3.	ACQUISITION ACTIVITY

August 31, 2018,

the Company completed the acquisition of The Peoples Bank (“TPB”) and then merged TPB with and into the Bank. The acquisition of TPB provided the Company with an opportunity to enter the Knoxville, Tennessee market, as well as southwest Virginia, and was consistent with the Company’s strategy to expand in selected metropolitan markets. As of the acquisition date, TPB’s assets totaled

$166.5

million, consisting primarily of pre-discounted gross loans totaling

$156.8

million. Total deposits were

$140.0

million. Purchase accounting adjustments were recorded as of the acquisition date, resulting in goodwill of

$7.4

million.

The acquisition of TPB was accounted for using the purchase method of accounting in accordance with ASC

805,

Business Combinations

. Assets acquired, liabilities assumed and consideration exchanged were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities is a complicated process involving significant judgment regarding the methods and assumptions to be used. Fair values are preliminary and subject to refinement for up to

one

year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available.

In accordance with the transaction agreement, the Company acquired

100%

of the capital stock of TPB for the purchase price of

$23.4

million calculated on the net book value of TPB as of

December 31, 2017

and a mutually agreed upon multiple of

1.62,

less certain mutually agreed upon deductions that are described in the transaction agreement, which reduced the purchase price by approximately

$0.4

million. Approximately

90%

of the purchase price was paid in cash, which totaled approximately

$20.7

million, and approximately

10%

was paid in the form of unregistered shares of the Company’s common stock, which consisted of

204,355

shares of FUSB common stock. The aggregate purchase price was subject to adjustment following the closing date of the transaction based on determination of TPB’s final net book value as of the date of closing, which resulted in the payment by the Company of an additional cash amount of approximately

$1.4

million.

A summary, at fair value, of the assets acquired and liabilities assumed in the TPB transaction, as of the acquisition date, is as follows:

FIRST US BANCSHARES, INC. AND SUBSIDIARIES

NET ASSETS ACQUIRED FROM THE PEOPLES BANK

AUGUST 31, 2018

(Dollars in Thousands)

	Acquired from TPB			Fair Value Adjustments			Fair Value as of August 31, 2018
Assets Acquired:
Cash and cash equivalents	$	3,085		$	—		$	3,085
Investment securities, available-for-sale		5,977			—			5,977
Federal Home Loan Bank stock, at cost		565			—			565
Loans		156,772			(2,195	)		154,577
Allowance for loan losses		(1,702	)		1,702			—
Net loans		155,070			(493	)		154,577
Premises and equipment, net		1,198			17			1,215
Other real estate owned		85			—			85
Other assets		551			(328	)		223
Core deposit intangible		—			2,048			2,048
Total assets acquired	$	166,531		$	1,244		$	167,775

Liabilities Assumed:
Deposits		140,033			342			140,375
Short-term borrowings		10,000			—			10,000
Other liabilities		437			—			437
Total liabilities assumed		150,470			342			150,812
Shareholders’ Equity Assumed:
Common stock		1,027			(1,027	)		—
Surplus		5,280			(5,280	)		—
Accumulated other comprehensive income, net of tax		17			(17	)		—
Retained earnings		9,737			(9,737	)		—
Total shareholders’ equity assumed		16,061			(16,061	)		—
Total liabilities and shareholders’ equity assumed	$	166,531		$	(15,719	)	$	150,812

Net assets acquired							$	16,963
Purchase price								24,398
Goodwill							$	7,435

The following is a description of the methods used to determine the fair values of significant assets and liabilities presented in the acquisition above.

Cash and cash equivalents

— The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of the assets.

Investment securities

— Prior to acquisition, the investment securities acquired were classified as available-for-sale and, accordingly, were recorded at fair value on a recurring basis. Fair value for most of the securities was based upon quoted prices of like or similar securities and determined using observable data including, among other things, dealer quotes, market spreads, cash flow, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus, prepayment speeds, credit information and the securities’ terms and conditions.

Federal Home Loan Bank stock, at cost

— Prior to acquisition, TPB maintained a required investment in the Federal Home Loan Bank (FHLB) of Atlanta which was, in part, based on TPB’s amount of borrowings with the FHLB. The investment was carried at cost as it is

not

readily marketable and, accordingly, there is

established market price for the investment. Upon acquisition, the Bank was able to absorb the investment into its own holdings of stock with the FHLB of Atlanta. The Bank has the ability to be reimbursed by the FHLB of Atlanta at cost for stock holdings as borrowings with the FHLB are paid down. Accordingly, the carrying amount of the assets is considered a reasonable estimate of fair value.

Loans

— Fair values for performing loans were determined based on a discounted cash flow methodology that aggregated model inputs and loan information into selected pools and calculated the loan level cash flows used to value the pools. The model calculated the contractual cash flows and expected cash flows, and then discounted the expected cash flows to present value in order to determine fair value. The assumptions used to estimate the fair value of the loans included unpaid principal balance, maturity date, coupon, prepayment speed, expected credit losses, and discount rates. The fair value adjustment, also described as the discount on the purchased loans, for the performing loans is being accreted into income over the lives of the loans. Purchased credit impaired loans were valued using the cost recovery method. The Company did

not

recognize any accretable yield, or income expected to be collected, associated with the PCI loans. The table below summarizes the carrying amounts and fair value adjustments of the loans acquired from TPB as of the acquisition date.

	August 31, 2018
	Acquired from TPB		Fair Value Adjustments			Fair Value as of August 31, 2018
	(Dollars in Thousands)
Purchased performing loans	$	153,862	$	(2,116	)	$	151,746
Purchased credit impaired loans		2,910		(79	)		2,831
Total purchased loans	$	156,772	$	(2,195	)	$	154,577

Allowance for loan losses

— In accordance with U.S. GAAP, the fair value of the acquired loans were adjusted to fair value and the pre-acquisition allowance for loan losses on TPB’s balance sheet was reversed.

Premises and equipment

— The fair value of acquired land and buildings was determined based on independent appraisals performed by a

third

-party appraiser. The fair value adjustment represents the difference between fair value and the carrying value at the date of acquisition. For furniture and fixtures, carrying value was considered to be a reasonable estimate of fair value.

Other real estate owned

— These assets are presented at the estimated net realizable value that management expects to receive when the properties are sold, net of related costs of disposal.

Other assets

— The fair value adjustment was due primarily to changes in deferred tax assets related to the transaction, as well as adjustment of certain prepaid assets associated with the TPB’s core processing vendor. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

Core deposit intangible

— This intangible asset represents the value of the relationships that TPB had with its deposit customers. The fair value of the core deposit intangible was estimated using a discounted cash flow methodology that gave consideration to expected customer attrition rates, cost of the deposit base and the net maintenance cost attributable to customer deposits.

Deposits

— The fair values used for the demand and savings deposits that comprise the transaction accounts acquired equal the amount payable on demand at the acquisition date. The fair value of certificates of deposit was determined using a discounted cash flow methodology whereby an estimate of the present value of contractual payments over the remaining life of the time deposit was determined. Future cash flows were discounted using market interest rates estimated based on the median offering rates of peer institutions at the time of the acquisition.

Short-term borrowings

— TPB’s short-term borrowings were comprised of daily renewable FHLB advances. Based on the short-term nature of the borrowings, the carrying amount of the liability was determined to be a reasonable approximation of fair value.

Other liabilities

— The carrying amount of these other liabilities was deemed to be a reasonable estimate of fair value.

Pro Forma Financial Information

The results of operations of TPB have been included in the Company’s consolidated financial statements since the acquisition date. The following schedule includes pro forma results (unaudited) for the year ended

December 31, 2018

and

2017,

as if the TPB acquisition occurred as of the beginning of the reporting periods presented. Non-recurring acquisition-related expenses totaling approximately

$1.6

million are included in non-interest expense for the year ended

December 31, 2018.

	Year Ended
	December 31,
	2018		2017
	(Dollars in Thousands, Except Per Share Data)
Summary of Operations
Net interest income	$	37,630	$	35,104
Provision for loan and lease losses		2,622		2,242
Net interest income after provision for loan and lease losses		35,008		32,862
Non-interest income		5,786		5,472
Non-interest expense		35,251		32,666
Income before income taxes		5,543		5,668
Provision for income taxes		1,440		4,037
Net income	$	4,103	$	1,631
Basic net income per share	$	0.66	$	0.26
Diluted net income per share	$	0.62	$	0.24

The pro forma information is presented for information purposes only and is

not

indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results.