Entegra Financial Corp. - FORM 10-Q

Attached files

file	filename
EX-31.01 - Entegra Financial Corp.	e00296_ex31-1.htm
EX-31.02 - Entegra Financial Corp.	e00296_ex31-2.htm
EX-32.01 - Entegra Financial Corp.	e00296_ex32.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the quarterly period ended:

June 30, 2015

Commission File Number: 001-35302

Entegra Financial Corp.

(Exact name of Registrant as specified in its Charter)


North Carolina	45-2460660
(State of Incorporation)	(I.R.S. Employer Identification No.)

14 One Center Court,
Franklin, North Carolina	28734
(Address of principal executive offices)	(Zip Code)

(828) 524-7000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On August 10, 2015, 6,546,375 shares of the issuer’s common stock (no par value), were issued and outstanding.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

FORM 10-Q

TABLE OF CONTENTS

		Page No.

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements	3
	Consolidated Balance Sheets – June 30, 2015 and December 31, 2014	3
	Consolidated Statements of Income – Three and Six Months Ended June 30, 2015 and 2014	4
	Consolidated Statements of Comprehensive Income – Three and Six Months Ended June 30, 2015 and 2014	5
	Consolidated Statements of Changes in Shareholders’ Equity – Six Months Ended June 30, 2015 and 2014	6
	Consolidated Statements of Cash Flows – Six Months Ended June 30, 2015 and 2014	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	46
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	73
Item 4.	Controls and Procedures	75

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	76
Item 1A.	Risk Factors	76
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	76
Item 3.	Defaults Upon Senior Securities	76
Item 4.	Mine Safety Disclosures	76
Item 5.	Other Information	76
Item 6.	Exhibits	77
	Signatures	79

Item 1. Financial Statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

	June 30, 2015			December 31, 2014
	(Unaudited)			(Audited)
Assets

Cash and due from banks	$	7,793		$	7,860
Interest-earning deposits		21,202			51,122
Cash and cash equivalents		28,995			58,982

Investments - available for sale		239,741			219,859
Investments - held to maturity (fair value of $40,534 and $30,890 at June 30, 2015 and December 31, 2014, respectively)		39,777			29,285
Other investments, at cost		7,432			4,908
Loans held for sale		9,635			10,761
Loans receivable		582,466			540,479
Allowance for loan losses		(9,451	)		(11,072	)
Fixed assets, net		14,981			13,004
Real estate owned		4,710			4,425
Interest receivable		3,236			2,925
Bank owned life insurance		20,638			20,417
Net deferred tax asset		19,351			2,089
Real estate held for investment		2,434			2,489
Loan servicing rights		2,158			2,187
Other assets		3,421			2,910

Total assets	$	969,524		$	903,648

Liabilities and Shareholders’ Equity

Liabilities:
Deposits	$	692,537		$	703,117
Federal Home Loan Bank advances		120,500			60,000
Junior subordinated notes		14,433			14,433
Other borrowings		2,366			—
Post employment benefits		9,975			9,759
Accrued interest payable		216			323
Other liabilities		2,355			8,697
Total liabilities		842,382			796,329

Commitments and contingencies (Note 14)

Shareholders’ Equity:
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding		—			—
Common stock - no par value, 50,000,000 shares authorized; 6,546,375 shares issued and outstanding as of June 30, 2015 and December 31, 2014		—			—
Additional paid in capital		63,651			63,651
Retained earnings		65,657			45,937
Accumulated other comprehensive loss		(2,166	)		(2,269	)
Total shareholders’ equity		127,142			107,319

Total liabilities and shareholders’ equity	$	969,524		$	903,648

The accompanying notes are an integral part of the consolidated financial statements.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended June 30,					Six Months Ended June 30,
	2015			2014		2015			2014
Interest income:
Interest and fees on loans	$	6,647		$	6,737	$	13,117		$	14,345
Interest on tax exempt loans		32			16		58			33
Taxable securities		1,278			973		2,514			1,952
Tax-exempt securities		84			92		154			185
Interest-earning deposits		22			18		46			28
Other		49			26		107			47
Total interest and dividend income		8,112			7,862		15,996			16,590

Interest expense:
Deposits		1,149			1,348		2,358			2,689
Federal Home Loan Bank advances		183			174		388			348
Junior subordinated notes		115			52		227			175
Other borrowings		26			—		52			—
Total interest expense		1,473			1,574		3,025			3,212

Net interest income		6,639			6,288		12,971			13,378

Provision for loan losses		—			6		(1,500	)		11
Net interest income after provision for loan losses		6,639			6,282		14,471			13,367

Noninterest income:
Servicing income, net		19			147		105			426
Mortgage banking		85			232		340			426
Gain on sale of SBA loans		3			—		214			74
Gain on sale of investments, net		123			317		287			379
Other than temporary impairment on cost method investment		(3	)		—		(3	)		(76	)
Service charges on deposit accounts		317			291		615			589
Interchange fees		322			291		600			541
Bank owned life insurance		133			129		262			258
Other		89			148		207			312
Total noninterest income		1,088			1,555		2,627			2,929

Noninterest expenses:
Compensation and employee benefits		3,817			2,947		7,514			5,894
Net occupancy		731			669		1,433			1,309
Federal Home Loan Bank prepayment penalty		1,762			—		1,762			—
Federal deposit insurance		279			258		563			696
Professional and advisory		261			182		511			380
Data processing		282			276		562			502
Net cost of operation of real estate owned		116			604		332			1,444
Other		933			732		2,080			1,556
Total noninterest expenses		8,181			5,668		14,757			11,781

Income (loss) before taxes		(454	)		2,169		2,341			4,515

Income tax expense (benefit)		(17,559	)		1,501		(17,379	)		1,756

Net income	$	17,105		$	668	$	19,720		$	2,759

Earnings per share - basic and diluted	$	2.61			N/A	$	3.01			N/A
Average shares outstanding - basic and diluted		6,546,375			N/A		6,546,375			N/A

The accompanying notes are an integral part of the consolidated financial statements.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014

Net income	$	17,105		$	668		$	19,720		$	2,759

Other comprehensive income (loss):
Change in unrealized holding gains and losses on securities available for sale		(2,172	)		2,314			(152	)		4,444
Reclassification adjustment for securities gains realized in net income		(123	)		(317	)		(287	)		(379	)
Amortization of unrealized loss on securities transferred to held to maturity		493			50			542			100
Change in deferred tax valuation allowance attributable to unrealized gains and losses on investment securities available for sale		(675	)		783			54			1,593
Other comprehensive income (loss), before tax		(2,477	)		2,830			157			5,758
Income tax effect related to items of other comprehensive income (loss)		675			(783	)		(54	)		(1,593	)
Other comprehensive income (loss), after tax		(1,802	)		2,047			103			4,165

Comprehensive income	$	15,303		$	2,715		$	19,823		$	6,924

The accompanying notes are an integral part of the consolidated financial statements.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

Six Months Ended June 30, 2015 and 2014

(Dollars in thousands)

	Common Stock
	Shares		Amount		Additional Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Loss			Total
Balance, December 31, 2013		—	$	—	$	—	$	39,994	$	(7,476	)	$	32,518

Net income		—		—		—		2,759		—			2,759
Other comprehensive income, net of tax		—		—		—		—		4,165			4,165
Balance, June 30, 2014		—	$	—	$	—	$	42,753	$	(3,311	)	$	39,442

Balance, December 31, 2014		6,546,375	$	—	$	63,651	$	45,937	$	(2,269	)	$	107,319

Net income		—		—		—		19,720		—			19,720
Other comprehensive income, net of tax		—		—		—		—		103			103
Balance, June 30, 2015		6,546,375	$	—	$	63,651	$	65,657	$	(2,166	)	$	127,142

The accompanying notes are an integral part of the consolidated financial statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	For the Six Months Ended June 30,
	2015			2014
Cash flows from operating activities:
Net income	$	19,720		$	2,759
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and leasehold amortization		506			433
Security amortization, net		1,007			529
Provision for loan losses		(1,500	)		11
Provision for real estate owned		166			1,097
Deferred income tax expense (benefit)		(17,262	)		1,756
Net increase (decrease) in deferred loan fees		(110	)		(176	)
Gain on sales of securities available for sale		(287	)		(379	)
Other than temporary impairment on cost method investment		3			76
Income on bank owned life insurance, net		(221	)		(226	)
Mortgage banking income, net		(340	)		(426	)
Gain on sales of SBA loans		(214	)		(74	)
Net realized gain on sale of real estate owned		(33	)		(10	)
Loans originated for sale		(14,950	)		(11,495	)
Proceeds from sale of loans originated for sale		16,630			9,702
Net change in operating assets and liabilities:
Interest receivable		(311	)		2
Loan servicing rights		29			(206	)
Other assets		(572	)		(481	)
Postemployment benefits		216			(264	)
Accrued interest payable		(107	)		45
Other liabilities		843			61
Net cash provided by operating activities	$	3,213		$	2,734

The accompanying notes are an integral part of the consolidated financial statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited), continued

(Dollars in thousands)

	For the Six Months Ended June 30,
	2015			2014
Cash flows from investing activities:
Activity for investment securities:
Purchases	$	(90,592	)	$	(43,178	)
Maturities/calls and principal repayments		31,890			11,909
Sales		25,707			15,425
Net increase in loans		(25,339	)		(12,261	)
Purchased loans		(20,369	)		—
Proceeds from sale of real estate owned		560			2,134
Real estate owned capitalized costs		(8	)		—
Purchase of fixed assets		(2,445	)		(423	)
Purchase of other investments, at cost		(2,674	)		—
Redemptions of other investments, at cost		150			209
Net cash used in investing activities	$	(83,120	)	$	(26,185	)
Cash flows from financing activities:
Net increase (decrease) in deposits	$	(11,264	)	$	28,350
Net increase in escrow deposits		684			595
Proceeds from FHLB advances		100,500			—
Repayment of FHLB advances		(40,000	)		—
Net cash provided by financing activities	$	49,920		$	28,945

Increase (decrease) in cash and cash equivalents		(29,987	)		5,494

Cash and cash equivalents, beginning of period	$	58,982		$	34,316

Cash and cash equivalents, end of period	$	28,995		$	39,810


Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest on deposits and other borrowings	$	3,132		$	3,167

Noncash investing and financing activities:
Real estate acquired in satisfaction of mortgage loans	$	1,689		$	1,063
Loans originated for disposition of real estate owned		794			863
Transfer of investment securities available for sale to held to maturity		—			4,399

The accompanying notes are an integral part of the consolidated financial statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

Entegra Financial Corp. (the “Company”) was incorporated on May 31, 2011 and became the holding company for Macon Bank, Inc. (the “Bank”) on September 30, 2014 upon the completion of Macon Bancorp’s merger with and into the Company, pursuant to which Macon Bancorp converted from the mutual to stock form of organization. The Company’s primary operation is its investment in the Bank. The Company also owns 100% of the common stock of Macon Capital Trust I (the “Trust”), a Delaware statutory trust formed in 2003 to facilitate the issuance of trust preferred securities. The Bank is a North Carolina state-chartered savings bank and has a wholly owned subsidiary, Macon Services, Inc., which owned a real estate investment property as of June 30, 2015. The consolidated financials are presented in these financial statements.

The Bank operates as a community-focused retail bank, originating primarily real estate based mortgage, consumer and commercial loans and accepting deposits from consumers and small businesses.

Estimates

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change, in the near term, relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate, management obtains independent appraisals for significant properties.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company, the Bank, and its wholly owned subsidiary. The accounts of the Trust are not consolidated with the Company. In consolidation all significant intercompany accounts and transactions have been eliminated.

Reclassification

Certain amounts in the prior years’ financial statements may have been reclassified to conform to the current year’s presentation. The reclassifications had no significant effect on our results of operations or financial condition as previously reported.

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K, filed with the SEC on March 30, 2015. In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet including the estimates inherent in the process of preparing financial statements. Unrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. The Company has reviewed events occurring through the issuance date of the Consolidated Financial Statements and no subsequent events have occurred requiring accrual or disclosure in these financial statements other than those included in this Quarterly Report on Form 10-Q.

Recent Accounting Standards Updates

In January 2014, the Financial Accounting Standards Board (“FASB”) amended the Receivables topic of the Accounting Standards Codification. The amendments are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to real estate owned. In addition, the amendments require a creditor to reclassify a collateralized consumer mortgage loan to REO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying its interest in the real estate collateral to the creditor to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. As an emerging growth company, the amendments will be effective for the Company for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. For non-emerging growth companies, the amendments are effective for annual periods, and interim periods within those annual periods beginning after December 15, 2014. Early implementation of the guidance is permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company has adopted the amendments and the related disclosures are included in Note 6. The amendments did not have a material effect on the Company’s financial statements.

In January 2015, the FASB issued guidance to eliminate from U.S. GAAP the concept of an extraordinary item, which is an event or transaction that is both (1) unusual in nature and (2) infrequently occurring. Under the new guidance, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company will apply the guidance prospectively. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. As an emerging growth company, the amendments will be effective for the Company for fiscal years beginning after December 15, 2015, and interim periods beginning after December 15, 2017. For non-emerging growth companies, the amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption of the guidance is permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. The Company does not expect these amendments to have a material effect on its financial statements.

In April 2015, the FASB issued guidance that will require debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This update affects disclosures related to debt issuance costs but does not affect existing recognition and measurement guidance for these items. As an emerging growth company, the guidance will be effective for the Company for fiscal years beginning after December 15, 2015, and interim periods beginning after December 15, 2016. For non-emerging growth companies, the guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption of the guidance is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In June 2015, the FASB issued amendments to clarify the Accounting Standards Codification (ASC), correct unintended application of guidance, and make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments were effective upon issuance (June 12, 2015) for amendments that do not have transition guidance. Amendments that are subject to transition guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company does not expect these amendments to have a material effect on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

NOTE 2. STOCK CONVERSION AND CHANGE IN CORPORATE FORM

On January 23, 2014, the Board of Directors of Macon Bancorp adopted a Plan of Conversion (the “Plan of Conversion”) which provided for the reorganization of Macon Bancorp from a North Carolina chartered mutual holding company into a stock holding company, Entegra Financial Corp., incorporated under the laws of the State of North Carolina (the “Conversion”).

In connection with the Conversion, the Company sold 6,546,375 shares of common stock at an offering price of $10.00 per share and received gross sales proceeds of $65.5 million. The Company recognized $1.7 million in reorganization and stock issuance costs as of September 30, 2014 which were deducted from the gross sales proceeds. Of the $63.7 million in net sales proceeds, $44.6 million, or approximately 70%, was contributed to the capital of the Bank upon completion of the Conversion on September 30, 2014.

Common Stock Offering Summary
(Dollars in thousands)

Gross proceeds	$	65,464
Issuance costs		(1,813	)
Net proceeds	$	63,651

Contributed to bank subsidiary	$	44,581
Retained by the Company		19,070
	$	63,651

On September 30, 2014, liquidation accounts were established by the Company and the Bank for the benefit of eligible depositors of the Bank as defined in the Plan of Conversion. Each eligible depositor will have a pro rata interest in the liquidation accounts for each of his or her deposit accounts based upon the proportion that the balance of each such account bears to the balance of all deposit accounts of the Bank as of the dates specified in the Plan of Conversion. The liquidation accounts will be maintained for the benefit of eligible depositors who continue to maintain their deposit accounts in the Bank. The liquidation accounts will be reduced annually to the extent that eligible depositors reduce their qualifying deposits. In the unlikely event of a complete liquidation of the Bank or the Company or both, and only in such event, eligible depositors who continue to maintain accounts will be entitled to receive a distribution from the liquidation accounts before any distribution may be made with respect to common stock. Neither the Company nor the Bank may declare or pay a cash dividend if the effect thereof would cause its equity to be reduced below either the amount required for the liquidation accounts or the regulatory capital requirements imposed by the Company’s or the Bank’s regulators.

NOTE 3. INVESTMENT SECURITIES

The amortized cost and estimated fair values of securities available for sale as of June 30, 2015 and December 31, 2014 are summarized as follows:

	June 30, 2015
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	39,814	$	231	$	(52	)	$	39,993
Municipal securities		32,453		167		(284	)		32,336
Mortgage-backed securities		166,199		443		(1,342	)		165,300
U.S. Treasury securities		1,500		18		—			1,518
Mutual funds		596		—		(2	)		594
	$	240,562	$	859	$	(1,680	)	$	239,741

	December 31, 2014
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	39,540	$	65	$	(123	)	$	39,482
Municipal securities		25,483		225		(150	)		25,558
Mortgage-backed securities		153,128		643		(1,053	)		152,718
U.S. Treasury securities		1,500		10		—			1,510
Mutual funds		590		1		—			591
	$	220,241	$	944	$	(1,326	)	$	219,859

The amortized cost and estimated fair values of securities held to maturity (“HTM”) as of June 30, 2015 and December 31, 2014 are summarized as follows:

	June 30, 2015
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	21,429	$	957	$	(42	)	$	22,344
Municipal securities		12,508		142		(232	)		12,418
Mortgage-backed securities		2,890		—		(63	)		2,827
Corporate debt securities		2,950		—		(5	)		2,945
	$	39,777	$	1,099	$	(342	)	$	40,534

	December 31, 2014
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	23,193	$	1,420	$	(5	)	$	24,608
Municipal securities		4,392		190		—			4,582
Trust preferred securities		1,000		—		—			1,000
Corporate debt securities		700		—		—			700
	$	29,285	$	1,610	$	(5	)	$	30,890

During the six months ended June 30, 2014, the Bank transferred the following investment securities from available for sale to held to maturity:

	At Date of Transfer
	During the Six Months Ended
	June 30, 2014
	(Dollars in thousands)

Book value	$	4,473
Market value		4,399

Unrealized loss	$	74

There were no transfers of investment securities from available for sale to held to maturity during the six months ended June 30, 2015.

Information pertaining to the activity for the three and six month periods ended June 30, 2015 and 2014 of unrealized losses related to HTM securities (before the impact of income taxes) previously recognized in accumulated other comprehensive income (“AOCI”) is summarized below:

	For the Three Months Ended						For the Six Months Ended
	June 30						June 30
(Dollars in thousands)	2015			2014			2015			2014
Beginning unrealized loss related to HTM securities previously recognized in AOCI	$	1,838		$	2,036		$	1,887		$	2,012
Additions for transfers to HTM		—			—			—			74
Amortization of unrealized losses on HTM securities previously recognized in AOCI		(493	)		(50	)		(542	)		(100	)
Ending unrealized loss in AOCI related to HTM securities previously recognized in AOCI	$	1,345		$	1,986		$	1,345		$	1,986

Information pertaining to securities with gross unrealized losses at June 30, 2015 and December 31, 2014, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

	June 30, 2015
	Less Than 12 Months				More Than 12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(Dollars in thousands)
Held to Maturity:
U.S. government agencies	$	5,685	$	42	$	—	$	—	$	5,685	$	42
Municipal securities		8,753		232		—		—		8,753		232
Mortgage-backed securities		2,828		63		—		—		2,828		63
Corporate debt securities		745		5		—		—		745		5
	$	18,011	$	342	$	—	$	—	$	18,011	$	342

Available for Sale:
U.S. government agencies	$	6,029	$	9	$	2,957	$	43	$	8,986	$	52
Municipal securities		18,915		262		1,405		22		20,320		284
Mortgage-backed securities		79,607		788		21,952		554		101,559		1,342
Mutual funds		596		2		—		—		596		2
	$	105,147	$	1,061	$	26,314	$	619	$	131,461	$	1,680

	December 31, 2014
	Less Than 12 Months				More Than 12 Months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(Dollars in thousands)
Held to Maturity:
U.S. government agencies	$	1,995	$	5	$	—	$	—	$	1,995	$	5
	$	1,995	$	5	$	—	$	—	$	1,995	$	5

Available for Sale:
U.S. government agencies	$	14,472	$	15	$	7,893	$	108	$	22,365	$	123
Municipal securities		4,306		49		8,409		101		12,715		150
Mortgage-backed securities		38,563		217		46,204		836		84,767		1,053
	$	57,341	$	281	$	62,506	$	1,045	$	119,847	$	1,326

Information pertaining to the number of securities with unrealized losses is detailed in the table below. The Company believes all unrealized losses as of June 30, 2015 and December 31, 2014 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

	June 30, 2015
	Less Than 12 Months		More Than 12 Months		Total
U.S. government agencies		6		1		7
Municipal securities		57		3		60
Mortgage-backed securities		49		14		63
Corporate debt securities		1		—		1
		113		18		131

	December 31, 2014
	Less Than 12 Months		More Than 12 Months		Total
U.S. government agencies		11		3		14
Municipal securities		9		19		28
Mortgage-backed securities		26		27		53
		46		49		95

For the three and six months ended June 30, 2015 and 2014 the Company had proceeds from sales of securities available for sale and their corresponding gross realized gains and losses as detailed below:

	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
	(Dollars in thousands)

Gross proceeds	$	12,010	$	8,503	$	25,707	$	15,425
Gross realized gains		123		317		307		378
Gross realized losses		—		—		20		—

The Company had securities pledged against deposits and borrowings of approximately $44.0 million and $10.7 million at June 30, 2015 and December 31, 2014, respectively.

The amortized cost and estimated fair value of investments in debt securities at June 30, 2015, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.

	Available for Sale
	Amortized Cost		Fair Value
	(Dollars in thousands)

Over 1 year through 5 years	$	31,828	$	31,994
After 5 years through 10 years		21,550		21,489
Over 10 years		20,985		20,958
		74,363		74,441
Mortgage-backed securities		166,199		165,300

Total	$	240,562	$	239,741

	Held to Maturity
	Amortized Cost		Fair Value
	(Dollars in thousands)

After 5 years through 10 years	$	8,886	$	8,848
Over 10 years		28,001		28,859
		36,887		37,707
Mortgage-backed securities		2,890		2,827

Total	$	39,777	$	40,534

NOTE 4. LOANS RECEIVABLE

Loans receivable as of June 30, 2015 and December 31, 2014 are summarized as follows:

	June 30, 2015			December 31, 2014
	(Dollars in thousands)

Real estate mortgage loans:
One-to four-family residential	$	232,167		$	227,209
Commercial real estate		192,021			179,435
Home equity loans and lines of credit		54,078			56,561
Residential construction		10,363			7,823
Other construction and land		54,369			50,298
Total real estate loans		542,998			521,326

Commercial and industrial		36,847			19,135
Consumer		5,295			3,200
Total commercial and consumer		42,142			22,335

Loans receivable, gross		585,140			543,661

Less: Net deferred loan fees		(1,585	)		(1,695	)
Unamortized premium		410			—
Unamortized discount		(1,499	)		(1,487	)

Loans receivable, net	$	582,466		$	540,479

The Bank had $148.8 million and $117.9 million of loans pledged as collateral to secure funding with the Federal Home Loan Bank of Atlanta (“FHLB”) at June 30, 2015 and December 31, 2014, respectively. The Bank also had $97.3 million and $97.7 million of loans pledged as collateral to secure funding with the Federal Reserve Bank (“FRB”) Discount Window at June 30, 2015 and December 31, 2014, respectively.

During January 2014, the Bank purchased the remaining participation balance of certain commercial real estate loans from the Federal Deposit Insurance Corporation (“FDIC”). The Bank had previously purchased a 50% participation in the loans from an institution that was subsequently taken into receivership by the FDIC. At the date of purchase, the outstanding loan balance purchased was $9.3 million and the loans were purchased at a total discount of $2.6 million. The loans were not deemed to be impaired at the time of purchase. Subsequent to the transaction, $2.8 million of the participation balance purchased was repaid, resulting in the Bank recognizing approximately $0.5 million of the initial discount, in addition to recognizing $0.3 million of previously collected but deferred interest. In addition, the Bank restructured a $1.8 million loan in the second quarter of 2014 and recognized $0.2 million of the discount in interest income.

During the six months ended June 30, 2015, the Bank purchased the remaining participation balance of a commercial real estate loan from another community bank. The Bank had previously purchased a 54% participation in the loan from the participating institution. At the date of purchase, the outstanding loan balance purchased was $1.6 million and the loan was purchased at a discount of $0.5 million. The loan was not deemed to be impaired at the time of purchase.

Also during the six months ended June 30, 2015, the Bank purchased $15.2 million in externally sourced loans which were comprised of $2.5 million in commercial SBA guaranteed loans, $10.0 million in commercial and industrial participation loans, and a $2.7 million commercial real estate whole loan purchase.

Included in loans receivable and other borrowings at June 30, 2015 are $2.4 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

The following tables present the activity related to the discount on purchased loans for the three and six month periods ended June 30, 2015 and 2014:

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
(Dollars in thousands)	2015			2014			2015			2014

Discount on purchased loans, beginning of period	$	1,587		$	1,974		$	1,487		$	—
Additional discount for new purchases		—			—			484			2,607
Accretion		(88	)		(92	)		(177	)		(187	)
Discount applied to charge-offs		—			—			(295	)		—
Interest income recognized for repayments and restructurings		—			(217	)		—			(755	)
Discount on purchased loans, end of period	$	1,499		$	1,665		$	1,499		$	1,665

NOTE 5. ALLOWANCE FOR LOAN LOSSES

The following tables present, by portfolio segment, the changes in the allowance for loan losses:

	Three Months Ended June 30, 2015
	One-to four Family Residential			Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land			Commercial		Consumer		Total

	(Dollars in thousands)

Beginning balance	$	2,773		$	2,363	$	1,168	$	304	$	1,990		$	596	$	417	$	9,611
Provision		(507	)		184		170		38		(304	)		82		337		—
Charge-offs		19			15		260		—		67			1		7		369
Recoveries		13			75		2		2		47			3		67		209
Ending balance	$	2,260		$	2,607	$	1,080	$	344	$	1,666		$	680	$	814	$	9,451

	Three Months Ended June 30, 2014
	One-to four Family Residential			Commercial Real Estate		Home Equity and Lines of Credit			Residential Construction			Other Construction and Land		Commercial			Consumer			Total

	(Dollars in thousands)

Beginning balance	$	3,265		$	2,851	$	1,453		$	501		$	3,256	$	340		$	290		$	11,956
Provision		(20	)		149		(136	)		(14	)		125		(61	)		(37	)		6
Charge-offs		85			205		188			—			132		125			18			753
Recoveries		22			51		17			—			8		150			104			352
Ending balance	$	3,202		$	2,450	$	1,488		$	524		$	3,712	$	259		$	321		$	11,561

	Six Months Ended June 30, 2015
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit		Residential Construction			Other Construction and Land			Commercial		Consumer		Total

	(Dollars in thousands)

Beginning balance	$	2,983		$	2,717		$	1,333	$	510		$	2,936		$	308	$	285	$	11,072
Provision		(607	)		(232	)		91		(168	)		(1,350	)		363		403		(1,500	)
Charge-offs		238			45			369		—			86			1		20		759
Recoveries		122			167			25		2			166			10		146		638
Ending balance	$	2,260		$	2,607		$	1,080	$	344		$	1,666		$	680	$	814	$	9,451

	Six Months Ended June 30, 2014
	One-to four Family Residential			Commercial Real Estate		Home Equity and Lines of Credit			Residential Construction			Other Construction and Land		Commercial			Consumer			Total

	(Dollars in thousands)

Beginning balance	$	3,693		$	4,360	$	1,580		$	501		$	3,516	$	336		$	265		$	14,251
Provision		(18	)		149		(137	)		(14	)		130		(62	)		(37	)		11
Charge-offs		516			1,998		331			—			475		125			63			3,508
Recoveries		23			335		34			—			86		155			174			807
Ending balance	$	3,202		$	2,450	$	1,488		$	524		$	3,712	$	259		$	321		$	11,561

The following tables present, by portfolio segment and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans:

	June 30, 2015
	One-to four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total

	(Dollars in thousands)

Allowance for loan losses
Individually evaluated for impairment	$	437	$	156	$	67	$	—	$	92	$	39	$	—	$	791
Collectively evaluated for impairment		1,823		2,451		1,013		344		1,574		641		814		8,660
	$	2,260	$	2,607	$	1,080	$	344	$	1,666	$	680	$	814	$	9,451

Loans Receivable
Individually evaluated for impairment	$	7,519	$	12,695	$	1,065	$	—	$	2,239	$	324	$	—	$	23,842
Collectively evaluated for impairment		224,648		179,326		53,013		10,363		52,130		36,523		5,295		561,298
	$	232,167	$	192,021	$	54,078	$	10,363	$	54,369	$	36,847	$	5,295	$	585,140

	December 31, 2014
	One-to four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total

	(Dollars in thousands)

Allowance for loan losses
Individually evaluated for impairment	$	719	$	235	$	14	$	—	$	705	$	3	$	—	$	1,676
Collectively evaluated for impairment		2,264		2,482		1,319		510		2,231		305		285		9,396
	$	2,983	$	2,717	$	1,333	$	510	$	2,936	$	308	$	285	$	11,072

Loans Receivable
Individually evaluated for impairment	$	9,912	$	17,828	$	1,686	$	—	$	3,911	$	328	$	—	$	33,665
Collectively evaluated for impairment		217,297		161,607		54,875		7,823		46,387		18,807		3,200		509,996
	$	227,209	$	179,435	$	56,561	$	7,823	$	50,298	$	19,135	$	3,200	$	543,661

Portfolio Quality Indicators

The Company’s portfolio grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. The Company’s internal credit risk grading system is based on experiences with similarly graded loans, industry best practices, and regulatory guidance. Credit risk grades are refreshed each quarter, at which time management analyzes the resulting information, as well as other external statistics and factors, to track loan performance.

The Company’s internally assigned grades pursuant to the Board-approved lending policy are as follows:

· Pass (1-5) – Acceptable loans with any identifiable weaknesses appropriately mitigated.

· Special Mention (6) – Potential weakness or identifiable weakness present without appropriate mitigating factors; however, loan continues to perform satisfactorily with no material delinquency noted. This may include some deterioration in repayment capacity and/or loan-to-value of securing collateral.

· Substandard (7) – Significant weakness that remains unmitigated, most likely due to diminished repayment capacity, serious delinquency, and/or marginal performance based upon restructured loan terms.

· Doubtful (8) – Significant weakness that remains unmitigated and collection in full is highly questionable or improbable.

· Loss (9) – Collectability is unlikely resulting in immediate charge-off.

Beginning as of March 31, 2015, we no longer risk grade consumer purposed loans within all categories for which the individual loan balance is less than $417,000. These loan types provide limited credit information subsequent to origination and therefore may not be properly risk graded within our standard risk grading system. All of our consumer purposed loans are now considered ungraded and will be analyzed on a performing versus non-performing basis. The non-performing ungraded loans will be deemed substandard when determining our classified assets. Consumer purposed loans may include residential loans, home equity loans and lines of credit, residential lot loans, and other consumer loans. This change in risk grading methodology did not have any impact on our allowance for loan losses calculation.

Description of segment and class risks

Each of our portfolio segments and the classes within those segments are subject to risks that could have an adverse impact on the credit quality of our loan portfolio. Management has identified the most significant risks as described below which are generally similar among our segments and classes. While the list in not exhaustive, it provides a description of the risks that management has determined are the most significant.

One-to four family residential

We centrally underwrite each of our one-to four family residential loans using credit scoring and analytical tools consistent with the Board-approved lending policy and internal procedures based upon industry best practices and regulatory directives. Loans to be sold to secondary market investors must also adhere to investor guidelines. We also evaluate the value and marketability of that collateral. Common risks to each class of non-commercial loans, including one-to-four family residential, include risks that are not specific to individual transactions such as general economic conditions within our markets, particularly unemployment and potential declines in real estate values. Personal events such as death, disability or change in marital status also add risk to non-commercial loans.

Commercial real estate

Commercial mortgage loans are primarily dependent on the ability of our customers to achieve business results consistent with those projected at loan origination resulting in cash flow sufficient to service the debt. To the extent that a customer’s business results are significantly unfavorable versus the original projections, the ability for our loan to be serviced on a basis consistent with the contractual terms may be at risk. While these loans are secured by real property and possibly other business assets such as inventory or accounts receivable, it is possible that the liquidation of the collateral will not fully satisfy the obligation. Other commercial real estate loans consist primarily of loans secured by multifamily housing and agricultural loans. The primary risk associated with multifamily loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in our customer having to provide rental rate concessions to achieve adequate occupancy rates. The performance of agricultural loans are highly dependent on favorable weather, reasonable costs for seed and fertilizer, and the ability to successfully market the product at a profitable margin. The demand for these products is also dependent on macroeconomic conditions that are beyond the control of the borrower.

Home equity and lines of credit

Home equity loans are often secured by first or second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values. A substantial decline in collateral value could render our second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies and disputes with first lienholders that may further weaken our collateral position. Further, the open-end structure of these loans creates the risk that customers may draw on the lines in excess of the collateral value if there have been significant declines since origination.

Residential construction and other construction and land

Residential mortgage construction loans are typically secured by undeveloped or partially developed land with funds to be disbursed as home construction is completed contingent upon receipt and satisfactory review of invoices and inspections. Declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the collateral’s current market value. Non-commercial construction and land development loans can experience delays in completion and/or cost overruns that exceed the borrower’s financial ability to complete the project. Cost overruns can result in foreclosure of partially completed collateral with unrealized value and diminished marketability. Commercial construction and land development loans are dependent on the supply and demand for commercial real estate in the markets we serve as well as the demand for newly constructed residential homes and building lots. Deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for our customers.

Commercial

We centrally underwrite each of our commercial loans based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. We strive to gain a complete understanding of our borrower’s businesses including the experience and background of the principals. To the extent that the loan is secured by collateral, which is a predominant feature of the majority of our commercial loans, or other assets including accounts receivable and inventory, we gain an understanding of the likely value of the collateral and what level of strength it brings to the loan transaction. To the extent that the principals or other parties are obligated under the note or guaranty agreements, we analyze the relative financial strength and liquidity of each guarantor. Common risks to each class of commercial loans include risks that are not specific to individual transactions such as general economic conditions within our markets, as well as risks that are specific to each transaction including volatility or seasonality of cash flows, changing demand for products and services, personal events such as death, disability or change in marital status, and reductions in the value of our collateral.

Consumer

The consumer loan portfolio includes loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment.

The following tables present the recorded investment in gross loans by loan grade:

June 30, 2015
Loan Grade		One-to Four-Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total

(Dollars in thousands)

	1	$	—	$	66	$	—	$	—	$	—	$	9,669	$	11	$	9,746
	2		—		—		—		—		—		99		—		99
	3		11,937		8,747		1,276		567		1,005		484		907		24,923
	4		40,356		57,355		2,474		4,914		11,247		17,527		1,620		135,493
	5		32,656		94,272		5,860		2,094		20,189		8,139		96		163,306
	6		2,995		15,866		—		999		1,973		419		—		22,252
	7		4,694		15,715		500		—		3,270		510		—		24,689
		$	92,638	$	192,021	$	10,110	$	8,574	$	37,684	$	36,847	$	2,634	$	380,508

	Ungraded Loan Exposure:

	Performing	$	137,904	$	—	$	43,380	$	1,789	$	16,640	$	—	$	2,659	$	202,372
	Nonperforming		1,625		—		588		—		45		—		2		2,260
	Subtotal	$	139,529	$	—	$	43,968	$	1,789	$	16,685	$	—	$	2,661	$	204,632

	Total	$	232,167	$	192,021	$	54,078	$	10,363	$	54,369	$	36,847	$	5,295	$	585,140

December 31, 2014
Loan Grade		One-to Four-Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total

(Dollars in thousands)

	1	$	—	$	68	$	—	$	—	$	—	$	2,511	$	20	$	2,599
	2		—		—		—		—		—		100		—		100
	3		63,065		14,356		5,978		690		5,154		483		454		90,180
	4		58,948		37,349		10,424		2,327		9,027		2,917		419		121,411
	5		44,445		90,397		10,486		3,048		21,024		6,399		179		175,978
	6		5,714		21,232		882		574		2,451		429		1		31,283
	7		7,400		14,139		1,568		—		5,404		555		—		29,066
		$	179,572	$	177,541	$	29,338	$	6,639	$	43,060	$	13,394	$	1,073	$	450,617

	Ungraded Loan Exposure:

	Performing	$	46,247	$	1,736	$	26,864	$	1,119	$	7,073	$	5,741	$	2,125	$	90,905
	Nonperforming		1,390		158		359		65		165		—		2		2,139
	Subtotal	$	47,637	$	1,894	$	27,223	$	1,184	$	7,238	$	5,741	$	2,127	$	93,044

	Total	$	227,209	$	179,435	$	56,561	$	7,823	$	50,298	$	19,135	$	3,200	$	543,661

Delinquency Analysis of Loans by Class

The following tables include an aging analysis of the recorded investment of past-due financing receivables by class. The Company does not accrue interest on loans greater than 90 days past due.

	June 30, 2015
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Over Past Due		Total Past Due		Current		Total Loans Receivable
	(Dollars in thousands)

One-to four-family residential	$	3,723	$	362	$	2,302	$	6,387	$	225,780	$	232,167
Commercial real estate		4,310		77		561		4,948		187,073		192,021
Home equity and lines of credit		493		—		1,088		1,581		52,497		54,078
Residential construction		119		—		—		119		10,244		10,363
Other construction and land		904		6		669		1,579		52,790		54,369
Commercial		—		9		—		9		36,838		36,847
Consumer		15		4		—		19		5,276		5,295
Total	$	9,564	$	458	$	4,620	$	14,642	$	570,498	$	585,140

	December 31, 2014
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Over Past Due		Total Past Due		Current		Total Loans Receivable
	(Dollars in thousands)

One-to four-family residential	$	6,298	$	448	$	2,669	$	9,415	$	217,794	$	227,209
Commercial real estate		2,136		909		1,006		4,051		175,384		179,435
Home equity and lines of credit		557		528		759		1,844		54,717		56,561
Residential construction		—		—		65		65		7,758		7,823
Other construction and land		1,530		964		473		2,967		47,331		50,298
Commercial		—		22		—		22		19,113		19,135
Consumer		247		4		1		252		2,948		3,200
Total	$	10,768	$	2,875	$	4,973	$	18,616	$	525,045	$	543,661

Impaired Loans

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of June 30, 2015 and December 31, 2014.

	June 30, 2015						December 31, 2014
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Recorded Balance		Unpaid Principal Balance		Specific Allowance
	(Dollars in thousands)
Loans without a valuation allowance
One-to four-family residential	$	5,337	$	5,379	$	—	$	5,943	$	6,096	$	—
Commercial real estate		9,514		11,096		—		14,231		16,515		—
Home equity and lines of credit		713		828		—		1,537		1,912		—
Residential construction		—		—		—		—		—		—
Other construction and land		1,236		1,683		—		1,901		2,579		—
Commercial		—		—		—		—		—		—
	$	16,800	$	18,986	$	—	$	23,612	$	27,102	$	—

Loans with a valuation allowance
One-to four-family residential	$	2,182	$	2,182	$	437	$	3,969	$	4,028	$	719
Commercial real estate		3,181		3,181		156		3,597		3,745		235
Home equity and lines of credit		352		510		67		149		149		14
Residential construction		—		—		—		—		—		—
Other construction and land		1,003		1,003		92		2,010		2,010		705
Commercial		324		323		39		328		328		3
	$	7,042	$	7,199	$	791	$	10,053	$	10,260	$	1,676

Total
One-to four-family residential	$	7,519	$	7,561	$	437	$	9,912	$	10,124	$	719
Commercial real estate		12,695		14,277		156		17,828		20,260		235
Home equity and lines of credit		1,065		1,338		67		1,686		2,061		14
Residential construction		—		—		—		—		—		—
Other construction and land		2,239		2,686		92		3,911		4,589		705
Commercial		324		323		39		328		328		3
	$	23,842	$	26,185	$	791	$	33,665	$	37,362	$	1,676

The following table presents average impaired loans and interest income recognized on those impaired loans, by class segment, for the periods indicated:

	Three Months Ended June 30,								Six Months Ended June 30,
	2015				2014				2015				2014
	Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized
	(Dollars in thousands)								(Dollars in thousands)
Loans without a valuation allowance
One-to four-family residential	$	5,598	$	45	$	5,839	$	39	$	5,607	$	87	$	5,400	$	83
Commercial real estate		9,536		114		15,059		137		9,555		214		14,293		238
Home equity and lines of credit		713		—		1,200		12		714		1		1,126		24
Residential construction		—		—		—		—		—		—		—		—
Other construction and land		1,239		8		5,795		57		1,241		18		6,169		115
Commercial		—		—		18		—		—		—		19		—
	$	17,086	$	167	$	27,911	$	245	$	17,117	$	320	$	27,007	$	460

Loans with a valuation allowance
One-to four-family residential	$	2,190	$	22	$	4,865	$	54	$	2,198	$	44	$	5,215	$	116
Commercial real estate		3,186		35		2,573		25		3,196		69		2,790		58
Home equity and lines of credit		431		1		229		2		431		2		303		6
Residential construction		—		—		1,921		—		—		—		1,932		—
Other construction and land		1,009		10		336		24		1,014		21		338		48
Commercial		326		5		—		—		326		10		—		—
	$	7,142	$	73	$	9,924	$	105	$	7,165	$	146	$	10,578	$	228

Total
One-to four-family residential	$	7,788	$	67	$	10,704	$	93	$	7,805	$	131	$	10,615	$	199
Commercial real estate		12,722		149		17,632		162		12,751		283		17,083		296
Home equity and lines of credit		1,144		1		1,429		14		1,145		3		1,429		30
Residential construction		—		—		1,921		—		—		—		1,932		—
Other construction and land		2,248		18		6,131		81		2,255		39		6,507		163
Commercial		326		5		18		—		326		10		19		—
	$	24,228	$	240	$	37,835	$	350	$	24,282	$	466	$	37,585	$	688

Nonperforming Loans

The following table summarizes the balances of nonperforming loans as of June 30, 2015 and December 31, 2014. Certain loans classified as Troubled Debt Restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.

	June 30, 2015		December 31, 2014
	(Dollars in thousands)

One-to four-family residential	$	4,602	$	5,661
Commercial real estate		5,602		7,011
Home equity loans and lines of credit		1,086		1,347
Residential construction		—		65
Other construction and land		995		2,679
Commercial		62		15
Consumer		2		2
Non-performing loans	$	12,349	$	16,780

Troubled Debt Restructurings (TDR)

The following tables summarize TDR loans as of the dates indicated:

	June 30, 2015
	Performing		Nonperforming		Total
	TDR’s		TDR’s		TDR’s
	(Dollars in thousands)

One-to-four family residential	$	4,246	$	372	$	4,618
Commercial real estate		7,550		5,165		12,715
Home equity and lines of credit		130		183		313
Residential construction		—		—		—
Other construction and land		1,430		491		1,921
Commercial		323		14		337

	$	13,679	$	6,225	$	19,904

	December 31, 2014
	Performing		Nonperforming		Total
	TDR’s		TDR’s		TDR’s
	(Dollars in thousands)

One-to-four family residential	$	5,760	$	715	$	6,475
Commercial real estate		10,710		3,797		14,507
Home equity and lines of credit		443		—		443
Residential construction		—		—		—
Other construction and land		1,519		672		2,191
Commercial		328		16		344

	$	18,760	$	5,200	$	23,960

Loan modifications that were deemed TDRs at the time of the modification during the period presented are summarized in the tables below:

	Three Months Ended June 30, 2015						Six Months Ended June 30, 2015
(Dollars in thousands)	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Forgiveness of principal:
Commercial real estate		—	$	—	$	—		1	$	1,988	$	1,693
		—	$	—	$	—		1	$	1,988	$	1,693

	Three Months Ended June 30, 2014						Six Months Ended June 30, 2014
(Dollars in thousands)	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Below market interest rate:
One-to four-family residential		1	$	218	$	161		2	$	409	$	326
Home equity loans and lines of credit		—		—		—		1		50		40
		1	$	218	$	161		3	$	459	$	366

Extended payment terms:
Other construction and land		1	$	666	$	556		2	$	720	$	596
Commercial real estate		3		4,451		3,039		7		6,770		5,332
Commercial		—		—		—		1		18		12
		4	$	5,117	$	3,595		10	$	7,508	$	5,940

The following table summarizes TDRs that defaulted during the three and six month periods ended June 30, 2014 and which were modified as TDRs within the previous 12 months. There were no TDRs that defaulted during the three or six month periods ending June 30, 2015 and which were modified as TDRs within the previous 12 months.

	Three Months Ended June 30, 2014				Six Months Ended June 30, 2014
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)
Below market interest rate:
One-to-four family residential		1	$	135		1	$	135
Home equity and lines of credit		—		—		—		—
Other construction and land		—		—		—		—
		1	$	135		1	$	135

Extended payment terms:
Commercial real estate		1	$	215		1	$	215

NOTE 6. REAL ESTATE OWNED

The following tables summarize real estate owned and changes in the valuation allowance for real estate owned as of June 30, 2015 and December 31, 2014 and for the three and six months ended June 30, 2015 and 2014.

	June 30,		December 31,
(Dollars in thousands)	2015		2014

Real estate owned, gross	$	6,268	$	6,185
Less: Valuation allowance		1,558		1,760

Real estate owned, net	$	4,710	$	4,425

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in thousands)	2015			2014			2015			2014
Valuation allowance, beginning	$	1,606		$	5,119		$	1,760		$	5,560
Provision charged to expense		23			462			91			1,097
Reduction due to disposal		(71	)		(2,920	)		(293	)		(3,996	)

Valuation allowance, ending	$	1,558		$	2,661		$	1,558		$	2,661

As of June 30, 2015, the Company had $2.7 million in loans secured by residential real estate properties for which formal foreclosure proceedings were in process. As of June 30, 2015, the Company had $0.7 million of residential real estate properties included in real estate owned.

NOTE 7. LOAN SERVICING

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage and other loans serviced for others is detailed below.

June 30, 2015		December 31, 2014
(Dollars in thousands)
$	245,209	$	246,348

The following summarizes the activity in the balance of loan servicing rights for the three and six months ended June 30, 2015 and 2014:

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Loan servicing rights, beginning of period	$	2,232		$	2,051		$	2,187		$	1,883
Capitalization from loans sold		83			162			216			210
Fair value adjustment		(157	)		(124	)		(245	)		(4	)
Loan servicing rights, end of period	$	2,158		$	2,089		$	2,158		$	2,089

The Bank held custodial escrow deposits of $1.4 million and $0.6 million for loan servicing accounts at June 30, 2015 and December 31, 2014, respectively.

NOTE 8. DEPOSITS

The following table summarizes deposit balances and interest expense by type of deposit as of and for the six months ended June 30, 2015 and 2014 and the year ended December 31, 2014.

	As of and for the								As of and for the Year Ended
	Six Months Ended June 30,								December 31,
	2015				2014				2014
(Dollars in thousands)	Balance		Interest Expense		Balance		Interest Expense		Balance		Interest Expense
Noninterest-bearing demand	$	95,604	$	—	$	80,959	$	—	$	86,110	$	—
Interest-bearing demand		98,447		76		89,912		63		92,877		149
Money Market		171,475		294		187,268		499		178,320		983
Savings		30,043		16		26,874		18		27,591		36
Time Deposits		296,968		1,972		327,563		2,109		318,219		4,193
	$	692,537	$	2,358	$	712,576	$	2,689	$	703,117	$	5,361

NOTE 9. BORROWINGS

The scheduled maturities and respective weighted average rates of outstanding FHLB advances, are as follows for the dates indicated:

		June 30, 2015					December 31, 2014
Year of Maturity		Balance		Weighted Average Rate			Balance		Weighted Average Rate
		(Dollars in thousands)
	2015	$	57,000		0.27	%	$	20,000		0.33	%
	2016		40,000		0.64	%		10,000		0.84	%
	2017		8,000		1.23	%		5,000		1.38	%
	2018		2,000		1.25	%		—		—
	2019		12,500		1.82	%		10,000		1.83	%
	2020		1,000		1.78	%		15,000		2.79	%
		$	120,500		0.64	%	$	60,000		1.37	%

During the second quarter of 2015, the Company prepaid a $15.0 million FHLB advance and incurred a prepayment penalty of $1.8 million. The advance, which carried an interest rate equal to 90-day LIBOR plus 2.56% and reset quarterly, was replaced with a $15.0 million three month fixed rate advance at a rate of 0.23%.

NOTE 10. JUNIOR SUBORDINATED DEBT

The Company issued $14.4 million of junior subordinated notes to its wholly owned subsidiary, Macon Capital Trust I, to fully and unconditionally guarantee the trust preferred securities issued by the Trust. These notes qualify as Tier I capital for the Company. The notes accrue and pay interest quarterly at a rate per annum, reset quarterly, equal to 90-day LIBOR plus 2.80% (3.08% at June 30, 2015). The notes mature on March 30, 2034.

The Company has the right to redeem the notes, in whole or in part, on or after March 30, 2009 at a price equal to 100% of the principal amount plus accrued and unpaid interest. In addition, the Company may redeem the notes in whole (but not in part) upon the occurrence of a capital disqualification event, an investment company event, or a tax event at a specified redemption price as defined in the indenture.

The Company also may, at its option, defer the payment of interest on the notes for a period up to 20 consecutive quarters, provided that interest will also accrue on the deferred payments of interest. The Company had previously deferred interest on the notes from December 31, 2010 to December 30, 2014. As of June 30, 2015, the Company was current on all interest payments due.

NOTE 11. INCOME TAXES

During the second quarter of 2015, the Company completed an analysis of all positive and negative evidence in assessing the need to maintain the valuation allowance against its net deferred tax asset. As a result of this analysis, the Company determined that significant positive evidence existed that would support the reversal of $17.6 million of the valuation allowance including the following:

A pattern of sustained profitability, excluding non-recurring items, since the first quarter of 2014;

A 3 year cumulative profit;

Forecasted earnings sufficient to utilize all remaining net operating losses prior to expiration beginning in 2025 for North Carolina and 2032 for Federal;

Significant improvements in asset quality;

Resolution of all remaining regulatory orders; and

A strong capital position enabling future earnings investments.

The remaining valuation allowance of $1.3 million is expected to be reversed through a reduction in the provision for income taxes during the third and fourth quarters of 2015 in accordance with the intra-period tax allocation rules under GAAP.

Remaining in accumulated other comprehensive income is $0.8 million in valuation allowance related to net deferred tax assets on investment securities. This valuation allowance will be recognized as tax expense on a security-by-security basis upon the sale or maturity of the individual securities. The tax expense is expected to be recognized over the remaining life of the securities of approximately 4.5 years.

The components of net deferred taxes as of June 30, 2015 and December 31, 2014 are summarized as follows:

	June 30,			December 31,
	2015			2014
	(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses	$	3,554		$	4,235
Deferred compensation and post employment benefits		3,523			3,514
Non-accrual interest		264			202
Valuation reserve for other real estate		586			673
North Carolina NOL carryover		1,093			1,404
Federal NOL carryover		12,106			12,392
Unrealized losses on securities		814			867
Other		506			393
Gross deferred tax assets		22,446			23,680
Less: valuation allowance		(1,300	)		(19,810	)
Total deferred tax assets		21,146			3,870

Deferred tax liabilities:
Fixed assets		302			461
Loan servicing rights		811			813
Deferred loan costs		534			413
Prepaid expenses		148			94
Total deferred tax liabilities		1,795			1,781

Net deferred tax asset	$	19,351		$	2,089

On July 23, 2013, North Carolina Governor Pat McCrory signed a major tax reform bill into law that lowered the North Carolina corporate income tax rate among other things. Specifically, the corporate income tax rate was reduced from 6.9% to 6% in 2014 and to 5% in 2015. The rate was to be further reduced to 4% during the 2016 tax year and to 3% for post-2016 tax years provided that specified revenue growth targets are reached. Based on state income tax revenues announced by the North Carolina Governor’s Office on July 29, 2015, the $20.2 billion revenue target for the fiscal year ended June 30, 2015 was met, resulting in a reduction of the state income tax rate to 4% effective January 1, 2016. As a result, the Company treated this announcement as a subsequent event and recorded a $0.4 million reduction in the net deferred tax asset as of June 30, 2015.

NOTE 12. EARNINGS PER SHARE

The following is a reconciliation of the numerator and denominator of basic and diluted net income per share of common stock:

(Dollars in thousands, except per share amounts)	For the Three Months Ended June 30, 2015		For the Six Months Ended June 30, 2015
Numerator:
Net income	$	17,105	$	19,720
Denominator:
Weighted-average common shares outstanding - basic		6,546,375		6,546,375
Effect of dilutive shares		—		—
Weighted-average common shares outstanding - diluted		6,546,375		6,546,375

Earnings per share - basic	$	2.61	$	3.01
Earnings per share - diluted	$	2.61	$	3.01

NOTE 13. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the components of accumulated other comprehensive income and changes in those components as of and for the three and six months ended June 30, 2015 and 2014.

	Three Months Ended June 30, 2015
	Available for Sale Securities			Held to Maturity Securities Transferred from AFS			Deferred Tax Valuation Allowance on Investment Securities			Total
	(Dollars in thousands)
Balance, beginning of period	$	910		$	(1,135	)	$	(139	)	$	(364	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities		—			—			(675	)		(675	)
Change in net unrealized holding losses on securities available for sale		(2,172	)		—			—			(2,172	)
Reclassification adjustment for net securities gains realized in net income		(123	)		—			—			(123	)
Transfer of net unrealized loss from available for sale to held to maturity		—			—			—			—
Amortization of unrealized gains and losses on securities transferred to held to maturity		—			493			—			493
Income tax benefit		873			(198	)		—			675

Balance, end of period	$	(512	)	$	(840	)	$	(814	)	$	(2,166	)

	Three Months Ended June 30, 2014
	(Dollars in thousands)
Balance, beginning of period	$	(2,052	)	$	(1,257	)	$	(2,049	)	$	(5,358	)

Change in deferred tax valuation allowance attributable to unrealized gains on investment securities		—			—			782			782
Change in unrealized holding gains on securities available for sale		2,314			—			—			2,314
Reclassification adjustment for net securities gains realized in net income		(317	)		—			—			(317	)
Transfer of net unrealized loss from available for sale to held to maturity		—			—			—			—
Amortization of unrealized gains and losses on securities transferred to held to maturity		—			50			—			50
Income tax benefit		(763	)		(19	)		—			(782	)

Balance, end of period	$	(818	)	$	(1,226	)	$	(1,267	)	$	(3,311	)

	Six Months Ended June 30, 2015
	Available for Sale Securities			Held to Maturity Securities Transferred from AFS			Deferred Tax Valuation Allowance on Investment Securities			Total
	(Dollars in thousands)
Balance, beginning of period	$	(236	)	$	(1,165	)	$	(868	)	$	(2,269	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities		—			—			54			54
Change in net unrealized holding losses on securities available for sale		(152	)		—			—			(152	)
Reclassification adjustment for net securities gains realized in net income		(287	)		—			—			(287	)
Transfer of net unrealized loss from available for sale to held to maturity		—			—			—			—
Amortization of unrealized gains and losses on securities transferred to held to maturity		—			542			—			542
Income tax benefit		163			(217	)		—			(54	)

Balance, end of period	$	(512	)	$	(840	)	$	(814	)	$	(2,166	)

	Six Months Ended June 30, 2014
	(Dollars in thousands)
Balance, beginning of period	$	(3,374	)	$	(1,242	)	$	(2,860	)	$	(7,476	)

Change in deferred tax valuation allowance attributable to unrealized gains on investment securities		—			—			1,593			1,593
Change in unrealized holding gains on securities available for sale		4,444			—			—			4,444
Reclassification adjustment for net securities gains realized in net income		(379	)		—			—			(379	)
Transfer of net unrealized loss from available for sale to held to maturity		74			(74	)		—			—
Amortization of unrealized gains and losses on securities transferred to held to maturity		—			100			—			100
Income tax benefit		(1,583	)		(10	)		—			(1,593	)

Balance, end of period	$	(818	)	$	(1,226	)	$	(1,267	)	$	(3,311	)

The following table shows the line items in the Consolidated Statements of Income affected by amounts reclassified from accumulated other comprehensive income:

	Three Months Ended June 30,				Six Months Ended June 30,
	2015		2014		2015		2014
	(Dollars in thousands)				(Dollars in thousands)

Gain on sale of investments, net	$	123	$	317	$	287	$	379
Tax effect		—		—		—		—
Impact, net of tax		123		317		287		379


Interest income - taxable securities		493		50		542		100
Tax effect		—		—		—		—
Impact, net of tax		493		50		542		100

Total reclassifications, net of tax	$	616	$	367	$	829	$	479

NOTE 14. COMMITMENTS AND CONTINGENCIES

To accommodate the financial needs of its customers, the Company makes commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. 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 many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family dwellings, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.

The following summarizes the Company’s approximate commitments to extend credit:

	June 30, 2015
	(Dollars in thousands)
Lines of credit	$	70,071
Standby letters of credit		654

	$	70,725

As of June 30, 2015, the Company had outstanding commitments to originate loans as follows:

	June 30, 2015
	Amount		Range of Rates
	(Dollar in thousands)

Fixed	$	8,746		2.99% to 6.00%
Variable		16,397		3.25% to 6.49%

	$	25,143

The allowance for unfunded commitments was $0.1 million at June 30, 2015 and December 31, 2014.

The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to Fannie Mae and maintained a reserve of $0.3 million as of June 30, 2015 and December 31, 2014.

In the normal course of business, the Company is periodically involved in litigation. In the opinion of the Company’s management, none of this litigation is expected to have a material adverse effect on the accompanying consolidated financial statements.

NOTE 15. FAIR VALUE DISCLOSURES

We use fair value measurements when recording and disclosing certain financial assets and liabilities. Securities available-for-sale, loan servicing rights and mortgage derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans and real estate owned.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. In determining fair value, we use various valuation approaches, including market, income and cost approaches. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability, which is developed, based on market data we have obtained from independent sources. Unobservable inputs reflect our estimate of assumptions that market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.

Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.

Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

Fair value estimates are made at a specific point of time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Company’s entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value also would affect significantly the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

Securities

We obtain fair values for debt securities from a third-party pricing service, which utilizes several sources for valuing fixed-income securities. The market evaluation sources for debt securities include observable inputs rather than significant unobservable inputs and are classified as Level 2. The service provider utilizes pricing models that vary by asset class and include available trade, bid and other market information. Generally, the methodologies include broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

Included in securities are investments in an exchange traded bond fund and U.S. Treasury bonds which are valued by reference to quoted market prices and considered a Level 1 security.

Loan Servicing Rights

Loan servicing rights are carried at fair value as determined by a third party valuation firm. The valuation model utilizes a discounted cash flow analysis using discount rates and prepayment speed assumptions used by market participants. The Company classifies loan servicing rights fair value measurements as Level 3.

Derivative Instruments

Derivative instruments include interest rate lock commitments and forward sale commitments. These instruments are valued based on the change in the value of the underlying loan between the commitment date and the end of the period. The Company classifies these instruments as Level 3.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. Loans held for sale carried at fair value are classified as Level 2.

Impaired Loans

Impaired loans are carried at the lower of recorded investment or fair value. The fair value of collateral dependent impaired loans is estimated using the value of the collateral less selling costs if repayment is expected from liquidation of the collateral. Appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or our knowledge of the borrower and the borrower’s business. Impaired loans carried at fair value are classified as Level 3. Impaired loans measured using the present value of expected future cash flows are not deemed to be measured at fair value.

Real Estate Owned

Real estate owned, obtained in partial or total satisfaction of a loan is recorded at the lower of recorded investment in the loan or fair value less cost to sell. Subsequent to foreclosure, these assets are carried at the lower of the amount recorded at acquisition date or fair value less cost to sell. Accordingly, it may be necessary to record nonrecurring fair value adjustments. Fair value, when recorded, is generally based upon appraisals by approved, independent, state certified appraisers. Like impaired loans, appraisals may be discounted based on our historical knowledge, changes in market conditions from the time of appraisal or other information available to us. Real estate owned carried at fair value is classified as Level 3.

In addition to financial instruments recorded at fair value in our financial statements, fair value accounting guidance requires disclosure of the fair value of all of an entity’s assets and liabilities that are considered financial instruments. The majority of our assets and liabilities are considered financial instruments. Many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaged in an exchange transaction. Also, it is our general practice and intent to hold our financial instruments to maturity and to not engage in trading or sales activities. For fair value disclosure purposes, we substantially utilize the fair value measurement criteria as required and explained above. In cases where quoted fair values are not available, we use present value methods to determine the fair value of our financial instruments.

Following is a description of valuation methodologies used for the disclosure of the fair value of financial instruments not carried at fair value:

Cash and Cash Equivalents

The carrying amount of such instruments is deemed to be a reasonable estimate of fair value.

Loans

The fair value of variable rate performing loans is based on carrying values adjusted for credit risk. The fair value of fixed rate performing loans is estimated using discounted cash flow analyses, utilizing interest rates currently being offered for loans with similar terms, adjusted for credit risk. The fair value of nonperforming loans is based on their carrying values less any specific reserve. A prepayment assumption is used to estimate the portion of loans that will be repaid prior to their scheduled maturity. No adjustment has been made for the illiquidity in the market for loans as there is no active market for many of the Company’s loans on which to reasonably base this estimate.

Bank Owned Life Insurance

Fair values approximate net cash surrender values.

Other Investments, at cost

No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value. Accordingly, the carrying amount is deemed to be a reasonable estimate of fair value.

Deposits

The fair values disclosed for demand deposits are equal to the amounts payable on demand at the reporting date. The fair value of certificates of deposit are estimated by discounting the amounts payable at the certificate rates using the rates currently offered for deposits of similar remaining maturities.

Advances from the FHLB

The fair values disclosed for fixed rate long-term borrowings are determined by discounting their contractual cash flows using current interest rates for long-term borrowings of similar remaining maturities. The carrying amounts of variable rate long-term borrowings approximate their fair values.

Junior Subordinated Notes

The carrying amount approximates fair value because the debt is variable rate tied to LIBOR.

Accrued Interest Receivable and Payable

Since these financial instruments will typically be received or paid within three months, the carrying amounts of such instruments are deemed to be a reasonable estimate of fair value.

Loan Commitments

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these

arrangements and the credit standing of the counterparties.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

Below is a table that presents information about certain assets and liabilities measured at fair value on a recurring basis:

	June 30, 2015
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Securities available for sale:
U.S. government agencies	$	—	$	39,993	$	—	$	39,993
Municipal securities		—		32,336		—		32,336
Mortgage-backed securities		—		165,300		—		165,300
U.S. Treasury securities		1,518		—		—		1,518
Mutual funds		594		—		—		594
		2,112		237,629		—		239,741

Loan servicing rights		—		—		2,158		2,158
Forward sales commitments		—		—		5		5
Interest rate lock commitments		—		—		13		13

Total assets	$	2,112	$	237,629	$	2,176	$	241,917

	December 31, 2014
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Securities available for sale:
U.S. government agencies	$	—	$	39,482	$	—	$	39,482
Municipal securities		—		25,558		—		25,558
Mortgage-backed securities		—		152,718		—		152,718
U.S. Treasury securities		1,510		—		—		1,510
Mutual funds		591		—		—		591
		2,101		217,758		—		219,859

Loan servicing rights		—		—		2,187		2,187
Forward sales commitments		—		—		9		9
Interest rate lock commitments		—		—		52		52

Total assets	$	2,101	$	217,758	$	2,248	$	222,107

The following table presents the changes in assets measured at fair value on a recurring basis for which we have utilized Level 3 inputs to determine fair value:

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Balance at beginning of period	$	2,368		$	2,071		$	2,248		$	1,888

Loan servicing right activity, included in servicing income, net
Capitalization from loans sold		83			162			216			210
Fair value adjustment		(157	)		(124	)		(245	)		(4	)

Mortgage derivative gains included in Other income		(118	)		47			(43	)		62

Balance at end of period	$	2,176		$	2,156		$	2,176		$	2,156

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The table below presents information about certain assets and liabilities measured at fair value on a nonrecurring basis. There were no loans held for sale carried at fair value at either June 30, 2015 or December 31, 2014.

	June 30, 2015
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential	$	—	$	—	$	5,337	$	5,337
Commercial real estate		—		—		9,514		9,514
Home equity loans and lines of credit		—		—		904		904
Other construction and land		—		—		1,236		1,236

Real estate owned:
One-to four family residential		—		—		671		671
Commercial real estate		—		—		1,039		1,039
Other construction and land		—		—		3,000		3,000

Total assets	$	—	$	—	$	21,701	$	21,701

	December 31, 2014
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential	$	—	$	—	$	6,407	$	6,407
Commercial real estate		—		—		14,551		14,551
Home equity loans and lines of credit		—		—		1,456		1,456
Other construction and land		—		—		2,227		2,227

Real estate owned:
One-to four family residential		—		—		220		220
Commercial real estate		—		—		774		774
Other construction and land		—		—		3,431		3,431

Total assets	$	—	$	—	$	29,066	$	29,066

There were no liabilities measured at fair value on a nonrecurring basis as of June 30, 2015 or December 31, 2014.

Impaired loans totaling $6.8 million at June 30, 2015 and $9.0 million at December 31, 2014, were measured using the present value of expected future cash flows. These impaired loans were not deemed to be measured at fair value on a nonrecurring basis.

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at June 30, 2015.

	Valuation Technique	Unobservable Input	General Range

Impaired loans	Discounted Appraisals	Collateral discounts and estimated selling cost		0 – 30%
Real estate owned	Discounted Appraisals	Collateral discounts and estimated selling cost		0 – 30%
Loan servicing rights	Discounted Cash Flows	Prepayment speed		8 – 25%
		Discount rate		12%
Forward sales commitments and interest rate lock commitments	Change in market price of underlying loan	Value of underlying loan		101 - 107%

The approximate carrying and estimated fair value of financial instruments are summarized below:

			Fair Value Measurements at June 30, 2015
	Carrying
(Dollars in thousands)	Amount		Total		Level 1		Level 2		Level 3
Assets:
Cash and equivalents	$	28,995	$	28,995	$	28,995	$	—	$	—
Securities available for sale		239,741		239,741		2,112		237,629		—
Securities held to maturity		39,777		40,534		—		40,534		—
Loans held for sale		9,635		10,293		—		10,293		—
Loans receivable, net		582,466		588,203		—		—		588,203
Other investments, at cost		7,432		7,432		—		7,432		—
Interest receivable		3,236		3,236		—		3,236		—
Bank owned life insurance		20,638		20,638		—		20,638		—
Loan servicing rights		2,158		2,158		—		—		2,158
Forward sales commitments		5		5		—		—		5
Interest rate lock commitments		13		13		—		—		13

Liabilities:
Demand deposits	$	395,569	$	395,569	$	—	$	395,569	$	—
Time deposits		296,968		300,083		—		—		300,083
Federal Home Loan Bank advances		120,500		122,997		—		122,997		—
Junior subordinated debentures		14,433		14,433		—		14,433		—
Accrued interest payable		216		216		—		216		—

			Fair Value Measurements at December 31, 2014
	Carrying
(Dollars in thousands)	Amount		Total		Level 1		Level 2		Level 3
Assets:
Cash and equivalents	$	58,982	$	58,982	$	58,982	$	—	$	—
Securities available for sale		219,859		219,859		2,101		217,758		—
Securities held to maturity		29,285		30,890		—		30,890		—
Loans held for sale		10,761		11,501		—		11,501		—
Loans receivable, net		529,407		546,450		—		—		546,450
Other investments, at cost		4,908		4,908		—		4,908		—
Interest receivable		2,925		2,925		—		2,925		—
Bank owned life insurance		20,417		20,417		—		20,417		—
Loan servicing rights		2,187		2,187		—		—		2,187
Forward sales commitments		9		9		—		—		9
Interest rate lock commitments		52		52		—		—		52

Liabilities:
Demand deposits	$	384,898	$	384,898	$	—	$	384,898	$	—
Time deposits		318,219		321,491		—		—		321,491
Federal Home Loan Bank advances		60,000		62,108		—		62,108		—
Junior subordinated debentures		14,433		14,433		—		14,433		—
Accrued interest payable		323		323		—		323		—

NOTE 16. REGULATORY MATTERS

The Company and the Bank are subject to various regulatory capital requirements administered by their respective federal and state banking regulators. Failure to satisfy minimum capital requirements may result in certain mandatory and additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined).

In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in the Bank’s Tier 1 capital.

The tables below summarize capital ratios and related information in accordance with Basel III as measured at June 30, 2015 and pre-existing rules at December 31, 2014.

Following are the required and actual capital amounts and ratios for the Bank:

	Actual					For Capital Adequacy Purposes				To Be Well-Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio		Amount		Ratio
As of June 30, 2015:
Tier 1 Leverage Capital	$	114,336		12.47	%	$	36,618		>4%	$	45,772		>5%
Common Equity Tier 1 Capital	$	114,336		18.76	%	$	27,433		>4.5%	$	39,625		>6.5%
Tier 1 Risk-based Capital	$	114,336		18.76	%	$	36,577		>6%	$	48,769		>8%
Total Risk-based Capital	$	122,063		20.02	%	$	48,769		>8%	$	60,962		>10%

As of December 31, 2014:
Tier 1 Leverage Capital	$	105,556		11.91	%	$	35,440		>4%	$	44,300		>5%
Tier 1 Risk-based Capital	$	105,556		19.89	%	$	21,231		>4%	$	31,847		>6%
Total Risk-based Capital	$	112,246		21.15	%	$	42,462		>8%	$	53,078		>10%

Following are the required and actual capital amounts and ratios for the Company:

	Actual					For Capital Adequacy Purposes
(Dollars in thousands)	Amount		Ratio			Amount		Ratio
As of June 30, 2015:
Tier I Leverage Capital	$	132,570		14.46	%	$	36,640		>4%
Common Equity Tier 1 Capital	$	125,074		20.45	%	$	27,458		>4.5%
Tier I Risk-based Capital	$	132,570		21.70	%	$	36,611		>6%
Total Risk Based Capital	$	140,308		22.97	%	$	48,814		>8%

As of December 31, 2014:
Tier I Leverage Capital	$	123,377		13.94	%	$	35,398		>4%
Tier I Risk-based Capital	$	123,377		23.24	%	$	21,236		>4%
Total Risk Based Capital	$	130,067		24.50	%	$	42,472		>8%

The Company and the Bank are no longer subject to any regulatory orders.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

•

statements of our goals, intentions and expectations;

•

statements regarding our business plans, prospects, growth and operating strategies;

•

statements regarding the asset quality of our loan and investment portfolios; and

•

estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company is under no duty to and do not undertake any obligation to update any forward-looking statements after the date of this Quarterly Report on Form 10-Q.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

	•	the occurrence of an ownership change under applicable tax rules that could limit our ability to utilize losses to offset future taxable income;

	•	general economic conditions, either nationally or in our market areas, that are worse than expected;

	•	credit quality deterioration as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

	•	the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

	•	weaknesses in the real estate market affect the value of real estate serving as collateral for loans in our portfolio

	•	competition among depository and other financial institutions;

	•	inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

	•	adverse changes in the securities markets;

	•	changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

	•	increased cybersecurity risk, including potential business disruptions or financial losses;

	•	our ability to enter new markets successfully and capitalize on growth opportunities;

	•	our ability to successfully integrate acquired entities, if any;

	•	changes in consumer spending, borrowing and savings habits;

	•	changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board (“FASB”), the Securities and Exchange Commission (“SEC”) and the Public Company Accounting Oversight Board (“PCAOB”);

	•	changes in our key personnel, and our compensation and benefit plans;

	•	changes in our financial condition or results of operations that reduce capital available to pay dividends or buyback shares;

	•	changes in the financial condition or future prospects of issuers of securities that we own; and

	•	other risks and uncertainties detailed in this Quarterly Report on Form 10-Q and, from time to time, in our other filings with the SEC.

For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

Our critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of June 30, 2015 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K.

The Jumpstart Our Business Startups Act (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of June 30, 2015 and December 31, 2014, there was not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance.

Overview

Entegra Financial Corp. was incorporated on May 31, 2011 to be the holding company for Macon Bank, Inc. (the Bank”) upon the completion of Macon Bancorp’s merger with and into Entegra Financial Corp., pursuant to which Macon Bancorp converted from the mutual to stock form of organization. Prior to the completion of the conversion, Entegra Financial Corp. did not engage in any significant activities other than organizational activities. On September 30, 2014, the mutual to stock conversion was completed and the Bank became the wholly owned subsidiary of Entegra Financial Corp. Also on September 30, 2014, Entegra Financial Corp. completed the initial public offering of its common stock. In this Discussion and Analysis section, terms such as “we,” “us,” “our” and the “Company” refer to Entegra Financial Corp.

We provide a full range of financial services through offices located in Cherokee, Henderson, Jackson, Macon, Polk and Transylvania counties in North Carolina and a loan production office in Greenville, South Carolina which is expected to become a full service branch in the fall of 2015. We provide full service retail and commercial banking products as well as wealth management services through a third party.

We earn revenue primarily from interest on loans and securities, and fees charged for financial services provided to our customers. Offsetting these revenues are the cost of deposits and other funding sources, provisions for loan losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense.

Our results of operations are significantly affected by general economic and competitive conditions in our market areas and nationally, as well as changes in interest rates, sources of funding, government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect our financial condition and results of operations.

Strategic Plan

We continue to execute on our Board of Director approved strategic plan which involves the following key components:

Positioning the Company for long-term independence by building a franchise that will provide above average shareholder returns;

Seeking acquisition opportunities that have reasonable earn-back periods and are accretive to return on equity while minimizing book value dilution;

Building long term franchise value by diversifying into high growth markets with geographic contiguity to our current markets;

Maximizing our capital leverage through organic and acquired asset growth;

Rational use of share repurchases to supplement shareholder returns and return excess capital to shareholders, but not at the expense of building long-term value.

The following discussion and analysis is presented on a consolidated basis and focuses on the major components of the Company’s operations and significant changes in its results of operations for the periods presented. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information included in this report and in our Annual Report on Form 10-K.

Earnings Summary

Net income for the three months ended June 30, 2015 was $17.1 million compared to $0.7 million for the same period in 2014. The increase in net income for the quarter was primarily the result of a non-cash income tax benefit resulting from the $17.6 million reversal of substantially all of the valuation allowance on the Company’s net deferred tax asset and partially offset by a FHLB advance prepayment penalty of $1.8 million, increased compensation of $0.9 million, and a decrease in noninterest income of $0.5 million.

Net income for the six months ended June 30, 2015 was $19.7 million compared to $2.8 million for the same period in 2014. The increase in net income for the six month period was primarily a result of the non-cash income tax benefit mentioned above and a negative provision for loan losses of $1.5 million. These items were partially offset by a reduction in net interest income of $0.4 million and an increase in compensation of $1.6 million, and the FHLB advance prepayment penalty of $1.8 million.

Net interest income increased $0.4 million, or 5.6%, to $6.6 million for the three months ended June 30, 2015 compared to the same period in 2014. The increase in net interest income for the period was primarily the result of an increase in interest income on taxable securities of $0.3 million and a decrease in interest expense on deposits of $0.2 million.

Net interest income decreased $0.4 million, or 3.0%, to $13.0 million for the six months ended June 30, 2015 compared to the same period in 2014. The decrease in net interest income for period was primarily the result of the favorable resolution of two commercial loans in the 2014 period, which resulted in the recognition of approximately $1.1 million of deferred interest and discounts, partially offset by an increase in interest income on taxable securities of $0.6 million and a decrease in interest expense on deposits of $0.3 million.

Due to continued improvement in asset quality and significantly reduced charge-off amounts, no provision for loan losses was needed during the three months ended June 30, 2015 and a negative provision for loan losses of $1.5 million was recognized for the six months ended June 30, 2015.

Non-GAAP Financial Measures

Statements included in this Management’s Discussion and Analysis include non-GAAP financial measures and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. This Management’s Discussion and Analysis and the accompanying tables discuss financial measures, such core net interest income, core noninterest expense, and core net income, which are non-GAAP measures. We believe that such non-GAAP measures are useful because they enhance the ability of investors and management to evaluate and compare the Company’s operating results from period to period in a meaningful manner. Non-GAAP measures should not be considered as an alternative to any measure of performance as promulgated under GAAP. Investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.

We analyze our net interest income, noninterest expense, and net income on a non-GAAP basis in order to exclude non-recurring items as detailed in the table below:

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)
Core Net Interest Income
Net Interest income (GAAP)	$	6,639		$	6,288		$	12,971		$	13,378
One-time deferred interest and discounts		—			(218	)		—			(1,125	)
Core net interest income (Non-GAAP)	$	6,639		$	6,070		$	12,971		$	12,253

Core Noninterest Expense
Noninterest expense (GAAP)	$	8,181		$	5,668		$	14,757		$	11,781
FHLB prepayment penalty		(1,762	)		—			(1,762	)		—
Core noninterest expense (Non-GAAP)	$	6,419		$	5,668		$	12,995		$	11,781

Core Net Income
Net income (GAAP) (1)	$	17,105		$	668		$	19,720		$	2,759
One-time deferred interest and discounts		—			(218	)		—			(1,125	)
Negative provision for loan losses		—			—			(1,500	)		—
FHLB prepayment penalty		1,762			—			1,762			—
Adjust actual income tax expense (benefit) to 35% estimated effective tax rate (1)		(18,017	)		818			(18,290	)		569
Core net income (Non-GAAP) (1)	$	850		$	1,268		$	1,692		$	2,203

(1) - The Company maintained a valuation allowance on its net deferred tax asset during the periods presented and therefore only recognized tax expense (benefit) for adjustments to its tax planning strategies and reversal of valuation allowance on net deferred tax assets. Core net income is reflected to adjust the income tax expense to an estimated 35% effective tax rate after the other adjustments have been applied.

Financial Condition At June 30, 2015 and December 31, 2014

Total assets increased $65.9 million, or 7.3%, to $969.5 million at June 30, 2015 from $903.6 million at December 31, 2014. This increase in assets was comprised primarily of loans, which increased $42.0 million, or 7.8%, investment securities, which increased $30.4 million, or 12.2%, and net deferred tax assets, which increased $17.3 million. The increases in loans and investments were mainly funded by FHLB advances which increased $60.5 million, or 100.8%, and available cash which decreased $30.0 million, or 50.8%.

Total liabilities increased $46.1 million, or 5.8%, to $842.4 million at June 30, 2015 from $796.3 million at December 31, 2014, due primarily to the $60.5 million increase in FHLB advances and partially offset by decreases of $10.6 million in deposits and $6.3 million in other liabilities. The decrease in deposits is mainly attributable to the maturity of the Company’s final brokered deposit of $9.0 million in June 2015.

Total equity increased $19.8 million, or 18.5%, to $127.1 million at June 30, 2015 from $107.3 million at December 31, 2014. This increase was the result of $19.7 million of net income for the period and a $0.1 million improvement in net unrealized holding gains and losses on securities available for sale.

Cash and Cash Equivalents

Total cash and cash equivalents decreased $30.0 million, or 50.8%, to $29.0 million at June 30, 2015 from $59.0 million at December 31, 2014 as a result of cash being used to invest in loans and investment securities. We continue to hold higher than normal levels of liquidity in cash and investments due to the current interest rate environment and in anticipation of rising interest rates.

Investment Securities

Our investment securities portfolio is classified as both “available-for-sale” and “held-to-maturity”. Available-for-sale securities are carried at fair value. The following table shows the amortized cost and fair value for our available for sale investment portfolio at the dates indicated.

	At June 30,				At December 31,
	2015				2014
	Amortized Cost		Fair value		Amortized Cost		Fair value
	(Dollars in thousands)
Investment securities available-for-sale:
U.S. Government and agency securities:
U.S. Government and agency obligations	$	36,814	$	37,036	$	33,540	$	33,572
U.S. Government structured agency obligations		3,000		2,957		6,000		5,910
U.S. Treasury Notes & Bonds		1,500		1,518		1,500		1,510
Municipal obligations		32,453		32,336		25,483		25,558
Mortgage-backed securities:
U.S. Government agency		114,870		114,214		123,321		123,043
SBA securities		40,294		40,095		20,713		20,652
Collateralized mortgage obligations		11,035		10,991		9,094		9,023
Mutual funds		596		594		590		591

Total securities available-for-sale	$	240,562	$	239,741	$	220,241	$	219,859

Available-for-sale investment securities increased $19.9 million, or 9.0%, to $239.7 million at June 30, 2015 from $219.9 million at December 31, 2014. We continue to invest our excess cash in available-for-sale securities as loan demand continues at a moderate pace and we grow our overall balance sheet.

Held to maturity investment securities are carried at amortized cost. The following table shows the amortized cost and fair value for our held-to-maturity investment portfolio as of the most recent quarter and year end.

	At June 30,				At December 31,
	2015				2014
	Amortized Cost		Fair value		Amortized Cost		Fair value
	(Dollars in thousands)
Investment securities held-to-maturity:
U.S. Government and agency securities:
U.S. Government and agency obligations	$	5,727	$	5,685	$	2,000	$	1,995
U.S. Government structured agency obligations		15,702		16,659		21,193		22,613
Municipal tax exempt		7,669		7,677		3,805		3,973
Municipal taxable		4,839		4,741		587		609
Collateralized mortgage obligations		2,890		2,827		—		—
Trust preferred securities		—		—		1,000		1,000
Corporate debt securities		2,950		2,945		700		700

Total securities held-to-maturity	$	39,777	$	40,534	$	29,285	$	30,890

Held-to-maturity investment securities increased $10.5 million, or 35.8%, to $39.8 million at June 30, 2015 from $29.3 million at December 31, 2014 as a result of the Company purchasing new securities with the intent to minimize the impact of future interest rate changes on accumulated other comprehensive income (loss).

In prior years, the Company reclassified certain municipal securities from available-for-sale to held-to-maturity. The reclassifications will remain in effect until the investments are called or mature. The difference between the book values and fair values at the date of the transfer will continue to be reported in a separate component of accumulated other comprehensive income (loss), and will be amortized into income over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a premium. Concurrently, the revised book values of the transferred securities (represented by the market value on the date of transfer) are being amortized back to their par values over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a discount.

Loans

The following table presents our loan portfolio composition and the corresponding percentage of total loans as of the dates indicated. Other construction and land loans include residential acquisition and development loans, commercial undeveloped land and one- to four-family improved and unimproved lots. Commercial real estate includes non-residential owner occupied and non-owner occupied real estate, multi-family, and owner-occupied investment property. Commercial business loans include unsecured commercial loans and commercial loans secured by business assets.

	At June 30,						At December 31,
	2015						2014
	Amount			Percent			Amount			Percent
	(Dollars in thousands)
Real estate loans:
One- to four-family residential	$	232,167			39.7	%	$	227,209			41.8	%
Commercial		192,021			32.8			179,435			33.0
Home equity loans and lines of credit		54,078			9.2			56,561			10.4
Residential construction		10,363			1.8			7,823			1.4
Other construction and land		54,369			9.3			50,298			9.3
Commercial		36,847			6.3			19,135			3.5
Consumer		5,295			0.9			3,200			0.6
Total loans, gross	$	585,140			100.0	%	$	543,661			100.0	%

Less:
Deferred loan fees, net		(1,585	)					(1,695	)
Unamortized premium		410						—
Unamortized discount		(1,499	)					(1,487	)

Total loans, net	$	582,466					$	540,479

Percentage of total assets		60.1	%					59.8	%

Net loans increased $42.0 million, or 7.8%, to $582.5 million at June 30, 2015 from $540.5 million at December 31, 2014. During 2015, we have experienced an improvement in loan demand which was enhanced by our new loan production office in Greenville, South Carolina and hiring of additional commercial lenders. We believe that economic conditions in our primary market area are continuing to improve, albeit at a moderate pace, and that these improving conditions are contributing to an increase in loan demand.

In addition, we purchased $15.2 million in externally sourced loans during the six months ended June 30, 2015 which were comprised of $2.5 million in commercial SBA guaranteed loans, $10.0 million in commercial and industrial participation loans, and a $2.7 million commercial real estate whole loan purchase. We will continue to evaluate opportunities to purchase loans while properly managing our risk, which we believe serves as a valuable supplement to organic loan growth.

Delinquent Loans

When a loan becomes 15 days past due, we contact the borrower to inquire as to why the loan is past due. When a loan becomes 30 days or more past due, we increase collection efforts to include all available forms of communication. Once a loan becomes 45 days past due, we generally issue a demand letter and further explore the reasons for non-repayment, discuss repayment options, and inspect the collateral. In the event the loan officer or collections staff has reason to believe restructuring will be mutually beneficial to the borrower and the Bank, the borrower will be referred to the Bank’s Credit Administration Staff to explore restructuring alternatives to foreclosure. Once the demand period has expired and it has been determined that restructuring is not a viable option, the Bank’s counsel is instructed to pursue foreclosure.

The accrual of interest on loans is discontinued at the time a loan becomes 90 days delinquent or when it becomes impaired, whichever occurs first, unless the loan is well secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual is reversed. Interest payments received on nonaccrual loans are generally applied as a direct reduction to the principal outstanding until the loan is returned to accrual status. Interest payments received on nonaccrual loans may be recognized as income on a cash basis if recovery of the remaining principal is reasonably assured. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Interest payments applied to principal while the loan was on nonaccrual may be recognized in income over the remaining life of the loan after the loan is returned to accrual status.

If a loan is modified in a TDR, the loan is generally placed on non-accrual until there is a period of satisfactory payment performance by the borrower (either immediately before or after the restructuring), generally six consecutive months, and the ultimate collectability of all amounts contractually due is not in doubt.

The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. We have no loans past due 90 days and over that are still accruing interest as of June 30, 2015 or December 31, 2014.

	Delinquent loans
	30-59 Days			60-89 Days			90 Days and over			Total
	(Dollars in thousands)
At June 30, 2015
Real estate loans:
One- to four-family residential	$	3,723		$	362		$	2,302		$	6,387
Commercial		4,310			77			561			4,948
Home equity loans and lines of credit		493			—			1,088			1,581
Residential construction		119			—			—			119
Other construction and land		904			6			669			1,579
Commercial		—			9			—			9
Consumer		15			4			—			19
Total loans	$	9,564		$	458		$	4,620		$	14,642
% of total loans, net		1.64	%		0.08	%		0.79	%		2.51	%

At December 31, 2014
Real estate loans:
One- to four-family residential	$	6,298		$	448		$	2,669		$	9,415
Commercial		2,136			909			1,006			4,051
Home equity loans and lines of credit		557			528			759			1,844
One- to four-family residential construction		—			—			65			65
Other construction and land		1,530			964			473			2,967
Commercial		—			22			—			22
Consumer		247			4			1			252
Total loans	$	10,768		$	2,875		$	4,973		$	18,616
% of total loans, net		1.99	%		0.53	%		0.92	%		3.44	%

We continue to experience stabilization in our delinquencies compared to prior periods as delinquent loans decreased $4.0 million, or 21.3%, to $14.6 million at June 30, 2015 from $18.6 million at December 31, 2014.

Non-Performing Assets

Non-performing loans include all loans past due 90 days and over, certain impaired loans (some of which may be contractually current), and TDR loans that have not yet established a satisfactory period of payment performance (some of which may be contractually current). Non-performing assets include non-performing loans and REO. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated.

	June 30,			December 31,
	2015			2014
	(Dollars in thousands)
Non-accrual loans:
Real estate loans:
One- to four-family residential	$	4,602		$	5,661
Commercial		5,602			7,011
Home equity loans and lines of credit		1,086			1,347
Residential construction		—			65
Other construction and land		995			2,679
Commercial		62			15
Consumer		2			2

Total non-performing loans		12,349			16,780

REO:
One- to four-family residential		671			220
Commercial real estate		1,039			774
Residential construction		—			—
Other construction and land		3,000			3,431

Total foreclosed real estate		4,710			4,425

Total non-performing assets	$	17,059		$	21,205


Troubled debt restructurings still accruing	$	13,679		$	18,760


Ratios:
Non-performing loans to total loans		2.12	%		3.10	%
Non-performing assets to total assets		1.76	%		2.35	%

Non-performing loans decreased $4.4 million, or 26.4%, to $12.4 million at June 30, 2015 from $16.8 million at December 31, 2014. Several commercial real estate and other construction and land relationships returned to accrual status during this period upon demonstration of sustained payment performance and cash flow coverage. In addition, $1.7 million of nonaccrual loans at December 31, 2014 were transferred to real estate owned during the first six months of 2015.

Real estate owned increased $0.3 million, or 6.4%, to $4.7 million at June 30, 2015 from $4.4 million at December 31, 2014. Although real estate owned balances have slightly increased, most of the transfers to real estate owned during the period were 1-4 family residential properties which are normally sold at a faster pace than other property types.

The overall decrease in non-performing assets reflects the improving economy in our primary market area which has resulted in fewer foreclosures and problem assets.

Classification of Loans

The following table sets forth amounts of classified and criticized loans at the dates indicated. As indicated in the table, loans classified as “doubtful” or “loss” are charged off immediately.

	At June 30,			At December 31,
	2015			2014
	(Dollars in thousands)

Classified loans:
Substandard	$	26,949		$	32,105
Doubtful		—			—
Loss		—			—

Total classified loans:		26,949			32,105
As a % of total loans, net		4.63	%		5.94	%

Special mention		22,252			31,283

Total criticized loans	$	49,201		$	63,388
As a % of total loans, net		8.45	%		11.73	%

Total classified loans decreased $5.2 million, or 16.1%, to $26.9 million at June 30, 2015 from $32.1 million at December 31, 2014. Total criticized loans decreased $14.2 million, or 22.4%, to $49.2 million at June 30, 2015 from $63.4 million at December 31, 2014. These reductions reflect an improving economy and an increasing number of criticized loans being paid off or upgraded as a consequence of improvements in our borrowers’ cash flows and payment performance. Management continues to dedicate significant resources to monitoring and resolving classified and criticized loans.

Allowance for Loan Losses

The allowance for loan losses reflects our estimates of probable losses inherent in our loan portfolio at the balance sheet date. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of our loans in light of historical experience, the nature and volume of our loan portfolio, adverse situations that may affect our borrowers’ abilities to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The methodology for determining the allowance for loan losses has two main components: the evaluation of individual loans for impairment and the evaluation of certain groups of homogeneous loans with similar risk characteristics.

A loan is considered impaired when it is probable that we will be unable to collect all principal and interest payments due according to the original contractual terms of the loan. We individually evaluate loans classified as “substandard” or nonaccrual and greater than $350,000 for impairment. If the impaired loan is considered collateral dependent, a charge-off is taken based upon the appraised value of the property (less an estimate of selling costs if foreclosure or sale of the property is anticipated). If the impaired loan is not collateral dependent, a specific reserve is established based upon an estimate of the future discounted cash flows after consideration of modifications and the likelihood of future default and prepayment.

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. Prior to the first quarter of 2015, we more heavily weighted the most recent four quarters than the least recent four quarters. Beginning in the first quarter of 2015, we no longer weight any quarters for our average loss rates. This change in weighting did not have a material impact on our allowance for loan losses methodology. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.5% to 14%.

The qualitative reserve adjusts the weighted average loss rates utilized in the base loss reserve for trends in the following internal and external factors:

• Non-accrual and classified loans

• Collateral values

• Loan concentrations

• Economic conditions – including unemployment rates, building permits, and a regional economic index.

Qualitative reserve adjustment factors decreased for favorable trends and decreased for unfavorable trends. These factors are subject to further adjustment as economic and other conditions change.

The following table sets forth activity in our allowance for loan losses at the dates and for the periods indicated.

	As of or for the Three Months Ended June 30,						As of or for the Six Months Ended June 30,
	2015			2014			2015			2014
	( Dollars in thousands)						( Dollars in thousands)
Balance at beginning of period	$	9,611		$	11,956		$	11,072		$	14,251

Charge-offs:
Real Estate:
One- to four-family residential		19			85			238			516
Commercial		15			205			45			1,998
Home equity loans and lines of credit		260			188			369			331
Residential construction		—			—			—			—
Other construction and land		67			132			86			475
Commercial		1			125			1			125
Consumer		7			18			20			63
Total charge-offs		369			753			759			3,508

Recoveries:
Real Estate:
One- to four-family residential		13			22			122			23
Commercial		75			51			167			335
Home equity loans and lines of credit		2			17			25			34
Residential construction		2			—			2			—
Other construction and land		47			8			166			86
Commercial		3			150			10			155
Consumer		67			104			146			174
Total recoveries		209			352			638			807

Net charge-offs		160			401			121			2,701

Provision for loan losses		—			6			(1,500	)		11

Balance at end of period	$	9,451		$	11,561		$	9,451		$	11,561

Ratios:
Net charge-offs to average loans outstanding		0.06	%		0.15	%		0.04	%		2.02	%
Allowance to non-performing loans at period end		76.53	%		93.48	%		76.53	%		93.48	%
Allowance to total loans at period end		1.62	%		2.18	%		1.62	%		2.18	%

Net charge-offs/recoveries for the quarter ended June 30, 2015 improved by $0.2 million, to net charge-offs of $0.2 million compared to net charge-offs of $0.4 million for the corresponding period in the prior year. For the six months ended June 30, 2015, net charge-offs decreased $2.6 million, or 95.5%, compared to the corresponding period in the prior year. We have continued to experience a reduction in charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of non-performing loans remained strong at 76.53% at June 30, 2015 compared to 93.48% at June 30, 2014.

Real Estate Owned (REO)

The table below summarizes the balances and activity in REO at the dates and for the periods indicated.

	June 30,		December 31,
	2015		2014
	(Dollars in thousands)

One- to four-family residential	$	671	$	220
Commercial real estate		1,039		774
Residential construction		—		—
Other construction and land		3,000		3,431
Total	$	4,710	$	4,425

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
	(Dollars in thousands)						(Dollars in thousands)
Balance, beginning of period	$	4,917		$	8,748		$	4,425		$	10,506
Additions		372			448			1,689			1,062
Disposals		(564	)		(1,253	)		(1,321	)		(2,979	)
Writedowns		(23	)		(462	)		(91	)		(1,097	)
Other		8			4			8			(7	)
Balance, end of period	$	4,710		$	7,485		$	4,710		$	7,485

Real estate owned increased $0.3 million, or 6.4%, to $4.7 million at June 30, 2015 from $4.4 million at December 31, 2014, as transfers to real estate owned exceeded disposals and writedowns during the period. Most of the transfers to real estate owned during the quarter were 1-4 family residential properties which are normally sold at a faster pace than other property types. We have experienced a significant decrease in the number and dollar amount of additions to REO, and have had moderate success in liquidating REO. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.

Net Deferred Tax Assets

Deferred income tax assets and liabilities are determined using the asset and liability method and are reported net in the Consolidated Balance Sheets. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rate and laws. When deferred tax assets are recognized, they are subject to a valuation allowance based on management’s judgment as to whether realization is more likely than not. In determining the need for a valuation allowance, we considered the following sources of taxable income:

Future reversals of existing taxable temporary differences;
Future taxable income exclusive of reversing temporary differences and carry forwards;
Taxable income in prior carryback years; and
Tax planning strategies that would, if necessary, be implemented.

A pattern of sustained profitability, excluding non-recurring items, since the first quarter of 2014

A 3 year cumulative profit;

Forecasted earnings sufficient to utilize all remaining net operating losses prior to expiration beginning in 2025 for North Carolina and 2032 for Federal;

Significant improvements in asset quality;

Resolution of all remaining regulatory orders; and

A strong capital position enabling future earnings investments.

Deposits

The following table presents deposits by category and percentage of total deposits as of the dates indicated.

	As of					As of
	June 30, 2015					December 31, 2014
	Balance		Percent			Balance		Percent
	(Dollars in thousands)
Deposit type:
Savings accounts	$	30,043		4.3	%	$	27,591		3.9	%
Time deposits		296,968		42.9			309,046		44.0
Brokered CDs		—		—			9,173		1.3
Money market accounts		171,475		24.8			178,320		25.4
Interest-bearing demand accounts		98,447		14.2			92,877		13.2
Noninterest-bearing demand accounts		95,604		13.8			86,110		12.2

Total deposits	$	692,537		100.0	%	$	703,117		100.0	%

Total deposits decreased $10.6 million, or 1.5%, to $692.5 million at June 30, 2015 from $703.1 million at December 31, 2014. The decrease in deposits is mainly attributable to the maturity of the Company’s final brokered deposit of $9.0 million in June 2015.

FHLB Advances

FHLB advances increased $60.5 million to $120.5 million at June 30, 2015 compared to $60.0 million at December 31, 2014. The additional funds were used to invest in loans and investment securities and to provide funding for future cash needs. The advances had a weighted average rate of 0.64% as of June 30, 2015 compared to 1.37% at December 31, 2014.

Junior Subordinated Notes

We had $14.4 million in junior subordinated notes outstanding at June 30, 2015 and December 31, 2014 payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. The effective interest rate was 3.08% and 3.05% at June 30, 2015 and December 31, 2014, respectively.

Equity

Comparison of Operating Results for the Three Months Ended June 30, 2015 and June 30, 2014.

General. Net income increased $16.4 million to $17.1 million for the three months ended June 30, 2015, compared to net income of $0.7 million for the three months ended June 30, 2014. The increase in net income for the quarter was primarily the result of a non-cash income tax benefit of $17.6 million resulting from the reversal of substantially all of the valuation allowance on the Company’s net deferred tax asset and partially offset by a FHLB advance prepayment penalty of $1.8 million, increased compensation of $0.9 million, and a decrease in noninterest income of $0.5 million.

Income before taxes decreased $2.6 million, or 120.9%, to a loss of $0.5 million for the three months ended June 30, 2015 compared to income of $2.2 million for the three months ended June 30, 2014. The decrease was primarily attributable to the FHLB advance prepayment penalty of $1.8 million, a decrease in noninterest income of $0.5 million, and an increase in compensation related expenses of $0.9 million.

Net Interest Income. Net interest income before provision for loan losses increased to $6.6 million for the three months ended June 30, 2015, compared to $6.3 million for the same period in 2014. The increase is primarily attributable to interest income from increased volume in investment securities during 2015.

The tax-equivalent net interest margin decreased to 3.06% for the quarter ended June 30, 2015 compared to 3.36% for the same period in 2014. The decrease in margin was primarily the result of decreased yields on loans and investments as well as $0.2 million of discounts recognized in the 2014 period from the favorable resolution of a commercial loan.

The following table sets forth the average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets on a tax-equivalent basis, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average tax-equivalent yields and cost for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

	For the Three Months Ended June 30,
	2015							2014
	Average Outstanding Balance		Interest		Yield/ Rate			Average Outstanding Balance		Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale	$	567,114	$	6,647		4.70	%	$	531,779	$	6,737		5.08	%
Loans, tax exempt (1)		4,616		48		4.21	%		1,947		24		4.99	%
Investments - taxable		255,571		1,278		2.01	%		181,657		973		2.15	%
Investment tax exempt (1)		9,054		127		5.64	%		8,737		139		6.40	%
Interest earning deposits		35,102		22		0.25	%		29,203		18		0.25	%
Other investments, at cost		5,942		49		3.31	%		3,450		26		3.02	%

Total interest-earning assets		877,399		8,172		3.74	%		756,773		7,918		4.20	%

Noninterest-earning assets		50,521							49,451

Total assets	$	927,920						$	806,224

Interest-bearing liabilities:
Savings accounts	$	29,008	$	8		0.11	%	$	26,619	$	9		0.14	%
Time deposits		309,430		961		1.25	%		327,430		1,057		1.29	%
Money market accounts		175,000		140		0.32	%		185,421		248		0.54	%
Interest bearing transaction accounts		96,118		40		0.17	%		84,116		35		0.17	%
Total interest bearing deposits		609,556		1,149		0.76	%		623,586		1,349		0.87	%

FHLB advances		85,462		183		0.86	%		40,000		174		1.74	%
Junior subordinated debentures		14,433		115		3.20	%		14,433		52		1.45	%
Other borrowings		2,159		26		4.83	%		—		—		0.00	%

Total interest-bearing liabilities		711,610		1,473		0.83	%		678,019		1,575		0.93	%

Noninterest-bearing deposits		91,090							75,789

Other non interest bearing liabilities		13,570							12,936

Total liabilities		816,270							766,744
Total equity		111,650							39,480

Total liabilities and equity	$	927,920						$	806,224


Tax-equivalent net interest income			$	6,699						$	6,343


Net interest-earning assets ⁽²⁾	$	165,789						$	78,754

Average interest-earning assets to interest-bearing liabilities		1.23							1.12

Tax-equivalent net interest rate spread ⁽³⁾						2.91	%						3.26	%
Tax-equivalent net interest margin ⁽⁴⁾						3.06	%						3.36	%

(1) Tax exempt loans and investments are calculated giving effect to a 34% federal tax rate.

(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(3) Tax-equivalent net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4) Tax-equivalent net interest margin represents tax equivalent net interest income divided by average total interest-earning assets.

The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to change in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on changes due to rate and the changes due to volume.

	For the Three Months Ended June 30, 2015 Compared to the Three Months Ended June 30, 2014
	Increase (decrease) due to:
	Volume			Rate			Total
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale (1)	$	432		$	(522	)	$	(90	)
Loans, tax exempt (2)		28			(4	)		24
Investment - taxable		373			(68	)		305
Investments - tax exempt (2)		5			(17	)		(12	)
Interest-earning deposits		4			0			4
Other investments, at cost		20			3			23

Total interest-earning assets		862			(608	)		254

Interest-bearing liabilities:
Savings accounts	$	1		$	(2	)	$	(1	)
Time deposits		(57	)		(39	)		(96	)
Money market accounts		(13	)		(95	)		(108	)
Interest bearing transaction accounts		5			0			5
FHLB advances		128			(119	)		9
Junior subordinated debentures		—			63			63
Other borrowings		26			—			26

Total interest-bearing liabilities		90			(192	)		(102	)

Change in tax-equivalent net interest income	$	772		$	(416	)	$	356

(1) Non-accrual loans are included in the above analysis.

(2) Interest income on tax exempt loans and investments are adjusted for based on a 34% federal tax rate

Net interest income before provision for loan losses increased to $6.6 million for the three months ended June 30, 2015, compared to $6.3 million for the same period in 2014. As indicated in the table above, an increase in net interest income of $0.8 million attributable to an improvement in volume was partially offset by a $0.4 million reduction in net interest earned attributable to a reduction in rates. The decline related to rate was primarily the result of the recognition of approximately $0.2 million of discounts recognized during the 2014 period from the favorable resolution of a commercial loan, continued repricing of loans at current market rates, and increased rate competition for new loans. These rate decreases on our interest earning assets were partially offset by decreased rates on deposits and borrowings.

The increase in tax-equivalent net interest income of $0.8 million related to volume was primarily the result of higher average loan and taxable investment balances which increased $38.0 million and $73.9 million, respectively, for the three months ended June 30, 2015 as compared to the same period in 2014. The increase in average loan and investment balances was partially offset by higher average FHLB advance balances which increased $45.5 million over the same periods.

The decrease in tax-equivalent net interest income of $0.4 million related to rate was primarily the result of decreased loan yields due to competition and the recognition of approximately $0.2 million of discounts recognized during the 2014 period as mention above. This was also a contributing factor for the decrease in our loan yields from 5.08% to 4.70% year over year. The decrease in average loan yields was partially offset by the impact of lower average interest bearing deposit yields which decreased 11 basis points to 0.76% in the quarter ended June 30, 2015 as compared to 0.87% in the three months ending June 30, 2014. In addition, a reduction in average rates on FHLB advances from 1.74% during the three months ended June 30, 2014 to 0.86% for the three months ended June 30, 2015 also contributed to the increase in this component of net interest income.

Our tax-equivalent net interest rate spread decreased by 35 basis points to 2.91% for the three months ended June 30, 2015 compared to 3.26% for the three months ended June 30, 2014, and our tax-equivalent net interest margin decreased 30 basis points to 3.06% for the three months ended June 30, 2015, compared to 3.36% for the three months ended June 30, 2014. As mentioned above, the decreases in our interest rate spread and margin were primarily a result of decreased loan yields due to competition and the $0.2 million of deferred interest and discounts recognized during the 2014 period from the favorable resolution of a commercial loan.

Provision for Loan Losses. For the three months ended June 30, 2015, we did not record a provision for loan losses compared to a provision of $5,000 for the same period in the prior year. Factors contributing to no recorded provision for loan losses were the continued improvement in asset quality, significantly reduced charge-off amounts, and a continued decline in the overall loss rates used in our allowance for loan losses model.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the three month periods ended June 30, 2015 and 2014:

	Three Months Ended June 30,
	2015			2014		Change
	(Dollars in thousands)
Servicing income, net	$	19		$	147	$	(128	)
Mortgage banking		85			232		(147	)
Gain on sale of SBA loans		3			—		3
Gain on sale of investments, net		123			317		(194	)
Other than temporary impairment on cost method investment		(3	)		—		(3	)
Service charges on deposit accounts		317			291		26
Interchange fees		322			291		31
Bank owned life insurance		133			129		4
Other		89			148		(59	)

Total	$	1,088		$	1,555	$	(467	)

The $0.1 million net decrease in servicing income was primarily the result of the valuation impact of the corresponding loan servicing rights compared to the prior year period.

The $0.1 million decrease in mortgage banking income is primarily due to changes in the valuation of mortgage banking derivatives compared to the prior year.

Net gains on sales of investments decreased $0.2 million for the three months ended June 30, 2015 compared to the three months ended June 30, 2014. The decrease in net gains on sales of investments is due to the sale of investments in the current rate environment having fewer gains than the prior year.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the three months ended June 30, 2015 and 2014:

	Three Months Ended June 30,
	2015		2014		Change
	(Dollars in thousands)

Compensation and employee benefits	$	3,817	$	2,947	$	870
Net occupancy		731		669		62
Federal Home Loan Bank prepayment penalty		1,762		—		1,762
Federal deposit insurance		279		258		21
Professional and advisory		261		182		79
Data processing		282		276		6
Net cost of operation of real estate owned		116		604		(488	)
Other		933		732		201

Total noninterest expenses	$	8,181	$	5,668	$	2,513

Compensation and employee benefits increased by $0.9 million, or 29.5%, for the three months ended June 30, 2015 compared to the three months ended June 30, 2014. This additional expense is related to increases in our number of employees, annual raises, employee benefits, incentives and commissions. The number of our full-time equivalent employees increased to 196 at June 30, 2015, as compared to 185 at June 30, 2014.

During the quarter, we prepaid a $15.0 million FHLB advance and incurred a prepayment penalty of $1.8 million. The advance, which carried an interest rate equal to 90-day LIBOR plus 2.56% and reset quarterly, was replaced with a $15.0 million three month fixed rate advance at a rate of 0.23%. As a result of the restructuring, the interest rate on the advance was reduced by 2.58% resulting in expected incremental pre-tax annual earnings of approximately $0.4 million.

The net cost of operation of real estate owned decreased $0.5 million, or 80.8%, for the three months ended June 30, 2015 compared to the three months ended June 30, 2014. This reduction reflects decreases in our levels of real estate owned compared to the prior year period along with more stabilized property values.

Income Taxes. We recorded $17.4 million of income tax benefit for the six months ended June 30, 2015, reflecting the reversal of $17.6 million in valuation allowance which was partially offset by tax expense recorded for tax planning strategies prior to the valuation allowance reversal. We continue to be in a net operating loss position for federal and state income tax purposes and do not have a material current tax liability or receivable.

Comparison of Operating Results for the Six Months Ended June 30, 2015 and June 30, 2014.

General. Net income increased $17.0 million to $19.7 million for the six months ended June 30, 2015, compared to net income of $2.8 million for the six months ended June 30, 2014. The increase in net income for the period was primarily the result of a non-cash income tax benefit of $17.6 million resulting from the reversal of substantially all of the valuation allowance on the Company’s net deferred tax asset and a negative provision for loan losses of $1.5 million which were partially offset by a FHLB advance prepayment penalty of $1.8 million, increased compensation of $1.6 million, and a decrease in noninterest income of $0.4 million.

Income before taxes decreased $2.2 million, or 48.2%, to $2.3 million for the six months ended June 30, 2015 compared to $4.5 million for the six months ended June 30, 2014. The decrease was primarily attributable to the FHLB advance prepayment penalty of $1.8 million, a decrease in noninterest income of $0.4 million, and an increase in compensation related expenses of $1.6 million.

Net Interest Income. Net interest income before provision for loan losses decreased to $13.0 million for the six months ended June 30, 2015, compared to $13.4 million for the same period in 2014. The decrease in net interest income was primarily the result of $1.1 million of deferred interest and discounts recognized in the 2014 period from the favorable resolution of two commercial loans partially offset by increased interest income from investment securities.

The tax-equivalent net interest margin decreased to 3.05% for the six months ended June 30, 2015 compared to 3.64% for the same period in 2014. The decline in margin was primarily the result of decreased yields on loans and investments and the recognition of $1.1 million of deferred interest and discounts recognized during the 2014 period from the favorable resolution of two commercial loans.

	For the Six Months Ended June 30,
	2015							2014
	Average Outstanding Balance		Interest		Yield/ Rate			Average Outstanding Balance		Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale	$	558,488	$	13,117		4.74	%	$	529,305	$	14,345		5.47	%
Loans, tax exempt (1)		4,073		88		4.35	%		1,963		50		5.14	%
Investments - taxable		250,422		2,514		2.02	%		178,313		1,952		2.21	%
Investment tax exempt (1)		7,829		233		6.01	%		8,749		280		6.46	%
Interest earning deposits		38,633		46		0.24	%		24,930		28		0.23	%
Other investments, at cost		5,424		107		3.98	%		3,546		47		2.67	%

Total interest-earning assets		864,869		16,105		3.76	%		746,806		16,702		4.51	%

Noninterest-earning assets		49,462							48,897

Total assets	$	914,331						$	795,703

Interest-bearing liabilities:
Savings accounts	$	28,480	$	16		0.11	%	$	26,224	$	18		0.14	%
Time deposits		313,992		1,972		1.27	%		325,728		2,109		1.31	%
Money market accounts		176,469		294		0.34	%		184,203		499		0.55	%
Interest bearing transaction accounts		93,365		76		0.16	%		81,150		63		0.16	%
Total interest bearing deposits		612,306		2,358		0.78	%		617,305		2,689		0.88	%

FHLB advances		72,811		388		1.07	%		40,003		348		1.75	%
Junior subordinated debentures		14,433		227		3.17	%		14,433		175		2.45	%
Other borrowings		1,980		52		5.30	%		—		—		0.00	%

Total interest-bearing liabilities		701,530		3,025		0.87	%		671,741		3,212		0.96	%

Noninterest-bearing deposits		88,561							73,238

Other non interest bearing liabilities		13,681							12,548

Total liabilities		803,772							757,527
Total equity		110,559							38,176

Total liabilities and equity	$	914,331						$	795,703


Tax-equivalent net interest income			$	13,080						$	13,490


Net interest-earning assets ⁽²⁾	$	163,339						$	75,065

Average interest-earning assets to interest-bearing liabilities		1.23							1.11

Tax-equivalent net interest rate spread ⁽³⁾						2.89	%						3.55	%
Tax-equivalent net interest margin ⁽⁴⁾						3.05	%						3.64	%

(1) Tax exempt loans and investments are calculated giving effect to a 34% federal tax rate.

(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(3) Tax-equivalent net interest rate spread represents the difference between the tax equivalent yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4) Tax-equivalent net interest margin represents tax equivalent net interest income divided by average total interest-earning assets.

	For the Six Months Ended June 30, 2015 Compared to the Six Months Ended June 30, 2014
	Increase (decrease) due to:
	Volume			Rate			Total
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale (1)	$	760		$	(1,988	)	$	(1,228	)
Loans, tax exempt (2)		47			(9	)		38
Investment - taxable		735			(173	)		562
Investments - tax exempt (2)		(28	)		(19	)		(47	)
Interest-earning deposits		16			2			18
Other investments, at cost		31			29			60

Total interest-earning assets		1,561			(2,158	)		(597	)

Interest-bearing liabilities:
Savings accounts	$	1		$	(3	)	$	(2	)
Time deposits		(75	)		(62	)		(137	)
Money market accounts		(20	)		(185	)		(205	)
Interest bearing transaction accounts		10			3			13
FHLB advances		210			(170	)		40
Junior subordinated debentures		—			52			52
Other borrowings		52			—			52

Total interest-bearing liabilities		178			(365	)		(187	)

Change in tax-equivalent net interest income	$	1,383		$	(1,793	)	$	(410	)

(1) Non-accrual loans are included in the above analysis.

(2) Interest income on tax exempt loans and investments are adjusted for based on a 34% federal tax rate

Net interest income before provision for loan losses decreased to $13.0 million for the six months ended June 30, 2015, compared to $13.4 million for the same period in 2014. As indicated in the table above, an increase in net interest earned of $1.4 million attributable to an improvement in volume was more than offset by a $1.8 million reduction in net interest earned attributable to a reduction in rates. The decline related to rate was primarily the result of the recognition of approximately $1.1 million of deferred interest and discounts recognized during the 2014 period from the favorable resolution of two commercial loans, continued repricing of loans at current market rates, and increased rate competition for new loans. These rate decreases on our interest earning assets were partially offset by decreased rates on deposits and borrowings.

The increase in tax-equivalent net interest income of $1.4 million related to volume was primarily the result of higher average loan and taxable investment balances which increased $31.3 million and $72.1 million, respectively, for the six months ended June 30, 2015 as compared to the same period in 2014. The increase in average loan and investment balances was partially offset by higher average FHLB advance balances which increased $32.8 million over the same periods.

The decrease in tax-equivalent net interest income of $1.8 million related to rate was primarily the result of the recognition of approximately $1.1 million of deferred interest and discounts recognized during the 2014 period as mentioned above. This was also the main factor for the decrease in our loan yields from 5.47% to 4.74% year over year. The decrease in average loan yields was partially offset by the impact of lower interest bearing deposit rates which decreased 10 basis points to 0.78% for the six months ended June 30, 2015 as compared to 0.88% in the six months ending June 30, 2014. In addition, a reduction in average rates on FHLB advances from 1.75% during the six months ended June 30, 2014 to 1.07% for the six months ended June 30, 2015 also contributed to the increase in this component of net interest income.

Our tax-equivalent net interest rate spread decreased by 66 basis points to 2.89% for the six months ended June 30, 2015 compared to 3.55% for the six months ended June 30, 2014, and our tax-equivalent net interest margin decreased 59 basis points to 3.05% for the six months ended June 30, 2015, compared to 3.64% for the six months ended June 30, 2014. As mentioned above, the decreases in our interest rate spread and margin were primarily a result of the $1.1 million of deferred interest and discounts recognized during the 2014 period from the favorable resolution of two commercial loans.

Provision for Loan Losses. For the six months ended June 30, 2015, we had a negative provision for loan losses of $1.5 million compared to a provision of $11,000 for the same period in the prior year. The decrease in the provision for loan losses was the result of improvements in asset quality, significantly reduced charge-off amounts, and a continued reduction in decline in the overall loss rates used in our allowance for loan losses model.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the six month periods ended June 30, 2015 and 2014:

	Six Months Ended June 30,
	2015			2014			Change
	(Dollars in thousands)
Servicing income, net	$	105		$	426		$	(321	)
Mortgage banking		340			426			(86	)
Gain on sale of SBA loans		214			74			140
Gain on sale of investments, net		287			379			(92	)
Other than temporary impairment on cost method investment		(3	)		(76	)		73
Service charges on deposit accounts		615			589			26
Interchange fees		600			541			59
Bank owned life insurance		262			258			4
Other		207			312			(105	)

Total	$	2,627		$	2,929		$	(302	)

The $0.3 million net decrease in servicing income was primarily the result of the valuation impact of the corresponding loan servicing rights compared to the prior year period.

The $0.1 million decrease in mortgage banking income is primarily due to changes in the valuation of mortgage banking derivatives compared to the prior year.

Gains on the sale of SBA loans increased $0.1 million as a result of a larger balance of SBA loans being sold during the six months ended June 30, 2015 compared to the same period in 2014.

Net gains on sales of investments decreased $0.1 million for the six months ended June 30, 2015 compared to the six months ended June 30, 2014. The decrease in net gains on sales of investments is due to the sale of investments in the current rate environment having fewer gains than the prior year.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the six months ended June 30, 2015 and 2014:

	Six Months Ended June 30,
	2015		2014		Change
	(Dollars in thousands)

Compensation and employee benefits	$	7,514	$	5,894	$	1,620
Net occupancy		1,433		1,309		124
Federal Home Loan Bank prepayment penalty		1,762		—		1,762
Federal deposit insurance		563		696		(133	)
Professional and advisory		511		380		131
Data processing		562		502		60
Net cost of operation of real estate owned		332		1,444		(1,112	)
Other		2,080		1,556		524

Total noninterest expenses	$	14,757	$	11,781	$	2,976

Compensation and employee benefits increased by $1.6 million, or 27.5%, for the six months ended June 30, 2015 compared to the six months ended June 30, 2014. This additional expense is related to increases in our number of employees, annual raises, employee benefits, incentives and commissions. The number of our full-time equivalent employees increased to 196 at June 30, 2015, as compared to 185 at June 30, 2014.

During the second quarter of 2015, we prepaid a $15.0 million FHLB advance and incurred a prepayment penalty of $1.8 million. The advance, which carried an interest rate equal to 90-day LIBOR plus 2.56% and reset quarterly, was replaced with a $15.0 million three month fixed rate advance at a rate of 0.23%. As a result of the restructuring, the interest rate on the advance was reduced by 2.58% resulting in expected incremental pre-tax annual earnings of approximately $0.4 million.

FDIC deposit insurance decreased $0.1 million, or 19.1%, for the six months ended June 30, 2015 compared to the six months ended June 30, 2014 as a result of a reduction in our assessment rates due to an improving risk profile.

The net cost of operation of real estate owned decreased $1.1 million, or 77.0%, for the six months ended June 30, 2015 compared to the six months ended June 30, 2014. This reduction reflects decreases in our levels of real estate owned compared to the prior year period along with more stabilized property values.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, proceeds from the sale of loans originated for sale, and principal repayments and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee, under the direction of our Chief Operating Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2015.

We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and FRB interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At June 30, 2015, cash and cash equivalents totaled $29.0 million. Included in this total is $5.1 million held at FRB and $16.1 million held at the FHLB in interest-earning accounts.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements. The following summarizes the most significant sources and uses of liquidity during the six months ended June 30, 2015 and 2014:

	Six Months Ended June 30,
	2015			2014
	(Dollars in thousands)
Operating activities:
Loans originated for sale	$	(14,950	)	$	(11,495	)
Proceeds from loans originated for sale		16,630			9,702

Investing activities:
Purchases of investments	$	(90,592	)	$	(43,178	)
Maturities and principal repayments of investments		31,890			11,909
Sales of investments		25,707			15,425
Net increase in loans		(25,339	)		(12,261	)
Purchase of loans		(20,369	)		—
Purchases of fixed assets		(2,445	)		(423	)
Purchases of other investments, at cost		(2,674	)		—

Financing activities:
Net increase (decrease) in deposits	$	(11,264	)	$	28,350
Proceeds from FHLB advances		100,500			—
Repayment of FHLB advances		(40,000	)		—

At June 30, 2015, we had $25.1 million in outstanding commitments to originate loans. In addition to commitments to originate loans, we had $70.7 million in unused lines of credit.

Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of June 30, 2015.

In addition to loans, we invest in securities that provide a source of liquidity, both through repayments and as collateral for borrowings. Our securities portfolio includes both callable securities (which allow the issuer to exercise call options) and mortgage-backed securities (which allow borrowers to prepay loans). Accordingly, a decline in interest rates would likely prompt issuers to exercise call options and borrowers to prepay higher-rate loans, producing higher than otherwise scheduled cash flows.

Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have borrowing agreements with the FHLB and the FRB discount window. The following summarizes our borrowing capacity as of June 30, 2015:

	Total		Used		Unused
(Dollars in thousands)	Capacity		Capacity		Capacity

FHLB	$	132,533	$	120,500	$	12,033
Unpledged Marketable Securities		277,480		44,026		233,454
FRB		51,285		—		51,285
	$	461,298	$	164,526	$	296,772

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based guidelines and framework under prompt corrective action provisions include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.

The tables below summarize capital ratios and related information in accordance with Basel III as measured at June 30, 2015 and pre-existing rules at December 31, 2014.

The following table summarizes the required and actual capital ratios of the Bank as of the dates indicated:

	Actual					For Capital Adequacy Purposes				To Be Well-Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio		Amount		Ratio
As of June 30, 2015:
Tier 1 Leverage Capital	$	114,336		12.47	%	$	36,618		>4%	$	45,772		>5%
Common Equity Tier 1 Capital	$	114,336		18.76	%	$	27,433		>4.5%	$	39,625		>6.5%
Tier 1 Risk-based Capital	$	114,336		18.76	%	$	36,577		>6%	$	48,769		>8%
Total Risk-based Capital	$	122,063		20.02	%	$	48,769		>8%	$	60,962		>10%

As of December 31, 2014:
Tier 1 Leverage Capital	$	105,556		11.91	%	$	35,440		>4%	$	44,300		>5%
Tier 1 Risk-based Capital	$	105,556		19.89	%	$	21,231		>4%	$	31,847		>6%
Total Risk-based Capital	$	112,246		21.15	%	$	42,462		>8%	$	53,078		>10%

The Company exceeded its regulatory capital ratios at June 30, 2015 and December 31, 2014, as set forth in the following table:

	Actual					For Capital Adequacy Purposes
(Dollars in thousands)	Amount		Ratio			Amount		Ratio
As of June 30, 2015:
Tier I Leverage Capital	$	132,570		14.46	%	$	36,640		>4%
Common Equity Tier 1 Capital	$	125,074		20.45	%	$	27,458		>4.5%
Tier I Risk-based Capital	$	132,570		21.70	%	$	36,611		>6%
Total Risk Based Capital	$	140,308		22.97	%	$	48,814		>8%

As of December 31, 2014:
Tier I Leverage Capital	$	123,377		13.94	%	$	35,398		>4%
Tier I Risk-based Capital	$	123,377		23.24	%	$	21,236		>4%
Total Risk Based Capital	$	130,067		24.50	%	$	42,472		>8%

The Company and the Bank are no longer subject to any regulatory orders.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

One of the most significant forms of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest –sensitive income and expense levels. Interest rate changes affect economic value of equity (“EVE”) by changing the net present value of a bank’s future cash flows, and the cash flows themselves as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and shareholder value. However, excessive risk can threaten a bank’s earnings, capital, liquidity and solvency. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. The Board of Directors of the Bank have established an Asset/Liability Management Committee (“ALCO”), which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board. Our ALCO monitors and manages market risk through rate shock analyses, economic value of equity, or EVE, analyses and simulations in order to avoid unacceptable earnings and market value fluctuations due to changes in interest rates.

One of the primary ways we manage interest rate risk is by selling the majority of our long-term fixed rate mortgages into the secondary markets, obtaining commitments to sell at locked-in interest rates prior to issuing a loan commitment. From a funding perspective, we expect to satisfy the majority of our future requirements with retail deposit growth, including checking and savings accounts, money market accounts and certificates of deposit generated within our primary markets. Deposits, exclusive of brokered certificates of deposit, decreased to $692.5 million at June 30, 2015, from $693.9 million at December 31, 2014. Brokered deposits declined $9.2 million to zero at June 30, 2015 from $9.2 million at December 31, 2014. If our funding needs exceed our deposits, we will utilize our excess funding capacity with the FHLB and the FRB.

We have taken the following steps to reduce our interest rate risk:

•

increased our personal and business checking accounts and our money market accounts, which are less rate-sensitive than certificates of deposit and which provide us with a stable, low-cost source of funds;

•

limited the fixed rate period on loans within our portfolio

•

utilized our securities portfolio for positioning based on projected interest rate environments;

•

priced certificates of deposit to encourage customers to extend to longer terms;

•

utilized FHLB advances for positioning.

We have not conducted hedging activities, such as engaging in futures, options or swap transactions.

Economic Value of Equity (EVE)

EVE is the difference between the present value of an institution’s assets and liabilities (the institution’s EVE) that would change in the event of a range of assumed changes in market interest rates. EVE is used to monitor interest rate risk beyond the 12 month time horizon of income simulations. The simulation model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of EVE. The model estimates the economic value of each type of asset, liability and off-balance sheet contract using the current interest rate yield curve with instantaneous increases or decreases of 100 to 400 basis points in 100 basis point increments. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, an NPV calculation for an interest rate decrease of greater than 100 basis points has not been prepared.

Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in EVE. Modeling changes in EVE require making certain assumptions that may or may not reflect the manner in which actual yields and costs, or loan repayments and deposit decay, respond to changes in market interest rates. In this regard, the EVE information presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE information provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

Net Interest Income

In addition to an EVE analysis, we analyze the impact of changing rates on our net interest income. Using our balance sheet as of a given date, we analyze the repricing components of individual assets, and adjusting for changes in interest rates at 100 basis point increments, we analyze the impact on our net interest income. Changes to our net interest income are shown in the following table based on immediate changes to interest rates in 100 basis point increments.

The table below reflects the impact of an immediate increase in interest rates in 100 basis point increments on Net Interest Income (NII) and Economic Value of Equity (EVE).

		June 30, 2015						December 31, 2014
Change in Interest Rates (basis points)		% Change in Pretax Net Interest Income			% Change in Economic Value of Equity			% Change in Pretax Net Interest Income			% Change in Economic Value of Equity
	+400		4.9			(17.9	)		10.6			(15.5	)
	+300		3.2			(14.5	)		7.3			(12.8	)
	+200		1.7			(10.4	)		4.2			(9.3	)
	+100		0.4			(5.8	)		1.6			(5.1	)
	—		—			—			—			—
	-100		(5.0	)		3.6			(6.2	)		1.7

The results from the rate shock analysis on NII are consistent with having an asset sensitive balance sheet. Having an asset sensitive balance sheet means assets will reprice at a faster pace than liabilities during the short-term horizon. The implications of an asset sensitive balance sheet will differ depending upon the change in market rates. For example, with an asset sensitive balance sheet in a declining interest rate environment, the interest rate on assets will decrease at a faster pace than liabilities. This situation could result in a decrease in NII and operating income. Conversely, with an asset sensitive balance sheet in a rising interest rate environment, the interest rate on assets will increase at a faster pace than liabilities. This situation could result in an increase in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 1.7% increase in NII as of June 30, 2015 as compared to a 4.2% increase in NII as of December 31, 2014.

The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has increased from December 31, 2014 to June 30, 2015. For example, a 200 basis point increase in rates would result in a 10.4% decrease in EVE as of June 30, 2015 as compared to a 9.3% decrease in EVE as of December 31, 2014.

Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including its Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of June 30, 2015. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that as of June 30, 2015, the end of the period covered by this Quarterly Report on Form 10-Q, the Company maintained effective disclosure controls and procedures.

Changes in Internal Control over Financial Reporting

There have been no changes to the Company’s internal controls over financial reporting that occurred during the quarter ended June 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not involved in any material pending legal proceedings. In the ordinary course of operations, we are often involved in legal proceedings. In the opinion of management, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the quarter ended June 30, 2015.

Item 1A. Risk Factors

There have been no material changes to the risk factors that we have previously disclosed in the “Risk Factors” section in our 2014 Annual Report on Form 10-K as filed with the SEC on March 30, 2015.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits

Exhibit No.	Description

2	Plan of Conversion, incorporated by reference to Exhibit 2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).

3.1	Articles of Incorporation of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.1 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).

3.2	Bylaws of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).

4	Form of Common Stock Certificate of Entegra Financial Corp., incorporated by reference to Exhibit 4 of the Registration Statement on Form S-1/A, filed with the SEC on June 27, 2014 (SEC File No. 333-194641).

10.1	Employment and Change of Control Agreement, dated as of October 9, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and Roger D. Plemens, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on October 15, 2014 (SEC File No. 001-35302)*

10.2	Employment and Change of Control Agreement, dated as of November 1, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and Ryan M. Scaggs, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on November 6, 2014 (SEC File No. 001-35302)*

10.3	Employment and Change of Control Agreement, dated as of November 1, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and David A. Bright, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K, filed with the SEC on November 6, 2014 (SEC File No. 001-35302)*

10.4	Form of Macon Bank, Inc. Severance and Non-Competition Agreement between Macon Bank, Inc. and each of (i) Carolyn H. Huscusson, (ii) Bobby D. Sanders, II, (iii) Laura W. Clark, and (iv) Marcia J. Ringle, incorporated by reference to Exhibit 10.4 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).*

10.5	Amended and Restated Trust Agreement, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.6 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).

10.6	Guarantee Agreement, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.7 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).

10.7	Junior Subordinated Indenture, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.8 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).

10.8	Salary Continuation Agreement between Macon Bank, Inc. and Carolyn H. Huscusson, dated November 6, 2007, incorporated by reference to Exhibit 10.11 of the Registration Statement on Form S-1/A, filed with the SEC on May 14, 2014 (SEC File No. 333-194641).*

10.9	Salary Continuation Agreement between Macon Bank, Inc. and Roger D. Plemens, dated June 23, 2003, incorporated by reference to Exhibit 10.12 of the Registration Statement on Form S-1/A, filed with the SEC on May 14, 2014 (SEC File No. 333-194641).*

10.10	Entegra Financial Corp. 2015 Long-Term Stock Incentive Plan incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on May 21, 2015.

31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32	Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101	Financial Statements filed in XBRL format.

*	Management contract or compensatory plan, contract or arrangement.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date: August 11, 2015	Entegra Financial Corp.
	(Registrant)


	By:	/s/ David A. Bright
	Name:	David A. Bright
	Title:	Chief Financial Officer
		(Authorized Officer)

EXHIBIT INDEX

Exhibit No.	Description

31.01	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.02	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.01	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101	Financial Statements filed in XBRL format.

Entegra Financial Corp. - FORM 10-Q - August 11, 2015

Attached files

Entegra Financial Corp. Reports