FIRST BANCORP /NC/ (FBNC) FY 2021 MD&A

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

Management’s Discussion and Analysis is intended to assist readers in understanding our results of operations and changes in financial position for the past three years. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in Item 8 of this Report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.

Overview and 2021 Highlights

The Company is a financial holding company headquartered in Southern Pines, North Carolina. We provide diversified financial services primarily though our principal subsidiary, First Bank, including commercial and consumer banking services, mortgage lending, SBA lending, accounts receivable financing, and investment advisory services. As of December 31, 2021, the Bank had a 121 branch network throughout North Carolina and South Carolina and 1,207 full-time equivalent employees. We have grown organically as well as through strategic acquisitions.

On October 15, 2021, we acquired Select which was headquartered in Dunn, North Carolina and operated through 22 branches in North Carolina, South Carolina, and Virginia. As of the acquisition date, Select had total assets of $1.8 billion, total loans of $1.3 billion, and total deposits of $1.6 billion. The conversion of Select’s core processing and related systems to the Bank’s systems will occur in March 2022. Until such time, Select branches will continue to operate under their current name.

The merger with Select, combined with organic growth over the year, resulted in significant growth to assets, liabilities and equity during 2021. Our total assets at December 31, 2021 were $10.5 billion, a 44.2% increase from a year earlier; total loans increased $1.4 billion to total $6.1 billion at December 31, 2021, and deposits grew $2.9 billion from the prior year end to total $9.1 billion.

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We earned net income of $95.6 million, or $3.19 diluted EPS, during 2021 compared to net income of $81.5 million, or $2.81 diluted EPS, in 2020. The main drivers to the increase in net income are as follows:

•Net interest income increased $28.3 million, or 13%, due to the combination of both higher interest income and lower interest expense. The NIM on a tax-equivalent basis was 3.16% for 2021, a decrease of 41 basis points from 2020. The growth in average earning assets offset the decline in yields.

•Interest income was a primary driver of higher net interest income and included a $5.9 million increase in interest income from loans and a $13.3 million increase in interest income from investment securities. Loan interest income was up related to the $315.6 million increase in average volume of loans driven by both organic growth and the Select acquisition. The increase in interest income from investment securities was due to higher average balances, which increased $1.4 billion in 2021, related to our decision to invest excess liquidity, which arose from high deposit growth, into investment securities.

•Reduced interest expense of $10.0 million also contributed to the the improved net interest income. We continued to reprice deposits downward given the low interest rate environment and lowered the cost of interest-bearing deposits by 27 basis points to 0.17% for 2021. Our total cost of deposits declined to 0.13% from 0.50% in 2020. The effects from the decline in funding costs were partially offset by an increase in average balance in interest-bearing liabilities.

•Provision for loans losses of $9.6 million was down from the $35.0 million provision in 2020 due to improving asset quality and improving economic forecasts which are factors in our CECL model calculations. The higher provision in 2020 was driven by historical estimates of probable losses incurred in the portfolio taking into consideration the impact of the COVID-19 pandemic on the overall economic environment and the potential impact on our loan portfolio. The provision for 2021 was related to the initial ACL for Select's non-PCD loans acquired of $14.1 million. Partially offsetting the initial Select provision, we reduced our ACL reserves $4.5 million during the year due to the economic forecast improvements in 2021.

•Noninterest income declined $7.7 million, which resulted primarily from a $3.2 million decrease in mortgage banking income related to lower levels of activity, a $1.9 million decrease in commissions on sales of financial and insurance products due to the sale of the majority of the assets of First Bank Insurance mid-year, and a loss of $1.2 million on security sales as compared to a gain of $8.0 million in 2020. Partially offsetting these reductions were higher levels of transactions and number of accounts generating service charge income and bankcard revenue. (See Noninterest Income section below for further discussion).

•Noninterest expense increased $23.4 million, primarily related to $16.8 million in merger expenses related to the Select acquisition. Also related to the Select acquisition were incremental costs of $2.3 million in personnel expense and $4.7 million in higher operating costs. (See Noninterest Expense section below for further discussion).

•Income tax expense was up $3.0 million relative to the higher pre-tax income. The effective tax rate of 20.5% was fairly consistent with the prior year.

Total loans amounted to $6.1 billion at December 31, 2021, an increase of $1.4 billion, or 28.5% from December 31, 2020. Core legacy loan growth for the year ended December 31, 2021, which we define as growth exclusive of PPP loans and loans acquired from Select, amounted to $382.8 million, a growth rate of 8.6%. A combination of low interest rates and economic recovery from the pandemic contributed to our 2021 core loan growth. Also contributing to our core growth is a continued focus on expansion in high-growth markets, hiring experienced bankers, and providing high levels of service to achieve growth.

The ACL on loans increased $26.4 million from the balance of $52.4 million at December 31, 2020. The increase in the ACL on loans was mainly due to a $14.6 million allowance recorded at adoption of the CECL standard as of January 1, 2021. The other driver was the Select loans acquired requiring a $4.9 million allowance recorded on the PCD loans and $14.1 million allowance on the initial provision for credit losses for the non-PCD loans. The ACL was 1.30% of total loans at December 31, 2021. With our adoption of CECL,we increased the allowance for unfunded commitments by $7.5 million. We also recorded an initial allowance on unfunded commitments of $3.9 million with the acquisition of Select.

Our asset quality remained strong in 2021. At December 31, 2021, net charge offs as a percentage of average loans was 0.05% as compared to 0.09% for the prior year. The total NPAs of $52.6 million were 0.50% of total

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assets at December 31, 2021. Total nonperforming assets increased $11.9 million in the fourth quarter of 2021 as a result of the acquisition of Select.

We continue to deploy excess liquidity into investment securities, which amounted to $3.1 billion at December 31, 2021, an increase of $1.5 billion, or 94.0%, compared to a year earlier.

Total deposits amounted to $9.1 billion at December 31, 2021, an increase of $2.9 billion, or 45.4%, from December 31, 2020. Core legacy deposit growth for the year ended December 31, 2021, which we define as organic growth exclusive of deposits acquired from Select, totaled $1.35 billion, a growth rate of 21.5%. The high core deposit growth is believed to be due to a combination of stimulus funds and changes in customer behaviors during the pandemic, as well as ongoing growth initiatives by the Company. We continue to emphasize relationship banking to new and existing customers and continually work to identify and introduce new products that will attract and retain customers.

We remain well-capitalized by all regulatory standards, with a total capital ratio at December 31, 2021 of 14.67% compared to 15.37% reported at December 31, 2020. The Company’s TCE ratio was 8.38% at December 31, 2021, a decrease of 70 basis points from a year earlier, with the decline resulting from the acquisition of Select and the high balance sheet growth experienced in 2021.

Impact of COVID-19

Overview. Our business has been, and continues to be, impacted by COVID-19 and its variants. While the economies of our markets have generally improved in 2021, the current pandemic is ongoing and dynamic in nature, and there are many related uncertainties, including, among other things, its severity and new variants that may arise; its ultimate duration and infection spikes that may occur; the impact on our customers, employees and vendors; the impact on the financial services and banking industry; and the ongoing impact on the economy as a whole.

Impact on our Operations. At the height of the pandemic, many jurisdictions in North Carolina in which we operate declared health emergencies related to COVID-19. The resulting closures and/or limited operations of non-essential businesses and related economic disruption impacted our operations as well as the operations of our customers. While most businesses have reopened and restrictions are currently limited in our areas, the occurrence of variants of the COVID-19 virus may result in future restrictions or closures. We continue to address the issues as they arise in order to facilitate the continued delivery of essential services while maintaining a high level of safety for our customers as well as our employees, including:

•Implementing our communications plans to ensure our employees, customers and critical vendors are kept abreast of developments affecting our operations;

•Temporarily closing financial center lobbies, limiting access to drive-through only or by appointment, as necessary given spikes in COVID-19 infection rates or due to staffing constraints;

•Expanding remote-access availability so that a significant portion of our workforce has the capability to work from home or other remote locations. All activities are performed in accordance with our compliance and information security policies designed to ensure customer data and other information is properly safeguarded; and

•Instituting mandatory social distancing policies and mask protocols for those employees not working remotely and who are unvaccinated. Members of certain operations teams may split into two teams that rotate their work location between work and home as necessary.

Impact on our Financial Position and Results of Operations. Our financial position and results of operations are particularly susceptible to the ability of our loan customers to meet loan obligations, the availability of our workforce, the availability of our vendors, and the decline in the value of assets held by us. The impact of the COVID-19 pandemic lessened in 2021, and we experienced increased commercial activity throughout our market areas. We have not realized significant negative impact on our loan portfolio or asset quality. Further, all COVID-19 deferral status loans have returned to regular payment schedules. While the economic pressures and uncertainties arising from the COVID-19 pandemic have resulted in, and may continue to result in, specific changes in consumer and business spending and borrowing habits, we have seen improvements in many industries in which we have loan exposure including retail/strip centers, hotels/lodging, restaurants, entertainment, and commercial real estate. See further information related to the risk exposure of our loan portfolio under the sections captioned "Provision for Credit Losses," “Loans,” and “Allowance for Credit Losses” elsewhere in this discussion.

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Legislative and Regulatory Developments. The federal government and the Federal Reserve and other bank regulatory agencies have taken actions to mitigate the economic effects of COVID-19. The Federal Reserve lowered the target for the federal funds rate to a range of between zero to 0.25% effective in March 2020. Recently, in response to inflationary concerns, the Federal Reserve indicated that it expects to increase the targeted federal funds rate during 2022. Our earnings and cash flows are largely dependent on our net interest income, as is discussed in detail below under "Interest Rate Risk." Increasing short term rates could negatively impact our NIM if funding costs rise.

Banks and bank holding companies have been particularly impacted by the COVID-19 pandemic as a result of disruption and volatility in the global capital markets. Bank regulatory agencies have been (and are expected to continue to be) proactive in responding to both market and supervisory concerns arising from the COVID-19 pandemic and its aftermath, as well as the potential impact on customers, especially borrowers. We continue to monitor any potential for new laws and regulations impacting lending and funding practices as well as capital and liquidity standards. Such changes could require us to maintain more capital, with common equity as a more predominant component, or manage the composition of our assets and liabilities to comply with formulaic liquidity requirements.

As discussed above, the economies of our market areas generally improved during 2021 as they recovered from the pandemic. However, the ongoing impact on the Company of the continuing pandemic, including infection rate spikes and new strains of COVID-19, is uncertain. The extent to which the COVID-19 pandemic has a further impact on our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the COVID-19 pandemic and actions taken by governmental authorities and other third parties in response to the COVID-19 pandemic.

Critical Accounting Policies and Estimates

The accounting principles we follow and our methods of applying these principles conform with GAAP and with general practices followed by the banking industry. Certain policies inherently have a greater reliance on the use of estimates, assumptions, or judgments and as such, have a greater possibility of producing results that could be materially different than originally reported. We have identified the determination of our ACL, business combinations and related fair value measurements, and intangible assets to be the accounting areas that require the most subjective or complex judgments, estimates, and assumptions, and where changes in those judgments, estimates, and assumptions (based on new or additional information, changes in the economic climate and/or market interest rates, etc.) could have a significant effect on our financial statements.

Our most significant accounting policies are presented in Note 1 to the accompanying consolidated financial statements. These policies, along with the disclosures presented in the other notes to the consolidated financial statements and in this MD&A, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

Allowance for Credit Losses on Loans and Unfunded Commitments

The ACL replaces the allowance for loan and lease losses as a credit accounting estimate as of January 1, 2021, when we adopted ASU 2016–13, Financial Instruments–Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ACL represents management’s current estimate of credit losses for the remaining estimated life of financial instruments. We perform periodic and systematic detailed reviews of the loan portfolio to identify trends and to assess the overall collectability of the portfolio. We believe the accounting estimate related to the ACL is a “critical accounting estimate” as: (1) changes in it can materially affect the provision for loan and lease losses and net income; (2) it requires management to predict borrowers’ likelihood or capacity to repay, including evaluation of inherently uncertain future economic conditions; (3) the value of underlying collateral must be estimated on collateral-dependent loans; (4) prepayment activity must be projected to estimate the life of loans that often are shorter than contractual terms; and (5) it requires estimation of a reasonable and supportable forecast period for credit losses. Accordingly, this is a highly subjective process and requires significant judgment since it is difficult to evaluate current and future economic conditions in relation to an overall credit cycle and estimate the timing and extent of loss events that are expected to occur prior to end of a loan’s estimated life.

Our ACL is assessed at each balance sheet date and adjustments are recorded in the provision for loan losses. The ACL is estimated based on loan level characteristics using historical loss rates, a reasonable and supportable economic forecast, and assumptions of probability of default and loss given default. Loan balances considered

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uncollectible are charged-off against the ACL. There are many factors affecting the ACL, some of which are quantitative, while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and is susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect our earnings or financial position in future periods.

PCD loans represent assets that are acquired with evidence of more than insignificant credit quality deterioration since origination at the acquisition date. At acquisition, the allowance for credit losses on PCD assets is booked directly to the ACL. Any subsequent changes in the ACL on PCD assets is recorded through the provision for credit losses.

We believe that the ACL is adequate to absorb the expected life of loan credit losses on the portfolio of loans and leases as of the balance sheet date. Actual losses incurred may differ materially from our estimates. For example, the impact of COVID–19 on both borrower credit and the greater macroeconomic environment is uncertain and changes in the duration, spread, and severity of the virus could affect our loss experience.

Additional information on the loan portfolio and ACL can be found in the sections of MD&A titled “Nonperforming Assets” and “Allowance for Credit Losses and Loan Loss Experience” below.

Business Combinations

Pursuant to applicable accounting guidance, we recognize assets acquired, including identified intangible assets (discussed further below), and the liabilities assumed in acquisitions at their fair values as of the acquisition date, with the related transaction costs expensed in the period incurred. Specified items such as acquired operating lease assets and liabilities as lessee, employee benefit plans, and income-tax related balances are recognized in accordance with accounting guidance that results in measurements that may differ from fair value. Determining the fair value of assets acquired and liabilities assumed often involves estimates based on internal or third-party valuations which include appraisals, discounted cash flow analysis, or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, discount rates, credit risk, multiples of earnings, or other relevant factors. The determination of fair value may require us to make point-in-time estimates about discount rates, future expected cash flows, market conditions, and other future events that can be volatile in nature and challenging to assess. While we use the best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, the estimates are inherently uncertain and subject to refinement.

The ACL for PCD assets is recognized within business combination accounting with no initial impact to net income. Changes in estimates of expected credit losses on PCD loans after acquisition are recognized as provision expense (or reversal of provision expense) in subsequent periods as they arise. The ACL for non-PCD assets is recognized as provision expense in the same reporting period as the business combination. Estimated loan losses for acquired loans are determined using methodologies and applying estimates and assumptions that were described previously in the Allowance for Credit Losses section.

Non-PCD loans acquired are generally estimated at fair value using a discounted cash flow approach with assumptions of discount rate, remaining life, prepayments, probability of default, and loss given default. The actual cash flows on these loans could differ materially from the fair value estimates. The amount we record as the fair values for the loans is generally less than the contractual unpaid principal balance due from the borrowers, with the difference being referred to as the “discount” on the acquired loans. Discounts on acquired non-PCD loans are amortized to interest income over their estimated remaining lives, which may include prepayment estimates in certain circumstances.

Similarly, premiums or discounts on acquired debt are amortized to interest expense over their remaining lives. Actual accretion or amortization of premiums and discounts from a business acquisition may differ materially from our estimates impacting our operating results.

Goodwill and Other Intangible Assets

We believe that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. ASC 350-10 establishes standards for the amortization of acquired intangible assets, generally over the estimated useful life of the related assets, and impairment assessment of

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goodwill. At December 31, 2021, we had core deposit and other intangibles of $17.8 million subject to amortization and $364.3 million of goodwill, which is not subject to amortization.

Goodwill arising from business combinations represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.

At each reporting date between annual goodwill impairment tests, we consider potential indicators of impairment. During 2020, with the heightened economic uncertainty and volatility surrounding COVID–19, we performed quarterly impairment assessments. Generally, absent potential impairment indicators, we perform an annual assessment of whether the events and circumstances resulted in it being more likely than not that the fair value of any reporting unit was less than its carrying value. Impairment indicators considered include the condition of the economy and banking industry; government intervention and regulatory updates; the impact of recent events to financial performance and cost factors of the reporting unit; performance of the Company's stock, and other relevant events. During 2021 there were no triggers warranting interim impairment assessments and for the 2021 annual assessment, we concluded that it was more likely than not that the fair value exceeded its carrying value.

The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangibles which represent the estimated value of the long-term deposit relationships acquired in the transaction. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. The core deposit intangibles are amortized over the estimated useful lives of the deposit accounts based on a method that we believe reasonably approximates the anticipated benefit stream from this intangible. The estimated useful lives are periodically reviewed for reasonableness and have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset’s carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.

Recent Accounting Standards and Pronouncements

For information relating to recent accounting standards and pronouncements, see Note 1 to our consolidated financial statements entitled “Summary of Significant Accounting Policies.”

RESULTS OF OPERATIONS

The following discussion reviews the results of operations and key drivers to change in the results of 2021 as compared to 2020. For a description of our results of operations for 2020, refer to the "Overview - 2020 Compared to 2019" section of Item 7 in our 2020 Form 10-K.

Net Interest Income

Net interest income is our largest source of revenue and is the difference between the interest earned on interest-earning assets (generally loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (generally deposits and borrowed funds). Changes in the net interest income are the result of changes in volume and the net interest spread which affects NIM. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. NIM refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. Net interest income is also influenced by external factors such as local economic conditions, competition for loans and deposits, and market interest rates.

Net interest income amounted to $246.4 million in 2021, an increase of $28.3 million, or 11.5%, from the $218.1 million in 2020. The increase was due in part to the Select acquisition and higher balances of investment securities, which more than offset the impact of the challenging rate environment. For 2021, average interest-earning assets

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increased $1.7 billion, or 27.8%, including growth of $315.6 million in average loans and $1.4 billion in average securities. The growth in interest-earning assets was driven by funds provided from growth in deposits. The Select acquisition in the fourth quarter also contributed to higher earning assets.

The impact on earnings of the interest-earning asset growth was partially offset by a decrease in our NIM on a tax-equivalent basis, which declined from 3.56% in 2020 to 3.16% in 2021. For internal purposes, we evaluate our NIM on a tax-equivalent basis by adding the tax benefit realized from tax-exempt loans and securities to reported interest income then dividing by total average earning assets. We believe that analysis of NIM on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest in different periods without taking into account the different mix of taxable versus non-taxable loans and investments that may have existed during those periods. The following is a reconciliation of reported net interest income to tax-equivalent net interest income and the resulting NIM as reported and on a tax-equivalent basis.

The reduction in our NIM was in large part a result of excess liquidity, as well as the impact of lower interest rates. While there were no interest rate reductions initiated by the Federal Reserve during 2021, the overall lower market rates impacted our portfolio yields on new and renewing assets. During 2021, our level of average securities and other short-term investments increased by $1.4 billion, or 95.8% at lower market yields, generally less than 1.50%, thus negatively impacting the NIM.

Our NIM for all periods benefited, by varying amounts, from the net accretion income, primarily associated with purchase accounting premiums/discounts associated with acquisitions. Presented in the table below is the amount of accretion which increased net interest income in each year.

The biggest component of the purchase accounting adjustments in each year was loan discount accretion on purchased loans. The increase in 2021 was driven by the acquisition of Select which resulted in $1.5 million in accretion during the fourth quarter of 2021, combined with $2.3 million in accelerated accretion earlier in the year from the payoff of several former failed-bank loans we previously acquired. Generally the level of loan discount accretion will decline each year due to the natural paydowns in acquired loan portfolios.

At December 31, 2021, 2020, and 2019, unaccreted loan discount on purchased loans amounted to $17.2 million, $8.9 million, and $12.7 million, respectively. We recorded an initial fair value loan discount mark of $19.3 million for the Select portfolio, which was reduced by the reclassification to ACL of $4.9 million related to PCD loans. The Select acquired portfolio comprises the majority of the remaining unaccreted loan discount at December 31, 2021.

In addition to the loan discount accretion recorded on acquired loans, we record accretion on the discounts associated with the retained unguaranteed portions of SBA loans sold in the secondary market. The level of SBA loan discount accretion will increase relative to the SBA loan portfolio with continued growth in that line of business. At December 31, 2021, 2020, and 2019, unaccreted loan discount on SBA loans amounted to $6.0 million, $7.3 million, and $7.1 million, respectively.

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Amortization of net deferred loan fees also impacts interest income. During 2021, we amortized net deferred PPP fees of $9.5 million as interest income compared to $4.1 million for 2020. At December 31, 2021, we had $2.6 million in remaining deferred PPP origination fees that will be recognized over the lives of the loans, with accelerated amortization expected to result from the loan forgiveness process. We expect substantially all of these fees will be recognized in the first quarter of 2022 as a result of the loan forgiveness process.

The following table presented the major components of the net interest income and NIM.

(1)Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized net loan fees, including late fees, prepayment fees, and deferred loan fee amortization, in the amounts of $9,690, $4,755, and $1,264 for 2021, 2020, and 2019, respectively.

(2)Includes accretion of discount on acquired and SBA loans of $8,814, $6,328, and $5,974 in 2021, 2020, and 2019, respectively.

(3)Includes tax-equivalent adjustments of $2,243, $1,468, and $1,641 in 2021, 2020, and 2019, respectively, to reflect the federal and state tax benefit that we receive related to tax-exempt securities and tax-exempt loans, which carry interest rates lower than similar taxable investments/loans due to their tax exempt status. This amount has been computed assuming a 23% tax rate and is reduced by the related nondeductible portion of interest expense.

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The following table presents additional detail regarding the estimated impact that changes in loan and deposit volumes and changes in the interest rates we earned/paid had on our net interest income in 2021 and 2020.

Note - Changes attributable to both volume and rate are allocated equally between rate and volume variances.

Overall, as demonstrated in the above table, net interest income grew $28.3 million in 2021, with higher earning asset volumes and lower rates on interest-bearing liabilities, which was partially offset by lower yields on interest-earning assets, driving the increase.

•For 2021, higher loan volume positively impacted interest income by $14.0 million, partially offset by lower interest rates on loans which negatively impacted interest income by $8.1 million, resulting in an increase in loan interest income of $5.9 million.

•Higher volumes of total securities balances contributed $24.4 million in additional interest income in 2021. This was partially offset by the impact of lower interest rates earned on those securities resulting in a negative impact of $11.0 million on interest income.

•Lower interest rates on other interest-earning assets (primarily overnight funds and presold mortgages held for sale) in 2021 resulted in $1.2 million in lower interest income, which was partially offset by higher volume.

•Lower interest rates paid on deposits drove a $9.7 million decrease in deposit interest expense in 2021. Reductions in rates on deposits more than offset the higher volumes of interest-bearing demand balances.

•Lower levels of borrowings resulted in a decrease in borrowings interest expense of $1.6 million in 2021.

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Provision for Credit Losses (Loans and Unfunded Commitments)

Prior to our implementation of CECL, the provision for credit losses was based on the then-applicable Incurred Loss model and represented an estimate of probable incurred losses in the loan portfolio at the end of each reporting period. Under CECL, the provision for credit losses represents our current estimate of life of loan credit losses in the loan portfolio and unfunded loan commitments. Our estimate of credit losses under CECL is determined using a complex model that relies on reasonable and supportable forecasts and historical loss information to determine the balance of the ACL and resulting provision for loan losses and provision for unfunded commitments which represents expected losses on unfunded loan commitments that are expected to result in outstanding loan balances. The allowance for unfunded commitments is included in other liabilities in the consolidated balance sheets.

The provision for loan losses was $9.6 million in 2021 under the CECL method, compared to $35.0 million in 2020 under the Incurred Loss method. The amount of provision recorded in each period was the amount required such that the total ACL reflected the appropriate balance as determined under the applicable accounting standards in effect at each balance sheet date. Under the CECL methodology, during 2021 we reversed $4.5 million in provision for credit losses due to improving asset quality and better economic forecasts. Offsetting the provision reversal was the "Day 2" provision expense of $14.1 million which was the calculated ACL recorded for Non-PCD loans acquired from Select after the initial credit mark adjustment was recorded to the loans. The elevated provision expense in 2020 was primarily a result of the higher estimated incurred losses resulting from macroeconomic effects of the COVID-19 pandemic and exposures to loans with characteristics or in industries that had greater loss exposure due to the economic uncertainties brought on by COVID-19.

Total net charge-offs for 2021 were $2.7 million compared to $4.0 million in 2020. In 2020, the higher net charge-offs were driven by $3.2 million of net charge-offs in our SBA portfolio, and was concentrated in the "commercial, financial, and agricultural" category.

Also under the CECL method, we recorded $5.4 million in provision for unfunded commitments, which included $3.9 million recorded in the fourth quarter of 2021 upon the acquisition of Select. There was no provision for unfunded commitments in 2020 under the Incurred Loss method. The provisions for 2021 were recorded primarily due to increases in construction and land development loan commitments during the year.

Additional discussion on the CECL method and our asset quality and credit metrics, which impact our provision for credit losses, is provided in the "Nonperforming Assets" and "Allowance for Credit Losses and Loan Loss Experience" sections following.

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Noninterest Income

Our noninterest income amounted to $73.6 million in 2021, $81.3 million in 2020, and $59.5 million in 2019.

Management evaluates noninterest income on a non-GAAP basis that excludes items such as securities gains and losses and other miscellaneous gains and losses because we believe excluding those items results in a more meaningful reflection of noninterest income from recurring sources. We refer to this as "adjusted noninterest income." A reconciliation of reported noninterest income to adjusted noninterest income is presented in the table below. Adjusted noninterest income amounted to $73.2 million in 2021, $73.4 million in 2020, and $59.6 million in 2019.

Service charges on deposit accounts increased $1.2 million, or 11.0%, in 2021 as compared to 2020. The increase in 2021 was primarily due to growth in the number of checking accounts generating fees, as well as higher NSF activity during the year. Also contributing to the increase was the addition of Select deposit accounts and related income in the fourth quarter of 2021.

Total "Other service charges, commissions and fees" related to net interchange income from bankcard activity amounted to $18.5 million in 2021, a 30.7% increase from the $14.1 million in 2019. The growth in card usage by our customers is related to the higher volume of outstanding cards giving rise to increased transaction volume as well as customer payment preferences. General growth of our bank also contributed to the increase in this line item in 2021.

"Other service charges, commissions and fees - other" includes items such as SBA guarantee servicing fees, ATM charges, wire transfer fees, safety deposit box rentals, fees from sales of personalized checks, and check cashing fees. The increases in this line item in 2021 of $1.1 million, or 18.2%, were primarily due to growth in the number of accounts and related transaction activity, as well as the Bank's deposit base increases.

Fees from presold mortgages amounted to $11.0 million in 2021, a decline of $3.2 million or 22.6% from 2020. The decrease was due in part to lower originations, combined with a higher percentage of mortgages retained in the portfolio during 2021 as compared to the prior year.

Commissions from sales of insurance and financial products amounted to $6.9 million in 2021, down $1.9 million from 2020. The decrease is due to the sale of the majority of the assets of First Bank Insurance, our property and casualty insurance subsidiary, in June 2021.

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The reduction in SBA consulting services in 2021 of $1.4 million, or 16.3%, is directly related to the wind-down of the PPP loan program. SBA Complete recognized $4.7 million in PPP fees during 2020 as compared to $3.2 million in 2021.

The increase in BOLI income in 2021 was related to the acquisition of Select which had $31.1 million in BOLI as of the date of acquisition.

During 2021, we sold approximately $106.5 million in securities at a loss of $1.2 million. This is compared to sales transactions in 2020 of $219.7 million for a gain of $8.0 million. The securities sold were in the normal course of business and our ALCO determination to adjust our portfolio in light of the market rates and the overall portfolio composition.

“Other gains (losses), net” amounted to a net gain of $1.6 million for 2021 related to the sale of the Company's property and casualty insurance subsidiary during the year.

Noninterest Expenses

Total noninterest expenses totaled $184.7 million, $161.3 million, and $157.2 million, for 2021, 2020, and 2019, respectively.

Total personnel expense increased from $101.0 million in 2020 to $103.2 million in 2021, an increase of $1.9 million, or 2.2%. Within personnel expense, salaries expense increased $1.9 million, or 2.6%, while employee benefits expense increased $0.4 million, or 2.5%. Within salaries expense, commissions declined $1.0 million, or 12.5%, related to the lower mortgage banking activity, while bonuses increased $2.1 million due to the improved corporate performance.

Merger and acquisition expenses amounted to $16.8 million in 2021 related to the acquisition of Select. The expenses were primarily comprised of severance costs and data processing conversion expenses.

Credit card expenses have increased $1.0 million, or 28.1%, relative to the higher levels of outstanding cards and activity generating revenue.

Telephone and data, software costs, data processing expenses, and advertising and marketing expenses did not vary significantly among the periods presented, increasing in 2021 related to higher levels of activity and the incremental costs from Select commencing in the fourth quarter of the year.

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Non-credit losses remained relatively unchanged for the periods presented, with losses primarily related to debit card and credit card fraud losses.

Income Taxes

We recorded income tax expense of $24.7 million in 2021, $21.7 million in 2020, and $24.2 million in 2019. Our effective tax rates were fairly stable at 20.5% for 2021, 21.0% for 2020, and 20.8% for 2019. We expect our effective tax rate to be approximately 21.0% in 2022.

ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION

Loans

The loan portfolio is the largest category of our earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans, and consumer loans. The majority of our loan portfolio is within our North Carolina and South Carolina market areas. We also have a portfolio of SBA loans that have been made on a nationwide basis. The diversity of the economic bases of our market areas has historically provided a stable lending environment.

Total loans amounted to $6.1 billion at December 31, 2021, an increase of $1.4 billion, or 28.5%, from December 31, 2020. Net loan growth for the year was as follows:

The following table provides a summary of the loan portfolio composition at each of the past five year ends.

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The majority of our loan portfolio over the years has been real estate mortgage loans, with all loan categories secured by real estate historically comprising approximately 87% to 89% of our outstanding loan balances. In 2020, our total loans secured by real estate decreased to 82% of outstanding loan balances due to an increase in PPP loans, which are unsecured loans and are included in the line item "commercial, financial, and agricultural" as discussed further below.

Except for construction, land development, and other land loans, the majority of our real estate loans are personal and commercial loans where cash flow from the borrower’s occupation or business is the primary repayment source, with the real estate pledged providing a secondary repayment source.

Residential real estate loans declined from 25% of total loans at December 31, 2018 to 17% of total loans at December 31, 2021. This decline was due to a combination of factors including consumers refinancing their home loans held by the Bank with long-term fixed rate loans, which we typically sell in the secondary market. Additionally, the Select loan portfolio acquired during 2021 had only a 12.8% mix of residential real estate loans, thus driving down the overall portfolio percentage in this category.

Commercial real estate loans as a percentage of total loans increased to 53% at December 31, 2021 primarily due to the Select acquisition as 51% of its loan portfolio was in this category.

Commercial, financial, and agricultural loans returned to the historical level of approximately 11% of total loans at December 31, 2021, decreasing from 17% at the prior year end. As noted above, the fluctuations were due primarily to PPP loans, which declined $197.3 million during 2021 due to forgiveness of loans. We began originating PPP in April 2020 under the provisions of the CARES Act and subsequent federal acts. These loans are fully guaranteed by the SBA and may be eligible for loan forgiveness under the provisions of the CARES Act. During 2020, we funded approximately $247.5 million of PPP loans. At December 31, 2020, we had a remaining balance of $240.9 million in PPP loans outstanding, which represented 30.8% of our commercial, financial, and agricultural loans and 5.1% of our total loans. During 2021, we originated an additional $113.4 million of PPP loans, assumed $17.3 million from Select, and processed total PPP loan forgiveness of $339.2 million. As of December 31, 2021, we had $39.0 million in outstanding PPP loans.

A summary of scheduled loan maturities, based on contractual maturity dates, over certain time periods is presented below, with fixed rate loans and adjustable rate loans shown separately.

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The above table is based on contractual scheduled maturities. Early repayment of loans or renewals at maturity are not considered in this table.

Approximately 14% of our accruing loans outstanding at December 31, 2021 mature within one year and 50% of total loans mature within five years, with both of those measures being consistent with recent years. As of December 31, 2021, the percentages of variable rate loans and fixed rate loans as compared to total performing loans were 23% and 77%, respectively. In recent years, the mix of variable rate loans to fixed rate loans has been shifting to more fixed rate loans which continue to be popular with many borrowers in order to lock in a low interest rate during the historically low interest rate environment that has been in effect. While fixed rate loans present risk to our Company if interest rates rise, we measure our interest rate risk closely and, as discussed in the section “Interest Rate Risk” below, we do not believe that an increase in interest rates would materially negatively impact our net interest income.

The Company’s loan portfolio is not concentrated in loans to any single borrower or to a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions.

In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries, and geographic regions, the Company monitors exposure to credit risk that could arise from potential 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. Additionally, there are industry practices that could subject the Company to increased credit risk should economic

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conditions change over the course of a loan’s life. For example, the Bank 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. The Company has determined that there is no concentration of credit risk associated with its lending policies or practices. Most of our business activity is with customers located within the markets where we have banking operations. Therefore, our exposure to credit risk is significantly affected by changes in the economy within our markets. Approximately 88% of our loan portfolio is secured by real estate and is therefore susceptible to changes in real estate valuations.

Nonperforming Assets

NPAs include nonaccrual loans, TDRs, loans past due 90 or more days and still accruing interest, and foreclosed properties. Nonaccrual loans are loans on which interest income is no longer being recognized or accrued because management has determined that the collection of interest is doubtful. Placing loans on nonaccrual status negatively impacts earnings because (i) interest accrued but unpaid as of the date a loan is placed on nonaccrual status is reversed and deducted from interest income, (ii) future accruals of interest income are not recognized until it becomes probable that both principal and interest will be paid, and (iii) principal charged-off, if appropriate, may necessitate additional provisions for loan losses that are charged against earnings. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms.

The following table summarizes our NPAs at the dates indicated.

As a matter of policy, we generally place all loans that are past due 90 or more days on nonaccrual basis. The amount in this category at December 31, 2021 is related to two loans acquired from Select, one of which was renewed and the other of which was placed on nonaccrual in January 2022.

The increase in nonperforming loans in 2020 was driven by our SBA loan portfolio and the impact of the pandemic, as many of the delinquent SBA loans which did not qualify for the SBA's relief payment plan defaulted for both pandemic and other reasons and were transferred to nonaccrual status. The $5.6 million increase in NPAs in 2021 was a direct result of the Select acquisition. While the balance of NPAs increased, our asset quality ratios improved in 2021 overall relative to the increased loan portfolio, and we continue to see improving trends in asset quality. Our total nonperforming loans to total loans declined 12 basis points to 0.82% at December 31, 2021, while our total NPA ratio decreased 14 basis points to 0.50% at December 31, 2021. Additional discussion of the credit quality classification status of our loans is contained in Note 4 to our consolidated financial statements.

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As of December 31, 2021, SBA loans accounted for approximately $16.8 million of our nonaccrual loans, or 9.8%, of the total non-PPP SBA portfolio, compared to $18.4 million, or 10.8%, of the non-PPP SBA portfolio at December 31, 2020. We continue to closely monitor the SBA loan portfolio and give it appropriate consideration when evaluating the adequacy of the ACL as those loans are generally considered inherently more risky than other loans in out portfolio. Refer to additional discussion of the ACL below.

As shown in Note 4 to the consolidated financial statements, our accruing past due loans (30 or more days) have declined $6.3 million to total $16.0 million at December 31, 2021, which is generally reflective of the improved economic conditions experienced during 2021. We had no loans in COVID-19 payment-deferral status as of year end.

We classify loans as “special mention” when there is a defined weakness or weaknesses that jeopardize the repayment by the borrower and there is a distinct possibility that we could sustain some loss if the deficiency is not corrected. Performing special mention loans, which are still accruing interest, totaled $43.1million and $61.3 million as of December 31, 2021 and 2020, respectively. In addition, loans that are in the risk category of "classified" which are still accruing interest totaled $21.3 million at December 31, 2021 and $25.4 million at December 31, 2020. These loans have a great risk of further deterioration and potential loss to the Bank.

Foreclosed properties includes primarily foreclosed real estate. Total foreclosed real estate amounted to $3.1 million at December 31, 2021, up from $2.4 million in 2020. The increase is related to two properties added with the Select acquisition. We continue to see active real estate markets and steady activity for sales of foreclosed properties.

Allowance for Credit Losses and Loan Loss Experience

The total allowance for credit losses amounted to $78.8 million at December 31, 2021 compared to $52.4 million at December 31, 2020. The increase was driven by (1) the initial $14.6 million ACL recorded at adoption of the CECL and (2) the initial "Day 2" provision for loan losses on Select acquired non-PCD loans of $14.1 million. In addition, there was $4.9 million "Day 1" ACL which we reclassified from credit fair value mark to ACL on the Select's acquired PCD loans.

As previously discuss in "Critical Accounting Policies and Estimates", we adopted CECL effective January 1, 2021. The ACL reflects our estimate of life of loan expected credit losses that will result from the inability of our borrowers to make required loan payments. We established the incremental increase in the ACL at adoption date through equity and subsequently record amounts needed to adjust the ACL for our current estimate of expected credit losses through a provision for credit losses charged to earnings. We record loans charged off against the ACL in the period in which such loans, in management's opinion, become uncollectible. Subsequent recoveries, if any, increase the ACL when they are recognized.

We use systematic methodologies to determine the ACL for loans and the allowance for certain off-balance-sheet credit exposures. The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loan portfolio. The allowance for unfunded commitments represents expected losses on unfunded loan commitments that are expected to result in outstanding loan balances and is included in other liabilities in the the consolidated balance sheets.

We consider the effects of past events, current conditions, and reasonable and supportable forecasts on the collectability of the loan portfolio. Our estimate of the ACL involves a high degree of judgment. Therefore, the process for determining expected credit losses may result in a range of expected credit losses. The ACL is calculated using collectively evaluated pools for loans with similar risk characteristics applying the DCF method. When a loan no longer shares similar risk characteristics with its segment, the loan is evaluated on an individual basis applying a DCF or asset approach for collateral-dependent loans. Refer to Note 1 of the consolidated financial statements for a discussion of our CECL methodology used to determine the ACL and allowance for unfunded commitments.

Our assessment of the ACL involves uncertainty and judgment and is subject to change in future periods. The amount of any changes could be significant if the assessment of loan quality or collateral values changes substantially with respect to one or more loan relationships or portfolios or if there is a significant change in the reasonable and supportable forecast used to model our expected credit losses. The allocation of the ACL is based on reasonable and supportable forecasts, historical data, subjective judgment, and estimates and therefore, may not be predictive of the specific amounts or loan categories in which charge-offs may ultimately occur. In addition,

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bank regulatory authorities, as part of their periodic examination of the Bank, may require adjustments to the provision for loan losses in future periods if, in their opinion, the results of their review warrant such additions.

We strive to maintain our loan portfolio in accordance with what management believes are conservative loan underwriting policies that result in loans specifically tailored to the needs of our market areas. Every effort is made to identify and minimize the credit risks associated with such lending strategies. We have no foreign loans, few agricultural loans, and we do not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of loans captioned in the Loan Portfolio Composition table in the above "Loans" section as “real estate” loans are personal and commercial loans where cash flow from the borrower’s occupation or business is the primary repayment source, with the real estate pledged providing a secondary repayment source. Collateral for the majority of these loans is located within our principal market area.

The following table sets forth the allocation of the allowance for loan losses by loan category at the dates indicated. However, the allowance for loan losses is available to absorb losses in all categories.

For the years indicated, the following table summarized our net loss experience by loan category and key ratios demonstrating the asset quality trends over the most recent five years.

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n/m – not meaningful

Net loan charge-offs amounted to $2.7 million in 2021, a decline from $4.0 million in 2020 which is indicative of the improving economic environment. In 2021, we recorded $2.5 million of charge-offs within our SBA loan portfolio, which were in the "commercial, financial, and agricultural" and "real estate - mortgage - commercial" categories and which accounted for 93% of our total net charge-offs for the year. The SBA loan portfolio recorded net charge-offs in 2020 of $3.2 million, or nearly 80% of total net charge-offs for that year.

The ACL to total loans ratio increased to 1.30% in 2021 from 1.11% as of the prior year end related to the implementation of CECL and the initial provision for the Select acquisition as previously discussed.

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Securities

Our securities portfolio totaled $3.1 billion at December 31, 2021, compared to $1.6 billion at December 31, 2020.

AFS securities were $2.6 billion at December 31, 2021, compared to $1.5 billion at December 31, 2020. HTM securities were $513.8 million at December 31, 2021, compared to $167.6 million at December 31, 2020.

The composition of the investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits. All of our mortgage-backed securities, which include both securities AFS and HTM securities, are issued by GSEs or GNMA, and are traded in liquid secondary markets. These securities are recorded on the balance sheet at fair value for the AFS portfolio and at cost for the HTM portfolio.

The increase in securities in each year presented was directly related to the significant increase in deposits generating liquidity in excess of levels needed to fund new loan originations. The excess cash balances were deployed into fixed rate securities so that we could realize higher yields.

The table below presents the composition, tax equivalent yields, and remaining maturities of our securities as of December 31, 2021. For more information about these securities, including gross unrealized gains and losses by type of security and securities pledged, see Note 3 to the consolidated financial statements.

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(1)Mortgage-backed securities are shown maturing in the periods consistent with their estimated lives based on expected prepayment speeds.

(2)Yields on tax-exempt investments have been adjusted to a taxable equivalent basis using a 23% tax rate.

The majority of our GSE securities carry one maturity date, often with an issuer call feature. At December 31, 2021, of the $69.2 million in AFS GSE securities, $38.8 million were issued by the FFCS, $28.5 million were issued by the FHLMC, and the remaining $1.9 million were issued by the FHLB.

Nearly all of our $2.5 billion in AFS mortgage-backed securities at December 31, 2021 were issued by the FHLMC, FNMA, GNMA, or the SBA, each of which is a government agency or government-sponsored corporation and guarantees the repayment of the securities. Included in this total are commercial mortgage-backed securities of $937.6 million. Mortgage-backed securities vary in their repayment in correlation with the underlying pools of mortgage loans.

At December 31, 2021, we held $513.8 million in securities classified as HTM, which are carried at amortized cost. These securities had fair values that were lower than their carrying values by $2.1 million at December 31, 2021. Approximately $20.2 million of the securities held to maturity are mortgage-backed securities that have been issued by either the FHLMC or FNMA. The remaining $493.6 million in securities HTM are comprised almost entirely of highly-rated municipal bonds issued by state and local governments throughout the nation. We have no significant concentration of bond holdings from one state or local government entity, with the single largest exposure to any one entity being $9.5 million. We have evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates, not by concerns about the ability of the issuers to meet their obligations.

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Deposits

Deposits represent the primary funding source for our loans and investments. Total deposits amounted to $9.1 billion at December 31, 2021, an increase of $2.9 billion, or 45.4%, from December 31, 2020. Deposit growth for the year was as follows:

Our high core deposit growth in 2021, which has continued from 2020, is believed to be due to a combination of stimulus funds and deposits arising from PPP loans, changes in customer behaviors during the pandemic, a flight to quality to FDIC-insured banks, as well as our ongoing deposit growth initiatives. We routinely engage in activities designed to grow and retain deposits, such as (1) emphasizing relationship banking to new and existing customers, where borrowers are encouraged and normally expected to maintain deposit accounts with us, (2) pricing deposits at rate levels that will attract and/or retain deposits, and (3) continually working to identify and introduce new products that will attract customers or enhance our appeal as a primary provider of financial services.

The following table presents summary of the deposit balances and mix at each of the past five year ends.

Our deposit mix continues a trend of being more heavily concentrated in transaction and non-time deposit accounts, with time deposits declining from 21% of total deposits at December 31, 2018, to 10% at December 31, 2021. This is beneficial for us, as non-time deposit accounts generally carry lower interest rates compared to time deposits and allows us to reprice these deposit categories at any time. We believe that the shift in mix from time deposits has been due in part to the relatively small gap between the interest rates that we pay on transaction accounts versus the rates we pay on time deposits. As demonstrated in the table below, the majority of our time deposits greater than $100,000 mature within one year, with 50% maturing within the next six months.

As a result of the strong retail deposit growth in 2020, we were able to reduce our level of brokered deposits during the year by $65.9 million, a decrease of 76.5%. Broker deposits were reduced a further $12.8 million in 2021.

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As of December 31, 2021, we held approximately $3.4 billion in uninsured deposits, including $224.6 million of uninsured time deposits.

The table below presents maturities of time deposits of $100,000 or more, and maturities of uninsured time deposits of more than $250,000 as of December 31, 2021.

At each of the past three year ends, we had no deposits issued through foreign offices, nor do we believe that we held any deposits by foreign depositors.

Borrowings

We typically utilize borrowings to provide balance sheet liquidity and to fund imbalances in our loan growth compared to our deposit growth. Total borrowings at December 31, 2021 increased $5.6 million since the prior year end. Select had $12.4 million of borrowings as of the acquisition date. During 2021, FHLB advances decreased $5.7 million through scheduled payments and the early repayment of one advance. Our borrowings outstanding are as follows:

As noted in the table above, at December 31, 2021, we had $69.1 million of borrowings structured as trust preferred capital securities which qualify as capital for regulatory capital adequacy requirements. The Company issued $46.4 million of these securities, $10.3 million was assumed from our acquisition of Carolina Bank, and $12.4 million was assumed from our acquisition of Select.

At December 31, 2021, the Company had three sources of readily available borrowing capacity:

•A line of credit with the FHLB of approximately $866 million which can structured as either short-term or long-term borrowings, depending on the particular funding or liquidity need, and is secured by our FHLB stock and a blanket lien on most of our real estate loan portfolio.

•A $100 million federal funds line of credit with a correspondent bank which provides for overnight unsecured federal funds purchased.

•A line of credit with the Federal Reserve of approximately $138 million which is secured by a blanket lien on a portion of our commercial and consumer loan portfolio (excluding real estate loans).

Refer to Note 9 to the consolidated financial statements for additional discussion of our borrowings.

Liquidity, Commitments, and Contingencies

Our liquidity is determined by our ability to convert assets to cash or to acquire alternative sources of funds to meet the needs of our customers who are withdrawing or borrowing funds, and our ability to maintain required reserve levels, pay expenses, and operate the Company on an ongoing basis. Our primary liquidity sources are net income from operations, cash and due from banks, federal funds sold, and other short-term investments. Our securities

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portfolio is comprised almost entirely of readily marketable securities which could also be sold to provide cash. In addition, we have available lines of credit from the FHLB and Federal Reserve.

Our overall liquidity started increasing in 2020 and continued into 2021 due to significant and continued deposit growth that outpaced our loan growth. Our liquid assets (cash and AFS securities) as a percentage of our total deposits and borrowings amounted to 33.6% at December 31, 2021.

We continue to believe our liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet our operating needs in the foreseeable future. We will continue to monitor our liquidity position carefully and will explore and implement strategies to increase liquidity if deemed appropriate.

In the normal course of business we have various outstanding contractual obligations that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows.

Presented below is a summary of our contractual obligations and other commercial commitments outstanding as of December 31, 2021.

In the normal course of business there are various outstanding commitments and contingent liabilities such as commitments to extend credit, which are not reflected in the financial statements.

As presented in the table above, at December 31, 2021, we had $21.3 million in standby letters of credit outstanding. We had no carrying amount for these standby letters of credit. The nature of standby letters of credit is that of a stand-alone obligation made on behalf of our customers to suppliers of the customers to guarantee payments owed to the supplier by the customer. The standby letters of credit are generally for terms of one year, at which time they may be renewed for another year if both parties agree. The payment of the guarantees would generally be triggered by a continued nonpayment of an obligation owed by the customer to the supplier. The maximum potential amount of future payments (undiscounted) we could be required to make under the guarantees in the event of nonperformance by the parties to whom credit or financial guarantees have been extended is represented by the contractual amount of the financial instruments discussed above. In the event that we are required to honor a standby letter of credit, a note, already executed by the customer, becomes effective providing repayment terms and any collateral. Over the past several years, we have had to honor only a few standby letters of

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credit, none of which resulted in any loss to the Company. We expect any draws under existing commitments to be funded through normal operations.

It has been our experience that deposit withdrawals are generally able to be replaced with new deposits when needed. Based on that assumption, management believes that it can meet its contractual cash obligations and existing commitments from normal operations.

Capital Resources and Shareholders’ Equity

Shareholders’ equity at December 31, 2021 amounted to $1.2 billion compared to $893.4 million at December 31, 2020. The two basic components that typically have the largest impact on our shareholders’ equity are net income, which increases shareholders’ equity, and dividends declared, which decrease shareholders’ equity. Additionally, any stock issuances can significantly increase shareholders’ equity, including those associated with acquisitions, and any stock repurchases reduce shareholders’ equity.

In 2021, the most significant factors that impacted our shareholders' equity were (1) the issuance of stock totaling $324.4 million in the Select acquisition which increased equity; (2) $95.6 million net income reported for 2021, which increased equity, (3) common stock dividends declared of $24.2 million, which reduced equity, and (4) other comprehensive loss of $39.3 million driven by unrealized losses on AFS securities which decreased equity. See the consolidated statements of shareholders’ equity within the consolidated financial statements for disclosure of other less significant items affecting shareholders’ equity.

As discussed in “Borrowings” above, we also currently have $69.1 million in trust preferred securities outstanding, all of which qualify as Tier I capital under regulatory standards.

We are not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on our liquidity, capital resources, or operations.

The Company and the Bank must comply with regulatory capital requirements established by the Federal Reserve and the Commissioner. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our financial statements.

The primary source of funds for the payment of dividends by the Company is dividends received from its subsidiary, the Bank. The Bank, as a North Carolina banking corporation, may declare dividends so long as such dividends do not reduce its capital below its applicable required capital (typically, the level of capital required to be deemed “adequately capitalized”). As of December 31, 2021, approximately $894.4 million of the Company’s investment in the Bank is restricted as to transfer to the Company without obtaining prior regulatory approval.

Our regulatory capital ratios as of December 31, 2021, 2020, and 2019 are presented in the table below. All of our capital ratios significantly exceeded the minimum regulatory thresholds for all periods presented.

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Our goal is to maintain our capital ratios at levels at least 200 basis points higher than the regulatory “well capitalized” thresholds set for banks. At December 31, 2021, our leverage ratio was 9.39% compared to the regulatory well capitalized bank-level threshold of 4.00% and our total risk-based capital ratio was 14.67% compared to the 10.50% regulatory well capitalized threshold. The reduction in our capital ratios in 2021 from the prior year end is directly related to the Select acquisition and the high balance sheet growth rate experienced in 2021.

In addition to regulatory capital ratios, we also closely monitor our ratio of TCE to tangible assets. This ratio was 8.38% at December 31, 2021 compared to 9.08% at December 31, 2020, with the decline of 70 basis points related to the significant asset growth that was a result of high deposit growth and the Select acquisition.

See “Supervision and Regulation” under “Business” in Item 1. and Note 15 to the consolidated financial statements for discussion of other matters that may affect our capital resources.

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Off-Balance Sheet Arrangements and Derivative Financial Instruments

Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements pursuant to which we have obligations or provide guarantees on behalf of an unconsolidated entity. We have no off-balance sheet arrangements of this kind other than letters of credit and repayment guarantees associated with our trust preferred securities.

Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivatives activities through December 31, 2021 and have no current plans to do so.

Interest Rate Risk (Including Quantitative and Qualitative Disclosures About Market Risk – Item 7A.)

Net interest income is our most significant component of earnings and we consider interest rate risk to be our most significant market risk. In addition to changes in volumes of loans and deposits, our level of net interest income is continually at risk due to the effect that changes in general market interest rate trends have on interest yields earned and paid with respect to our various categories of earning assets and interest-bearing liabilities. It is our policy to maintain portfolios of earning assets and interest-bearing liabilities with maturities and repricing opportunities that will afford protection, to the extent practical, against wide interest rate fluctuations.

Our exposure to interest rate risk is analyzed on a regular basis by management using standard "gap" reports (which measure the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period), maturity reports, and an asset/liability software model that simulates future levels of interest income and expense based on current interest rates, expected future interest rates, and various intervals of “shock” interest rates. Over the years, we have been able to maintain a fairly consistent yield on average earning assets (NIM), even during periods of changing interest rates. Over the past five years, our NIM has ranged from a low of 3.16% (realized in 2021) to a high of 4.09% (realized in 2018). The 93 basis point reduction in NIM between the high and low point during this period was a direct result of the Federal Reserve monetary policy enacted at the beginning of the COVID-19 pandemic resulting in a reduction in short-term market interest rates totaling 150 basis points in March 2020.

The following table sets forth our interest rate sensitivity analysis based on a gap analysis as of December 31, 2021, using stated maturities for all fixed rate instruments except mortgage-backed securities (which are allocated in the periods of their expected payback) and securities and borrowings with call features that are expected to be called (which are shown in the period of their expected call).

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As illustrated above, at December 31, 2021, we had $2.8 billion more in interest-bearing liabilities that are subject to interest rate changes within one year than earning assets. This generally would indicate that net interest income would experience downward pressure in a rising interest rate environment and would benefit from a declining interest rate environment. However, this method of analyzing interest rate sensitivity only measures the magnitude of the timing differences and does not address earnings, market value, or management actions. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. In addition to the effects of “when” various rate-sensitive products reprice, market rate changes may not result in uniform changes in rates among all products. For example, included in interest-bearing liabilities subject to interest rate changes within one year at December 31, 2021 were deposits totaling $4.9 billion comprised of checking, savings, and certain types of money market deposits with interest rates set by management. These types of deposits historically have not repriced with, or in the same proportion, as general market indicators.

Generally, when rates change, our interest-sensitive assets that are subject to adjustment reprice immediately at the full amount of the change, while our interest-sensitive liabilities that are subject to adjustment reprice at a lag to the rate change and typically not to the full extent of the rate change. In the short-term (less than 12 months), this generally results in the Bank being asset-sensitive, meaning that our net interest income benefits from an increase in interest rates and is negatively impacted by a decrease in interest rates, which is what we experienced following

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the March 2020 interest rate cuts. The acquisition of Select did not change our interest-rate sensitivity position or outlook as Select's and our balance sheets were similarly structured.

Because of the static nature and limitations as discussed above of the gap report, we also employ an earnings simulation model to analyze the sensitivity of net interest income to movements in interest rates. The model is based on actual cash flows and repricing characteristics for on- and off-balance sheet instruments and incorporates market-based assumptions regarding the impact of changing interest rates on the prepayment rate of certain assets and liabilities. Earnings-simulation analysis captures not only the potential of these interest sensitive assets and liabilities to mature or reprice, but also the probability that they will do so. Moreover, earnings-simulation analysis considers the relative sensitivities of these balance sheet items and projects their behavior over an extended period of time. The following table presents the Company-estimated net interest income sensitivity as of December 31, 2021. These results assume a static balance sheet and an immediate, sustained 100 or 200 basis point upward and downward shock to the yield curve. While it is unlikely market rates would immediately move 100 or 200 basis points upward or downward on a sustained basis, this is another tool used by management and the Board of Directors to gauge interest rate risk.

The general discussion above applies most directly in a “normal” interest rate environment in which longer-term maturity instruments carry higher interest rates than short-term maturity instruments, and is less applicable in periods in which there is a “flat” interest rate curve. A “flat yield curve” means that short-term interest rates are substantially the same as long-term interest rates. Due to actions taken by the Federal Reserve related to short-term interest rates and the impact of the global economy on longer-term interest rates, we are currently in a very low and flat interest rate curve environment. A flat interest rate curve is an unfavorable interest rate environment for many banks, including the Bank, as short-term interest rates generally drive our deposit pricing and longer-term interest rates generally drive loan pricing. When these rates converge, the profit spread we realize between loan yields and deposit rates narrows, which pressures our net interest margin.

As indicated in the table above, assuming some increase in interest rates in the next 12 months, we may see some benefit to our NIM from raising rates if we are able to maintain stable funding costs. Our experience historically has been that our demand deposit accounts have lagged the timing and amount of general market increases. However, we expect continued pressure on NIM from market competition for quality loans and the investment of liquidity in lower earning assets until loan demand increases sufficiently to deploy excess liquidity from short-term investments and securities.

We have no market risk sensitive instruments held for trading purposes, nor do we maintain any foreign currency positions. Our assets and liabilities have estimated fair values that do not materially differ from their carrying amounts.

See additional discussion regarding net interest income, as well as discussion of the changes in the annual net interest margin, in the section entitled “Net Interest Income” above.

Inflation

Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed, determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation as discussed above under Interest Rate Risk. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plant and inventories. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits. Also, general increases in the price of goods and services will result in increased operating expenses.

Current Accounting Matters

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We prepare our consolidated financial statements and related disclosures in conformity with standards established by, among others, the FASB. Because the information needed by users of financial reports is dynamic, the FASB frequently issues new rules and proposes new rules for companies to apply in reporting their activities. See Note 1 to our consolidated financial statements for a discussion of recent rule proposals and changes.

Selected Consolidated Financial Data

The following tables present certain selected consolidated financial data and quarterly financial data for additional information and trend analysis.

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