BayFirst Financial Corp.: Form 10-K for the period ended Dec 31, 2022

BayFirst Financial Corp. (“BayFirst” or the “Company”) is a bank holding company that operates through its wholly owned subsidiary, BayFirst National Bank (the “Bank”). BayFirst commenced its bank holding company operations on September 1, 2000, by acquiring all shares of the Bank. BayFirst’s primary source of income is from the Bank, which serves a broad spectrum of consumers and small businesses in the Tampa Bay region and is supported by a national SBA lending business line. BayFirst utilizes this national business line to provide financial support for the delivery and expansion of traditional banking services, and to serve as a specialized lead product to introduce the Bank to new customers in the Tampa Bay region. BayFirst strives to be a progressive institution in its products and services, technology, design, and social responsibility. As of December 31, 2022, BayFirst had consolidated total assets of $938.9 million, total loans of $728.7 million, total deposits of $795.1 million, and total shareholders’ equity of $91.9 million. BayFirst’s corporate office is located at the BayFirst Executive Center, 700 Central Avenue, St. Petersburg, Florida 33701.

BayFirst National Bank

The Bank commenced operations on February 12, 1999, as a Florida state-chartered commercial bank. In 2022, the Bank converted its charter to a national banking association. The Bank currently operates out of its main office and eight additional banking centers located in the Tampa Bay area, and 1 loan production office in Sarasota. The Bank’s main office is located at the BayFirst Executive Center. The Bank does not engage in any foreign business activities.

The Bank offers its products and services through its Community Banking Division and its separately branded loan origination platform, CreditBench. CreditBench is a government guaranteed lender with specific expertise in originating SBA 7(a) loans throughout the nation.

CreditBench also has an advanced technology platform for our SBA 7(a) Small Loan Program, called FlashCap, that enables the Bank to utilize and support technology-enabled banking products and services as well as various financial technology applications.

Community Banking

The Bank has structured its community banking services and charges for such services in a manner designed to attract consumers, small and medium sized businesses, and professionals located primarily in Pinellas, Hillsborough, Sarasota, Manatee, and Pasco Counties. The Bank focuses on customers that are seeking the flexibility and personalized relationships that a community bank can provide. The Bank offers specialized business and personal checking accounts, internet banking and online bill payment, remote capture and deposit, cash management, wire transfers, safety deposit boxes, courier services, retail investment services, and ACH originations, among other services. Retail investment services are facilitated through an independent broker-dealer through a relationship with a shared service organization.

The Bank also offers customary community bank deposit products, including interest-bearing and noninterest-bearing checking accounts, MMDAs, savings accounts, certificates of deposit and IRAs. The consumer product offering also includes unique programs, including, among others: 1) the NuStart checking that assists customers in rebuilding their access to the banking system, 2) the TrendSetters Club which offers special benefits for those customers age 50+ years, and 3) the Cash Kids’ Club savings account that offers those age 12 and under special rates while teaching children basic financial skills through interactive and mobile application tools. The Bank’s business deposit products and related services include free checking accounts, interest-bearing checking accounts, savings accounts, money market accounts, and access to business mobile and online banking, treasury management, cash management, merchant processing services, remote deposit capture, and night depository.

A wide range of loans are also offered, including commercial, consumer, and real estate loans. The commercial lending efforts are directed principally toward businesses and professionals who otherwise do business with us, and include commercial real estate mortgages, construction and development loans, working capital loans, and business expansion loans. In addition, the Bank has a minority lending program for women or minority business owners looking to take their business to the next level. BayFirst focuses its SBA and commercial lending divisions on providing the customer quick turnaround, competitive rates, and an easy application process. The Bank offers personal lines of credit, auto, boat, and recreational vehicle loans, residential mortgages, and home equity lines of credit. The Bank has been particularly successful in penetrating the small business community. The Bank participates in interbank credit arrangements to permit the Bank to take part in corporate or other business entity loans for amounts which are greater than its lending limits.

As of December 31, 2022, the Community Banking Division operated from eight banking centers in the Tampa Bay area: five in Pinellas County, one in Hillsborough County, one in Manatee County, and one in Sarasota County. Additionally, the Bank opened a second Tampa banking center in February 2023 with two additional banking centers planned in Sarasota currently under construction with one expected to open in mid 2023 and the other in late 2023 or early 2024, expanding the network of banking centers throughout the Tampa Bay region.

CreditBench

The Bank, through its separately branded loan origination platform CreditBench, originates government guaranteed loans on a nationwide basis, with a particular emphasis on SBA 7(a) loans. Government guaranteed loans are designed to assist small businesses in obtaining financing. CreditBench’s loan origination efforts are targeted to a broad range of industries and geographies, with a focus on building relationships with borrowers. This diversification is intended to mitigate the Bank’s credit risk. Deposit products are also marketed to borrowers, particularly those borrowers in the Bank's primary market area.

CreditBench originates loans through two distinct channels. One is its team of SBA lenders, known as the Core SBA Team. The other is for smaller loans that are processed through financial technology platforms, collectively known and branded as FlashCap. CreditBench’s Core SBA Team makes government guaranteed loans throughout the U.S., with a particular emphasis on business acquisition financing. Currently, the Core SBA Team is concentrated in the Tampa Bay area with an expanding national sales team. FlashCap employs an internal sales team and uses referral partners and financial technology companies to originate SBA loans nationwide. Underwriting, quality control, and technology are centralized and scalable for potential increases in loan volume. Late in the second quarter of 2022, the Company launched BOLT, an SBA 7(a) loan product designed to expeditiously provide working capital loans of $150 thousand or less to businesses throughout the country. CreditBench also originates USDA B&I loans for businesses located in qualifying areas.

The federal government guarantees 75% to 90% of SBA loan balances and up to 80% of USDA B&I loan balances as an incentive for financial institutions to make loans to small businesses. Eligible uses of SBA and USDA B&I loans are for working capital, equipment financing, debt refinancing, purchase of inventory, new construction, building acquisitions, business acquisitions, and startup expenses. The program maximum limit for SBA loans is $5.0 million, and the program limit for USDA loans is $25.0 million. Both can be priced competitively relative to conventional financing.

In March of 2020, the Bank made the strategic decision to become an active PPP lender, using local marketing efforts and a nationwide, online application platform. The Bank used the Federal Reserve’s PPPLF to fund a significant portion of these loans. The Bank funded its last PPP loans in the third quarter of 2021. As of December 31, 2022, the Bank had $19.2 million of PPP loans remaining on the books.

The Bank manages its government guaranteed lending program through a staff experienced in business development, loan documentation and monitoring, and accounting. Emphasis is placed on proper loan documentation to ensure full guarantee performance in the event of payment defaults.

The revenue generated from CreditBench’s loan originations is primarily derived from three sources: interest income, loan servicing, and premiums from the sale of loans. The Bank may elect to hold the government guaranteed portion of a loan on its balance sheet to increase interest income. Alternatively, the Bank may sell that portion to realize a premium on the sale.

In addition, the Bank may also sell a portion of the unguaranteed balance of certain government guaranteed loans, depending on a loan’s terms, the offer price, its liquidity and capital positions, and the perceived credit risk.

Residential Mortgage Division

In the third quarter of 2022, management decided to discontinue its nationwide residential lending business. Prior to those decisions, the Residential Mortgage Division operated from the banking centers in the Tampa Bay area and loan production offices nationwide. As a result of the discontinuance, the nationwide residential line of business was reclassified as a discontinued operation and reported in the financial statements as such. The Bank continues to offer fixed and variable rate home mortgages for the purchase and refinance of residential properties through the community banking centers, as well as a loan production center.

The Bank sells most of the residential mortgage loans which are originated into the secondary market through a broker arrangement. The Bank also originates loans to be held in its loan portfolio. The portfolio loans are generally high quality, adjustable rate, non-conforming mortgages located in the primary service area where there is a greater opportunity to cross-sell other Bank products and services. The ability to fund such non-conforming loans provides the Bank a competitive advantage compared to non-bank mortgage lenders. In 2022, the Bank retained in its loan portfolio an increased volume of originated residential mortgage loans than in previous years.

The Bank’s residential mortgages are originated, processed, underwritten, and closed to secondary market standards or Bank policy. In connection with the origination of mortgage loans intended for sale, the Bank uses a broker to underwrite, close, and sell the loans. For loans held in its loan portfolio, the Bank underwrites and closes these loans in-house utilizing the brokers’ technology system. There are no free-standing derivatives associated with the current lending process.

The Bank engages a subservicer for residential mortgage loans that is currently servicing most portfolio residential mortgage loans.

Competition

All phases of the Bank’s operations are highly competitive. Many of the commercial banks and other competitors have assets, capital, lending limits, and name recognition that are materially larger than the Bank’s. The Bank competes with other financial service providers for loans and deposits. These competitors include:

• larger national, super-regional, and regional financial institutions that have well-established branches and significant market share in the communities the Bank serves;
• non-bank SBA lenders;
• finance companies, investment banking and brokerage firms, and insurance companies that offer bank-like products;
• credit unions, which can offer highly competitive rates on loans and deposits because they receive tax advantages not available to commercial banks;
• other community banks that compete with the Bank for clients desiring a high level of service; and
• technology-based financial institutions, including large national, super-regional, and regional banks offering online deposit, bill payment and mortgage loan application services.

Some of the non-traditional financial institution competitors are not subject to the same degree of regulatory oversight to which the Bank is subject.

Among the advantages that the larger competitors have over the Bank are their ability to finance wide-ranging marketing campaigns and to allocate their investment assets to products with the highest yields and demands. Several of the competitors offer certain services, such as trust departments, that the Bank does not offer. By virtue of their greater total capital, these financial service providers have substantially higher loan-to-one borrower limits than the Bank (loans-to-one borrower limits apply to an individual customer’s total extension of credit as a percentage of a bank’s total capital). These competitors may intensify their advertising and other marketing activities to counter any efforts by the Bank to attract new business.

To compete with the financial institutions in its primary service area, the Bank capitalizes upon the flexibility that its independent status allows, including making decisions locally. This includes solicitation of business, professional, and personal accounts through the personal efforts of the Bank’s directors and officers. The Bank believes that a locally-based bank is often perceived by the local business community as possessing a clearer understanding of local commerce and the needs of the community. Consequently, its customers expect that the Bank will be able to make prudent lending decisions quicker and with a better understanding of the market than larger competitors. The Bank focuses on the smaller commercial customer because this segment offers the greatest concentration of potential business and historically has tended to demonstrate a higher degree of loyalty in their banking relationships. The Bank can respond quickly to changes in the interest rates paid on time and savings deposits and charged on loans, and to charges imposed on depository accounts, so as to remain competitive in the marketplace. If there are customers whose loan demands exceed the Bank’s loan limits, the Bank can arrange for such loans on a participation basis with other financial institutions.

Various legislative actions in recent years have led to increased competition among financial institutions. With the enactment of various laws and regulations affecting interstate banking expansion, it is easier for financial institutions located outside of Florida to enter the Florida market, including the Bank’s target markets. In addition, recent legislative and regulatory changes and technological advances have enabled customers to conduct banking activities without regard to geographic barriers, through internet and telephone-based banking and similar services. There can be no assurance that the United States Congress, the Florida Legislature, or the applicable bank regulatory agencies will not enact legislation or promulgate regulations that may further increase competitive pressures on the Bank.

Lending Philosophy and Credit Risk Management

Historically, the Company believes they have made sound, high-quality loans while recognizing that lending involves a degree of risk. The Bank’s centralized credit approval process and loan policies are designed to assist management in managing this risk. The policies provide a general framework for loan origination, monitoring, and funding. The Bank’s loan approval process is characterized by centralized authority supported by a risk control environment that provides for prompt and thorough underwriting of loans. The loan approval process begins with obtaining detailed financial and other information from the Bank’s borrowers. The Bank also relies on its loan and executive officers’ in-depth knowledge of its markets and borrowers.

Regardless of the loan type or amount, no single individual has sole loan approval authority. The objective of the loan approval process is to provide a disciplined, consistent, predictable, and collaborative approach to larger credits, while maintaining responsiveness to client needs. Commercial loan decisions are documented as to the borrower’s business, loan purpose, the evaluation of the repayment source and associated risks, the evaluation of collateral, loan covenants, loan monitoring requirements, and the risk rating rationale. The Bank’s strategy for approving loans is to follow conservative loan policies and consistent underwriting practices which include:

• Granting credit on a sound basis with full knowledge of the purpose and source of repayment for such credit;
• Ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan;
• Requiring documentation, including appraisals or valuations, sufficient to enable informed underwriting;
• Developing and adhering to desired levels of diversification for the loan portfolio as a whole and for loans within each category; and
• Ensuring that each loan is properly documented and that any insurance coverage requirements are satisfied.

The loan policies generally include other underwriting guidelines for loans collateralized by real estate. These underwriting standards are designed to determine the maximum loan amount that a borrower has the capacity to repay based, in part, upon the borrower’s cash flow and income. The loan policies include maximum amortization schedules and loan terms for each category of loans. In addition, the loan policies provide guidelines for personal guarantees, appraisals and valuations, loan-to-value ratios, environmental review, loans to employees, executive officers and directors, problem loan identification, maintenance of an adequate loan loss reserve, and other matters relating to lending practices.

The Community Banking Centers originate residential mortgage, consumer and commercial loans. The Bank utilizes a broker arrangement to originate residential mortgage loans to be sold in the secondary market. These residential mortgage loans are underwritten to meet secondary market standards so that loans can be sold into the secondary market. Some residential mortgage loans are held for its portfolio. Portfolio loans are primarily underwritten by the Bank on the borrowers’ financial strength and cash flow, with conservative loan-to-value requirements. Consumer loans include loans to individuals for automobiles, boats, and other major consumer personal, family, or household purposes. They are underwritten on the credit quality of the individual borrower and may be secured or unsecured. Commercial lending products include a wide variety of credit facilities, such as owner occupied and non-owner occupied commercial real estate, multifamily real estate, construction, land acquisition, and commercial and industrial loans. In general, the Bank’s commercial lending strategy focuses on the financial strength and successful track record of commercial loan applicants more than the project or type of property that would serve as collateral for a loan. These loans are underwritten by an independent in-house Credit Underwriting Department in accordance with its credit policy.

CreditBench primarily originates loans through the SBA 7(a) program, and, to a lesser extent, through the USDA’s B&I program. Occasionally, CreditBench originates loans through the SBA’s 504 loan program, the International Trade Loan program, and the SBA Express Loan program. CreditBench originates two distinct types of loans: complex loans and non-complex loans. The non-complex loans are originated pursuant to the SBA 7(a) Small Loan Program up to $350,000 and are underwritten through a streamlined underwriting and packaging process. Although the SBA 7(a) Small Loan Program permits broader underwriting and loan purpose parameters, non-complex CreditBench loans are limited to those underwritten via historical cash flow and exclude start-up and business acquisition financing. Within the FlashCap program, we offer BOLT loans up to $150,000 for working capital purposes. BOLT loans are guaranteed up to 85% by the SBA and primarily underwritten based upon predictive scores and character analysis of the business and its principals. All CreditBench loans regardless of size which require projection-based underwriting or have other complex characteristics, such as business acquisition financing, are underwritten subject to SBA or USDA B&I guidelines and contain a thorough underwriting analysis based on the credit quality of any guarantor as well as the historical and projected debt service coverage.

Risk Management

The Company believes that effective risk management and control processes are critical to safety and soundness of the Bank, the ability to predict and manage the challenges that they face, and, ultimately, the long-term corporate success. Risk management refers to the activities by which the Company identifies, measures, monitors, evaluates, and manages the risks they face in the course of banking activities. These risks include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial, and reputational risk exposures. The Board of Directors, both directly and through their committees, are responsible for overseeing the risk management processes, including quarterly enterprise risk management assessments and annual assessments in the following areas: (i) cyber; (ii) BSA/anti-money laundering; and (iii) third-party risk, with each of the committees of the Board of Directors assuming a different and important role in overseeing the management of the risks.

The Audit and Risk Management Committees of the Board of Directors are responsible for overseeing risks associated with financial matters (particularly financial reporting, accounting practices and policies, disclosure controls and procedures, and internal control over financial reporting) as well as other enterprise risks. The Compensation Committee of the Board of Directors has primary responsibility for risks and exposures associated with the compensation policies, plans, and practices regarding both executive compensation, Board compensation, and the compensation structure generally. The Compensation Committee, in conjunction with the Chief Executive Officer and other members of the management team, as appropriate, reviews the incentive compensation arrangements to ensure these programs are consistent with applicable laws and regulations, including safety and soundness requirements, and do not encourage imprudent or excessive risk-taking by the employees. The Nominating Committee of the Board of Directors oversees risks associated with the independence of the Board of Directors and potential conflicts of interest.

The senior management team is responsible for implementing the risk management processes by assessing and managing the risks they face, including strategic, operational, regulatory, investment, and execution risks, on a day-to-day basis, and reporting to the Board of Directors regarding the risk management processes. The senior management team is also responsible for creating and recommending to the Board of Directors for approval of appropriate risk appetite metrics reflecting the aggregate levels and types of risk they are willing to accept in connection with the operation of the business and pursuit of the business objectives.

The role of the Board of Directors in the Company’s risk oversight is consistent with the leadership structure, with the Chief Executive Officer and the other members of senior management having responsibility for assessing and managing the risk exposure, and the Board of Directors and their committees providing oversight in connection with those efforts. The Company believes this division of risk management responsibilities presents a consistent, systemic, and effective approach for identifying, managing, and mitigating risks throughout the Company’s operations.

Information Technology Systems

The Company has made, and continues to make, significant investments in its information technology systems and staff to support banking activities. The Company believes this investment will support continued growth and enable them to enhance the capabilities to offer new products, improve overall customer experience, improve profitability through efficiencies, maintain and improve cybersecurity, and provide scalability for future growth. The Company utilizes nationally recognized software vendors and their cloud/hosted models, which allow them to outsource the processing of data. The Company’s internal network and e-mail systems are administered by a managed service provider specializing in financial institutions, and they maintain production infrastructure in a data center facility near Tampa, Florida. This site provides for power and connectivity redundancy, and they maintain a disaster recovery program, including a cloud-based recovery environment.

The majority of the other systems, including electronic funds transfer, transaction processing, and online banking services are hosted by third-party service providers. The scalability of this infrastructure will support the Bank’s growth strategy. In addition, the tested capability of these vendors to automatically switch over to standby systems should allow the Bank to recover the systems and provide business continuity quickly in case of a disaster.

Privacy, Data Protection and Cybersecurity

The regulatory framework for data privacy and cybersecurity is rapidly evolving. Current federal law requires financial institutions to periodically disclose their privacy policies and practices related to sharing client information. Such laws allow consumer clients to opt out of having their information shared with unaffiliated third parties under certain circumstances. Other federal and state laws and regulations impact the ability to share certain information with affiliates and non-affiliates for marketing and/or non-marketing purposes, or to contact clients with marketing offers. Current federal law also requires financial institutions to implement a comprehensive information security program. Such programs must include administrative, procedural, and physical safeguards to ensure the security and confidentiality of client records and personal information. These security and privacy policies and procedures are in effect across the Bank.

Federal banking agencies pay close attention to the cybersecurity practices of banks. Such agencies include a review of an institution’s information technology program and its ability to prevent cyberattacks. The FFIEC released its Architecture, Infrastructure, and Operations (AIO) Booklet in June 2021. The AIO Booklet calls for a layered security approach that incorporates administrative, procedural, and physical controls to include employee, vendor, and client awareness training. The Bank’s cybersecurity and information security practices incorporate preventative, detective, corrective, compensatory, and deterrent controls. Failing to have adequate cybersecurity safeguards in place, in accordance with AIO and other applicable regulations and laws, can result in supervisory criticism, monetary penalties and reputational harm.

In November 2021, the Federal Reserve, OCC, and FDIC adopted a new regulation for computer-security incident notification requirements for banking organizations and their bank service providers. Among other things, this regulation requires a bank to notify its primary federal regulator within 36 hours after identifying a "computer-security incident" that the bank believes in good faith could: (i) materially disrupt or degrade its business or operations in a manner that would threaten the viability of its operations and result in clients being unable to access their deposit and other accounts; (ii) result in a material loss of revenue, earnings or franchise value; or (iii) pose a threat to the financial stability of the United States.

Data privacy and data protection are also areas of increasing regulatory and legislative focus. The Bank is subject to rules and regulations issued by the Federal Trade Commission, which regulates unfair or deceptive acts or practices, including those related to data privacy and cybersecurity. Like other lenders, the Bank uses credit bureaus in its underwriting activities. Use of such data is regulated under the Fair Credit Reporting Act, which also regulates identity theft prevention programs, reporting information to credit bureaus, prescreening individuals for credit offers, sharing of information between affiliates, and using affiliate data for marketing purposes. Federal law further requires financial institutions to explain their information-sharing practices to their clients and to protect sensitive client information.

Human Capital

Since opening in 1999, BayFirst has grown significantly without losing sight of its commitment to making an impact in the communities served and being Here for What’s Next® in the lives of the Company’s customers, communities, employees, and investors. As of December 31, 2022, BayFirst had 292 employees (289 full-time and 3 part-time) and recognizes that they are its greatest asset. Providing a work environment that is inclusive, transparent, and comfortable for all is foundational to the Bank’s core beliefs. The Company is an organization that values open communication and collaboration in a professional and challenging, yet informal atmosphere.

Total Rewards

The Bank’s industry-leading compensation and benefits package helps attract and retain top talent throughout the U.S. and demonstrates its belief that engaged and satisfied employees directly correlate to engaged and satisfied customers, generating long-term value for the Company’s stakeholders.

The Bank’s goal is to provide the most competitive compensation and benefit plans possible. In 2021, BayFirst established a living minimum wage of $18 per hour. The Bank has a generous 401(k) plan, plus a discretionary profit-sharing contributions to its Employee Stock Ownership Plan. All employees are shareholders through their participation in the ESOP. Additionally, employees have the opportunity to grow their ownership through a discounted non-qualified Employee Stock Purchase Plan.

BayFirst offers a wide range of health and welfare plans designed to fit its diverse population. The Bank provides 100% employer-paid premiums for medical, dental, vision, disability, and life insurance for the employee. The Bank offers an employee wellness program designed to support the whole employee which encompasses physical, mental, social, and financial wellness.

BayFirst provides both paid maternity and paternity leave through the parental leave program. In addition, the Banks’ no-cost, short-term disability policy is administered in-house and provides up to 12 weeks of medical leave at 100% pay. The Bank recognizes the burdensome expense of dependent care and provides a company match to employees’ dependent care FSA accounts. The Bank provides paid volunteer time off to all employees building engagement and pride in the organization while encouraging teams to give back to their communities.

Training and Development

As part of the commitment to being a top employer in the industry and the premier community bank of Tampa Bay, BayFirst offers a growing internal Learning and Development Center where employees not only learn compliance and regulation, but also have the opportunity to strengthen core competencies for career growth and personal development.

The Bank offers both a tuition reimbursement and student loan assistance program to all eligible employees. The Bank offers these programs to nurture the professional development of the Bank’s colleagues and ease the financial burden associated with continuing education.

Social Governance: Diversity, Equity, and Inclusion

The Bank’s cultural foundation of being current and comfortable for all drives the Diversity, Equity, and Inclusion committee’s efforts throughout the entire organization. The diversity enhances its workforce, expands the markets and fosters a culture of belonging for its employees, customers and communities in which the Bank serves.

As of December 31, 2022, the Bank’s employee base was comprised of individuals from all walks of life, genders, ethnicities, races, ages and differing economic and social backgrounds. Females represented 62% of the Company’s employee base while minorities represented 32% of its population. The officer base was 47% female and 23% minority.

BayFirst has an active Diversity, Equity, and Inclusion council with a purpose of ensuring BayFirst reflects the values, respects the viewpoints, and acknowledges the differences of not only the community members it serves, but also the people it employs. Through its focus on these three core components, the Council seeks to build an environment where everyone belongs, everyone is heard, everyone is aware of what’s next, and everyone is given the opportunity to succeed. The Council actively advocates for the ongoing implementation and evaluation of internal and external programs, initiatives, and procedures to ensure the bank remains forward-thinking and aligned with the ever-evolving societal landscape. Through its focus on diversity, equity, and inclusion, the Council works to fulfill its obligation to be the voice for all associated with BayFirst.

Employee Engagement

The Bank believes employee engagement is what sets the Bank apart from the competition. The Bank endeavors to recruit and retain some of the best and brightest talent across the U.S. When highly talented, skilled and driven individuals join the organization, they bring with them some of the best ideas, strategies, procedures and thoughts.

BayFirst understands that harnessing this level of engagement is critical to its success and has developed several channels to do so. The Bank’s Bright Ideas Submission Portal allows any employee to submit their ideas for improvement or change of policies, procedures, benefits or any other item they believe will improve the organization. To ensure employees understand the commitment of listening to feedback, each Bright Idea submission is reviewed by the CEO.

The CEO also hosts a quarterly CEO’s Council where individuals from across the organization spend the day with the CEO and executive team, providing feedback and input on improvement opportunities. The Bank also completes periodic Officer’s Surveys where each officer is asked to provide feedback on specific areas of the organization and its strategy.

One of the greatest engagement and communication tools is the “What’s Next” call where ALL employees are invited to a weekly video conference where ideas are exchanged, updates are provided, and business and individual recognitions are communicated.

The Bank’s efforts were recognized through an anonymous employee survey which ranked BayFirst in the top 15 of the 2022 Best Places to Work in Tampa Bay.

Environmental, Social, and Governance Policy

In 2021, BayFirst advanced its ESG initiatives by forming a Board of Directors’ level committee and developing a policy and policy statement. As a progressive institution, BayFirst is committed to the highest standards in all aspects of its operations. As both a Tampa Bay community bank and a nationwide lender, the Company believes it is their responsibility to take an important role in advancing the values they hold, including being an exemplary corporate citizen, providing fair and equitable access to the banking system, engaging with the communities, addressing climate change, providing full disclosure and transparency, providing a safe and secure banking experience, and offering the team the best possible workplace and opportunity for advancement. The main pillars of BayFirst’s ESG policy include 1) Fair and Equitable Access to Banking Services, 2) Environmental Sustainability, 3) Community Engagement, 4) Employee/Workforce Management and Well Being, and 5) Governance, Data Security, and Business Ethics.

Supervision and Regulation

General

As a bank holding company, the Company is subject to an extensive body of state and federal banking laws and regulations that impose specific requirements and restrictions on virtually all aspects of the Company’s operations. The Company is affected by government monetary policy and by regulatory measures affecting the banking industry in general.

The following is a summary of some of the statutes, rules, and regulations that affect the operations. This summary is qualified in its entirety by reference to the particular statutory and regulatory provision referred to below, and is not intended to be an exhaustive description of the applicable statutes or regulations. Any change in applicable laws or regulations may have a material adverse effect on the business.

BayFirst Financial Corp.

BayFirst is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended. As such, the Company is required to file annual reports and other information with the Federal Reserve regarding the Company’s business operations and those of the subsidiary. The Company is also subject to the supervision of, and to periodic inspections by, the Federal Reserve.

The BHCA generally requires every bank holding company to obtain approval from the Federal Reserve before:

• acquiring all or substantially all of the assets of a bank;
• acquiring direct or indirect ownership or control of 5% or more of the voting shares of any bank or bank holding company; or
• merging or consolidating with another bank holding company.

The BHCA and the Change in Bank Control Act, together with regulations promulgated by the Federal Reserve, require that, depending on the particular circumstances, either the Federal Reserve’s approval must be obtained or notice must be furnished to the Federal Reserve and not disapproved prior to any person or company, not a bank holding company, acquiring control of a bank holding company, subject to certain exemptions. Control is conclusively presumed to exist when an individual or company acquires 25% or more of any class of voting securities of a bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities and either the bank holding company has registered securities under Section 12 of the Exchange Act or no other person owns a greater percentage of that class of voting securities immediately after the transaction.

Additionally, the BHCA provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below. As a result of the USA Patriot Act, the Federal Reserve is also required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions.

Except as authorized by the BHCA and Federal Reserve regulations or order, a bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of 5% or more of the voting shares of any company engaged in any business other than the business of banking or managing and controlling banks. The primary exception allows the ownership of shares by a bank holding company in any company the activities of which the Federal Reserve has determined to be so closely related to banking or to managing or controlling banks that ownership of shares of that company is appropriate. Activities the Federal Reserve has determined by regulation to be proper incidents to the business of banking, and thus permissible for bank holding companies, include:

• making or servicing loans and certain types of leases;
• engaging in certain insurance and discount brokerage activities;
• performing certain data processing services;
• acting in certain circumstances as a fiduciary or investment or financial advisor;
• providing management consulting services;
• owning savings associations; and
• making investments in corporations or projects designed primarily to promote community welfare.

In accordance with Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks. In adhering to the Federal Reserve’s policy, the Company may be required to provide financial support to the Bank at a time when, absent such Federal Reserve policy, it might not be deemed advisable to provide such assistance. Under the BHCA, the Federal Reserve may also require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that the activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition. The Dodd-Frank Act codified the Federal Reserve’s policy on serving as a source of financial strength. Such support may be required at times when, absent this Federal Reserve policy, a holding company may not be inclined to provide it. A bank holding company, in certain circumstances, could be required to guarantee the capital plan of an undercapitalized banking subsidiary.

The Federal Reserve also has authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices, or which constitute violations of laws or regulations. The Federal Reserve may impose civil money penalties for activities conducted by a bank holding company, its nonbanking subsidiaries, and officials of either on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1.0 million for each day the activity continues.

National Banks

National Banks are subject to regulation, periodic examination, enforcement authority and oversight by the OCC extending to all aspects of the bank’s operations. OCC regulations govern permissible activities, capital requirements, dividend limitations, investments, loans and other matters. Deposits are insured by the FDIC for a maximum of $250,000 per account ownership. For this protection, banks must pay a quarterly statutory assessment and comply with the rules and regulations of the FDIC. The assessment levied on a bank for deposit insurance varies, depending on the capital position of each bank, and other supervisory factors.

The FDIA provides that, in the event of the “liquidation or other resolution” of a bank, the claims of depositors of the bank, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver will have priority over other general unsecured claims against the bank. If a bank fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors.

Areas regulated and monitored by the bank regulatory authorities include but are not limited to requirements concerning security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, establishment of branches, corporate reorganizations, transactions with affiliates, maintenance of books and records, and adequacy of staff training to carry out safe lending and deposit gathering practices.

Restrictions on Transactions with Affiliates and Loans to Insiders

Sections 23A and 23B of the Federal Reserve Act restrict transactions by banks with their affiliates. An affiliate of a bank is any company or entity which controls, is controlled by or is under common control with the bank. Generally, Sections 23A and 23B: (1) limit the extent to which a bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of that bank’s capital stock and surplus (i.e., tangible capital); and (2) require that all such transactions be on terms substantially the same, or at least as favorable to the bank or subsidiary, as those provided to a non-affiliate. The term “covered transaction” includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions.

Section 23A also covers investment funds managed by an institution as an affiliate, as well as other procedural and substantive matters. In addition, Sections 23A and 23B include coverage of transactions with insiders relative to credit exposure arising from derivative transactions. An insured depository institution is also prohibited from purchasing or selling an asset to an executive officer, director, or principal shareholder (or any related interest of such a person) unless the transaction is on market terms, and, if the transaction exceeds 10% of the institution’s capital, it is approved in advance by a majority of the disinterested directors.

A bank’s authority to extend credit to executive officers, directors and greater than 10% shareholders, as well as entities controlled by such persons, is subject to Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder by the Federal Reserve. Among other things, these loans must be made on terms substantially the same as those offered to unaffiliated individuals, the amount of loans a bank may make to these persons is based, in part, on the bank’s capital position, and specified approval procedures must be followed in making loans which exceed specified amounts.

Anti-tying Restrictions

Bank holding companies and affiliates are prohibited from tying the provision of services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Capital Adequacy Requirements

Banks are subject to regulatory capital requirements imposed by the Federal Reserve and the FDIC. Until a bank holding company reaches $3 billion in assets, the risk-based capital and leverage guidelines issued by the Federal Reserve are applied to bank holding companies on a nonconsolidated basis, unless the bank holding company is engaged in nonbank activities involving significant leverage, or it has a significant amount of outstanding debt held by the general public. Instead, a bank holding company with less than $3 billion generally applies the risk-based capital and leverage capital guidelines on a bank only basis and must only meet a debt-to-equity ratio at the holding company level. The Federal Reserve risk-based capital guidelines apply directly to insured state banks, regardless of whether they are subsidiaries of a bank holding company. Both agencies’ requirements, which are substantially similar, establish minimum capital ratios in relation to assets, both on an aggregate basis as adjusted for credit risks and off-balance sheet exposures. The risk weights assigned to assets are based primarily on credit risks. Depending upon the riskiness of a particular asset, it is assigned to a risk category. Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, risk weights from 0% to 250% are applied to different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Capital is then classified into three categories, Common Equity Tier 1, Additional Tier 1, and Tier 2. CET1 Capital is the sum of common stock instruments and related surplus net of treasury stock, retained earnings, AOCI and qualifying minority interests, less applicable regulatory adjustments and deductions that include AOCI (if an irrevocable option to neutralize AOCI is exercised). Mortgage-servicing assets, deferred tax assets, and investments in financial institutions are limited to an aggregate of 15% of CET1 and 10% of CET1 individually. Additional Tier 1 Capital includes noncumulative perpetual preferred stock, Tier 1 minority interests, grandfathered trust preferred securities, and Troubled Asset Relief Program instruments, less applicable regulatory adjustments and deductions. Tier 2 Capital includes subordinated debt and preferred stock not included in Additional Tier 1 Capital, total capital minority interests not included in Tier 1, and ALLL not exceeding 1.25% percent of risk-weighted assets, less applicable regulatory adjustments and deductions.

Smaller banks are subject to the following capital level threshold requirements:

Community banks are subject to the following minimum capital requirements.

Federal banking regulators have adopted regulations revising the risk-based capital guidelines to further ensure that the guidelines take adequate account of interest rate risk. Interest rate risk is the adverse effect that changes in market interest rates may have on its financial condition and is inherent to the business of banking. Under the regulations, when evaluating a bank’s capital adequacy, the revised capital standards now explicitly include a bank’s exposure to declines in the economic value of its capital due to changes in interest rates. The exposure of a bank’s economic value generally represents the change in the present value of its assets, less the change in the value of its liabilities, plus the change in the value of its interest rate off-balance sheet contracts.

Federal bank regulatory agencies possess broad powers to take prompt corrective action as deemed appropriate for an insured depository institution and its holding company, based on the institution’s capital levels. The extent of these powers depends upon whether the institution in question is considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” Generally, as an institution is deemed to be less well capitalized, the scope and severity of the agencies’ powers increase, ultimately permitting the agency to appoint a receiver for the institution. Business activities may also be influenced by an institution’s capital classification. For instance, only a “well capitalized” depository institution may accept brokered deposits without prior regulatory approval and can engage in various expansion activities with prior notice, rather than prior regulatory approval. However, rapid growth, poor loan portfolio performance or poor earnings performance, or a combination of these factors, could change the capital position of the bank in a relatively short period of time. Failure to meet these capital requirements could subject the bank to prompt corrective action provisions of the FDIA, which may include filing with the appropriate bank regulatory authorities a plan describing the means and a schedule for achieving the minimum capital requirements. In addition, the Company would not be able to receive regulatory approval of any application that required consideration of capital adequacy, such as a branch or merger application, unless the Company could demonstrate a reasonable plan to meet the capital requirement within an acceptable period of time.

In 2019, the Federal banking regulatory agencies adopted a rule to simplify the methodology for measuring capital adequacy for smaller, uncomplicated banks. The CBLR is calculated as the ratio of tangible equity capital divided by average total consolidated assets. CBLR tangible equity is defined as total equity capital, prior to including minority interests, and excluding accumulated other comprehensive income, deferred tax assets arising from net operating loss and tax credit carryforwards, goodwill, and other intangible assets (other than mortgage servicing assets). Under the rule, a qualifying organization may elect to use the CBLR framework if its CBLR is greater than 9%.

Branching

National banks and state banks can establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.

Deposit Insurance Assessments

The deposits of a bank are insured by the FDIC up to the limits under applicable law, which currently is set at $250,000 for accounts under the same ownership. Banks are subject to deposit insurance premium assessments. The FDIC imposes a risk-based deposit premium assessment system. Under this system, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, long-term debt ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are assessed quarterly. The FDIC has published guidelines on the adjustment of assessment rates for certain institutions. The assessment base on which a bank’s deposit insurance premiums is paid to the FDIC is now calculated based on its average consolidated total assets less its average equity. Congressional bills and other proposals could result in additional significant changes to the financial services and banking system, including, but not limited to, provisions for limitations on deposit insurance coverage or changing the timing and method financial institutions use to pay for deposit insurance. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank’s business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business or change the Corporation’s competitive landscape. Whether any future legislation will be enacted or additional regulations will be adopted, and how they might impact the Company, cannot be determined at this time.

Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a bank’s federal regulatory agency. Deposits and certain claims for administrative expenses and employee compensation against insured depository institutions are afforded a priority over other general unsecured claims against the institution, including federal funds and letters of credit, in the liquidation or other resolution of that institution by any receiver appointed by federal authorities. These priority creditors include the FDIC.

Dividends

BayFirst’s ability to pay cash dividends may depend almost entirely upon the aggregate amount of dividends that the Bank is able to pay and that the Bank is permitted to pay, by statutes or regulations, to the Company. Additionally, the FBCA provides that the Company may only pay dividends if the dividend payment would not render BayFirst insolvent, or cause BayFirst to be unable to meet obligations as they come due. These provisions could have the effect of limiting the ability to pay dividends.

Banking regulations limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits of the Bank for that year combined with the retained net profits for the preceding two years.

The Federal Reserve expects bank holding companies to serve as a source of strength to their subsidiary bank(s), which may require them to retain capital for investment in their subsidiary bank(s), rather than pay dividends to shareholders. As stated previously, the Bank may not pay dividends to BayFirst, if, after paying those dividends, the bank would fail to meet the required minimum levels under the risk-based capital guidelines and the minimum leverage ratio requirements. Payment of dividends by the Bank may be restricted at any time at the discretion of its applicable regulatory authorities if they deem such dividends to constitute an unsafe and/or unsound banking practice.

Fiscal and Monetary Policies

The business and earnings of a bank may be significantly affected by the fiscal and monetary policies of the federal government and its agencies. Banks are particularly affected by the policies of the Federal Reserve, which regulates the supply of money and credit in the United States. Among the instruments of monetary policy available to the Federal Reserve are: (i) conducting open market operations in United States government securities; (ii) changing the discount rates of borrowings of depository institutions; (iii) imposing or changing reserve requirements against depository institutions’ deposits; and (iv) imposing or changing reserve requirements against certain borrowing by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. For that reason alone, the policies of the Federal Reserve have a material effect on the earnings of banks.

Other Laws

State usury and credit laws limit the amount of interest and other charges collected or contracted by a bank on loans. Bank loans are subject to federal laws applicable to credit transactions, such as the:

• Federal Truth-In-Lending Act, which governs disclosures of credit terms to consumer borrowers;
• Community Reinvestment Act, which requires financial institutions to meet their obligations to provide for the total credit needs of the communities they serve, including investing their assets in loans to low and moderate-income borrowers;
• Home Mortgage Disclosure Act requiring financial institutions to provide information to enable public officials to determine whether a financial institution is fulfilling its obligations to meet the housing needs of the community it serves;
• Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed, or other prohibitive factors in extending credit;
• Real Estate Settlement Procedures Act, which requires lenders to disclose certain information regarding the nature and cost of real estate settlements, and prohibits certain lending practices, as well as limits escrow account amounts in real estate transactions;
• Fair Credit Reporting Act governing the collection of consumer debts by collection agencies; and
• The rules and regulations of various federal agencies charged with the responsibility of implementing such federal laws.

Bank operations are also subject to the:

• Gramm-Leach-Bliley Act of 1999, which contains privacy provisions that requires the Bank to maintain privacy policies intended to safeguard consumer financial information, to disclose these policies to the customers, and allow customers to “opt out” of having their financial service providers disclose their confidential financial information to nonaffiliated third parties, subject to certain exceptions;
• Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
• Electronic Funds Transfer Act and Regulation E, which govern automatic deposits to, and withdrawals from, deposit accounts and customers’ rights and liabilities arising from the use of debit cards, automated teller machines, and other electronic banking services.

Anti-Money Laundering

Banks are subject to significant regulation and supervision relative to anti-money laundering:

• such regulation is broad and includes the extraterritorial jurisdiction of the United States;
• compliance and due diligence obligations are significant and may be costly;
• banks may be compelled to produce documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States; and
• banks enjoy a safe harbor from civil liability to customers for banks’ activities under anti-money laundering laws and regulation.

The U.S. Treasury, in cooperation with the federal banking agencies, the SEC, the Commodity Futures Trading Commission, and the Department of Justice:

• requires customer identification and verification;
• imposes the money-laundering program requirement to the major financial services sectors, including insurance and unregistered investment companies, such as hedge funds; and
• facilitates and permits the sharing of information between law enforcement and financial institutions, as well as among financial institutions themselves.

Enforcement of the anti-money laundering laws and regulations is significant, on the part of both state and federal regulators.

Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Act has had a broad impact on the financial services industry, imposing significant regulatory and compliance changes, including the designation of certain financial companies as systemically significant, the imposition of increased capital, leverage, and liquidity requirements, and numerous other provisions designed to improve supervision and oversight of, and strengthen safety and soundness within, the financial services sector. Additionally, the Dodd-Frank Act established a framework of authority to conduct systemic risk oversight within the financial system to be distributed among federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the OCC, and the FDIC. The following items provide a brief description of certain key provisions of the Dodd-Frank Act that affect banks:

• Limitation on debit card transaction fees. The amount a provider can charge for debit card transaction fees, commonly referred to as interchange fees, is now limited to $0.21 plus 0.05% of the price of the transaction (plus $0.01, if the provider has certain fraud prevention standards in place).
• Mortgage loan origination and risk retention. Additional regulatory requirements have been put in place that may affect the operations and result in increased compliance costs. For example, new standards have been created for mortgage loan originations on all lenders, including banks and thrifts, in an effort to require steps to verify a borrower’s ability to repay. In addition, the Dodd-Frank Act generally requires lenders or securitizers to retain an economic interest in the credit risk relating to loans the lender sells or mortgage and other asset-backed securities that the securitizer issues. These applicable rules generally require a sponsor of this type of transaction to retain an economic interest equal to at least 5% percent of the aggregate credit risk of the assets collateralizing an issuance.
• Expanded FDIC resolution authority. While insured depository institutions have long been subject to the FDIC’s resolution process, the Dodd-Frank Act created a new mechanism for the FDIC to conduct the orderly liquidation of certain “covered financial companies,” including bank and thrift holding companies and systemically significant nonbank financial companies.
• Consumer Financial Protection Bureau. An independent CFPB was created within the Federal Reserve. The CFPB is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The CFPB has rulemaking authority over many of the statutes governing products and services offered to bank and thrift consumers.
• Transactions with affiliates and insiders. The Dodd-Frank Act generally enhanced the restrictions on transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions.”
• Enhanced lending limits. The Dodd-Frank Act strengthened the limits on a depository institution’s credit exposure to one borrower.

Future Legislation

Various other legislative and regulatory initiatives, including proposals to overhaul the banking regulatory system are from time to time introduced in Congress and state legislatures, as well as regulatory agencies. The latest example was the passing of the Dodd-Frank Act. Future legislation regarding financial institutions may change banking statutes and the operating environment of the Company in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation will be enacted, and if enacted, the effect that it or any implementing regulations, would have on the financial condition or results of operations of the Company. The nature and extent of future legislative and regulatory changes affecting financial institutions is very unpredictable at this time.

Available Information

The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge on the Company’s website at www.bayfirstfinancial.com (http://www.bayfirstfinancial.com) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. These documents are also available on the SEC’s website at www.sec.gov (http://www.sec.gov).

Our business and results of operations are subject to numerous risks and uncertainties, many of which are beyond our control. The material risks and uncertainties that management believes affect the Company are described below. Additional risks and uncertainties that management is not aware of or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our securities could decline significantly, and you could lose all or part of your investment. Some statements in the following risk factors constitute forward-looking statements. Please refer to “Cautionary Note Regarding Forward-Looking Statements” in Item 7 of this report.

Risk Factor Summary

Our business is subject to uncertainties and risks and our risk factors can be broadly summarized by the following:

• Our ability to grow the size and geographic scope of our loan generation, loan sale, and deposit gathering business, and the infrastructure needed to support it;
• Possible loan defaults, devaluation of collateral, adverse political, environmental, or economic events, and competition;
• Interest rates and available sources of liquidity;
• Our ability to raise capital and the effects of doing so on our shareholders;
• The potential that we are subject to fraud, incorrect judgments, or other bad acts of third parties;
• Laws, regulations, rules, and standards to which we are subject and the government agencies with which we interact;
• Recruitment, retention, development, performance, and potential bad acts of our key executives and other employees, as well as transactions with them and our directors;
• Dividend and other restrictions placed on us by our outstanding preferred stock, restrictions that may be imposed by future issuances of preferred stock, and our pledging of the stock in the Bank to secure a loan;
• Rapidly developing technology;
• Estimates used in certain valuations, including our loan loss reserve; and
• Features of our stock, such as liquidity, dilution, the lack of preemptive rights, our SEC reporting status, and the concentration of ownership among our insiders.

Risk Factors Related to Our Business

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business. Actions by the Federal Home Loan Bank of Atlanta or the Board of Governors of the Federal Reserve System may reduce our borrowing capacity. Additionally, we may not be able to attract deposits at competitive rates. Our inability to raise funds through traditional deposits, brokered deposits, borrowings, the sale of investment securities or loans, and other sources could negatively affect our liquidity or result in increased funding costs. Liquidity may also be adversely impacted by bank supervisory and regulatory authorities mandating changes in the composition of our balance sheet to asset classes that are less liquid.

Changes in interest rates affect our profitability and assets.

Our profitability depends to a large extent on the Bank’s net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and expenses on interest-bearing liabilities, such as deposits and borrowings. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control including inflation, economic recession, unemployment, money supply, domestic and international events, and changes in the United States and other financial markets.

At December 31, 2022, our one-year interest rate sensitivity position was asset sensitive, such that a gradual increase in interest rates during the next twelve months would have a positive impact on our net interest income. Our results of operations are affected by changes in interest rates and our ability to manage this risk. The difference between interest rates charged on interest-earning assets and interest rates paid on interest-bearing liabilities may be affected by changes in market interest rates, changes in relationships between interest rate indices, and changes in the relationships between long-term and short-term market interest rates. Our net interest income may be reduced if: (i) more interest-earning assets than interest-bearing liabilities reprice or mature during a time when interest rates are declining; or (ii) more interest-bearing liabilities than interest-earning assets reprice or mature during a time when interest rates are rising. In addition, the mix of assets and liabilities could change as varying levels of market interest rates might present our customer base with more attractive options.

We may be unable to continue to produce the volume of loans necessary to support our SBA and other government guaranteed lending business.

Our business strategy places a significant emphasis on SBA and other government guaranteed lending. In order to successfully implement this strategy, we must originate and fund a substantial dollar amount of loans. To do so, we must identify qualified and interested borrowers and have sufficient capital and liquidity to support and fund such loans. If we are not successful in implementing this strategy, our income and results of operations may be adversely affected.

We depend on the sale of both the guaranteed and unguaranteed portions of our government guaranteed loans, but also face risks relating to the retained portions of unguaranteed loans.

Our strategy historically has been, and may continue to be, to sell both the guaranteed balances of SBA and other government guaranteed loans, as well as a percentage of the unguaranteed portions of such loans, within legally allowable limits. A material portion of our net income and profitability depended, and may continue to depend, on gains on sales of the guaranteed portions of the government guaranteed loans that we originate. We also from time to time pursue the sales of unguaranteed portions of such loans, which provide us with additional liquidity and capital capacity to permit us to make additional loans when needed. Our ability to sell both the guaranteed and unguaranteed portions of these loans is dependent upon our ability to identify purchasers with the demand and capacity to buy them, the attractiveness of the loans, our underwriting quality, and other factors. Our ability to continue to make new loans and hold them in our loan portfolio will be limited by our current capital and liquidity positions. To the extent we retain the unguaranteed portion of these loans in our portfolio, we may be required to make significant provisions to our ACL. The Bank adopted ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments effective January 1, 2023. This standard requires financial institutions to determine periodic estimates of lifetime expected credit losses on financial instruments and other commitments to extend credit. This changed the current method of providing allowances for credit losses that are probable, which may require us to increase our allowance for loan losses.

Our loan origination processes present heightened opportunities for borrower or referral fraud.

The loans we originate through our technology partners and referral sources are obtained primarily through an online application process. We do not generally meet with the borrowers in person. Our referral sources also are involved in assisting the borrowers with completing their loan applications. Therefore, it is difficult for us to definitively ascertain or confirm a borrower’s identity, structure, creditworthiness, or veracity in completing the loan application process. If a borrower or a referral source intentionally, or unintentionally, provides us with incorrect information that we rely on in underwriting a loan, we could be subject to increased credit risk for that loan. Such increased risk could result in increased loan losses or heightened provisions to our ACL, either of which would adversely affect our credit quality and net income. We may also become subject to heightened regulatory scrutiny for making loans to such borrowers and may be required to dedicate time and other resources to addressing regulatory concerns.

Our loan referral sources operate independently from us and may take actions for which we may be held responsible.

Our referral sources for SBA and other government guaranteed loans operate independently from us and have the initial interactions with many loan applicants and borrowers. As part of those interactions, our referral sources may take actions which violate laws, regulations, or our policies. These may include, among other things, charging impermissible fees, failing to provide or properly complete required documentation or disclosures, making false or misleading statements, or encouraging an applicant to make misrepresentations. In certain instances, the Bank may be held responsible by an applicant or a government agency for such actions. If that were to happen, the Bank may be required to pay restitution or fines, be subject to regulatory enforcement actions, or lose certain statuses with the SBA or other government agencies.

We rely heavily on technology partners and other referral sources in our SBA loan origination process.

As part of our SBA lending strategy, we use the services of technology partners and other referral sources. These arrangements allow us to originate loans throughout the U.S. via the internet. We do not have an exclusivity arrangement with any referral source. Therefore, we cannot be assured that we will be able to originate and close or maintain any specific level of SBA loans through such sources in the future. In addition, our technology partners are subject to online commerce risks generally, including hacking and use of the site by persons using fraudulent credentials. Should we not continue to generate a substantial volume of loan business through our use of referral sources, or if they experience operational interruptions, or direct loans to other lenders, our SBA lending may be materially reduced, which could reduce our net income and our asset growth.

Our operations are growing at a rapid pace and our training programs and operational protocols may lag behind our growth.

Our branch network and SBA lending operations are expanding at a rapid pace. As a result, we may not be able to provide comprehensive or timely training to staff.

We may also not develop appropriate operational protocols as we expand our products and services. If we fail to do so, our employees may not have a set of standards and expectations pursuant to which they perform their assigned duties. If we are not able to fully and promptly provide training to our employees, or develop appropriate protocols, our employees may be susceptible to mistakes, fail to recognize fraud or other weaknesses in our operations, or fail to recognize or mitigate other risks.

The COVID-19 pandemic has disrupted economic conditions, the financial and labor markets and workplace operating environments and the effects of such disruptions will depend on future developments, which are highly uncertain and are difficult to predict.

While COVID-19 pandemic conditions have improved, past and potential future government actions taken to reduce the spread of the virus have been weighing on the macroeconomic environment. As a result, lingering economic uncertainty and reduced economic activity remains. In addition, new virus strains could adversely impact our borrowers’, customers’, and business partners’ workforces and operations. As a result, we may experience losses due to operational factors impacting us or our borrowers, employees, customers, or business partners.

The effects of the COVID-19 pandemic have varied significantly by region, and the extent of the effects of the pandemic on the U.S. and global economies, labor markets and financial markets are likely to continue to change. Future developments will be highly uncertain and cannot be predicted, including the effectiveness of post-pandemic remote working arrangements, third party providers’ abilities to continue to support our operations, and any further actions taken by governmental authorities and other third parties. Accordingly, the pandemic and related dynamics could continue to materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels. Further, there are no comparable recent events to provide guidance as to the effect a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change.

Changes in economic and political conditions could adversely affect our earnings through declines in deposits, loan demand, the ability of our customers to repay loans and the value of the collateral securing our loans.

Our success depends to a significant extent upon local and national economic and political conditions, as well as governmental fiscal and monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy, an increasing federal government budget deficit, slowing gross domestic product, tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, trade wars, and other factors beyond our control may adversely affect our deposit levels and composition, the quality of investment securities available for purchase, demand for loans, the ability of our borrowers to repay their loans, and the value of the collateral securing loans. Recent political developments in Russia and Ukraine may result in substantial changes in economic and political conditions for the U.S. and the remainder of the world. Disruptions in U.S. and global financial markets, and changes in oil production and supply in the Middle East and Russia, also affect the economy and stock prices in the U.S., which can affect our earnings, capital, as well as the ability of our customers to repay loans.

A shutdown of the Federal government would likely result in us being temporarily unable to make SBA and other government guaranteed loans.

If the Federal government experiences a shutdown, it is likely that the SBA, and other agencies which guaranty some of the loans we make, will be unable to process those loans. As a result, our ability to make those loans would be delayed. During such a delay, it is possible that prospective borrowers could obtain financing from other sources or elect not to borrow. Any delay in closing these types of loans, or losing the opportunity to make them, could result in decreased fee and interest income and adversely affect our financial performance.

Changes in the laws or regulations governing our SBA and other government guaranteed lending activities and our mortgage lending business may adversely affect our ability to operate them profitably.

Our SBA and other government lending programs and our mortgage lending activities are subject to laws and regulations administered by government agencies such as the SBA, the United States Department of Housing and Urban Development, and the United States Department of Agriculture. If any of these laws or regulations change, or the policies and practices of these agencies change, such changes may impact our ability to offer such products in a profitable manner, or at all. If we are unable to profitably offer these products, our net income will likely decrease and our financial condition and performance will likely deteriorate.

We may not be able to retain or grow our core deposit base, which could adversely impact our funding costs.

We rely on client deposits as our primary source of funding for our lending activities. Our future growth will largely depend on our ability to retain and grow our core deposit base. Our retention and acquisition of customer deposits are subject to potentially dramatic fluctuations in availability or price due to certain factors outside of our control, such as increasing competitive pressures for deposits, changes in interest rates and returns on other investment classes, client perceptions of our financial health and general reputation, or a loss of confidence by clients in us or the banking sector generally. Such factors could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current client deposits or attract additional deposits. Additionally, any such loss of funds could result in lower loan originations or the need to sell investment securities at a loss, which could have a material adverse effect on our business, financial condition and results of operations.

Unrealized losses in the Bank’s investment portfolio could affect liquidity.

As market interest rates increased during 2022, the unrealized losses on the Bank’s investment portfolio also increased. The increase in unrealized losses is reflected in Accumulated Other Comprehensive Income (“AOCI”) on the balance sheet and reduces book capital, and therefore, the tangible common equity ratio. Unrealized losses do not affect regulatory capital ratios.

The Bank’s access to liquidity sources could be affected by unrealized losses if investments must be sold at a loss, tangible capital ratios continue to decline from an increase in unrealized losses or realized credit losses, the FHLB or other sources reduce capacity or bank regulators impose restrictions on the Bank such as a limit on interest rates it may pay on deposits or its ability to access brokered deposits.

We have expanded into new markets with which we have less familiarity with than our historic markets.

We intend to continue to expand the geographic scope of our SBA and USDA loan origination efforts when we identify attractive opportunities. Our senior management and Board of Directors have less familiarity with these markets than they do with our Florida markets. We are dependent on the expertise and actions of the bankers we have hired to be successful in these markets.

We are dependent on our management team and any of their departure, or subsequent employment with a competitor could adversely affect our operations.

Our growth and development are particularly dependent upon the personal efforts and abilities of our executive officers and other qualified personnel. The loss or unavailability of such officers or employees could have a material adverse effect on our operations and prospects. Such adverse effect may be magnified if any such officer or employee were to become employed with a competitor of ours. In early 2023, our Chief Executive Officer Anthony Leo announced his retirement effective at the end of the year. Our Boards have selected current Bank President Thomas Zernick to become Chief

Executive Officer of the Company. If this transition is not effective or if we encounter problems in implementing it, our performance may suffer.

We have pledged the outstanding shares of the Bank to secure a loan, and if we cannot repay the loan when due, the lender may foreclose on the loan and take ownership of the Bank.

We have pledged 100% of the outstanding shares of the Bank’s capital stock to secure a term loan with another financial institution with a balance of $2.8 million as of December 31, 2022. If we do not have cash available at BayFirst or we are unable to fund dividends from the Bank to BayFirst, we may not be able to make principal or interest payments due on the loan. If we cannot repay or refinance the loan on or prior to maturity, the lender may foreclose on the pledged stock and take ownership of the Bank. In which case, we may not have any source of revenue and it would be unlikely that we would continue to operate. The loan currently matures on March 10, 2029.

We engage in transactions with our directors and their related interests, which creates the potential for conflicts of interest.

Directors Mark S. Berset and Derek S. Berset are owners of an insurance agency from which the Bank purchases insurance. From time to time the Bank makes loans to, and accepts deposits from, officers and directors and their affiliates. Further, from time to time, in the ordinary course of business, the Company has entered into transactions with certain members of its Board of Directors for various professional services.

Such insider transactions present reputational and corporate governance risks to BayFirst and the Bank. Insider transactions often draw the scrutiny of regulators and shareholders. If they were to identify terms of the transactions, or aspects of the process through which we entered into them, that they deemed to be inappropriately unfavorable to BayFirst or the Bank, such regulators or shareholders might take enforcement or legal action against us. Similarly, insider transactions may present an opportunity for taking advantage of BayFirst or the Bank. If any such events were to occur, BayFirst and the Bank may incur expenses or become engaged in time consuming enforcement or legal processes that could negatively affect our performance.

We may not be able to collect on the guarantees of our SBA or other government guaranteed loans if borrowers default.

In order to collect on their guarantees, we must strictly comply with the standards set by the SBA or other government agencies. If our government guaranteed loans or our servicing and administration of them do not comply with such standards, we may not be able to collect on their guarantees in the event of default. In such case, our asset quality, earnings, and growth prospects could be adversely affected.

Our Internet-based systems and online commerce activities are subject to security threats that could adversely affect our business.

Third party, or internal, systems and networks may fail to operate properly or become disabled due to deliberate attacks or unintentional events. Our operations are vulnerable to disruptions from human error, natural disasters, power loss, computer viruses, spam attacks, denial of service attacks, unauthorized access, and other unforeseen events. Undiscovered data corruption could render our customer information inaccurate. These events may obstruct our ability to provide services, underwrite loans, and process transactions. Any such incident could put confidential customer information at risk, which may result in significant liability to us, subject us to additional regulatory scrutiny, damage our reputation, result in a loss of customers, cause us to incur significant expense to remediate any damage and inhibit current and potential customers from using our online banking services, any or all of which could have a material adverse effect on our results of operations and financial condition.

A failure or breach, including cyberattacks, of our computer systems or other technologies could disrupt our business, result in the disclosure of confidential information, and create significant financial and legal exposure.

There is no assurance that our computer systems and other technologies will provide absolute security. In the case of a failure or breach of such systems, their functionality may be disabled. In addition, the confidentiality and integrity of our and our clients’ information may be compromised. Further, to access our products and services, our clients may use computers and mobile devices that are beyond our security systems. Our clients’ or our websites or systems may be subject to attacks intended to obtain unauthorized access to confidential information, destroy data, or disable or sabotage services, often through the introduction of computer viruses or malware, cyberattacks, and other means.

Furthermore, the methods of cyberattacks change frequently and may not be recognized until or after launch. Therefore, we may not be able to anticipate or implement effective preventive measures against all possible security breaches. Any successful cyberattack or other security breach may result in the misappropriation, loss, or other unauthorized disclosure of confidential customer information. Such an event may also compromise our ability to function and could severely damage our reputation, erode confidence in the security of our systems, products, and services, expose us to the risk of litigation and liability, and disrupt our operations. Any successful cyberattack may subject us to regulatory investigations, litigation or enforcement, or require the payment of regulatory penalties or require us to undertake costly remediation efforts. All or any of these could adversely affect our business, financial condition, or results of operations and damage our reputation.

The valuation of our SBA and USDA related servicing rights is based on estimates and subject to fluctuation based on market conditions and other factors that are beyond our control.

The fair value of our SBA and USDA servicing rights is estimated by a third party based upon projections of expected future cash flows generated by the loans we service, historical prepayment rates, future prepayment estimates, portfolio characteristics, interest rates based on interest rate yield curves, volatility, market demand for servicing rights, and other factors. While this evaluation process uses historical and other objective information, the valuation of our servicing rights is ultimately an estimate based on our experience, judgment, and expectations regarding our servicing portfolio and the broader market. This is an inherently uncertain process and the value of our servicing rights may be adversely impacted by factors that are beyond our control, which may in turn cause us to record valuation allowances which could have a material adverse effect on our business, results of operations, and financial condition.

Changes in business and economic conditions, in particular those of the Florida markets in which we operate, could lead to lower asset quality and decreased earnings.

Unlike larger national or regional banks that are more geographically diversified, our business and earnings are closely tied to general business and economic conditions in our market area. The local economy is heavily influenced by tourism, real estate, and other service-based industries. Factors that could affect the local economy include declines in tourism, higher energy costs, reduced consumer or corporate spending, natural disasters or adverse weather and a significant decline in real estate values. A sustained economic downturn could adversely affect the quality of our assets, credit losses, and the demand for our products and services, which could lead to lower revenue and lower earnings.

Most expansion activities require approval of our regulators, which we may not be able to obtain, or that may impose conditions that we find to be unacceptable.

Branch openings, and other expansion activities, generally require the approval of our regulators. We may not be able to obtain such approvals if our regulators do not believe we are financially or managerially strong enough to integrate or manage such activities. In addition, our regulators consider our capital, liquidity, profitability, regulatory compliance, including with the Community Reinvestment Act and the Bank Secrecy Act, and levels of goodwill and intangibles when considering acquisition and expansion proposals. Our regulators may also impose conditions in approvals that we find to be unacceptable, prohibitive, or otherwise undesirable. In any of those instances, we may be unable or unwilling to consummate a transaction or undertake an expansionary activity.

We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to material penalties and have negative effects on our business.

The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act, and other fair lending laws and regulations impose obligations and nondiscriminatory lending requirements on financial institutions. The banking regulators and the U.S. Department of Justice are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the Community Reinvestment Act or fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on branch expansion, merger and acquisition activity, and restrictions on entering new business lines. Private parties may also have the ability to challenge our performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition, results of operations, and future prospects.

We may be required to make increases in our loan loss reserve and to charge off loans in the future, which could adversely affect our results of operations.

The determination of the appropriate level of the loan loss reserve involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks, which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors within and outside of our control, may require an increase in the loan loss reserve. In addition, our regulators periodically review our loan loss reserve and may request an increase in the provision for loan losses or the recognition of loan charge-offs, based on judgments different than those of management. Furthermore, the Financial Accounting Standards Board has issued a current expected credit loss rule, which will change our accounting for losses by requiring us to record, at the time of origination, credit losses expected throughout the life of loans, held-to-maturity investment securities, and certain other assets and off-balance sheet credit exposures as opposed to the current practice of recording losses when it is probable that a loss event has occurred. We implemented this new standard on January 1, 2023 and we will recognize a one-time adjustment to the allowance. We have not yet determined the magnitude of such adjustment or the overall impact on financial results but expect it to be between $3 million and $5 million. Also, if charge-offs in future periods exceed the allowance, we will need additional provisions to increase the allowance, which would result in a decrease in net income and capital, and could have a material adverse effect on our financial condition and results of operations.

If real estate values in our markets decline, we could experience losses upon foreclosure of the loan or sale of the real estate.

A material portion of our loan portfolio consists of mortgages secured by real estate located in Pinellas, Pasco, Hillsborough, Manatee, and Sarasota Counties, Florida. Real estate values in our market may decline due to changes in national, regional or local economic conditions; fluctuations in interest rates and the availability of loans to potential purchasers; changes in the tax laws and other governmental statutes, regulations and policies; and acts of nature. If real estate values decline in our market, the value of the real estate collateral securing our loans will likely be reduced. Any reduction in the value of the collateral securing our loans could reduce the amount of money we could realize on the sale of any collateral and thereby adversely affect our financial performance.

Hurricanes or other adverse weather events, as well as climate change, could negatively affect our local economies or disrupt our operations, which could have an adverse effect on our business and results of operations.

Our market areas in Florida are susceptible to hurricanes, tropical storms, and related flooding and wind damage. Such weather events can disrupt operations, result in damage to properties and negatively affect the local economies in the markets where we operate. Such weather events could result in a decline in loan originations, a decline in the value, or destruction of properties securing our loans and an increase in delinquencies, foreclosures, or loan losses. Our business and results of operations may be adversely affected by these and other negative effects of future hurricanes, tropical storms, related flooding and wind damage and other similar weather events. Climate change may be increasing the severity and frequency of adverse weather conditions, making the impact from these types of natural disasters on us or customers worse.

Further, concerns over the long-term impacts of climate change have led and may continue to lead to governmental efforts around the world to mitigate those impacts. Investors, consumers, and businesses also may change their behavior on their own as a result of these concerns. The State of Florida could be disproportionately impacted by long-term climate changes. We and our customers may face cost increases, asset value reductions, and changes in supply or demand for products and services resulting from new laws, regulations, and changing consumer and investor preferences regarding responses to climate change.

Our loan portfolio includes a material amount of commercial real estate and commercial and industrial loans.

The credit risk associated with commercial real estate loans and C&I loans is a result of several factors, including the concentration of principal in a limited number of loans and to borrowers in similar lines of business, the size of loan balances, the effects of general economic conditions on the demand for C&I products and services and income-producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Repayment of commercial real estate and C&I loans in some cases is dependent upon the successful operation of the related business or the development or sale of the related real estate. If the actual or potential cash flow from a business or property is reduced, the borrower’s ability to repay the loan may be impaired. As a result, repayment of these loans may, to a greater extent than other types of loans, be subject to adverse conditions in the real estate market or economy. In addition, if the Bank forecloses on the collateral securing C&I loans, the potential market for selling such collateral may be limited to persons already engaged in a similar business. That may result in the Bank recovering an amount for such collateral less than the amount of the loan or taking an extended time to liquidate such collateral.

Our use of appraisals in deciding whether to make a loan secured by real property or how to value the loan in the future may not accurately describe the net value of the collateral that we can realize.

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values may fluctuate over relatively short periods of time, especially in times of heightened economic uncertainty, this estimate might not accurately describe the net value of the collateral after the loan has been closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. In addition, we rely on appraisals and other valuations to establish the value of foreclosed real estate and to determine certain loan impairments. If any of these valuations are inaccurate, our consolidated financial statements may not reflect the correct value of our foreclosed upon real estate, and our loan loss reserve may not accurately reflect loan impairments. Inaccurate valuations of properties could materially adversely affect our business, results of operations and financial condition.

We operate in a highly competitive industry and market area.

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources than we do. Such competitors primarily include Internet banks and national, regional and community banks within the various markets we serve. We also face competition from many other types of financial institutions, including, without limitation, savings and loan institutions, credit unions, mortgage companies, other finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes, as well as continued consolidation. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Our success depends on our ability to compete successfully in our market area, and there is no guarantee that we will be able to do so.

We may face risks with respect to future expansion.

We may consider and enter into new lines of business or offer new products or services. We may acquire all or parts of other institutions and we may engage in additional de novo branch expansion. Expansion involves a number of risks, including the costs associated with identifying and evaluating potential acquisitions and merger partners, inaccurate estimates and judgments regarding credit, operations, management and market risks of the target institution, our ability to finance expansion, possible dilution to our existing shareholders, the diversion of our management’s attention to the negotiation of a transaction, the integration of the operations and personnel of combining businesses, and the possibility of unknown or contingent liabilities.

We may need additional capital in the future, but such capital may not be available when needed.

We may need to obtain additional debt or equity financing to fund future growth and meet our capital needs. We cannot guarantee that such financing will be available to us on acceptable terms or at all. If our financial performance is unsatisfactory or if negative economic events or disruptions in the capital markets occur, it may not be possible for us to find sources of sufficient capital for our business operations. If we are unable to obtain future financing, we may not have the resources available to fund our planned growth.

We are subject to government regulation and monetary policy that could constrain our growth and profitability.

We are subject to extensive federal government supervision and regulations that impose substantial limitations with respect to lending activities, purchases of investment securities, the payment of dividends, and many other aspects of our business. Many of these regulations are intended to protect depositors, the public, and the FDIC, but not our shareholders. The banking industry is heavily regulated. We are subject to examinations, supervision and comprehensive regulation by various federal and state agencies. Our compliance with these regulations is costly and restricts certain activities. The burden imposed by federal and state regulations puts banks at a competitive disadvantage compared to less regulated competitors such as finance companies, mortgage banking companies, and leasing companies. Federal economic and monetary policy may also affect our ability to attract deposits, make loans, and achieve our planned operating results. New laws and regulations may increase costs of regulatory compliance. Further, additional legislation and regulations that could significantly affect our power and authority, and operations may be enacted or adopted in the future which could have a material adverse effect on our financial condition and results of operations.

Legislation and regulatory proposals enacted in response to market and economic conditions may materially adversely affect our business and results of operations.

Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for our competitors. For example, the Dodd-Frank Act in particular represented a significant overhaul of many aspects of the regulation of the financial services industry, some of which have yet to be implemented. In addition, because regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal or state regulation of financial institutions may change in the future and impact our operations. Recent and forthcoming changes to banking regulations may impact the profitability of our business activities, require changes to some of our business practices, or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. It may also require us to hold higher levels of regulatory capital and/or liquidity and it may cause us to adjust our business strategy and limit our future business opportunities. We cannot predict the effects of future legislation and new or revised regulations on us, our competitors, or on the financial markets and economy, although they may significantly increase costs and impede the efficiency of our internal business processes.

Changes in local, national, or global economic and political conditions could adversely affect results of operations by affecting deposits and loan demand, credit quality and our relationships with vendors.

Our success depends to a significant extent upon local, national, and, to a lesser extent, global economic and political conditions. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy, government budget deficits, slowing gross domestic product, tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, military hostilities, terrorism, trade wars, economic sanctions, and other factors beyond our control may adversely affect our deposit levels and composition, the quality of investment securities in our portfolio or available for purchase, demand for loans, the ability of our borrowers to repay their loans, the value of the collateral securing loans, and the ability of our vendors to perform according to contractual requirements. Recent political and military developments in Russia, Ukraine, and elsewhere may result in substantial changes in economic and political conditions for the U.S. and the remainder of the world. Disruptions in U.S. and global financial markets, and changes in global oil production and supply in the Middle East and Russia, also affect the economy and stock prices in the U.S., which can affect our earnings, capital, the ability of our customers to repay loans, and other aspects of our operations.

Inflation could negatively impact our business and our profitability.

Significant or prolonged inflation may impact our profitability by negatively impacting our fixed costs and expenses, including increasing funding costs and executive and other employee compensation expense, and negatively impacting the demand for banking products and services. Additionally, inflation may lead to a decrease in client purchasing power and negatively affect the need or demand for loans or deposit accounts. If significant inflation continues, our business could also be negatively affected by, among other things, increased loan default and losses. If we experience such effects of inflation, our results of operations could suffer.

ESG risks could adversely affect our reputation and shareholder, employee, client and third party relationships.

As a publicly traded company, we face increasing public scrutiny related to ESG activities. If we fail to act responsibly in areas, such as DEI, environmental stewardship, human capital management, support for our local communities, corporate governance, and transparency, or fail to consider ESG factors in our business operations, our reputation may be adversely affected. Furthermore, as a result of the diversity of our clients and business partners, we may face negative publicity because of the identity of our clients or business partners and the public’s view of those entities. Additionally, we may face pressure to not do business in certain industries that are viewed as harmful to the environment or are otherwise negatively perceived, which could impact our growth. If we, or our clients or business partners, become the subject of such negative publicity, our ability to attract and retain clients, employees, and business partners, may be negatively impacted, which could affect our results of operation or growth prospects.

Additionally, investors and shareholder advocates are increasing their emphasis on how corporations address ESG issues in their business strategies.

An economic downturn could have a material adverse effect on our capital, financial condition, results of operations, and future growth.

We monitor market conditions and economic factors throughout, and beyond, our geographic markets. If economic conditions were to worsen nationally, regionally, or locally, we could experience a decline in credit quality and loan and deposit demand. Such declines could negatively affect our business and have a material adverse effect on our capital, financial condition, results of operations, and future growth. In addition, international economic and political uncertainty could impact the U.S. financial markets by potentially suppressing stock prices, including ours, and adding to overall market volatility, which could adversely affect our business. The effects of any economic downturn on our business could continue for many years after the downturn is considered to have ended.

We may incur losses if asset values decline, including due to changes in interest rates and prepayment speeds.

We have a large portfolio of financial instruments, including loans and loan commitments, debt securities, and certain other assets and liabilities that we measure at fair value that are subject to valuation and impairment assessments. We determine these values based on applicable accounting guidance. For financial instruments measured at fair value, this requires us to base fair value on exit price and to maximize the use of observable inputs and minimize the use of unobservable inputs in fair value measurements. The fair values of financial instruments include adjustments for market liquidity, credit quality, and other transaction-specific factors, if appropriate. Gains or losses on these instruments can have a direct impact on our results of operations. Increases in interest rates or changes in spreads may adversely impact the fair value of loans or debt securities and, accordingly, for debt securities classified as available for sale, may adversely affect accumulated other comprehensive income and, thus, capital levels. These market factors also may adversely impact the value of debt securities we hold to meet regulatory liquidity requirements. Decreases in interest rates may increase prepayments of certain assets, and, therefore, may adversely affect net interest income.

Technological changes, including online and mobile banking, have the potential of disrupting our business model, and we may have fewer resources than many competitors to invest in technological improvements.

The financial services industry continues to undergo rapid technological changes with frequent introductions of new technology-driven products and services, including mobile and online banking services. Changes in customer behaviors have increased the need to offer these options to our customers. In addition to serving clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to invest in and use technology to provide products and services that provide convenience to customers and to create additional efficiencies in our operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services in a timely manner in response to changes in customer behaviors, thus adversely impacting our operations. Many of our competitors have substantially greater resources to invest in technological improvements and banking regulators may permit emerging technology companies to engage in activities previously reserved to traditional commercial banks. Such competition could adversely affect our performance and results of operations.

Changes in accounting standards may affect our performance.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, there are changes in the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and statements of operations. Future changes in financial accounting and reporting standards could require us to apply a new or revised standard retroactively, which could result in a material adverse effect on our financial condition or could even require us to restate prior period financial statements.

We face risks related to our operational, technological, and organizational infrastructure.

Our ability to grow and compete is dependent on our ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while we expand. Similar to other financial institutions, our operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or outside persons, and exposure to external events. We are dependent on our operational infrastructure to help manage these risks. In addition, we are heavily dependent on the strength and capability of our technology systems, which we use both to interface with our customers and to manage our internal financial and other systems. Our ability to develop and deliver new products that meet the needs of our existing customers and attract new ones depends on the functionality of our technology systems.

Risks Related to Our Securities

A vibrant public trading market for our common stock has not and may not develop, which may hinder your ability to sell the common stock and may lower the market price of the stock.

Our common stock is quoted and traded on Nasdaq under the symbol “BAFN.” However, this listing has not yet resulted in a substantially liquid market for our common stock. We cannot be certain if or when such a market may develop. Accordingly, investors should consider the potential illiquid and long-term nature of an investment in our common stock. You may, therefore, be required to bear the risks of this investment for an indefinite period of time.

Shareholders may face dilution resulting from the issuance of common stock in the future.

We may issue common stock without shareholder approval, up to the number of authorized shares set forth in our Articles of Incorporation. Our Board may determine, from time to time, a need to obtain additional capital through the issuance of additional shares of common stock or other securities. There can be no assurance that such shares will be issued at prices or on terms better than or equal to historical prices or terms. The issuance of any additional shares of common stock by us in the future may result in a reduction of the book value or market price, if any, of the then-outstanding common stock. Issuance of additional shares of common stock will reduce the proportionate ownership and voting power of our existing shareholders.

The price of our common stock could be volatile.

The market price of our common stock may be volatile and could be subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include, among other things: variations in our quarterly results of operations; recommendations by securities analysts; performance of other companies that investors deem comparable to us; economic factors unrelated to our performance; general market conditions; and changes in government regulations. In addition, if the market for stocks in our industry, or the stock market in general, experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition, or results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.

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

An investment in our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC. Investment in our common stock is inherently risky for the reasons described herein, and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you could lose some or all of your investment.

Owning our stock will not give you the right to participate in any future offerings of our capital stock and your ownership could be diluted.

As a shareholder, you are not automatically entitled to purchase additional shares of common stock in future issuances of our common stock; therefore, you may not be able to maintain your current percentage of ownership in BayFirst. If we decide to issue additional shares of common stock or conduct an additional offering of stock, your ownership in BayFirst could be diluted and your potential share of future profits may be reduced.

Management has broad discretion concerning the use of our capital.

We use our capital to maintain liquidity and to continue to support the growth of the Bank. This growth may include the opening of branch offices, increasing the size and volume of loans, or other such activities that may require additional capital. Capital may also be used to service our outstanding debt. Our management may determine that it is in the best interest of the Company or the Bank to apply our capital in a manner that is inconsistent with a shareholder’s wishes. Failure to use such funds effectively might harm your investment.

If equity research analysts do not publish research or reports about our business, or if they do publish such reports but issue unfavorable commentary or downgrade our common stock, the price and trading volume of our common stock could decline.

The trading market for our common stock could be affected by whether and to what extent equity research analysts publish research or reports about us and our business. We cannot predict at this time whether any research analysts will cover us and our common stock or whether they will publish research and reports on us. The price of our stock could decline if one or more securities analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us. If any of the analysts who elect to cover us downgrade their recommendation with respect to our common stock, our stock price could decline rapidly. If any of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our common stock price or trading volume to decline and our common stock to be less liquid.

Our Board of Directors owns a significant percentage of our shares and will be able to make decisions to which you may be opposed.

As of December 31, 2022, BayFirst’s directors and named executive officers as a group owned approximately 14.98% of our outstanding common stock. In addition, the directors and named executive officers have stock options to acquire shares of common stock, which, if fully exercised within sixty days of December 31, 2022, would have resulted in them owning approximately 19.41% of our outstanding common stock. Our directors and executive officers are expected to exert a significant influence on the election of Board members and on the direction of the Company. This influence could negatively affect the price of our shares or be inconsistent with other shareholders’ desires.

We have outstanding preferred stock and our Board may authorize the issuance of additional series of preferred stock.

We have 1,000,000 shares of authorized preferred stock, no par value. Of those, 10,000 shares have been designated as Series A Preferred Stock, of which 6,395 shares were outstanding as of December 31, 2022, with a $1,000 liquidation preference and a 9% (subject to increase to 11% if we have not redeemed the shares by the tenth anniversary of their issuance in 2019) per annum quarterly dividend. We also have 20,000 authorized shares of Series B Convertible Preferred Stock, of which 3,210 shares were outstanding as of December 31, 2022, with a $1,000 liquidation preference and an 8% per annum dividend (subject to increase to 9% if we have not redeemed the shares by the tenth anniversary of their issuance in 2020 and 2021), which is otherwise on a parity with our Series A Preferred Stock as to priority of dividends and liquidation preference. Additionally, our Articles of Incorporation provide that our Board of Directors may authorize additional series of preferred stock without shareholder approval. Accordingly, the issuance of new shares of preferred stock may adversely affect the rights of the holders of shares of our common stock.

BayFirst has outstanding debt and either BayFirst or the Bank may incur additional debt.

BayFirst has outstanding debt and either BayFirst or the Bank may incur additional debt. At December 31, 2022, BayFirst had a $2.84 million term loan and $5.99 million in subordinated debt. BayFirst’s obligation to make payments on its debt will reduce the amount of cash available to BayFirst to pay dividends on its common stock. Either or both of BayFirst or the Bank may issue additional debt. Payments due on such debt will further reduce the amount of money available to BayFirst to pay dividends on its common stock.

We are restricted by law and government policy in our ability to pay dividends to our shareholders.

Holders of shares of our capital stock are only entitled to receive such dividends as our Board may declare out of funds legally available for such payments. Although we have recently declared cash dividends on our common stock, we are not required to do so and may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock. Furthermore, the terms of our subordinated debt and the preferred stock will prohibit us from declaring or paying any dividends on any junior series of our capital stock, including our common stock, or from repurchasing, redeeming or acquiring such junior stock, unless we have declared and paid full dividends on our outstanding preferred stock for the most recently completed dividend period. The holders of our outstanding Series A Preferred Stock are entitled to receive quarterly cash dividends at 9% per annum (subject to increase to 11% if we have not redeemed the shares by the tenth anniversary of their issuance in 2019) and the holders of our Series B Convertible Preferred Stock are entitled to receive quarterly cash dividends at 8% per annum (subject to increase to 9% if we have not redeemed the shares by the tenth anniversary of their issuance in 2020 and 2021). Additionally, our Articles of Incorporation provide that our Board of Directors may authorize and issue additional series of preferred stock without shareholder approval. Any preferred shares issued in the future may further restrict our ability to declare or pay dividends on any junior stock, including the common stock.

We are also subject to state and federal statutory and regulatory limitations on our ability to pay dividends on our capital stock. For example, it is the policy of the Federal Reserve that bank holding companies should generally pay dividends on common stock only out of earnings, and only if prospective earnings retention is consistent with the organization’s expected future needs, asset quality and financial condition. Moreover, the Federal Reserve will closely scrutinize any dividend payout ratio exceeding 30% of after-tax net income. You should not purchase common stock if you will need or expect an investment that pays dividends.

We are an emerging growth company, and the reduced disclosure requirements applicable to emerging growth companies may make our common stock less attractive to investors.

We are an emerging growth company, as defined in the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies. These include not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We may take advantage of these exemptions until we are no longer an emerging growth company, which could be as long as five full fiscal years following the initial listing of our common stock on Nasdaq. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the price of our common stock may be more volatile.

Further, the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies are required to comply with the new or revised financial accounting standards. The JOBS Act provides that an emerging growth company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. We have not opted out of such extended transition period. This means that when a standard is issued or revised and it has different application dates for public business entities or non-public business entities we, as an emerging growth company, can adopt the new or revised standard at the time non-public entities do so. This may make our financial statements not comparable with those of public companies which are neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period because of the potential differences in accounting standards used.

We are a smaller reporting company and are exempt from certain disclosure requirements, which could make our common stock less attractive to potential investors.

We are a smaller reporting company, as defined under the Exchange Act, and may continue to be so after we no longer qualify as an emerging growth company. As a smaller reporting company, we will: (i) not be required and may not include a Compensation Discussion and Analysis section in our proxy statements, (ii) provide only two years of financial statements; and (iii) not need to provide a table of selected financial data. We also will have other scaled disclosure requirements that are less comprehensive than issuers that are not smaller reporting companies which could make our common stock less attractive to potential investors. We cannot predict if investors will find our common stock less attractive as a result of our reliance on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the price of our common stock may be more volatile.

Certain provisions of Florida and federal law may discourage or prevent a takeover of BayFirst and result in a lower market price for our common stock.

Florida and federal law contain anti-takeover provisions that apply to us. These provisions could discourage potential buyers from seeking to acquire us in the future, even if the proposed transaction would allow shareholders to realize a premium for their shares and even if a majority of our shareholders wish to participate in such a transaction. As a result, these provisions could also adversely affect the market price of our common stock.

Our fractional shares may be difficult to sell and you may be required to indefinitely hold a fractional share.

We have issued, and may continue to issue, fractional shares of our common stock. Although the owner of a fractional share will have all the rights of a shareholder, it may be difficult to sell a fractional share of BayFirst common stock. Established trading markets and exchanges, such as Nasdaq, do not permit the trading of fractional shares. Certain brokers do facilitate the trading of fractional shares, but we can offer no assurances as to whether any specific broker does. If you want to sell a fractional share and cannot identify a broker to facilitate such a trade, you will have to hold that fractional share until you identify a private buyer for it. If you cannot locate a private buyer, you will have to hold that fractional share indefinitely.

The following table contains information concerning the current and intended locations of the Bank’s full-service banking centers. The Bank also operates 1 loan production office located in Sarasota.

In addition, the Bank acquired the following properties to be used as full-service banking centers.

In the normal course of business, the Company is named or threatened to be named as a defendant in various lawsuits, none of which they expect to have a material effect on the Company. However, given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to its business (including laws and regulations governing consumer protection, fair lending, fair labor, privacy, information security, anti-money laundering and anti-terrorism), the Company, like all banking organizations, is subject to heightened legal and regulatory compliance and litigation risk. There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or to which its property is the subject.

The following discussion is an analysis of the results of operations for the fiscal years ended December 31, 2022 and December 31, 2021 and financial condition as of December 31, 2022 and December 31, 2021. This discussion and analysis should be read in conjunction with the consolidated financial statements and related notes.

In addition to the historical information contained herein, this Form 10-K includes "forward-looking statements" within the meaning of such term in the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic, global military hostilities, or climate changes, including its effects on the economic environment, its customers and its operations, as well as any changes to federal, state or local government laws, regulations or orders in connection with them; the ability of the Company to implement its strategy and expand its banking operations; changes in interest rates and other general economic, business and political conditions, including changes in the financial markets or global military hostilities; changes in business plans as circumstances warrant; risks related to mergers and acquisitions; changes in benchmark interest rates used to price loans and deposits, changes in tax laws, regulations and guidance; and other risks detailed from time to time in filings made by the Company with the SEC. Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements.

Forward-looking statements generally can be identified by the use of forward-looking terminology such as "will," "propose," "may," "plan," "seek," "expect," "intend," "estimate," "anticipate," "believe," "continue," or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and the Company does not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise.

Selected Financial Data - Unaudited

(Dollars in thousands, except per share data)

32

(Dollars in thousands, except per share data)

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

Some of the financial measures included in this report are not measures of financial condition or performance recognized by GAAP. These non-GAAP financial measures include tangible common shareholders' equity and tangible book value per common share. The management team uses these non-GAAP financial measures in its analysis of its performance, and they believe that providing this information to financial analysts and investors allows them to evaluate capital adequacy.

The following presents these non-GAAP financial measures along with their most directly comparable financial measures calculated in accordance with GAAP:

Tangible Common Shareholders' Equity and Tangible Book Value Per Common Share

(Dollars in thousands, except per share data)

(Unaudited)

(Unaudited)

(Unaudited)

Application of Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in accordance with GAAP requires the Company to make estimates and judgments that affect reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases those estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates.

Accounting policies, as described in detail in the notes to the Company’s consolidated financial statements, are an integral part of the Company’s consolidated financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and financial position. Management believes that the critical accounting policies and estimates listed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. At December 31, 2022, the most critical of these significant accounting policies in understanding the estimates and assumptions involved in preparing the consolidated financial statements were the policies related to the allowance for loan losses, and fair value measurement of investment securities, SBA servicing rights and SBA loans held for investment at fair value, which are discussed more fully below.

Allowance for Loan Losses

The allowance for loan losses is calculated with the objective of maintaining a reserve sufficient to absorb estimated losses. Management's determination of the appropriateness of the allowance is based on periodic evaluations of the loan portfolio, lending-related commitments, and other relevant factors. This evaluation is inherently subjective as it requires numerous estimates, including the loss content for internal risk ratings, collateral values, and the amounts and timing of expected future cash flows. In addition, management may include qualitative adjustments intended to capture the impact of other uncertainties in the lending environment such as underwriting standards, current economic and political conditions, and other factors affecting the credit quality. Changes to one or more of the estimates used could result in a different estimated allowance for loan losses.

Fair Value Measurements

Investments and certain SBA loans are recorded at fair value on a recurring basis. Additionally, from time to time, other assets and liabilities may be recorded at fair value on a nonrecurring basis, such as impaired loans, other real estate, SBA servicing rights, and certain other assets and liabilities. Fair value is an estimate of the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (i.e., not a forced transaction, such as a liquidation or distressed sale) between market participants at the measurement date and is based on the assumptions market participants would use when pricing an asset or liability. Fair value measurement and disclosure guidance establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. Valuations generated from model-based techniques that use at least one significant assumption not observable in the market are considered Level 3 and reflect estimates of assumptions market participants would use in pricing the asset or liability.

Changes in these estimates that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, could have a material impact on the Company’s financial position or results of operation.

Further, the Company is an emerging growth company. The JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies are required to comply with the new or revised financial accounting standards. The JOBS Act provides that an emerging growth company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. The Company has elected to take advantage of this extended transition period. This means that when a standard is issued or revised and it has different application dates for public or private companies, the Company, as an emerging growth company, can adopt the new or revised standard at the time private companies do so. This may make the Company’s financial statements not comparable with those of public companies which are neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period because of the potential differences in accounting standards used.

Overview

The following discussion and analysis presents the financial condition and results of operations on a consolidated basis. However, because the Company conducts all of its material business operations through the Bank, the discussion and analysis relates to activities primarily conducted at the subsidiary level. The following discussion should be read in conjunction with the consolidated financial statements.

As a one-bank holding company, the Company generates most of its revenue from interest on loans and gain-on-sale income derived from the sale of loans into the secondary market. The primary source of funding for its loans is deposits. The Company is dependent on noninterest income, which is derived primarily from net gain on the sales of the guaranteed portion of government guaranteed loans. The largest expenses are interest on those deposits and borrowings, professional fees, and salaries and commissions plus related employee benefits. The Company measures its performance through its net interest income after provision for loan losses, return on average assets, and return on average common equity, while maintaining appropriate regulatory leverage and risk-based capital ratios.

Recent Developments

First Quarter Common Stock Dividend. On January 24, 2023, BayFirst’s Board of Directors declared a first quarter 2023 cash dividend of $0.08 per common share, payable March 15, 2023 to common shareholders of record as of March 1, 2023. This dividend marks the 27th consecutive quarterly cash dividend paid since BayFirst initiated cash dividends in 2016.

First Quarter Preferred Series A Stock Dividend. BayFirst’s Board of Directors declared a quarterly cash dividend of $22.50 on the Series A Preferred Stock. The dividend will be payable April 3, 2023 to shareholders of record as of January 16, 2023. The amount and timing of the dividend is in accordance with the terms of the Series A Preferred Stock.

First Quarter Preferred Series B Stock Dividend. BayFirst’s Board of Directors declared a quarterly cash dividend of $20.00 on the Series B Convertible Preferred Stock. The dividend will be payable April 3, 2023 to shareholders of record as of January 16, 2023. The amount and timing of the dividend is in accordance with the terms of the Series B Convertible Preferred Stock.

Management Succession. On February 6, 2023, BayFirst Financial Corp. issued a press release announcing that Anthony N. Leo will retire as Chief Executive Officer at the end of 2023. Leo will remain a Director of the Company and will also serve as Special Counsel for strategic matters. The Board of Directors has appointed Thomas G. Zernick to succeed Leo as Chief Executive Officer on January 1, 2024. He was also appointed to serve as a Director of the Company. Zernick has served as President of the Company since February 2022, and previously served as President of its CreditBench Division, which provides government guaranteed lending to businesses throughout the nation. He joined the Company in 2016.

Stock Repurchase Program. On February 28, 2023, the Board of Directors approved the Company’s 2023 Stock Repurchase Program (“Program”). The Program permits the Company to repurchase up to $1,000,000 of the Company’s issued and outstanding common stock. The Program will continue until the earlier of: (i) the date an aggregate of $1,000,000 of common stock has been repurchased; (ii) December 31, 2023; or (iii) the termination of the plan by the Board of Directors.

Results of Operations

BayFirst’s operating results depend on its net interest income, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities, consisting primarily of deposits. Net interest income is determined by the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (“interest rate spread”) and the relative amounts of interest-earning assets and interest-bearing liabilities. The interest rate spread is affected by regulatory, economic, and competitive factors which influence interest rates, loan demand, and deposit flows. In addition, its operating results can be affected by the level of nonperforming assets, as well as the level of the noninterest income and the noninterest expenses, such as salaries and employee benefits, and occupancy and equipment costs, as well as income taxes.

The Company is dependent on noninterest income, which is derived primarily from net gain on the sales of the guaranteed portion of government guaranteed loans, as well as fair value adjustments for certain loans which management has elected the fair value option. While the Company retains some of its government guaranteed loans on the balance sheet, we may sell both the guaranteed balance of its government guaranteed loans, as well as a percentage of the unguaranteed portions of such loans. The sale of the guaranteed portions of the loans generates noninterest income.

In the second quarter of 2022, the Bank discontinued its primary consumer direct residential mortgage business line. In the third quarter of 2022, management decided to discontinue the nationwide residential lending business. As a result of the discontinuance, the nationwide residential line of business was reclassified as a discontinued operation and reported in the financial statements as such.

Net Income (Loss)

The Company had net loss for the year ended December 31, 2022 of $349 thousand or $0.22 per diluted common share, compared to net income for the year ended December 31, 2021 of $24.6 million or $5.91 per diluted common share. The decrease of $25.0 million from the previous year was primarily due to a decrease of $21.4 million in net income from mortgage banking activity which is a discontinued operation. Additionally, there was a $13.8 million gain on sale of PPP loans in 2021 which did not recur, noninterest expense on continuing operations increased $4.9 million, and PPP fee and interest income decreased $18.3 million. These items were partially offset by an $11.6 million increase in non-PPP loan interest and fee income, a $4.6 million increase in fair value gains related to held for investment SBA loans, and higher gains of $17.5 million on non-PPP SBA loan sales. The decrease in net income from discontinued operations was primarily the result of a decrease in gain on sale of residential mortgage loans of $64.2 million and the recognition of restructuring charges of $4.3 million for the discontinuation of the nationwide residential mortgage division, partially offset by lower noninterest expense of $41.0 million.

Net Interest Income

Net interest income from continuing operations was $30.0 million for the year ended 2022, a decrease of $6.5 million or 17.9% from $36.5 million for the year ended 2021. The decrease was mainly due to a decline in net PPP loan interest income of $18.3 million, partially offset by higher interest income on non-PPP loans of $11.6 million.

Net interest margin including discontinued operations improved to 3.97% for the year ended 2022, compared to 3.23% for the year ended 2021.

Average Balance Sheet and Analysis of Net Interest Income

The following table sets forth, for the periods indicated, information regarding: (i) the total dollar amount of interest and dividend income of BayFirst from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average cost; (iii) net interest income; (iv) interest rate spread; (v) net interest margin; and (vi) ratio of average interest-earning assets to average interest-bearing liabilities. Loans in nonaccrual status, for the purposes of the following computations, are included in the average loan balances. FRB, FHLB, and FNBB restricted equity holdings are included in other interest-earning assets. The Company did not have a significant amount of tax-exempt assets.

(Dollars in thousands)

Rate/Volume Analysis

The table below presents the effects of volume and rate changes on interest income and expense for the periods indicated. Changes in volume are changes in the average balance multiplied by the previous period’s average rate. Changes in rate are changes in the average rate multiplied by the average balance from the previous period. The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB, FHLB, and FNBB restricted equity holdings are included in other interest-earning assets. The Company did not have a significant amount of tax-exempt assets.

(Dollars in thousands)

Provision for Loan Losses

The provision for loan losses is charged to operations to increase the total allowance to a level deemed appropriate by management and is based upon the volume and type of lending the Bank conducts, industry standards, the amount of nonperforming loans, general economic conditions, particularly as they relate to its market area, and other factors that may affect the ability to collect on the loans in its portfolio.

As the financial impact of the COVID-19 pandemic became more predictable throughout 2021 and 2022, the Company began adjusting downward its allowance for loan losses from the historic high levels reached in 2020 at the onset of the pandemic. The Company recorded a negative provision for loan losses for the year ended December 31, 2022 of $700 thousand compared to a $3.5 million negative provision for the year ended December 31, 2021. The increase of $2.8 million in the provision for loan losses expense was primarily due to the loan growth. During the year ended December 31, 2022, net loan charge offs totaled $3.7 million compared to $4.2 million during the year ended December 31, 2021.

The ALLL was $9.0 million at December 31, 2022 and $13.5 million at December 31, 2021.

Noninterest Income

The following table presents noninterest income from continuing operations for the years ended December 31, 2022 and December 31, 2021.

(Dollars in thousands)

Noninterest income from continuing operations was $31.6 million for the year ended December 31, 2022, an increase of $9.6 million or 43.6% from $22.0 million for the year ended December 31, 2021. The increase was primarily due to higher gains on the sale of non-PPP SBA loans of $17.5 million and an increase related to held for investment SBA loan fair value gains of $4.6 million, partially offset by the $13.8 million gain on sale of PPP loans in 2021 which did not recur.

Noninterest Expense

The following table presents noninterest expense from continuing operations for the years ended December 31, 2022 and December 31, 2021.

(Dollars in thousands)

Noninterest expense was $55.2 million during the year ended December 31, 2022, an increase of $4.9 million or 9.8% from $50.3 million for the year ended December 31, 2021. The increase was primarily due to higher salaries and benefits, occupancy expense, and loan origination and collection expense.

Discontinued Operations

Net loss from discontinued operations was $5.8 million for the year 2022, which was a $21.4 million reduction from net income of $15.6 million for the year ended 2021. The reduction in net income was primarily the result of a decrease in residential loan fee income of $64.2 million and the restructuring charges for the discontinuation of residential mortgage division of $4.3 million recognized in 2022. This was partially offset by a $41.0 million decrease in noninterest expense excluding the restructuring charge and a decrease in income tax expense of $7.1 million.

Income Taxes

Income tax expense from continuing operations was $1.6 million for the year ended December 31, 2022, a decrease of $1.1 million from income tax expense of $2.7 million for the year ended December 31, 2021. The decrease was primarily due to the decrease in pre-tax earnings from continuing operations. Income tax benefit from discontinued operations was $1.9 million for the year ended December 31, 2022, a change of $7.1 million from income tax expense of $5.2 million for the year ended December 31, 2021. The change was primarily due to the decrease in pre-tax earnings from discontinued operations.

At December 31, 2022, the Company had $2.2 million of federal net operating loss carryforward and $362 thousand of state net operating loss carryforward. The net operating loss carryforwards do not expire. At December 31, 2021, the Company did not have any net operating loss carryforward.

The effective income tax rate was 51.60% for the year ended December 31, 2022 and 24.20% for the year ended December 31, 2021.

Financial Condition

Investment Securities

The following table presents the fair value of the Company's investment securities portfolio classified as available for sale as of December 31, 2022 and December 31, 2021.

(Dollars in thousands)

The following table presents the fair value of the Company's investment securities portfolio classified as held to maturity as of December 31, 2022 and December 31, 2021.

(Dollars in thousands)

No investment securities were pledged as of December 31, 2022 or December 31, 2021, and there were no sales of investment securities during the year ended December 31, 2022 or the year ended December 31, 2021.

During the second quarter of 2022, the Company transferred a $1.5 million previously designated available for sale investment security to a held to maturity designation at estimated fair value. The reclassification was permitted as the Company has appropriately determined the ability and intent to hold the investment security as an investment until maturity or call. The investment security had no unrealized net gain or loss at the time of transfer since it was purchased near the end of the first quarter of 2022.

The investment securities available for sale presented in the following tables are reported at amortized cost and by contractual maturity as of December 31, 2022 and December 31, 2021. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below.

(Dollars in thousands)

(Dollars in thousands)

The investment securities held to maturity presented in the following tables are reported at amortized cost and by contractual maturity as of December 31, 2022 and December 31, 2021. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities receive monthly principal payments, which are not reflected below.

(Dollars in thousands)

(Dollars in thousands)

Loan Portfolio Composition

Through the efforts of the management team and loan officers, strong loan production resulted from its ability to take advantage of the economic recovery and consolidation in its markets. Senior management and loan officers have continued to develop new sources of loan referrals, particularly among centers of local influence and real estate professionals, and have also enjoyed repeat business from loyal customers in the markets the Bank serves. The Bank has no concentration of credit in any industry that represents 10% or more of its loan portfolio. The following table sets forth the composition of its loan portfolio, including LHFS as of the dates indicated.

(Dollars in thousands)

42

In general, construction loans are originated as construction-to-permanent loans. Third party take-out financing, where applicable, is typically in the form of permanent first mortgage conforming loans.

During the year ended December 31, 2022, the Bank originated approximately $254.9 million in loans through conventional lending channels, $386.0 million in loans through CreditBench (its SBA lending function), and $946.1 million through the Residential Mortgage Lending Division. During the year ended December 31, 2021, the Bank originated approximately $94.9 million in loans through conventional lending channels, $169.5 million through CreditBench, exclusive of PPP loans, $329.3 million of PPP loans, and $2.22 billion through the Residential Mortgage Lending Division. During the year ended December 31, 2022, the Company sold guaranteed balances of SBA loans of $311.8 million. Additionally, the Company purchased $16.6 million of government guaranteed loans and $37.2 million of consumer loans.

Loan Maturity/Rate Sensitivity

The following table shows the contractual maturities of our loans at December 31, 2022. Loan balances in this table include loans held for investment at fair value, loans held for investment at amortized cost, discount on retained balances of loans sold, premium and discount on loans purchased, and deferred loan costs, net.

(Dollars in thousands)

The following table shows the loans with contractual maturities of greater than one year that have fixed or adjustable interest rates at December 31, 2022.

(Dollars in thousands)

Credit Risk

The Bank’s primary business is making commercial, consumer, and real estate loans. This activity inevitably has risks for potential loan losses, the magnitude of which depends on a variety of economic factors affecting borrowers, which are beyond its control. The Bank has developed policies and procedures for evaluating the overall quality of its credit portfolio and the timely identification of potential problem loans. Management’s judgment as to the adequacy of the allowance is based upon a number of assumptions about the economic environment that it believes impacts credit quality as of the balance sheet date that it believes to be reasonable, but which may or may not prove accurate. Thus, there can be no assurance that charge-offs in future periods will not exceed the ALLL, or that additional increases in the ALLL will not be required.

Allowance for Loan Losses. The Bank must maintain an adequate ALLL based on a comprehensive methodology that assesses the probable losses inherent in its loan portfolio. The Bank maintains an ALLL based on a number of quantitative and qualitative factors, including levels and trends of past due and nonaccrual loans, asset classifications, loan grades, change in volume and mix of loans, collateral value, historical loss experience, size and complexity of individual credits, and economic conditions. Provisions for loan losses are provided on both a specific and general basis. Specific allowances are provided for impaired credits for which the expected/anticipated loss is measurable. General valuation allowances are determined by a portfolio segmentation based on collateral type with a further evaluation of various quantitative and qualitative factors noted above.

The Bank periodically reviews the assumptions and formulates methodologies by which changes are made to the specific and general valuation allowances for loan losses in an effort to refine such allowances in light of the current status of the factors described above. The methodology is presented to and approved by the Bank’s Board of Directors.

All adversely classified loans are evaluated for impairment. If a loan is deemed impaired, it is evaluated for potential loss exposure. The evaluation occurs at the time the loan is classified and on a regular basis thereafter (at least quarterly). This evaluation is documented in a status report relating to a specific loan or relationship. Specific allocation of reserves on impaired loans considers the value of the collateral, the financial condition of the borrower, and industry and current economic trends. The Bank reviews the collateral value, cash flow, and tertiary support on each impaired credit. Any deficiency outlined by a real estate collateral evaluation analysis, or cash flow shortfall, is accounted for through a specific allocation for the loan.

For performing loans which are evaluated collectively, a portfolio segmentation based on loan type is performed. The government guaranteed loan balances are included in the collectively evaluated portfolio balances. The loss factors for each segment are calculated using actual loan loss history for each segment of loans over the most recent one to three years, depending on the segment and vintage year of the loans in the segment of government guaranteed loans. The Bank’s actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.

These economic factors include consideration of the following: levels of, and trends in delinquencies and impaired loans; levels of, and trends in charge-offs and recoveries; migration of loans to the classification of special mention, substandard, or doubtful; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentration.

While management believes its ALLL is adequate as of December 31, 2022, future adjustments to its allowance may be necessary if economic conditions differ substantially from the assumptions used in making the determination.

Nonperforming Assets. At December 31, 2022, we had $3.7 million in nonperforming assets, excluding government guaranteed loan balances, and its ALLL represented 1.29% of total loans held for investment at amortized cost. At December 31, 2021, we had $4.0 million in nonperforming assets, excluding government guaranteed loan balances, and its ALLL represented 2.34% of total loans held for investment at amortized cost. Total loans held for investment at December 31, 2022 and December 31, 2021 included government guaranteed loans and loans measured at fair value, which had no reserves allocated to them. ALLL as a percentage of loans held for investment at amortized cost, not including government guaranteed loan balances, was 1.62% at December 31, 2022, compared to 4.07% at December 31, 2021. The decrease was the result of the reduction in qualitative factors which were elevated as a result of the uncertainty of the impact of the COVID-19 pandemic.

The following table sets forth certain information on nonaccrual loans and foreclosed assets, the ratio of such loans and foreclosed assets to total assets as of the dates indicated, and certain other related information.

(Dollars in thousands)

The following table sets forth information with respect to activity in the ALLL for the periods shown:

(Dollars in thousands)

45

The following table details net charge-offs to average loans outstanding by loan category for the years ended December 31, 2022 and December 31, 2021.

(Dollars in thousands)

The Bank recorded a negative provision of $700 thousand during the year ended December 31, 2022, compared to a negative provision of $3.5 million for the same period in 2021. During 2020 and the first quarter of 2021, the Bank increased the qualitative factors in the allowance for loan losses calculation to reflect the decline in economic indicators caused by the COVID-19 pandemic, resulting in significant provision expense in those periods. As asset quality has remained stable and as many of the Company’s SBA loans were bolstered by additional government support, the current year decrease in the allowance is deemed appropriate. Since 2016, the Company’s loan losses have been incurred primarily in its SBA unguaranteed loan portfolio, particularly loans originated under the SBA 7(a) Small Loan Program. The Small Loan Program represents loans of $350 thousand or less and such loans carry an SBA guarantee of 75% to 90% of the loan, depending on the original principal balance. The default rate on loans originated in the SBA 7(a) Small Loan Program is significantly higher than the Bank’s other SBA 7(a) loans, conventional commercial loans, or residential mortgage loans.

Nonperforming assets to total assets, excluding government guaranteed loan balances, were 0.40% as of December 31, 2022, as compared to 0.43% as of December 31, 2021. Since the majority of the Company’s loan portfolio consisted of SBA loans, most of which received from the SBA principal and interest payments under Section 1112 of the CARES Act during 2020 and 2021, asset quality trends may appear more favorable than they otherwise would without the SBA’s support under the CARES Act. As of December 31, 2022, there were no loans under payment deferral as a result of COVID-19 pandemic.

SBA and Other Government Guaranteed Loans

The following table sets forth, for the periods indicated, information regarding the SBA and other government guaranteed lending activity, excluding PPP loans.

(Dollars in thousands)

46

The Bank makes government guaranteed loans throughout the United States. The following table sets forth, at the dates indicated, information regarding the geographic disbursement of its SBA loan portfolio. The “All Other” category includes states with less than 5% in any period presented.

(Dollars in thousands)

Residential Mortgage Loans

The following table sets forth, for the periods indicated, information regarding the residential mortgage lending activity from discontinued operations.

(Dollars in thousands)

Deposits

General. In addition to deposits, sources of funds available for lending and for other purposes include loan repayments and proceeds from the sales of loans. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are influenced significantly by general interest rates and market conditions. Borrowings, as well as available lines of credit, may be used on a short-term basis to compensate for reductions in other sources, such as deposits at less than projected levels.

Deposits. Deposits are sourced principally from within its primary service area of Pinellas, Hillsborough, Manatee, Pasco, and Sarasota Counties, Florida. The Bank offers a wide selection of deposit instruments including demand deposit accounts, NOW accounts, money-market accounts, regular savings accounts, certificate of deposit accounts, and retirement savings plans (such as IRA accounts).

Certificate of deposit rates are set to encourage longer maturities as cost and market conditions will allow. Deposit account terms vary, with the primary differences being the minimum balance required, the time period the funds must remain on deposit and the interest rate. The Bank emphasizes commercial banking relationships in an effort to increase demand deposits as a percentage of total deposits. Deposit interest rates are set by management at least monthly or more often if conditions require it, based on a review of loan demand, recent cash flows and a survey of rates among competitors.

Brokered deposits. At times, the Bank has brokered time deposit and non-maturity deposit relationships available to diversify its funding sources. Brokered deposits offer several benefits relative to other funding sources, such as: maturity structures which cannot be duplicated in the current retail market, deposit gathering outside the market of the existing deposit base, the unsecured nature of these liabilities, and the ability to quickly generate funds. The Bank’s internal policy limits the use of brokered deposits as a funding source to no more than 15% of total assets. The Company's ability to accept or renew brokered deposits is contingent upon the Bank maintaining a capital level of "well capitalized." At December 31, 2022 and December 31, 2021, the Company had $746 thousand and $759 thousand, respectively, of brokered deposits.

The amount of each of the following categories of deposits, at the dates indicated, are as follows:

(Dollars in thousands)

At December 31, 2022, the Company held approximately $308.4 million of deposits that exceeded the FDIC insurance limit.

The following table provides information on the maturity distribution of the time deposits exceeding the FDIC insurance limit of $250 thousand as of December 31, 2022.

(Dollars in thousands)

Other Borrowings

At December 31, 2022, the Company had short-term FRB borrowings of $25.0 million at 4.50% and no borrowings from the FHLB. There were no borrowings from the FHLB or FRB at December 31, 2021.

The Bank is a member of the FHLB of Atlanta, which provides short- and long-term funding collateralized by mortgage-related assets to its members. FHLB short-term borrowings bear interest at variable rates set by the FHLB. Any advances that the bank were to obtain would be secured by a blanket lien on $210.8 million of real estate-related loans as of December 31, 2022. Based on this collateral and the Company's holdings of FHLB stock, the Company was eligible to borrow up to an additional $128.6 million from the FHLB at December 31, 2022.

In addition, the Bank has a line of credit with the Federal Reserve Bank secured by $62.5 million of commercial loans as of December 31, 2022. FRB short-term borrowings bear interest at variable rates based on the Federal Open Market Committee's target range for the federal funds rate. Based on this collateral, the Company was eligible to borrow up to an additional $17.0 million from the FRB at December 31, 2022.

In June 2021, the Company issued $6.0 million of Subordinated Debentures (the “Debentures”) that mature June 30, 2031 and are redeemable after five years. The Debentures carry interest at a fixed rate of 4.50% per annum for the initial five years of their term and carry interest at a floating rate for the final five years of their term. Under the terms of the Debentures, the floating rates are based on a SOFR benchmark plus 3.78% per annum. The Debentures were issued to redeem a $6.0 million Subordinated Debenture which was issued in December 2018 and which carried interest at a fixed rate of 6.875% per annum.The balance of Subordinated Debentures outstanding at the Company, net of offering costs, amounted to $6.0 million at December 31, 2022 and December 31, 2021.

In March 2020, the Company renegotiated the terms of its outstanding senior debt and combined its line of credit and term note into one amortizing note with quarterly principal and interest payments with interest at Prime (6.25% at December 31, 2022). The note matures on March 10, 2029 and the balance of the note was $2.8 million and $3.3 million at December 31, 2022 and December 31, 2021, respectively. The note is secured by 100% of the stock of the Company and requires the Company to comply with certain loan covenants during the term of the note.

In April 2020, the Company entered into the Federal Reserve Bank’s PPPLF. Under the PPPLF, advances were secured by pledges of loans to small businesses originated by the Company under the PPP. The PPPLF accrued interest at 0.35% per annum and matured at various dates equal to the maturity date of the PPPLF collateral pledged to secure the advance, and accelerated on and to the extent of any PPP loan forgiveness reimbursement by the SBA for any PPPLF collateral or the date of purchase by the SBA from the borrower of any PPPLF collateral. On the maturity date of each advance, the Company repaid the advance plus accrued interest. The balance outstanding on this facility was $69.7 million at December 31, 2021. In the first quarter of 2022, the Company repaid the remaining balance of the advance.

Capital Resources

Shareholders' equity is influenced primarily by earnings, dividends, the Company's sales and repurchases of its common and preferred stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on available for sale investment securities.

Shareholders' equity decreased $4.4 million to $91.9 million at December 31, 2022 as compared to $96.3 million at December 31, 2021. The decrease was the result of an increase of $3.3 million of accumulated other comprehensive loss due to increases in net unrealized losses on available for sale investment securities, net loss of $349 thousand, dividend declared on its preferred stock of $832 thousand, and dividends declared on its common stock of $1.3 million during the year ended December 31, 2022.

The Company strives to maintain an adequate capital base to support its activities in a safe and sound manner while at the same time attempting to maximize shareholder value. Management assesses capital adequacy against the risk inherent in the balance sheet, recognizing that unexpected loss is the common denominator of risk and that common equity has the greatest capacity to absorb unexpected loss.

The Bank is subject to regulatory capital requirements imposed by various regulatory banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by banking regulators that, if undertaken, could have a direct material effect on BayFirst’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.

In 2020, the Federal banking regulatory agencies adopted a rule to simplify the methodology for measuring capital adequacy for smaller, uncomplicated banks. This CBLR is calculated as the ratio of tangible equity capital divided by average total consolidated assets. CBLR tangible equity is defined as total equity capital, prior to including minority interests, and excluding accumulated other comprehensive income, deferred tax assets arising from net operating loss and tax credit carryforwards, goodwill, and other intangible assets (other than mortgage servicing assets). Under the proposal, a qualifying organization may elect to use the CBLR framework if its CBLR is greater than 9%. The Bank has elected not to use the CBLR framework.

At December 31, 2022 and December 31, 2021, the Bank's capital ratios were in excess of the requirement to be "well capitalized" under the regulatory guidelines.

As of the dates indicated, the Bank met all capital adequacy requirements to which it is subject. The Bank’s actual capital amounts and percentages are as shown in the table below:

(Dollars in thousands)

(1) Minimum to be considered “adequately capitalized” under Basel III Capital Adequacy.

(2) Minimum to be considered “well capitalized” under Prompt Corrective Actions Provisions.

Off-Balance Sheet Arrangements

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments primarily include unfunded loan commitments, unfunded lines of credit, and standby letters of credit. The Bank uses these financial instruments to meet the financing needs of its customers. These financial instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not present unusual risks and management does not anticipate any accounting losses that would have a material effect on the Bank.

A summary of the amounts of the Bank’s financial instruments, with off-balance sheet risk as of the dates indicated, is as follows:

(Dollars in thousands)

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Management evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Bank upon extension of credit is based on management’s credit evaluation of the counterparty.

Standby letters-of-credit are conditional lending commitments that the Bank issues to guarantee the performance of a customer to a third party and to support private borrowing arrangements. Essentially, letters of credit issued have expiration dates within one year of the issue date. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit. The Bank may hold collateral supporting those commitments. Newly issued or modified guarantees that are not derivative contracts have been recorded on the Bank’s balance sheet at their fair value at inception.

In general, loan commitments and letters of credit are made on the same terms, including with respect to collateral, as outstanding loans. Each customer’s creditworthiness and the collateral required are evaluated on a case-by-case basis.

Contractual Obligations

In the ordinary course of its operations, the Company enters into certain contractual obligations. Total contractual obligations at December 31, 2022 were $174.9 million, an increase of $39.9 million from $135.0 million at December 31, 2021. The increase was primarily due to an increase in time deposits of $85.4 million and an increase in short-term FRB borrowings of $25.0 million, partially offset by the payoff of $69.7 million in PPP Liquidity Facility.

The following tables present our contractual obligations as of December 31, 2022 and December 31, 2021.

(Dollars in thousands)

Liquidity

Liquidity management is the process by which the Bank manages the flow of funds necessary to meet its financial commitments on a timely basis and at a reasonable cost to take advantage of earnings enhancement opportunities. These financial commitments include withdrawals by depositors, credit commitments to borrowers, expenses of the operations, and capital expenditures. The Bank generally maintains a liquidity ratio of liquid assets to total assets of at least 7.0%. Liquid assets include cash and due from banks, federal funds sold, interest-bearing deposits with banks and unencumbered investment securities available for sale. The on-balance sheet liquidity ratio at December 31, 2022 was 12.58%, as compared to 16.76% at December 31, 2021.

During the year ended December 31, 2022, the Bank purchased additional investment securities, some of which were classified as investment securities available for sale. The fair value of all of the investment securities available for sale totaled $42.3 million at December 31, 2022.

During each of the quarters of 2021 and the first two quarters of 2022, the Bank paid a dividend of $250 thousand to BayFirst. The Bank also paid a $500 thousand dividend in the third quarter of 2022 and a $750 thousand dividend in the fourth quarter of 2022 to BayFirst. Prior to that, the Bank retained its earnings to support its growth. BayFirst’s liquidity had historically been dependent solely on funds received from the issuance and sale of subordinated debt and preferred stock. BayFirst’s liquidity needs are to make interest payments on its debt obligations, dividends on shares of its Series A Preferred Stock, Series B Convertible Preferred Stock, and common stock, and payment of certain operating expenses. As of December 31, 2022, BayFirst Financial Corp. held $559 thousand in cash and cash equivalents.

The Company expects that all the liquidity needs, including the contractual commitments can be met by currently available liquid assets and cash flows. In the event any unforeseen demand or commitments were to occur, the Company would access the borrowing capacity with the FHLB, FRB, and lines of credit with other financial institutions. The Company does not rely on investment securities as the main source of liquidity and does not foresee the need to sell investment securities for cash flow purposes. In addition, the Company has the ability to obtain wholesale deposits as another source of liquidity. The Company expects that the currently available liquid assets and the ability to borrow from the FHLB, FRB, and other financial institutions would be sufficient to satisfy the liquidity needs without any material adverse effect on the Company’s liquidity.

A description of BayFirst’s and the Bank’s debt obligations is set forth above under the heading “Other Borrowings.”

Market Risk and Interest Rate Sensitivity

Market risk is the risk of loss from adverse changes in market prices and rates. Its market risk arises primarily from interest-rate risk inherent in loan and deposit taking activities. To that end, the Company actively monitors and manages its interest-rate risk exposure. The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance-sheet transactions are aggregated, and the resulting net positions are identified. Disclosures about the fair value of financial instruments, which reflect changes in market prices and rates, should also be considered.

The objective in managing interest-rate risk is to minimize the adverse impact of changes in interest rates on net interest income and capital, while adjusting the asset-liability structure to obtain the maximum yield-cost spread on that structure. The Company relies primarily on its asset-liability structure to control interest rate risk. A sudden or substantial increase in interest rates may impact its earnings, to the extent that the interest rates borne by assets and liabilities do not change at the same rate, to the same extent, or on the same basis.

The Company established a comprehensive interest rate risk management policy which is administered by management’s Asset-Liability Committee. The policy establishes risk limits, which are quantitative measures of the percentage change in net interest income (net interest income at risk) and the fair value of equity capital (economic value of equity at risk) resulting from a hypothetical change in interest rates for maturities from one day to 30 years. Management measures the potential adverse impacts that changing interest rates may have on its short-term earnings, long-term value, and liquidity with computer-generated simulation analysis. The simulation model is designed to capture call features and interest rate caps and floors embedded in investment and loan contracts. As with any method of analyzing interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology used. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from the assumptions used in modeling. The methodology does not measure the impact that higher rates may have on borrowers’ ability to service their debts, or the impact of rate changes on demand for loan and deposit products.

To minimize the potential for adverse effects of changes in interest rates on the results of the operations, we monitor assets and liabilities to better match the maturities and repricing terms of the interest-earning assets and interest-bearing liabilities. To do this, the Company (i) emphasizes the origination of adjustable-rate and variable-rate loans to be held for investment; (ii) maintains a stable core deposit base; and (iii) maintains a significant portion of liquid assets (cash, interest-bearing deposits with other banks, and available for sale investment securities).

Management regularly reviews its exposure to changes in interest rates. Among the factors they consider are changes in the mix of interest-earning assets and interest-bearing liabilities, interest rate spreads and repricing periods. ALCO reviews, on at least a quarterly basis, its interest rate risk position.

The interest rate risk position is measured and monitored at the Bank using net interest income simulation models and economic value of equity sensitivity analysis that captures both short-term and long-term interest-rate risk exposure.

Modeling the sensitivity of net interest income and the economic value of equity to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. The models used for these measurements rely on estimates of the potential impact that changes in interest rates may have on the value and prepayment speeds on all components of its loan portfolio, investment portfolio, as well as embedded options and cash flows of other assets and liabilities. Balance sheet growth assumptions are also included in the simulation modeling process. The analysis provides a framework as to what the overall sensitivity position is as of the most recent reported position and the impact that potential changes in interest rates may have on net interest income and the economic value of its equity.

Net interest income simulation involves forecasting net interest income under a variety of interest rate scenarios including instantaneous shocks.

The estimated impact on the net interest income as of December 31, 2022 and December 31, 2021, assuming immediate parallel moves in interest rates, is presented in the table below.

Management strategies may impact future reporting periods, as the actual results may differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the difference between actual experience and the characteristics assumed, as well as changes in market conditions. Market-based prepayment speeds are factored into the analysis for loan and investment securities portfolios. Rate sensitivity for transactional deposit accounts is modeled based on both historical experience and external industry studies.

The Company uses economic value of equity sensitivity analysis to understand the impact of interest rate changes on long-term cash flows, income, and capital. Economic value of equity is based on discounting the cash flows for all balance sheet instruments under different interest rate scenarios.

The table below presents the change in the economic value of equity as of December 31, 2022 and December 31, 2021, assuming immediate parallel shifts in interest rates. Changes noted between the two periods reflect recent enhancements in the asset/liability modeling, including projected values for non-maturity deposits in changing interest rate environments.

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Evaluation of Disclosure Controls and Procedures

An evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Exchange Act), was carried out under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer as of December 31, 2022, the last day of the period covered by this Annual Report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of December 31, 2022, in ensuring that the information required to be disclosed in the reports the Company files or submits under the Exchange Act is (i) accumulated and communicated to management (including the Company’s Chief Executive Officer and Chief Financial Officer) as appropriate to allow timely decisions regarding required disclosures, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control Over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fiscal period to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.