First Reliance Bancshares, Inc.
Annual Report 2023

Plain-text annual report

Annual Report 2023 Dear Fellow Shareholders: As we reflect on 2023, I am pleased to share our annual report with insights into our performance, accomplishments, and vision for the future. The past year provided one of the most difficult operating environments for banks since the Great Recession. Amid the backdrop of multiple high-profile bank failures and questions surrounding regional bank stability, First Reliance enjoyed another successful year in 2023. Focused on the ongoing execution of our strategic plan, the balance sheet continued to be a source of strength with exceptional asset quality metrics and solid liquidity and capital ratios. While navigating unexpected challenges and fluid economic conditions, we began to see our net interest margin expand in the fourth quarter of 2023. During the year, we took action to enhance our future net interest margin by repositioning a portion of our investment securities portfolio. The bank incurred a non-recurring $1.5 million loss on the sale of securities, with a very short earn back period. We are also looking forward to our loan portfolio, consisting of predominately fixed rate loans, to continue to reprice to current market rates as our deposit cost increases begin to slow. Taken together this should help usher in net interest margin expansion at some point in 2024 and beyond. In the meantime, we remain committed to disciplined cost management practices while delivering exception service to our clients. The bank continued to see organic growth in 2023, including loan growth of approximately $44 million and deposit growth of approximately $60 million. Loan growth included the absorption of approximately $14 million of runoff in the bank’s legacy indirect automobile loan portfolio. While the mortgage environment remained challenging, we made several key production hires during the year and onboarded several new mortgage partners through our correspondent/wholesale channel. We also implemented technology enhancements in our mortgage business creating operational efficiencies and an improved customer experience. Improving these internal fundamentals within our mortgage division has been a key objective while we await the stabilization of mortgage rates and an improvement in the mortgage landscape. We are proud of our continued progress despite numerous headwinds in 2023 and are excited about what we can accomplish in 2024. ® i Performance Asset Growth Total assets grew by $37.0 million during 2023, or 4.0%, from $937.1 million at December 31, 2022 to $974.2 million at December 31, 2023. This growth was mainly driven by an increase in loans and investment securities, offset by a decrease in cash. Total Assets ($ in millions) $910.8 $937.1 $974.2 $710.2 Loan Growth and Asset Quality During 2023, we grew loans by $44.4 million, or 6.7%, from $661.3 million at December 31, 2022 to $705.7 million at December 31, 2023. Our asset quality remained strong during the year, with the ratio of nonperforming assets to total assets decreasing to 0.04% at December 31, 2023 from 0.05% at December 31, 2022. 2020 2021 2022 2023 Total Loans ($ in millions) $586.4 $661.3 $705.7 $478.0 2020 2021 2022 2023 Deposit Growth For the full year 2023, total deposits increased $60.4 million, or 7.6%; from $798.2 million at December 31, 2022 to $858.6 million at December 31, 2023. Transaction deposits to total deposits decreased from 51.05% at December 31, 2022, to 41.30% at December 31, 2023. Total Deposits ($ in millions) $780.8 $798.2 $858.6 $594.0 Tangible Book Value During the year, tangible book value per share rose by 13.2% to $8.68 at December 31, 2023, from $7.67 at December 31, 2022. 2020 2021 2022 2023 Tangible Book Value Per Share $8.46 $8.12 $7.67 $8.68 2020 2021 2022 2023 ® ii Our customers remain at the heart of everything we do. Throughout the year, we have continued to invest in technology and innovation to enhance their banking experience. From digital banking solutions to personalized services, we are dedicated to meeting the evolving needs of our customers and providing them with best-in-class financial products and services. We are very proud that our mobile app is 4.9 stars in the Apple store as rated by our clients. We have continued to invest in robust security measures and fraud detection technologies to protect our customers’ assets and ensure the safety and security of their financial transactions. We continue to recognize that our employees are our greatest asset. These team members are a driving force behind our success, and their enthusiasm and dedication are essential to providing exceptional service to our clients. Our employees understand that having long-term relationships with clients and deep ties to our community are extremely important. Looking ahead, we remain cautiously optimistic about the future. While uncertainties persist, we are confident in our ability to adapt and thrive in a rapidly changing environment. By remaining committed to the core banking principles of safety and soundness, profitability, and growth, we believe that First Reliance Bank is well-positioned for long- term success. Staying true to our core values and putting our customers first will continue to be a key to reaching our goals. In closing, I would like to express my gratitude to our shareholders, customers, employees, and partners for their continued support and dedication. Together, we will continue to build a brighter future for First Reliance. Sincerely, F.R. “Rick” Saunders Jr. Chief Executive Officer ® iii First Reliance Bancshares, Inc. and Subsidiary Report on Consolidated Financial Statements As of and for the years ended December 31, 2023 and 2022 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 ................................................................................................. 9-59 Independent Auditor’s Report The Board of Directors First Reliance Bancshares, Inc. and Subsidiary Florence, South Carolina Opinion We have audited the consolidated financial statements of First Reliance Bancshares, Inc. and Subsidiary (the “Company”), which comprise the consolidated balance sheets as of December 31, 2023 and 2022, 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”). In our opinion, the accompanying financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Basis for Opinion We conducted our audits in accordance with auditing standards generally accepted in the United States of in the Auditor’s America (GAAS). Our responsibilities under those standards are further described Responsibilities for the Audit of the Financial Statements section of our report. We are required to be independent of the Company and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements relating to our audits. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Change in Accounting Principle As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2023 due to the adoption of Financial Accounting Standards Board Accounting Standards Codification No. 326, Financial Instruments – Credit Losses (ASC 326). The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. Our opinion is not modified with respect to this matter. Responsibilities of Management for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America, and for 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. In preparing the financial statements, management is required to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued or available to be issued. elliottdavis.com 1 Auditor’s Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not absolute assurance and therefore is not a guarantee that an audit conducted in accordance with GAAS will always detect a material misstatement when it exists. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Misstatements are considered material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the financial statements. In performing an audit in accordance with GAAS, we: • • Exercise professional judgment and maintain professional skepticism throughout the audit. Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, and design and perform audit procedures responsive to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. • Obtain an understanding of internal control relevant to the audit 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 Company’s internal control. Accordingly, no such opinion is expressed. • • Evaluate the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluate the overall presentation of the financial statements. Conclude whether, in our judgment, there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern for a reasonable period of time. We are required to communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit, significant audit findings, and certain internal control–related matters that we identified during the audit. Columbia, South Carolina March 26, 2024 2 First Reliance Bancshares, Inc. and Subsidiary Consolidated Balance Sheets As of December 31, 2023 and 2022 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 Nonmarketable equity securities Total investment securities Mortgage loans held for sale Loans receivable Less allowance for credit losses Loans, net Premises, furniture and equipment, net Accrued interest receivable 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 Subordinated debentures Junior subordinated debentures Accrued interest payable Lease liability Reserve for unfunded commitments Other liabilities Total liabilities Shareholders’ Equity 2023 2022 $ $ $ 4,353,883 $ 17,590,169 21,944,052 - 128,517 171,399,573 949,800 172,477,890 7,155,912 705,672,390 (8,393,493) 697,278,897 22,298,348 3,453,458 18,190,892 7,775,295 11,638,174 74,316 690,917 5,342,365 5,836,677 974,157,193 $ 210,603,869 $ 144,039,452 334,715,713 40,806,186 128,431,287 858,596,507 307,517 5,000,000 15,412,697 10,310,000 1,076,368 5,592,934 407,487 6,057,759 902,761,269 3,916,889 29,880,421 33,797,310 258,718 133,715 162,096,848 1,787,200 164,017,763 7,940,056 661,250,516 (7,659,794) 653,590,722 22,811,450 2,765,106 18,835,768 8,628,905 10,441,422 147,094 690,917 5,977,748 7,210,167 937,113,146 255,426,725 152,012,419 287,043,628 23,152,023 80,549,048 798,183,843 7,367,861 30,000,000 15,380,951 10,310,000 331,678 6,197,620 - 6,045,329 873,817,282 Series D non-cumulative preferred stock, $0.01 par value; 70,000 shares authorized; 52,332 and 53,732 shares issued and outstanding at December 31, 2023 and 2022, respectively 523 537 Common stock, $0.01 par value; 20,000,000 shares authorized; 8,772,329 and 8,730,262 shares issued; and 8,139,077 and 8,140,311 shares outstanding at December 31, 2023 and 2022, respectively Capital surplus Treasury stock, at cost, 633,252 and 589,951 shares at December 31, 2023 and 2022, respectively Nonvested restricted stock Retained earnings Accumulated other comprehensive loss Total shareholders’ equity Total liabilities and shareholders’ equity 87,723 55,471,379 (4,821,348) (2,517,557) 33,748,274 (10,573,070) 71,395,924 974,157,193 $ $ 87,303 53,967,630 (4,502,374) (2,121,128) 29,916,355 (14,052,459) 63,295,864 937,113,146 See Notes to Consolidated Financial Statements 3 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Operations For the years ended December 31, 2023 and 2022 Interest income: Loans, including fees Investment securities: Taxable Tax exempt Other interest income Total Interest expense: Deposits Federal Home Loan Bank advances Subordinated debentures Other interest expense Total Net interest income Provision for credit losses on loans Provision for (release of) credit losses on unfunded commitments Net interest income after provision for credit losses Noninterest income: Mortgage banking income Service charges on deposit accounts Other service charges, commissions, and fees Income from bank owned life insurance Loss on sale of investment securities Gain on disposal of fixed assets Gain on sale of mortgage servicing rights Other Total Noninterest expenses: Salaries and benefits Occupancy and equipment Data processing, technology, and communications Professional fees Marketing 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 Statements 4 2023 2022 $ 36,170,561 $ 28,564,688 6,078,622 63,193 2,076,368 44,388,744 12,546,015 1,388,896 1,429,229 51,688 15,415,828 3,639,528 115,481 885,851 33,205,548 1,964,637 109,983 1,072,846 17,213 3,164,679 28,972,916 30,040,869 847,398 (478,551) 480,000 - 28,604,069 29,560,869 3,821,146 1,373,920 2,160,491 528,462 (1,525,631) 29,719 - 531,448 6,919,555 18,273,828 3,428,830 3,613,544 420,445 687,261 3,286,247 29,710,155 3,733,991 1,392,412 2,092,696 359,872 - 23,259 681,827 696,157 8,980,214 19,006,038 3,589,102 3,268,335 751,377 743,379 3,611,560 30,969,791 5,813,469 7,571,292 1,210,053 1,640,280 $ 4,603,416 $ 5,931,012 7,822,882 8,163,934 7,779,396 8,127,148 $ 0.59 $ 0.56 0.76 0.73 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Comprehensive Income For the years ended December 31, 2023 and 2022 Net income Other comprehensive gain (loss), net of tax: Unrealized holding gains (losses) on securities available-for-sale Reclassification adjustment for realized losses included in earnings Income tax (expense) benefit Other comprehensive gain (loss), net of tax 2023 2022 $ 4,603,416 $ 5,931,012 3,082,832 1,525,631 (1,129,074) 3,479,389 (18,429,822) - 4,514,391 (13,915,431) Comprehensive income (loss) $ 8,082,805 $ (7,984,419) 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, 2023 and 2022 Preferred Stock Amount Shares Common Stock Shares Amount Capital Surplus Treasury Stock Nonvested Restricted Stock Accumulated Other Retained Comprehensive Income (Loss) Earnings Total Balance, December 31, 2021 54,732 547 8,793,108 87,931 53,855,594 (4,322,496) (2,668,238) 23,985,343 (137,030) 70,801,651 Balance, December 31, 2022 53,732 537 8,730,262 87,303 53,967,630 (4,502,374) (2,121,128) 29,916,355 (14,052,459) 63,295,864 Net income Other comprehensive loss, net of tax Conversion of Preferred Stock - Series D to Common Stock Net issuance of Common Stock Restricted stock forfeitures Net change in restricted stock Stock based compensation Purchase of treasury stock Adoption of new accounting standard Net income Other comprehensive income, net of tax Conversion of Preferred Stock - Series D to Common Stock Issuance of Common Stock Restricted stock forfeitures Net change in restricted stock Stock based compensation Purchase of treasury stock - - - - - - - - (1,000) (10) 1,000 10 - - - 36,925 369 553,740 (100,771) (1,007) (814,127) - - - - - - - 372,423 - (179,878) - - - - - - - - - - - - (1,400) (14) 1,400 14 - - - - 51,312 513 130,876 (10,645) (107) (73,892) - - - - - - - 1,446,765 - (318,974) - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 547,110 - - 5,931,012 - 5,931,012 - - - - - - - (13,915,431) (13,915,431) - - - - - - - 554,415 (815,440) 547,110 372,423 (179,878) - - - - - - (396,429) - - (771,497) 4,603,416 - - (771,497) 4,603,416 - - - - - - - 3,479,389 3,479,389 - - - - - - - 131,389 (73,999) (396,429) 1,446,765 (318,974) Balance, December 31, 2023 52,332 $ 523 8,772,329 $87,723 $ 55,471,379 $ (4,821,348) $ (2,517,557) $ 33,748,274 $ (10,573,070) $ 71,395,924 See Notes to Consolidated Financial Statements 6 First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Cash Flows December 31, 2023 and 2022 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses loans held for investment Provision for (release of) credit losses – unfunded commitments Depreciation expense Loss on change in fair value of marketable equity securities Discount accretion and premium amortization on investment securities Discount accretion on purchased loans Gain on disposal of fixed assets Loss on sale of other real estate owned Loss on sale of investment securities Originations of mortgages held for sale Proceeds from sales of mortgages held for sale Mortgage banking income Proceeds from sale of mortgage servicing rights Gain on sale of mortgage servicing rights Core deposit intangible amortization Gain on extinguishment of debt Amortization of debt issuance costs Deferred income taxes Decrease (increase) in cash surrender value of life insurance Stock based compensation expense Decrease in ROU asset Increase in mortgage servicing rights, net Increase in accrued interest receivable Decrease (increase) in other assets Increase in accrued interest payable Decrease in lease liabilities Increase in other liabilities Net cash provided by operating activities Cash flows from investing activities: Purchases of securities available-for-sale Maturities of securities available-for-sale Proceeds on sales of securities available-for-sale Net decrease (increase) in nonmarketable equity securities Net decrease (increase) in time deposits in other banks Net increase in loans receivable Purchases of premises, furniture and equipment Proceeds from death benefits received on BOLI Proceeds from disposal of premises, furniture and equipment Proceeds from sale of other real estate owned Net cash used in investing activities 7 2023 2022 $ 4,603,416 $ 5,931,012 847,398 (478,551) 1,126,296 5,198 141,659 (245,842) (29,719) - 1,525,631 (202,205,102) 206,810,392 (3,821,146) - - 72,778 - 31,746 (70,382) (528,462) 1,446,765 480,000 - 1,112,170 4,144 407,576 (303,103) (23,259) 15,838 - (221,328,200) 240,966,438 (3,733,991) 5,621,661 (681,827) 97,380 (5,314) 31,746 13,700 (359,872) 54,623 656,472 635,383 (1,324,159) (1,196,752) (1,061,963) (688,352) (1,672,790) 1,373,490 188,946 744,690 (604,686) (584,030) 844,734 25,347,932 12,431 9,029,728 (55,030,945) 10,484,793 38,184,599 837,400 258,718 (43,901,721) (628,895) 1,173,338 45,420 - (48,577,293) (113,005,110) 12,850,125 1,000,000 (950,200) (1,545) (74,361,722) (1,146,305) - 50,950 119,162 (175,444,645) First Reliance Bancshares, Inc. and Subsidiary Consolidated Statements of Cash Flows December 31, 2023 and 2022 See Notes to Consolidated Financial Statements Cash flows from financing activities: Net (decrease) increase in demand deposits, interest-bearing transaction accounts and savings accounts Net increase (decrease) in certificates of deposit and other time deposits Net (decrease) increase in advances from Federal Home Loan Bank Net (decrease) increase in securities sold under agreements to repurchase Issuance of common stock (Increase) decrease in nonvested restricted stock Purchase of treasury stock Net cash provided by financing activities Net (decrease) 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: Net change in unrealized gains on investment securities Adoption of ASU 2016-13 2023 2022 (5,123,738) 65,536,402 (25,000,000) (7,060,344) 57,390 (396,429) (318,974) 27,694,307 39,576,828 (22,226,308) 20,000,000 (4,004,464) 56,775 547,110 (179,878) 33,770,063 (11,853,258) (116,326,650) 33,797,310 150,123,960 $ 21,944,052 $ 33,797,310 $ 610,065 $ 14,671,138 2,246,350 2,975,733 $ 3,479,389 $ 771,497 (13,915,431) - See Notes to Consolidated Financial Statements 8 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 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 credit losses (“ACL”) on loans, including valuation allowances of specifically reviewed loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the valuation of investment securities. In connection with the determination of the ACL 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 ACL 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 ACL on loans and reserves on foreclosed real estate. Such agencies may require the Company to recognize additions to the ACL 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 ACL on loans, unfunded commitments, and evaluation of reserves on 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, 2023 and 2022, the majority of the total loan portfolio was to borrowers from within these areas. 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. 9 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued 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 or its corporations, obligations of state and local governments, collateralized loan obligations, and corporate securities. In the opinion of management, there is minimal 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. Accounting Standards Adopted in 2023: On January 1, 2023, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASC 326). This standard replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology. CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities, and some off-balance sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit deteriorated (“PCD”) loans will receive an initial allowance at the acquisition date that represents an adjustment to the amortized cost basis of the loan, with no impact to earnings. In addition, CECL made changes to the accounting for available-for-sale (“AFS”) debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities if management does not intend to sell and does not believe that it is more likely than not they will be required to sell. There was no allowance for credit losses recorded on AFS securities in 2023. The Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023, using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. The transition adjustment of the adoption of CECL included an increase in the allowance for credit losses on loans of $114,221, which is presented as a reduction to net loans outstanding, and an increase in the allowance for credit losses on unfunded loan commitments of $886,038, which is presented on the balance sheet. The Company recorded a net decrease to retained earnings of $771,497 as of January 1, 2023, for the cumulative effect of adopting CECL, which reflects the transition adjustments noted above, net of the applicable deferred tax assets recorded. Results for reporting periods beginning after January 1, 2023, are presented under CECL while prior period amounts continue to be reported in accordance with previously applicable accounting standards (“Incurred Loss”). 10 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Accounting Standards Adopted in 2023, continued: The Company adopted ASC 326 using the prospective transition approach for PCD assets that were previously classified as purchased credit impaired (“PCI”) under ASC 310-30. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2023, the amortized cost basis of PCD assets were adjusted to reflect the addition of $23,681 to establish the allowance for credit losses. The remaining interest-related discount of approximately $441,936 will be accreted into interest income at the effective interest rate as of January 1, 2023. Regarding PCD assets, the Company elected to disaggregate the former PCI pools and no longer considers these pools to be the unit of account; contractually delinquent PCD loans will be reported as nonaccrual loans using the same criteria as other loans. The Company adopted ASC 326 using the prospective transition approach for debt securities for which other-than- temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have any other-than-temporarily impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined that there was no allowance for credit losses on available-for-sale securities. The following table illustrates the impact on the allowance for credit losses from the adoption of ASC 326: January 1, 2023 As Reported Under ASC 326 December 31, 2022 Pre-ASC 326 Adoption Impact of ASC 326 Adoption Assets: Loans, at amortized cost Allowance for credit losses on loans: Construction Residential Non-Residential Commercial and industrial Consumer and other Total allowance for credit losses Liabilities: Allowance for credit losses unfunded Commitments $ $ $ $ 661,274,197 $ 661,250,516 $ 23,681 (522,313) $ (2,083,881) (3,669,567) (800,070) (698,184) (7,774,015) $ (516,545) $ ($2,048,171) (3,612,062) (790,172) (692,844) (7,659,794) $ (5,768) (35,710) (57,505) (9,898) (5,340) (114,221) 886,038 $ - $ (886,038) On January 1, 2023, the Company adopted ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures,” which are intended to improve the decision usefulness of information provided to investors about certain loan re-financings, restructurings, and write-offs. There was no material effect on the Company’s financial statements with this adoption. 11 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Accounting Standards Adopted in 2023, continued: In December 2022, the FASB issued ASU 2022-06, which provided amendments to extend the period of time preparers can use the reference rate reform relief guidance under Accounting Standards Codification (ASC) Topic 848 from December 31, 2022 to December 31, 2024, to address the fact that all London Interbank Offered Rate (LIBOR) tenors were not discontinued as of December 31, 2021, and some tenors will be published until June 2023. The amendments are effective immediately for all entities and applied prospectively. This change impacted the interest rate paid on some loans and on Trust Preferred Securities (debt) (see note 12) and the new rates were effective July 1, 2023. This change did not have a material impact on the Company’s financial statements. Recently issued accounting pronouncements: In December 2023, the FASB amended the Income Tax topic in the Accounting Standards codification to improve the transparency of income tax disclosures. The amendments are effective for annual periods beginning after December 15, 2024 (for public entities) and for annual periods beginning after December 15, 2025 (for all other entities). Early adoption is permitted for annual financial statements that have not yet been issued or made available for issuance. The Company does not expect these amendments to have a material effect of 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. 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 credit related are recorded in an ACL account and reported as provision for credit losses in the income statement. 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. The amortization of premiums are recognized to the first call date and accretion of discounts are recognized in interest income using a methodology that approximates a level yield of interest over the estimated remaining period to maturity. Allowance for credit losses – AFS securities For available-for-sale securities, management evaluates all investments in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security, or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value, and the entire loss is recorded in earnings. If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, performance on any underlying collateral, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal 12 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued payments and adverse conditions specifically related to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected is compared to the amortized cost basis of the security and any excess is recorded as an allowance for credit loss, limited to the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an allowance for credit loss is recognized in other comprehensive income. Changes in the allowance for credit loss are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance for credit loss when management believes an available-for-sale security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met. At December 31, 2023, there was no allowance for credit loss related to the available-for-sale portfolio. Accrued interest receivable on available-for-sale debt securities totaled $1,221,459 at December 31, 2023 and was excluded from the estimate of credit losses. Marketable equity securities: Marketable equity securities are carried at fair value, with changes in fair value recorded within other noninterest income in the consolidated statements of operations. Dividends received on marketable equity securities are included as a separate component of interest income. Nonmarketable equity securities: At December 31, 2023 and 2022, nonmarketable equity securities consist of the following: Federal Home Loan Bank stock Community Bankers Bank stock Total 2023 2022 $ $ 891,700 $ 1,729,100 58,100 949,800 $ 1,787,200 58,100 Nonmarketable equity securities are carried at cost since there is 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 that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their amortized cost basis, net of any charge-offs. Amortized cost is the principal balance outstanding, net of purchase premiums or discounts and deferred fees and costs. Accrued interest receivable related to loans totaled $2,231,999 at December 31, 2023 and was reported in accrued interest receivable on the consolidated balance sheets. Interest income is recognized in the period earned and is computed based upon the unpaid principal balance. Loans receivable, continued: 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 13 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued 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. Past due status is based on contractual terms of the loan. A loan is considered to be past due when a scheduled payment has not been received 30 days after the contractual due date. 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 using a straight-line method. Allowance for credit losses- Loans: The allowance for credit losses represents the portion of the loan's amortized cost basis that the Company does not expect to collect due to credit losses over the loan's life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for credit losses is based on the loan's amortized cost basis, excluding accrued interest receivable, as the Company promptly charges off uncollectible accrued interest receivable. Management’s determination of the appropriateness of the allowance is based on periodic evaluation of the loan portfolio, lending-related commitments and other relevant factors, including macroeconomic forecasts and historical loss rates. In the future, the Company may update information and forecasts that may cause significant changes in the estimate in those future quarters. The Company calculates its expected credit loss using a non-discounted cash flow methodology that calculates the lifetime loss rate. Loss estimates within the collectively assessed population, used for non-impaired loans that share common risk characteristics, are based on a combination of pooled assumptions and loan-level characteristics. Expected losses for the Bank’s collectively assessed loan segments are estimated using a loan- level probability of default ("PD") / loss given default ("LGD") cash flow method with an exposure at default ("EAD") model. Our third-party provider, Abrigo, supports the model and the Valuant Index used by the Company. For each segment, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, probability of default rates, and loss given default rates. Due to limited historical losses, the modeling of quantitative loss inputs such as PD and LGD utilize the Valuant Index. In order to estimate the life of a loan, the contractual term of the loan is adjusted for estimated prepayments based on market information and the Company’s prepayment history. The Company also considers the need to adjust historical information to reflect the extent to which management expects losses through a reasonable and supportable forecast. The Bank has elected to utilize the regression model built off the Valuant Index to reasonably forecast expected PDs based on expected changes in the National Unemployment Rate. For loss estimation purposes, the Company disaggregates the loan portfolio into five loan segments: 1) Construction real estate; 2) Residential real estate; 3) Non-residential real estate; 4) Commercial and industrial; and 5) Consumer and other. Each of these loan segments receives the application of qualitative inputs for loss estimation purposes (see paragraph on page 15 for more detail on qualitative factors). 14 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Allowance for credit losses- Loans, continued: These loan segments include: Construction real estate loans. Includes commercial construction, land acquisition and development loans, single- family construction to small businesses and individuals. These loans are generally secured by the land or the real property being built and are made based on the Company’s assessment of the value of the property on an as- completed basis and repayment depends upon project completion and sale, refinancing, or operation of the real estate. Residential real estate loans. Includes 1-4 family mortgage loans, residential line of credit loans, and residential construction loans. All of these loan types are primarily made with respect to and secured by single family homes, which are both owner-occupied and investor owned. Repayment depends primarily upon the cash flow of the borrower as well as the value of the real estate collateral. Non-residential real estate loans. Includes commercial real estate non-owner occupied and owner- occupied loans to finance commercial real estate investment properties for various purposes including use as offices, warehouses, production facilities, health care facilities, hotels, mixed-use residential/commercial, manufacturing housing communities, assisted living facilities, retail centers, restaurants, churches and agricultural based facilities. Commercial real estate owner-occupied loans are typically repaid through the ongoing business operations of the borrower. Commercial real estate non-owner occupied loans are typically repaid with the funds received from the sale or refinancing of the property or rental income from such property. industrial loans. Commercial and loans are typically made to small-sized Commercial and manufacturing, wholesale, retail and service businesses, and farmers for working capital and operating needs and business expansions. Commercial and industrial loans generally include lines of credit and loans with maturities of five years or less. Commercial and industrial loans are generally made with operating cash flows as the primary source of repayment, but may also include collateralization by inventory, accounts receivable, equipment and personal guarantees. industrial Consumer and other loans. Includes loans to individuals for personal, family and household purposes, including car, boat and other recreational vehicle loans, manufactured homes (without real estate) and personal lines of credit. Consumer loans are generally secured by vehicles and other household goods, with repayment depending primarily on the cash flow of the borrower. The Company's loss rate models estimate the lifetime loss rate for the pools of loan segments by combining the calculated loss rate based on each variable within the model, including the macroeconomic variables. The lifetime loss rate for the pool is then multiplied by the loan balances to determine the expected credit losses on the pool. The quantitative models require loan data and macroeconomic variables based on the inherent credit risks in each portfolio to more accurately measure the credit risks associated with each. The quantitative models pool loans with similar risk characteristics and collectively assesses the lifetime loss rate for each pool to estimate its expected credit loss. Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. These qualitative factor adjustments may increase or decrease the Company’s estimate of expected credit losses, and includes those that 15 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued are relevant to the institution as of the reporting date, which may include, but are not limited to: levels of and trends in delinquencies and performance of loans; levels of and trends in write-offs and recoveries collected; trends in volume and terms of loans; effects of any changes in reasonable and supportable economic forecasts; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and expertise; available relevant information sources that contradict the Company’s own forecast; effects of changes in prepayment expectations or other factors affecting assessments of loan contractual terms; industry conditions; and effects of changes in credit concentrations. When loans no longer share similar risk characteristics with other loans in any given pool, the loan is evaluated on an individual basis. When the borrower is experiencing financial difficulty and repayment is expected to be provided through operations or sale of collateral, the expected credit losses are based on the fair value of collateral at the reporting date, adjusted for selling costs as appropriate. Allowance for loan losses – Prior to the adoption of ASC 326 The allowance for loan losses is management’s estimate of losses inherent in the loan portfolio. It is established through the provision for loan losses charged to earnings. Charged-off loans are charged against the allowance when the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. 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 impaired. For these loans, an allowance is established when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired 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 through 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, less estimated costs to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. 16 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Allowance for loan losses – Prior to the adoption of ASC 326, continued: 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 loan modification in 2023 or as troubled debt restructuring for calendar years 2022 and prior. Loan modifications or restructurings 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. 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 and directors 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 or market value, with any subsequent decreases in fair value recognized in mortgage banking income. 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 recorded in mortgage banking 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. The Company’s servicing assets are initially measured at fair value and are subsequently measured using either the fair value method or the amortization method, depending on the asset class, which has been determined to be vintage (or loan origination) year. 17 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Mortgage servicing rights, continued: 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 accounted for using the fair value method are carried at fair value with changes in fair value, changes due to paydowns and payoffs of underlying loans, and servicing fees (cost) recorded in mortgage banking income in the consolidated statements of operations. For MSRs accounted for using the amortization method, the amortization is determined in proportion to, and over the period of, the estimated net servicing income and recorded in mortgage banking income in the consolidated statements of operations. These MSRs are evaluated quarterly for possible impairment. If the impairment evaluation indicates that the carrying amount of the servicing assets exceeds their fair value, the carrying amount is reduced by recording a charge to income in the amount of such excess and establishing a valuation reserve allowance. If impairment is determined to be other-than-temporary, a direct write-off of the carrying amount would be recorded. Core deposit intangible: As a result of a business combination, 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. An impairment charge is recognized if the carrying value of the reporting unit’s goodwill exceeds its implied fair value. The Company has performed the annual impairment analysis as of December 31, 2023 and concluded no impairment exists. 18 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued 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 assesses the need to recognize an initial liability for the fair value of obligations assumed under the guarantee. If determined to be necessary based on the nature of the guarantee, the Company will establish 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 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 any 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 increases in the reserve will not be required in future periods. The Company may from time-to-time be required to repurchase mortgage loans previously sold to investors due to loan nonperformance. Based on management’s analysis of current representations and guarantees, the Company had a reserve of $11,736 and $25,000 at December 31, 2023 and December 31, 2022, respectively. Derivatives and hedging: At the inception of a derivative contract, the Company designates the derivative as one of the three types based on the Company’s intentions and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“non-designated derivative”). For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to he hedged risk, are recognized in current earnings as the fair values change. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Changes in fair value of derivatives not designated are reported currently in earnings, as non-interest income. Accrued settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Accrued settlements on derivatives not designated are reported in non-interest income. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged. The Company formally documents the relationship between derivatives and hedged items, as well as the risk- management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship. This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are designated are highly effective in offsetting changes in fair value s or cash flows of the hedged items. The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes 19 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Derivatives and hedging, continued: in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction in no longer probable, a hedged firm commitment in no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended. When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as non- interest income. When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, the gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings. The Company is exposed to losses if a counterparty fails to make its payments under a contract in which the Company is in the net receiving position. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. All of the contracts to which the Company is a party settle monthly or quarterly. In addition, the Company obtains collateral above certain thresholds of the fair value of its derivatives for each dealer counterparty based upon their credit standing and the Company has netting agreements with the dealers with which it does business. Revenue 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, 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. Service Charges on Deposit Accounts: 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 deposit 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. 20 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Revenue recognition, continued: Check Card Fee Income: Included within other service charges, commissions and fees, 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 Mastercard 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. Gains/Losses on OREO Sales: Gains/losses on the sale of OREO are included in noninterest expense 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. 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. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. 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 were $663,603 and $662,468 for 2023 and 2022, respectively, and are recorded within marketing expense. Retirement benefits: A 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. 21 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Retirement benefits, continued: 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 $601,534 and $460,803 to salaries and benefits expense for the retirement savings plan in 2023 and 2022, respectively. In addition, the Company made elective contributions to the employee stock ownership plan during 2023 and 2022 totaling $0 and $150,021, respectively, which is 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 2023 and 2022, the supplemental retirement expense was $208,864 and $202,087. The current accrued but unfunded amount is $2,770,812 and $2,588,144 at December 31, 2023 and 2022, 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 $18,190,892 and $18,835,768 at December 31, 2023 and 2022, respectively. The Company has split-dollar life insurance arrangements with certain of its officers. At December 31, 2023 and 2022, the split-dollar liability relating to these arrangements totaled $465,420 and $438,042 respectively. For 2023 and 2022, the Company recognized net expenses of $27,378 and $25,765, respectively, related to these arrangements, which are recorded within salaries and benefits expense. Stock-based compensation: The Company can issue stock options, restricted stock, restricted stock units, and other stock-based awards to directors, officers and other key employees. The Company accounts for stock compensation in accordance with Accounting Standards Codification (“ASC”) Topics 718 and 505. Under those provisions, the Company has adopted a fair value-based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized on a straight-line basis over the service period, which is usually the vesting period, taking into account retirement eligibility. As a result, compensation expense relating to stock-based awards is reflected in net income as part of salaries and benefit expense in the consolidated statements of operations. 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 market price of the shares. Dividends on shares held by the ESOP are charged to retained earnings. At December 31, 2023 and 2022, the ESOP owned 474,671 and 472,962 shares of the Company’s common stock with an estimated value of $4,067,930 and $4,124,228, respectively. All of these shares were allocated to participants. 22 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued 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 20). 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. Off-balance sheet financial instruments and unfunded commitments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded. The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to provision for credit losses in the Company’s income statements. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for credit losses on unfunded commitments is included as a separate line item on the Company’s consolidated balance sheets. Comprehensive income: The Company reports comprehensive income in accordance with ASC 220, “Comprehensive Income.” The standard requires that all items that are required to be reported under accounting standards as comprehensive income be reported in a financial statement that is displayed with the same prominence as other consolidated financial statements. The disclosure requirements have been included in the Company’s consolidated statements of comprehensive income. 23 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1. Summary of Significant Accounting Policies, Continued Business combinations and Purchased Credit Deteriorated Loans: 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. Upon adoption of ASC 326, loans that were designated as PCI loans under the previous accounting guidance were classified as PCD loans without reassessment. In future acquisitions, the Company may purchase loans, some of which have experienced more than insignificant credit deterioration since origination. In those cases, the Company will consider internal loan grades, delinquency status and other relevant factors in assessing whether purchased loans are PCD. PCD loans are recorded at the amount paid. An initial allowance for credit loss is determined using the same methodology as other loans held for investment, but with no impact to earnings. The initial allowance for credit loss determined on a collective basis is allocated to individual loans. The sum of the loan's purchase price and allowance for credit loss becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent to initial recognition, PCD loans are subject to the same interest income recognition and impairment model as non-PCD loans, with changes to the allowance for credit loss recorded through provision expense. Business combinations and method of accounting for loans acquired, prior to ASC 326: Prior to the adoption of ASC 326, Purchased credit-impaired (“PCI”) loans were 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. 24 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1.Summary of Significant Accounting Policies, Continued Segment Reporting: The Company’s operations are managed and financial performance is evaluated on an organization-wide basis. Accordingly, management has deemed the banking and finance operations as one reportable operating segment. 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 bases, 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. Note 2. Investment Securities The amortized cost and estimated fair values of securities available-for-sale were: Amortized Gross Unrealized Cost Gains Losses Fair Value December 31, 2023 U.S. Treasury securities U.S. agency securities Municipal securities Mortgage-backed securities Corporate bonds Collateralized loan obligations Total $ - 7,325,867 35,290,138 101,484,996 15,979,202 25,323,438 185,403,641 $ $ $ - 31,009 - 268,159 174,054 53,912 527,134 $ - 366,871 4,182,595 8,689,940 1,290,795 1,000 $ 14,531,201 $ $ - 6,990,005 31,107,543 93,063,215 14,862,461 25,376,350 171,399,573 Amortized Gross Unrealized Cost Gains Losses Fair Value December 31, 2022 U.S. Treasury securities U.S. agency securities Municipal securities Mortgage-backed securities Corporate bonds Collateralized loan obligations Total $ 32,718,585 5,805,577 37,994,173 76,923,586 7,905,067 19,362,390 $ 180,709,378 $ $ 25 - - 4,891 - - - 4,891 $ 1,910,616 430,391 5,819,703 9,710,832 480,369 265,510 $ 18,617,421 $ $ 30,807,969 5,375,186 32,179,361 67,212,754 7,424,698 19,096,880 162,096,848 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 2. Investment Securities, Continued At December 31, 2023 and 2022, the Company had marketable equity securities totaling $128,517 and $133,715, respectively. The Company did not have any securities classified as held-to-maturity at December 31, 2023 and 2022. The following is a summary of maturities of securities available-for-sale as of December 31, 2023. 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 as paydowns are expected to occur before contractual maturity dates. 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 Amortized Cost $ 4,553,854 53,740,424 25,624,366 83,918,644 101,484,996 $185,403,641 Fair Value $ 4,487,074 49,066,812 24,782,472 78,336,358 93,063,215 $171,399,573 The following tables show gross unrealized losses and fair value of securities available-for-sale, aggregated by investment category, and length of time that individual securities have been in a continuous realized loss position at December 31, 2023 and 2022. Securities Available-for-Sale Less Than 12 Months U.S. Treasury securities U.S. agency securities Municipal securities Mortgage-backed securities Corporate bonds Collateralized loan obligations Total Securities Available-for-Sale Greater Than 12 Months U.S. Treasury securities U.S Agency securities Municipal securities Mortgage-backed securities Corporate bonds Collateralized loan obligations Total December 31, 2023 Fair Value Unrealized Losses December 31, 2022 Fair Value Unrealized Losses $ - $ - - 11,734,826 4,875,345 - $ 16,610,171 $ - $ 21,910,468 $ - - 105,404 290,436 - 5,375,186 18,086,471 38,317,573 5,225,203 14,700,000 429,864 265,510 395,840 $ 103,614,901 $ 8,668,317 1,020,843 430,391 2,756,674 3,765,035 December 31, 2023 Fair Value Unrealized Losses December 31, 2022 Fair Value Unrealized Losses $ - $ - $ 8,897,501 $ 889,773 - 3,063,029 5,945,797 50,505 - $ 109,131,377 $ 14,135,361 $ 50,426,516 $ 9,949,104 - 12,184,339 28,895,181 449,495 - 4,661,522 31,107,543 62,432,359 5,930,953 4,999,000 366,871 4,182,595 8,584,536 1,000,359 1,000 26 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 2. Investment Securities, Continued At December 31, 2023 and 2022, the Company had eighty-one and eighty-three, respectively, individual investments available-for-sale that were in an unrealized loss position. 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 unrealized losses were attributable to changes in market interest rates and were not attributable to deterioration in credit quality. During 2023, the Company sold all US Treasury securities and two US Agency securities with proceeds totaling $38,184,599. There was one gain recognized of $6,846 and eight losses recognized totaling $1,532,477. During 2022, the Company sold securities with proceeds of $1,000,000 and had no gains or losses on these sales. During 2023 and 2022, the Company recognized losses of $5,198 and $4,144, respectively, within the consolidated statement of operations related to the decrease in fair value of marketable equity securities. At December 31, 2023 and 2022, investment securities with a par value of $39,011,850 and $10,392,607 and a fair market value of $34,527,077 and $8,880,434, respectively, were pledged as collateral for securities under agreements to repurchase and to secure public deposits. Note 3. Loans and Allowance for Credit 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 2023 2022 $ $ 35,634,919 220,618,838 355,271,860 611,525,617 61,152,820 32,993,953 705,672,390 $ $ 45,458,457 181,006,315 317,559,308 544,024,080 65,479,589 51,746,847 661,250,516 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 2023 and 2022 totaled $206,810,392 and $240,966,438, 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. 27 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, continued Credit Quality 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 managements 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. Risk ratings are updated on an ongoing basis and are subject to change by continuous loan monitoring processes. Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. 28 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, continued Effective January 1, 2023, the Company adopted the accounting guidance in ASU 2022-02 which requires the presentation of gross charge-offs by year of origination. The Company prospectively adopted ASU 2022-02; therefore, prior period activity of gross charge-offs by year of origination are not included in the below tables. 2023 2022 2021 2020 2019 Prior Revolving Total Term Loans by Year of Origination Commercial and Industrial: Pass Special Mention Substandard Watch Total $ 10,836,164 $16,560,384 $ 6,305,177 $ 3,650,115 $ - 15,693 40,664 3,706,472 - 126,990 93,979 11,008,477 16,781,353 - 63,663 69,364 6,438,203 - 91,067 81,246 5,478,561 $ 2,081,635 $ - - 401,976 5,880,536 - - 105,421 2,187,056 15,084,685 $ 59,996,719 - 337,492 818,609 15,150,723 61,152,820 - 40,080 25,959 Current-period gross charge-offs Construction: Pass Special Mention Substandard Watch Total Current-period gross charge-offs Consumer and Other: Pass Special Mention Substandard Watch Total Current-period gross charge-offs - 147,144 - 43,347 - - - 190,491 5,393,944 22,275,803 - - - 5,393,944 22,275,803 - - - 3,906,834 - - - 3,906,834 515,555 - - - 515,555 1,694,826 - - 629,272 2,324,098 563,884 843 - 653,959 1,218,686 - 34,350,845 843 - - - - 1,283,230 - 35,634,919 - - - - - - - - 4,483,471 - - - 4,483,471 4,942,558 14,083,657 - 47,825 275,857 4,946,558 14,407,338 - - 4,000 4,419,155 - - 34,171 4,453,326 2,181,234 - 905 225,683 2,407,821 1,074,145 697 9,735 28,518 1,113,095 1,179,199 32,363,418 697 58,644 571,194 1,182,344 32,993,953 - 180 2,965 50,279 16,326 134,712 12,255 1,917 6,317 6,932 228,738 Nonresidential Real Estate: Pass Special Mention Substandard Watch Total Current-period gross charge-offs Residential Real Estate: Pass Special Mention Substandard Watch Total Current-period gross charge-offs 40,048,570 99,471,905 103,062,042 33,053,132 - - 5,159,354 40,928,730 99,684,479 105,208,210 38,212,487 - - 212,574 - - 2,146,168 - - 880,160 22,132,405 38,205,818 136,778 171,217 1,560,317 23,354,518 40,074,130 - - 1,222,112 7,809,301 343,783,174 136,783 5 - 171,217 - 11,180,687 7,809,307 355,271,860 - - - - - - - - 65,619,634 49,323,968 35,748,640 16,276,194 - - - 66,390,393 49,323,968 35,791,326 16,276,194 145,492 - 625,267 - - 42,686 - - - 6,432,800 14,476,616 (85) - 416,922 6,432,800 14,893,452 - - - 31,481,583 219,359,435 145,407 29,122 1,084,874 31,510,705 220,618,838 - 29,122 - - - - - - - - - 29 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, Continued The following table is a summary of the Company’s recorded investment in loans by credit quality indicators as of December 31, 2022, prior to the adoption of ASC 326: Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial Consumer and Industrial and Other Pass Special mention Substandard Doubtful Total $ 652,585,645 $ 43,936,751 $ 180,272,587 $ 313,044,651 $ 537,253,989 $ 64,171,086 $ 51,160,570 428,383 157,894 - $ 661,250,516 $ 45,458,457 $ 181,006,315 $ 317,559,308 $ 544,024,080 $ 65,479,589 $ 51,746,847 1,143,229 165,274 - 1,521,706 - - 6,180,336 589,755 - 7,751,948 912,923 - 3,993,505 521,152 - 665,125 68,603 - The following is an analysis of the allowance for credit or loan losses by class of loans for the years ended December 31, 2023 and 2022: Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other December 31, 2023 Beginning balance Adjustment to allowance for adoption of ASU 2016-13 Provisions Recoveries Charge-offs Ending balance $ 7,659,794 $ 516,545 $ 2,048,171 $ 3,612,062 $ 6,176,778 $ 790,172 $ 692,844 114,221 847,398 191,309 (419,229) 8,393,493 $ $ 5,768 (99,581) 5,500 - 35,710 706,366 68,485 - 57,505 175,984 68,366 - 98,983 782,769 142,351 - 9,898 171,890 5,265 (190,491) 428,232 $ 2,858,732 $ 3,913,917 $ 7,200,881 $ 786,734 $ 5,340 (107,261) 43,693 (228,738) 405,878 There were no loans individually evaluated as of December 31, 2023 under ASU 2016-13. Prior to the adoption of ASC 326 on January 1, 2023, the Company calculated the allowance for loan losses under the incurred loss methodology. The following tables are disclosures related to the allowance for loan losses in prior periods. Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other December 31, 2022 Beginning balance Provisions Recoveries Charge-offs Ending balance $ 7,039,576 $ 480,000 346,173 (205,955) $ 7,659,794 $ 545,727 $ (249,752) 220,570 - 1,654,957 $ 310,032 83,182 - 2,797,228 $ 814,834 - - 4,997,912 $ 875,114 303,752 - 516,545 $ 2,048,171 $ 3,612,062 $ 6,176,778 $ 998,690 $ (112,426) 4,892 (100,984) 790,172 $ 1,042,974 (282,688) 37,529 (104,971) 692,844 30 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Loan Losses, Continued December 31, 2022 Real Estate Loans Total Construction Residential Non- Residential Total Real Estate Loans Commercial and Industrial Consumer and Other $ - $ - $ - $ - $ - $ - $ 7,659,794 516,545 2,048,171 3,612,062 6,176,778 790,172 - 692,844 $ 7,659,794 $ 516,545 $ 2,048,171 $ 3,612,062 $ 6,176,778 $ 790,172 $ 692,844 $ 1,028,657 $ 660,221,859 - $ 490,123 $ 538,534 $ 1,028,657 $ - $ 45,458,457 180,516,192 317,020,774 542,995,423 65,479,589 - 51,746,847 $ 661,250,516 $ 45,458,457 $ 181,006,315 $317,559,308 $ 544,024,080 $ 65,479,589 $ 51,746,847 Allowance Evaluated for impairment Individually Collectively Allowance for loan losses Total Loans Evaluated for impairment Individually Collectively Loans receivable Prior to the adoption of ASU 2016-13, loans were considered impaired when, based on current information and events, it was probable the company would be unable to collect all amounts due in accordance with the original contractual terms of the loan agreements. Impaired loans include loans on nonaccrual status and accruing troubled debt restructurings. When determining if the Company would be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement, the Company considered the borrower’s capacity to pay, which included such factors as the borrower’s current financial statements, an analysis of global cash flow sufficient to pay all debt obligations and an evaluation of secondary sources of repayment, such as guarantor support and collateral value. The Company individually assessed for impairment all nonaccrual loans greater than $100,000. The tables below include all loans deemed impaired, whether or not individually assessed for impairment. If a loan was deemed impaired, a specific valuation allowance was allocated, if necessary, so that the loan was reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment was expected solely from the collateral. Interest payments on impaired loans were typically applied to principal unless collectability of the principal amount was reasonably assured, in which case interest was recognized on a cash basis. The following summarizes the Company’s impaired loans as of December 31, 2022: Recorded Investment Unpaid Principal Related Allowance Average Balance Interest Income Recognized With no related allowance recorded: Real estate loans Construction Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total $ - $ - $ 490,123 538,534 1,028,657 - - 490,123 553,402 1,043,525 - - $ 1,028,657 $ 1,043,525 $ 31 - $ - $ - - - - - - $ 1,083,776 $ 519,676 564,100 1,083,776 - - - 34,413 38,574 72,987 - - 72,987 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, Continued With an allowance recorded: Real estate loans Construction Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total Total Real estate loans Construction Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total $ $ $ - $ - - - - - - $ - $ - - - - - - $ - $ - - - - - - $ - $ - - - - - - $ - $ - $ 490,123 538,534 1,028,657 - - 490,123 553,402 1,043,525 - - $ 1,028,657 $ 1,043,525 $ - $ - $ - - - - - - $ 1,083,776 $ 519,676 564,100 1,083,776 - - - - - - - - - - 34,413 38,574 72,987 - - 72,987 The following is an aging analysis of the Company’s loan portfolio at December 31, 2023: 30 - 59 Days 60 - 89 Days Past Due Past Due Greater Than 90 Days Total Past Due Current Total Loans Receivable Past Due > 90 Days and Accruing $ Real estate loans Construction Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total - $ 196,010 - - 13,512 732 $ 210,254 $ - $35,634,919 $ - $ - - - - 6,090 6,090 $ 185,168 $ 401,512 $705,270,878 $ 196,010 220,442,828 85,684 355,186,176 281,694 611,243,923 61,053,841 32,973,114 - $ - 85,684 85,684 85,467 14,017 98,979 20,839 35,634,919 $ 220,618,838 355,271,860 611,525,617 61,152,820 32,993,953 705,672,390 $ The following is an aging analysis of the Company’s loan portfolio at December 31, 2022: 30 - 59 Days 60 - 89 Days Past Due Past Due Greater Than 90 Days Total Past Due Current Total Loans Receivable Past Due > 90 Days and Accruing $ Real estate loans Construction Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total $ - $ - - - - 58,808 58,808 $ - $ - - - 54,172 - - $ - - - 75,730 35,047 - $45,458,457 $ - 181,006,315 - 317,559,308 - 544,024,080 65,349,688 51,652,992 129,901 93,855 54,172 $ 110,777 $ 223,756 $661,026,760 $ 45,458,457 $ 181,006,315 317,559,308 544,024,080 65,479,589 51,746,847 661,250,516 $ 32 - - - - - - - - - - - - - - First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, Continued The following is an analysis of the Company’s nonaccrual loan portfolio recorded at December 31, 2023 and 2022: CECL December 31, 2023 Nonaccrual Loans with No Allowance Nonaccrual Loans with an Allowance Incurred Loss December 31, 2022 Nonaccrual Loans Total Nonaccrual Loans Real estate loans Residential Nonresidential Total real estate loans Commercial and industrial Consumer and other Total $ - $ 140,661 140,661 98,979 56,100 295,740 $ - $ - - - - - $ - $ 140,661 140,661 98,979 56,100 295,740 $ 68,602 199,406 268,008 75,730 129,456 473,194 The Company recognized $48,187 of interest income on nonaccrual loans during the year ended December 31, 2023. Modifications Made to Borrowers Experiencing Financial Difficulty The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon asset origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. The Company uses a probability of default/loss given default model to determine the allowance for credit losses. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification. Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Company modifies loans by providing principal forgiveness, extension of maturity date, or interest rate reduction. When principal forgiveness is provided, the amortized cost basis of the asset is written off against the allowance for credit losses, since it is deemed uncollectible. In some cases, the Company will modify a certain loan by providing multiple types of concessions. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness or rate reduction, may be granted. As of December 31, 2023, the Company has a total of 10 loans with modifications. 9 loans with term extensions and 1 loan with a rate reduction. The outstanding balance of these loans totals $915,585, or 0.13% of total loans outstanding. The composition includes: (1) 3 nonresidential real estate loans with an outstanding balance of $477,686 or 0.07% of total loans outstanding; (2) 4 residential real estate loans with an outstanding balance of $344,941 or 0.05% of total loans outstanding, and (3) 3 commercial and industrial loans with an outstanding balance of $92,958 or 0.01% of total loans outstanding. All 10 loans were current (not past due) as of December 31, 2023. 33 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, Continued Unfunded Commitments and related allowance for credit losses 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. 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 and equipment, and income-producing commercial properties. The Company maintains an allowance for off-balance sheet credit exposures such as unfunded balances for existing lines of credit, commitments to extend future credit, as well as both standby and commercial letters of credit when there is a contractual obligation to extend credit and when this extension of credit is not unconditionally cancellable (i.e., the commitment cannot be canceled at any time). The allowance for off-balance sheet credit exposures is adjusted as a provision for credit loss expense or (release). The estimate includes consideration of the likelihood that funding will occur, which is based on a historical funding study derived from internal information, and an estimate of expected credit losses on commitments expected to be funded over its estimated life, which are the same loss rates that are used in computing the allowance for credit losses on loans and are discussed in Note 1. The allowance for credit losses for unfunded loan commitments of $407,487 at December 31, 2023, is separately classified on the balance sheet within Other Liabilities. The total unfunded commitments (loans) at December 31, 2023 was $109,525,058. The following table presents the balance and activity in the allowance for credit losses for unfunded loan commitments for the year ended December 31, 2023. Balance, December 31, 2022 Adjustment to allowance for unfunded commitments for adoption of ASU 2016-13 Provision for credit losses (release) – unfunded commitments for Balance, December 31, 2023 $ $ - 886,038 (478,551) 407,487 Total Allowance for Credit Losses – Unfunded Commitments 34 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3. Loans and Allowance for Credit Losses, Continued Acquired loans: Upon adoption of ASC 326, loans that were designated as PCI loans under the previous accounting guidance were classified as PCD loans without reassessment. The information below relates to years ended December 31, 2022. Loans acquired through acquisitions are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. Discounts on loans that are not considered impaired at acquisition are recorded as an accretable discount and are accreted into interest income over the terms of the related loans. The remaining balance of acquired non-PCI loans was $3.2 million with remaining accretable yield of $62 thousand at December 31, 2022. For acquired loans that are considered impaired at the time of acquisition (PCI), the difference between the contractually required payments and expected cash flows is recorded as a nonaccretable discount. The following table presents changes in the carrying value of PCI loans for the years ended December 31, 2022: Balance at beginning of period Change due to payments received and accretion Advances Balance at end of period 2022 $ $ 2,094,575 (719,334) 175,729 1,550,970 The following table presents changes in the nonaccretable yield for PCI loans for the year ended December 31, 2022: Balance at beginning of period Reclassification to accretable yield Change due to recoveries (charge-offs) Balance at end of period 2022 $ $ 278,362 (107,011) - 171,351 The following table presents changes in the accretable yield for PCI loans for the year ended December 31, 2022: Balance at beginning of period Reclassification from nonaccretable yield Accretion, net cash basis interest collections Balance at end of period 2022 431,412 107,011 (264,388) 274,035 $ $ The Company did not include acquired loans within the calculation of allowance for loan losses as of December 31, 2022, as the remaining discount was in excess of calculated allowance on those loans. 35 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 4. 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 2023 2022 $ 8,632,700 $ 8,632,700 16,895,393 16,952,575 2,249,098 2,249,098 11,146,395 11,542,204 941,716 828,763 39,752,349 40,318,293 (16,940,899) $ 22,298,348 $ 22,811,450 (18,019,945) Depreciation expense for the years ended December 31, 2023 and 2022 amounted to $1,126,296 and $1,112,170, respectively. At December 31, 2023 and 2022, construction in progress consists mainly of architect fees and site work for potential new branches. As of December 31, 2023, there were no material commitments outstanding for the construction or purchase of premises, furniture and equipment. Note 5. Other Real Estate Owned Transactions in other real estate owned for the years ended December 31, 2023 and 2022 are summarized below: Beginning balance Additions Sales Write downs Ending balance 2023 2022 $ $ - $ - - - - $ 135,000 - (135,000) - - The Company did not sell any other real estate owned during 2023 nor foreclose on any real property during 2023. The Company recognized a loss on the sale of other real estate owned of $15,838 for the year ended December 31, 2022. Note 6. Mortgage Servicing Rights The Company retains the right to service the residential mortgage loans that it sells to the Federal National Mortgage Association (“FNMA”) and Freddie Mac (“FHLMC”) and recognizes those rights as an asset on the consolidated balance sheets. 36 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 6. Mortgage Servicing Rights, continued The Company’s servicing assets are initially measured at fair value and are subsequently measured using either the fair value method or the amortization method, depending on the asset class, which has been determined to be vintage (or loan origination) year. Vintage year classes prior to 2020 are measured using the fair value method while subsequent vintage year classes are measured using the amortization method. MSRs accounted for under the amortization method are subsequently accounted for at lower of cost or fair value, net of accumulated amortization, which is recorded in proportion to, and over the period of, net servicing income. Any changes in fair value during the period for MSRs carried under the fair value method, as well as amortization and impairment of MSRs under the amortization method, are recorded in mortgage banking income in the consolidated statements of operations. The following table presents the activity for MSRs accounted for using the amortization method for the years ended December 31, 2023 and 2022: 2023 2022 Balances, beginning of year Amount capitalized Sales proceeds, net Amount amortized Balances, end of year 2,287,337 - $ 5,798,967 $ 9,681,076 2,370,641 (4,939,834) (1,312,916) $ 7,272,550 $ 5,798,967 (813,754) The following table presents the activity for MSRs accounted for using the fair value method for the years ended December 31, 2023 and 2022: Balances, beginning of year Changes in fair value (1) Changes in unpaid principal balance (2) Balances, end of year 2023 2022 $ 4,642,455 $ 4,376,021 281,434 1,251,171 (558,265) (984,737) $ 4,365,624 $ 4,642,455 (1) Represents changes in value primarily due to market driven changes in interest rates and prepayment speeds. (2) Represents changes in value of the MSRs due to i) passage of time, including the impact from both regularly scheduled loan principal payments and partial paydowns, and ii) loans that paid off fully during the period. 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. Conversely, as interest rates increase, generally, the MSRs fair value will increase. Measurement of fair value is limited to the conditions that exist 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, 2023 and 2022, the aggregate amount of loans serviced by the Company for the benefit of others totaled $1.0 billion and $0.9 billion respectively. 37 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 6. Mortgage Servicing Rights, continued The characteristics and sensitivity analysis of the MSRs are included in the following table as of December 31, 2023 and 2022. Composition of residential loans serviced for others Fixed-rate mortgage loans Weighted average expected life Constant prepayment rate (“CPR”) Weighted average discount rate Note 7. Derivative Financial Instruments 2023 98% 7.4 years 7.73% 8.53% 2022 100% 7.7 years 7.65% 8.53% The non-designated derivative positions of the Company for the years ended December 31, 2023 and 2022 are reported as other assets or other liabilities, net, and are as follows: Derivative assets (liabilities): Mortgage loan interest rate lock commitments Mortgage loan forward sales commitments 2023 2022 Fair value Notional value Fair value Notional value $ 282,781 $ 16,996,582 $ 56,402 $ 7,320,976 (141,797) 18,000,000 35,000 8,000,000 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 or liabilities, net, and as such, the changes in the fair market value of the derivative positions are recognized in the consolidated statements of operations within mortgage banking income. The Company had one fair value hedge and the following table presents the gross notional amount and estimated fair value of the derivative instruments as of December 31, 2023: December 31, 2023 Fair Value Hedge: Interest rate contracts: Pay fixed, receive variable – loans Total derivatives Notional Amount Assets Liabilities Fair Value $ $ 50,000,000 $ 50,000,000 $ 115,056 $ 115,056 $ 136,061 136,061 The above derivative is under a master netting arrangement. However, as of December 31, 2023, there were no other outstanding derivative contracts. The fair value of the hedged item is recorded in loans and the derivative item is recorded in other liabilities in the statement of financial condition. There were no outstanding derivative contracts as of December 31, 2022. 38 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 7. Derivative Financial Instruments, continued The following represents the carrying value of the hedged item (loans) in fair hedging relationship: December 31, 2023 Fair Value Hedge: Interest rate contracts: Commercial real estate loans Total Hedged Asset Basis Designated Discontinued Hedge Basis Adjustment $ $ 256,115,000 $ 256,115,000 $ 115,056 $ 115,056 $ - - During the year ended December 31, 2023, there was no income recorded on interest settlements. Changes in the fair value of the hedged item of $115,056 was offset by changes in the fair value of the swap derivative of $136,061. The residual was a result of the hedge ineffectiveness and recorded as an offset to interest income on the consolidated statements of operations. No portion of the change in fair value of derivatives designated as hedges was excluded from the effectiveness testing. No hedges were terminated during the year ended December 31, 2023. Note 8. Core Deposit Intangible The following table presents information about our intangible assets as of December 31: 2023 2022 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization Core deposit intangibles $ 880,000 $ 805,684 $ 880,000 $ 732,906 Based on the core deposit intangibles as of December 31, 2023, the following table presents the aggregate amortization expense for each of the succeeding years ending December 31: 2024 2025 2026 Total Amount 48,177 23,576 2,563 74,316 $ $ Amortization expense of $72,778 and $97,380 related to the core deposit intangibles was recognized in 2023 and 2022, respectively, and was recorded within other noninterest expense. 39 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 9. Deposits At December 31, 2023, the scheduled maturities of time deposits were as follows: Maturing In: 2024 2025 2026 2027 2028 Total $ Amount 144,529,823 12,917,927 10,919,314 564,332 306,077 $ 169,237,473 Included in total time deposits at December 31, 2023 and 2022, respectively, were brokered time deposits of $44,608,000 and $25,483,000. Interest expense on time deposits that meet or exceed the FDIC insurance limit of $250,000 was $2,250,298 and $204,579 for the years ended December 31, 2023 and 2022, respectively. Note 10. 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 Note 11. Federal Home Loan Bank Advances Federal Home Loan Bank advances consisted of the following at December 31: 2023 2022 $ 13,468,150 5,734,357 0.10% 1.18% 307,517 $ 7,367,861 13,805,033 10,128,626 0.15% 0.17% Fixed rate January 25, 2023 January 27, 2023 December 30, 2024 Interest Rate 4.23% 4.23% 5.57% 2023 2022 $ - - 5,000,000 $ 5,000,000 $20,000,000 10,000,000 - $ 30,000,000 At December 31, 2023 and 2022, the Company has pledged certain loans totaling $202,760,138 and $240,843,061, respectively, as collateral to secure its borrowings from the FHLB. Additionally, the Company’s FHLB stock is pledged to secure the borrowings. 40 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 12. 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 three-month Chicago Mercantile Exchange (CME) Term SOFR plus a spread adjustment plus 1.83%. 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, 2023 and 2022, the Company had accrued and unpaid interest totaling $72,069 and $72,870, respectively. Note 13. Borrowings On June 2, 2020, the Company entered into subordinated debt agreements with eight financial institutions totaling $5,500,000. The debt initially bears interest at a fixed rate of 5.875% per annum until June 1, 2025 and then variable at three-month SOFR (“Secured Overnight Financing Rate”) plus 5.51%, payable quarterly with principal and unpaid interest due at maturity, June 1, 2030. On September 22, 2021, the Company entered into subordinated debt agreements with eleven financial institutions totaling $10,000,000. The debt initially bears interest at a fixed rate of 3.375% per annum until October 1, 2026 and then variable at three-month SOFR plus 2.45%, payable quarterly with principal and unpaid interest due at maturity, October 1, 2031. The Company recorded $158,732 in debt issuance costs associated with the subordinated debt, which is recorded net within subordinated debentures and will be amortized over five years. At December 31, 2023, remaining debt issuance costs to be amortized totaled $87,303. At December 31, 2023 and 2022, the Company had accrued and unpaid interest totaling $72,473 and $67,985, respectively, on its subordinated debt. Note 14. Shareholders’ Equity Common Stock - The following is a summary of the changes in common stock outstanding for the years ended December 31, 2023 and 2022. Common shares outstanding at beginning of the period Conversion of Series D preferred stock to common stock Purchase of treasury stock Restricted stock issued Additional shares granted Forfeiture of restricted shares Common shares outstanding at end of the period 2023 2022 8,140,311 1,400 (43,301) 28,859 22,453 (10,645) 8,139,077 8,258,410 1,000 (55,253) 46,033 7,918 (117,797) 8,140,311 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 41 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 14. Shareholders’ Equity, Continued 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. The Company’s 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 Stockholders 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 senior to all Common Stock. 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, 2023, the Bank had undivided profits of $45,174,451. 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. In addition, under Federal Reserve regulations, the amounts of loans or advances from the Bank to the parent company are restricted. Note 15. Income Taxes Income tax provision for the years ended December 31, 2023 and 2022 is summarized as follows: Provision Current income tax expense (benefit) Federal State Total current Deferred income tax expense (benefit) Federal State Total deferred Change in valuation allowance Total income tax expense 2023 2022 $ 1,212,421 $ 1,516,652 109,928 1,626,580 68,014 1,280,435 (70,382) (73,637) (144,019) 13,700 (54,328) (40,628) 73,637 54,328 $ 1,210,053 $ 1,640,280 42 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 15. Income Taxes, Continued The components of deferred tax assets and deferred tax liabilities as of December 31, are as follows: 2023 2022 Deferred tax assets: Allowance for credit losses Net operating losses Non-accrual interest Deferred compensation Purchase accounting on acquisition Leases Unrealized losses on securities available-for-sale Other Gross deferred tax assets Less, valuation allowance Net deferred tax assets Deferred tax liabilities: Prepaid expenses Accumulated depreciation Mark to market adjustments Deferred loan origination costs Total gross deferred tax liabilities Net deferred tax assets recognized 3,949,184 3,665 887,150 15,281 52,620 3,430,996 259,031 10,296,931 $ 1,699,004 $ 1,482,227 3,920,899 3,092 754,245 77,332 46,173 4,560,070 146,244 10,990,282 (835,811) 10,154,471 (909,448) 9,387,483 19,552 254,869 946,388 391,379 1,612,188 19,552 148,520 994,110 363,384 1,525,566 $ 7,775,295 $ 8,628,905 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, 2023, 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 2023, the balance in the valuation allowance changed by $73,637. 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 $14,554,949 and $14,767,644 for the years ended December 31, 2023 and 2022, respectively. Net operating losses of $3,556,045 expire at various times from 2029-2037, with the remainder having no expiration date. The Company’s ability to benefit from the use of net operating loss carryforwards of $14,554,949 is limited annually under Section 382 of the Internal Revenue Code. The Company has state net operating losses of $22,598,617 and $20,751,748 for the years ended December 31, 2023 and 2022, respectively. State net operating loss carry forwards of $9,431,034 expire at various times from 2024-2037, with the remainder having no expiration date. 43 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 15. 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, 2023 and 2022 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 Excess tax benefit of stock-based compensation Change in valuation allowance Other, net Total 2023 2022 $ 1,220,828 $ 1,589,971 43,924 (23,991) 725 (75,573) (44,859) 54,328 95,755 $ 1,210,053 $ 1,640,280 (4,442) (13,002) 2,724 (110,977) (13,594) 73,637 54,879 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 2020 and subsequent years are subject to review by taxing authorities. Note 16. 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, 2023 and 2022, the Company had related party loans totaling $150,716 and $560,195, respectively. Below is a table reflecting the loan activity during 2023 and 2022: Beginning balance Paid off loans New loans originated Paid down loans Ending balance 2023 2022 $ $ 560,195 $ 1,030,108 (752,877) (451,559) 296,112 49,374 (13,148) (7,294) 560,195 150,716 $ Deposits from directors and executive officers and their related interests totaled $4,232,085 and $6,873,006 at December 31, 2023 and 2022, respectively. Note 17. 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, 2023, 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. 44 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 18. Leases, right of use assets and lease liabilities The Company has operating leases on eight of its facilities that are accounted for under ASC 842. The Company had operating right-of-use assets of $5,342,365 and $5,977,748 as of December 31, 2023 and 2022, respectively. The Company had lease liabilities of $5,592,934 and $6,197,620 as of December 31, 2023 and 2022, respectively. Rental expense under the leases for the years ended December 31, 2023 and 2022 was $972,378 and $1,025,162, respectively, and was recorded within occupancy and equipment expense in the consolidated statements of operations. The weighted average remaining lease term as of December 31, 2023 was 9.8 years and the weighted average discount rate used was 2.86%. The following table shows future undiscounted lease payments for operating leases with initial terms of one year or more as of December 31, 2023: 2024 2025 2026 2027 2028 Thereafter Total undiscounted lease payments Less effect of discounting Present value of estimate lease payments (lease liability) Note 19. Equity Incentive Plan $ 787,965 747,704 674,042 679,104 580,125 2,661,817 6,130,756 (537,823) $ 5,592,934 During 2021, shareholders of the Company approved the 2021 Equity Incentive Plan (the “2021 Plan") under which an aggregate of 600,000 shares of common stock have been reserved for issuance as stock-based awards, including stock options, restricted stock, restricted stock units, and other stock-based awards. The maximum aggregate shares subject to options is restricted to 80,000 in any calendar year to any one participant. Options may be granted for a term of up to ten years from the effective date of the grant. The aggregate number of shares subject to awards of restricted stock and other stock-based awards is restricted to 50,000 in any calendar year to any one participant. At the time of adoption of the 2021 Plan, the Company sunset two equity incentive pools, the 2017 Equity Incentive Plan (the “2017 Plan”) and a Restricted Stock Reserve. The 2021 Plan, the 2017 Plan, and the Restricted Stock Reserve are referred to collectively as the “Plans.” At December 31, 2023, there were 306,395 shares available for grant under the 2021 Plan and no shares available for grant under the 2017 Plan or Restricted Stock Reserve. The Company can issue 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 employment, performance, or other conditions established at the time of grant. Under the terms of the Plans, the restricted shares will vest completely based on the individual grant’s vesting period, which is generally between two and ten years. The shares are forfeited entirely if the participant terminates employment for any reason other than changes in control or death or disability. Any shares 45 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 19. Equity Incentive Plan, Continued of restricted stock that are forfeited will again become available for issuance under the Plans. 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. Nonvested restricted stock for the years ended December 31, 2023 and 2022 is summarized in the following table. Nonvested at January 1 Granted Vested Forfeited Nonvested at December 31 2023 2022 Weighted- Average Grant-Date Fair Value Shares Weighted- Average Grant-Date Fair Value Shares 340,388 $ 44,912 (68,370) (10,645) 306,285 $ 7.80 8.25 7.93 6.95 7.86 453,719 $ 46,033 (58,593) (100,771) 340,388 $ 7.36 9.64 6.87 7.19 7.80 The vesting schedule for these shares as of December 31, 2023 is as follows: 2024 2025 2026 2027 2028 and thereafter Total Shares 82,040 40,778 96,767 16,700 70,000 306,285 The Company recognized stock-based compensation costs related to restricted stock of $524,479 and $493,519 for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, there was $1,482,193 of total unrecognized compensation cost related to the nonvested restricted stock that will be recognized over the remainder of their vesting schedule. No stock options were granted during the years ended December 31, 2023 and 2022. Activity related to stock options is summarized in the following table. Weighted- Average Remaining Life (Years) Weighted- Average Exercise Price $ 1.80 - - - .80 .80 7.27 - - - 7.27 7.27 Options 169,440 - - - 169,440 164,200 Outstanding at December 31, 2022 Granted Exercised Forfeited Outstanding at December 31, 2023 Options exercisable as of December 31, 2023 46 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 19. Equity Incentive Plan, Continued The Company recognized stock-based compensation costs related to stock options of $43,302 and $54,623 for the years ended December 31, 2023 and 2022, respectively. As of December 31, 2023, there was no more unrecognized compensation cost related to the outstanding stock options that will be recognized over the remainder of their vesting schedule. The company from time-to-time also grants performance and/or time restricted stock units (“RSUs”) to key employees. These awards help align the interests of these employees with the interests of the shareholders of the Company by providing economic value directly related to the performance of the Company. Dividends are not paid in respect to the awards and the holder does not have the right to vote the shares during the vesting period. The value of the RSUs awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expenses on a straight-line basis typically over the vesting period the performance and/or time target is to be achieved. Nonvested RSUs for the year December 31, 2023 and 2022 is summarized in the following table. 2023 2022 Nonvested at January 1 Granted Vested Forfeited Nonvested at December 31 Weighted- Average Grant-Date Fair Value Shares 35,000 $ 149,153 (7,000) - 177,153 $ 9.08 7.94 9.08 - 8.12 The vesting schedule for these shares as of December 31, 2023 is as follows: 2024 2025 2026 2027 2028 and thereafter Total Weighted Average Grant-Date Fair Value Shares - 35,000 - - 35,000 $ - 9.08 - - 9.08 Shares 14,817 80,970 27,816 14,150 39,400 177,153 The Company recognized stock-based compensation costs related to restricted stock units of $408,836 and $15,925 for the year ended December 31, 2023 and December 31, 2022, respectively. As of December 31, 2023, there was $1,071,369 of total unrecognized compensation cost related to nonvested RSUs that will be recognized over a total weighted-average period of 8 years. Note 20. 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. 47 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 20. Income Per Common Share, continued The following is a summary of the income per common share calculations for the years ended December 31, 2023 and 2022. 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 21. Regulatory Matters 2023 2022 $ 4,603,416 $ 5,931,012 - $ 4,603,416 $ 5,931,012 - $ 4,603,416 $ 5,931,012 7,779,396 0.76 7,822,882 0.59 $ $ $ 4,603,416 $ 5,931,012 7,779,396 347,752 8,127,148 0.73 7,822,882 341,052 8,163,934 0.56 $ $ 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. 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 48 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 21. Regulatory Matters, continued 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 in 2016 and was fully phased in by 2019, and now consist 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, 2023 and 2022. Actual Amount Ratio For Capital Adequacy Purposes Ratio Amount To Be Well Capitalized Under Prompt Corrective Action Provisions Ratio Amount $ 110,003 101,201 101,201 101,201 13.86% $ 63,500 47,625 12.75% 39,229 10.32% 35,719 12.75% 8.00% $ 79,375 63,500 6.00% 49,036 4.00% 51,594 4.50% 10.00% 8.00% 5.00% 6.50% $ 102,986 95,319 95,319 95,319 13.43% $ 61,356 46,017 12.43% 36,770 10.37% 34,513 12.43% 8.00% $ 76,696 61,356 6.00% 45,963 4.00% 49,852 4.50% 10.00% 8.00% 5.00% 6.50% (Dollars in Thousands) December 31, 2023 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, 2022 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) Note 22. Unused Lines of Credit The Company had available at December 31, 2023 one unsecured line of credit, which was unused, to purchase up to $10,000,000 of federal funds. Also, as of December 31, 2023, the Company had the ability to borrow funds from the FHLB of up to $202,760,138. At that date, $5,000,000 had been advanced. Note 23. 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. 49 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, continued 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 and marketable equity securities 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 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. 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. There were no loans held for sale requiring fair value adjustments at December 31, 2023 and 2022. Mortgage Servicing Rights – Fair Value Method - 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 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 accounted for using the fair value method as recurring Level 3. 50 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, Continued Derivative Financial Instruments, Non-designated – The fair value of the Company’s interest rate swap agreements to facilitate customer transactions are based upon fair values provided from entities that engage in interest rate swap activity and is based upon projected future cash flows and interest rates. The fair value of interest rate lock commitments associated with the mortgage pipeline is based on fees currently charged to enter into similar agreements, and for mortgage loan forward sales commitments, the difference between current levels of interest rates and the committed rates is also considered. These financial instruments are classified as Level 2. Examples of derivatives classified as Level 2 include interest rate lock commitments written for the residential mortgage loans that the Company intends to sell. Derivative Financial Instruments, Fair Value Hedge – Pay fixed swaps used to hedge interest rate risk related to the commercial real estate loan portfolio are reported at fair value utilizing Level 2 inputs. The fair values of the interest rate swap are based on derivative market data as of the valuation date. 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, 2023 and 2022. Total Level 1 Level 2 Level 3 December 31, 2023 Available-for-sale securities: U.S. Treasury securities U.S. agency securities Municipal securities Mortgage-backed securities Collateralized loan obligations Corporate bonds Total available-for-sale securities Marketable equity securities Mortgage servicing rights Derivative assets (liabilities): Mortgage loan interest rate lock commitments Mortgage loan forward sales commitments Derivative assets Derivative liabilities $ - $ 6,990,005 31,107,543 93,063,215 25,376,350 14,862,460 171,399,573 128,516 4,356,624 282,781 (141,797) 115,056 (136,061) $ 176,004,692 $ - $ - - - - - - - - - $ 6,990,005 31,107,543 93,063,215 25,376,350 14,862,460 171,399,573 128,516 - - - - - - $ 171,648,068 $ 282,781 (141,797) 115,056 (136,061) - - - - - - - - 4,356,624 - - - - 4,356,624 51 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, Continued Total Level 1 Level 2 Level 3 December 31, 2022 Available-for-sale securities: U.S. Treasury securities U.S. agency securities Municipal securities Mortgage-backed securities Collateralized loan obligations Corporate bonds Total available-for-sale securities Marketable equity securities Mortgage servicing rights Derivative assets (liabilities): Mortgage loan interest rate lock commitments Mortgage loan forward sales commitments U.S. Treasury futures contracts $ 30,807,969 $ 5,375,186 32,179,361 67,212,784 19,096,880 7,424,698 162,096,848 133,715 4,642,455 56,402 35,000 - $ 166,964,420 $ - $ - - - - - - - - 30,807,969 $ 5,375,186 32,179,361 67,212,754 19,096,880 7,424,698 162,096,848 133,715 - - - - - $ 162,321,965 $ 56,402 35,000 - - - - - - - - 4,642,455 - - - 4,642,455 The changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows: Balance, December 31, 2021 Changes in fair value recognized in earnings (1) Changes in unpaid principal balance (2) Balance, December 31, 2022 Changes in fair value recognized in earnings (1) Changes in unpaid principal balance (2) Balance, December 31, 2023 Mortgage Servicing Rights $ 4,376,021 1,251,171 (984,737) 4,642,455 281,434 (558,265) $ 4,356,624 (1) Represents changes in value primarily due to market driven changes in interest rates and prepayment speeds. (2) Represents changes in value of the MSRs due to i) passage of time, including the impact from both regularly scheduled loan principal payments and partial paydowns, and ii) loans that paid off fully during the period. 52 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, Continued 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, 2023 and December 31, 2022, aggregated by level in the fair value hierarchy within which those measurements fall. Total Level 1 Level 2 Level 3 December 31, 2023 Mortgage servicing rights Total December 31, 2022 Impaired loans (PreCECL adoption) Mortgage servicing rights Total $ $ $ $ 7,272,550 $ 7,272,550 $ - $ - $ - $ - $ 7,272,550 7,272,550 Total Level 1 Level 2 Level 3 1,028,657 $ 5,798,967 6,827,624 $ - $ - - $ - $ - - $ 1,028,657 5,798,967 6,827,624 Collateral-dependent loans held for investment – Collateral-dependent loans are loans for which, based on current information and events, the Company has determined foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the loan to be provided substantially through the operation or sale of the collateral and it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collateral-dependent loans are classified as Level 3. There were no collateral dependent loans at December 31, 2023. Impaired Loans (Pre ASC 326) - Loans that are considered impaired are recorded at fair value on a nonrecurring basis. Once a loan is considered impaired, the fair value is measured using one of several methods, including collateral liquidation value, market value of similar debt or discounted cash flows. Those impaired loans not requiring a specific charge against the allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investment in the loan. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair value of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be Level 3 inputs. 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 a current appraised value or when a current 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. There was no OREO at December 31, 2023. 53 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, Continued Mortgage Servicing Rights – Amortization Method - 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 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 accounted for using the amortization method as nonrecurring Level 3. The Company had no liabilities measured at fair value on a non-recurring basis. For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2023 and December 31, 2022, the significant unobservable inputs used in the fair value measurements were as follows: Fair Value as of December 31, 2023 Asset Valuation Technique Significant Observable Inputs Significant Unobservable Inputs Mortgage servicing $ 7,272,550 Discounted cash flows Comparable sales rights Weighted average discount rate – 9% Constant prepayment rate – 6.5% Fair Value as of December 31, 2022 Impaired loans $ 1,028,657 Valuation Technique Significant Observable Inputs Significant Unobservable Inputs Appraisal Value/Comparison Sales Appraisals and/or sales of comparable properties Appraisals discounted 5% to 20% for sales commissions and other holding cost Mortgage servicing $ 5,798,967 rights Discounted cash flows Comparable sales Weighted average discount rate – 9% Constant prepayment rate – 6.5% 54 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, Continued 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 judgment 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, 2023 and 2022. December 31, 2023 Carrying Value Fair Value Level 1 Level 2 Level 3 Financial Assets: Cash and cash equivalents Mortgage loan held for sale Loans held for investments, net Nonmarketable equity securities Financial Liabilities: Deposits without stated maturities Deposits with stated maturities Securities sold under agreements to Repurchase FHLB Advances Subordinated debentures $ 21,944,052 7,155,912 697,278,897 949,800 $ 21,944,052 $ 21,944,052 $ 7,155,912 660,550,181 949,800 - - - 7,155,912 949,800 - $ - - - 660,550,181 - 689,359,034 169,237,473 689,359,034 167,687,049 - 689,359,034 - 167,687,049 - - 307,517 5,000,000 25,772,697 307,517 5,000,000 22,679,342 - - - 307,517 5,000,000 - - - 22,679,342 December 31, 2022 Carrying Value Fair Value Level 1 Level 2 Level 3 Financial Assets: Cash and cash equivalents Mortgage loan held for sale Loans held for investments, net Nonmarketable equity securities Financial Liabilities: Deposits without stated maturities Deposits with stated maturities Securities sold under agreements to Repurchase FHLB Advances Subordinated debentures $ 33,797,310 7,940,056 653,590,722 1,787,200 $ 33,979,310 $ 33,979,310 $ 7,940,056 623,018,294 1,787,200 - - - 7,940,056 1,787,200 - $ - - - 623,018,294 - 694,482,772 103,701,071 694,482,772 102,407,841 - 694,482,772 - 102,407,841 - - 7,367,861 30,000,000 25,690,951 7,367,861 30,000,000 22,827,166 - - - 7,367,861 30,000,000 - - - 22,827,166 55 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 23. Fair Value Measurements, Continued Cash and cash equivalents The carrying amount approximates fair value for these instruments. Mortgage loans held for sale Loans held for sale are carried at the lower of cost or fair value. These loans currently consist of one-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, net 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. 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 carrying value. 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. Securities sold under agreements to repurchase The fair value of securities sold under agreements to repurchase generally mature within 31 days and the stated balance approximates their fair value. 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. Federal Home Loan Bank advances Fair value is estimated based on discounted cash flows using current market rates for borrowing with similar terms. 56 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 24. First Reliance Bancshares, Inc. (Parent Company Only) Condensed Balance Sheets Assets Cash Investment in banking subsidiary Marketable equity securities Nonmarketable equity securities Investment in trust Deferred tax asset 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 Loss on change in fair value of marketable equity securities Total income Expenses Interest expense Salaries and employee benefits Other expenses Total expenses Loss 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 57 December 31, 2023 2022 $ 3,240,882 $ 3,867,380 82,867,930 91,669,697 133,715 128,516 58,100 58,100 310,000 310,000 2,001,469 1,923,969 $ 97,331,164 $ 89,238,594 $ 10,310,000 $ 10,310,000 15,380,951 15,412,697 110,924 68,001 144,542 140,855 25,942,730 25,935,240 71,395,924 63,295,864 $ 97,331,164 $ 89,238,594 For the years ended December 31, 2023 2022 $ 181,159 $ (5,198) 175,961 9,808 (4,144) 5,664 1,429,229 566,836 55,044 2,051,109 1,072,846 252,642 43,356 1,368,844 (1,875,148) 6,093,876 (1,363,180) 7,020,265 4,218,728 384,688 5,657,085 273,927 $ 4,603,416 $ 5,931,012 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 24. 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 taxes, net of allowance Net equity in undistributed earnings of banking subsidiary Amortization of debt issuance costs Loss on change in fair value of marketable equity securities Stock based compensation expense Decrease in other assets Increase in accrued interest payable Decrease in accrued salary benefits Net cash provided (used) in operating activities Cash flows from financing activities Issuance of common stock Decrease (increase) in nonvested restricted stock Purchase of treasury stock Net cash provided (used in) by financing activities Net decrease in cash Cash and cash equivalents, beginning of year Cash and cash equivalents, ending of year For the years ended December 31, 2023 2022 $ 4,603,416 $ 5,931,012 77,500 (6,093,876) 31,746 5,199 1,446,765 - 3,687 (42,923) 31,514 21,655 (7,020,265) 31,746 4,144 54,623 - 46,621 (122,890) (1,053,354)3 57,391 (396,429) (318,974) (658,012) 56,775 547,110 (179,878) 424,007 (626,498) (629,347) 3,867,380 4,496,727 $ 3,240,882 $ 3,867,380 58 First Reliance Bancshares, Inc. and Subsidiary Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 25. 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 performed an evaluation to determine whether there have been any subsequent events since the balance sheet date and determined that no subsequent events occurred requiring accrual or disclosure. 59 (888) 543-5510 www.firstreliance.com 

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