borrowers are typically smaller businesses with less-credit worthy borrowers themselves, each of which have historically been more negatively impacted by an economic downturn than other segments of borrowers. In addition, these loans are often secured by used motor vehicles and are subject to adverse conditions in the automobile market including risks associated with declining values. While we currently limit total exposure to this type of lending to 175% of subsidiary bank Tier 1 capital, a prolonged economic downturn could result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

Changes in the financial markets could impair the value of our available-for-sale investment portfolio.

Our available-for-sale (“AFS”) investment securities portfolio is a significant component of our total interest-earning assets. Total AFS investment securities averaged $127.0 million in the year ended December 31, 2021, as compared to $88.3 million for 2020. This represents 11.3% and 9.3% of the average interest-earning assets for the years ended December 31, 2021 and 2020, respectively. At December 31, 2021, the AFS investment portfolio was 9.6% of total interest-earning assets. Turmoil in the financial markets could impair the market value of our investment portfolio, which could adversely affect our net income and possibly our capital.

As of December 31, 2021, securities which have unrealized losses were not considered to be “other than temporarily impaired,” and we believe it is more likely than not we will be able to hold these until they mature or recover our current book value. We currently maintain substantial liquidity which supports our ability to hold these investments until they mature, or until there is a market price recovery. However, if we were to cease to have the ability and intent to hold these investments until maturity or the market prices do not recover, and we were to sell these securities at a loss, it could adversely affect our net income and possibly our capital.

We are subject to interest rate risk, which could adversely affect our financial condition and profitability.

A significant portion of our banking assets are subject to changes in interest rates. For example, as of December 31, 2021, 28.7% of our loan portfolio consisted of floating or adjustable interest rate loans. Like most financial institutions, our earnings significantly depend on our net interest income, the principal component of our earnings, which is the difference between interest earned by us from our interest-earning assets, such as loans and investment securities, and interest paid by us on our interest-bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will negatively impact our earnings. Many factors beyond our control impact interest rates, including economic conditions, governmental monetary policies, inflation, recession, changes in unemployment, the money supply, and disorder and instability in domestic and foreign financial markets. Changes in monetary policies of the various government agencies could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could also affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets and liabilities.

In a declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates. Interest rate increases often result in larger payment requirements for our floating interest rate borrowers, which increases the potential for default. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. An increase (or decrease) in interest rates may also require us to increase (or decrease) the interest rates that we pay on our deposits.

Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to increases in nonperforming assets, charge-offs and delinquencies, further increases to the allowance for loan losses, and a reduction of income recognized, among others, which could have a material adverse effect on our results of operations and cash flows. Further, when we place a loan on non-accrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets could have a material adverse impact on our net interest income.

Additionally, an increase in interest rates may not increase our net interest income to the same extent we currently anticipate based on our modeling estimates and the assumptions underlying such modeling. Our failure to benefit from an increased interest rate environment to the extent we currently estimate, to the same extent as our competitors or at all could have a material adverse effect on our business, financial condition and results of operations.

In response to the COVID-19 pandemic, the FOMC cut short-term interest rates to a record low range of 0% to 0.25% in 2020, although, in mid-December 2021, the Federal Reserve indicated that three 25 basis point rate hikes were expected in 2022. If short-term interest rates were to continue at their historically low levels for a prolonged period and assuming longer-term interest rates fall further, we could experience net interest margin compression as our interest-earning assets would continue to reprice downward while our interest-bearing liability rates could fail to decline in tandem, which would have an adverse effect on our net interest income. Similarly, if short-term interest rates increase and long-term interest rates do not increase, or increase but at a slower rate, we could experience net interest margin compression as our rates on interest earning assets decline measured relative to rates on our interest-bearing liabilities. Any such occurrence could have a material adverse effect on our net interest income and on our business, financial condition and results of operations.

Continued uncertainty regarding, and potential deterioration in, the fiscal position of the U.S. federal government and possible downgrades in U.S. Treasury and federal agency securities could adversely affect us and our banking operations.

The long-term outlook for the fiscal position of the U.S. federal government is uncertain, as illustrated by the 2011 downgrade by certain rating agencies of the credit rating of the U.S. government and federal agencies. In addition to causing economic and financial market disruptions, uncertainty regarding the fiscal position of the U.S. federal government (which could lead to, among other things, a future credit ratings downgrade of the U.S. government and federal agencies, failure to raise the U.S. statutory debt limit, or deterioration in the fiscal outlook of the U.S. federal government), could adversely affect the market value of the U.S. and other government and governmental agency securities that we hold, the availability of those securities as collateral for borrowing and our ability to access capital markets on favorable terms. In particular, it could increase interest rates and disrupt payment systems, money markets, and long-term or short-term fixed income markets, adversely affecting the cost and availability of funding, which could negatively affect our profitability. Also, the adverse consequences of this uncertainty could extend to those to whom we extend credit and could adversely affect their ability to repay their loans. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Lending Activities

Our decisions regarding credit risk and reserves for loan losses may materially and adversely affect our business.

Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:

the duration of the credit;

credit risks of a particular customer;

changes in economic and industry conditions; and

in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We evaluate the collectability of our loan portfolio and we maintain an allowance for loan losses that represents management’s judgment of probable losses and risks inherent in our loan portfolio that we believe to be adequate based on a variety of factors including but not limited to:

an ongoing review of the quality, mix, and size of our overall loan portfolio;

the risk characteristics of various classifications of loans;

our historical loan loss experience;

evaluation of economic conditions;

regular reviews of loan delinquencies and loan portfolio quality;

the views of our regulators;

geographic and industry loan concentrations; and

the amount and quality of collateral, including guarantees, securing the loans.

There is no precise method of predicting credit losses; therefore, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would result in a decrease of our net income, and possibly our capital. We decreased our provision for loan losses by $1.8 million in 2021 compared to $3.1 million in 2020, mainly due to a decrease in net charge offs and and adjustments to qualitative factors.

In addition, our regulators, as an integral part of their periodic examination, review our methodology for calculating, and the adequacy of, our allowance and provision for loan losses. Although we believe that the methodology used by us to determine the amount of both the allowance for loan losses and provision is effective, the regulators or our auditor may conclude that changes are necessary based on information available to them at the time of their review, which could impact our overall credit portfolio. Such changes could result in, among other things, modifications to our methodology for determining our allowance or provision for loan losses or models, reclassification or downgrades of our loans, increases in our allowance for loan losses or other credit costs, imposition of new or more stringent concentration limits, restrictions in our lending activities and/or recognition of further losses. Further, if actual charge-offs in future periods exceed the amounts allocated to the allowance for loan losses, we may need additional provisions for loan losses to restore the adequacy of our allowance for loan losses.

We may have higher loan losses than we have allowed for in our allowance for loan losses.

Our actual loan losses could exceed our allowance for loan losses. As of December 31, 2021, approximately 12.3% of our loan portfolio is composed of construction and land loans, 45.4% of commercial real estate loans and 25.1% of commercial loans. Repayment of such loans is generally considered more subject to market risk than residential mortgage loans. Industry experience shows that a portion of loans will become delinquent and a portion of loans will require partial or entire charge-off. Regardless of the underwriting criteria utilized, losses may be experienced as a result of various factors beyond our control, including among other things, changes in market conditions affecting the value of loan collateral and problems affecting the credit of our borrowers.

While the COVID-19 fiscal stimulus and relief programs appear to have delayed any materially adverse financial impact to the Bank, once these stimulus programs have been fully exhausted, we believe our credit metrics could worsen and loan losses could ultimately materialize. Any potential loan losses will be contingent upon a number of factors beyond our control, such as a slower return to pre-pandemic routines, which will be influenced by a number of factors including increases in new COVID-19 cases, hospitalizations and deaths leading to additional government imposed restrictions; refusals to receive the vaccines along with concerns related to new strains of the virus; supply chain issues remaining unresolved longer than anticipated; unemployment increases while consumer confidence and spending falls; and rising geopolitical tensions.

We are exposed to higher credit risk related to our commercial real estate, commercial, financial and agriculture, and real estate construction and land development lending.

Commercial real estate, real estate construction and land development, and commercial lending usually involves higher credit risks than that of single-family residential lending. At December 31, 2021, the following loan types accounted for the stated percentages of our total loan portfolio: commercial real estate (owner and non-owner occupied)—45.4%, real estate construction and land development—12.3%, and commercial, financial and agriculture—25.1%.

Commercial real estate loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends in some cases on successful development of their properties, as well as the factors affecting residential real estate borrowers. These loans may involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner.

Commercial, financial and agricultural loans are typically based on the borrowers’ ability to repay the loans from the cash flow of their businesses, which may be unpredictable, and the collateral securing these loans may fluctuate in value. Our commercial loans are typically made to small- to medium-sized businesses, which often have shorter operating histories and less sophisticated record keeping systems than larger entities. As a result, these smaller entities may be less able to withstand adverse competitive, economic and financial conditions than larger borrowers. Although such loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible, and inventories may be obsolete or of limited use. In addition, business assets may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral value provided by the borrower and liquidity of the guarantor. Further, the performance of agricultural loans is highly dependent on favorable weather, reasonable costs for seed and fertilizer, and the ability to successfully market the product at a profitable margin. The demand for these products is also dependent on macroeconomic conditions that are beyond the control of the borrower.

Risk of loss on construction and land development loans depends largely upon whether our initial estimate of the property’s value at completion of construction exceeds the cost of the property construction (including interest) and the availability of permanent take-out financing. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our customers.

Commercial real estate, commercial, financial and agriculture, and real estate construction and land development loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review, and monitoring cannot eliminate all of the risks related to these loans.

If we fail to effectively manage credit risk, our business and financial condition will suffer.

We must effectively manage credit risk. There are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting and guidelines, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers and risks resulting from uncertainties as to the future value of collateral. There is no assurance that our credit risk monitoring and loan approval procedures are or will be adequate or will reduce the inherent risks associated with lending.

Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval, review and administrative practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of our loan portfolio. Many of our loans are made to small and medium-sized businesses that are less able to withstand competitive, economic and financial pressures than larger borrowers. Consequently, we may have significant exposure if any of these borrowers becomes unable to pay their loan obligations as a result of economic or market conditions, or personal circumstances. In addition, we are a middle-market lender, as such, the relative size of individual credits in our commercial portfolio increases the potential impact from singular credit events. A failure to effectively measure and limit the credit risk associated with our loan portfolio may result in loan defaults, foreclosures and additional charge-offs, and may necessitate that we significantly increase our allowance for loan losses, each of which could adversely affect our net income. As a result, our inability to successfully manage credit risk could have a material adverse effect on our business, financial condition and results of operations.

Our underwriting decisions may materially and adversely affect our business.

While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. As of December 31, 2021, approximately $33.0 million of our loans, or 24.3% of the Bank’s regulatory capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines, of which only nine loans totaling approximately $4.3 million had loan-to-value ratios of 100% or more. In addition, supervisory limits on commercial loan-to-value exceptions are set at 30% of the Bank’s capital. At December 31, 2021, $24.9 million of our commercial loans, or 18.3% of the Bank’s regulatory capital, exceeded the supervisory loan-to-value ratio. The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

Risks Related to Laws and Regulations

The phase-out of LIBOR could negatively impact our net interest income and require significant operational work.

The United Kingdom’s Financial Conduct Authority (“FCA”) regulates the London Interbank Offered Rate (“LIBOR”), the reference rate previously used for many of our transactions, including our lending and borrowing and our purchase and sale of securities, as well as the derivatives that we use to manage risk related to such transactions. The FCA announced in July 2017 that the sustainability of LIBOR could not be guaranteed. Accordingly, although the FCA confirmed the extension of overnight and 1-, 3-, 6-, and 12-month LIBOR through June 30, 2023 in order to accord financial institutions greater time with which to manage the transition from LIBOR, the FCA is no longer persuading, or compelling, banks to submit to LIBOR. The federal banking agencies previously determined that banks must cease entering into any new contract that use LIBOR as a reference rate by no later than December 31, 2021.

The discontinuation of LIBOR, changes in LIBOR, or changes in market perceptions of the acceptability of LIBOR as a benchmark could result in changes to our risk exposures (for example, if the anticipated discontinuation of LIBOR adversely affects the availability or cost of floating-rate funding and, therefore, our exposure to fluctuations in interest rates) or otherwise result in losses on a product or having to pay more or receive less on securities that we own or have issued. In addition, such uncertainty could result in pricing volatility and increased capital requirements, loss of market share in certain products, adverse tax or accounting impacts, and compliance, legal and operational costs and risks associated with client disclosures, discretionary actions taken or negotiation of fallback provisions, systems disruption, business continuity, and model disruption. We have exposure to LIBOR-based products, including loans, securities, subordinated debt, and we have transitioned away from the use of LIBOR to alternative rates for all new contracts as of December 31, 2021. We continue to prepare for the transition of our existing LIBOR exposures prior to the final LIBOR cessation date of June 30, 2023. During the first quarter of 2021, we began the process of indexing renewals to alternative indexes, including SOFR and the Wall Street Journal Prime Rate. We continue to monitor market developments and regulatory updates, including recent announcements from the ICE Benchmark Administrator, as well as collaborate with regulators and industry groups on the transition of existing exposures. In addition, the implementation of LIBOR reform proposals may result in increased compliance costs and operational costs, including costs related to continued participation in LIBOR and the transition to a replacement reference rate or rates. We cannot reasonably estimate the expected cost.

Imposition of limits by the bank regulators on commercial and multi-family real estate lending activities could curtail our growth and adversely affect our earnings.

In 2006, the FDIC, the Federal Reserve and the OCC issued joint guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” (the “CRE Guidance”). Although the CRE Guidance did not establish specific lending limits, it provides that a bank’s commercial real estate lending exposure could receive increased supervisory scrutiny where (i) total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans, represent 300% or more of an institution’s total risk-based capital, and the outstanding balance of the commercial real estate loan portfolio has increased by 50% or more during the preceding 36 months, or (ii) construction and land development loans exceed 100% of the Bank’s total risk-based capital. Our total non-owner-occupied commercial real estate loans represented 155.3% of the Bank’s total risk-based capital at December 31, 2021, and our construction and land development loans represented 55.4% of the Bank’s total risk-based capital at December 31, 2021.

In December 2015, the regulatory agencies released a new statement on prudent risk management for commercial real estate lending (the “2015 Statement”). In the 2015 Statement, the regulatory agencies, among other things, indicated their intent to continue “to pay special attention” to commercial real estate lending activities and concentrations going forward. If the FDIC, our primary federal regulator, were to impose restrictions on the amount of commercial real estate loans we can hold in our portfolio, for reasons noted above or otherwise, our earnings would be adversely affected.

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

Our deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, we are required to pay quarterly deposit insurance premium assessments to the FDIC. Although we cannot predict what the insurance assessment rates will be in the future, either deterioration in our risk-based capital ratios or adjustments to the base assessment rates could have a material adverse impact on our business, financial condition, results of operations, and cash flows.

Our use of third-party vendors and our other ongoing third-party business relationships are subject to increasing regulatory requirements and attention.

We regularly use third party vendors as part of our business. We also have substantial ongoing business relationships with other third parties. These types of third-party relationships are subject to increasingly demanding regulatory requirements and attention by our federal bank regulators. Recent regulation requires us to enhance our due diligence, ongoing monitoring and control over our third-party vendors and other ongoing third-party business relationships. We expect that our regulators will hold us responsible for deficiencies in our oversight and control of our third-party relationships and in the performance of the parties with which we have these relationships. As a result, if our regulators conclude that we have not exercised adequate oversight and control over our third party vendors or other ongoing third party business relationships or that such third parties have not performed appropriately, we could be subject to enforcement actions, including civil money penalties or other administrative or judicial penalties or fines as well as requirements for customer remediation, any of which could have a material adverse effect our business, financial condition or results of operations.

We are subject to extensive regulation that could restrict our activities, have an adverse impact on our operations, and impose financial requirements or limitations on the conduct of our business.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. As a bank holding company, the Company is subject to Federal Reserve regulation. In addition, the Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC, the regulating authority that insures customer deposits. Also, as a member of the FHLB, our Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Regulation by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of our shareholders. Our Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against us under these laws could have a material adverse effect on our results of operations.

Further, changes in laws, regulations and regulatory practices affecting the financial services industry could subject us to increased capital, liquidity and risk management requirements, create additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

We face risks related to the adoption of future legislation and potential changes in federal regulatory agency leadership, policies, and priorities.

With a new Congress taking office in 2021, Democrats retained control of the U.S. House of Representatives, and gained control of the U.S. Senate, albeit with a majority found only in the tie-breaking vote of Vice President Harris. However slim the majorities, though, the net result was a unified Democratic control of the White House and both chambers of Congress, and consequently Democrats are able to set the agenda both legislatively, in the Administration, and in the regulatory agencies that have rulemaking and supervisory authority over the financial services industry generally and the Company and the Bank specifically. Congressional committees with jurisdiction over the banking sector have pursued oversight and legislative initiatives in a variety of areas, including addressing climate-related risks, promoting diversity and equality within the banking industry and addressing other Environmental, Social, and Governance matters, improving competition in the banking sector and enhancing oversight of bank mergers and acquisitions, establishing a regulatory framework for digital assets and markets, and oversight of the COVID-19 pandemic response and economic recovery. The prospects for the enactment of major banking reform legislation are unclear at this time.

Moreover, the turnover of the presidential administration resulted in certain changes in the leadership and senior staffs of the federal banking agencies, the CFPB, CFTC, SEC, and the Treasury Department, with certain significant leadership positions yet to be filled, including the Comptroller of the Currency, the Chair of the FDIC and three vacancies among the Governors of the Federal Reserve Board, including the Vice Chair for Supervision. These changes have impacted the rulemaking, supervision, examination and enforcement priorities and policies of the agencies and likely will continue to do so over the next several years. The potential impact of any changes in agency personnel, policies and priorities on the financial services sector, including the Company and the Bank, cannot be predicted at this time. Regulations and laws may be modified at any time, and new legislation may be enacted that will affect us. Any future changes in federal and state laws and regulations, as well as the interpretation and implementation of such laws and regulations, could affect us in substantial and unpredictable ways, including those listed above or other ways that could have a material adverse effect on our business, financial condition or results of operations.

We are subject to strict capital requirements, which could be amended to be more stringent, in the future.

We are subject to regulatory requirements specifying minimum amounts and types of capital that we must maintain and an additional capital conservation buffer. From time to time, the regulators change these regulatory capital adequacy guidelines. If we fail to meet these capital guidelines and other regulatory requirements, we or our subsidiaries may be restricted in the types of activities we may conduct and we may be prohibited from taking certain capital actions, such as paying dividends, repurchasing or redeeming capital securities, and paying certain bonuses.

In particular, the capital requirements applicable to the Bank under the Basel III rules became fully phased-in on January 1, 2019. The Bank is now required to satisfy additional, more stringent, capital adequacy standards than it had in the past. While we expect to meet the requirements of the Basel III rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial condition and results of operations. In addition, these requirements could have a negative impact on our ability to lend, grow deposit balances, make acquisitions, make capital distributions in the form of dividends or share repurchases, or pay certain bonuses needed to attract and retain key personnel. Higher capital levels could also lower our return on equity.

Federal, state and local consumer lending laws restrict our ability to originate certain mortgage loans and increase our risk of liability with respect to such loans and increase our cost of doing business.

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. The Consumer Financial Protection Bureau, or CFPB, issued several rules on mortgage lending, notably a rule requiring all home mortgage lenders to determine a borrower’s ability to repay the loan. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” under federal regulations may be provided with certain protections from liability to a borrower. Federal regulations define a “qualified mortgage” to have certain specified characteristics, and generally prohibit loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being “qualified mortgages.” While federal regulations generally provide “qualified mortgages” with a “safe harbor” status for lenders, a rebuttable presumption of compliance with the ability-to-repay requirements will attach to “qualified mortgages” that are “higher priced” per the federal regulations. In response to these laws and related federal rules (including CFPB rules), we have tightened, and in the future may further tighten, our mortgage loan underwriting standards to determined borrowers’ ability to repay. Although it is our policy not to make predatory loans and to determine borrowers’ ability to repay, these laws and related rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.

We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The U.S. Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.

New accounting standards may require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The measure of our allowance for loan losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, has issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us in 2023. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.

The new CECL standard will become effective for us on January 1, 2023 and for interim periods within that year. We are currently evaluating the impact the CECL model will have on our accounting, but we expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our business, financial condition and results of operations; however, we expect that the new CECL standard may result in an increase in our allowance for loan losses given the change to estimated losses over the contractual life of the loan portfolio and may lead to more volatility in our allowance for loan losses and our earnings. The amount of any change to our allowance for loan losses will depend, in part, upon the composition of our loan portfolio at the adoption date as well as economic conditions and loss forecasts at such date.

The Federal Reserve Board may require us to commit capital resources to support the Bank.

The Federal Reserve Board requires a bank holding company to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve Board may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. In addition, the Dodd-Frank Act directs the federal bank regulators to require that all companies that directly or indirectly control an insured depository institution serve as a source of strength for the institution. Under these requirements, in the future, we could be required to provide financial assistance to our Bank if the Bank experiences financial distress.

A capital injection may be required at times when we do not have the resources to provide it, and therefore we may be required to borrow the funds. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely impact the holding company’s cash flows, financial condition, results of operations and prospects.

Failure to comply with government regulation and supervision could result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation.

Our operations are subject to extensive regulation by federal, state, and local governmental authorities. With any disruption in the financial markets, we expect that the government will pass new regulations and laws that will impact us. Compliance with such regulations may increase our costs and limit our ability to pursue business opportunities. Failure to comply with laws, regulations, and policies could result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation. While we have policies and procedures in place that are designed to prevent violations of these laws, regulations, and policies, there can be no assurance that such violations will not occur.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

The federal Bank Secrecy Act, the USA Patriot Act and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively affect our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

From time to time we are, or may become, involved in suits, legal proceedings, information-gatherings, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.

Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, the subject of information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank regulatory agencies, self-regulatory agencies and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions, restrictions on the way we conduct our business or reputational harm.

Risks Related to Operations

Liquidity needs could adversely affect our financial condition and results of operations.

Dividends from the Bank provide the primary source of funds for the Company. The primary sources of funds for the Bank are client deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings, or lay-offs, inclement weather, natural disasters and international instability.

Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to clients on alternative investments and general economic conditions. We may experience stress on our liquidity management as a result of the COVID-19 pandemic. As customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit. We may also see deposit levels decrease as a result of distressed economic conditions. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include proceeds from Federal Home Loan Bank, or FHLB, advances, sales of investment securities and loans, and federal funds lines of credit from correspondent banks, as well as out-of-market deposits. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if we continue to grow and experience increasing loan demand. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.

The Company is a stand-alone entity with its own liquidity needs to service its debt or other obligations. Other than dividends from the Bank, the Company does not have additional means of generating liquidity without obtaining additional debt or equity funding. If we are unable to receive dividends from the Bank or obtain additional funding, we may be unable to pay our debt or other obligations.

New or acquired banking office facilities and other facilities may not be profitable.

Although we have been able to expand to several new locations in recent years, we may not be able to identify profitable locations for new banking offices. The costs to start up new banking offices or to acquire existing branches, and the additional costs to operate these facilities, may increase our noninterest expense and decrease our earnings in the short term. If branches of other banks become available for sale, we may acquire those offices. It may be difficult to adequately and profitably manage our growth through the establishment or purchase of additional banking offices and we can provide no assurance that any such banking offices will successfully attract enough deposits to offset the expenses of their operation. In addition, any new or acquired banking offices will be subject to regulatory approval, and there can be no assurance that we will succeed in securing such approval.

We are dependent on key individuals, and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.

Mason Y. Garrett, the Company’s chairman and chief executive officer, JB Schwiers, the Company’s president and the Bank’s chief executive officer, and John B. Garrett, our chief financial officer, have extensive and long-standing ties within our primary market area and substantial experience with our operations, and they have contributed significantly to our business. If we lose the services of Mr. M. Garrett, Mr. Schwiers, and/or Mr. J. Garrett, they would be difficult to replace, and our business and development could be materially and adversely affected.

Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel, including other executive vice presidents. Competition for personnel is intense, and the process of locating key personnel with the combination of skills and attributes required to execute our business strategy may be lengthy. In 2021, there has been a dramatic increase in workers leaving their positions throughout our industry and other industries that is being referred to as the “great resignation,” and the market to build, retain and replace talent has become even more highly competitive. We may not be successful in retaining key personnel, and the unexpected loss of services of one or more of our key personnel could have a material adverse effect on our business because of their skill, knowledge of our primary markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to the Company, or at all, which could have a material adverse effect on our business, results of operation, financial condition, and future prospects

Our historical operating results may not be indicative of our future operating results.

We may not be able to sustain our historical rate of growth, and, consequently, our historical results of operations will not necessarily be indicative of our future operations. Various factors, such as economic conditions, regulatory and legislative considerations, and competition, may also impede our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected because a high percentage of our operating costs are fixed expenses.

New lines of business or new products and services may subject us to additional risk.

From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and/or new products or services could have a material adverse effect on our business, financial condition and results of operations.

We are subject to losses due to errors, omissions or fraudulent behavior by our employees, clients, counterparties or other third parties.

We are exposed to many types of operational risk, including the risk of fraud by employees and third parties, clerical recordkeeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially and adversely affected if employees, clients, counterparties or other third parties caused an operational breakdown or failure, either as a result of human error, fraudulent manipulation or purposeful damage to any of our operations or systems.

In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information, which we do not independently verify. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. Our financial condition and results of operations could be negatively impacted to the extent we incorrectly assess the creditworthiness of our borrowers, fail to detect or respond to deterioration in asset quality in a timely manner, or rely on financial statements that do not comply with GAAP or are materially misleading.

In addition, criminals committing fraud increasingly are using more sophisticated techniques and in some cases are part of larger criminal rings, which allow them to be more effective. This type of fraudulent activity has taken many forms, ranging from check fraud, mechanical devices attached to ATM machines, social engineering and phishing attacks to obtain personal information or impersonation of our clients through the use of falsified or stolen credentials. Additionally, an individual or business entity may properly identify themselves, particularly when banking online, yet seek to establish a business relationship for the purpose of perpetrating fraud. Further, in addition to fraud committed against us, we may suffer losses as a result of fraudulent activity committed against third parties. Increased deployment of technologies, such as chip card technology, defray and reduce aspects of fraud; however, criminals are turning to other sources to steal personally identifiable information, such as unaffiliated healthcare providers and government entities, in order to impersonate the consumer to commit fraud. Many of these data compromises are widely reported in the media.

As a result of the increased sophistication of fraud activity, we have increased our spending on systems and controls to detect and prevent fraud. This will result in continued ongoing investments in the future. Nevertheless, these investments may prove insufficient and fraudulent activity could result in losses to us or our customers; loss of business and/or customers; damage to our reputation; the incurrence of additional expenses (including the cost of notification to consumers, credit monitoring and forensics, and fees and fines imposed by the card networks); disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability any of which could have a material adverse effect on our business, financial condition and results of operations.

A failure in or breach of our operational or security systems or infrastructure, or those of our third-party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.

We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, and terrorists, activists, and other external parties. As customer, public, and regulatory expectations regarding operational and information security have increased, our operating systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting, and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunication outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics (such as COVID-19); events arising from local or larger scale political or social matters, including terrorist acts; and as described below, cyber-attacks.

As noted above, our business relies on our digital technologies, computer and email systems, software and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our customers’ or other third parties’ confidential information. Third parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide service or security solutions for our operations, and other unaffiliated third parties, including the South Carolina Department of Revenue, which had customer records exposed in a 2012 cyber-attack, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As a result, cyber security and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputation damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material effect on our results of operations or financial condition.

We are subject to environmental risks that could result in losses.

In the course of business, the Bank may acquire, through foreclosure, or deed in lieu of foreclosure, properties securing loans it has originated or purchased which are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, the Bank may be required to remove these substances from the affected properties at our sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have a material adverse effect on our business, results of operations and financial condition.

In addition, we are subject to the growing risk of climate change. Among the risks associated with climate change are more frequent severe weather events. Severe weather events such as hurricanes, tropical storms, tornados, winter storms, freezes, flooding and other large-scale weather catastrophes in our markets subject us to significant risks and more frequent severe weather events magnify those risks. Large-scale weather catastrophes or other significant climate change effects that either damage or destroy residential or multifamily real estate underlying mortgage loans or real estate collateral, or negatively affects the value of real estate collateral or the ability of borrowers to continue to make payments on loans, could decrease the value of our real estate collateral or increase our delinquency rates in the affected areas and thus diminish the value of our loan portfolio. Such events could also cause downturns in economic and market conditions generally, which could have an adverse effect on our business and financial results. The potential losses and costs associated with climate change related risks are difficult to predict and could have a material adverse effect on our business, financial condition and results of operation.

Risks Related to Our Industry

We could experience a loss due to competition with other financial institutions or nonbank companies.

We face substantial competition in all areas of our operations from a variety of different competitors, both within and beyond our principal markets, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, community and internet banks within the various markets in which we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative and regulatory changes and continued consolidation. In addition, as customer preferences and expectations continue to evolve, technology has lowered barriers to entry and made it possible for banks to offer products and services in more areas in which they do not have a physical location and for nonbanks, such as FinTech companies, to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Banks, securities firms, and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting), and merchant banking. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

Our ability to compete successfully depends on a number of factors, including, among other things:

our ability to develop, maintain, and build upon long-term customer relationships based on top quality service, high ethical standards, and safe, sound assets;

our ability to expand our market position;

the scope, relevance, and pricing of the products and services we offer to meet our customers’ needs and demands;

the rate at which we introduce new products and services relative to our competitors;

customer satisfaction with our level of service; and

industry and general economic trends.

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

In addition, downgrades in the credit or financial strength ratings assigned to the counterparties with whom we transact could create the perception that our financial condition will be adversely impacted as a result of potential future defaults by such counterparties. Additionally, we could be adversely affected by a general, negative perception of financial institutions caused by the downgrade of other financial institutions. Accordingly, ratings downgrades for other financial institutions could affect the market price of our stock and could limit our access to or increase our cost of capital.

Failure to keep pace with technological change could adversely affect our business.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. In addition, we depend on internal and outsourced technology to support all aspects of our business operations. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business, financial condition and results of operations.

Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

Negative public opinion surrounding our Bank and the financial institutions industry generally could damage our reputation and adversely impact our earnings.

Reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our Bank and the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, mergers and acquisitions, cybersecurity incidents, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees, could impair the confidence of our investors, counterparties and business partners and can affect our ability to effect transactions and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business.

Risks Related to an Investment in Our Common Stock

Our ability to pay cash dividends is limited, and we may be unable to pay future dividends even if we desire to do so.

The Federal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Federal Reserve’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. In addition, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect our ability to pay dividends or otherwise engage in capital distributions.

Our ability to pay cash dividends may be limited by regulatory restrictions, by our Bank’s ability to pay cash dividends to the Company and by our need to maintain sufficient capital to support our operations. As a South Carolina-chartered bank, the Bank is subject to limitations on the number of dividends that it is permitted to pay. Unless otherwise instructed by the S.C. Board, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the S.C. Board. If our Bank is not permitted to pay cash dividends to us, it is unlikely that we would be able to pay cash dividends on our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our board of directors. Although we have historically paid cash dividends on our common stock, we are not required to do so, and our board of directors could reduce or eliminate our common stock dividend in the future.

Our stock price may be volatile, which could result in losses to our investors and litigation against us.

Our stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to: actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, our announcement of developments related to our businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and non-traditional competitors, news reports of trends, irrational exuberance on the part of investors, new federal banking regulations, and other issues related to the financial services industry. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of volatility in the market price of its securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from our normal business.

Our principal shareholders and management own a significant percentage of our voting shares and are able to exercise significant influence over our business and have the power to block transactions that could benefit our other shareholders.

As of December 31, 2021, Mason Y. Garrett and his two sons, Harold E. Garrett and John B. Garrett (collectively, the “Garretts”), own a total of approximately 26.0% of our outstanding shares of voting stock and together constitute our largest shareholder. As a result, the Garretts have the ability to significantly influence the outcome of matters requiring approval of our shareholders. Consequently, the Garretts have significant influence over our operations and outcome of shareholder votes on the approval of mergers and acquisitions or changes in corporate control which, among other things, could discourage potential acquirers from attempting to acquire the Company, thereby impeding or preventing the consummation of acquisition or change of control transactions in which our shareholders might otherwise receive a premium for their shares.

Securities analysts may not initiate coverage or continue to cover our common stock.

The trading market for our common stock will depend in part on the research and reports that securities analysts publish about us and our business. We do not have any control over these securities analysts, and they may not cover our common stock. If securities analysts do not cover our common stock, the lack of research coverage may adversely affect our market price. If we are covered by securities analysts, and our common stock is the subject of an unfavorable report, the price of our common stock may decline. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the financial markets, which could cause the price or trading volume of our common stock to decline.

Future sales of our stock by our shareholders or the perception that those sales could occur may cause our stock price to decline.

Although our common stock is quoted on the OTC Market, the trading volume in our common stock is lower than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the relatively low trading volume of our common stock, significant sales of our common stock in the public market, or the perception that those sales may occur, could cause the trading price of our common stock to decline or to be lower than it otherwise might be in the absence of those sales or perceptions.

Economic and other circumstances may require us to raise capital at times or in amounts that are unfavorable to us. If we have to issue shares of common stock, they will dilute the percentage ownership interest of existing shareholders and may dilute the book value per share of our common stock and adversely affect the terms on which we may obtain additional capital.

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments or to strengthen our capital position. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control and our financial performance. We cannot provide assurance that such financing will be available to us on acceptable terms or at all, or if we do raise additional capital that it will not be dilutive to existing shareholders.

If we determine, for any reason, that we need to raise capital, our board generally has the authority, without action by or vote of the shareholders, to issue all or part of any authorized but unissued shares of stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. Additionally, we are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market price of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or from the perception that such sales could occur. If we issue preferred stock that has a preference over the common stock with respect to the payment of dividends or upon liquidation, dissolution or winding-up, or if we issue preferred stock with voting rights that dilute the voting power of the common stock, the rights of holders of the common stock or the market price of our common stock could be adversely affected. Any issuance of additional shares of stock will dilute the percentage ownership interest of our shareholders and may dilute the book value per share of our common stock. Shares we issue in connection with any such offering will increase the total number of shares and may dilute the economic and voting ownership interest of our existing shareholders.

Failure to maintain effective internal controls over financial reporting could have an adverse effect on our business and results of operations.

Effective internal control is necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, we could be subject to regulatory action or other litigation, and our operating results could be adversely affected. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. As part of our ongoing monitoring of internal controls, we may discover material weaknesses or significant deficiencies in our internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. We continually work on improving our internal controls. However, we cannot be certain that these measures will ensure that we implement and maintains adequate controls over our financial processes and reporting. Any failure to maintain effective controls or to timely implement any necessary improvement of our internal and disclosure controls could, among other things, result in losses from fraud or error, harm our reputation, or cause investors to lose confidence in our reported financial information, all of which could have a material adverse effect on our results of operation and financial condition.

Any and all of these factors could have a material adverse effect on us and lead to a decline in the price of our common stock.

Provisions of our articles of incorporation and bylaws, South Carolina law, and state and federal banking regulations, could delay or prevent a takeover by a third party.

Our articles of incorporation and bylaws could delay, defer, or prevent a third-party takeover, despite possible benefit to the shareholders, or otherwise adversely affect the price of our common stock. Our governing documents:

authorize 20,000,000 shares of common stock and 20,000,000 shares of preferred stock (the terms, including voting rights, of which may be established by the board of directors) that may be issued by the board of directors without shareholder approval;

require advance notice of proposed nominations for election to the board of directors and business to be conducted at a shareholder meeting;

require the board of directors, when considering whether a proposed plan of merger, consolidation, exchange, or sale of all, or substantially all, of the assets of the Company, to consider the interests of the Company’s employees and the communities in which the Company and its subsidiaries do business in addition to the interests of the Company’s shareholders;

provide that the number of directors shall be fixed from time to time by resolution adopted by a majority of the directors then in office, but may not consist of fewer than five nor more than 25 members; and

provide that no individual who is or becomes a “business competitor” or who is or becomes affiliated with, employed by, or a representative of any individual, corporation, or other entity which the board of directors, after having such matter formally brought to its attention, determines to be in competition with us or any of our subsidiaries (any such individual, corporation, or other entity being a “business competitor”) shall be eligible to serve as a director if the board of directors determines that it would not be in our best interests for such individual to serve as a director (any financial institution having branches or affiliates within the counties in which we operate is presumed to be a business competitor unless the board of directors determines otherwise).

In addition, the South Carolina business combinations statute provides that a 10% or greater shareholder of a resident domestic corporation cannot engage in a “business combination” (as defined in the statute) with such corporation for a period of two years following the date on which the 10% shareholder became such, unless the business combination or the acquisition of shares is approved by a majority of the disinterested members of such corporation’s board of directors before the 10% shareholder’s share acquisition date. This statute further provides that at no time (even after the two-year period subsequent to such share acquisition date) may the 10% shareholder engage in a business combination with the relevant corporation unless certain approvals of the board of directors or disinterested shareholders are obtained or unless the consideration given in the combination meets certain minimum standards set forth in the statute. The law is very broad in its scope and is designed to inhibit unfriendly acquisitions, but it does not apply to corporations whose articles of incorporation contain a provision electing not to be covered by the law. Our articles of incorporation do not contain such a provision. An amendment of our articles of incorporation to that effect would, however, permit a business combination with an interested shareholder even though such status was obtained prior to the amendment.

Finally, the Change in Bank Control Act and the Bank Holding Company Act generally require filings and approvals prior to certain transactions that would result in a party acquiring control of the Company or the Bank.

An investment in our common stock is not an insured deposit.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. An investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in Annual Report on Form 10-K and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

General Risk Factors

We may be exposed to a need for additional capital resources in the future and these capital resources may not be available when needed or at all.

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments or to strengthen our capital position. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control and our financial performance. Accordingly, we cannot provide assurance that such financing will be available to us on acceptable terms or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, our current shareholders’ interests could be diluted.

We are party to various claims and lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained.

From time to time, we, our directors and our management are or may be the subject of various claims and legal actions by customers, employees, shareholders and others. Whether such claims and legal actions are legitimate or unfounded, if such claims and legal actions are not resolved in our favor, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services. In light of the potential cost, reputational damage and uncertainty involved in litigation, we have in the past and may in the future settle matters even when we believe we have a meritorious defense. Certain claims may seek injunctive relief, which could disrupt the ordinary conduct of our business and operations or increase our cost of doing business. Our insurance or indemnities may not cover all claims that may be asserted against us. Any judgments or settlements in any pending litigation or future claims, litigation or investigation could have a material adverse effect on our business, reputation, financial condition and results of operations.

MD&A (Item 7)

13,622 words

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is presented on a consolidated basis and focuses on the major components of our operations and significant changes in our results of operations for the periods presented. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information included elsewhere in this Annual Report on Form 10-K. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in our operations or results of operations for any future periods.

We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this Annual Report on Form 10-K.

Overview

The Company was incorporated in 2000 under the laws of South Carolina and is a bank holding company registered under the Bank Holding Company Act of 1956. The Company’s primary purpose is to serve as the holding company for the Bank. On October 2, 2000, pursuant to a Plan of Exchange approved by the shareholders of the Bank, all of the outstanding shares of capital stock of the Bank were exchanged for shares of the Company, and the Company became the owner of all of the outstanding capital stock of the Bank. The Company presently engages in no business other than that of owning the Bank and has no employees.

The Company has one non-bank subsidiary, the GrandSouth Capital Trust I, a Delaware statutory trust, formed to facilitate the issuance of trust preferred securities. The GrandSouth Trust is not consolidated in the Company’s financial statements.

We provide a full range of financial services through offices located throughout South Carolina. We provide full-service retail and commercial banking products.

COVID-19 Pandemic

The COVID-19 pandemic and variants of the virus continue to create disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. The impact of the COVID-19 pandemic and its related variants is fluid and continues to evolve, adversely affecting many of our customers. Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and in the United States as a whole. The unprecedented and rapid spread of COVID-19 and its variants and their associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities have resulted and continue to result in less economic activity, and volatility and disruption in financial markets.

The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations remains uncertain and will depend on various developments and other factors, including the effect of governmental and private sector initiatives, the effect of the continued rollout of vaccinations for the virus, whether such vaccinations will be effective against another resurgence of the virus, including any new strains, and the ability for customers and businesses to return to, and remain in, their pre-pandemic routine.

Lending Operations and Accommodations to Customers

We are focused on serving the needs of our commercial and consumer customers and have offered flexible loan payment arrangements, including short-term loan modifications or forbearance payments, and reduced or waived certain fees on deposit accounts. During 2020, we granted short-term deferrals related to the COVID-19 crisis for $93.0 million of loans, which as of December 31, 2020 had all resumed payments or had been paid off. During 2021, the Bank did not grant any deferrals related to the COVID-19 crisis.

We also participated in the Small Business Administration’s Paycheck Protection Program (“PPP”). During 2020 and 2021, we secured funding of 272 loans and 95 loans, respectively, through the PPP totaling approximately $37.4 million and $12.0 million, net of deferred lending fees for the same periods, respectively. PPP loans totaled $1.3 million and $22.5 million as of December 31, 2021 and December 31, 2020, respectively.

Impact on Results of Operations and Financial Condition

We are monitoring the impact of the COVID-19 pandemic on the operations and value of our investments. We mark to market our AFS investments and review our investment portfolio for impairment at each period end. Because of changing economic and market conditions affecting issuers, we may be required to recognize impairments on the securities we hold as well as reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our investment portfolio.

As of December 31, 2021, we had $0.7 million of goodwill. At each quarter end in 2021, we have considered whether a quantitative assessment of our goodwill was required because of the significant economic disruption caused by the COVID-19 pandemic. At December 31, 2021, we determined no goodwill impairment was required. However, further delayed recovery or further deterioration in market conditions related to the general economy, financial markets, and the associated impacts on our customers, employees and vendors, among other factors, could significantly impact the impairment analysis and may result in future goodwill impairment charges that, if incurred, could have an adverse effect on our results of operations and financial condition.

Capital and Liquidity

As of December 31, 2021, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by loan losses.

We continue to monitor unfunded commitments through the pandemic, including home equity lines of credit, for evidence of increased credit exposure as borrowers utilize these lines for liquidity purposes. As clients manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit. We believe that we have ample liquidity to meet the needs of our customers through our low cost deposits, our ability to borrow against approved lines of credit (federal funds purchased) from correspondent banks, and our ability to obtain advances secured by certain securities and loans from the Federal Home Loan Bank (“FHLB”).

Critical Accounting Estimates

Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements, which could have a material impact on our future financial condition and results of operations.

Certain policies inherently have 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. We have identified the determination of the allowance for loan losses to be an accounting area that requires the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate. Therefore, we consider this policy, discussed below, to be a critical accounting policy and estimate and discuss it directly with the Audit Committee of our board of directors.

Additional information about our critical and significant accounting policies can be found in Note 1 of our audited consolidated financial statements as of December 31, 2021, included in Item 8 of this Annual Report on Form 10-K.

Allowance for Loan Losses (“ALL”) – The ALL reflects our estimates of probable losses inherent in the loan portfolio at the balance sheet date. Our management evaluates the ALL on a regular basis. It is based on the collectability of our loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available and such revisions can materially affect our financial results.

The methodology for determining the ALL has two main components: the evaluation of individual loans for impairment and the evaluation of certain groups of homogeneous loans with similar risk characteristics.

A loan is considered impaired when it is probable that we will be unable to collect all principal and interest payments due according to the original contractual terms of the loan agreement. We individually evaluate loans, or relationships, greater than $200,000 for impairment that are classified as nonaccrual, TDRs, or performing substandard loans. If the impaired loan is considered collateral dependent, a charge-off is taken based upon the appraised value of the property (less an estimate of selling costs if foreclosure is anticipated) compared to the loan’s carrying value, if necessary. If the impaired loan is not collateral dependent, a specific reserve is established based upon an estimate of the future discounted cash flows after consideration of modifications and the likelihood of future default and prepayment.

The allowance for non-impaired loans consists of a base historical loss reserve and a qualitative reserve. The loss rates for the base loss reserve, segmented into seven loan categories, contain average net loss rates ranging from approximately 0.00% to 0.56%.

The qualitative reserve adjusts the average loss rates utilized in the base loss reserve for trends in the following internal and external factors:

Changes in lending and loan review policies;

Economic conditions – including unemployment rates, federal macroeconomic data, housing prices and sales, and regional economic outlooks;

Changes in the nature and volume of the portfolio and in the terms of the loans;

Experience, ability, and depth of lending management;

Volume and severity of past due, nonaccrual, and classified loans;

Changes in the quality of the institution's loan review system;

Collateral values;

Loan concentrations and loan growth; and

The effect of other external factors such as competition, legal and regulatory requirements on the level of estimated credit losses.

Qualitative reserve adjustment factors are decreased for favorable trends and increased for unfavorable trends. There is no certainty that our ALL will be appropriate over time to cover losses in our portfolio as economic and market conditions may ultimately differ from our reasonable and supportable forecast; however, we believe our estimate has been reasonably accurate in determining ALL adequacy.

Financial Highlights

The following table sets forth certain financial highlights ( in thousands, except per share data ) concerning the Company and its wholly-owned subsidiary. The information was derived from audited consolidated financial statements. The information should be read in conjunction with the audited consolidated financial statements and notes, which are presented elsewhere in this report.

As of and for the year ended December 31,

Income Statement Data:

Net interest income

Provision for loan losses

Noninterest income

Noninterest expense

Income before taxes

Provision for income taxes

Net income

Per Common Share Data:

Weighted average shares of common stock outstanding, basic

Weighted average shares of common stock outstanding, diluted

Total shares of common stock outstanding

Basic income per common share

Diluted income per common share

Dividends declared per common share

Dividend payout ratio

Book value (at end of period)

Balance Sheet Data:

Total loans

Allowance for loan losses

Total assets

Total Deposits

Total shareholders’ equity

Common shareholders’ equity

Performance Ratios:

Return on average assets

Return on average equity

Net interest rate spread (1)

Net interest margin (2)

Efficiency ratio (3)

Asset Quality Data (at Period End):

Net charge-offs to average loans

Nonperforming assets to total loans

Allowance for loan losses to nonperforming loans

Allowance for loan losses to total loans

Balance Sheet and Capital Ratios (4) :

Total loans to total deposits

Tangible common equity to tangible assets

Leverage ratio

Tier 1 risk-based capital ratio

Total risk-based capital ratio

The interest rate spread represents the difference between the fully taxable equivalent weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period.

The net interest margin represents fully taxable equivalent net interest income as a percentage of average interest-earning assets for the period.

The efficiency ratio represents noninterest expense as a percentage of the sum of net interest income on a fully taxable equivalent basis and noninterest income.

Capital ratios are for GrandSouth Bancorporation, Inc. on a consolidated basis.

Comparison of Financial Condition at December 31, 2021 and 2020

General

Total assets increased $113.9 million, or 10.5%, to $1.2 billion at December 31, 2021 from $1.1 billion at December 31, 2020. This increase in assets was primarily due to increases in interest-earnings deposits of $69.5 million, or 135.8%, from $51.1 million at December 31, 2020 to $120.6 million at December 31, 2021, and loans, which increased $54.9 million, or 6.3%, from $878.5 million at December 31, 2020 to $933.5 million at December 31, 2021.

Total liabilities increased $103.1 million, or 10.3%, to $1.1 billion at December 31, 2021 from $1.0 billion at December 31, 2020, due primarily to the $112.6 million increase in total deposits, which was partially offset by the $11.0 million decrease in FHLB advances.

Total shareholders’ equity increased $10.9 million to $97.4 million at December 31, 2021 compared to $86.5 million at December 31, 2020. This increase was primarily attributable to $16.1 million of net income and $1.4 million from the exercise of stock options, partially offset by the repurchases of $3.9 million of our common stock and $0.1 million of our preferred stock and dividends declared of $2.2 million. Tangible book value per common share, a non-GAAP measure, increased $2.44 to $18.47 at December 31, 2021 from $16.03 at December 31, 2020.

Cash and Cash Equivalents

Total cash and cash equivalents increased $61.1 million to $124.1 million at December 31, 2021 from $63.0 million at December 31, 2020, primarily due to the increase of total deposits, partially offset by the increase in loans. We continue to hold adequate levels of liquid and short-term assets.

Investment Securities

Our investment securities portfolio is classified as AFS. AFS securities are carried at fair value. The following table shows the amortized cost and fair value for our AFS investment portfolio at the dates indicated ( in thousands ).

December 31, 2021

December 31, 2020

Amortized

Cost

Fair

Value

Amortized

Cost

Fair

Value

U.S. government agencies

State and municipal obligations

Mortgage-backed securities - agency

Collateralized mortgage obligations - agency

Asset-backed securities

Corporate bonds

AFS investment securities increased $1.3 million, or 1.1%, to $112.0 million at December 31, 2021 from $110.7 million at December 31, 2020. Corporate bonds, which increased $7.8 million, or 169.3%, to $12.4 million at December 31, 2021 from $4.6 million at December 31, 2020, include subordinated debt issued by community banks that are within and outside of our footprint. We continue to look for opportunities to re-deploy funds from investment securities to higher yielding loans.

During 2021, we decided to sell $28.2 million of our AFS investment securities that were below market rates and as a result in an unrealized loss position. While this resulted in a $0.8 million loss on sale, we believe making this balance sheet change will assist in positioning us for better earnings in the future.

We believe the number of securities in an unrealized loss position is due entirely to interest rate fluctuation from the time that many of these securities were originally purchased. We regularly review our investment portfolio for impairment that is other than temporary (“OTTI”) and concluded that no OTTI existed during the years ended December 31, 2021 and December 31, 2020. In addition, we do not currently intend to sell the securities, nor do we believe it is more likely than not that we would be required to sell these securities before their anticipated recovery of amortized cost. The number and dollar amount of securities in an unrealized loss position decreased between December 31, 2020 and December 31, 2021, as indicated in the table below ( in thousands ).

12 Months or Less

More Than 12 Months

Total

Number of

Securities

Fair Value

Unrealized

Losses

Number of

Securities

Fair Value

Unrealized

Losses

Number of

Securities

Fair Value

Unrealized

Losses

As of December 31, 2021

As of December 31, 2020

We closely monitor the financial condition of the issuers of our municipal securities. As of December 31, 2021, the fair value of our municipal securities portfolio balance consists of approximately 34.1% of general obligation bonds and 65.9% of revenue bonds. As of December 30, 2021, and December 31, 2020, all of our municipal securities were performing and rated A or better by either Moody’s or Standard and Poor’s.

The composition and maturities of the available-for-sale investment securities portfolio at December 31, 2021 are summarized in the following table ( in thousands ). Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. The composition and maturity distribution of the securities portfolio is subject to change depending on rate sensitivity, capital, and liquidity needs. The weighted average yield was calculated using net income (interest accrual plus or minus accretion/amortization) divided by ending book value.

Less than one year

More than one year

through five years

More than five years

through ten years

More than ten years

Total securities

Amortized

Cost

Weighted

Average

Yield

Amortized

Cost

Weighted

Average

Yield

Amortized

Cost

Weighted

Average

Yield

Amortized

Cost

Weighted

Average

Yield

Amortized

Cost

Weighted

Average

Yield

U.S. government

agencies

State and municipal obligations

Mortgage-backed securities - agency

Collateralized mortgage obligations - agency

Asset-backed securities

Corporate bonds

Total securities available-for-sale

Tax exempt municipal obligations are shown on a tax equivalent basis using a 21% federal tax rate.

Other Investments

As of December 31, 2021, we held $3.0 million in other investments accounted for at cost which was a decrease of $3.3 million, or 52.3%, compared to $6.3 million at December 31, 2020. The following table summarizes other investments as of the dates indicated ( in thousands ):

December 31,

FHLB stock

CRA qualified preferred stock

Certificates of deposit with other banks

Investment in trust preferred securities

Total other investments

The amount of FHLB stock required to be owned by the Bank is determined by the amount of FHLB advances outstanding. The decrease in our FHLB stock of $0.8 million to $0.7 million at December 31, 2021, compared to $1.5 million at December 31, 2020 was the result of decreased FHLB borrowings. FHLB advances totaled $5.0 million and $16.0 million as of December 31, 2021 and 2020, respectively.

Loans

The following table presents our loan portfolio composition and the corresponding percentage of total loans as of the dates indicated ( in thousands ). Other construction and land loans include residential acquisition and development loans and loans on commercial undeveloped land and one-to-four family improved and unimproved lots. Commercial real estate loans include loans on non-residential owner-occupied and non-owner-occupied real estate, multi-family, and owner-occupied investment property. Commercial loans include unsecured commercial loans and commercial loans secured by business assets.

December 31,

Balance

Percent

Balance

Percent

Balance

Percent

Real estate mortgage loans:

One-to four-family residential

Commercial real estate

Home equity loans and lines of credit

Residential construction

Other construction and land

Commercial

Consumer

Loans receivable, gross

Net deferred loan costs (fees)

Unamortized discount

Unamortized premium

Loans receivable, net of deferred fees

Loans receivable, net of deferred fees increased $54.9 million, or 6.3%, to $933.5 million at December 31, 2021, compared to $878.5 million at December 31, 2020. Most of our loan growth in concentrated in One-to-four family residential and Commercial real estate with increases of $18.7 million, or 16.4% and $53.8 million, or 14.6%, respectively, as compared to relative balances as of December 31, 2020. This growth was partially offset by a decrease in our Consumer loan portfolio, which contracted by $28.2 million, or 79.8%, as compared to the relative balance as of December 31, 2020.

In 2021, we processed 95 loans under the PPP for a total of $12.0 million in loans funded and $0.6 million of lender fees collected. As of December 31, 2021, 83 of these loans totaling $10.8 million had been forgiven and lender fee income totaling $0.5 million had been recognized and is included in Interest and fees on loans in the Consolidated Statements of Income.

In 2020, we processed 272 loans under the PPP for a total of $39.0 million in loans funded and $1.6 million of lender fees collected. As of December 31, 2020, 80 of these loans totaling $15.9 million had been forgiven and lender fee income totaling $1.0 million had been recognized and is included in Interest and fees on loans in the Consolidated Statements of Income. As of December 31, 2021, 271 of the loans originated under the PPP in 2020 totaling $38.9 million had been forgiven and lender fees income totaling $1.6 million had been recognized and is included in Interest and fees on loans in the Consolidated Statements of Income.

In 2021, $24.6 million of the purchased student loan portfolio was sold which, along with the continued paydowns, decreased the balance as of December 31, 2021 to $0.7 million from $25.6 million at December 31, 2020. The sale resulted in a net gain of $1.2 million.

Maturities and Sensitivity of Loans to Changes in Interest Rates

Renewal of loans is subject to the same credit approval and underwriting standards as new loans, the terms of which may be modified upon renewal. The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity ( in thousands ).

December 31, 2021

One year

or less

Over one

year to five

years

Over five

years to fifteen

years

Over

fifteen years

Total

Real estate loans:

One-to-four family residential

Commercial

Home equity loans and lines of credit

Residential construction

Other construction and land

Commercial

Consumer

Loans receivable, net of deferred fees

Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

Longer term One-to-four family residential, Residential construction, Commercial real estate, and Home equity loans and lines of credit typically carry interest rates which adjust to certain LIBOR indexes or The Wall Street Journal Prime Rate. Longer term One-to-four family residential construction loans represent construction-to-permanent loans which, upon completion of the construction phase, become One-to-four family residential loans.

The following table sets forth the recorded investment of all loans maturing after one year that have either fixed interest rates or floating or adjustable interest rates ( in thousands ).

December 31, 2021

Fixed

Floating or

adjustable

Total

Real estate loans:

One-to-four family residential

Commercial

Home equity loans and lines of credit

Residential construction

Other construction and land

Commercial

Consumer

Total

Delinquent Loans

When a loan becomes 15 days past due, we contact the borrower to inquire as to the status of the loan payment. When a loan becomes 30 days or more past due, we increase collection efforts to include all available forms of communication. Once a loan becomes 45 days past due, we generally issue a demand letter and further explore the reasons for non-repayment, discuss repayment options, and inspect the collateral. In the event the loan officer or collections staff has reason to believe restructuring will be mutually beneficial to the borrower and the Bank, the borrower is referred to the Bank’s Credit Administration staff to explore restructuring alternatives to foreclosure. Once the demand period has expired and it has been determined that restructuring is not a viable option, the Bank’s counsel is instructed to pursue foreclosure.

The accrual of interest on loans is discontinued at the time a loan becomes 90 days delinquent or when it becomes impaired, whichever occurs first, unless the loan is well secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual is reversed. Interest payments received on nonaccrual loans are generally applied as a direct reduction to the principal outstanding until the loan is returned to accrual status. Interest payments received on nonaccrual loans may be recognized as income on a cash basis if recovery of the remaining principal is reasonably assured. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Interest payments applied to principal while the loan was on nonaccrual may be recognized in income over the remaining life of the loan after the loan is returned to accrual status.

If a loan is modified in a TDR, the loan is generally placed on non-accrual until there is a period of satisfactory payment performance by the borrower (either immediately before or after the restructuring), generally six consecutive months, and the ultimate collectability of all amounts contractually due is not in doubt. For a discussion of TDRs, see the section entitled “Troubled Debt Restructurings” below.

We had one loan 90 days or more past due that was still accruing interest as of December 31, 2021 for $50.0 thousand that was not 98% guaranteed by the issuing agency. We had no loans 90 days or more past due that are still accruing interest as of December 31, 2020 that are not 98% guaranteed by the issuing agency.

Delinquent loans

( In thousands )

30-59 Days

60-89 Days

90 Days

and over

Total

December, 2021

Real estate loans:

One-to-four family residential

Commercial

Consumer

Total delinquent loans

% of total loans, net

December, 2020

Real estate loans:

One-to-four family residential

Commercial

Consumer

Total delinquent loans

% of total loans, net

December 31, 2019

Real estate loans:

One-to-four family residential

Commercial

Residential construction

Other construction and land

Commercial

Consumer

Total delinquent loans

% of total loans, net

December 31, 2018

Real estate loans:

One-to-four family residential

Commercial

Other construction and land

Commercial

Consumer

Total delinquent loans

% of total loans, net

December 31, 2017

Real estate loans:

One-to-four family residential

Commercial

Other construction and land

Commercial

Consumer

Total delinquent loans

% of total loans, net

Total delinquencies as a percentage of loans have decreased from 0.58% at December 31, 2020 to 0.07% at December 31, 2021, representing a decrease of 87.29% over the period. Delinquent loans decreased $4.4 million, or 86.50%, to $0.7 million at December 31, 2021 from $5.1 million at December 31, 2020. The decrease in 30-59 days delinquencies of $1.8 million, or 97.07%, from December 31, 2020 to December 31, 2021 is concentrated primarily in consumer loans. The sale of $24.6 million of the purchased student loan portfolio in 2021 drove the past due consumer balances lower. As of December 31, 2020, purchased student loans made up 99.6% of the $5.1 million total consumer past due balance. We continue to focus on collection efforts and favorable resolutions.

Nonperforming Assets

Nonperforming loans include all loans past due 90 days and over that are not 98% guaranteed by the issuing agency, certain impaired loans, and TDR loans that have not yet established a satisfactory period of payment performance (some of which may be contractually current). Nonperforming assets include nonperforming loans and real estate owned (“REO”). The table below sets forth the amounts and categories of our nonperforming assets at the dates indicated ( in thousands ).

December 31,

Nonaccrual loans:

Real estate loans:

One-to-four family residential

Commercial

Home equity loans and lines of credit

Residential construction

Other construction and land

Commercial

Consumer

Total nonperforming loans (1)

REO:

One-to-four family residential

Commercial real estate

Other construction and land

Total foreclosed real estate

Total nonperforming assets

TDRs still accruing

Ratios:

Nonperforming loans to total loans

Nonperforming assets to total assets

At December 31, 2021, total nonperforming loans were comprised of only nonaccrual loans.

Nonperforming loans as a percentage of total loans increased from 0.06% at December 31, 2020, to 0.14% at December 31, 2021, representing an increase of 133.3% over the period. Nonperforming assets as a percentage of total assets decreased from 0.23% at December 31, 2020, to 0.18% at December 31, 2021, or a decrease of 21.7% over the period. The gross interest income that would have been recorded under the original terms of the nonaccrual loans was $0.1 million as of December 31, 2021 and $0.2 million as of December 31, 2020. The changes in nonperforming loans and nonperforming assets is the result of the resolution and disposal of nonperforming loans and nonperforming assets by means of restructure, foreclosure, deed in lieu of foreclosure and short sales for less than the indebtedness, in which cases the deficiency is charged-off.

REO was $0.8 million and $1.9 million as of December 31, 2021 and 2020, respectively, but has declined $5.8 million, or 87.4% since December 31, 2017.

Troubled Debt Restructurings

In situations where, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession that we would not otherwise consider, for other than an insignificant period of time, the related loan is classified as a TDR. We strive to identify borrowers in financial difficulty early so that we may work with them to modify their loans before they reach nonaccrual status. Modified terms generally include extensions of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar risk characteristics, reductions in contractual interest rates, periods of interest-only payments, and principal deferments. A restructuring that results in only a delay in payments that is insignificant is not considered an economic concession. While unusual, there may be instances of forgiveness of loan principal. We individually evaluate all substandard loans that experience a modification of terms to determine if a TDR has occurred.

All TDRs over $200,000 are considered to be impaired loans and are reported as such for the remaining life of the loan, unless the restructuring agreement specifies an interest rate equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk and the ultimate collectability of all amounts contractually due is not in doubt. We may also remove a loan from TDR and impaired status if the loan is subsequently restructured and at the time of the subsequent restructuring the borrower is not experiencing financial difficulties and, under the terms of the subsequent restructuring agreement, no concession has been granted to the borrower.

The following table presents our TDRs by accrual status as of the dates indicated ( in thousands ).

December 31,

TDRs still accruing interest

TDRs not accruing interest

Total TDRs

As noted in the above table, the majority of our borrowers with restructured loans have been able to comply with the revised payment terms for at least six consecutive months, resulting in their respective loans being restored to accrual status.

The following table presents details of TDRs made in each of the periods indicated ( in thousands ):

Modification Type

Number of

TDR Loans

Pre-Modification

Recorded

Investment

Post-Modification

Recorded

Investment

Year ended December 31, 2021

Extended payment terms

Year ended December 31, 2020

Extended payment terms

During 2021, we have continued to be proactive in working with borrowers to identify potential issues and restructure certain loans to prevent future losses.

As of December 31, 2020, all loans with short-term deferral related to the COVID-19 pandemic had resumed making payments or had been paid off. During 2021, the Bank did not grant any deferrals related to the COVID-19 crisis.

Classification of Loans

The following table sets forth amounts of classified and criticized loans at the dates indicated. As indicated in the table, loans classified as “doubtful” or “loss” are charged off immediately ( in thousands ).

December 31,

Classified loans:

Substandard

Doubtful

Loss

Total classified loans:

Special mention

Total criticized loans

Total classified loans as a% of total loans, net

Total criticized loans as a% of total loans, net

Total classified loans to total loans increased to 0.46% at December 31, 2021, from 0.42% at December 31, 2020. Total criticized loans to total loans increased to 1.48% at December 31, 2021, from 1.31% at December 31, 2020. Management continues to dedicate resources to monitoring and resolving classified and criticized loans.

Allowance for Loan Losses

The allowance for loan losses reflects our estimates of probable losses inherent in our loan portfolio at the balance sheet date. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of our loans in light of historical experience, the nature and volume of our loan portfolio, adverse situations that may affect our borrowers’ abilities to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The methodology for determining the allowance for loan losses has two main components: the evaluation of individual loans for impairment and the evaluation of certain groups of homogeneous loans with similar risk characteristics.

A loan is considered impaired when it is probable that we will be unable to collect all principal and interest payments due according to the original contractual terms of the loan. We individually evaluate loans, or relationships, greater than $200,000 for impairment that are classified as nonaccrual, TDRs, or performing substandard loans. If the impaired loan is considered collateral dependent, a charge-off is taken based upon the appraised value of the property less an estimate of selling costs if foreclosure or sale of the property is anticipated. If the impaired loan is not collateral dependent, a specific reserve is established based upon an estimate of the future discounted cash flows after consideration of modifications and the likelihood of future default and prepayment.

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The loss rates for the base loss reserve, segmented into seven loan categories, contain average net loss/(recovery) rates ranging from approximately 0.0% to 0.6%.

The qualitative reserve adjusts the average loss rates utilized in the base loss reserve for trends in the following internal and external factors:

Changes in lending and loan review policies;

Economic conditions – including unemployment rates, federal macroeconomic data, housing prices and sales, and regional economic outlooks;

Changes in the nature and volume of the portfolio and in the terms of the loans;

Experience, ability, and depth of lending management;

Volume and severity of past due, nonaccrual, and classified loans;

Changes in the quality of the institution's loan review system;

Collateral values;

Loan concentrations and loan growth; and

The effect of other external factors such as competition, legal and regulatory requirements on the level of estimated credit losses.

The following table summarizes the net charge-off detail as a percenrage of average loans by loan composition for the periods indicated ( in thousands ).

Year ended December 31,

Amount

Percent

Amount

Percent

Amount

Percent

Real Estate:

One-to-four family residential

Commercial real estate

Home equity loans and lines of credit

Residential construction

Other construction and land

Commercial

Consumer

Total

Ratios:

Net charge-offs to average loans outstanding

Allowance to nonperforming loans at period end (1)

Allowance to total loans at period end

At December 31, 2021, total nonperforming loans were comprised of only nonaccrual loans.

Our allowance as a percentage of total loans increased to 1.47% at December 31, 2021 from 1.43% at December 31, 2020 primarily as the result of loan growth and changes in the composition of the bank’s loan portfolio.

We have continued to experience limited charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of nonperforming loans decreased to 1,017.27% at December 31, 2021 from 2,358.72% at December 31, 2020 primarily as the result of the increased balance of nonperforming loans during the period.

Allocation of Allowance for Loan Losses

The table below summarizes the allowance for loan losses balance and percent of total loans by loan category ( in thousands ).

December 31,

Allowance

Real estate mortgage loans:

One-to-four family residential

Commercial real estate

Home equity loans and lines of credit

Residential construction

Other construction and land

Commercial

Consumer

Total allowance for loan losses

Loan balance in each category, expressed as a percentage of total loans, net of deferred fees.

As discussed above, we compute our allowance for loan losses either through a specific allowance to individually impaired loans or through a general allowance applied to homogeneous loans by loan type. The above allocation represents the allocation of the allowance by loan type regardless of specific or general allocations. The largest allocation has been made to one-to-four family, commercial real estate, and commercial due to the elevated risk in those categories of loans.

The table below summarizes balances, charge-offs, and specific allowances related to impaired loans as of the dates indicated ( in thousands ).

Recorded

Balance

Unpaid Principal

Balance

Partial

Charge-Offs

Specific

Allowance

% of Specific

Allowance & Partial

Charge-off to Unpaid

Principal Balance

As of December 31, 2021

Loans without a valuation allowance

Loans with a valuation allowance

Total

As of December 31, 2020

Loans without a valuation allowance

Loans with a valuation allowance

Total

As indicated in the above table, during the periods presented, we have consistently maintained more than 2% of impaired loans in a reserve, either through a direct charge-off or in a specific reserve included as part of the allowance for loan losses. The total dollar amount of impaired loans increased $1.1 million, or 59.7%, to $2.8 million at December 31, 2021 compared to $1.8 million at December 31, 2020. The increase in impaired loans is attributable to loans becoming impaired during 2021 in excess of those that were paid off, charged off or returned to non-impaired status upon changes to borrowers’ status that made collectability of all amounts contractually due no longer in doubt.

REO

The tables below summarize the balances and activity in REO as of the dates and for the periods indicated ( in thousands ).

As of December 31,

Commercial real estate

Other construction and land

Total

As of December 31,

Balance, beginning of year

Additions

Disposals

Writedowns

Balance, end of year

As indicated in the above table, the balance in REO has totaled $0.8 million and $1.9 million at December 31, 2021 and 2020, respectively. We continue to write-down REO as needed and maintain focus on disposing of our remaining properties.

As of December 31, 2021, our REO property with the largest balance of $0.7 million consisted of approximately eight acres of commercial land with frontage on U.S. Highway 153 in Anderson, South Carolina. The property was acquired in October 2013.

Bank Owned Life Insurance (“BOLI”)

BOLI policies are recorded at book value based on cash surrender values provided by a third-party administrator. The assets of the separate BOLI account are invested in the Lincoln National Life Insurance Co. Investment Allocation account rated AA- which is composed primarily of U.S. Government agency sponsored funds and mortgage-backed securities fund. The assets in the general account are invested in four insurance carriers with ratings ranging from AA- to AA+. The assets of the hybrid account are invested in two different insurance carriers with ratings ranging from A+ to A++.

The following table summarizes the composition of BOLI as of the dates indicated ( in thousands ):

December 31,

Separate account

General account

Hybrid

Total

Net Deferred Tax Assets

Deferred income tax assets and liabilities are determined using the asset and liability method and are reported on a net basis in our consolidated balance sheets. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rates and laws. When deferred tax assets are recognized, they are subject to a valuation allowance based on management’s judgment as to whether realization is more likely than not. In determining the need for a valuation allowance, we consider the following sources of taxable income:

future reversals of existing taxable temporary differences;

future taxable income exclusive of reversing temporary differences and carryforwards;

taxable income in prior carryback years; and

tax planning strategies that would, if necessary, be implemented.

We determined a tax valuation allowance totaling $0.4 million and $0.3 million was required as of December 31, 2021 and 2020, respectively, related to state net operating losses of the Company.

Goodwill

Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as business combinations. Goodwill has an indefinite useful life and is evaluated for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount of the reporting unit exceeds its fair value. We had $0.7 million of goodwill as of December 31, 2021, and 2020.

Deposits

The following table presents average deposits by category, percentage of total average deposits and average rates for the periods indicated ( in thousands ).

For the Years Ended December 31,

Average

Balance

Percent of

Total

Average

Balance

Weighted

Average

Rate

Average

Balance

Percent of

Total

Average

Balance

Weighted

Average

Rate

Deposit type:

Savings accounts

Time deposits

Money market accounts

Interest-bearing demand accounts

Noninterest-bearing demand accounts

Total deposits

As indicated in the above table, average deposit balances increased approximately $158.3 million, or 18.5%, for the year ended December 31, 2021 compared December 31, 2020. The increase in total average deposits was mainly attributable to the $135.8 million, or 44.3%, increase in money market accounts and $75.4 million, or 42.9%, in noninterest-bearing demand accounts, offset by a $89.4 million, or 26.9%, decline in time deposits.

The following table presents details of the applicable interest rates on our certificates of deposit at the dates indicated ( in thousands ).

December 31,

Interest Rate:

Less than 1.00%

Total

The following table presents contractual maturities for certificates of deposit, as of December 31, 2021, in amounts equal to or greater than $250,000 ( in thousands ):

Equal to or

greater than

Three months or less

Over three months through six months

Over six months through one year

Over one year

Total

At December 31, 2021 and 2020, we estimate that we have approximately $393.8 million and $295.0 million, respectively, in uninsured deposits including related interest accrued and unpaid. Since it is not reasonably practicable to provide a precise measure of uninsured deposits, these amounts are estimates and are based on the same methodologies and assumptions used for the Bank’s regulatory reporting requirements by the FDIC for the Call Report.

Borrowings

We had fixed rate FHLB advances totaling $5.0 million and $16.0 million as of December 31, 2021 and 2020, respectively. FHLB advances are secured by qualifying one-to-four family permanent and commercial loans and by a blanket collateral agreement with the FHLB. At December 31, 2021, we had unused borrowing capacity with the FHLB of $30.7 million based on collateral pledged at that date. We had total additional credit availability with the FHLB of $355.7 million as of December 31, 2021, if additional collateral was available and pledged.

The following table sets forth information concerning balances and interest rates on our FHLB advances as of or for the period indicated ( in thousands ).

As of or for the

Year Ended

December 31,

Balance at end of period

Average balance during period

Maximum outstanding at any month end

Weighted average interest rate at end of period

Weighted average interest rate during period

Junior Subordinated Notes

We had $35.9 million and $35.7 million in three issuances of junior subordinated notes outstanding at December 31, 2021 and 2020. Notes totaling $8.2 million, payable to an unconsolidated subsidiary, accrue interest at 1.85% above the 90-day LIBOR, adjusted quarterly. Notes totaling $10.0 million accrue interest at a fixed rate of 6.50% until November 30, 2023, at which time the interest will accrue at 3.43% above the 90-day LIBOR, adjusted quarterly. Notes totaling $18.0 million issued in 2020 accrue interest at a fixed rate of 4.375% until November 15, 2025, at which time the interest will accrue at 4.16% above the 90-day Secured Overnight Financing Rate (SOFR), adjusted quarterly. The effective interest rate on the notes was 4.43% at December 31, 2021 and 4.44% at December 31, 2020.

Equity

Total shareholders’ equity increased $10.9 million to $97.4 million at December 31, 2021 compared to $86.5 million at December 31, 2020. This increase was primarily attributable to $16.1 million of net income partially offset by common and preferred stock repurchases of $4.0 million and dividends declared totaling $2.2 million.

Discussion of Results of Operation

Like most financial institutions, net interest income is our primary source of revenue. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest incurred on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends upon the relative mix of interest-earning assets and interest-bearing liabilities, the ratio of interest-earning assets to total assets and of interest-bearing liabilities to total funding sources, and movements in market interest rates. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction. Our asset and liability management committee (“ALCO”) seeks to manage interest rate risk under a variety of rate environments by structuring our balance sheet and off-balance sheet positions.

Average Balances and Net Interest Income Analysis

The following table sets forth the average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets on a tax-equivalent basis, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average tax-equivalent yields and cost for the periods indicated. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

For the Years Ended December 31,

(In thousands, fully taxable equivalent)

Average

Outstanding

Balance

Interest

Yield/

Rate

Average

Outstanding

Balance

Interest

Yield/

Rate

Average

Outstanding

Balance

Interest

Yield/

Rate

Interest-earning assets:

Loans - Core Bank (1)

Loans - CarBucks (2)

Investments - taxable

Investment tax exempt (3)

Federal funds sold and other interest earning deposits

Other investments, at cost

Total interest-earning assets

Noninterest-earning assets

Total assets

Interest-bearing liabilities:

Savings accounts

Time deposits

Money market accounts

Interest bearing transaction accounts

Total interest bearing deposits

FHLB advances

Junior subordinated debentures

Federal funds purcahsed

Total interest-bearing liabilities

Noninterest-bearing deposits

Other non interest bearing liabilities

Total liabilities

Total equity

Total liabilities and equity

Tax-equivalent net interest income

Net interest-earning assets (2)

Average interest-earning assets to interest-bearing liabilities

Tax-equivalent net interest rate spread (3)

Tax-equivalent net interest margin (4)

Tax exempt loans and investments are calculated giving effect to a 21% federal tax rate, or $74,000, $52,000, and $30,000 for the years ended December 31, 2021, 2020, and 2019, respectively.

Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

Tax-equivalent net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.

Tax-equivalent net interest margin represents tax equivalent net interest income divided by average total interest-earning assets.

For the years ended December 31, 2021, 2020 and 2019, we did not have any securities purchased with agreements to repurchase or commercial paper.

The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to change in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the absolute values of changes due to rate and the changes due to volume.

For the Year Ended December 31, 2021

For the Year Ended December 31, 2020

Compared to the Year Ended December 31, 2020

Compared to the Year Ended December 31, 2019

Increase (decrease) due to:

( In thousands )

Volume

Rate

Total

Volume

Rate

Total

Interest-earning assets:

Loans - Core Bank (1)

Loans - CarBucks (1)

Investment - taxable

Investments - tax exempt (2)

Interest-earning deposits

Other investments, at cost

Total interest-earning assets

Interest-bearing liabilities:

Savings accounts

Time deposits

Money market accounts

Interest bearing transaction accounts

FHLB advances

Junior subordinated debentures

Other borrowings

Total interest-bearing liabilities

Change in tax-equivalent net interest income

Nonaccrual loans are included in the above analysis.

Interest income on tax exempt loans and investments are adjusted for based on a 21% federal tax rate.

Comparison of Years Ended December 31, 2021 and 2020.

General . Net income for the year ended December 31, 2021 was $16.1 million, compared to $8.6 million for 2020. The increase in net income was primarily the result of increases in net interest income and noninterest income of $8.2 million and $1.3 million, respectively, and a decrease in provision for loan losses of $1.8 million, partially offset by increases in noninterest expense totaling $1.1 million.

Net Interest Income . Net interest income increased $8.2 million, or 19.6%, to $49.9 million for the year ended December 31, 2021, compared to $41.7 million for 2020. The increase in net interest income was primarily due to a $104.7 million increase in average loans, a $38.8 million increase in average investments, both taxable and tax exempt and decreases in costs on our average time deposits and money market accounts. These changes were partially offset by the decline in yields on our loans and investments during the period and a $82.9 million increase in our average interest-bearing liabilities.

Our tax-equivalent net interest margin was 4.44% for the year ended December 31, 2021, compared to 4.42% for 2020, an increase of two basis points. The increase in net interest margin was primarily attributable to interest rate reductions which impacted our cost of funds in the year ended December 31, 2021, partially offset by the impact of these interest rate reductions on our loans, investments, and interest-earning deposits.

CarBucks provides specialty floor plan inventory financing for more than 2,000 small automobile dealers in over 20 states. Credit lines are established for each approved dealer using Board approved underwriting guidelines. Advances and repayments on credit lines averaging $0.1 million are vehicle specific. The inventory typically consists of over 12,000 floored used vehicles with an average price of $8,400 per unit, generally has an average 61-day turnover, and generates approximately $250 in financing fees per vehicle which is included in loan interest income.

CarBucks net income increased $1.9 million to $5.3 million for the year ended December 31, 2021 compared to $3.5 million for the same period in 2020. Net interest income increased $2.3 million to $17.2 million for the 2021 period from $14.9 million for the same period a year ago primarily due to increased fees related to increases in inventory. Provision for loan losses decreased $0.6 million for the year ended December 31, 2021 compared to 2020 due to decreased net charge offs and lower qualitative adjustments related to COVID-19 uncertainty in 2021. Noninterest expense increased $0.3 million to $9.9 million for the 2021 period compared to $9.6 million for the same period in 2020 due primarily to increased salary and overhead allocation expenses.

Provision for Loan Losses . We recorded a provision for loan losses for the year ended December 31, 2021 of $1.3 million due to organic loan growth and certain qualitative adjustments in response to shifts in used car demand which could impact our CarBucks portfolio. This compares to a $3.1 million provision for loan losses in 2020. We are experiencing continued stabilization in asset quality, low charge-off amounts and a decline in the historical loss rates used in our allowance for loan losses model. In light of ongoing supply chain disruptions, labor shortages and the associated impact on monetary policy, there is a risk that loss rates could increase.

Noninterest Income

The following table summarizes the components of noninterest income and the corresponding changes between the years ended December 31, 2021 and 2020 ( in thousands ):

Years Ended December 31,

Change

Service charges on deposit accounts

Gain (loss) on sale of investment securities available for sale

Net gain on sale of loan portfolio

Net gain on settlement of litigation

Bank owned life insurance

Net gain on sale of premises and equipment

Other noninterest income

Total noninterest income

Our noninterest income increased $1.3 million to $3.8 million in the year ended December 31, 2021, compared to 2020. This increase was driven by a $1.2 million gain on sale of a portion of the loan portfolio and a $0.8 million gain on the settlement of litigation, partially offset by a $0.8 million loss on sale of investment securities available for sale.

Noninterest Expense

The following table summarizes the components of noninterest expense and the corresponding change between the years ended December 31, 2021 and 2020 ( in thousands ):

Years Ended December 31,

Change

Compensation and employee benefits

Net occupancy

Federal deposit insurance

Professional and advisory

Data processing

Marketing and advertising

Net cost of operation of REO

Other

Total noninterest expenses

Our noninterest expense increased $1.1 million to $31.1 million in the year ended December 31, 2021, compared to 2020.

Compensation and employee benefits increased $0.8 million, or 3.7%, for the year ended December 31, 2021 as compared to 2020. The increase is primarily related to increased full-time equivalent employees, annual raises and increases in employee benefits, incentives and commissions.

Federal deposit insurance premiums increased $0.1 million for the year ended December 31, 2021, compared to 2020, primarily due to higher deposit balances.

Professional and advisory expenses decreased $0.2 million for the year ended December 31, 2021, compared to 2020, primarily as a result of the reduced reliance on external advisors.

Data processing expenses increased $0.1 million for the year ended December 31, 2021, compared to 2020, primarily due to an increased number of accounts and transactions.

Marketing and advertising increased $22 thousand for the year ended December 31, 2021, compared to 2020, primarily due to sponsorship contributions and donations in 2021 that were not paid in 2020.

Net cost of operation of REO decreased $0.3 million for the year ended December 31, 2021, compared to 2020, primarily due to valuation adjustments for updated appraisals or sales contract amounts.

Other noninterest expense increased $0.4 million for the year ended December 31, 2021, compared to 2020, primarily as the result of software maintence and license fees and a one-time fee rated to the prepayment of FHLB advances, partially offset by a decrease in office supplies expense.

Income Taxes

Income tax expense totaled $5.2 million for the year ended December 31, 2021 compared to $2.5 million for 2020. Income tax expense for the years ending December 31, 2021 and 2020 benefited from tax-exempt income related to municipal bond investments and BOLI income resulting in effective tax rates of 24.3% and 22.4%, respectively. The increase in the effective tax rate is primarily attributable to the growth of taxable income exceeding that of nontaxable income.

We continue to have unutilized net operating losses for state income tax purposes and do not have a material current tax receivable or liability.

Liquidity, Market Risk, and Capital Resources

Liquidity . Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our ALCO, under the direction of our Chief Financial Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of the COVID-19 pandemic. We believe that, as of December 31, 2021, we have enough sources of liquidity to satisfy our liquidity needs for the next twelve months and thereafter.

We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and Federal Reserve Bank of Richmond (“FRB”) interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At December 31, 2021, cash and cash equivalents totaled $124.1 million. Included in this total was $102.5 million held at the FRB, $1.2 million held at the FHLB, and $16.9 million held at correspondent banks in interest-earning accounts.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our consolidated statements of cash flows included in our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. The following summarizes the most significant sources and uses of liquidity during the years ended December 31, 2021 and 2020 ( in thousands ):

Years Ended December 31,

Investing activities:

Purchases of investments

Maturities and principal repayments of investments

Sales of investments

Net increase in loans

Purchase of fixed assets

Redemption of other investments, at cost

Financing activities:

Net increase in deposits

Repurchase of common stock

Proceeds from issuance of subordinated debt

Proceeds from FHLB advances

Repayment of FHLB advances

Dividends paid on common stock

In addition, because the Company is a separate entity from the Bank, it must provide for its own liquidity. The Company is responsible for payment of dividends declared on its common and preferred stock and interest and principal on any outstanding debt or trust preferred securities. The Company currently has internal capital resources to meet these obligations. While the Company has access to capital, the ultimate sources of its liquidity are dividends from the Bank and tax allocation agreements, which are limited by applicable law and regulations. The Bank paid no dividends to the Company in 2021 or 2020.

At December 31, 2021, we had $327.6 million in outstanding commitments to extend credit through unused lines of credit and stand-by letters of credit.

During 2021, we entered into an agreement to fund capital contributions of up to $1 million with a financial technology company. As of December 31, 2021, none of the commitment has been funded. We will account for our ownership interest in the financial technology company in accordance with Subtopic 946-323 as an equity method investment. We have unfunded commitments of $1 million related to this agreement as of December 31, 2021.

Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of December 31, 2021.

In addition to loans, we invest in securities that provide a source of liquidity, both through repayments and as collateral for borrowings. Our securities portfolio includes both callable securities (which allow the issuer to exercise call options) and mortgage-backed securities (which allow borrowers to prepay loans). Accordingly, a decline in interest rates would likely prompt issuers to exercise call options and borrowers to prepay higher-rate loans, producing higher than otherwise scheduled cash flows.

Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have a borrowing agreement with the FHLB. The following summarizes our borrowing capacity as of December 31, 2021 ( in thousands ):

Total

Used

Unused

Capacity

FHLB

Loan collateral capacity

Pledgeable marketable securities

FHLB totals

Fed funds lines

Market Risk . One of the most significant forms of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest-sensitive income and expense levels. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive risk can threaten our earnings, capital, liquidity and solvency. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. The board of directors of the Bank has established an ALCO, which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Our ALCO monitors and seeks to manage market risk through rate shock analyses, economic value of equity analyses and simulations in order to avoid unacceptable earnings and market value fluctuations due to changes in interest rates.

From a funding perspective, we expect to satisfy the majority of our future requirements with retail deposit growth, including checking and savings accounts, money market accounts and certificates of deposit generated within our primary markets. If our funding needs exceed our deposits, we will utilize our excess funding capacity with the FHLB.

We have taken the following steps to reduce our interest rate risk:

increased our personal and business checking accounts and our money market accounts, which are less rate-sensitive than certificates of deposit and which provide us with a stable, low-cost source of funds;

limited the fixed rate period on loans within our portfolio;

utilized our securities portfolio for positioning based on projected interest rate environments;

priced certificates of deposit to encourage customers to extend to longer terms; and

utilized FHLB advances for positioning.

Net Interest Income . We analyze the impact of changing rates on our net interest income. Using our balance sheet as of a given date, we analyze the repricing components of individual assets, and, adjusting for changes in interest rates at 100 basis point increments, we analyze the impact on our net interest income. Changes to our net interest income are shown in the following table based on immediate changes to interest rates in 100 basis point increments.

The table below reflects the impact of an immediate increase in interest rates in 100 basis point increments on Pretax Net Interest Income (“NII”).

December 31,

Change in Interest Rates

(basis points)

% Change in

Pretax Net

Interest Income

% Change in

Pretax Net

Interest Income

The results from the rate shock analysis on NII are consistent with having an asset sensitive balance sheet. Having an asset sensitive balance sheet means assets will reprice at a faster pace than liabilities during the short-term horizon. The implications of an asset sensitive balance sheet will differ depending upon the change in market rates. For example, with an asset sensitive balance sheet in a declining interest rate environment, the interest rate on assets will decrease at a faster pace than liabilities. This situation generally results in a decrease in NII and operating income. Conversely, with an asset sensitive balance sheet in a rising interest rate environment, the interest rate on assets will increase at a faster pace than liabilities. This situation generally results in an increase in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 5.9% increase in NII as of December 31, 2021 as compared to a 5.4% increase in NII as of December 31, 2020, suggesting that there is a benefit for the Company to net interest income in rising interest rates The Company generally seeks to remain neutral to the impact of changes in interest rates by maximizing current earnings while balancing the risk of changes in interest rates.

Capital Resources . Regulatory capital rules adopted in July 2013 and fully-phased in as of January 1, 2019, which we refer to as the Basel III rules or 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). 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 common equity Tier 1 equal to 2.5% of risk-weighted assets.

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based guidelines and framework under prompt corrective action provisions include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.

The tables below summarize the capital amounts and ratios of the Bank and the minimum regulatory requirements in accordance with Basel III and the prompt corrective action provisions at December 31, 2021 and 2020 ( in thousands ).

Actual

For Capital Adequacy

Purposes (1)

To Be Well-

Capitalized Under

Prompt Corrective

Action Provisions

As of December 31, 2021:

Amount

Ratio

Amount

Ratio

Amount

Ratio

Tier 1 Leverage Capital

Common Equity Tier 1 Capital

Tier 1 Risk-based Capital

Total Risk-based Capital

As of December 31, 2020:

Tier 1 Leverage Capital

Common Equity Tier 1 Capital

Tier 1 Risk-based Capital

Total Risk-based Capital

Includes capital conservation buffer of 2.50%.

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 Company is not subject to the prompt corrective action provisions applicable to the Bank. The tables below summarize the capital amounts and ratios of the Company and the minimum regulatory requirements in accordance with Basel III at December 31, 2021 and December 31, 2020 ( in thousands).

Actual

For Capital Adequacy

Purposes (1)

As of December 31, 2021:

Amount

Ratio

Amount

Ratio

Tier I Leverage Capital

Common Equity Tier 1 Capital

Tier I Risk-based Capital

Total Risk Based Capital

As of December 31, 2020:

Tier I Leverage Capital

Common Equity Tier 1 Capital

Tier I Risk-based Capital

Total Risk Based Capital

Includes capital conservation buffer of 2.50%.

Off-Balance Sheet Arrangements

To accommodate the financial needs of our customers, we make commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since we expect many of these commitments to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness and the amount of collateral we obtain, if we deem it to be necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family residential real estate, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.

The following summarizes our approximate commitments to extend credit ( in thousands ):

December 31,

Lines of credit

Standby letters of credit

Grandsouth Bancorporation

Annual report (10-K)

Top insiders

All filings

Risk Factors (Item 1A)

MD&A (Item 7)

External resources

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