Organization and Summary of Significant Accounting Policies

Basis of Financial Statement Presentation

Basis of Financial Statement Presentation. The consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America and general practices within the banking industry. In the normal course of business, the Company encounters two significant types of risk: economic and regulatory. Economic risk is comprised of interest rate risk, credit risk, and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities reprice on a different basis than its interest-earning assets. Credit risk is the risk of default on the Company’s investment or loan portfolios resulting from the borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of the investment portfolio, collateral underlying loans receivable, and the value of the Company’s investments in real estate.

Use of Estimates. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

On July 1, 2020, the Company adopted ASU 2016-13, Financial Instruments – Credit Losses, also known as the current expected credit loss (“CECL”) standard, which created material changes to the existing critical accounting policy that existed at June 30, 2020. Effective July 1, 2020, the significant accounting policy which was considered to be the most critical in preparing the Company’s consolidated financial statements is the determination of the allowance for credit losses (“ACL”) on loans.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for credit losses, and estimated fair values of purchased loans.

Interest-bearing Time Deposits

Interest-bearing Time Deposits. Interest-bearing deposits in banks mature within seven years and are carried at cost.

Federal Reserve Bank and Federal Home Loan Bank Stock

Federal Reserve Bank and Federal Home Loan Bank Stock. The Bank is a member of the Federal Reserve and the Federal Home Loan Bank (FHLB) systems. Capital stock of the Federal Reserve and the FHLB is a required investment based upon a predetermined formula and is carried at cost.

Off-Balance Sheet Credit Exposures

Off-Balance Sheet Credit Exposures. Off-balance sheet credit instruments include 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 non-performance 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 ACL on off-balance sheet credit exposures is estimated by loan pool on a quarterly basis under the current CECL model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur and is included in other liabilities on the Company’s consolidated balance sheets. The Company records an ACL on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable. In prior periods the charge for credit loss expense for off-balance sheet credit exposures was included in other non-interest

expense in the Company’s consolidated statements of income, whereas under updated regulatory accounting guidelines, that figure is combined with the provision for credit losses beginning July 1, 2020.

Premises and Equipment

Premises and Equipment. Premises and equipment are stated at cost less accumulated depreciation and include expenditures for major betterments and renewals. Maintenance, repairs, and minor renewals are expensed as incurred. When property is retired or sold, the retired asset and related accumulated depreciation are removed from the accounts and the resulting gain or loss taken into income. The Company reviews property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment loss recognized is measured by the amount by which the carrying amount exceeds the fair value of the assets.

Depreciation is computed by use of straight-line and accelerated methods over the estimated useful lives of the assets. Estimated lives are generally seven to forty years for premises, three to seven years for equipment, and three years for software.

Intangible Assets

Intangible Assets. The Company’s intangible assets at June 30, 2021 included gross core deposit intangibles of $15.3 million with $10.1 million accumulated amortization, gross other identifiable intangibles of $3.8 million with accumulated amortization of $3.8 million, and mortgage servicing rights of $1.9 million. At June 30, 2020, the Company’s intangible assets included gross core deposit intangibles of $15.3 million with $8.7 million accumulated amortization, gross other identifiable intangibles of $3.8 million with accumulated amortization of $3.8 million, and mortgage servicing rights of $1.1 million. The Company’s core deposit intangible assets are being amortized using the straight line method, over periods ranging from five to seven years, with amortization expense expected to be approximately $1.4 million in fiscal 2022, $1.4 million in fiscal 2023, $1.4 million in fiscal 2024, $807,000 in fiscal 2025, $328,000 in fiscal 2026, and none thereafter. As of June 30, 2021, and June 30, 2020, there was no impairment indicated.

Income Taxes

Income Taxes. The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying

the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to the management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

The Company recognizes interest and penalties on income taxes as a component of income tax expense.

The Company files consolidated income tax returns with its subsidiaries, the Bank and SB Real Estate Investments, LLC, with a tax year ended June 30. Southern Bank Real Estate Investments, LLC files a separate REIT return for federal tax purposes, and also files state income tax returns with a tax year ended December 31.

Outside Directors' Retirement

Outside Directors’ Retirement. The Bank adopted a directors’ retirement plan in April 1994 for outside directors. The directors’ retirement plan provides that each non-employee director (participant) shall receive, upon termination of service on the Board on or after age 60, other than termination for cause, a benefit in equal annual installments over a five year period. The benefit will be based upon the product of the participant’s vesting percentage and the total Board fees paid to the participant during the calendar year preceding termination of service on the Board. The vesting percentage shall be determined based upon the participant’s years of service on the Board, whether before or after the reorganization date.

In the event that the participant dies before collecting any or all of the benefits, the Bank shall pay the participant’s beneficiary. No benefits shall be payable to anyone other than the beneficiary, and shall terminate on the death of the beneficiary.

Earnings Per Share

Earnings Per Share. Basic earnings per share available to common stockholders is computed using the weighted-average number of common shares outstanding. Diluted earnings per share available to common stockholders includes the effect of all weighted-average dilutive potential common shares outstanding during each year.

Transfers Between Fair Value Hierarchy Levels

Transfers Between Fair Value Hierarchy Levels. Transfers in and out of Level 1 (quoted market prices), Level 2 (other significant observable inputs) and Level 3 (significant unobservable inputs) are recognized on the period ending date.

New Accounting Pronouncements

The following paragraphs summarize the impact of new accounting pronouncements:

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, with early adoption permitted for certain removed and modified disclosures. Adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which the Company adopted July 1, 2020. The Update amended guidance on reporting credit losses for financial assets held at amortized cost basis and available for sale debt securities. For financial assets held at amortized cost basis, Topic 326 eliminated the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The Update affects loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, and any other financial assets not excluded from the scope that have the contractual right to receive cash. Adoption was applied on a modified retrospective basis, through a cumulative-effect adjustment to retained earnings. Adoption resulted in an increase to the ACL of $8.9 million, related to the transition from the incurred loss model to the CECL ACL model, and an increase of $434,000 related to the transition from PCI to PCD methodology, relative to the ALLL as of June 30, 2020. The Company also recorded an adjustment to the reserve for unfunded commitments recorded in other liabilities of $268,000. The impact at adoption was reflected as an adjustment to beginning retained earnings, net of income taxes, in the amount of $7.2 million. In accordance with the new standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. The adoption of ASU 2016-13 in fiscal 2021 could also impact the Company’s future earnings, perhaps materially

The following table illustrates the impact of adoption of ASU 2016-13:


	July 1, 2020
	As reported		As reported		Impact of
	under		prior to		adoption
(dollars in thousands)	ASU 2016-13		ASU 2016-13		ASU 2016-13

Loans receivable	$	2,142,363	$	2,141,929	$	434
Allowance for credit losses on loans:
Real Estate Loans:
Residential		8,396		4,875		3,521
Construction		1,889		2,010		(121)
Commercial		15,988		12,132		3,856
Consumer loans		2,247		1,182		1,065
Commercial loans		5,952		4,940		1,012
Total allowance for credit losses on loans	$	34,472	$	25,139	$	9,333
Total allowance for credit losses on off-balance sheet credit exposures	$	2,227	$	1,959	$	268

The above table includes the impact of ASU 2016-13 adoption for PCD assets previously classified as PCI. The change in the ACL includes $434,000 attributable to residential and commercial real estate loans, and the amortized cost basis of loans receivable was increased for those loans by that total amount.

In March 2020, the CARES Act was signed into law, creating a forbearance program for federally backed mortgage loans, protects borrowers from negative credit reporting due to loan accommodations related to the National Emergency, and provides financial institutions the option to temporarily suspend certain requirements under U.S. GAAP related to troubled debt restructurings (TDR) for a limited period of time to account for the effects of COVID-19. The Company has elected to not apply ASC Subtopic 310-40 for loans eligible under the CARES Act, based on the modification’s (1) relation to COVID-19, (2) execution for a loan that was not more than 30-days past due as of December 31, 2019, and (3) execution between March 1, 2020, and the earlier of the date that falls 60 days following the termination of the declared National Emergency, or December 31, 2020. The 2021 Consolidated Appropriations Act, signed into law in December 2020, extended the window during which loans may be modified without classification as TDRs under ASC Subtopic 310-40, to the earlier of January 1, 2022, or 60 days following the termination of the declared National Emergency.

Credit losses recognized on investments

401(k) Retirement Plan

401(k) Retirement Plan. The Bank has a 401(k) retirement plan that covers substantially all eligible employees. The Bank makes “safe harbor” matching contributions of up to 4% of eligible compensation, depending upon the percentage of eligible pay deferred into the plan by the employee. Additional profit-sharing contributions of 5% of eligible salary have been accrued for the plan year ended June 30, 2021, which the board of directors authorizes based on management recommendations and financial performance for fiscal 2021. Total 401(k) expense for fiscal 2021, 2020, and 2019, $1.7 million, $1.5 million, and $1.3 million, respectively. At June 30, 2021, 401(k) plan participants held approximately 394,000 shares of the Company’s stock in the plan. Employee deferrals and safe harbor contributions are fully vested. Profit-sharing or other contributions vest over a period of five years.

2008 Equity Incentive Plan. The Company adopted an Equity Incentive Plan (the EIP) in 2008, reserving for award 132,000 shares (split-adjusted). EIP shares were available for award to directors, officers, and employees of the Company and its affiliates by a committee of outside directors. The committee held the power to set vesting requirements for each award under the EIP. At the 2017 annual meeting, shareholders approved the 2017 Omnibus Incentive Plan, which provided that no further awards would be made under the EIP. From fiscal 2012 through fiscal 2017, the Company awarded 122,803 shares, and no awards were made under the plan since fiscal 2017. All EIP awards were in the form of either restricted stock vesting at the rate of 20% of such shares per year, or performance-based restricted stock vesting at up to of 20% of such shares per year, contingent on the achievement of specified profitability targets over a three-year period. During fiscal 2021, 2020, and 2019, there were 2,700, 2,825, and 7,100 EIP shares (split-adjusted) vested each year, respectively. Compensation expense, in the amount of the fair market value of the common stock at the date of grant, is recognized pro-rata over the five years during which the shares vest. The EIP

expense for fiscal 2021, 2020, and 2019 was $84,000, $88,000, and $141,000, respectively. At June 30, 2021, unvested compensation expense related to the EIP was approximately $51,000.

2003 Stock Option Plan. The Company adopted a stock option plan in October 2003 (the 2003 Plan). Under the plan, the Company granted options to purchase 242,000 shares (split-adjusted) to employees and directors, of which, options to purchase 187,000 shares (split-adjusted) have been exercised, options to purchase 45,000 shares (split-adjusted) have been forfeited, and 10,000 remain outstanding. Under the 2003 Plan, exercised options may be issued from either authorized but unissued shares, or treasury shares. At the 2017 annual meeting, shareholders approved the 2017 Omnibus Incentive Plan, which provided that no further awards would be made under the 2003 Plan.

As of June 30, 2021, there was no remaining unrecognized compensation expense related to unvested stock options under the 2003 Plan. The aggregate intrinsic value of stock options outstanding, all of which were exercisable, at June 30, 2021, was $274,000. During fiscal 2020, options to purchase 10,000 shares were exercised; no options to purchase shares were exercised in fiscal 2021 or 2019. The intrinsic value of options vested in fiscal 2020 and 2019 was $14,000, and $35,000, respectively, and no options vested in fiscal 2021.

2017 Omnibus Incentive Plan. The Company adopted an equity-based incentive plan in October 2017 (the 2017 Plan). Under the 2017 plan, the Company reserved for issuance 500,000 shares of common stock for awards to employees and directors, against which full value awards (stock-based awards other than stock options and stock appreciation rights) are to be counted on a 2.5-for-1 basis. The 2017 Plan authorized awards to be made to employees, officers, and directors by a committee of outside directors. The committee held the power to set vesting requirements for each award under the 2017 Plan. Under the 2017 Plan, stock awards and shares issued pursuant to exercised options may be issued from either authorized but unissued shares, or treasury shares.

Under the 2017 Plan, options to purchase 79,500 shares have been issued to employees, of which none have been exercised or forfeited, and 79,500 remain outstanding. As of June 30, 2021, there was $489,000 in remaining unrecognized compensation expense related to unvested stock options under the 2017 Plan, which will be recognized over the remaining weighted average vesting period. The aggregate intrinsic value of in-the-money stock options outstanding under the 2017 Plan at June 30, 2021, was $728,000, and no options were exercisable at June 30, 2021, at a strike price in excess of the market price. The intrinsic value of options vested in fiscal 2021 was $87,000. No in-the-money options were vested in fiscal 2020 or 2019.

Full value awards totaling 18,925, 15,525, and 15,000 shares, respectively, were issued to employees and directors in fiscal 2021, 2020, and 2019. All full value awards were in the form of either restricted stock vesting at the rate of 20% of such shares per year, or performance-based restricted stock vesting at up to 20% of such shares per year, contingent on the achievement of specified profitability targets over a three-year period. During fiscal 2021, 2020, and 2019, full value awards of 9,770, 7,080 and 4,200 shares were vested, respectively. Compensation expense, in the amount of the fair market value of the common stock at the date of grant, is recognized pro-rata over the five years during which the shares vest. Compensation expense for full value awards under the 2017 Plan for fiscal 2021, 2020, and 2019 was $351,000, $293,000, and $189,000, respectively. At June 30, 2021, unvested compensation expense related to full value awards under the 2017 Plan was approximately $1.5 million.

Changes in options outstanding under the 2003 Plan and the 2017 Plan were as follows:

Standby Letters of Credit

Standby Letters of Credit. In the normal course of business, the Company issues various financial standby, performance standby, and commercial letters of credit for its customers. As consideration for the letters of credit, the institution charges letter of credit fees based on the face amount of the letters and the creditworthiness of the counterparties. These letters of credit are standalone agreements, and are unrelated to any obligation the depositor has to the Company.

Standby letters of credit are irrevocable conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers.

The Company had total outstanding standby letters of credit amounting to $4.0 million at June 30, 2021, and $3.2 million at June 30, 2020, with terms ranging from 12 to 24 months. At June 30, 2021, the Company’s deferred revenue under standby letters of credit agreements was nominal.