First Reliance Bancshares, Inc.
Annual Report 2019

Plain-text annual report

To Our Shareholders I am pleased to report that our company had an exceptional year, highlighted by outstanding financial performance, the addition of key team members and significant progress toward strategic initiatives. Our achievements are a testament to our vision for the company, our ability to execute our long-term plan, and our commitment to shareholder value. We are extremely well-positioned for the future in spite of the recent economic impact from the coronavirus. Much of our success can be attributed to the tireless commitment of our associates, who focus their efforts every day on our core purpose, which is “to make the lives of our customers better.” By putting our customers first, we continue to set ourselves apart from our competitors, providing intangible benefits that go beyond dollars and cents. We continue to be recognized for our excellent corporate culture as evidenced by our being named one of the Best Places to Work in South Carolina for the 14th consecutive year! In our 20-year history, 2019 was pivotal. We began to realize the benefits of our Greenville acquisition, as well as our expansions into Winston-Salem, Myrtle Beach and the Lake Norman area - all of which helped us grow total assets by 13% to $661.6 million. Although we are excited about our success, we recognize that we have significant challenges ahead, including economic uncertainty, increased competition, and an ever-complex regulatory environment. We are well positioned to meet these challenges and continue to achieve our goals of growth, profitability and efficiency. Our Markets The markets we serve are one of our greatest strengths. We now have banking operations in three of the fastest growing metropolitan statistical areas (MSA) in the United States (Myrtle Beach, Charleston and Charlotte). Our Myrtle Beach market grew loans this year by $15 million and deposits by $8 million. We are finalizing our plans for a new Myrtle Beach branch on Grissom Parkway that will be constructed in 2020. The investment we made in North Carolina last year continues to pay off as the market grew loans by $40 million and deposits by $9 million. We will relocate our Winston-Salem branch to a new expanded, full-service location, which will better position us for growth. We are also looking for branch sites in the Lake Norman area. i Financial Strength Net Income Net income for 2019 grew $4.1 million or $0.51 per diluted share compared to $0.31 per diluted share for the same period a year ago, a 65% increase. That was despite a one-time mortgage servicing rights (MSR) valuation adjustment totaling $1.1 million, and a declining rate environment which saw a 75% basis point decline in interest rates by the Federal Reserve in the second part of the year. Loan Growth We had an exceptional year of loan growth in both our new and existing markets, growing loans by $49.3 million, 11.4% overall, in a highly competitive market. Most of this loan growth came organically through our commercial, mortgage and consumer loan portfolios. Total loans grew to $480,185,395. While loans increased, our asset quality remained strong with non- performing assets declining overall by $451,000 to 0.28% compared to 0.39% a year ago. Deposit Growth Total deposits increased 6.1% to $505.1 million while growing our non-interest bearing transaction accounts by 33%. We intentionally reduced our exposure to higher cost deposits during the second half of the year to lower our cost of funds going into 2020. ii Tangible Book Value One of the best measures of our success in building value for our shareholders is tangible book value per share. In 2019, we successfully grew tangible book value per share by 10.6% or $6.76. This reflects the strong underlying performance of our business. Assets We achieved double-digit asset growth in 2019, with assets growing by $76.6 million, or 13.1% to $661.6 million. Our sales and marketing efforts have been laser focused this year on winning the main checking account for consumers and businesses. Treasury services saw double-digit growth in commercial deposit accounts and treasury service products. Our average services per household are now 5.6, which is a good indication that our customers are doing more business with us overall and like our brand of banking. Our Mortgage Business Mortgage production in 2019 was robust. With a favorable mortgage rate environment, production totaled $363 million, which exceeded our forecast by $100 million. We expect favorable rates to continue into 2020 and for the refinance market to heat up, which should bode well for our mortgage production team. Our People Another key indicator of our success and momentum is our ability to attract and recruit talented and experienced people to our team. This year we welcomed Robert Dozier as our Executive Vice President and Chief Banking Officer. Robert has over 30 years of financial service experience. He iii most recently served as Executive Vice President and Chief Business Officer at the Federal Home Loan Bank of Atlanta (FHLBA) where he oversaw Sales, Corporate Communications, Community Investment Services, Government Relations and Financial Operations Management. The FHLBA is a $135 billion dollar wholesale bank owned by 850 financial service institutions throughout the Southeast. He will be responsible for the bank's commercial platform, corporate strategy and strategic market expansion of our footprint. In addition, Brent Mackie joined us as our Regional Executive Midlands. Brenton has more than 30 years of banking experience having previously served as Regional President and Senior Vice President for South State Bank, where he managed and supported the commercial, consumer, mortgage and wealth management lines of business. Most recently, we announced that Frank Bullard has joined us as Market President for Charleston, SC. Frank is responsible for the strategic market expansion of our footprint in the Charleston market, and he will oversee sales management and community development throughout that footprint. Frank has more than 37 years of experience in the banking industry. He began his career in BB&T’s Management Development Program in 1981 and has served in retail and commercial banking roles in both Carolinas. He was Market President for the Charleston/Coastal markets prior to his retirement in 2019. Frank has had an incredible banking career, and we are honored and excited that he is willing to come out of retirement to assist First Reliance Bank as we continue our progress in the Charleston region. We are excited about all of the new opportunities these talented and highly experienced bankers add to our team. As the banking industry continues to evolve, will continue to seek out and recruit the very best people available and continue to strengthen our team. Commitment to Technology Technology continues to be a hot topic in the banking world. As we look to 2020 and beyond, it is clear that we are undergoing a period of transformative change in the way consumers behave and use technology. Customer expectations of a bank’s technology platform continue to rise. The big four continue to invest heavily in consumer-facing technology to win the retail-banking customer. Many community banks are handcuffed with old technology provided by their core operating systems. Much of this technology is outdated and inferior to what the larger banks are now offering. Although building personal relationships in the communities we serve will continue to be our top priority, we have made the commitment to pursue best-in-class technology solutions for our customers and not be locked into any one provider. This will allow us the flexibility to offer innovative solutions and an excellent experience to our customers. We have already begun to vet options and plan to roll out significant enhancements in 2020. iv Our Brand We understand the important role that community banks play in the communities they serve. With many of our community bank competitors being acquired by larger banks in 2019, we believe that our brand has the unique opportunity to fill the voids left in our markets. We are still small enough to properly serve the community banking needs of individuals and small businesses in our local markets, and yet big enough to have the resources that will best enable our customers to succeed. Our customers love our brand and the way we do business. 90% of our customers indicating that they are satisfied with their level of service and 81% stating that they are likely to recommend us to their friends and family. In 2019 we leveraged new digital platforms to enhance our brand awareness, which significantly helped us to grow our non-interest bearing transaction accounts. We plan to continue this effort in 2020. A New World As we look ahead to 2020 our world is experiencing unprecedented disruption because of COVID-19. Americans and people around the world are being asked and/or forced to shelter in place, social distance themselves and avoid unnecessary travel. Our global economic outlook is uncertain. But what is certain is that many of our customers and our communities are being negatively impacted. As a result, we have stepped up to help. We are proactively calling our business customers to check in on them and invite help. We have initiated community-wide efforts to support local restaurants, teachers and healthcare workers, and we stand ready to provide more help where needed. As difficult and uncertain as the road before us might be, we have never been more prepared to help make the lives of our customers BETTER. The year ahead will be full of new challenges. However, through strong leadership, our fully engaged team of associates and our focus on results, we have never been better positioned for success. Thank you for the support you show our associates, our bank and me. Thank You and Best Regards, F.R. “Rick” Saunders Jr. President & CEO v First Reliance Bancshares, Inc. and Subsidiary Report on Consolidated Financial Statements For the years ended December 31, 2019 and 2018 First Reliance Bancshares, Inc. and Subsidiary Contents Page Independent Auditor’s Report .............................................................................................................................. 1-2 Consolidated Financial Statements Consolidated Balance Sheets ............................................................................................................................... 3 Consolidated Statements of Operations .............................................................................................................. 4 Consolidated Statements of Comprehensive Income ......................................................................................... 5 Consolidated Statements of Changes in Shareholders' Equity ............................................................................ 6 Consolidated Statements of Cash Flows .......................................................................................................... 7-8 Notes to Consolidated Financial Statements ................................................................................................. 9-56 Independent Auditor's Report The Board of Directors and Shareholders First Reliance Bancshares, Inc. and Subsidiary Florence, South Carolina Report on the Consolidated Financial Statements We have audited the accompanying consolidated financial statements of First Reliance Bancshares, Inc. and its Subsidiary which comprise the consolidated balance sheets as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended and the related notes to the consolidated financial statements (collectively, “the financial statements”). Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. elliottdavis.com Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Reliance Bancshares, Inc. and its Subsidiary as of December 31, 2019 and 2018, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Columbia, South Carolina March 31, 2020 2 First Reliance Bancshares, Inc. and Subsidiary Consolidated Balance Sheets As of December 31, 2019 and 2018 Assets Cash and cash equivalents: Cash and due from banks Interest-bearing deposits with other banks Total cash and cash equivalents Time deposits in other banks Marketable equity securities Securities available-for-sale Securities held-to-maturity (fair value of $10,746,649, and $14,250,850 at December 31, 2019 and 2018, respectively) Nonmarketable equity securities Total investment securities Mortgage loans held for sale Loans receivable Less allowance for loan losses Loans, net Premises, furniture and equipment, net Accrued interest receivable Other real estate owned Cash surrender value life insurance Net deferred tax assets Mortgage servicing rights Core deposit intangibles Goodwill Right of use asset Other assets Total assets Liabilities and Shareholders’ Equity Liabilities Deposits Noninterest-bearing transaction accounts Interest-bearing transaction accounts Savings Time deposits $250,000 and over Other time deposits Total deposits Securities sold under agreement to repurchase Advances from Federal Home Loan Bank Federal Funds Purchased Subordinated debentures Junior subordinated debentures Accrued interest payable Lease liability Other liabilities Total liabilities Shareholders’ Equity Preferred stock Series D non-cumulative preferred stock, no par value; 572 and 581 shares issued and outstanding at December 31, 2019 and 2018, respectively Common stock, $0.01 par value; 20,000,000 shares authorized, 8,033,579 and 8,002,172 shares issued and outstanding at December 31, 2019 and 2018, respectively Non voting common stock, $0.01 par value; 430,000 shares authorized, 410,499 and 410,499 shares issued and outstanding at December 31, 2019 and 2018, respectively Capital surplus Treasury stock, at cost, 183,591 and 94,505 shares at December 31, 2019 and 2018, respectively Nonvested restricted stock Retained earnings Accumulated other comprehensive income (loss) Total shareholders’ equity Total liabilities and shareholders’ equity See Notes to Consolidated Financial Statements 3 2019 2018 $ $ $ $ 12,945,355 27,395,328 40,340,683 253,911 30,895 35,684,146 10,417,168 2,423,200 48,555,409 27,901,419 480,185,395 (3,529,855) 476,655,540 20,420,506 1,473,581 347,552 17,692,385 6,579,640 11,022,638 513,035 690,917 5,669,144 3,496,549 661,612,909 137,312,316 89,168,078 120,472,195 36,317,110 121,817,938 505,087,637 14,637,332 43,300,000 16,500,000 4,965,214 10,310,000 416,302 5,701,327 3,609,637 604,527,449 572 80,336 4,105 51,136,879 (1,283,469) (1,253,706) 8,092,455 308,288 57,085,460 661,612,909 $ $ $ $ 4,638,332 29,923,656 34,561,988 253,003 168,151 33,388,645 14,107,252 1,393,500 49,057,548 12,713,361 430,795,891 (2,788,188) 428,007,703 20,310,879 1,318,104 341,519 17,306,312 7,923,572 9,023,859 684,217 690,917 - 2,796,830 584,989,812 103,201,256 83,251,127 120,801,341 42,870,456 126,044,529 476,168,709 16,852,981 20,000,000 - 4,934,877 10,310,000 447,883 - 4,106,913 532,821,363 581 80,022 4,105 50,904,763 (624,120) (1,508,630) 4,003,616 (691,888) 52,168,449 584,989,812 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Operations For the years ended December 31, 2019 and 2018 Interest income: Loans, including fees Investment securities: Taxable Tax exempt Other interest income Total Interest expense: Time deposits Other deposits Other interest expense Total Net interest income Provision for loan losses Net interest income after provision for loan losses Noninterest income: Service charges on deposit accounts Income from mortgage operations Income from bank owned life insurance Gain on sale of investment securities Mortgage servicing rights fair value adjustment Other service charges, commissions, and fees Other Total Noninterest expenses: Salaries and benefits Occupancy Furniture and equipment related expenses Acquisition-related costs Other Total Income before income taxes Income tax expense Net income Average common shares outstanding, basic Average common shares outstanding, diluted Income per common share: Basic income per common share Diluted income per common share See Notes to Consolidated Financial Statement 4 2019 2018 $ 26,189,861 $ 22,010,885 1,197,956 136,964 329,038 27,853,819 4,071,602 562,913 1,322,522 5,957,037 1,039,259 147,950 426,598 23,624,692 2,191,437 534,572 964,475 3,690,484 21,896,782 19,934,208 983,803 510,356 20,912,979 19,423,852 1,681,812 6,900,740 386,073 37,245 (1,307,299) 1,548,202 456,192 9,702,965 15,369,271 2,376,794 1,821,523 - 5,706,284 25,273,872 1,597,211 4,813,820 390,557 800,000 324,840 1,510,405 487,529 9,924,362 15,373,131 2,227,135 2,021,351 1,005,195 5,549,562 26,176,374 5,342,072 3,171,840 1,253,233 741,606 $ 4,088,839 $ 2,430,234 7,937,617 7,738,547 8,062,486 7,867,586 $ $ 0.52 0.51 0.31 0.31 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Comprehensive Income For the years ended December 31, 2019 and 2018 Net income Other comprehensive loss, net of tax: Securities available-for-sale Unrealized holding losses arising during the period Income tax benefit Net of income taxes Securities held-to-maturity Amortization of net unrealized gains capitalized on securities transferred from available-for-sale Income tax benefit Net of income taxes Other comprehensive income (loss) 2019 2018 $ 4,088,839 $ 2,430,234 1,373,026 (336,391) 1,036,635 (449,738) 67,265 (382,473) (49,616) 13,157 (36,459) (14,987) 3,680 (11,307) 1,000,176 (393,778) Comprehensive income $ 5,089,015 $ 2,036,454 See Notes to Consolidated Financial Statements 5 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Changes in Shareholders’ Equity For the years ended December 31, 2019 and 2018 Preferred Stock Common Stock Capital Surplus Treasury Stock Nonvested Restricted Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Balance, December 31, 2017 $ 2,956,192 $ 78,875 $ 46,941,229 $ (229,844) $ (868,399) $ 1,573,382 $ (298,110) $ 50,153,325 Net income Other comprehensive loss, net of tax Conversion of Preferred Stock - Series E to Common Stock Conversion of Preferred Stock - Series D to Common Stock Net issuance of Common Stock Net change in restricted stock Stock based compensation Purchase of Treasury Stock - - - - - - (2,955,593) 4,105 2,951,488 (18) 18 - 1,129 954,314 - 57,732 - - - - - (394,276) - - - - - - - - 9 - - - 305 173,432 - 58,684 Net income Other comprehensive income, net of tax Conversion of Preferred Stock - Series D to Common Stock Net issuance of Common Stock Net change in restricted stock Stock based compensation Purchase of Treasury Stock - - (9) - - - - - - - - - - - - - - - - - - 2,430,234 - 2,430,234 - - - - (640,231) - - - (393,778) (393,778) - - - - - - - - - - - - - - 955,443 (640,231) 57,732 (394,276) - 4,088,839 - 4,088,839 - - - 254,924 - - - 1,000,176 1,000,176 - - - - - - - - - - - 173,737 254,924 58,684 (659,349) Balance, December 31, 2018 581 84,127 50,904,763 (624,120) (1,508,630) 4,003,616 (691,888) 52,168,449 - (659,349) Balance, December 31, 2019 $ 572 $ 84,441 $ 51,136,879 $ (1,283,469) $ (1,253,706) $ 8,092,455 $ 308,288 $ 57,085,460 See Notes to Consolidated Financial Statements 6 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Cash Flows For the years ended December 31, 2019 and 2018 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash used in operating activities: Provision for loan losses Depreciation and amortization expense Gain on fair value of marketable equity securities Discount accretion and premium amortization Discount accretion on purchased loans Amortization of lease liability Net gain on sale of other real estate owned Gain on investment securities Write down of other real estate owned Originations of mortgages held for sale Proceeds from sales of mortgages held for sale Gain on sale of mortgage loans Core deposit intangible amortization Deferred income taxes, net of allowance Increase in interest receivable Increase (decrease) in interest payable Increase in cash surrender value of life insurance Stock based compensation expense (Increase) decrease in other assets Increase in mortgage servicing rights, net Decrease in other liabilities Net cash used in operating activities Cash flows from investing activities: Purchases of securities available-for-sale Maturities of securities available-for-sale Maturities of securities held-to-maturity Proceeds on sales of securities available-for-sale Proceeds from sale of marketable equity securities Purchase of trust preferred security Proceeds from sale of trust preferred security Net increase in nonmarketable equity securities Net (increase) decrease in time deposits in other banks Net increase in loans receivable Purchases of premises, furniture and equipment Proceeds from disposal of premises, furniture and equipment Net cash from acquisition of Independence Bancshares, Inc. Proceeds from sale of other real estate owned Net cash used in investing activities See Notes to Consolidated Financial Statements 7 2019 2018 $ 4,088,839 $ 2,430,234 983,803 814,612 (13,410) 60,105 277,741 491,586 (27,676) (23,834) 500 (362,990,674) 353,530,732 (5,728,116) 171,182 1,020,697 (155,477) 31,581 (386,073) 58,684 (712,875) (1,998,779) (497,277) (11,004,129) (8,289,581) 5,840,439 3,643,639 1,485,000 153,332 - - (1,029,700) (908) (50,092,638) (990,793) 66,554 - 204,400 (49,010,256) 510,356 900,631 (38,151) 97,010 206,394 - (203,685) (800,000) - (262,987,343) 263,027,079 (4,867,159) 195,783 670,812 (94,058) 177,054 (390,557) 57,732 650,503 (2,666,193) (40,053) (3,163,611) (9,947,760) 13,148,433 2,854,814 - - (2,300,000) 3,100,000 (34,300) 4,349,017 (44,964,315) (1,139,657) - 2,118,594 2,618,946 (30,196,228) First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Cash Flows For the years ended December 31, 2019 and 2018 Cash flows from financing activities: Net increase (decrease) in demand deposits, interest-bearing transaction accounts and savings accounts Net (decrease) increase in certificates of deposit and other time deposits Net increase (decrease) in advances from Federal Home Loan Bank Net increase in federal funds purchased Net increase in securities sold under agreements to repurchase Net proceeds from issuance of common stock Decrease of restricted stock Accretion of debt issuance costs Purchase of treasury stock Net cash provided by financing activities Net increase cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Cash paid during the year for: Income taxes Interest Supplemental noncash investing and financing activities: Transfer from loans to other real estate owned Net change in unrealized gains (losses) on investment securities Initial recognition of right-of-use asset Initial recognition of lease liability 2019 2018 39,698,865 (10,779,937) 23,300,000 16,500,000 (2,215,649) 173,737 (254,924) 30,337 (659,349) 65,793,080 (20,352,894) 63,189,511 (2,000,000) - 2,923,330 955,443 (640,231) 22,914 (394,276) 43,703,797 5,778,695 9,931,169 34,561,988 24,630,819 $ 40,340,683 $ 34,561,988 $ $ (44,786) $ 5,988,618 8,448 3,496,280 $ 183,257 1,000,176 6,192,913 6,192,913 395,565 (393,778) - - See Notes to Consolidated Financial Statements 8 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies Organization: First Reliance Bancshares, Inc. (the “Company”) was incorporated under the laws of the State of South Carolina on April 12, 2001 to serve as a bank holding company for its subsidiary, First Reliance Bank (the “Bank”), and acquired all of the shares of the Bank on April 1, 2002 in a statutory share exchange. First Reliance Bank was incorporated on August 9, 1999 and commenced business on August 16, 1999. The principal business activity of the Bank is to provide banking services to domestic markets throughout South Carolina and North Carolina. The Bank is a South Carolina chartered commercial bank, and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). The consolidated financial statements include the accounts of the parent company and its wholly-owned subsidiary after elimination of all significant intercompany balances and transactions. In 2005, the Company formed First Reliance Capital Trust I (the "Trust") for the purpose of issuing trust preferred securities. In accordance with current accounting guidance, the Trust is not consolidated in these financial statements. Management’s Estimates: The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans, including valuation allowances for impaired loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans and evaluating other-than-temporary- impairment of investment securities. In connection with the determination of the allowances for losses on loans and valuation of foreclosed real estate, management obtains independent appraisals in accordance with regulatory policy. Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment. While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowances may be necessary, based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for losses on loans and foreclosed real estate may change materially in the near term. Concentrations of Credit Risk: Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of loans receivable, investment securities, federal funds sold and amounts due from banks. The Company makes loans to individuals and small businesses for various personal and commercial purposes primarily throughout South Carolina and North Carolina. At December 31, 2019 and 2018, the majority of the total loan portfolio was to borrowers from within these areas. 9 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Concentrations of Credit Risk, continued: The Company’s loan portfolio is not concentrated in loans to any single borrower or a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to groups of borrowers or industries that would also be affected by sector-specific economic conditions. In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, management monitors exposure to credit risk from concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g., principal deferral periods, loans with initial interest-only periods, etc.), and loans with high loan-to-value ratios. Management has determined that there is minimal concentration of credit risk associated with its lending policies or practices. There are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rate principal- amortizing loans with maturities prior to the loan being fully paid (i.e., balloon payment loans). These loans are underwritten and monitored to manage the associated risks and management believes that these particular practices do not subject the Company to unusual credit risk. The Company’s investment portfolio consists principally of obligations of the United States and its agencies or its corporations and obligations of state and local governments. In the opinion of management, there is no concentration of credit risk in its investment portfolio. The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant. Debt Securities Available-for-Sale: Debt securities available-for-sale are carried at amortized cost and adjusted to fair value by recognizing the aggregate unrealized gains or losses in a valuation account. Aggregate market valuation adjustments are recorded as part of accumulated other comprehensive income in shareholders’ equity, net of deferred income taxes. Reductions in market value considered by management to be other than temporary are reported as a realized loss and a reduction in the cost basis of the security. The adjusted cost basis of investments available-for-sale is determined by specific identification and is used in computing the gain or loss upon sale. Debt Securities Held-to-Maturity: Investment securities held-to-maturity are stated at cost, adjusted for amortization of premium and accretion of discount computed by the straight-line method. The Company has the ability and management has the intent to hold designated investment securities to maturity. Reductions in market value considered by management to be other than temporary are reported as a realized loss and a reduction in the cost basis of the security. Marketable Equity Securities: Marketable equity securities are carried at fair value, with changes in fair value recorded through the consolidated statements of operations. Dividends received on marketable equity securities are included as a separate component of interest income. 10 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Nonmarketable Equity Securities: At December 31, 2019 and 2018, nonmarketable equity securities consist of the following: Federal Home Loan Bank stock Community Bankers Bank stock Total 2019 2018 $ 2,365,100 58,100 $ 2,423,200 $ 1,335,400 58,100 $ 1,393,500 Nonmarketable equity securities are carried at cost since no quoted market value and no ready market exists. Investment in the Federal Home Loan Bank of Atlanta (“FHLB”) is a condition to borrowing from that bank, and the stock is pledged to collateralize such borrowings. Dividends received on nonmarketable equity securities are included as a separate component of interest income. Loans Receivable: Loans receivable are stated at their unpaid principal balance, net of charge offs. Interest income is computed using the simple interest method and is recorded in the period earned. When serious doubt exists as to the collectability of a loan or when a loan becomes contractually 90 days past due as to principal or interest, interest income is discontinued unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest. When interest accruals are discontinued, income earned but not collected is reversed. Loans are removed from nonaccrual status when they become current as to both principal and interest, when concern no longer exists as to the collectability of the principal and interest, and after a sufficient history of satisfactory payment performance has been established. Loan origination and commitment fees and certain direct loan origination costs are deferred and amortized as an adjustment of the related loan yields. Generally, these amounts are amortized over the contractual life of the related loans or commitments. The Company identifies impaired loans through its normal internal loan review process. Loans on the Company’s problem loan watch list are considered potentially impaired loans. These loans are evaluated in determining whether all outstanding principal and interest are expected to be collected. Loans are not considered impaired if a minimal payment delay occurs and all amounts due, including accrued interest at the contractual interest rate for the period of delay, are expected to be collected. Allowance for Loan Losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the collectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. 11 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Allowance for Loan Losses, continued: 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 the 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. The allowance consists of specific and general components. The specific component relates to loans that are classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows or collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement. In situations where, for economic or legal reasons related to a borrower’s financial difficulties, a concession to the borrower is granted that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring. The restructuring of a loan may include the transfer from the borrower to the Company of real estate, receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan, modification of the loan terms, or a combination of the above. Premises, Furniture and Equipment: Premises, furniture and equipment are stated at cost, less accumulated depreciation. The provision for depreciation is computed by the straight-line method, based on the estimated useful lives for buildings of 40 years and for furniture and equipment of 5 to 10 years. Leasehold improvements are amortized over the term of the lease. The cost of assets sold or otherwise disposed of and the related allowance for depreciation is eliminated from the accounts and the resulting gains or losses are reflected in the consolidated statements of operations when incurred. Maintenance and repairs are charged to current expense. The costs of major renewals and improvements are capitalized based upon the Company's policy. 12 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Other Real Estate Owned: Other real estate owned includes real estate acquired through foreclosure. Other real estate owned is carried at the lower of cost or the fair market value minus estimated costs to sell. Any write-downs at the date of foreclosure are charged to the allowance for loan losses. Expenses to maintain such assets and subsequent changes in the valuation allowance are included in other noninterest expense along with gains and losses on disposal. Cash Surrender Value of Life Insurance: Cash surrender value of life insurance represents the cash value of policies on certain current and former officers of the Company. Residential Mortgage Loans Held for Sale: Loans held for sale represent loans originated or acquired by the Company with the intent to sell. The Company has elected the lower of cost or market in accounting for residential mortgage loans held for sale. These loans are initially recorded and carried at lower of cost of market value, with changes in fair value recognized in income from mortgage operations. Loan origination fees are recorded when earned. The Company issues rate lock commitments to borrowers on prices quoted by secondary market investors. Derivatives related to these commitments are recorded as either assets or liabilities in the balance sheet and are measured at fair value. Changes in the fair value of the derivatives are reported in current income or other comprehensive income depending on the purpose for which the derivative is held. The Company does not currently engage in any activities that qualify for hedge accounting. Accordingly, changes in fair value of these derivative instruments are included in noninterest income in the consolidated statements of operations. Mortgage Servicing Rights: Mortgage servicing rights (“MSRs”) represent the present value of the future net servicing fees from servicing mortgage loans. Servicing assets and servicing liabilities must be initially measured at fair value, if practicable. For subsequent measurements, an entity can choose to measure servicing assets and liabilities based on fair value. The Company uses the fair value measurement option for MSRs. The methodology used to determine the fair value of MSRs is subjective and requires the development of a number of assumptions, including anticipated prepayments of loan principal. Fair value is determined by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates and other assumptions validated through comparison to trade information, industry surveys and with the use of independent third party appraisals. Risks inherent in the MSRs’ valuation include higher than expected prepayment rates and/or delayed receipt of cash flows. The value of MSRs is significantly affected by mortgage interest rates available in the marketplace, which influence mortgage loan prepayment speeds. In general, during periods of declining interest rates, the value of mortgage servicing rights declines due to increasing prepayments attributable to increased mortgage refinance activity. Conversely, during periods of rising interest rates, the value of servicing rights generally increases due to reduced refinance activity. MSRs are carried at fair value with changes in fair value and servicing fees (cost) recorded on the consolidated statements of operations. 13 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Core Deposit Intangible: As a result of an acquisition, the Company may recognize an intangible asset representing the estimated value of core deposits assumed. The Company amortizes the intangible assets over their estimated useful lives. Core deposit intangibles are periodically reviewed for reasonableness and are evaluated for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. Goodwill: Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Goodwill is not amortized but tested for impairment on an annual basis, or more often, if events or circumstances indicate there may be impairment. Goodwill impairment exists when a reporting unit’s carrying value of goodwill exceeds its implied fair value. Authoritative guidance governing the testing of indefinite lived intangible assets for impairment allows the option to first assess Goodwill by utilizing qualitative factors in determining if it is more likely than not that carrying value exceeds fair value. If, through this analysis, it is determined that it is more likely than not that carrying value exceeds fair value, then the next step requires estimation of the fair value of the reporting unit by quantitative assessment. If the fair value of the reporting unit exceeds its carrying value, no further testing is required. If the carrying value exceeds the fair value, further analysis is required to determine whether an impairment charge must be recorded based upon the implied fair value of goodwill and, if so, the amount of such charge. The Company has performed the annual impairment analysis as of December 31, 2019 and concluded no impairment exists. Liabilities for Representations and Warranties: The Company is exposed to certain liabilities under representations and warranties made to purchasers of mortgage loans and servicing rights that require indemnification or repurchase of loans. At the time it issues a guarantee, the Company is required to recognize an initial liability for the fair value of obligations assumed under the guarantee. The Company establishes a contingency reserve for its liabilities under representations and warranties provided to purchasers of its mortgage loans and servicing rights. This reserve is maintained at a level considered appropriate by management to provide adequately for known and inherent losses. The reserve is based upon a continuing review of past loss experience, estimates and assumptions of risk elements and future economic conditions. Additions to the reserve are recorded in other expenses. Management's judgment about the adequacy of the reserve is based upon a number of assumptions about future events which it believes to be reasonable but which may or may not be accurate. There is no assurance that additional increases in the reserve will not be required. The Company may from time-to-time be required to repurchase mortgage loans previously sold to investors due to loan nonperformance. At December 31, 2019, the Company had $0, recorded for potential indemnifications to other third-party purchasers based on management’s analysis. 14 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Income Taxes: Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the amount of taxable income and pretax financial income and between the tax bases of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Interest and penalties related to income tax matters are recognized in income tax expense. Advertising Expense: Advertising and public relations costs are generally expensed as incurred. External costs incurred in producing media advertising are expensed the first time the advertising takes place. External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent. Advertising and public relations costs of $200,187 and $306,278 were included in the Company's results of operations for 2019 and 2018, respectively. Retirement Benefits: A trusteed retirement savings plan is sponsored by the Company and provides retirement benefits to substantially all officers and employees who meet certain age and service requirements. The plan includes a “salary reduction” feature pursuant to Section 401(k) of the Internal Revenue Code. In 2004, the Company converted the 401(k) plan to a 404(c) plan. The 404(c) plan changes investment alternatives to include the Company's stock. Under the plan and present policies, participants are permitted to make contributions up to 15% of their annual compensation. At its discretion, the Company can make matching contributions up to 6% of the participants’ compensation. The Company charged $242,670 and $273,094 to earnings for the retirement savings plan in 2019 and 2018, respectively. In addition, the Company made an elective contribution to the retirement savings plan during 2019 and 2018 totaling $154,384 and $142,952, respectively, recorded within salaries and benefits expense. During 2006, the Board of Directors approved a supplemental retirement plan for the directors and certain officers. These benefits are not qualified under the Internal Revenue Code and they are not funded. For 2019 and 2018, the supplemental retirement expense was $169,881 and $157,905. The current accrued but unfunded amount is $2,054,855 and $1,899,641 at December 31, 2019 and 2018, respectively. However, certain funding is provided informally and indirectly by bank owned life insurance policies. The cash surrender value of the life insurance policies is recorded as a separate line item in the accompanying consolidated balance sheets at $17,692,385 and $17,306,312 at December 31, 2019 and 2018, respectively. The Company has split-dollar life insurance arrangements with certain of its officers. At December 31, 2019 and 2018, the split-dollar liability relating to these arrangements totaled $365,200 and $343,718, respectively. For 2019 and 2018, the Company recognized net expenses of $21,482 and $20,221, respectively, related to these arrangements and recorded within salaries and benefits expense. 15 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Equity Incentive Plan: On January 19, 2006, the Company approved the 2006 Equity Incentive Plan (the "2006 Plan") which expired January 19, 2016. The Company approved on April 20, 2017, the 2017 Equity Incentive Plan (the "2017 Plan"). These plans provide for the granting of dividend equivalent rights, options, performance unit awards, phantom shares, stock appreciation rights and stock awards, each of which shall be subject to such conditions based upon continued employment, passage of time or satisfaction of performance criteria or other criteria as permitted by the plan. The 2006 Plan allowed granting up to 950,000 shares of stock to officers, employees, and directors, consultants and service providers of the Company or its affiliates. Awards may be granted for a term of up to ten years from the effective date of grant. The 2017 Plan allows granting up to 500,000 shares. The maximum aggregate shares subject to options is restricted to 80,000 in any calendar year to any one participant. The aggregate number of restricted stock shares available to be granted during any calendar to any one participant is limited to 50,000 shares. Awards may be granted for a term of up to five years from the effective date of the grant. Under these Plans, the Board of Directors has sole discretion as to the exercise date of any awards granted. The per-share exercise price of incentive stock options may not be less than the market value of a share of common stock on the date the option is granted. The related compensation cost for all stock-based awards is recognized over the service period for awards expected to vest. Any options that expire unexercised or are canceled become available for re-issuance. The Company's equity incentive plans are further described in Note 21. Common Stock Owned by the Employee Stock Ownership Plan (“ESOP”): All shares held by the ESOP are treated as outstanding for purposes of computing earnings per share. Purchases and redemptions of the Company’s common stock by the ESOP are at estimated fair value as determined by independent valuations. Dividends on shares held by the ESOP are charged to retained earnings. At December 31, 2019 and 2018, the ESOP owned 497,684 and 487,820 shares of the Company’s common stock with an estimated value of $3,153,877 and $2,169,854, respectively. All of these shares were allocated to participants. Income Per Common Share: Basic income per common share represents income available to common shareholders divided by the weighted- average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock options and similar share-based compensation instruments and are determined using the treasury stock method (see Note 22). Statements of Cash Flows: For purposes of reporting cash flows in the consolidated financial statements, the Company considers certain highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. Changes in the valuation account of securities available-for-sale, including the deferred tax effects, are considered noncash transactions for purposes of the statement of cash flows and are presented in detail in the notes to the consolidated financial statements. 16 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Off-Balance Sheet Financial Instruments: In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. These financial instruments are recorded in the consolidated financial statements when they become payable by the customer. Business Combinations and Method of Accounting for Loans Acquired: The Company accounts for its acquisitions under Financial Accounting Standards Board (“FASB”) ASC Topic 805, “Business Combinations,” which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” Purchased credit-impaired loans (“PCI”) are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB Accounting Standards Codification Topic 310- 30, “Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality,” formerly American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer,” and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be PCI loans. Evidence of credit quality deterioration as of purchase dates may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. The Company considers expected prepayments and estimates the amount and timing of expected principal, interest and other cash flows for each loan or pool of loans meeting the criteria above, and determines the excess of the loan’s scheduled contractual principal and contractual interest payments over all cash flows expected to be collected at acquisition as an amount that should not be accreted (nonaccretable difference). The remaining amount, representing the excess of the loan’s or pool’s cash flows expected to be collected over the fair value for the loan or pool of loans, is accreted into interest income over the remaining life of the loan or pool (accretable difference). Subsequent to the acquisition date, increases in cash flows expected to be received in excess of the Company’s initial estimates are reclassified from nonaccretable difference to accretable difference and are accreted into interest income on a level-yield basis over the remaining life of the loan. Decreases in cash flows expected to be collected are recognized as impairment through the provision for loan losses. Acquired non-PCI loans are recorded at their initial fair value and adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and additional provisioning that may be required. 17 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Recently Issued Accounting Pronouncements: The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company. In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2022. Early adoption is permitted for all organizations for periods beginning after December 15, 2018. The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. The Company is evaluating the impact of the ASU on the consolidated financial statements. The Company expects the ASU will have no material impact on the recorded allowance for loan losses given the change to estimated losses over the contractual life of the loans adjusted for expected prepayments. In addition to the allowance for loan losses, the Company will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time. In January 2017, the FASB amended the Goodwill and Other Topic of the Accounting Standards Codification to simplify the accounting for goodwill impairment for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2020. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company did not experience a material effect on its financial statements. In August 2018, the FASB amended the Fair Value Measurement Topic of the Accounting Standards Codification. The amendments remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its financial statements. In November 2018, the FASB issued guidance to amend the Financial Instruments—Credit Losses topic of the Accounting Standards Codification. The guidance aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic. The amendments will be effective for the Company for reporting periods beginning after December 15, 2022. Early adoption is permitted for all organizations for periods beginning after December 15, 2018. The Company is currently in the process of evaluating the impact of adoption of this guidance on the financial statements. 18 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Recently Issued Accounting Pronouncements, continued: In May 2019, the FASB issued guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The amendments will be effective for the Company for reporting periods beginning after December 15, 2020. The Company does not expect these amendments to have a material effect on its financial statements. In November 2019, the FASB issued guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (CECL). The new effective dates will be fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. The Company is currently in the process of evaluating the impact of adoption of this guidance on its financial statements. In November 2019, the FASB issued guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the Accounting Standards Codification. For entities that have not yet adopted the amendments in ASU 2016-13, the amendments are effective for fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. Early adoption is permitted in any interim period as long as an entity has adopted the amendments in ASU 2016-13. The Company does not expect these amendments to have a material effect on its financial statements. In December 2019, the FASB issued guidance to simplify accounting for income taxes by removing specific technical exceptions that often produce information investors have a hard time understanding. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows. Risks and Uncertainties: In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets. Credit risk is the risk of default on the Company's loan portfolio that results from borrower's inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company. The Company is subject to the regulations of various governmental agencies (regulatory risk). These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators' judgments based on information available to them at the time of their examination. 19 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 1. Summary of Significant Accounting Policies, Continued Reclassifications: Certain captions and amounts in the 2018 consolidated financial statements were reclassified to conform with the 2019 presentation. The reclassifications did not have an impact on net income or shareholders’ equity. Note 2. Mergers and Acquisitions On January 22, 2018, the Company acquired the outstanding common stock of Independence Bancshares, Inc. and its subsidiary, Independence Bank (collectively "INB") which are headquartered in Greenville, South Carolina. In connection with the acquisition, the Company acquired $82.3 million of assets and assumed $80.4 million of liabilities. The total purchase price was $2.5 million consisting of cash. The INB transaction was accounted for using the acquisition method of accounting, and accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at fair value on the acquisition date. Fair values are subject to refinement for up to a year. The following table presents the assets acquired and liabilities assumed as of January 22, 2018, as recorded by the Company on the acquisition date and initial fair value adjustments: 20 As Recorded byFair ValueAs RecordedINBAdjustmentsby the CompanyAssetsCash and cash equivalents4,681,439$ -$ 4,681,439$ Investment securities10,436,646 (110,297) 10,326,349 Certificates of deposit with other insitutions4,500,000 - 4,500,000 Loans54,976,229 (2,454,693) 52,521,536 Allowance for Loan Losses(1,290,000) 1,290,000 - Premises and equipment1,953,390 (412,599) 1,540,791 Core Deposit Intangible- 880,000 880,000 Other Real Estate Owned1,178,900 (524,450) 654,450 Deferred Tax Asset- 4,066,293 4,066,293 Other assets3,218,853 (106,152) 3,112,701 Total assets79,655,457$ 2,628,102$ 82,283,559$ LiabilitiesDeposits80,336,319$ (98,290)$ 80,238,029$ Other Liabilities173,602 - 173,602 Total liabilities80,509,921 (98,290) 80,411,631 Net assets acquired over liabilities assumed1,871,928$ Consideration: Cash exchanged 2,562,845$ Goodwill690,917$ First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 2. Mergers and Acquisitions, Continued The merger included the acquisition of $54.9 million in loans and $80.3 million in deposits. The loan portfolio was purchased at a $2.5 million discount. The deposits were purchased for a premium, including an $880,000 core deposit intangible. The amortization of the core deposit intangible is based on the cash flows used to value the asset over approximately nine years utilizing sum of years’ digits methodology The consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $690,917, representing the intangible value of INB’s business within the markets it served. Merger-related charges related to the INB acquisition during 2018 totaled $1,005,195, and were recorded in the consolidated statements of operations. These merger-related expenses include legal, accounting, auditing, investment banker, travel, and other costs associated with closing the acquisition. Note 3. Cash and Due From Banks The Company is required to maintain balances with the Federal Reserve computed as a percentage of deposits. At December 31, 2019 and 2018, this requirement was $7,158,000 and $5,395,000, respectively, net of vault cash and balances on deposit with the Federal Reserve. Note 4. Investment Securities The amortized cost and estimated fair values of securities available-for-sale were: Amortized Cost Gross Unrealized Gains Losses Fair Value December 31, 2019 U.S. Government sponsored agencies $ 10,734,597 Municipal securities 1,383,917 19,228,985 Mortgage-backed securities 3,901,433 Corporate bonds $ 35,248,932 Total December 31, 2018 U.S. Government sponsored agencies $ 14,160,679 Municipal securities 1,382,787 15,904,130 Mortgage-backed securities 2,878,863 Corporate bonds $ 34,326,459 Total $ 272,415 80,748 233,536 18,280 $ 604,979 $ $ 68,328 - 85,440 15,997 169,765 $ 10,938,684 1,464,665 19,377,081 3,903,716 $ 35,684,146 $ 62,666 - 47,277 - $ 109,943 $ 293,495 49,336 398,839 306,087 $ 1,047,757 $ 13,929,850 1,333,451 15,552,568 2,572,776 $ 33,388,645 At December 31, 2019 and 2018, the Company had marketable equity securities totaling $30,895 and $168,151, respectively. 21 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 4. Investment Securities, Continued The amortized cost and estimated fair values of securities held-to-maturity were: Amortized Cost Gross Unrealized Gains Losses Fair Value December 31, 2019 U.S. Government sponsored agencies $ Mortgage-backed securities Municipals Total 2,869,656 4,997,336 2,578,386 $ 10,445,378 $ 66,033 93,564 144,232 $ 303,829 $ $ - 2,558 - 2,558 $ 2,935,689 5,088,342 2,722,618 $ 10,746,649 Capitalization of net unrealized gains on securities transferred from available-for-sale Total 28,210 $ 10,473,588 December 31, 2018 U.S. Government sponsored agencies $ Mortgage-backed securities Municipals Total 3,384,184 8,109,388 2,592,277 $ 14,085,849 $ 46,545 108,090 96,068 $ 250,703 $ $ - 85,702 - 85,702 $ 3,430,729 8,131,776 2,688,345 $ 14,250,850 Capitalization of net unrealized gains on securities transferred from available-for-sale Total 21,405 $ 14,107,252 The following is a summary of maturities of securities available-for-sale and held-to-maturity as of December 31, 2019. The amortized cost and fair values are based on the contractual maturity dates. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty. Mortgage-backed securities are presented as a separate line, maturities of which are based on expected maturities since paydowns are expected to occur before contractual maturity dates. Due within one year Due after one year but within five years Due after five years through ten years Due after ten years Mortgage-backed securities Total Debt Securities Available-for-Sale Debt Securities Held-to-Maturity Amortized Cost $ 2,500,000 3,552,020 1,000,000 8,967,928 16,019,948 19,228,985 $ 35,248,933 22 Fair Value $ 2,498,005 3,538,405 1,018,280 9,252,375 16,307,065 19,377,081 $ 35,684,146 Amortized Cost $ - - 565,422 4,882,620 5,448,042 4,997,336 $ 10,445,378 Fair Value $ - - 604,091 5,054,216 5,658,307 5,088,342 $ 10,746,649 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 4. Investment Securities, Continued The following tables show gross unrealized losses and fair value of securities available-for-sale and securities held- to-maturity, aggregated by investment category, and length of time that individual securities have been in a continuous realized loss position at December 31, 2019 and 2018. Securities Available-for-Sale Less Than 12 Months Mortgage-backed securities Corporate bonds Total 12 Months or More December 31, 2019 Fair Value Unrealized Losses December 31, 2018 Fair Value Unrealized Losses $ $ $ 440,380 - 440,380 5,168 - 5,168 $ 172,307 2,572,776 2,745,083 $ 3,399 306,087 309,486 U.S. Government sponsored agencies Mortgage-backed securities Corporate Bonds Total Total securities available-for-sale 5,514,542 5,185,486 2,885,436 13,585,464 $ 14,025,844 Securities Held-to-Maturity Less Than 12 Months Mortgage-backed securities Total 12 Months or More Mortgage-backed securities Total Total securities held-to-maturity $ 1,239,512 1,239,512 - - 1,239,512 $ 68,328 80,272 15,997 164,597 169,765 9,016,917 10,545,054 1,333,451 20,895,422 $ 23,640,505 $ 2,558 2,558 478,186 478,186 - - 2,558 3,485,073 3,485,073 3,963,259 $ 293,495 395,440 49,336 738,271 1,047,757 1,134 1,134 84,568 84,568 85,702 $ $ $ $ $ $ At December 31, 2019, eight securities classified as available-for-sale and one security classified as held-to-maturity were in a loss position as detailed in the preceding tables. The Company does not intend to sell these securities in the near future and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost. The Company believes that, based on industry analyst reports and credit ratings, the deterioration in value is attributable to changes in market interest rates and, therefore, these losses are not considered other-than-temporary. During 2019, the Company sold securities with proceeds of $1,638,332 and gross gains of $23,834. During 2018, the Company sold securities with proceeds of $3,100,000 and gross gains of $800,000. During 2018, the Company recognized gain of $38,151 within the consolidated statement of operations related to the increase in fair value of marketable equity securities as a result of the adoption of ASU 2016-01. During 2019, the Company recognized a gain of $13,410 within the consolidated statement of operations related to the increase in fair value of marketable equity securities. At December 31, 2019 and 2018, investment securities with a par value of $14,832,908 and $18,122,712 and a fair market value of $15,103,164 and $17,342,165, respectively, were pledged as collateral for securities under agreements to repurchase. 23 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses Major classifications of loans receivable are summarized as follows at December 31: Real estate loans: Construction Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total loans 2019 2018 $ $ 41,246,207 129,087,825 171,148,893 341,482,925 58,439,799 80,262,671 480,185,395 $ $ 30,404,245 124,789,754 144,103,065 299,297,064 48,522,654 82,976,173 430,795,891 The Company has pledged certain loans as collateral to secure its borrowings from the Federal Home Loan Bank which totaled $183,459,356 and $137,040,574 at December 31, 2019 and 2018, respectively. Loans sold with limited recourse are 1-4 family residential mortgages originated by the Company and sold to various other financial institutions. These loans are sold with the agreement that a loan may be returned to the Company within 90 days of purchase, at any time in the event the Company fails to provide necessary documents related to the mortgages to the buyers, or if the Company makes false representations or warranties to the buyers. Loans sold under these agreements in 2019 and 2018 totaled $353,530,732 and $263,027,079, respectively. The Company uses the same credit policies in making loans held for sale as it does for on-balance-sheet instruments. Sales commitments are to sell loans at an agreed upon price and are generally funded within 60 days. The following is an analysis of the allowance for loan losses by class of loans for the years ended December 31, 2019 and 2018. December 31, 2019 Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other Beginning balance Provisions Recoveries Charge-offs Ending balance $ 3,529,855 $ $ 2,788,188 $ 983,803 321,714 (563,850) 83,200 $ 1,049,913 $ (20,826) 118,484 - (413,291) 114,281 (54,384) 676,598 $ 1,809,711 $ 569,416 - - 618,558 680,963 62,441 (54,384) (18,520) (490,946) 871,016 359,919 $ 167,541 26,508 135,299 232,765 535,448 $ 180,858 $ 696,519 $ 1,246,014 $ 2,123,391 $ December 31, 2018 Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other Beginning balance Provisions Recoveries Charge-offs Ending balance $ 2,788,188 $ 168,541 $ $ 2,453,875 $ 510,356 384,989 669,783 402,516 66,967 (561,032) (587) (37,537) (1,725) (39,849) (475) (520,708) 618,558 372,356 $ 1,526,794 $ 172,517 133,450 985,897 $ 19,271 82,282 257,298 $ 85,778 17,318 (169,726) 84,972 676,598 $ 1,809,711 $ 83,200 $ 1,049,913 $ 22,062 300,704 359,919 $ 24 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The following is a summary of loans evaluated for impairment individually and collectively, by class, for the years ended December 31, 2019 and 2018. December 31, 2019 Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other Allowance Evaluated for impairment Individually Collectively Allowance for loan losses Total Loans Evaluated for impairment Individually Collectively Loans receivable Allowance Evaluated for impairment Individually Collectively Allowance for loan losses Total Loans Evaluated for impairment Individually Collectively Loans receivable $ 27,273 $ - $ - $ 24,375 $ 24,375 $ 2,837 $ 3,502,582 180,858 696,519 1,221,639 2,099,016 532,611 61 870,955 $ 3,529,855 $ 180,858 $ 696,519 $ 1,246,014 $ 2,123,391 $ 535,448 $ 871,016 $ 4,370,202 $ 475,815,193 41,246,207 - $ 2,478,331 $ 1,652,395 $ 4,130,726 $ 169,496,498 337,352,199 126,609,494 115,524 $ 58,324,275 123,952 80,138,719 $ 480,185,395 $ 41,246,207 $ 129,087,825 $ 171,148,893 $ 341,482,925 $ 58,439,799 $ 80,262,671 December 31, 2018 Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other $ 178,065 $ - $ 49,382 $ 15,742 $ 65,124 $ 2,610,123 83,200 1,000,531 660,856 1,744,587 103,665 $ 256,254 9,276 609,282 $ 2,788,188 $ 83,200 $ 1,049,913 $ 676,598 $ 1,809,711 $ 359,919 $ 618,558 $ 9,624,852 $ 421,171,039 30,404,245 - $ 2,684,974 $ 5,977,695 $ 8,622,669 $ 138,125,370 290,674,395 122,104,780 762,731 $ 47,759,923 199,452 82,776,721 $ 430,795,891 $ 30,404,245 $ 124,789,754 $ 144,103,065 $ 299,297,064 $ 48,522,654 $ 82,976,173 25 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The following summarizes the Company’s impaired loans as of December 31, 2019. With no related allowance recorded: Real estate Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total With an allowance recorded: Nonresidential Total real estate loans Commercial and industrial Consumer and other Total Total Real estate Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total Recorded Investment Unpaid Principal Related Allowance Average Balance Interest Income Recognized $ 2,478,331 $ 2,478,331 $ 1,559,820 4,038,151 91,407 98,047 1,559,821 4,038,152 168,849 128,458 $ 4,227,606 $ 4,335,459 $ $ 2,561,287 $ 1,881,542 - 4,442,829 - 137,562 - - 133,031 - $ 4,713,422 $ 152,256 130,091 282,347 9,396 11,062 302,805 $ $ 92,575 $ 92,575 24,117 25,905 142,597 $ 92,575 $ 92,575 24,117 25,905 142,597 $ 24,375 $ 24,375 2,837 61 27,273 $ 96,008 $ 96,008 25,042 28,164 149,214 $ 6,848 6,848 1,840 1,427 10,115 $ 2,478,331 $ 2,478,331 $ - $ 2,561,287 $ 1,652,395 4,130,726 115,524 123,952 1,652,396 4,130,727 192,966 154,363 24,375 24,375 2,837 61 1,977,550 4,537,837 162,604 161,195 $ 4,370,202 $ 4,478,056 $ 27,273 $ 4,861,636 $ 152,256 136,939 289,195 11,236 12,489 312,920 26 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The following summarizes the Company’s impaired loans as of December 31, 2018. With no related allowance recorded: Real estate Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total With an allowance recorded: Real estate Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total Total Real estate Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total Recorded Investment Unpaid Principal Related Allowance Average Balance Income Recognized $ 2,570,672 $ 2,778,105 $ 5,878,253 8,448,925 658,693 158,808 5,878,253 8,656,358 710,037 200,253 $ 9,266,426 $ 9,566,648 $ - $ 3,123,478 $ - - - - - $ 11,424,271 $ 7,259,531 10,383,009 713,908 327,354 170,470 411,822 582,292 39,363 12,941 634,596 $ $ 114,302 $ 99,442 213,744 104,038 40,644 358,426 $ 114,302 $ 105,343 219,645 104,038 61,987 385,670 $ 49,382 $ 15,742 65,124 103,665 9,276 178,065 $ 136,424 $ 164,890 301,314 127,385 66,072 494,771 $ 1,679 5,469 7,148 5,892 3,536 16,576 $ 2,684,974 $ 2,892,407 $ 5,977,695 8,662,669 762,731 199,452 5,983,596 8,876,003 814,075 262,240 49,382 $ 3,259,902 $ 15,742 65,124 103,665 9,276 7,424,421 10,684,323 841,293 393,426 $ 9,624,852 $ 9,952,318 $ 178,065 $ 11,919,042 $ 172,149 417,291 589,440 45,255 16,477 651,172 The following is an aging analysis of the Company’s loan portfolio at December 31, 2019: 30 - 59 Days 60 - 89 Days Past Due Past Due Greater Than 90 Days Total Past Due Current Total Loans Receivable Recorded Investment> 90 Days and Accruing Real estate Construction Residential Nonresidential Total real estate loans Consumer and industrial Consumer and other Total $ - $ - 156,322 156,322 - 148,559 $ 304,881 $ - $ - $ - - - - 12,171 12,171 $ 522,300 $ 839,352 $479,346,043 $ - $ 41,246,207 $ 128,688,079 170,992,571 340,926,857 58,427,555 79,991,631 399,746 - 399,746 12,244 110,310 399,746 156,322 556,068 12,244 271,040 41,246,207 $ 129,087,825 171,148,893 341,482,925 58,439,799 80,262,671 480,185,395 $ - - - - 6,294 49,672 55,966 27 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The following is an aging analysis of the Company’s loan portfolio at December 31, 2018: 30 - 59 Days 60 - 89 Days Past Due Past Due Greater Than 90 Days Total Past Due Current Total Loans Receivable Recorded Investment> 90 Days and Accruing Real estate Construction Residential Nonresidential Total real estate loans Consumer and industrial Consumer and other Total $ - $ - $ - $ 46,967 - 46,967 - 131,068 117,606 106,146 223,752 18,973 119,509 $ 178,035 $ 942,415 $ 362,234 $ 1,482,684 $429,313,207 $ 859,533 205,588 1,065,121 23,287 394,276 694,960 99,442 794,402 4,314 143,699 - $ 30,404,245 $ 124,789,754 123,930,221 144,103,065 143,897,477 299,297,064 298,231,943 48,499,367 48,522,654 82,581,897 82,976,173 430,795,891 $ 30,404,245 $ - 114,301 - 114,301 - 31,961 146,262 The following is an analysis of the Company’s nonaccrual loan portfolio recorded at December 31, 2019 and 2018: Real Estate Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Troubled Debt Restructurings 2019 2018 $ 590,561 517,639 1,108,200 39,438 328,183 $ 1,475,821 $ 664,667 205,588 870,255 673,698 321,807 $ 1,865,760 The following table summarizes the carrying balance of troubled debt restructurings (“TDRs”) as of December 31, 2019 and 2018: Performing TDRs Nonperforming TDRs Total TDRs 2019 2018 $ 2,469,036 1,462,960 $ 3,931,996 $ 3,786,544 482,552 $ 4,269,096 Loans classified as TDRs may be removed from this status for disclosure purposes after a specified period of time if the TDR is subsequently restructured, and the newly restructured agreement specifies an interest rate equal to or greater than the rate that the lender was willing to accept at the time of the restructuring for a new loan with comparable risk, the loan is performing in accordance with the terms specified by the restructured agreement, and certain other criteria are met. The Company has not removed any loans from TDR status through subsequent restructurings during 2019 or 2018. 28 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The following is an analysis of TDRs identified during 2019: Troubled Debt Restructurings Real Estate Residential Nonresidential Commercial and industrial Consumer and other For the year ended December 31, 2019 Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Number of Contracts 1 1 1 4 7 $ $ 24,151 494,423 24,117 48,102 590,793 $ $ 24,151 494,423 24,117 48,102 590,793 During the year ended December 31, 2019, we modified seven loans that were considered to be troubled debt restructurings. The Company provided rate and term concessions for four of these loans due to bankruptcies and the other three loans were restructured due to borrower’s inability to obtain financing elsewhere. During the year ended December 31, 2019, no loans that had previously been restructured during the year subsequently defaulted during the year. The following is an analysis of TDRs identified during 2018: Troubled Debt Restructurings Real Estate Residential Nonresidential Commercial and industrial Consumer and other For the year ended December 31, 2018 Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Number of Contracts 3 4 1 11 19 $ 288,584 2,250,846 96,000 122,444 $ 2,757,874 $ $ 288,584 2,250,846 96,000 122,444 2,757,874 During the year ended December 31, 2018, we modified nineteen loans that were considered to be troubled debt restructurings. The Company provided rate concessions for five of these loans and extensions for nineteen of the loans. During the year ended December 31, 2018, three loans with an unpaid principal balance of $143,979 as of December 31, 2018 that had previously been restructured during the year subsequently defaulted during the year. All loans modified in troubled debt restructurings are evaluated for impairment. The nature and extent of impairment of TDRs, including those which have experienced a subsequent default, are considered in determining an appropriate level of allowance for credit losses. 29 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued Credit Indicators Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt, including, among other factors: current financial information, historical payment experience, credit documentation, public information, and current economic trends. The following definitions are utilized for risk ratings, which are consistent with the definitions used in supervisory guidance: Special Mention - Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date. Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. The following table lists the loan guides used by the Bank as credit quality indicators and the balance in each category at December 31, 2019: Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial Consumer and Other Pass Special mention Substandard Doubtful Totals $ 464,643,034 $ 40,308,707 $ 125,951,550 $ 162,804,795 $ 329,065,052 $ 56,150,250 $ 79,427,732 496,093 338,846 - $ 480,185,395 $ 41,246,207 $ 129,087,825 $ 171,148,893 $ 341,482,925 $ 58,439,799 $ 80,262,671 11,998,802 3,543,559 - 9,641,982 2,775,891 - 2,166,887 969,388 - 1,860,727 428,822 - 6,537,595 1,806,503 - 937,500 - - The following table lists the loan guides used by the Bank as credit quality indicators and the balance in each category at December 31, 2018: Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial Consumer and Other Pass Special mention Substandard Doubtful Totals $ 410,896,316 $ 30,404,245 $ 120,829,193 $ 133,380,172 $ 284,613,610 $ 44,136,536 $ 82,146,170 493,821 336,182 - $ 430,795,891 $ 30,404,245 $ 124,789,754 $ 144,103,065 $ 299,297,064 $ 48,522,654 $ 82,976,173 13,543,249 6,356,326 - 9,748,050 4,935,404 - 2,857,269 1,103,292 - 3,301,378 1,084,740 - 6,890,781 3,832,112 - - - - 30 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The Company enters into financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit. 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. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by the other parties to the instrument is represented by the contractual notional amount of the instrument. Since certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments to extend credit as it does for on-balance-sheet instruments. Letters of credit are conditional commitments issued to guarantee a customer’s performance to a third party and have essentially the same credit risk as other lending facilities. Collateral held for commitments to extend credit and standby letters of credit varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties. The following table summarizes the Company’s off-balance sheet financial instruments whose contract amounts represent credit risk for the years ended December 31: Commitments to extend credit Standby letters of credit Acquired Loans: 2019 2018 $ 92,921,655 589,196 $ 71,885,360 158,765 On January 22, 2018, the Company acquired INB (see Note 2 for more information). PCI loans acquired totaled $17.3 million, and acquired performing loans totaled $35.2 million, both net of purchase discounts. The gross contractual amount receivable for PCI loans and acquired performing loans was approximately $19 million and $36 million, respectively, as of the acquisition date. The fair value of the total loan portfolio was estimated to be $52.5 million, which represents a $2.5 million discount. The following table presents changes in the carrying value of PCI loans for the year ended December 31, 2019 and 2018: Balance at beginning of period Additions due to acquisition of INB Change due to payments received and accretion Advances Balance at end of period $ $ 14,666,715 - (5,646,148) 93,398 9,113,965 $ $ - 17,313,626 (3,042,422) 395,511 14,666,715 2019 2018 31 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 5. Loans and Allowance for Loan Losses, Continued The following table presents changes in the nonaccretable yield for PCI loans for the year ended December 31, 2019 and 2018: Balance at beginning of period Additions due to acquisition of INB Reclassification to accretable yield Change due to charge-offs Balance at end of period 2019 2018 $ $ 1,048,796 - (95,494) (461,929) 491,373 $ $ - 1,423,522 (158,064) (216,662) 1,048,796 The following table presents changes in the accretable yield for PCI loans for the year ended December 31, 2019 and 2018 2019 2018 Balance at beginning of period Additions due to acquisition of INB Reclassification for nonaccretable yield Accretion, net cash basis interest collections Balance at end of period $ $ 618,281 - 95,494 (152,687) 561,088 $ $ - 421,179 158,064 39,038 618,281 Note 6. Premises, Furniture and Equipment Premises, furniture and equipment consisted of the following for the years ended December 31: Land Buildings Leasehold improvements Furniture and equipment Construction in progress Total Less, accumulated depreciation Premises and equipment, net 2019 2018 $ 7,951,239 $ 7,497,839 14,766,184 14,822,259 1,021,789 1,630,762 9,322,077 9,464,291 1,062,491 1,308,421 33,916,310 34,931,042 (14,510,536) (13,605,431) $ 20,420,506 $ 20,310,879 Depreciation expense for the years ended December 31, 2019 and 2018 amounted to $814,612 and $900,631, respectively. At December 31, 2019 and 2018, construction in progress consists mainly of architect fees and site work for potential new branches. As of December 31, 2019, there were no material commitments outstanding for the construction/or purchase of premises, furniture and equipment. 32 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 7. Other Real Estate Owned Transactions in other real estate owned for the years ended December 31, 2019 and 2018 are summarized below: 2019 2018 Beginning balance Additions Sales Write downs Ending balance $ 341,519 183,257 $ 1,706,765 1,050,015 (176,724) (2,415,261) (500) - 341,519 347,552 $ $ The Company recognized net gains of $27,676 and $203,685 on the sale of other real estate owned for the years ended December 31, 2019 and 2018, respectively. Note 8. Mortgage Servicing Rights The Company retains right to service the residential mortgage loans that it sells to the Federal National Mortgage Association (“FNMA”) and Freddie Mac (“FHLMC”). The Company accounts for MSRs at fair value. The changes in fair value are recorded in income from mortgage operations. The following table presents the activity for residential MSRs for the years ended December 31, 2019 and 2018: Balances, beginning of year Additions Change in MSR fair value Balances, end of year 2019 2018 $ 9,023,859 3,306,078 (1,307,299) $ 11,022,638 $ 6,357,666 2,991,033 (324,840) $ 9,023,859 The fair value of MSRs is highly sensitive to changes in assumptions and fair value is determined by estimating the present value of the asset’s future cash flows utilizing market-based prepayment rates, discount rates and other assumptions validated through comparison to trade information, industry surveys and with the use of independent third party appraisals. Changes in prepayment speed assumptions have the most significant impact on the fair value of MSRs. Generally, as interest rates decline, mortgage loan prepayments accelerate due to increased refinance activity, which results in a decrease in the fair value of the MSRs. Measurement of fair value is limited to the conditions existing and the assumptions utilized as of a particular point in time, and those assumptions may not be appropriate if they are applied at a different time. At December 31, 2019, the aggregate amount of loans serviced by the Company for the benefit of others totaled $982,517,259. 33 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 8. Mortgage Servicing Rights, Continued The characteristics and sensitivity analysis of the MSRs are included in the following table as of December 31, 2019 and 2018. Composition of residential loans serviced for others Fixed-rate mortgage loans Weighted average life Constant prepayment rate (“CPR”) Weighted average discount rate Note 9. Derivatives 2019 2018 100.00% 100.00% 9.19 years 8.93 years 9.00% 8.56% 10.57% 9.48% The derivative positions of the Company for the years ended December 31, 2019 and 2018 are reported as other assets and liabilities and are as follows: Derivative assets (liabilities): Mortgage loan interest rate lock commitments Mortgage loan forward sales commitments 2019 2018 Fair value Notional value Fair value Notional value $ 713,496 $ 19,895,637 $ 416,076 $ 22,415,124 (49,453) 18,000,000 (186,133) 22,250,000 The Company uses derivatives to reduce interest rate risk incurred as a result of market movements. These derivatives primarily consist of mortgage loan interest rate lock commitments. A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or reference interest rate. The Company uses derivatives primarily to minimize interest rate risk related to its pipeline of loan interest rate lock commitments issued on residential mortgage loans in the process of origination for sale or loans held for sale. The Company’s derivative positions are classified as trading assets and liabilities, and as such, the changes in the fair market value of the derivative positions are recognized in the consolidated statements of operations within income from mortgage operations. Note 10. Core Deposit Intangible The following table presents information about our intangible assets related to acquisition of INB on January 22, 2018 as of December 31: 2019 2018 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization Core deposit intangibles $ 880,000 $ 366,965 $ 880,000 $ 195,783 34 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 10. Core Deposit Intangible, Continued Based on the core deposit intangibles as of December 31, 2019, the following table presents the aggregate amortization expense for each of the succeeding years ending December 31: 2020 2021 2022 2023 2024 and thereafter Total Amount 146,582 121,980 97,379 72,778 74,316 513,035 $ $ Amortization expense of $171,182 and $195,783 related to the core deposit intangibles was recognized in 2019 and 2018, respectively. Note 11. Deposits At December 31, 2019, the scheduled maturities of time deposits were as follows: Maturing In: 2020 2021 2022 2023 2024 Total $ Amount 145,158,645 7,340,876 2,679,311 1,439,054 1,517,162 $ 158,135,048 Included in total time deposits at December 31, 2019 and 2018 were brokered time deposits of $13,459,783 and $4,966,726. Note 12. Securities Sold Under Agreements to Repurchase Securities sold under agreements to repurchase generally mature on a one to thirty day basis. Under the terms of the repurchase agreement, the Company sells an interest in securities issued by United States Government agencies and agrees to repurchase the same securities the following business day. Information concerning securities sold under agreements to repurchase is summarized as follows at December 31: Balance at December 31 Maximum month-end balance during the year Average balance during the year Average interest rate at the end of the year Average interest rate during the year 35 2019 2018 $ 14,637,332 15,778,316 13,301,943 0.51% 0.56% $ 16,852,981 18,649,225 16,591,130 0.15% 0.15% First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 12. Securities Sold Under Agreements to Repurchase, Continued At December 31, 2019 and 2018, investment securities with a par value of $14,832,908 and $18,122,712 and a fair market value of $15,103,164 and $17,342,165, respectively, were pledged as collateral for the underlying agreements. Note 13. Federal Home Loan Bank Advances Federal Home Loan Bank advances consisted of the following at December 31: Fixed rate February 8, 2019 August 8, 2019 February 7, 2020 September 20, 2029 October 25, 2020 January 27, 2020 Daily rate January 17, 2020 Interest Rate 2.36% 2.64% 2.76% 1.62% 1.34% 1.80% 1.78% 2019 2018 - - 3,300,000 10,000,000 5,000,000 5,000,000 3,400,000 3,300,000 3,300,000 - - - 20,000,000 $ 43,300,000 10,000,000 $ 20,000,000 At December 31, 2019 and 2018, the Company has pledged certain loans totaling $183,459,356 and $137,040,574, respectively, as collateral to secure its borrowings from the FHLB. Additionally, the Company’s FHLB stock is pledged to secure the borrowings. Note 14. Junior Subordinated Debentures On June 30, 2005, the Trust (a non-consolidated subsidiary) issued $10,000,000 in trust preferred securities (callable without penalty) with a maturity of November 23, 2035. Interest on these securities is payable quarterly at the three-month LIBOR rate plus 2.75%. In accordance with generally accepted accounting principles, the Trust has not been consolidated in these financial statements. The Company received from the trust the $10,000,000 proceeds from the issuance of the securities and the $310,000 initial proceeds from the capital investment in the Trust, and accordingly has shown the funds due to the trust as $10,310,000 junior subordinated debentures. Current regulations allow the entire amount of junior subordinated debentures to be included in the calculation of regulatory capital. As of December 31, 2019 and 2018, the Company had accrued and unpaid interest totaling $40,237 and $50,073, respectively. 36 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 15. Borrowings On August 5, 2016, the Company entered into subordinated debt agreements with eight lenders which totaled $5,000,000. The debt initially bears interest at a fixed rate of 7.00% per annum until August 1, 2021 and then variable at three-month LIBOR plus 5.86%, payable quarterly with principal and unpaid interest due at maturity, August 5, 2026. The Company recorded $111,450 in issuance costs associated with the subordinated debt, which is recorded net within subordinated debentures and to be amortized over five years. As of December 31, 2019, remaining issuance costs to be amortized totaled $34,786. On July 8, 2016, the Company obtained a note with CresCom Bank in the amount of $7,000,000. The debt bore interest at a fixed rate of 4.95% per annum with principal and interest due quarterly based on a nine year amortization of the principal amount outstanding and any outstanding principal and unpaid interest due at maturity, July 8, 2021. The Company recorded $115,284 in issuance costs associated with the note payable, which was recorded net within the note payable and to be amortized over five years. The debt was securitized by the assignment of Company common stock. The note was paid in full during 2017. Proceeds from the subordinated debt and note payable were used to repay the Series A and Series B Preferred Stock as described in Note 16. Note 16. Shareholders’ Equity Common Stock - The following is a summary of the changes in common stock outstanding for the years ended December 31, 2019 and 2018. Common shares outstanding at beginning of the period Conversion of Series D preferred stock to common stock Conversion of Series E preferred stock to non-voting common stock Restricted stock issuance Forfeiture of restricted shares Common shares outstanding at end of the period 2019 2018 8,412,671 850 - 130,557 (100,000) 8,444,078 7,887,486 1,800 410,499 132,886 (20,000) 8,412,671 During 2018, the Company authorized 430,000 shares of non-voting common stock, for which the 410,499 shares of Series E Preferred Stock issued during 2017 were converted to non-voting common stock during 2018. Preferred Stock - The Company’s Articles of Incorporation authorizes the issuance of a class of 10,000,000 shares of preferred stock, having no par value. Subject to certain conditions, the Company’s Board of Directors is authorized to issue preferred stock without shareholder approval. Under the Articles of Incorporation, the Board of Directors is authorized to determine the terms of one or more series of preferred stock, including the preferences, rights, and limitations of each series. 37 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 16. Shareholders’ Equity, Continued On March 6, 2009, the Company completed a transaction with the United States Treasury (the “Treasury”) under the Troubled Asset Relief Program Capital Purchase Program, whereby the Company sold 15,349 shares of its Series A Cumulative Perpetual Preferred Stock (the “Series A Shares”) to the Treasury. In addition, the Treasury received a warrant to purchase 767 shares of the Company’s Series B Cumulative Perpetual Preferred Stock (the “Series B Shares”), which was immediately exercised for a nominal exercise price. The preferred shares issued to the Treasury qualify as Tier 1 capital for regulatory purposes. On March 1, 2013, the Treasury auctioned the subject securities in a private transaction with unaffiliated third-party investors. The Series A Preferred Stock was a senior cumulative perpetual preferred stock that had a liquidation preference of $1,000 per share, paid cumulative dividends at a rate of 5% per year (approximately $767,000 annually) for the first five years and beginning May 15, 2014, at a rate of 9% per year (approximately $1,381,000 annually). Dividends were payable quarterly. At any time, the Company could, at its option and with regulatory approval, redeem the Series A Preferred Stock at par value plus accrued and unpaid dividends. The Series A Preferred Stock was generally non-voting. The Series B Preferred Stock was a cumulative perpetual preferred stock that had the same rights, preferences, privileges, voting rights and other terms as the Series A Preferred Stock, except that dividends were to be paid at the rate of 9% per year so long as the Series A Preferred Stock was outstanding and could not be redeemed until all the Series A Preferred Stock had been redeemed. The Series A and Series B Preferred Shares would received preferential treatment in the event of liquidation, dissolution or winding up of the Company. The net amount of the accretion and amortization was treated as a deemed dividend to preferred shareholders in the computation of income (loss) per share. During 2016, the Company redeemed both Series A and Series B Preferred Stock outstanding totaling $15,179,709 and $767,000, respectively. The preferred stock was repaid through borrowings obtained as described in Note 15. The Series D Preferred Stock ("Series D Shares") is a fixed rate non-cumulative perpetual preferred stock, created July 16, 2015, with the authorized issuance of 70,000 shares. The Series D shares were created for the purpose of converting Common Stock holders with 200 shares or less to Series D Shares. The Series D Shares have no voting rights, and in the event dividends are declared on Common Stock, will be entitled to 4% more than those paid on the Common Stock. Series D Shares will, with respect to ranking to include but not limited to dividends and rights upon liquidation, be junior to the Series A Preferred Stock and the Series B Preferred Stock, and will rank senior to all Common Stock. On September 22, 2017, the Company issued 410,499 shares of Series E Preferred Stock ("Series E Shares"). The Series E Shares were created in conjunction with the 2017 common stock issuance. The Series E Shares have no voting rights, and are entitled to receive dividends as declared in the same per share amount as common stock. During 2018, the Series E Shares were converted to 410,499 shares of non-voting common stock. 38 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 16. Shareholders’ Equity, Continued Restrictions on Shareholders’ Equity - South Carolina banking regulations restrict the amount of dividends that can be paid to shareholders. All of the Bank’s dividends to the Company are payable only from the undivided profits of the Bank. At December 31, 2019, the Bank had undivided profits of $ 17,670,183. The Bank is authorized to dividend 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Commissioner of Banks provided that the Bank received a composite CAMELS rating of one or two at the last Federal or State regulatory examination. Under Federal Reserve regulations, the amounts of loans or advances from the Bank to the parent company are also restricted. Note 17. Other Operating Expense Other operating expenses are summarized below for the years ended December 31: Advertising Office supplies, postage and printing Telephone Professional fees and services Supervisory fees and assessments Debit and credit card expenses Insurance expenses Net cost of other real estate owned Core deposit amortization Other Total Note 18. Income Taxes 2019 2018 $ 200,187 322,021 313,198 1,339,913 164,890 925,883 215,072 11,549 171,182 2,042,389 $ 5,706,284 $ 306,279 364,275 312,631 730,057 343,855 959,931 230,268 21,874 195,783 2,084,609 $ 5,549,562 Income tax provision for the years ended December 31, 2019 and 2018 is summarized as follows: Provision Current income tax expense Federal State Total current Deferred income tax expense (benefit) Federal State Total deferred Change in valuation allowance Total income tax expense 39 2019 2018 $ $ - 232,536 232,536 - 70,794 70,794 1,005,350 (56,175) 949,175 71,522 $ 1,253,233 $ 589,897 19,579 609,476 61,336 741,606 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 18. Income Taxes, Continued The components of deferred tax assets and deferred tax liabilities as of December 31, are as follows: Deferred tax assets: Allowance for loan losses Accumulated depreciation Net operating losses Non-accrual interest Unrealized loss on securities available for sale Deferred compensation Federal and state credits Other real estate owned Purchase accounting on acquisition Leases Other Gross deferred tax assets Less, valuation allowance Net deferred tax assets Deferred tax liabilities: Accumulated depreciation Prepaid expenses Unrealized gains on securities available for sale Market to market adjustments Other Total gross deferred tax liabilities Net deferred tax assets recognized $ 2019 2018 596,882 - 8,292,928 12,893 - 589,609 - - 163,668 6,758 129,225 9,791,963 (626,955) 9,165,008 $ 585,519 2,945 8,670,310 10,829 224,520 507,915 15,493 24,636 309,455 - 135,056 10,486,678 (555,433) 9,931,245 14,779 21,547 98,715 2,387,453 62,874 2,585,368 $ 6,579,640 - 22,645 1,943,298 41,730 2,007,673 $ 7,923,572 Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the net deferred tax assets to net realizable value. As of December 31, 2019, management has determined that it is more likely than not that the majority of the deferred tax asset from continuing operations will be realized. In 2019, the balance in the valuation allowance changed by $71,522. The remaining valuation allowance relates to the parent company’s state operating loss carryforwards for which realizability is uncertain. The Company has federal net operating losses of $36,630,028 and $38,719,915 for the years ended December 31, 2019 and 2018, respectively. The Company has state net operating losses of $15,205,628 and $13,648,822 for the years ended December 31, 2019 and 2018, respectively. In addition, the Company has Alternative Minimum Tax ("AMT") credit carryforwards which have been reclassified to taxes receivable to reflect the refundable nature of the credits under the Tax Cuts and Jobs Act. 40 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 18. Income Taxes, Continued A reconciliation between the income tax expense and the amount computed by applying the federal statutory rate of 21% to income before income taxes for the years ended December 31, 2019 and 2018 follows: Tax expense at statutory rate State income tax expense (benefit), net of federal income tax benefit Tax-exempt interest income Disallowed interest expense Life insurance surrender value Change in valuation allowance Other, net Total 2019 2018 $ 1,121,835 139,325 (28,525) 1,393 (81,075) 71,522 28,758 $ 1,253,233 $ $ 666,086 71,395 (30,839) 949 (82,017) 61,336 54,696 741,606 The Company had analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions. Tax returns for 2016 and subsequent years are subject to review by taxing authorities. Note 19. Related Party Transactions Certain parties (principally certain directors and executive officers of the Company, their immediate families and business interests) are loan customers of the Company. In compliance with relevant law and regulations, the Company’s related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the lender and do not involve more than the normal risk of collectability. As of December 31, 2019 and 2018, the Company had related party loans totaling $1,318,435 and $1,422,497, respectively. Deposits from directors and executive officers and their related interests totaled $2,546,515 and $1,610,022 at December 31, 2019 and 2018, respectively. Note 20. Commitments and Contingencies In the ordinary course of business, the Company may, from time to time, become a party to legal claims and disputes. At December 31, 2019, management and legal counsel are not aware of any pending or threatened litigation or unasserted claims or assessments that could result in losses, if any, that would be material to the consolidated financial statements. Effective January 1, 2019, the Company adopted ASC 842 “Leases”. Currently, the Company has operating leases on eleven of its facilities that are accounted for under this standard. At December 31, 2019 the Company had operating lease right of use asset of $5,669,144, and operating lease liability of $5,701,327. Rental expense recorded under the leases for the years ended December 31, 2019 and 2018 was $1,028,736 and $937,904, respectively. 41 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 20. Commitments and Contingencies The weighted average remaining lease term as of December 31, 2019 is 10.32 years and the weighted average discount rate used is 3.12%. The following table shows future undiscounted lease payments for operating leases with initial terms of one year or more as of December 31, 2019 are as follow: 2020 2021 2022 2023 2024 Thereafter Total undiscounted lease payments Less effect of discounting Present value of estimate lease payments (lease liability) Note 21. Equity Incentive Plan $ 815,341 628,880 651,205 583,722 595,877 3,316,203 6,591,228 (889,901) $ 5,701,327 On April 20, 2017, the Company approved the 2017 Plan (collectively "the Plan"). The 2017 Plan allows granting up to 500,000 shares. The maximum aggregate shares subject to options is restricted to 80,000 in any calendar year to any one participant. The aggregate number of shares subject to awards of restricted stock is restricted to 50,000 in any calendar year to any one participant. Awards may be granted for a term of up to five years from the effective date of the grant. The Company can issue the restricted shares as of the grant date either by the issuance of share certificate(s) evidencing restricted shares or by documenting the issuance in uncertificated or book entry form on the Company's stock records. Except as provided by the Plans, the employee does not have the right to make or permit to exist any transfer or hypothecation of any restricted shares. When restricted shares vest, the employee must either pay the Company within two business days the amount of all tax withholding obligations imposed on the Company or make an election pursuant to Section 83(b) of the Internal Revenue Code to pay taxes at grant date. Restricted shares may be subject to one or more objective employment, performance or other forfeiture conditions established by the Plan Committee at the time of grant. Under the terms of the Plans, the restricted shares will vest completely based on the individual grants vesting period, which is between four and seven years. The shares are forfeited entirely if the participant terminates employment for any reason other than changes in control. Any shares of restricted stock that are forfeited will again become available for issuance under the Plan. An employee or director has the right to vote the shares of restricted stock after grant until they are forfeited. Compensation cost for restricted stock is equal to the market value of the shares at the date of the award and is amortized to compensation expense over the vesting period. Dividends, if any, will be paid on awarded but unvested stock. 42 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 21. Equity Incentive Plan During 2019 and 2018, the Company issued 130,557 and 132,886 shares, respectively, of restricted stock pursuant to the 2017 Equity Incentive Plan, as amended. As of December 31, 2019 and 2018, 558,176 and 579,838 shares, respectively, issued under the Plans vest between the fourth and seventh anniversary of the date of grant, depending on the individual restricted stock grant and thus will be fully vested in 2024, subject to meeting the performance criteria of the Plan. During 2019 and 2018, 8,496 and 26,618 shares, respectively, were issued which vested during each of the respective years. The weighted-average fair value of restricted stock issued during 2019 and 2018 was $7.07 and $7.39 per share, respectively. During 2019 and 2018, 100,000 and 27,930 shares, respectively, were either forfeited or cancelled having a weighted average price of $7.50. Also, during 2019 and 2018, 53,552 and 26,618 shares were exercised, respectively. The weighted-average fair value of restricted stock Exercised during 2019 and 2018 was $5.84 and $3.82, respectively. Deferred compensation expense of $354,714 and $294,069 during 2019 and 2018, respectively, was recorded in salaries and employee benefits expense. During 2019 no stock options were issued. During 2018, the Company issued 40,000 stock options pursuant to the 2017 Equity Incentive Plan. The fair value of 2018 options granted was estimated on the date of the grant using the Black-Scholes option pricing, resulting in a total expense of $92,958. The Black-Scholes model with assumptions is presented below: Grant date Total number of options granted Expected volatility Expected term Expected dividend Risk-free rate Grant date fair value January 18, 2018 40,000 20.58% 7 years 0.00% 2.55% $7.75 Outstanding at December 31, 2018 Granted Exercised Forfeited Outstanding at December 31, 2019 Options exercisable as of December 31, 2019 Weighted- Average Remaining Life (Years) Weighted- Average Exercise Price $ 7.26 - - - 7.26 7.26 3.80 3.77 Options 200,000 - - - 200,000 82,944 The Company recognized stock-based compensation costs related to stock options of $58,684 and $57,532 for the years ended December 31, 2019 and 2018, respectively. As of December 31, 2019, there was $248,984 of total unrecognized compensation cost related to the outstanding stock options that will be recognized over the remainder of their vesting schedule. At December 31, 2019, there were 300,000 stock awards available for grant under the 2017 Equity Incentive Plan. 43 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 22. Income Per Common Share Net income available to common shareholders represents net income adjusted for preferred dividends including dividends declared, accretions of discounts and amortization of premiums on preferred stock issuances and cumulative dividends related to the current dividend period that have not been declared as of period end. The following is a summary of the income per common share calculations for the years ended December 31, 2019 and 2018. Income available to common shareholders Net income Preferred stock dividends Net income available to common shareholders Basic income per common share: Net income available to common shareholders Average common shares outstanding - basic Basic income per common share Diluted income per common share: Net income available to common shareholders Average common shares outstanding - basic Dilutive potential common shares Average common shares outstanding - diluted Diluted income per common share Note 23. Regulatory Matters 2019 2018 $ 4,088,839 - $ 4,088,839 $ 2,430,234 - $ 2,430,234 $ 4,088,839 $ 2,430,234 7,937,617 7,738,547 $ 0.52 $ 0.31 $ 4,088,839 $ 2,430,234 7,937,617 7,738,547 124,869 8,062,486 129,039 7,867,586 $ 0.51 $ 0.31 The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct adverse material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios (set forth in the table below) of Tier 1, Common Equity Tier 1 (“CET1”), and total capital as a percentage of assets and off-balance-sheet exposures, adjusted for risk-weights ranging from 0% to 150%. Tier 1 capital of the Bank consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available-for- sale, minus certain intangible assets, while CET1 is comprised of Tier 1 capital, adjusted for certain regulatory deductions and limitations. Tier 2 capital consists of the allowance for loan losses subject to certain limitations. Total capital for purposes of computing the capital ratios consists of the sum of Tier 1 and Tier 2 capital. 44 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 23. Regulatory Matters, Continued The Bank is also required to maintain capital at a minimum level based on total assets, which is known as the leverage ratio. The Bank is required to maintain a required minimum leverage ratio of 4%. Effective March 31, 2015, quantitative measures established by applicable regulatory standards, including the newly implemented Basel III revised capital adequacy standards and relevant provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd Frank Act”), require the Bank to maintain (i) a minimum ratio of Tier 1 capital to average total assets, after certain adjustments, of 4.00%, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of 6.00%, (iii) a minimum ratio of total-capital to risk-weighted assets of 8.00% and (iv) a minimum ratio of CET1 to risk-weighted assets of 4.50%. A “well-capitalized” institution must generally maintain capital ratios 2% higher than the minimum guidelines. In order to avoid restrictions on capital distributions or discretionary bonus payments to executives, the Bank is required to maintain a “capital conservation buffer” in addition to its minimum risk-based capital requirements. This buffer is required to consist solely of CET1, but the buffer applies to all three risk-based measurements (CET1, Tier 1 and total capital). The capital conservation buffer began to be phased in incrementally over time, beginning January 1, 2016 at 0.625% and was fully effective on January 1, 2019, consisting of an additional amount of Tier 1 capital equal to 2.5% of risk-weighted assets. The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements at December 31, 2019 and 2018. (Dollars in Thousands) December 31, 2019 The Bank Total capital (to risk-weighted assets) Tier 1 capital (to risk-weighted assets) Tier 1 capital (to average assets) Common Equity Tier 1 Capital (to risk-weighted assets) December 31, 2018 The Bank Total capital (to risk-weighted assets) Tier 1 capital (to risk-weighted assets) Tier 1 capital (to average assets) Common Equity Tier 1 Capital (to risk-weighted assets) Actual Amount Ratio For Capital Adequacy Purposes Ratio Amount To Be Well Capitalized Under Prompt Corrective Action Provisions Ratio Amount $ 62,299 58,752 58,752 58,752 11.54% $ 43,183 32,387 10.88 24,290 9.23 25,473 10.88 8.00% $ 53,978 43,183 6.00 35,086 4.00 31,841 4.50 10.00% 8.00 5.00 6.50 $ 56,216 53,191 53,191 53,191 12.05% $ 37,308 27,981 11.41 22,380 9.51 20,986 11.41 8.00% $ 46,635 37,308 6.00 27,975 4.00 30,313 4.50 10.00% 8.00 5.00 6.50 45 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 24. Unused Lines of Credit The Bank had available at December 31, 2019 several unsecured lines of credit, which were unused, to purchase up to $22,500,000 of federal funds from one unrelated correspondent institution. Also, as of December 31, 2019, the Bank had the ability to borrow funds from the FHLB of up to $150,158,851. At that date, $43,300,000, had been advanced. Note 25. Fair Value Measurements Generally accepted accounting principles (“GAAP”) provide a framework for measuring and disclosing fair value that requires disclosures about the fair value of assets and liabilities recognized in the balance sheet, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans). Fair value is defined as the exchange in price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of the lower of cost or market accounting or the writing down of individual assets. The following methods and assumptions were used to estimate the fair value of significant financial instruments: Fair Value Hierarchy The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These levels are: Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets. Level 2 Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques. Following is a description of valuation methodologies used for assets and liabilities recorded at fair value. Securities Available-for-Sale and Marketable Equity Securities - Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation 46 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 25. Fair Value Measurements, Continued techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. Loans - The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value, and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At December 31, 2019 and 2018, a significant portion of impaired loans were evaluated based upon the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3. Mortgage Loans Held for Sale - Mortgage loans held for sale are comprised of loans originated for sale in the ordinary course of business. The fair value of mortgage loans originated for sale in the secondary market is based on purchase commitments or quoted prices for the same or similar loans and are classified as recurring Level 2. Other Real Estate Owned - Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charges to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. Mortgage Servicing Rights - Mortgage servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The Company stratifies its mortgage servicing portfolio on the basis of loan type. The assumptions used in the discounted cash flow model are those that market participants would use in estimating future net servicing income. Assumptions in the valuation of mortgage servicing rights may include estimated loan repayment rates, the discount rate, servicing costs, and the timing of cash flows, among other factors. The Company measures mortgage servicing rights as recurring Level 3. 47 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 25. Fair Value Measurements, Continued Derivatives - The Company’s valuation techniques and inputs to internally-developed models depend on the type of derivative and nature of the underlying rate, price or index upon which the derivative's value is based. Key inputs can include yield curves, credit curves, foreign-exchange rates, prepayment rates, volatility measurements and correlation of such inputs. Where model inputs can be observed in a liquid market and the model does not require significant judgment, such derivatives are typically classified as Level 2 of the fair value hierarchy. Examples of derivatives classified as Level 2 include interest rate lock commitments written for our residential mortgage loans that we intend to sell. When instruments are traded in less liquid markets and significant inputs are unobservable, such derivatives are classified as Level 3. Additionally, significant judgments are required when classifying financial instruments within the fair value hierarchy, particularly between Level 2 and 3, as is the case for certain derivatives. The tables below present the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy at December 31, 2019 and 2018. Total Level 1 Level 2 Level 3 December 31, 2019 Available-for-sale securities: U.S. Government sponsored agencies Municipal securities Mortgage-backed securities Corporate bonds Total available-for-sale securities Marketable equity securities Mortgage loans held for sale Mortgage servicing rights Derivative assets (liabilities): Mortgage loan interest rate lock commitments Mortgage loan forward sales commitments Available-for-sale securities: U.S. Government sponsored agencies Municipal securities Mortgage-backed securities Corporate bonds Total available-for-sale securities Marketable equity securities Mortgage loans held for sale Mortgage servicing rights Derivative assets (liabilities): Mortgage loan interest rate lock commitments Mortgage loan forward sales commitments - - - - - - - - - - - $ 10,938,684 1,464,665 19,377,081 3,903,716 35,684,146 30,895 27,901,419 - $ - - - - - - - 11,022,638 713,496 (49,453) $ 64,280,503 - - $ 11,022,638 December 31, 2018 Level 1 Level 2 Level 3 - - - - - - - - - - - $ $ 13,929,850 1,333,451 15,552,568 2,572,776 33,388,645 168,151 12,713,361 - - - - - - - - 9,023,859 416,076 (186,133) $ 46,500,100 $ - - 9,023,859 $ $ $ $ 10,938,684 1,464,665 19,377,081 3,903,716 35,684,146 30,895 27,901,419 11,022,638 713,496 (49,453) $ 75,303,141 Total $ 13,929,850 1,333,451 15,552,568 2,572,776 33,388,645 168,151 12,713,361 9,023,859 416,076 (186,133) $ 55,523,959 $ 48 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 25. Fair Value Measurements, Continued The changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows: Balance, December 31, 2017 Transfers into/out of Level 3 Purchases, sales, issuances and settlements, net Total net gains (losses) included in: Net income Balance, December 31, 2018 Transfers into/out of Level 3 Purchases, sales, issuances and settlements, net Total net gains (losses) included in: Net income Balance, December 31, 2019 Mortgage Servicing Rights $ 6,357,666 - 2,991,033 (324,840) 9,023,859 - 3,306,078 (1,307,299) $ 11,022,638 Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2019 and December 31, 2018, aggregated by level in the fair value hierarchy within which those measurements fall. December 31, 2019 Impaired loans Other real estate owned Total assets at fair value December 31, 2018 Impaired loans Other real estate owned Total assets at fair value Total Level 1 Level 2 Level 3 $ $ $ $ 4,342,929 347,552 4,690,481 Total 9,446,787 341,519 9,788,306 $ $ $ $ Level 1 - - - - - - $ $ $ $ Level 2 - - - - - - $ $ $ $ 4,342,929 347,552 4,690,481 Level 3 9,446,787 341,519 9,788,306 The Company had no liabilities measured at fair value on a non-recurring basis. 49 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 25. Fair Value Measurements, Continued For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2019 and December 31, 2018, the significant unobservable inputs used in the fair value measurements were as follows: Fair Value as of December 31, 2019 Valuation Technique Significant Observable Inputs Significant Unobservable Inputs Impaired loans $ 4,342,929 Appraisal Value Appraisals and/or sales of comparable properties Other real estate $ 347,552 owned Appraisal Value/Comparison Sales/Other estimates Appraisals and/or sales of comparable properties Appraisals discounted 5% to 30% for sales commissions and other holding cost Appraisals discounted 10% to 20% for sales commissions and other holding cost Fair Value as of December 31, 2018 Valuation Technique Significant Observable Inputs Significant Unobservable Inputs Impaired loans $ 9,446,787 Appraisal Value Appraisals and/or sales of comparable properties Other real estate $ 341,519 owned Appraisal Value/Comparison Sales/Other estimates Appraisals and/or sales of comparable properties Appraisals discounted 5% to 30% for sales commissions and other holding cost Appraisals discounted 10% to 20% for sales commissions and other holding cost Fair Value of Financial Instruments The following table includes the estimated fair value of the Company’s financial assets and financial liabilities. The methodologies for estimating the fair value of financial assets and financial liabilities measured on a recurring and nonrecurring basis are discussed above. The methodologies for estimating the fair value for other financial assets and financial liabilities are discussed below. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is required to interpret market data in order to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation techniques may have a material effect on the estimated fair value amounts at December 31, 2019 and 2018. 50 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 25. Fair Value Measurements, Continued December 31, 2019 2018 Carrying Value Fair Value Carrying Value Fair Value Cash and cash equivalents Securities available-for-sale Marketable equity securities Securities held-to-maturity Mortgage loans held for sale Loans held for investment, net Nonmarketable equity securities Deposits Securities sold under agreement to repurchase Federal funds purchased Federal Home Loan Bank advances Subordinated debentures $ 40,340,683 $ 40,340,683 $ 34,561,988 $ 34,561,988 33,388,645 168,151 14,250,850 12,713,361 426,199,683 1,393,500 477,204,481 16,852,981 - 20,020,000 14,546,533 33,388,645 168,151 14,107,252 12,713,361 428,007,703 1,393,500 476,168,709 16,852,981 - 20,000,000 15,244,877 35,684,146 30,895 10,417,168 27,901,419 476,655,540 2,423,200 505,087,637 14,637,332 16,500,000 43,300,000 15,275,214 35,684,146 30,895 10,746,649 27,901,419 474,301,267 2,423,200 505,307,623 14,637,332 16,500,000 42,997,000 13,813,483 Cash and cash equivalents The carrying amount approximates fair value for these instruments. Investment securities The fair value of investment securities are generally determined using widely accepted valuation techniques including market prices, matrix pricing, and broker-quote-based applications. Loans held for sale Loans held for sale are carried at the lower of cost or fair value. These loans currently consist of on-to-four family residential real estate loans originated for sale to qualified third parties. Fair value is based upon the contractual price to be received from these third parties, which may be different than cost. Loans held for investment Fair values are estimated for portfolios of loans with similar financial characteristics if collateral-dependent. Loans are segregated by type. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect observable market information incorporating the credit, liquidity, yield and other risks inherent in the loan. The estimate of maturity is based upon the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of the current economic and lending conditions. Fair value for significant non-performing loans is generally based upon recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discounted rates are judgmentally determined using available market information and specific borrower information. Loan fair value estimated using exit price notion as of December 31, 2019 based on adoption of ASU 2016-01. The methods used to estimate fair value of loans do not necessarily represent an exit price as of December 31, 2018. 51 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 25. Fair Value Measurements, Continued Nonmarketable equity securities Nonmarketable equity securities are carried at original cost basis, as cost approximates fair value and there is no ready market for such investments. Deposits The fair value of deposits with no stated maturity date, such as noninterest-bearing demand deposits, savings and money market and checking accounts, is based on the discounted value of estimated cash flows. The fair value of time deposits is based upon the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. Notes payable The fair carrying value of notes payable is estimated by using discounted cash flow analyses based on incremental borrowing rates for similar types of instruments These are classified as Level 2. Subordinated debentures The fair value of subordinated debentures is estimated by using discounted cash flow analyses based on incremental borrowing rates for similar types of instruments These are classified as Level 2. Federal Home Loan Bank advances Fair value is estimated based on discounted cash flows using current market rates for borrowing with similar terms and are classified as of Level 2. Other borrowings The fair value of federal funds purchased and securities under agreements to repurchase approximate the carrying amount because of the short maturity of these borrowings. 52 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 26. Revenue and Recognition In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. Deposit Service Charges: The Bank earns fees from its deposit customers for account maintenance, transaction-based and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposits accounts are charged to deposit customers for specific services provided to the customer, such as non- sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer. Check Card Fee Income: Check card fee income represents fees earned when a debit card issued by the Bank is used. The Bank earns interchange fees from debit cardholder transactions through the VISA payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the card. Certain expenses directly associated with the debit card are recorded on a net basis with the fee income. This income is recognized within “Other” below. 53 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 26. Revenue and Recognition, Continued Gains/Losses on OREO Sales: Gains/losses on the sale of OREO are included in non-interest income and are generally recognized when the performance obligation is complete. This is typically at delivery of control over the property to the buyer at the time of each real estate closing. December 31, 2019 December 31, 2018 $ $ Non-Interest Income Deposit service charges Mortgage banking income (1) Income from bank owned life insurance (1) Gain on sale of securities (1) Gain on nonmarketable securities (1) Other service charges, commissions and fees Other (2) Total non-interest income (1) Not within the scope of ASC 606 (2) Includes Check Card Fee income discussed above. No other items are within the scope of ASC 606 1,681,812 5,593,441 386,073 21,168 16,077 1,548,202 456,192 9,702,965 1,597,211 5,138,660 390,557 - 800,000 1,510,405 487,529 9,924,362 $ $ Note 27. Subsequent Events Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed events occurring through March 31, 2020, the date the financial statements were available to be issued. The 2019 novel coronavirus (or “COVID-19”) has adversely affected, and may continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak in December 2019 and January 2020, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. Such events also may adversely affect business and consumer confidence, generally, and the Company and its customers, and their respective suppliers, vendors and processors may be adversely affected. On March 3, 2020, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company’s financial condition and results of operations. 54 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 27. First Reliance Bancshares, Inc. (Parent Company Only) Condensed Balance Sheets Assets Cash Investment in banking subsidiary Equity securities Nonmarketable equity securities Investment in trust Deferred tax asset Other assets Total assets Liabilities Junior subordinated debentures Subordinated debentures Accrued salary benefits Accrued interest payable Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity Condensed Statements of Operations Income Interest income Gain on sale of trust preferred security Dividend from banking subsidiary Gain on fair value of equity securities Total income Expenses Salaries and employee benefits Equipment expense Interest expense Acquisition-related costs Other expenses Total expenses Income before income taxes and equity in undistributed income of banking subsidiary Equity in undistributed earnings of banking subsidiary Net income before income taxes Income tax benefit Net income 55 December 31, 2019 2018 $ 1,380,350 69,046,787 30,895 58,100 310,000 1,687,908 129,637 $ 72,643,677 $ 3,235,365 62,420,978 168,151 58,100 310,000 1,338,543 81,897 $ 67,613,034 $ 10,310,000 4,965,214 105,196 177,807 15,558,217 57,085,460 $ 72,643,677 $ 10,310,000 4,934,877 - 199,708 15,444,585 52,168,449 $ 67,613,034 For the years ended December 31, 2019 2018 $ $ 14,161 - - 16,076 30,237 666,563 56,154 782,220 37,210 393,749 1,935,896 12,023 800,000 2,100,000 38,151 2,950,175 351,801 57,630 765,076 1,005,195 293,160 2,472,862 (1,905,659) 5,625,633 477,313 1,653,666 3,719,974 (368,865) $ 4,088,839 2,130,979 (299,256) $ 2,430,234 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2019 and 2018 Note 27. First Reliance Bancshares, Inc. (Parent Company Only), Continued Condensed Statements of Cash Flows Cash flows from operating activities Net income Adjustments to reconcile net income to net cash used in operating activities: Deferred income tax expense Net equity in undistributed earnings of banking subsidiary Gain on sale of trust preferred security Gain on fair value of equity securities Stock based compensation expense Increase (decrease) in accrued interest payable Increase in other assets Increase in accrual salary benefits Net cash used in operating activities Cash flows from by investing activities Proceeds from sale of equity security Purchase of trust preferred security Proceeds from sale of trust preferred security Net cash provided by investing activities Cash flows from financing activities Net proceeds from issuance of common stock Accretion of debt issuance costs Decrease (increase) in restricted stock Capital contribution to subsidiary Purchase of treasury stock Net cash used in financing activities Decrease in cash Cash and cash equivalents, beginning of year Cash and cash equivalents, ending of year For the years ended December 31, 2019 2018 $ 4,088,839 $ 2,430,234 (349,365) (5,625,633) - 16,076 58,683 (21,901) (47,740) 105,196 (1,775,845) 121,180 - - 121,180 173,738 30,337 254,924 - (659,349) (200,350) (318,756) (1,653,666) (800,000) (38,151) 57,732 15,219 (15,459) - (963,078) - (2,300,000) 3,100,000 800,000 955,443 22,914 (640,231) (15,000,000) (394,276) (15,056,150) (1,855,015) 3,235,365 $ 1,380,350 (14,578,997) 17,814,362 $ 3,235,365 56 There’s More to Banking Than Money.R www.firstreliance.com 888.543.5510 

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