CAROLINA BANK HOLDINGS INC - FORM 10-Q

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EX-31.2 - EXHIBIT 31.2 - CAROLINA BANK HOLDINGS INC	v417300_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - CAROLINA BANK HOLDINGS INC	v417300_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - CAROLINA BANK HOLDINGS INC	v417300_ex31-1.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 000-31877

Carolina Bank Holdings, Inc.

(Exact name of registrant as specified in its charter)

North Carolina	56-2215437
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

101 North Spring Street, Greensboro, North Carolina	27401
(Address of principal executive offices)	(Zip Code)

(336) 288-1898

(Registrant’s telephone number, including area code)

n/a

(Former name, former address and former fiscal year, if changed since last report)

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. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨	Accelerated filer ¨

Non-accelerated filer ¨ (Do not check if a smaller reporting company)	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 x No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

There were 4,992,380 shares of the Issuer’s common stock, $1.00 par value, outstanding as of August 11, 2015.

CAROLINA BANK HOLDINGS, INC.

INDEX

		Page

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)	2

Consolidated Balance Sheets as of June 30, 2015 and December 31, 2014		2

Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014		3

Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014		4

Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2015 and 2014		5

Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014		6

Notes to Consolidated Financial Statements		7

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	33

Item 4.	Controls and Procedures	42

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	43

Item 5.	Other Information	43

Item 6.	Exhibits	43

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

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

Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350

ITEM 1. Financial Statements

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Balance Sheets

	June 30,			December 31,
	2015			2014
	(unaudited)
	(in thousands, except share data)
Assets
Cash and due from banks	$	6,245		$	7,942
Interest-bearing deposits with banks		25,343			38,232
Bank term deposits		14,106			14,106
Securities available-for-sale, at fair value		48,198			51,200
Securities held-to-maturity (fair values of $15,253 in 2015 and $15,945 in 2014)		15,068			15,644
Loans held for sale		70,897			39,780
Loans		461,000			472,189
Less allowance for loan losses		(5,795	)		(6,520	)
Net loans		455,205			465,669
Premises and equipment, net		18,916			18,311
Other real estate owned		5,352			5,610
Bank-owned life insurance		11,660			11,483
Other assets		12,695			11,286
Total assets	$	683,685		$	679,263

Liabilities and Stockholders' Equity
Deposits
Non-interest bearing demand	$	112,751		$	106,163
NOW, money market and savings		339,731			344,919
Time		140,237			143,816
Total deposits		592,719			594,898

Advances from the Federal Home Loan Bank		2,733			2,785
Securities sold under agreements to repurchase		63			176
Subordinated debentures		19,610			19,610
Other liabilities and accrued expenses		10,100			9,139
Total liabilities		625,225			626,608

Commitments - Note O
Stockholders' equity
Preferred stock, no par value, authorized 1,000,000 shares;
Series A shares issued and outstanding 0 in 2015 and 10,994 in 2014		-			10,994
Common stock, $1 par value; authorized 20,000,000 shares;
issued and outstanding 4,986,380 in 2015 and 3,434,680 in 2014		4,986			3,435
Additional paid-in capital		28,875			16,339
Retained earnings		23,702			20,748
Stock in directors' rabbi trust		(1,641	)		(1,465	)
Directors' deferred fees obligation		1,641			1,465
Accumulated other comprehensive income		897			1,139
Total stockholders’ equity		58,460			52,655
Total liabilities and stockholders’ equity	$	683,685		$	679,263

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Income (unaudited)

	Three Months					Six Months
	Ended June 30,					Ended June 30,
	2015		2014			2015		2014
	(in thousands, except per share data)
Interest income
Loans	$	6,025	$	5,858		$	12,017	$	11,612
Investment securities, taxable		325		411			663		831
Investment securities, nontaxable		125		136			247		278
Interest from deposits in banks		65		49			126		109
Total interest income		6,540		6,454			13,053		12,830

Interest expense
NOW, money market, savings		237		240			476		476
Time deposits		287		407			599		825
Other borrowed funds		151		164			303		328
Total interest expense		675		811			1,378		1,629

Net interest income		5,865		5,643			11,675		11,201
Provision for loan losses		535		346			835		1,116
Net interest income after provision for loan losses		5,330		5,297			10,840		10,085
Non-interest income
Service charges		312		321			615		620
Mortgage banking income		3,721		1,954			6,628		3,287
Gain on sale of investment securities available-for-sale		-		94			27		143
Other		95		(29	)		141		40
Total non-interest income		4,128		2,340			7,411		4,090

Non-interest expense
Salaries and benefits		4,582		4,016			8,900		7,851
Occupancy and equipment		759		793			1,535		1,554
Foreclosed property expense		155		58			24		163
Professional fees		454		546			903		1,004
Outside data processing		265		275			539		526
FDIC insurance		130		133			261		267
Advertising and promotion		160		173			353		494
Stationery, printing and supplies		147		141			298		278
Other		449		577			830		910
Total non-interest expense		7,101		6,712			13,643		13,047

Income before income taxes		2,357		925			4,608		1,128
Income tax expense		691		175			1,313		113
Net income		1,666		750			3,295		1,015
Dividends on preferred stock		94		247			341		438
Net income available to common stockholders	$	1,572	$	503		$	2,954	$	577
Net income per common share
Basic	$	0.38	$	0.15		$	0.78	$	0.17
Diluted	$	0.32	$	0.15		$	0.70	$	0.17

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (unaudited)

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

Net income	$	1,666		$	750		$	3,295		$	1,015

Other comprehensive income (loss):
Investment securities available-for-sale:
Unrealized holding gains (losses)		(515	)		403			(340	)		861
Tax effect		175			(137	)		116			(293	)
Reclassification of gains recognized in net income		-			(94	)		(27	)		(143	)
Tax effect		-			32			9			49
		(340	)		204			(242	)		474

Comprehensive income	$	1,326		$	954		$	3,053		$	1,489

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statement of Stockholders' Equity (unaudited)

Six months ended June 30, 2015 and 2014

														Stock in			Directors'		Accumulated
				Convertible					Additional					Directors'			Deferred		Other
	Preferred			Preferred			Common		Paid-In		Retained			Rabbi			Fees		Comprehensive
	Stock			Stock			Stock		Capital		Earnings			Trust			Obligation		Income			Total
	(in thousands)

Balance, December 31, 2014	$	10,994		$	-		$	3,435	$	16,339	$	20,748		$	(1,465	)	$	1,465	$	1,139		$	52,655

Net income		-			-			-		-		3,295			-			-		-			3,295
Other comprehensive loss, net of tax		-			-			-		-		-			-			-		(242	)		(242	)

Directors' fees deferred less payment of deferred fees		-			-			-		-		-			(176	)		176		-			-
Stock options exercised		-			-			2		16		-			-			-		-			18
Convertible preferred stock issued		-			14,069			-		-		-			-			-		-			14,069
Convertible preferred stock converted to common stock		-			(14,069	)		1,549		12,520		-			-			-		-			-
Preferred stock retired		(10,994	)		-			-		-		-			-			-		-			(10,994	)
Preferred stock dividends		-			-			-		-		(341	)		-			-		-			(341	)

Balance, June 30, 2015	$	-		$	-		$	4,986	$	28,875	$	23,702		$	(1,641	)	$	1,641	$	897		$	58,460

Balance, December 31, 2013	$	10,994		$	-		$	3,429	$	16,226	$	18,336		$	(1,347	)	$	1,347	$	619		$	49,604

Net income		-			-			-		-		1,015			-			-		-			1,015
Other comprehensive income, net of tax		-			-			-		-		-			-			-		474			474

Directors' fees deferred less payment of deferred fees		-			-			-		-		-			(148	)		148		-			-
Stock options exercised		-			-			3		21		-			-			-		-			24
Preferred stock dividends		-			-			-		-		(438	)		-			-		-			(438	)

Balance, June 30, 2014	$	10,994		$	-		$	3,432	$	16,247	$	18,913		$	(1,495	)	$	1,495	$	1,093		$	50,679

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

	Six Months
	Ended June 30,
	2015			2014
		(in thousands)
Cash flows from operating activities
Net income	$	3,295		$	1,015
Adjustments to reconcile net income to net cash provided by (used for) operating activities
Provision for loan losses		835			1,116
Depreciation		412			440
Increase in cash surrender value of bank-owned life insurance		(177	)		(175	)
Deferred income taxes		290			106
Amortization, net of accretion		56			56
Capitalized interest on fixed asset construction		(26	)		-
Increase in fair value of loans held for sale		(556	)		(260	)
Gain on sale of other real estate owned		(183	)		(37	)
Gain on sale of investments		(27	)		(143	)
Gain on sale of loans held for sale		(5,537	)		(3,099	)
Impairment of other real estate owned		173			115
Proceeds from sale of loans held for sale		353,044			231,007
Originations of loans held for sale		(378,068	)		(248,567	)
Increase in interest rate lock commitments		(613	)		-
Increase in other assets		(941	)		(1,475	)
Increase in other liabilities and accrued expenses		1,065			598
Net cash used for operating activities		(26,958	)		(19,303	)

Cash flows from investing activities
Increase in bank term deposits		-			(747	)
Purchases of investment securities available-for-sale		(595	)		(5,171	)
Purchases of investment securities held-to-maturity		-			(2,015	)
Maturities and calls of securities available-for-sale		979			1,905
Maturities and calls of securities held-to-maturity		176			191
Repayments from mortgage-backed securities available-for-sale		992			1,579
Repayments from mortgage-backed securities held-to-maturity		335			307
Net (increase) decrease in loans		9,081			(25,694	)
Proceeds from sales of investment securities		1,295			4,218
Purchases of premises and equipment		(991	)		(534	)
Proceeds from sales of other real estate owned		816			1,319
Net cash provided by (used for) investing activities		12,088			(24,642	)

Cash flows from financing activities
Net decrease in deposits		(2,179	)		(1,784	)
Net proceeds from issuance of preferred stock converted to common stock		14,069			-
Repurchase of preferred stock		(10,994	)		-
Net increase (decrease) in Federal Home Loan Advances		(52	)		9,950
Decrease in securities sold under agreements to repurchase		(113	)		(2,538	)
Proceeds from exercise of stock options		18			24
Dividends paid		(465	)		(384	)
Net cash provided by financing activities		284			5,268

Net decrease in cash and cash equivalents		(14,586	)		(38,677	)
Cash and cash equivalents at beginning of period		46,174			64,896
Cash and cash equivalents at end of period	$	31,588		$	26,219

Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	1,424		$	1,616
Cash paid during the period for income taxes	$	1,334		$	4
Supplemental disclosure of non-cash transactions
Transfer of loans to other real estate owned	$	548		$	3,499
Change in unrealized gains on securities available-for-sale, net of tax	$	(242	)	$	474

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note A – Summary

Carolina Bank Holdings, Inc. (the “Holding Company”) is a North Carolina corporation organized in 2000. In August 2000 pursuant to the plan of exchange approved by the shareholders of Carolina Bank (the “Bank”), all of the outstanding shares of common stock of the Bank were exchanged for shares of common stock of the Holding Company. The Holding Company presently has no employees.

The Bank was incorporated in August 1996, and began banking operations in November 1996. It is engaged in lending and deposit gathering activities in Guilford, Alamance, Randolph and Forsyth counties of North Carolina and operates under the laws of North Carolina, the Rules and Regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank has three locations in Greensboro, two offices in Winston-Salem and an office in Asheboro, Burlington and High Point. The Bank opened its second office in Winston-Salem in August 2015 which had been under construction during 2014 and 2015. One of the Greensboro branches closed on July 31, 2015 due to an expiring lease in December of 2015. All banking offices are in the Piedmont Triad region of North Carolina. A wholesale mortgage banking division is located at the Greensboro corporate headquarters, and mortgage loan production offices are located in Burlington, Chapel Hill, Pinehurst, and Sanford.

The Holding Company files periodic reports with the Securities and Exchange Commission and is also subject to regulation by the Federal Reserve Board.

Note B – Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. The Bank also owns two limited liability companies for the purpose of holding foreclosed real estate, the assets and operations of which are consolidated into the Bank and included herein. All significant inter-company and intra-company transactions and balances have been eliminated.

Note C – Basis of presentation

In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and six months ended June 30, 2015 and 2014, in conformity with accounting principles generally accepted in the United States of America. Operating results for the three and six months ended June 30, 2015 and 2014 are not necessarily indicative of the results that may be expected for future annual periods.

The Company’s financial statements are presented in accordance with Accounting Standards Codification (“ASC”) Topic 105, “The FASB Accounting Standards Codification and The Hierarchy of Generally Accepted Accounting Principles”, which codifies generally accepted accounting principles (GAAP) in the United States.

The organization and business of the Company, accounting policies followed, and other information are contained in the notes to the financial statements of the Company as of and for the years ended December 31, 2014 and 2013, filed with the Securities and Exchange Commission as part of the Company’s annual report on Form 10-K. These financial statements should be read in conjunction with the annual financial statements.

Note D - Use of estimates

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. 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 other real estate owned.

Note E - Stock compensation plans

The Company’s shareholders approved the 2009 Omnibus Stock Ownership and Long Term Incentive Plan (“Omnibus Plan”) in 2009 to replace three expired stock option plans, a nonqualified plan for directors (Director Plan) and two incentive stock option plans for management and employees (Employee Plans). The Omnibus Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock, long-term incentive compensation units and stock appreciation rights to employees and directors. An aggregate of 500,000 shares of the Company’s common stock were reserved for issuance under the terms of the Omnibus Plan, and 490,000 shares remain available for grant at June 30, 2015.

There were no stock option grants in the first six months of 2015 or 2014. There was no compensation expense in the six months ended June 30, 2015 or 2014 related to stock options. At June 30, 2015, there was no unrecognized compensation cost related to unvested share-based compensation.

As a result of the exercise of stock options, 1,700 new common shares were issued in the first six months of 2015.

Note F - Earnings per common share

Earnings per common share has been determined on a basic basis and a diluted basis which considers potential stock issuances. For the three and six months ended June 30, 2015 and 2014, basic earnings per common share has been computed based upon the weighted average common shares outstanding.

The only potential issuances of Company stock are stock options granted to various officers of the Bank. Convertible preferred stock, which was sold in a private placement offering on March 31, 2015, was converted to 1,550,000 shares of common stock on May 22, 2015. The additional common shares of 1,550,000 were included in diluted weighted average shares for one day in the first quarter of 2015 and for the entire second quarter of 2015 and were included in basic weighted average shares for thirty nine days in the second quarter of 2015. The following is a summary of the diluted earnings per common share calculation for the three and six months ended June 30, 2015 and 2014.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2015		2014		2015		2014
	(in thousands, except per share data)

Net income available to common stockholders	$	1,572	$	503	$	2,954	$	577

Weighted average outstanding shares - basic		4,099		3,430		3,769		3,430
Dilutive effect of stock options and convertible preferred stock		890		4		456		4
Weighted average shares - diluted		4,989		3,434		4,225		3,434

Diluted net income per share	$	0.32	$	0.15	$	0.70	$	0.17

For the three months ended June 30, 2015 and 2014, there were stock options covering 26,570 and 70,620 shares, respectively, that were excluded in computing diluted common shares outstanding given that they were anti-dilutive since the exercise price exceeded the average market price for the period.

Note G – Preferred stock and convertible preferred stock

In December 2008, the shareholders of the Company approved an amendment to the Articles of Incorporation authorizing the issuance of up to 1,000,000 shares of preferred stock, no par value. In January 2009, the Company issued 16,000 shares of preferred stock, Series A, to the U.S. Treasury and received $16 million under the Capital Purchase Program. The Company granted a warrant to purchase 357,675 shares of common stock at a price of $6.71 per share to the U.S. Treasury as part of the preferred stock transaction. In accordance with accounting principles, the preferred stock and common stock warrant were valued independently and their relative fair market values were allocated to the $16 million received. Under the relative value method, $14,159,000 was allocated to the preferred stock and $1,841,000 to the common stock warrant. The discount of $1,841,000 on the preferred stock was accreted over five years, prior to 2014, using the effective yield method, thereby increasing preferred stock dividends. Dividends at 5% per annum were payable quarterly for the first five years; the dividend increased to 9% per annum after the fifth year effective February 16, 2014.

The U.S. Treasury sold its holding of $16 million in preferred stock to private investors in February 2013, and the warrant to the U.S. Treasury was repurchased by the Company for $1.8 million in April 2013. The Company retired 5,006 shares of its outstanding Series A preferred stock for $4,958,000 in August 2013 and retired the remaining 10,994 shares for $10,994,000 in May of 2015.

On March 31, 2015, the Company issued 15,500 shares of Series B convertible preferred stock at $975 per share in a private placement offering and received $14,069,000 in net proceeds after offering expenses of $1,044,000. The net proceeds from this private placement were used to retire the remaining Series A preferred stock in May of 2015 and to improve capital levels. All 15,500 shares of the Series B convertible preferred stock were converted into 1,550,000 shares of common stock on May 22, 2015 following shareholder approval. No dividends were ever declared or paid on the Series B convertible preferred stock.

Note H – Subordinated debentures

In December 2004, the Company issued $10,310,000 of unsecured junior subordinated debentures which accrue and pay interest quarterly at three month LIBOR plus 2% per annum. These debentures were issued to Carolina Capital Trust (“Carolina Trust”), a wholly owned subsidiary of the Company which is not consolidated in these consolidated financial statements pursuant to accounting principles governing Consolidated Variable Interest Entities. Carolina Trust acquired these debentures using the proceeds of its offerings of common securities to the Company and $10 million of Trust Preferred Securities to outside investors. The Trust Preferred Securities qualify as Tier 1 capital under current Federal Reserve Board guidelines. The Dodd-Frank Wall Street Reform and Consumer Protection Act eliminated trust preferred securities as an element of Tier 1 capital for certain institutions. However, bank holding companies with assets of less than $15 billion as of December 31, 2009, were permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital. The Company has entered into contractual arrangements which, in the aggregate, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Carolina Trust under the Trust Preferred Securities. The Trust Preferred Securities are redeemable upon maturity of the debentures on January 7, 2035, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Carolina Trust in whole or in part at any time.

In August and September of 2008, Carolina Bank issued $9,300,000 of unsecured junior subordinated notes to outside investors which accrue and pay interest quarterly at three month LIBOR plus 4% per annum. The notes qualify as Tier 2 capital for the Bank, subject to a 20% reduction which began on October 1, 2013 and continues each year thereafter until maturity. The notes are redeemable upon maturity on September 30, 2018, or earlier at the Bank’s option, in whole or part subject to regulatory approval, beginning September 30, 2013. The expenses of the offering of $373,000 were capitalized at issuance and were amortized over sixty months. The notes are subordinate to the rights of payment to depositors, bankers acceptances, letters of credit and general creditors.

Note I – Operating segments

The Company is considered to have three principal business segments in 2015 and 2014, the Commercial/Retail Bank, the Mortgage Banking Division, and the Holding Company. The Mortgage Banking Division began originating home mortgage loans through third parties and selling these loans to investors in late 2007. A retail mortgage operation was added to the mortgage banking division in July 2010. Financial performance, reflective of inter-company and intra-company eliminations, for the three and six months ended June 30, 2015 and 2014, and selected balance sheet information, reflective of inter-company and intra-company eliminations, at June 30, 2015 and 2014 for each segment is as follows:

	Three months ended June 30, 2015									Three months ended June 30, 2014
	Commercial/		Mortgage							Commercial/		Mortgage
	Retail		Banking		Holding					Retail		Banking			Holding
	Bank		Division		Company			Total		Bank		Division			Company			Total
	(in thousands)									(in thousands)
Interest income	$	5,981	$	557	$	2		$	6,540	$	6,063	$	390		$	1		$	6,454
Interest expense		59		557		59			675		368		385			58			811
Net interest income (loss)		5,922		-		(57	)		5,865		5,695		5			(57	)		5,643
Provision for loan losses		535		-		-			535		346		-			-			346
Net interest income (loss) after provision for loan losses		5,387		-		(57	)		5,330		5,349		5			(57	)		5,297
Non-interest income		407		3,721		-			4,128		418		1,922			-			2,340
Non-interest expense		4,373		2,657		71			7,101		4,443		2,223			46			6,712
Income (loss) before income taxes		1,421		1,064		(128	)		2,357		1,324		(296	)		(103	)		925
Income tax (benefit) expense		320		415		(44	)		691		323		(113	)		(35	)		175
Net income (loss)	$	1,101	$	649	$	(84	)	$	1,666	$	1,001	$	(183	)	$	(68	)	$	750

	Six months ended June 30, 2015									Six months ended June 30, 2014
	Commercial/		Mortgage							Commercial/		Mortgage
	Retail		Banking		Holding					Retail		Banking			Holding
	Bank		Division		Company			Total		Bank		Division			Company			Total
	(in thousands)									(in thousands)
Interest income	$	12,079	$	970	$	4		$	13,053	$	12,226	$	601		$	3		$	12,830
Interest expense		291		970		117			1,378		914		599			116			1,629
Net interest income (loss)		11,788		-		(113	)		11,675		11,312		2			(113	)		11,201
Provision for loan losses		835		-		-			835		1,116		-			-			1,116
Net interest income (loss) after provision for loan losses		10,953		-		(113	)		10,840		10,196		2			(113	)		10,085
Non-interest income		783		6,628		-			7,411		805		3,285			-			4,090
Non-interest expense		8,650		4,889		104			13,643		8,692		4,280			75			13,047
Income (loss) before income taxes		3,086		1,739		(217	)		4,608		2,309		(993	)		(188	)		1,128
Income tax (benefit) expense		736		651		(74	)		1,313		552		(375	)		(64	)		113
Net income (loss)	$	2,350	$	1,088	$	(143	)	$	3,295	$	1,757	$	(618	)	$	(124	)	$	1,015

Total assets	$	610,520	$	72,756	$	409		$	683,685	$	618,455	$	50,263		$	444		$	669,162
Net loans		455,205		70,897		-			526,102		457,503		49,301			-			506,804
Equity		2,350		1,088		55,022			58,460		1,757		(618	)		49,540			50,679

The mortgage banking division experienced strong growth in originations from 2007 through 2012 due to low interest rates and due to the purchase of a retail loan production office in July of 2010. Origination of home mortgage loans has been volatile over the past few years and is dependent on a number of factors including the level of interest rates, general economic conditions, real estate values, and underwriting criteria to qualify borrowers. Mortgage loan originations were $378.1 million, $248.6 million, and $572.7 million for the first six months of 2015, 2014 and 2013, respectively. Interest rate risk has been minimized by obtaining optional loan sales commitments when loan origination commitments are made or by entering into hedging transactions whereby mortgage-backed securities are sold for the estimated closing value of loan commitments. Borrower fraud is a risk that has been minimized by prudent underwriting and by obtaining indemnification from the originating bank or broker for the risks the Company assumes. Warranty provisions and related warranty liabilities were recorded in 2009 and subsequent years to provide for potential claims that might arise from borrower fraud or underwriting errors. Warranty expenses were $53,000 and $39,000 for the three months ended June 30, 2015 and 2014, respectively, and were $96,000 and $71,000 for the six months ended June 30, 2015 and 2014, respectively. The warranty liability, which is available to fund future warranty claims, was $1,494,000 and $1,440,000 at June 30, 2015 and December 31, 2014, respectively. Fourteen warranty claims or losses and seven fair value adjustments from repurchases totaling $1,094,000 have been incurred since establishment of the mortgage banking division in 2007. In addition, nine loans with a total current carrying balance, including fair value loss adjustments recorded when transferred, of $2,468,000 have been repurchased and are included in loans held for investment.

Note J - Securities

A summary of the amortized cost, gross unrealized gains and losses and estimated fair values of securities available-for-sale and held-to-maturity follows:

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

Available-for-sale
Municipal securities	$	17,472	$	620	$	62	$	18,030
FNMA, FHLMC, and GNMA
mortgage-backed securities		17,668		563		-		18,231
Corporate securities		9,863		117		7		9,973
Asset-backed securities		1,794		103		-		1,897
Unrestricted stock		42		25		-		67
	$	46,839	$	1,428	$	69	$	48,198

Held-to-maturity
Municipal securities	$	7,543	$	148	$	23	$	7,668
FNMA mortgage-backed
securities		5,608		22		34		5,596
Asset-backed securities		1,917		72		-		1,989
	$	15,068	$	242	$	57	$	15,253

December 31, 2014

Available-for-sale
Municipal securities	$	19,093	$	831	$	28	$	19,896
FNMA, FHLMC, and GNMA
mortgage-backed securities		18,670		682		-		19,352
Corporate securities		9,822		149		7		9,964
Asset-backed securities		1,847		83		-		1,930
Unrestricted stock		42		16		-		58
	$	49,474	$	1,761	$	35	$	51,200

Held-to-maturity
Municipal securities	$	7,722	$	198	$	22	$	7,898
FNMA mortgage-backed
securities		5,945		38		-		5,983
Asset-backed securities		1,977		87		-		2,064
	$	15,644	$	323	$	22	$	15,945

The scheduled maturities of debt securities available-for-sale at June 30, 2015 were as follows:

	Bullet Securities				Declining Balance Securities				Total
			Estimated				Estimated				Estimated
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
	(in thousands)
Available-for-sale
Due in one year or less	$	998	$	1,000	$	-	$	-	$	998	$	1,000
Due from one to five years		8,428		8,601		2,666		2,719		11,094		11,320
Due from five to ten years		9,677		9,992		4,922		5,214		14,599		15,206
Over ten years		8,232		8,409		11,874		12,196		20,106		20,605
	$	27,335	$	28,002	$	19,462	$	20,129	$	46,797	$	48,131
Held-to-maturity
Due in one year or less	$	-	$	-	$	-	$	-	$	-	$	-
Due from one to five years		-		-		-		-		-		-
Due from five to ten years		2,449		2,484		-		-		2,449		2,484
Over ten years		5,094		5,184		7,525		7,585		12,619		12,769
	$	7,543	$	7,668	$	7,525	$	7,585	$	15,068	$	15,253

The Company sold two municipal securities with a total book value of $1,268,000 at a $27,000 gain during the first quarter of 2015.

Securities with a carrying value of approximately $19,822,000 and $25,327,000 were pledged to secure retail repurchase agreements and certain deposits at June 30, 2015 and December 31, 2014, respectively.

Management evaluates securities for other-than-temporary impairment at least quarterly. Consideration is given to the length of time and the extent to which the fair values have been less than amortized cost, the financial condition and near-term prospects of the security issuers, and the intent and ability to retain impaired investments for a period to allow recovery in fair value.

At June 30, 2015, five municipal securities with $5,568,000 in total fair value, one FNMA mortgage-backed security with $4,122,000 in fair value, and one corporate debt security with $973,000 in fair value had total unrealized losses of $126,000. Values on these securities with unrealized losses fluctuate based on changes in the values of U.S. Treasury bonds with similar characteristics, debt ratings changes of the issuing institutions, financial performance of the related institutions, world events, and demand for the securities. As management has the ability and intent to hold these debt securities until maturity, no declines are deemed to be other-than-temporary.

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

	Less Than 12 Months						12 Months or Greater						Total
	Number				Gross		Number				Gross		Number				Gross
	of		Fair		Unrealized		of		Fair		Unrealized		of		Fair		Unrealized
	Securities		Value		Losses		Securities		Value		Losses		Securities		Value		Losses
	(dollars in thousands)
June 30, 2015:
Municipal securities		4	$	5,326	$	77		1	$	242	$	8		5	$	5,568	$	85
FNMA, FHLMC, GNMA
mortgage-backed securities		1		4,122		34		-		-		-		1		4,122		34
Corporate securities		-		-		-		1		973		7		1		973		7
Total		5	$	9,448	$	111		2	$	1,215	$	15		7	$	10,663	$	126

December 31, 2014:
Municipal securities		1	$	1,469	$	22		5	$	4,977	$	28		6	$	6,446	$	50
Corporate securities		-		-		-		1		972		7		1		972		7
		1	$	1,469	$	22		6	$	5,949	$	35		7	$	7,418	$	57

Note K - Loans and allowance for loan losses

The activity in the allowance for loan losses for the first six months of 2015 and 2014 and related asset balances at June 30, 2015 and December 31, 2014 is summarized as follows:

	Construction &			Commercial			Home Equity			Residential			Commercial			Consumer
	Development			Real Estate			Lines			Real Estate			& Industrial			& Other			Unallocated			Total
	(in thousands)
Allowance for loan losses:
2015
Beginning of year balance	$	1,495		$	2,144		$	766		$	483		$	1,413		$	28		$	191		$	6,520
Provision for loan losses		(609	)		1,733			(254	)		257			(104	)		(1	)		(187	)		835
Charge-offs		-			(1,867	)		(104	)		(110	)		(117	)		(4	)		-			(2,202	)
Recoveries		-			346			4			16			267			9			-			642
Balance at June 30,	$	886		$	2,356		$	412		$	646		$	1,459		$	32		$	4		$	5,795
2014
Beginning of year balance	$	1,459		$	2,564		$	580		$	472		$	2,562		$	17		$	9		$	7,663
Provision for loan losses		26			282			427			39			382			98			182			1,436
Charge-offs		(22	)		(1,050	)		(244	)		(147	)		(1,913	)		(109	)		-			(3,485	)
Recoveries		32			348			3			119			382			22			-			906
Balance at December 31,	$	1,495		$	2,144		$	766		$	483		$	1,413		$	28		$	191		$	6,520

Balances at June 30, 2015
Allowance for loan losses:
Balance at June 30,	$	886		$	2,356		$	412		$	646		$	1,459		$	32		$	4		$	5,795
Ending balance individually evaluated for impairment	$	-		$	307		$	5		$	247		$	18		$	-		$	-		$	577
Ending balance collectively evaluated for impairment	$	886		$	2,049		$	407		$	399		$	1,441		$	32		$	4		$	5,218
Loans Outstanding:
Balance at June 30,	$	72,730		$	195,177		$	72,179		$	54,188		$	64,401		$	2,325		$	-		$	461,000
Ending balance individually evaluated for impairment	$	643		$	15,674		$	380		$	5,078		$	1,170		$	-		$	-		$	22,945
Ending balance collectively evaluated for impairment	$	72,087		$	179,503		$	71,799		$	49,110		$	63,231		$	2,325		$	-		$	438,055

Balances at December 31, 2014
Allowance for loan losses:
Balance at December 31,	$	1,495		$	2,144		$	766		$	483		$	1,413		$	28		$	191		$	6,520
Ending balance individually evaluated for impairment	$	-		$	357		$	127		$	216		$	22		$	-		$	-		$	722
Ending balance collectively evaluated for impairment	$	1,495		$	1,787		$	639		$	267		$	1,391		$	28		$	191		$	5,798
Loans Outstanding:
Balance at December 31,	$	75,869		$	215,280		$	71,006		$	51,902		$	54,359		$	3,773		$	-		$	472,189
Ending balance individually evaluated for impairment	$	1,056		$	10,848		$	614		$	5,520		$	522		$	-		$	-		$	18,560
Ending balance collectively evaluated for impairment	$	74,813		$	204,432		$	70,392		$	46,382		$	53,837		$	3,773		$	-		$	453,629

A loan is past due when the borrower has not made a payment by the contractual due date. The following table presents the carrying value of loans that are past due thirty days or more. Loans which are ninety days or more past due are generally on non-accrual status, at which time all accrued interest is removed from interest income. All non-accrual loans are reflected in the past due ninety days or more category shown in the following table:

													Loans Past
	Number of Days Past Due												Due 90 Days
					90 Days		Total				Total		or More
	30-59 Days		60-89 Days		or More		Past Due		Current		Loans		& Accruing
	(in thousands)
At June 30, 2015
Real Estate Loans:
Construction & development	$	-	$	-	$	598	$	598	$	72,132	$	72,730	$	-
Commercial real estate		-		318		8,273		8,591		186,586		195,177		-
Home equity lines		25		-		252		277		71,902		72,179		-
Residential real estate		-		157		1,805		1,962		52,226		54,188		-
Total real estate		25		475		10,928		11,428		382,846		394,274		-
Commercial & industrial		-		-		788		788		63,613		64,401		-
Consumer & other		-		-		-		-		2,325		2,325		-
Total loans	$	25	$	475	$	11,716	$	12,216	$	448,784	$	461,000	$	-

At December 31, 2014
Real Estate Loans:
Construction & development	$	-	$	-	$	990	$	990	$	74,879	$	75,869	$	-
Commercial real estate		-		-		3,107		3,107		212,173		215,280		-
Home equity lines		-		-		355		355		70,651		71,006		-
Residential real estate		622		38		1,923		2,583		49,319		51,902		-
Total real estate		622		38		6,375		7,035		407,022		414,057		-
Commercial & industrial		-		70		83		153		54,206		54,359		-
Consumer & other		25		-		-		25		3,748		3,773		-
Total loans	$	647	$	108	$	6,458	$	7,213	$	464,976	$	472,189	$	-

Loans are determined to be impaired when, based on current information and events, it is probable that all amounts will not be collected when due according to the contractual terms of the original loan agreement. At June 30, 2015 and December 31, 2014, the total recorded investment in impaired loans amounted to approximately $22,945,000 and $18,560,000, respectively. Of these impaired loans, $11,716,000 and $6,458,000 were on non-accrual at June 30, 2015 and December 31, 2014, respectively.

The recorded investment and related information for impaired loans is summarized as follows:

	Impaired Loans
	At end of period						For Period Ended
			Unpaid		Related		Average		Interest
	Recorded		Principal		Loan Loss		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(in thousands)
June 30, 2015
*With no related allowance recorded*
Real Estate Loans:
Construction & development	$	643	$	643	$	-	$	791	$	1
Commercial real estate		10,767		14,722		-		15,898		305
Home equity lines		201		362		-		363		8
Residential real estate		3,401		3,577		-		3,609		89
Total real estate		15,012		19,304		-		20,661		403
Commercial & industrial		788		794		-		796		10
Consumer & other		-		-		-		-		-
Total loans		15,800		20,098		-		21,457		413
*With an allowance recorded*
Real Estate Loans:
Construction & development		-		-		-		-		-
Commercial real estate		4,907		5,135		307		5,175		139
Home equity lines		179		245		5		245		10
Residential real estate		1,677		1,759		247		1,778		47
Total real estate		6,763		7,139		559		7,198		196
Commercial & industrial		382		382		18		393		10
Consumer & other		-		-		-		-		-
Total loans		7,145		7,521		577		7,591		206
Total impaired loans	$	22,945	$	27,619	$	577	$	29,048	$	619
December 31, 2014
*With no related allowance recorded*
Real Estate Loans:
Construction & development	$	1,056	$	1,056	$	-	$	875	$	6
Commercial real estate		5,300		7,980		-		8,133		386
Home equity lines		320		527		-		528		20
Residential real estate		3,685		3,914		-		3,964		145
Total real estate		10,361		13,477		-		13,500		557
Commercial & industrial		116		1,110		-		1,640		1
Consumer & other		-		-		-		-		-
Total loans		10,477		14,587		-		15,140		558
*With an allowance recorded*
Real Estate Loans:
Construction & development		-		-		-		-		-
Commercial real estate		5,548		5,943		357		6,026		288
Home equity lines		294		350		127		351		17
Residential real estate		1,835		1,911		216		1,998		217
Total real estate		7,677		8,204		700		8,375		522
Commercial & industrial		406		417		22		447		22
Consumer & other		-		-		-		-		-
Total loans		8,083		8,621		722		8,822		544
Total impaired loans	$	18,560	$	23,208	$	722	$	23,962	$	1,102

Loans that are past due 90 days or more or where there is serious doubt as to collectability are placed on non-accrual status. Non-accrual loans are not returned to accrual status unless principal and interest are current and borrowers have demonstrated the ability to make contractual payments. Accrued interest is reversed through a charge to income when loans are placed on non-accrual and future payments on non-accrual loans are generally applied to principal. The following is a summary of non-accrual loans at June 30, 2015 and December 31, 2014:

	June 30,		December 31,
	2015		2014
	(in thousands)
Real Estate Loans:
Construction & development	$	598	$	990
Commercial real estate		8,273		3,107
Home equity lines		252		355
Residential real estate		1,805		1,923
Total real estate		10,928		6,375
Commercial & industrial		788		83
Consumer & other		-		-
Total loans	$	11,716	$	6,458

Loans are graded according to an internal loan rating classification system when originated. Loan grades are periodically reevaluated during servicing, internal loan reviews, and external loan reviews. The general categories of the internal loan rating classification are:

Pass - Acceptable loans

Special Mention - Loans with potential identified weaknesses in administration or servicing.

Classified - Adversely classified loans with identified weaknesses, and potential or identified losses of principal and/or interest due.

The following is a breakdown of loans by the general categories of the internal rating system:

At June 30, 2015
	Pass		Special Mention		Classified		TOTAL
	(in thousands)
Real Estate Loans:
Construction & development	$	72,009	$	45	$	676	$	72,730
Commercial real estate		177,034		5,525		12,618		195,177
Home equity lines		71,258		117		804		72,179
Residential real estate		48,828		1,724		3,636		54,188
Total real estate		369,129		7,411		17,734		394,274
Commercial & industrial		60,356		3,257		788		64,401
Consumer & other		2,325		-		-		2,325
Total loans	$	431,810	$	10,668	$	18,522	$	461,000

At December 31, 2014
	Pass		Special Mention		Classified		TOTAL
	(in thousands)
Real Estate Loans:
Construction & development	$	74,813	$	66	$	990	$	75,869
Commercial real estate		194,767		12,965		7,548		215,280
Home equity lines		69,937		40		1,029		71,006
Residential real estate		45,310		2,723		3,869		51,902
Total real estate		384,827		15,794		13,436		414,057
Commercial & industrial		53,449		817		93		54,359
Consumer & other		3,773		-		-		3,773
Total loans	$	442,049	$	16,611	$	13,529	$	472,189

During 2015 and 2014, the Company restructured certain loans to improve the likelihood that the loans would be repaid in full under the modified terms in accordance with reasonable repayment schedules. Management evaluates each of these loans in accordance with generally accepted accounting principles to determine whether they should be reported as troubled debt restructurings.

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories:

Rate Modification - A modification in which the interest rate is changed.

Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest Only Modification – A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification – Any other type of modification, including the use of multiple categories above.

There were no available commitments for troubled debt restructurings outstanding at June 30, 2015.

The following tables present troubled debt restructurings as of June 30, 2015 and December 31, 2014:

	Troubled Debt Restructurings
	June 30, 2015
					Non-Accrual				Total
	Accrual Status				Status				Modifications
	#		Amount		#		Amount		#		Amount
	($ in thousands)
Real Estate Loans:
Construction & development		1	$	45		2	$	598		3	$	643
Commercial real estate		11		7,114		3		2,074		14		9,188
Home equity lines		0		-		0		-		0		-
Residential real estate		10		1,909		4		886		14		2,795
Total real estate		22		9,068		9		3,558		31		12,626
Commercial & industrial		1		382		0		-		1		382
Consumer & other		0		-		0		-		0		-
Total loans		23	$	9,450		9	$	3,558		32	$	13,008

	December 31, 2014
					Non-Accrual				Total
	Accrual Status				Status				Modifications
	#		Amount		#		Amount		#		Amount
	($ in thousands)
Real Estate Loans:
Construction & development		1	$	66		4	$	990		5	$	1,056
Commercial real estate		12		7,360		4		2,339		16		9,699
Home equity lines		0		-		0		-		0		-
Residential real estate		10		1,943		5		920		15		2,863
Total real estate		23		9,369		13		4,249		36		13,618
Commercial & industrial		2		405		1		5		3		410
Consumer & other		0		-		0		-		0		-
Total loans		25	$	9,774		14	$	4,254		39	$	14,028

The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

Troubled debt restructurings are classified as impaired loans when modified, and fair value calculations are performed to determine the specific reserves required in the allowance for loan losses related to these loans. Troubled debt restructurings can be removed from such status and returned to non-impaired status in years subsequent to restructure if the interest rate charged at restructure was greater than or equal to the rate charged for a new extension of credit with comparable risk and if the loan is performing and there is no available information to indicate that performance will not continue.

The following tables present newly restructured loans that occurred during the three months ended June 30, 2015 and 2014, respectively:

	New Troubled Debt Restructurings
	Three Months Ended June 30, 2015
	Rate				Term				Payment				Combination				Total
	Modifications				Modifications				Modifications				Modifications				Modifications
	#		Amount		#		Amount		#		Amount		#		Amount		#		Amount
	($ in thousands)
Pre-Modification Outstanding Recorded Investment:
Real Estate Loans:
Construction & development		0	$	-		0	$	-		0	$	-		1	$	-		1	$	-
Total real estate		0		-		0		-		0		-		1		-		1		-
Consumer & other		0		-		0		-		0		-		0		-		0		-
Total loans		0	$	-		0	$	-		0	$	-		1	$	-		1	$	-

Post-Modification Outstanding Recorded Investment:
Real Estate Loans:
Construction & development		0	$	-		0	$	-		0	$	-		1	$	293		1	$	293
Total real estate		0		-		0		-		0		-		1		293		1		293
Consumer & other		0		-		0		-		0		-		0		-		0		-
Total loans		0	$	-		0	$	-		0	$	-		1	$	293		1	$	293

	Three Months Ended June 30, 2014
Pre-Modification Outstanding Recorded Investment:
Real Estate Loans:
Residential real estate		0	$	-		1	$	411		0	$	-		0	$	-		1	$	411
Total real estate		0		-		1		411		0		-		0		-		1		411
Commercial & industrial		0		-		0		-		1		850		0		-		1		850
Total loans		0	$	-		1	$	411		1	$	850		0	$	-		2	$	1,261

Post-Modification Outstanding Recorded Investment:
Real Estate Loans:
Residential real estate		0	$	-		1	$	409		0	$	-		0	$	-		1	$	409
Total real estate		0		-		1		409		0		-		0		-		1		409
Commercial & industrial		0		-		0		-		1		842		0		-		1		842
Total loans		0	$	-		1	$	409		1	$	842		0	$	-		2	$	1,251

The following tables present newly restructured loans that occurred during the six months ended June 30, 2015 and 2014, respectively:

	New Troubled Debt Restructurings
	Six Months Ended June 30, 2015
	Rate				Term				Payment				Combination				Total
	Modifications				Modifications				Modifications				Modifications				Modifications
	#		Amount		#		Amount		#		Amount		#		Amount		#		Amount
	($ in thousands)
Pre-Modification Outstanding Recorded Investment:
Real Estate Loans:
Construction & development		0	$	-		0	$	-		0	$	-		1	$	-		1	$	-
Total real estate		0		-		0		-		0		-		1		-		1		-
Consumer & other		0		-		0		-		0		-		0		-		0		-
Total loans		0	$	-		0	$	-		0	$	-		1	$	-		1	$	-

Post-Modification Outstanding Recorded Investment:
Real Estate Loans:
Construction & development		0	$	-		0	$	-		0	$	-		1	$	293		1	$	293
Total real estate		0		-		0		-		0		-		1		293		1		293
Consumer & other		0		-		0		-		0		-		0		-		0		-
Total loans		0	$	-		0	$	-		0	$	-		1	$	293		1	$	293

	Six Months Ended June 30, 2014
Pre-Modification Outstanding Recorded Investment:
Real Estate Loans:
Residential real estate		0	$	-		1	$	411		0	$	-		0	$	-		1	$	411
Total real estate		0		-		1		411		0		-		0		-		1		411
Commercial & industrial		0		-		0		-		1		850		0		-		1		850
Total loans		0	$	-		1	$	411		1	$	850		0	$	-		2	$	1,261

Post-Modification Outstanding Recorded Investment:
Real Estate Loans:
Residential real estate		0	$	-		1	$	409		0	$	-		0	$	-		1	$	409
Total real estate		0		-		1		409		0		-		0		-		1		409
Commercial & industrial		0		-		0		-		1		842		0		-		1		842
Total loans		0	$	-		1	$	409		1	$	842		0	$	-		2	$	1,251

There were no troubled debt restructurings with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the six months ended June 30, 2015 and 2014.

Troubled debt restructuring defaults can result in a higher allowance for loan losses and a corresponding higher provision for loan losses because defaults generally negatively impact the timing of and expected collections from these impaired loans. Impaired loans, which include troubled debt restructurings, are evaluated for specific additions to the allowance for loan losses by subtracting the recorded investment in these impaired loans from their fair values. Fair value is generally determined by the present value of future cash flows, collateral value, or liquidation value. Defaults generally reduce the present value of the future cash flows and can negatively impact the collateral values if declining real estate values are impacting the sale of collateral.

Loans secured by one to four family residential properties with unpaid principal balances of $574,000 at June 30, 2015 were in the process of foreclosure. These loans have been evaluated for impairment and related allowances for loan losses have been made where collateral values are less than principal loan balances.

Note L – Fair value measurements

The Company has adopted the accounting standards within FASB Accounting Standards Codification (ASC) 820 “Fair Value Measurements and Disclosures”, which provides a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company has not elected the fair value option to value liabilities. Securities available-for-sale, loans held for sale, and interest rate lock commitments are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

When measuring fair value, valuation techniques should be appropriate in the circumstances and consistently applied. A hierarchy is used to prioritize valuation inputs into the following three levels to determine fair value:

Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 – observable inputs other than the quoted prices included in Level 1.

Level 3 – unobservable inputs.

Fair Value on a Recurring Basis. The Company measures certain assets at fair value on a recurring basis and the following is a general description of the methods used to value such assets.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities and certain corporate bonds that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and most corporate debt securities. Securities classified as Level 3 include asset-backed securities and corporate debt securities in less liquid markets.

Loans Held for Sale

The Company opted to account for loans held for sale at fair value which is measured based on what secondary markets are currently offering for portfolios with similar characteristics or based on sales commitments actually made to investors. As such, the Company classifies loans subject to recurring fair value adjustments as Level 2 valuation.

Interest Rate Lock Commitments

The mortgage banking division of the Company sells its residential mortgage loans held for sale on a forward best efforts basis at a fixed price or on a mandatory basis by entering into forward sale mortgage-backed securities transactions at approximately the same time that fixed rate commitments are given to borrowers. The value of the estimated interest rate lock commitments given to borrowers were marked to market through the income statement during 2015. The significant unobservable input used in the Level 3 fair value measurement of the Company’s Interest Rate Lock Commitments (IRLCs) on loans held for sale is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. The closing ratio is largely dependent on loan processing stages and the change in prevailing interest rates from the time of the rate lock. The closing ratio is computed by management using historical data.

The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing due to delays in meeting commitment closing dates. The Company classifies interest rate lock commitments as Level 3. Gain or loss on interest rate lock commitments for the period is included in mortgage banking income of non-interest income on the Consolidated Statements of Income. The mortgage banking division resumed reporting IRLCs in 2015 after having suspended recognition in 2014 due to immateriality. Below is a summary of activity related to interest rate lock commitments for the six months ended June 30, 2015 and 2014.

	Interest Rate Lock Commitments
	Level 3
	Fair Value		Fair Value
	(in thousands)

Balance, December 31, 2014 and 2013	$	-	$	-
Gains, net of losses, included in other income		613		-
Transfers in and out		-		-
Balance, June 30, 2015 and 2014	$	613	$	-

Assets measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014 are summarized below:

	Assets
	Measured at		Fair Value Measured Using
Description	Fair Value		Level 1		Level 2		Level 3
	(in thousands)

At June 30, 2015:
Securities available-for-sale:
Municipal securities	$	18,030	$	-	$	18,030	$	-
Mortgage-backed securities		18,231		-		18,231		-
Corporate securities		9,973		-		9,973		-
Asset backed securities		1,897		-		1,897		-
Unrestricted stock		67		67		-		-
Total available-for-sale securities		48,198		67		48,131		-
Loans held for sale		70,897		-		70,897		-
Interest rate lock commitments		613		-		-		613
Total	$	119,708	$	67	$	119,028	$	613

At December 31, 2014:
Securities available-for-sale:
Municipal securities	$	19,896	$	-	$	19,896	$	-
Mortgage-backed securities		19,352		-		19,352		-
Corporate securities		9,964		-		9,964		-
Asset-backed securities		1,930		-		1,930		-
Unrestricted stock		58		58		-		-
Total available-for-sale securities		51,200		58		51,142		-
Loans held for sale		39,780		-		39,780		-
Total	$	90,980	$	58	$	90,922	$	-

Fair Value on a Non-recurring Basis. The Company measures certain assets at fair value on a non-recurring basis and the following is a general description of the methods used to value such assets.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Impaired loans are recorded at fair value less estimated selling costs. Once a loan is identified as individually impaired, the Company measures impairment. Fair values of impaired loans are generally estimated using one of several methods, including collateral value, liquidation value, discounted cash flows and, in rare cases, the market value of the note. Those impaired loans not requiring an allowance represent loans for which the net present value of the expected cash flows or fair value of the collateral less costs to sell exceed the recorded investments in such loans. At June 30, 2015 and December 31, 2014, a majority of the total impaired loans were evaluated based on the fair value of the collateral. When the fair value of the collateral is based on an executed sales contract with an independent third party, the Company records the impaired loans as nonrecurring Level 1. If the collateral is based on another observable market price or a current appraised value, the Company records the impaired loans as nonrecurring Level 2. When an appraised value is not available or the Company determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s original effective interest rate. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned and Repossessed Assets

Properties acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying value or the new fair value less estimated selling costs. Fair value is generally based upon current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the asset as nonrecurring Level 2. However, the Company also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals such as changes in absorption rates or market conditions from the time of valuation. In situations where an appraisal less estimated selling costs is used to determine fair value, management adjustments are significant to the fair value measurements, or other means are used to estimate fair value in the absence of an appraisal, the Company records the impaired loan as nonrecurring Level 3 within the valuation hierarchy.

Assets measured at fair value on a non-recurring basis at June 30, 2015 and December 31, 2014 are summarized below:

	Assets
	Measured at		Fair Value Measured Using
Description	Fair Value		Level 1		Level 2		Level 3
	(in thousands)

At June 30, 2015:
Impaired loans	$	22,368	$	-	$	-	$	22,368
Other real estate owned		5,352		-		-		5,352

At December 31, 2014:
Impaired loans	$	17,838	$	-	$	-	$	17,838
Other real estate owned		5,610		-		-		5,610

Fair Value on a Recurring or Non-recurring Basis – Unobservable Inputs for Level 3. For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of June 30, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

				Significant	Significant
			Valuation	Unobservable	Unobservable
Description	Fair Value		Technique	Inputs	Input Value
	($ in thousands)
At June 30, 2015:
Impaired loans	$	22,368	Discounted appraisals	Collateral discounts	8.00%-10.00%
			Discounted cash flows	Cash flow estimates/ discounted rates	0% - 100% / original note rate
Other real estate owned		5,352	Discounted appraisals	Collateral discounts	8.00%-10.00%

Net derivative assets /liabilities:
Interest rate lock commitments		613	Pricing models	Loan closing ratios	25% - 100% 81% Average

At December 31, 2014:
Impaired loans	$	17,838	Discounted appraisals	Collateral discounts	8.00%-10.00%
			Discounted cash flows	Cash flow estimates/ discounted rates	0% - 100% / original note rate
Other real estate owned		5,610	Discounted appraisals	Collateral discounts	8.00%-10.00%

Fair Value of items not valued as such. The Company measures certain financial assets and liabilities at fair value for disclosure purposes only. The assumptions used in estimating the fair value of these financial instruments are detailed below:

Securities Held to Maturity

The fair values of securities held to maturity are recorded on a non-recurring basis when an impairment in value that is deemed to be other than temporary occurs. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. At June 30, 2015, there were no fair value adjustments related to $15,068,000 of securities held to maturity.

Net non-impaired loans held for investment: For variable rate loans, fair values are based on carrying values. Fixed rate commercial, other installment, and certain real estate mortgage loans are valued using discounted cash flows. The discount rates used to determine the present value of these loans are based on interest rates currently being charged by the Company on comparable loans as to credit risk and term.

Time deposits: Discounted cash flows have been used to value fixed rate and variable rate term deposits. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.

Trust preferred subordinated debt: The fair value of trust preferred debt was determined by discounting cash flows using a rate 300 basis points higher than the actual current rate over an estimated remaining term of 12.0 years in 2015 and 12.5 years in 2014. The trust preferred debt was issued at favorable rates in 2004, and current rates are approximately 300 basis points higher when available. The Basel III capital guidelines allow for inclusion of trust preferred securities as Tier 1 capital, up to certain “quantitative limits” for banks with less than $15 billion in consolidated assets.

The following table presents the carrying amount, fair value, and placement in the fair value hierarchy of financial instruments at June 30, 2015 and December 31, 2014. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and due from banks and interest-bearing deposits with banks, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as non-interest bearing demand deposits, NOW, money market and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

					Fair Value Measurements
					Quoted
					Prices in
					Active Markets		Significant
					for Identical		Other		Significant
					Assets or		Observable		Unobservable
	Carrying		Fair		Liabilities		Inputs		Inputs
	Amount		Value		(Level 1)		(Level 2)		(Level 3)
	(in thousands)
June 30, 2015
Financial Instruments - Assets
Investment securities held-to-maturity	$	15,068	$	15,253	$	-	$	15,253	$	-
Net non-impaired loans held for investment		432,836		434,257		-		-		434,257

Financial Instruments - Liabilities
Time deposits		140,237		140,158		-		-		140,158
Trust preferred subordinated debt		19,610		16,987		-		-		16,987

December 31, 2014
Financial Instruments - Assets
Investment securities held-to-maturity	$	15,644	$	15,945	$	-	$	15,945	$	-
Net non-impaired loans held for investment		447,831		448,603		-		-		448,603

Financial Instruments - Liabilities
Time deposits		143,816		143,881		-		-		143,881
Subordinated debentures		19,610		16,885		-		-		16,885

Note M – Derivatives and financial instruments

A derivative is a financial instrument or arrangement that derives its cash flows and value by reference to an underlying instrument, index or referenced interest rate. These instruments are designed to hedge exposures to interest rate risk or for speculative purposes. The Company increased its use of derivatives related to hedging interest rate lock commitments during the second quarter of 2015 as noted below.

Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

The Company currently sells mortgage loans on a best efforts basis and a mandatory basis in order to minimize the impact of changing interest rates on the value of fixed loan commitments given to borrowers. Optional commitments to sell mortgage loans are consummated at approximately the same time that optional commitments are given to borrowers to originate the loans under best efforts sales. Mandatory loan sales are generally made after loans are closed; the related fixed rate loan commitments granted to borrowers when they lock in their loan rates are hedged by selling mortgage-backed securities on a forward basis. The sold mortgage-backed securities are later purchased to close the hedge once the mandatory sales are consummated. The Company resumed selling loans on a mandatory basis and re-instituted hedging mortgage loan rate lock commitments during the second quarter of 2015.

The table below provides the carrying values of derivative instruments of mortgage loan rate lock commitments and mortgage-backed securities forward sales at June 30, 2015:

	Carrying		Carrying		Gain		Notional
	Value of		Value of		Included		Amount of
Derivatives designated as	Assets		Liabilities		in Income		Derivative
hedging instruments:	(in thousands)

At June 30, 2015:
Mortgage loan interest rate lock commitments (hedged through best efforts sales commitments)	$	410	$	-	$	410	$	47,695

Mortgage loan interest rate lock commitments (hedged through mortgage-backed securities forward sales)		223		20		203		22,228

Mortgage-backed securities forward sales		110		92		18		30,250

The mortgage banking division resumed reporting IRLCs in 2015 after having suspended recognition in 2014 due to immateriality.

The below presents the aggregate fair value and aggregate unpaid principal of loans held for sale at June 30, 2015 and December 31, 2014:

June 30, 2015

December 31, 2014

Aggregate Fair

Value Less

Aggregate

Unpaid

Aggregate

Unpaid

Fair Value

Principal

Fair Value

Principal

(in thousands)

Loans held for sale, at fair value

70,897

69,914

983

39,780

39,353

427

Interest income on loans held for sale is recognized based on contractual rates and is reflected in interest income on loans in the consolidated statements of operations. The following table details net gains resulting from changes in fair value of these loans which were recorded in mortgage banking income in the consolidated statements of operations during the six months ended June 30, 2015 and 2014, respectively. These changes in fair value are mostly offset by economic hedging activities and also fluctuate based on the change in the aggregate loan principal outstanding. An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk.

	Loans Held for Sale, At Fair Value
	Six Months Ended June 30,
	2015		2014
	(in thousands)
Net gains resulting from changes in fair value	$	556	$	260

Note N – Impact of recently adopted accounting standards

On January 15, 2014, the FASB issued ASU 2014-01, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force), to provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low income housing tax credit. The ASU modifies the conditions that an entity must meet to be eligible to use a method other than the equity or cost methods to account for qualified affordable housing project investments. The ASU permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if those conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). An entity that has used the effective yield method to account for its investments in qualified affordable housing before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments were effective for the Company on a retrospective basis for interim and annual reporting periods beginning January 1, 2015. The Company has a $3 million qualified affordable housing investment of which $1.2 million has been amortized through non-interest income using the effective yield method which approximates the proportional amortization method. These amendments did not have a material effect on the Company’s consolidated financial statements.

In January, 2015, the FASB issued ASU No. 2015-01, Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. The ASU eliminates the concept of extraordinary items from U.S. GAAP. Existing U.S. GAAP required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless the event or transaction is both unusual in nature and infrequent in occurrence. The amendments will eliminate the requirements for reporting entities to consider whether an underlying event or transaction is extraordinary, however, the presentation and disclosure guidance for items that are unusual in nature or occur infrequently will be retained and will be expanded to include items that are both unusual in nature and infrequently occurring. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The amendments may be applied either prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. These amendments are not expected to have a material effect on the Company’s consolidated statement of financial position.

In June 2014, the FASB issued guidance which makes limited amendments to the guidance on accounting for certain repurchase agreements. The new guidance (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. The amendments were effective for the Company for the reporting period beginning with the first quarter of 2015. The amendments did not have a material effect on the Company’s consolidated financial statements.

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In January 2014, the FASB amended 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 other real estate owned (OREO). In addition, the amendments require a creditor to reclassify a collateralized consumer mortgage loan to OREO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The amendments will be effective for the Company for annual periods, and interim periods within those annual periods beginning after December 15, 2014, with early implementation of the guidance 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. Additionally, the ASU requires interim and annual disclosure of both (1) the amount of foreclosed real estate held and (2) the recorded investment in mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. These amendments did not have a material effect on the Company’s consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis, which amends the consolidation requirements in Accounting Standards Codification (ASC) 810, Consolidation, and significantly changes the consolidation analysis required under U.S. GAAP. The amendments include the following:

•

Limited partnerships will be considered variable interest entities (VIEs), unless the limited partners have either substantive kick-out or participating rights.

•

The amendments change the effect that fees paid to a decision maker or service provider have on the consolidation analysis. Specifically, it is less likely that the fees themselves will be considered a variable interest, that an entity will be a VIE, or that consolidation will result.

•

The amendments significantly modify how variable interests held by a reporting entity’s related parties or de facto agents affect its consolidation conclusion.

•

For entities other than limited partnerships, the amendments clarify how to determine whether the equity holders (as a group) have power over the entity (this will most likely result in a change to current practice). The clarification could affect whether the entity is a VIE.

•

The deferral of ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities, for investments in certain investment funds has been eliminated.

The amendments are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015 and are not expected to have a material effect on the Company’s consolidated financial statements.

The FASB published ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, on April 7, 2015. Debt issuance costs are specific incremental costs, other than those paid to the lender, that are directly attributable to issuing a debt instrument (i.e., third party costs). To simplify presentation of debt issuance costs, the amendments in ASU 2015-03 require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented in the balance sheet as a deferred charge (i.e., an asset). This presentation differed from the presentation for a debt discount, which is a direct adjustment to the carrying value of the debt (i.e., a contra liability). The guidance in ASU 2015-03 is limited to the presentation of debt issuance costs. The amendments do not affect the recognition and measurement of debt issuance costs. Therefore, the amortization of such costs should continue to be calculated using the effective interest method and be reported as interest expense. For public business entities, the amendments in ASU 2015-03 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. These amendments are not expected to have a material effect on the Company’s consolidated financial statements.

On April 15, 2015, the FASB issued ASU 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which clarifies the circumstances under which a cloud computing customer would account for the arrangement as a license of internal-use software. Existing U.S. generally accepted accounting principles (U. S. GAAP) does not include explicit guidance about a customer’s accounting for fees paid in a cloud computing arrangement. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. An arrangement would contain a software license element if both of the following criteria are met:

The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty.

It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

For public business entities, the amendments in ASU 2015-05 are effective for interim and annual periods beginning after December 15, 2015. These amendments are not expected to have a material effect on the Company’s consolidated financial statements.

Several other accounting standards have been issued or proposed by the FASB or other standards-setting bodies during the periods presented or will be effective subsequent to June 30, 2015. The FASB proposal on Current Expected Credit Loss (“CECL”) is expected to be released in 2015 and will likely be effective in 2018 or 2019. CECL is expected to require institutions of all sizes to recognize an immediate allowance for expected credit losses on loans and securities which could materially exceed the current historical loss rate method currently used to calculate the allowance for loan losses. 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 consolidated financial position, results of operations or cash flows.

Note O - Commitments

In the normal course of business there are outstanding commitments for the extension of credit which are not reflected in the financial statements. At June 30, 2015 and December 31, 2014, pre-approved but unused lines of credit for loans totaled approximately $193,764,000 and $174,665,000, respectively. In addition, we had $1,752,000 and $1,812,000 in standby letters of credit at June 30, 2015 and December 31, 2014, respectively. These commitments represent no more than the normal lending risk that we commit to borrowers. If these commitments are drawn, we will obtain collateral if it is deemed necessary based on our credit evaluation of the counter-party. We believe these commitments can be funded through normal operations.

The Company leases land for its main office, four loan production offices, and two branch facilities under operating leases. The Friendly Avenue Branch in Greensboro closed at the end of July 2015 due to the expiration of the related lease in December 2015 which could not be successfully re-negotiated.

Total future minimum lease payments, excluding renewal options, at June 30, 2015 under the leases are as follows:

Future Mininum Lease Payments at June 30, 2015
	(in thousands)
Due in one year	$	487
Due in Years 2 and 3		656
Due in Years 4 and 5		620
Due after Year 5		2,723
	$	4,486

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to assist in understanding our financial condition and results of operations. Because we have no material operations and conduct no business on our own other than owning our subsidiaries, Carolina Bank and Carolina Capital Trust, and because Carolina Capital Trust has no operations other than the issuance of its trust preferred securities, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of Carolina Bank. Carolina Bank also owns two limited liability companies for the purpose of holding foreclosed real estate, the assets and operations of which are consolidated into Carolina Bank and included herein. For ease of reading and because the financial statements are presented on a consolidated basis, Carolina Bank Holdings, Inc. and Carolina Bank are collectively referred to herein as “we”, “our”, or “us”, unless otherwise noted.

Forward-looking Statements

This report contains forward-looking statements with respect to our financial condition and results of operations and business. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following:

General economic conditions may deteriorate and negatively impact the ability of our borrowers to repay loans and our depositors to maintain balances.

Changes in interest rates could reduce our net interest income.

Competitive pressures among financial institutions may increase.

Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which we are engaged.

New products developed and new methods of delivering products could result in a reduction in our business and income.

Increases in interest rates, increases in warranty losses, or changes in the securitization of mortgages could negatively impact our mortgage banking income.

Adverse changes may occur in the securities market.

Technology fraud and related losses are a major threat to banks of all sizes and to bank customers.

Local, state or federal taxing authorities may take tax positions that are adverse to us.

Unpredictable natural and other disasters could have an adverse effect on our operations or on the willingness of our customers to access our financial services.

Comparison of Financial Condition

Assets. Our total assets increased by $4.4 million, or 0.7%, from $679.3 million at December 31, 2014, to $683.7 million at June 30, 2015. During the six months ended June 30, 2015, cash and due from banks, interest-bearing deposits with banks and investment securities decreased $18.2 million, loans held-for-sale increased $31.1 million, while net loans held for investment decreased $10.5 million. Our mortgage banking division originates and sells residential mortgage loans through other banks, brokers, our retail offices and four loan production offices. Originations of residential mortgage loans for the first six months of 2015 were approximately $378 million compared to $249 million in first six months of 2014. Originations in 2015 were positively impacted by low interest rates, an improved economy, and by better weather.

Liabilities. Total deposits decreased by $2.2 million, or 0.4%, from $594.9 million at December 31, 2014, to $592.7 million at June 30, 2015. Our non-interest bearing deposits, which are a major strategic focus, grew $6.6 million, or 6.2% during the first six months to $112.8 million at June 30, 2015. Our branching activities are designed to enhance customer convenience and related deposit gathering activities as well as provide new sources for loans. While deposit growth has been an ongoing goal, wholesale sources of funding such as Federal Home Loan Bank (“FHLB’) advances, repurchase borrowings, and brokered deposits may be utilized where cost beneficial and when necessary to meet liquidity requirements. Retail repurchase agreements and FHLB advances declined slightly in the first six months of 2015. We had approximately $31.5 million in out-of-market time deposits from other institutions and $19.7 million in brokered deposits at June 30, 2015, an aggregate increase of $8.6 million in these two types of accounts from December 31, 2014. The increase in these out-of-market time deposits in the first six months of 2015 was designed to increase the duration of liabilities to better match asset durations.

Stockholders’ Equity. Total stockholders’ equity increased $5.8 million at June 30, 2015 to $58.5 million due to net proceeds of $14.1 million obtained in a convertible preferred stock offering which was later converted to common stock. The net proceeds of the offering were used to redeem $11.0 million in Series A preferred stock in May of 2015 and provide additional capital to support future growth. Retained net income also added to stockholder’ equity during the first six months of 2015.

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

General. Net income was $1,666,000 and $750,000 for the second quarter of 2015 and 2014, respectively. Net income available to common stockholders was $1,572,000, or $0.32 per diluted share, for the three months ended June 30, 2015 compared to $503,000, or $0.15 per diluted share, for the three months ended June 30, 2014. Net income available to common stockholders represents net income less preferred stock dividends. Higher net income in 2015 resulted from a 41% increase in residential mortgage loan originations and related fee income in our mortgage banking division and from higher net interest income. Our mortgage banking division recorded net income of $649,000 in the second quarter of 2015 compared to net loss of $183,000 in the second quarter of 2014. The commercial/retail bank realized net income of $1,101,000 and $1,001,000 in the second quarter of 2015 and 2014, respectively. Our primary markets in the Triad of North Carolina experienced deteriorating economic conditions in 2009 through 2011 which negatively impacted our borrowers as evidenced by increasing defaults and loan charge-offs. Economic conditions have gradually improved since 2011 in our primary markets as evidenced by lower unemployment rates, and decreasing loan charge-offs and impaired loans.

Net interest income. Net interest income of $5,865,000 for the three months ended June 30, 2015 increased $222,000, or 3.93%, from the second quarter of 2014. The net yield on interest earning assets, adjusted to a fully taxable basis was 3.65% in the second quarter of 2015 and 3.74% in the second quarter of 2014. The low short-term interest rate environment which has persisted for several years, created a challenge to growing net interest income because loan and investment yields generally decline faster than liability costs. A shift in our average asset balances to loans and to loans held for sale, growth of 31.5% in average non-interest bearing deposits and higher stockholders’ equity have had a positive impact on our net interest income in the current challenging low interest rate environment.

The table below provides a detailed analysis of the effective yields and rates on categories of interest-earning assets and interest-bearing liabilities for the periods indicated.

Net Interest Income and Average Balance Analysis

	For the Three Months Ended June 30,
	2015							2014
	Average		Interest		Average			Average		Interest		Average
	Balance (1.)		Inc./Exp.		Yield/Cost			Balance (1.)		Inc./Exp.		Yield/Cost
	(Dollars in thousands)
Interest-earning assets
Interest-earning deposits	$	62,284	$	65		0.42	%	$	41,361	$	49		0.48	%
Nontaxable investments (2.)		16,199		188		4.66	%		18,693		204		4.38	%
Taxable investments		47,437		325		2.75	%		60,759		411		2.71	%
Loans held for sale		62,483		557		3.58	%		36,971		390		4.23	%
Loans (3.)		465,914		5,501		4.74	%		455,798		5,485		4.83	%
Interest-earning assets		654,317		6,636					613,582		6,539
Interest-earning assets						4.07	%						4.27	%

Non interest-earning assets		44,784							43,142

Total assets	$	699,101						$	656,724

Interest-bearing liabilities
Interest checking	$	53,214	$	9		0.07	%	$	44,577	$	8		0.07	%
Money market and savings		291,265		228		0.31	%		296,061		232		0.31	%
Time certificates and IRAs		142,930		287		0.81	%		144,088		407		1.13	%
Other borrowings		22,433		151		2.70	%		25,024		164		2.63	%
Total interest-bearing liabilities		509,842		675					509,750		811
Cost on average
Interest-bearing liabilities						0.53	%						0.64	%
Non-interest-bearing liabilities
Demand deposits		118,577							90,186
Other liabilities		7,044							6,393
Total non-interest-bearing liabilities		125,621							96,579
Total liabilities		635,463							606,329
Stockholders' equity		63,638							50,395
Total liabilities and equity	$	699,101						$	656,724
Net interest income			$	5,961						$	5,728
Net yield on average interest-earning assets						3.65	%						3.74	%
Interest rate spread						3.54	%						3.64	%

(1.)

Average balances are computed on a daily basis.

(2.)

Interest income and yields related to certain investment securities and loans exempt from federal income tax are stated on a fully taxable basis using a 34% federal tax rate, reduced by the nondeductible portion of interest expense.

(3.)

Nonaccrual loans are included in the average loan balance.

Provision for loan losses. The provision for loan losses amounted to $535,000 and $346,000 for the three months ended June 30, 2015 and 2014, respectively. The amount of the provision for loan losses increased in 2015 because one loan relationship of approximately $8.1 million defaulted and went into receivership during the second quarter of 2015. Due to the default, loan charge-offs exceeded loan recoveries by $1,694,000 in the second quarter of 2015. Loan charge-offs exceeded loan recoveries by $1,432,000 in the second quarter of 2014. We believe the allowance for loan losses is appropriate based on asset quality indicators and other factors.

Non-interest income. Total non-interest income amounted to $4,128,000 for the three months ended June 30, 2015 compared to $2,340,000 for the three months ended June 30, 2014. Mortgage banking income increased $1,767,000, or 90.4% due to an increase of approximately 41% in residential mortgage loan originations and related sales and from an increase in mortgage loan applications which are used to calculate the value of interest rate lock commitments. Mortgage banking income consists of loan origination fees, gains from sales of loans and related servicing assets, and from the increase in the value of interest rate lock commitments.

Non-interest expense. Total non-interest expense amounted to $7,101,000 and $6,712,000 for the three months ended June 30, 2015 and 2014, respectively. Salaries and employee benefits increased $566,000, or 14.1%, primarily from an increase in incentive compensation in our mortgage banking division due to increased originations and in our retail/commercial bank due to accrual of bonuses related to 2015 financial and non-financial goals. The number of full-time equivalent employees decreased to 192 at June 30, 2015 from 195 at June 30, 2014. Foreclosed property expense increased $97,000 to $155,000 in the second quarter of 2015 due to higher impairment charges. Professional fees decreased $92,000 due to a decline in legal fees related to problem loans.

Income taxes. Income tax expense as a percentage of net income before income taxes was 29.3% and 18.9% in the second quarter of 2015 and 2014, respectively. The lower tax rate in 2014 resulted from higher non-taxable income from municipal interest and increase in cash value of life insurance as a percentage of taxable income.

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

General. Net income was $3,295,000 and $1,015,000 for the six months ended June 30, 2015 and 2014, respectively. Net income available to common stockholders was $2,954,000, or $0.70 per diluted share, for the six months ended June 30, 2015 compared to $577,000, or $0.17 per diluted share, for the six months ended June 30, 2014. Higher net income in 2015 resulted primarily from higher net interest income, lower provision for loan losses, and higher mortgage banking income.

Net interest income. Net interest income of $11,675,000 for the six months ended June 30, 2015 increased $474,000, or 4.2%, from the six months ended June 30, 2014 due to a $31.0 million increase in average interest-earning assets while average interest-bearing liabilities declined $1.2 million. Growth in average non-interest-bearing demand deposits of $25.6 million and higher stockholders’ equity provided the funding for the increase in interest-earning assets. The net yield on interest earning assets, adjusted to a fully taxable basis, was stable at 3.70% in 2015 and 3.72% in 2014.

The table below provides a detailed analysis of the effective yields and rates on categories of interest-earning assets and interest-bearing liabilities for the periods indicated.

Net Interest Income and Average Balance Analysis

	For the Six Months Ended June 30,
	2015							2014
	Average		Interest		Average			Average		Interest		Average
	Balance (1.)		Inc./Exp.		Yield/Cost			Balance (1.)		Inc./Exp.		Yield/Cost
	(Dollars in thousands)
Interest-earning assets
Interest-earning deposits	$	59,911	$	126		0.42	%	$	51,688	$	109		0.43	%
Nontaxable investments (2.)		16,238		371		4.61	%		18,715		417		4.49	%
Taxable investments		48,422		663		2.76	%		61,008		831		2.75	%
Loans held for sale		52,839		970		3.70	%		29,020		601		4.18	%
Loans (2.) (3.)		468,976		11,113		4.78	%		454,923		11,028		4.89	%
Interest-earning assets		646,386		13,243					615,354		12,986
Interest-earning assets						4.13	%						4.26	%

Non interest-earning assets		44,598							41,984

Total assets	$	690,984						$	657,338

Interest-bearing liabilities
Interest checking	$	51,634	$	18		0.07	%	$	43,918	$	16		0.07	%
Money market and savings		293,239		458		0.31	%		296,360		460		0.31	%
Time certificates and IRAs		143,101		599		0.84	%		146,311		825		1.14	%
Other borrowings		22,555		303		2.71	%		25,117		328		2.63	%
Total interest-bearing liabilities		510,529		1,378					511,706		1,629
Cost on average
Interest-bearing liabilities						0.54	%						0.64	%
Non-interest-bearing liabilities
Demand deposits		114,470							88,899
Other liabilities		7,392							6,564
Total non-interest-bearing liabilities		121,862							95,463
Total liabilities		632,391							607,169
Stockholders' equity		58,593							50,169
Total liabilities and equity	$	690,984						$	657,338
Net interest income			$	11,865						$	11,357
Net yield on average interest-earning assets						3.70	%						3.72	%
Interest rate spread						3.59	%						3.61	%

(1.) Average balances are computed on a daily basis.

(2.) Interest income and yields related to certain investment securities and loans exempt from federal income tax are stated on a fully taxable basis using a 34% federal tax rate, reduced by the nondeductible portion of interest expense.

(3.) Nonaccrual loans are included in the average loan balance.

Provision for loan losses. The provision for loan losses amounted to $835,000 and $1,116,000 for the six months ended June 30, 2015 and 2014, respectively. The amount of the provision for loan losses declined in 2015 primarily because fewer allowances for loan losses were required on impaired loans. We believe the allowance for loan losses is appropriate based on asset quality indicators and other factors.

Non-interest income. Total non-interest income increased to $7,411,000 for the six months ended June 30, 2015 from $4,090,000 for the six months ended June 30, 2014. The increase in 2015 resulted primarily from an increase in mortgage banking income of $3,341,000 to $6,628,000 for the six months ended June 30, 2015. Loan originations in our mortgage banking division were $378.1 million in 2015 which was 52% higher than in 2014.

Non-interest expense. Total non-interest expense amounted to $13,643,000 and $13,047,000 for the six months ended June 30, 2015 and 2014, respectively. Salaries and employee benefits increased $1,049,000, or 13.4%, primarily from an increase in incentive compensation in our mortgage banking division due to increased originations and in our retail/commercial bank due to accrual of bonuses related to 2015 financial and non-financial goals. Foreclosed property expense declined $139,000 to $24,000 in the first half of 2015 due to higher net gains from foreclosed property sales and from lower expenses maintaining fewer real estate owned properties. Advertising and promotion declined $141,000 to $353,000 in 2015 due to a change to a new advertising agency. Professional fees decreased $101,000, or 10.1% in 2015 to $903,000, primarily from decreased legal fees related to problem loans.

Income taxes. Income tax expense was $1,313,000, or 28.5% of income before income taxes, for the six months ended June 30, 2015, compared to $113,000, or 10.0% of income before income taxes, for the six months ended June 30, 2014. Tax credits and non-taxable income represented a larger percentage of income in the 2014 period which accounted for the lower income tax rate in 2014.

Asset Quality

Non-performing assets, composed of other real estate owned, other repossessed assets, and non-accrual loans, totaled $17,068,000 at June 30, 2015, compared to $12,112,000 at December 31, 2014. Non-performing assets, as a percentage of total assets, was 2.50% at June 30, 2015, compared to 1.78% at December 31, 2014. There were no loans 90 days or more past due and still accruing interest at June 30, 2015 or December 31, 2014, respectively. Other real estate owned was $5,352,000 at June 30, 2015 and $5,610,000 at December 31, 2014. The increase in non-performing assets at June 30, 2015 resulted from a business relationship that defaulted on $8.1 million in loans and was placed in receivership during the second quarter of 2015. A loan charge-off of $1.8 million was recognized on the new non-performing loans in the second quarter of 2015.

Loans are graded according to an internal loan rating classification system, and “classified loans” represent adversely classified loans with identified weaknesses and potential or identified losses of principal and/or interest due. Classified loans increased to $18,522,000 at June 30, 2015 from $13,529,000 at December 31, 2014 but are down from $26,209,000 at December 31, 2013. The previously mentioned business loan relationship that defaulted in the second quarter of 2015 was the primary reason for the increase in classified loans at June 30, 2015. Continuing efforts to improve asset quality are a top priority. Loan rating classification information is detailed in Note K to the consolidated financial statements as of June 30, 2015.

The economic conditions in our primary markets in North Carolina, have improved as evidenced by a drop in the unemployment rate. The seasonally adjusted unemployment rate in North Carolina decreased to 5.8% in June 2015 from 6.8% in June 2014 and from 8.3% in June 2013. Other economic data such as retail sales and housing starts have also improved materially in the past year. A large portion of our loans are made to businesses and real estate developers and are secured by real estate. Real estate prices have improved in our markets but are still lower than in 2008 in many areas.

Our allowance for loan losses is composed of two parts, a specific portion related to non-performing loans and performing impaired loans and a general section related to non-impaired loans. The specific portion of our allowance for loan losses, which relates to impaired loans, decreased to $577,000 at June 30, 2015 from $722,000 at December 31, 2014, and impaired loans increased to $22,945,000 at June 30, 2015 from $18,560,000 at December 31, 2014. The specific portion of our allowance relating to impaired loans decreased in 2015 primarily because of charge-offs taken in the second quarter of 2015 on impaired loans, thereby reducing the amount of the specific allowances required. The general portion of our allowance for loan losses decreased to $5,218,000 on non-impaired loans of $438,055,000 at June 30, 2015 from $5,798,000 on non-impaired loans of $453,629,000 at December 31, 2014. The general portion of our allowance applies to non-impaired loans and was determined by applying estimated loss ratios inherent in the loan portfolio, ranging from 0.06% on loans secured by 1-4 family residential construction to 2.27% on commercial and industrial loans, to categories of non-impaired loans at each period end. We have used the latest sixteen quarters to determine the estimated loss ratios inherent in the loan portfolio since the third quarter of 2014. We had previously used twelve quarters but believe sixteen quarters more accurately reflects expected losses over time and results in a higher allowance for loan losses than twelve quarters. The general section of our allowance also includes a qualitative component which is calculated based on nine environmental factors such as the changes in economic and business conditions that affect the collectability of the loan portfolio and changes in the value of collateral dependent loans. The qualitative component of the general section of our allowance for loan losses, including a small unallocated allowance, was $683,000 and $1,243,000 at June 30, 2015 and December 31, 2014, respectively. A number of environmental factors improved during the six months ending June 30, 2015, especially economic and business conditions.

The allowance for loan losses is increased by direct charges to operating expense, the provision for loan losses. Losses on loans or charge-offs are deducted from the allowance in the period that loans are deemed to become uncollectible or in the period that updated appraisals indicate a loss in value of non-performing, collateral dependent, real estate loans. Recoveries of previously charged-off loans are added back to the allowance. Net loan charge-offs (charge-offs minus recoveries) totaled $1,560,000 and $1,576,000 for the six months ended June 30, 2015 and 2014, respectively.

Liquidity and Capital Resources

The objective of our liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses our ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.

Our primary sources of internally generated funds are principal and interest payments on loans receivable, non-interest income and proceeds from loans sales related to residential mortgage banking, and cash flows generated from operations. External sources of funds include increases in deposits, repurchase agreements, lines of credit from banks, including the Federal Reserve, and advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

Carolina Bank is required under applicable federal regulations to maintain specified levels of liquid investments in qualifying types of investments. Cash and due from banks, interest-bearing deposits in banks, bank term deposits, investment securities available-for-sale, and loans held for sale by our mortgage banking division are the primary liquid assets of Carolina Bank. We regularly monitor Carolina Bank’s liquidity position to ensure its liquidity is sufficient to meet its anticipated needs. Short-term liquidity in the form of cash and due from banks, interest-bearing deposits in banks, and bank term deposits decreased to $45.7 million at June 30, 2015 from $60.3 million at December 31, 2014. The decline in short-term liquidity was offset by an increase of $31.1 million in loans held for sale, which are residential mortgage loans that are in the process of being funded by investors. We believe our current liquidity levels are adequate to meet our anticipated future needs. We maintained substantial secondary sources of liquidity during 2014 and 2015 in the form of unused secured lines of credit from the FHLB and the Federal Reserve which in total approximated $177 million at June 30, 2015. We also have $25 million in discretionary, uncommitted, unsecured Federal funds lines from three correspondent banks.

We are subject to various regulatory capital requirements administered by bank regulatory agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. As of June 30, 2015 and December 31, 2014, our levels of capital exceeded all applicable published regulatory requirements. During 2013, Basel III capital requirements were adopted by United States banking regulators. The Basel III regulations establish a common equity Tier 1 capital requirement of 4.5% in 2015 and 7.0% by 2019. The new regulations change risk weights for certain on and off balance sheet assets and require deductions from capital for certain types of assets. Capital ratios for Carolina Bank were as follows at June 30, 2015 and December 31, 2014, respectively: Tier 1 leverage – 9.24%, 9.11%; Tier 1 risk-based – 11.23%, 11.42%; Common Tier 1 risk-based – 11.23%, N/A; Total risk-based – 13.21%, 13.67%. The decline in the total risk-based capital ratio from December 31, 2014 to June 30, 2015 is primarily the result of a reduction in the allowance for loan losses which is a component of total risk-based capital.

Due to our historical growth, the recent difficult economic environment, increased regulatory capital requirements, and our anticipation of continued growth, we issued $16 million in Series A preferred stock to the United States Treasury under the Capital Purchase Program in January 2009 to increase our capital which could further support future growth and assist us in meeting future regulatory capital requirements. The United States Treasury sold our preferred stock to private investors in 2013, and we subsequently repurchased $5.0 million of the preferred stock from private investors. We also repurchased a warrant for common stock granted to the United States Treasury as part of the Capital Purchase Program for $1.8 million in 2013. The remaining preferred stock which was issued in 2009 was repurchased in May of 2015 from the proceeds of a Series B convertible preferred stock offering on June 30, 2015.

On March 31, 2015, the Company issued 15,500 shares of convertible preferred stock, Series B, at $975 per share in a private placement offering and received $14.1 million in net proceeds. The net proceeds from the offering were used to retire the remaining Series A preferred stock of $11.0 million in May 2015 and to improve capital levels. The convertible preferred stock, Series B, was converted into 1,550,000 shares of common stock in May 2015, and no dividends were declared or paid on the newly issued convertible preferred stock.

Interest Rate Sensitivity

Interest rate sensitivity management is concerned with the timing and magnitude of re-pricing assets compared to liabilities and is a part of asset/liability management. It is the objective of interest rate sensitivity management to generate stable growth in net interest income, and to control the risks associated with interest rate movements. We measure interest rate risk by using simulation analysis. Prior to 2010, simulation analysis indicated, in the absence of growth or changes in the mix of assets and liabilities, our net interest income generally increased when short-term interest rates rose and declined when short-term interest rates fell. In late 2010, we set our Carolina Bank prime at 4.50% when the Wall Street Journal Prime declined to 3.25% with the expectation that the Carolina Bank prime would not rise again until the Wall Street Journal Prime exceeded 4.50%. Our simulation analysis as of June 30, 2015 indicates that our net interest income will decline approximately 3.5% in one year, if interest rates rise gradually 1% over a one year time period, and will decline 4.4% over a one year time period if interest rates rise gradually 4% over a one year time period. The delay in adjusting our loans tied to the Carolina Bank prime or at floors is the major reason for the potential decline in net interest income as the Wall Street Journal Prime increases. Our simulation analysis assumes that our money market and premium savings account rates, which together compose approximately 48% of our deposits, only rise 1.30% with the first 2% increase in the Federal funds rate, then rise 1.50% with the next 2% increase in the Federal funds rate, and increase 0.85% for each remaining 1% increase in the Federal funds rate beyond the first 4% increase. We have also increased our fixed rate loans in recent quarters, and customers have shown an increased preference for short-term deposits over the past few years, all which have increased our risk to higher interest rates.

The negative impact on net income from an interest rate rise is projected to be greater than the negative impact on net interest income as noted above due to the anticipated decline in mortgage banking income which is a component of non-interest income. Increasing interest rates could reduce residential mortgage originations and related income significantly.

Inflation

Since our assets and liabilities are primarily monetary in nature, our performance is more affected by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not necessarily be the same. Since our Carolina Bank prime rate, which is used to price most of our commercial variable rate loans, is currently higher than the Wall Street Journal prime rate, we do not expect our Carolina Bank prime rate to increase as much as the Wall Street Journal prime until the two reach parity at 6.25%.

While the effect of inflation on a financial institution is normally not as significant as is its influence on those businesses which have large investments in plant and inventories, it does have an effect. During periods of high inflation, there are normally corresponding increases in the money supply, and financial institutions will normally experience above average growth in assets, loans and deposits. Also, general increases in the prices of goods and services will result in increased operating expenses.

ITEM 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have conducted an evaluation of our disclosure controls and procedures as of June 30, 2015. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the applicable Securities and Exchange Commission Rules and Forms. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation of these controls by our Chief Executive Officer and Chief Financial Officer.

Management of the Company has evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, changes in the Company's internal controls over financial reporting (as defined in Rule 13a−15(f) and 15d−15(f) of the Exchange Act) during the second quarter of 2015. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the second quarter that have materially affected or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

There are various claims and lawsuits in which the Company and the Bank are periodically involved incidental to their business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.

Item 5. Other Information

The Bank’s Friendly Avenue branch in Greensboro, NC closed at the end of July 2015 due to the expiration of the related lease in December 2015. The opening of our second branch in Winston-Salem occurred in August 2015.

Item 6. Exhibits

Exhibit No.		Description of Exhibit
31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1		Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.
101		Interactive data files providing financial information from the Registrant’s Quarterly report on Form 10-Q for the quarterly period ended June 30, 2015, in XBRL (eXtensible Business Reporting Language).

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.

	Carolina Bank Holdings, Inc.

Date: August 12, 2015	By:	/s/ Robert T. Braswell
		Robert T. Braswell
		President and Chief Executive Officer

Date: August 12, 2015	By:	/s/ T. Allen Liles
		T. Allen Liles
		Chief Financial and Principal Accounting Officer

Exhibit Index

Exhibit No.		Description of Exhibit
31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1		Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.
101		Interactive data files providing financial information from the Registrant’s Quarterly report on Form 10-Q for the quarterly period ended June 30, 2015, in XBRL (eXtensible Business Reporting Language).

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CAROLINA BANK HOLDINGS INC Reports