Entegra Financial Corp. - FORM 10-Q

Attached files

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EX-32.01 - Entegra Financial Corp.	e00448_ex32-01.htm
EX-31.02 - Entegra Financial Corp.	e00448_ex31-02.htm
EX-31.01 - Entegra Financial Corp.	e00448_ex31-01.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended:

June 30, 2016

Commission File Number: 001-35302

Entegra Financial Corp.
(Exact name of Registrant as specified in its Charter)

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

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

(828) 524-7000
(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Smaller reporting company o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On August 8, 2016, 6,466,375 shares of the issuer’s common stock (no par value), were issued and outstanding.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

FORM 10-Q
TABLE OF CONTENTS

		Page No.

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	3
	Consolidated Balance Sheets – June 30, 2016 and December 31, 2015	3
	Consolidated Statements of Income – Three and Six Months Ended June 30, 2016 and 2015	4
	Consolidated Statements of Comprehensive Income – Three and Six Months Ended June 30, 2016 and 2015	5
	Consolidated Statements of Changes in Shareholders’ Equity – Six Months Ended June 30, 2016 and 2015	6
	Consolidated Statements of Cash Flows – Six Months Ended June 30, 2016 and 2015	7
	Notes to Consolidated Financial Statements	9-43
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	44
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	72
Item 4.	Controls and Procedures	74

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	75
Item 1A.	Risk Factors	75
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75
Item 3.	Defaults Upon Senior Securities	75
Item 4.	Mine Safety Disclosures	75
Item 5.	Other Information	75
Item 6.	Exhibits	76
	Signatures	78

Item 1. Financial Statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

	June 30,			December 31,
	2016			2015
	(Unaudited)			(Audited)
Assets

Cash and due from banks	$	11,805		$	8,421
Interest-earning deposits		46,140			32,229
Cash and cash equivalents		57,945			40,650


Investments - trading		4,991			4,714
Investments - available for sale		291,334			238,862
Investments - held to maturity (fair value of $31,970 and $41,812 at June 30, 2016 and December 31, 2015, respectively)		30,907			41,164
Other investments, at cost		10,798			8,834
Loans held for sale		7,300			8,348
Loans receivable		721,461			624,072
Allowance for loan losses		(8,940	)		(9,461	)
Fixed assets, net		20,600			17,673
Real estate owned		5,413			5,369
Interest receivable		4,260			3,554
Bank owned life insurance		21,059			20,858
Net deferred tax asset		15,957			18,830
Loan servicing rights		2,392			2,344
Goodwill		1,872			711
Core deposit intangible		1,059			590
Other assets		4,219			4,304

Total assets	$	1,192,627		$	1,031,416

Liabilities and Shareholders’ Equity

Liabilities:
Deposits	$	828,874		$	716,617
Federal Home Loan Bank advances		193,500			153,500
Junior subordinated notes		14,433			14,433
Other borrowings		2,675			2,198
Post employment benefits		10,253			10,224
Accrued interest payable		265			213
Other liabilities		5,653			2,762
Total liabilities		1,055,653			899,947

Commitments and contingencies (Note 13)

Shareholders’ Equity:
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding		—			—
Common stock - no par value, 50,000,000 shares authorized; 6,466,375 and 6,546,375 shares issued and outstanding as of June 30, 2016 and December 31, 2015, respectively		—			—
Common stock held by Rabbi Trust, at cost; 14,000 shares at June 30, 2016 and December 31, 2015		(279	)		(279	)
Additional paid in capital		62,759			63,722
Retained earnings		71,987			69,762
Accumulated other comprehensive gain (loss)		2,507			(1,736	)
Total shareholders’ equity		136,974			131,469

Total liabilities and shareholders’ equity	$	1,192,627		$	1,031,416

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended June 30,					Six Months Ended June 30,
	2016		2015			2016		2015
Interest income:
Interest and fees on loans	$	8,255	$	6,647		$	15,461	$	13,117
Interest on tax exempt loans		98		32			143		58
Taxable securities		1,422		1,278			2,880		2,514
Tax-exempt securities		306		84			449		154
Interest-earning deposits		54		22			90		46
Other		122		49			227		107
Total interest and dividend income		10,257		8,112			19,250		15,996

Interest expense:
Deposits		1,032		1,149			1,974		2,358
Federal Home Loan Bank advances		319		183			594		388
Junior subordinated notes		128		115			254		227
Other borrowings		30		26			56		52
Total interest expense		1,509		1,473			2,878		3,025

Net interest income		8,748		6,639			16,372		12,971

Provision for loan losses		—		—			—		(1,500	)
Net interest income after provision for loan losses		8,748		6,639			16,372		14,471

Noninterest income:
Servicing income, net		75		19			191		105
Mortgage banking		220		85			360		340
Gain on sale of SBA loans		284		3			618		214
Gain on sale of investments, net		429		123			698		287
Other than temporary impairment on cost method investment		—		(3	)		—		(3	)
Service charges on deposit accounts		387		317			781		615
Interchange fees		382		322			724		600
Bank owned life insurance		94		133			201		262
Other		228		89			401		207
Total noninterest income		2,099		1,088			3,974		2,627

Noninterest expenses:
Compensation and employee benefits		4,257		3,817			8,267		7,514
Net occupancy		835		731			1,651		1,433
Federal Home Loan Bank prepayment penalty		—		1,762			—		1,762
Marketing and advertising		302		85			502		237
Federal deposit insurance		184		279			360		563
Professional and advisory		293		261			505		511
Data processing		400		282			751		562
Merger-related expenses		1,771		—			1,916		—
Net cost of operation of real estate owned		210		116			496		332
Other		1,061		848			2,144		1,843
Total noninterest expenses		9,313		8,181			16,592		14,757

Income (loss) before taxes		1,534		(454	)		3,754		2,341

Income tax expense (benefit)		676		(17,559	)		1,530		(17,379	)

Net income	$	858	$	17,105		$	2,224	$	19,720

Earnings per common share:
Basic	$	0.13	$	2.61		$	0.34	$	3.01
Diluted	$	0.13	$	2.61		$	0.34	$	3.01
Weighted average common shares outstanding:
Basic		6,466,665		6,546,375			6,492,209		6,546,375
Diluted		6,482,079		6,546,375			6,506,485		6,546,375

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015

Net income	$	858		$	17,105		$	2,224		$	19,720

Other comprehensive income (loss):
Change in unrealized holding gains and losses on securities available for sale		3,049			(2,172	)		6,504			(152	)
Reclassification adjustment for securities gains realized in net income		(429	)		(123	)		(698	)		(287	)
Amortization of unrealized loss on securities transferred to held to maturity		139			493			570			542
Change in deferred tax valuation allowance attributable to unrealized gains and losses on investment securities available for sale		94			(675	)		295			54
Change in unrealized holding gains and losses on cash flow hedge		(45	)		—			(45	)		—
Other comprehensive income (loss), before tax		2,808			(2,477	)		6,626			157
Income tax effect related to items of other comprehensive income (loss)		(1,022	)		675			(2,383	)		(54	)
Other comprehensive income (loss), after tax		1,786			(1,802	)		4,243			103

Comprehensive income	$	2,644		$	15,303		$	6,467		$	19,823

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

Six Months Ended June 30, 2016 and 2015

(Dollars in thousands)

	Common Stock
	Shares			Amount		Additional Paid in Capital			Retained Earnings		Accumulated Other Comprehensive Income (Loss)			Common Stock held by Rabbi Trust			Total
Balance, December 31, 2014		6,546,375		$	—	$	63,651		$	45,937	$	(2,269	)	$	—		$	107,319

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

Balance, December 31, 2015		6,546,375		$	—	$	63,722		$	69,762	$	(1,736	)	$	(279	)	$	131,469

Net income		—			—		—			2,224		—			—			2,224
Other comprehensive income, net of tax		—			—		—			—		4,243			—			4,243
Stock compensation expense		—			—		427			—		—			—			427
Repurchase of common stock		(80,000	)				(1,390	)		—		—			—			(1,390	)
Balance, June 30, 2016		6,466,375		$	—	$	62,759		$	71,987	$	2,507		$	(279	)	$	136,974

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	For the Six Months Ended June 30,
	2016			2015
Cash flows from operating activities:
Net income	$	2,224		$	19,720
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and leasehold amortization		609			506
Security amortization, net		1,257			1,007
Trading account income		(178	)		—
Provision for loan losses		—			(1,500	)
Provision for real estate owned		508			91
Amortization of core deposit intangible		61			—
Share-based compensation		427			—
Deferred income tax expense (benefit)		1,598			(17,262	)
Net increase (decrease) in deferred loan fees		(236	)		(110	)
Gain on sales of securities available for sale		(698	)		(287	)
Other than temporary impairment on cost method investment		—			3
Income on bank owned life insurance, net		(201	)		(221	)
Mortgage banking income, net		(360	)		(340	)
Gain on sales of SBA loans		(618	)		(214	)
Net realized loss on sale of real estate owned		(178	)		(33	)
Loans originated for sale		(14,897	)		(14,950	)
Proceeds from sale of loans originated for sale		16,923			16,630
Net change in operating assets and liabilities:
Interest receivable		(154	)		(311	)
Loan servicing rights		(48	)		29
Other assets		69			(497	)
Postemployment benefits		29			216
Accrued interest payable		22			(107	)
Other liabilities		626			843
Net cash provided by operating activities	$	6,785		$	3,213

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited), continued

(Dollars in thousands)

	For the Six Months Ended June 30,
	2016			2015
Cash flows from investing activities:
Activity for investment securities:
Purchases	$	(103,802	)	$	(90,592	)
Maturities/calls and principal repayments		24,760			31,890
Sales		75,709			25,707
Net increase in loans		(33,339	)		(25,339	)
Purchased loans		—			(20,369	)
Proceeds from sale of real estate owned		1,222			560
Real estate owned capitalized costs		—			(8	)
Purchase of fixed assets		(144	)		(2,445	)
Purchase of other investments, at cost		(1,410	)		(2,674	)
Redemptions of other investments, at cost		—			150
Net cash paid in business combination		(5,912	)		—
Net cash used in investing activities	$	(42,916	)	$	(83,120	)
Cash flows from financing activities:
Net increase (decrease) in deposits	$	23,026		$	(11,264	)
Net increase in escrow deposits		815			684
Proceeds from FHLB advances		40,000			100,500
Repayment of FHLB advances		(9,025	)		(40,000	)
Repurchase of common stock		(1,390	)		—
Net cash provided by financing activities	$	53,426		$	49,920

Increase(decrease) in cash and cash equivalents		17,295			(29,987	)

Cash and cash equivalents, beginning of period	$	40,650		$	58,982

Cash and cash equivalents, end of period	$	57,945		$	28,995

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest on deposits and other borrowings	$	2,945		$	3,132
Acquisitions
Assets acquired	$	110,196		$	—
Liabilities assumed		97,877			—
Net assets	$	12,319		$	—

Noncash investing and financing activities:
Real estate acquired in satisfaction of mortgage loans	$	673		$	1,689
Loans originated for disposition of real estate owned		—			794
Investments to be settled		2,293			—

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

Entegra Financial Corp. (the “Company”) was incorporated on May 31, 2011 and became the holding company for Entegra Bank (the “Bank”) on September 30, 2014 upon the completion of Macon Bancorp’s merger with and into the Company, pursuant to which Macon Bancorp converted from the mutual to stock form of organization. The Company’s primary operation is its investment in the Bank. The Company also owns 100% of the common stock of Macon Capital Trust I (the “Trust”), a Delaware statutory trust formed in 2003 to facilitate the issuance of trust preferred securities. The Bank is a North Carolina state-chartered savings bank and has a wholly owned subsidiary, Entegra Services, Inc., which was inactive as of June 30, 2016. The consolidated financials are presented in these financial statements.

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

Estimates

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

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

Principles of Consolidation

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

Reclassification

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

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K, filed with the SEC on March 15, 2016. In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

Acquisition Activities

The Company accounts for business combinations under the acquisition method of accounting. Assets acquired and liabilities assumed are measured and recorded at fair value at the date of acquisition, including identifiable intangible assets. If the fair value of net assets purchased exceeds the fair value of consideration paid, a bargain purchase gain is recognized at the date of acquisition. Conversely, if the consideration paid exceeds the fair value of the net assets acquired, goodwill is recognized at the acquisition date. Fair values are subject to refinement for a period not to exceed one year after the closing date of an acquisition as information relative to closing date fair values becomes available.

The determination of the fair value of loans acquired takes into account credit quality deterioration and probability of loss; therefore, the related allowance for loan losses is not carried forward.

All identifiable intangible assets that are acquired in a business combination are recognized at fair value on the acquisition date. Identifiable intangible assets are recognized separately if they arise from contractual or other legal rights or if they are separable (i.e., capable of being sold, transferred, licensed, rented, or exchanged separately from the entity). Deposit liabilities and the related depositor relationship intangible assets may be exchanged in observable exchange transactions. As a result, the depositor relationship intangible asset is considered identifiable, because the separability criterion has been met.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet including the estimates inherent in the process of preparing financial statements. Unrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. The Company has reviewed events occurring through the issuance date of the Consolidated Financial Statements and no subsequent events have occurred requiring accrual or disclosure in these financial statements other than as described in Footnote 16.

Recent Accounting Standards Updates

In January 2016, the Financial Accounting Standards Board (“FASB”) amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company is currently evaluating the impact on its financial statements.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments 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 financial statements.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them to apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

In June 2016, the FASB issued amendments to Accounting Standards Update 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in the Update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. Thereby, providing financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by the reporting entity. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is currently evaluating the impact on its financial statements.

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

NOTE 2. INVESTMENT SECURITIES

The amortized cost and estimated fair values of securities available for sale as of June 30, 2016 and December 31, 2015 are summarized as follows:

	June 30, 2016
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	13,100	$	134	$	—		$	13,234
Municipal securities		94,766		2,879		(4	)		97,641
Mortgage-backed securities		169,306		2,081		(416	)		170,971
U.S. Treasury securities		1,499		58		—			1,557
Corporate debt securities		7,198		117		(3	)		7,312
Mutual funds		609		10		—			619
	$	286,478	$	5,279	$	(423	)	$	291,334

	December 31, 2015
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	25,633	$	123	$	(36	)	$	25,720
Municipal securities		39,751		311		(204	)		39,858
Mortgage-backed securities		172,327		276		(1,429	)		171,174
U.S. Treasury securities		1,500		10		—			1,510
Mutual funds		602		—		(2	)		600
	$	239,813	$	720	$	(1,671	)	$	238,862

The amortized cost and estimated fair values of securities held to maturity (“HTM”) as of June 30, 2016 and December 31, 2015 are summarized as follows:

	June 30, 2016
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	2,723	$	283	$	—		$	3,006
Municipal securities		12,625		525		(7	)		13,143
Mortgage-backed securities		4,531		71		—			4,602
U.S. Treasury securities		1,002		6		—			1,008
Corporate debt securities		10,026		193		(8	)		10,211
	$	30,907	$	1,078	$	(15	)	$	31,970

	December 31, 2015
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)

U.S. government agencies	$	15,877	$	645	$	(23	)	$	16,499
Municipal securities		12,428		199		(93	)		12,534
Mortgage-backed securities		4,834		4		(62	)		4,776
U.S. Treasury securities		1,002		—		(7	)		995
Corporate debt securities		7,023		25		(40	)		7,008
	$	41,164	$	873	$	(225	)	$	41,812

Information pertaining to the activity for the three and six month periods ended June 30, 2016 and 2015 of unrealized losses related to HTM securities (before the impact of income taxes) previously recognized in accumulated other comprehensive income (“AOCI”) is summarized below:

	For the Three Months Ended						For the Six Months Ended
	June 30						June 30
(Dollars in thousands)	2016			2015			2016			2015

Beginning unrealized loss related to HTM securities previously recognized in AOCI	$	472		$	1,838		$	903		$	1,887
Additions for transfers to HTM		—			—			—			—

Amortization of unrealized losses on HTM securities previously recognized in AOCI		(139	)		(493	)		(570	)		(542	)

Ending unrealized loss in AOCI related to HTM securities previously recognized in AOCI	$	333		$	1,345		$	333		$	1,345

The increase in amortization during the three months ended June 30, 2015 was due to an increase in securities called.

Information pertaining to securities with gross unrealized losses at June 30, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

	June 30, 2016
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)

Held to Maturity:
Municipal securities	$	—	$	—	$	1,204	$	7	$	1,204	$	7
Corporate debt securities		743		8		—		—		743		8
	$	743	$	8	$	1,204	$	7	$	1,947	$	15

Available for Sale:
Municipal securities	$	1,153	$	3	$	359	$	1	$	1,512	$	4
Mortgage-backed securities		39,310		271		11,705		145		51,015		416
Corporate debt securities		1,020		3		—		—		1,020		3
	$	41,483	$	277	$	12,064	$	146	$	53,547	$	423

	December 31, 2015
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)

Held to Maturity:
U.S. government agencies	$	5,705	$	23	$	—	$	—	$	5,705	$	23
Municipal securities		4,365		93		—		—		4,365		93
Mortgage-backed securities		2,693		62		—		—		2,693		62
U.S. Treasury securities		995		7		—		—		995		7
Corporate debt securities		4,911		40		—		—		4,911		40
	$	18,669	$	225	$	—	$	—	$	18,669	$	225

Available for Sale:
U.S. government agencies	$	13,317	$	36	$	—	$	—	$	13,317	$	36
Municipal securities		18,769		176		947		28		19,716		204
Mortgage-backed securities		102,419		926		20,905		503		123,324		1,429
Mutual funds		600		2		—		—		600		2
	$	135,105	$	1,140	$	21,852	$	531	$	156,957	$	1,671

Information pertaining to the number of securities with unrealized losses is detailed in the table below. The Company believes all unrealized losses as of June 30, 2016 and December 31, 2015 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

	June 30, 2016
	Less Than 12 Months		More Than 12 Months		Total
U.S. government agencies		9		5		14
Municipal securities		1		3		4
Mortgage-backed securities		11		5		16
Corporate debt securities		3		—		3
		24		13		37

	December 31, 2015
	Less Than 12 Months		More Than 12 Months		Total
U.S. government agencies		13		—		13
Municipal securities		51		2		53
Mortgage-backed securities		71		15		86
U.S. Treasury securities		1		—		1
Corporate debt securities		9		—		9
Mutual funds		1		—		1
		146		17		163

For the three and six months ended June 30, 2016 and 2015 the Company had proceeds from sales of securities available for sale and their corresponding gross realized gains and losses as detailed below:

	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
	(Dollars in thousands)

Gross proceeds	$	41,204	$	12,010	$	75,709	$	25,707
Gross realized gains		445		123		732		307
Gross realized losses		16		—		34		20

The Company had securities pledged against deposits and borrowings of approximately $126.4 million and $69.6 million at June 30, 2016 and December 31, 2015, respectively.

The amortized cost and estimated fair value of investments in debt securities at June 30, 2016, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.

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

Less than 1 year	$	2,046	$	2,058
Over 1 year through 5 years		21,312		21,635
After 5 years through 10 years		24,762		25,382
Over 10 years		69,052		71,288
		117,172		120,363
Mortgage-backed securities		169,306		170,971

Total	$	286,478	$	291,334

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

Over 1 year through 5 years	$	1,002	$	1,008
After 5 years through 10 years		10,492		10,702
Over 10 years		14,882		15,658
		26,376		27,368
Mortgage-backed securities		4,531		4,602

Total	$	30,907	$	31,970

NOTE 3. ACQUISITION ACTIVITIES

The Company has determined that the acquisition described below constitutes a business combination as defined in ASC Topic 805, Business Combinations. Accordingly, as of the date of the acquisition, the Company recorded the assets acquired and liabilities assumed at fair value. The Company determined fair values in accordance with the guidance provided in ASC Topic 820, Fair Value Measurements. Fair value is established by discounting the expected future cash flows with a market discount rate for like maturity and risk instruments. The estimation of expected future cash flows requires significant assumptions about appropriate discount rates, expected future cash flows, market conditions and other future events. Actual results could differ materially. The Company made the determinations of fair value using the best information available at the time; however, the assumptions used are subject to change and, if changed, could have a material effect on the Company’s financial position and results of operations.

On April 1, 2016, the Bank acquired Old Town Bank of Waynesville, North Carolina. In connection with the acquisition, the Bank acquired $110.2 million of assets and assumed $97.9 million of liabilities. Total consideration transferred was $13.5 million of cash. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $1.2 million, none of which is deductible for tax purposes. Loans purchased with evidence of credit impairment were not material.

The purchased assets and assumed liabilities were recorded at their acquisition date fair values, and are summarized in the table below (in thousands.)

	As recorded by		Fair Value			As recorded by
	Old Town Bank		Adjustments (1)			the Company
Assets
Cash and cash equivalents	$	7,573	$	—		$	7,573
Investments		30,882		246			31,128
Loans		64,736		272			65,008
Fixed assets		3,414		(22	)		3,392
Interest receivable		552		—			552
Core deposit intangible		—		530			530
Other real estate owned		880		43			923
Deferred tax asset		259		200			459
Other assets		937		(306	)		631
Total assets acquired	$	109,233	$	963		$	110,196

Liabilities
Deposits	$	88,059	$	648		$	88,707
FHLB advances		9,000		25			9,025
Accrued Interest payable		30		—			30
Other liabilities		125		(10	)		115
Total liabilities assumed		97,214		663			97,877

Excess of assets acquired over liabilities assumed	$	12,019	$	300		$	12,319
Purchase price							13,486
Goodwill						$	1,167

(1)

Fair values are subject to refinement for a period not to exceed one year after the closing date of an acquisition as information relative to closing date fair values becomes available. In particular, the fair value of collateral dependent loans and other real estate owned may change to the extent that the Company receives updated appraisals indicating changes in valuation assumptions at acquisition.

NOTE 4. LOANS RECEIVABLE

Loans receivable as of June 30, 2016 and December 31, 2015 are summarized as follows:

	June 30, 2016			December 31, 2015
	(Dollars in thousands)

Real estate mortgage loans:
One-to four-family residential	$	268,699		$	248,633
Commercial real estate		276,371			214,413
Home equity loans and lines of credit		51,675			53,446
Residential construction		14,270			7,848
Other construction and land		52,576			57,316
Total real estate loans		663,591			581,656

Commercial and industrial		55,530			41,046
Consumer		5,098			3,639
Total commercial and consumer		60,628			44,685

Loans receivable, gross		724,219			626,341

Less: Net deferred loan fees		(1,152	)		(1,388	)
Unamortized premium		467			557
Unamortized discount		(2,073	)		(1,438	)

Loans receivable, net	$	721,461		$	624,072

The Bank had $126.2 million and $119.5 million of loans pledged as collateral to secure funding with the Federal Home Loan Bank of Atlanta (“FHLB”) at June 30, 2016 and December 31, 2015, respectively. The Bank also had $81.8 million and $88.4 million of loans pledged as collateral to secure funding with the Federal Reserve Bank (“FRB”) Discount Window at June 30, 2016 and December 31, 2015, respectively.

Included in loans receivable and other borrowings at June 30, 2016 are $2.7 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

The following tables present the activity related to the discount on purchased loans for the three and six month periods ended June 30, 2016 and 2015:

	For the Three Months Ended						For the Six Months Ended
	June 30,						June 30,
(Dollars in thousands)	2016			2015			2016			2015

Discount on purchased loans, beginning of period	$	1,361		$	1,587		$	1,438		$	1,487
Additional discount for new purchases		870			—			870			484
Accretion		(158	)		(88	)		(235	)		(177	)
Discount applied to charge-offs		—			—			—			(295	)
Discount on purchased loans, end of period	$	2,073		$	1,499		$	2,073		$	1,499

NOTE 5. ALLOWANCE FOR LOAN LOSSES

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

	Three Months Ended June 30, 2016
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit			Residential Construction			Other Construction and Land			Commercial			Consumer			Total
	(Dollars in thousands)

Beginning balance	$	2,725		$	3,808		$	959		$	143		$	1,177		$	536		$	150		$	9,498
Provision		—			—			—			—			—			—			—			—
Charge-offs		(52	)		(431	)		(93	)		—			(120	)		(10	)		(16	)		(722	)
Recoveries		6			2			21			32			7			4			92			164
Ending balance	$	2,679		$	3,379		$	887		$	175		$	1,064		$	530		$	226		$	8,940

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

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

	Six Months Ended June 30, 2016
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit			Residential Construction			Other Construction and Land			Commercial			Consumer			Total
	(Dollars in thousands)

Beginning balance	$	2,455		$	3,221		$	1,097		$	278		$	1,400		$	603		$	407		$	9,461
Provision		293			587			(214	)		(135	)		17			(185	)		(363	)		—
Charge-offs		(98	)		(431	)		(130	)		—			(437	)		(10	)		(26	)		(1,132	)
Recoveries		29			2			134			32			84			122			208			611
Ending balance	$	2,679		$	3,379		$	887		$	175		$	1,064		$	530		$	226		$	8,940

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

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

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

	June 30, 2016
	One-to four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)

Allowance for loan losses
Individually evaluated for impairment	$	242	$	63	$	6	$	—	$	164	$	34	$	—	$	509
Collectively evaluated for impairment		2,437		3,316		881		175		900		496		226		8,431
	$	2,679	$	3,379	$	887	$	175	$	1,064	$	530	$	226	$	8,940

Loans Receivable
Individually evaluated for impairment	$	4,689	$	9,940	$	779	$	—	$	1,833	$	311	$	—	$	17,552
Collectively evaluated for impairment		264,010		266,431		50,896		14,270		50,743		55,219		5,098		706,667
	$	268,699	$	276,371	$	51,675	$	14,270	$	52,576	$	55,530	$	5,098	$	724,219

	December 31, 2015
	One-to four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)

Allowance for loan losses
Individually evaluated for impairment	$	344	$	61	$	6	$	—	$	61	$	38	$	—	$	510
Collectively evaluated for impairment		2,111		3,160		1,091		278		1,339		565		407		8,951
	$	2,455	$	3,221	$	1,097	$	278	$	1,400	$	603	$	407	$	9,461

Loans Receivable
Individually evaluated for impairment	$	6,315	$	9,013	$	313	$	—	$	1,509	$	318	$	—	$	17,468
Collectively evaluated for impairment		242,318		205,400		53,133		7,848		55,807		40,728		3,639		608,873
	$	248,633	$	214,413	$	53,446	$	7,848	$	57,316	$	41,046	$	3,639	$	626,341

Portfolio Quality Indicators

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

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

●

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

●

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

●

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

●

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

●

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

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

Description of segment and class risks

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

One-to four family residential

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

Commercial real estate

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

Home equity and lines of credit

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

Residential construction and other construction and land

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

Commercial

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

Consumer

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

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

June 30, 2016

Loan Grade	One-to Four- Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)

1	$	—	$	63	$	—	$	—	$	—	$	10,504	$	—	$	10,567
2		—		4,368		—		—		—		1,484		—		5,852
3		26,997		22,970		1,528		472		1,094		3,451		—		56,512
4		68,958		126,695		3,726		7,636		8,869		27,775		70		243,729
5		25,987		91,156		3,604		1,419		24,636		9,848		347		156,997
6		2,145		14,910		7		1,216		1,378		262		—		19,918
7		4,628		14,266		466		—		2,207		446		—		22,013
	$	128,715	$	274,428	$	9,331	$	10,743	$	38,184	$	53,770	$	417	$	515,588

Ungraded Loan Exposure:

Performing	$	139,296	$	1,943	$	42,281	$	3,527	$	14,326	$	1,760	$	4,681	$	207,814
Nonperforming		688		—		63		—		66		—		—		817
Subtotal	$	139,984	$	1,943	$	42,344	$	3,527	$	14,392	$	1,760	$	4,681	$	208,631

Total	$	268,699	$	276,371	$	51,675	$	14,270	$	52,576	$	55,530	$	5,098	$	724,219

December 31, 2015

Loan Grade	One-to Four- Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)

1	$	—	$	65	$	—	$	—	$	—	$	10,336	$	—	$	10,401
2		—		4,446		—		—		—		99		—		4,545
3		18,518		11,396		1,358		525		1,479		1,734		—		35,010
4		46,942		74,542		1,961		2,036		13,850		18,586		1		157,918
5		33,886		97,469		6,648		1,347		22,864		9,274		592		172,080
6		2,903		13,171		—		1,106		1,718		297		—		19,195
7		3,335		13,106		—		—		579		458		—		17,478
	$	105,584	$	214,195	$	9,967	$	5,014	$	40,490	$	40,784	$	593	$	416,627

Ungraded Loan Exposure:

Performing	$	141,771	$	218	$	43,158	$	2,834	$	16,707	$	262	$	3,046	$	207,996
Nonperforming		1,278		—		321		—		119		—		—		1,718
Subtotal	$	143,049	$	218	$	43,479	$	2,834	$	16,826	$	262	$	3,046	$	209,714

Total	$	248,633	$	214,413	$	53,446	$	7,848	$	57,316	$	41,046	$	3,639	$	626,341

Delinquency Analysis of Loans by Class

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

	June 30, 2016
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Over Past Due		Total Past Due		Current		Total Loans Receivable
	(Dollars in thousands)

One-to four-family residential	$	3,914	$	2,787	$	1,866	$	8,567	$	260,132	$	268,699
Commercial real estate		2,811		478		3,079		6,368		270,003		276,371
Home equity and lines of credit		201		195		530		926		50,749		51,675
Residential construction		224		218		—		442		13,828		14,270
Other construction and land		1,600		19		1,387		3,006		49,570		52,576
Commercial		132		82		239		453		55,077		55,530
Consumer		16		1		1		18		5,080		5,098
Total	$	8,898	$	3,780	$	7,102	$	19,780	$	704,439	$	724,219

	December 31, 2015
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Over Past Due		Total Past Due		Current		Total Loans Receivable
	(Dollars in thousands)

One-to four-family residential	$	5,610	$	1,260	$	1,205	$	8,075	$	240,558	$	248,633
Commercial real estate		1,585		—		605		2,190		212,223		214,413
Home equity and lines of credit		369		38		322		729		52,717		53,446
Residential construction		—		—		—		—		7,848		7,848
Other construction and land		208		397		138		743		56,573		57,316
Commercial		625		—		—		625		40,421		41,046
Consumer		12		4		—		16		3,623		3,639
Total	$	8,409	$	1,699	$	2,270	$	12,378	$	613,963	$	626,341

Impaired Loans

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of June 30, 2016 and December 31, 2015.

	June 30, 2016						December 31, 2015
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Recorded Balance		Unpaid Principal Balance		Specific Allowance
	(Dollars in thousands)
Loans without a valuation allowance
One-to four-family residential	$	2,658	$	2,712	$	—	$	4,289	$	4,403	$	—
Commercial real estate		8,178		10,193		—		7,226		8,809		—
Home equity and lines of credit		679		794		—		213		328		—
Residential construction		—		—		—		—		—		—
Other construction and land		900		1,069		—		658		818		—
Commercial		—		—		—		—		—		—
	$	12,415	$	14,768	$	—	$	12,386	$	14,358	$	—

Loans with a valuation allowance
One-to four-family residential	$	2,031	$	2,031	$	243	$	2,026	$	2,026	$	344
Commercial real estate		1,762		1,762		63		1,787		1,787		61
Home equity and lines of credit		100		100		5		100		100		6
Residential construction		—		—		—		—		—		—
Other construction and land		933		1,028		164		851		851		61
Commercial		311		311		34		318		318		38
	$	5,137	$	5,232	$	509	$	5,082	$	5,082	$	510

Total
One-to four-family residential	$	4,689	$	4,743	$	243	$	6,315	$	6,429	$	344
Commercial real estate		9,940		11,955		63		9,013		10,596		61
Home equity and lines of credit		779		894		5		313		428		6
Residential construction		—		—		—		—		—		—
Other construction and land		1,833		2,097		164		1,509		1,669		61
Commercial		311		311		34		318		318		38
	$	17,552	$	20,000	$	509	$	17,468	$	19,440	$	510

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

	Three Months Ended June 30,								Six Months Ended June 30,
	2016				2015				2016				2015
	Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized
	(Dollars in thousands)								(Dollars in thousands)
Loans without a valuation allowance
One-to four-family residential	$	2,681	$	19	$	5,598	$	45	$	2,690	$	55	$	5,607	$	87
Commercial real estate		8,416		13		9,536		114		8,419		59		9,555		214
Home equity and lines of credit		679		3		713		—		679		5		714		1
Residential construction		—		—		—		—		—		—		—		—
Other construction and land		908		8		1,239		8		912		16		1,241		18
Commercial		—		—		—		—		—		—		—		—
	$	12,684	$	43	$	17,086	$	167	$	12,700	$	135	$	17,117	$	320

Loans with a valuation allowance
One-to four-family residential	$	2,036	$	—	$	2,190	$	22	$	2,043	$	24	$	2,198	$	44
Commercial real estate		1,768		14		3,186		35		1,775		41		3,196		69
Home equity and lines of credit		100		1		431		1		100		2		431		2
Residential construction		—		—		—		—		—		—		—		—
Other construction and land		985		8		1,009		10		989		18		1,014		21
Commercial		312		4		326		5		315		9		326		10
	$	5,201	$	27	$	7,142	$	73	$	5,222	$	94	$	7,165	$	146

Total
One-to four-family residential	$	4,717	$	19	$	7,788	$	67	$	4,733	$	79	$	7,805	$	131
Commercial real estate		10,184		27		12,722		149		10,194		100		12,751		283
Home equity and lines of credit		779		4		1,144		1		779		7		1,145		3
Residential construction		—		—		—		—		—		—		—		—
Other construction and land		1,893		16		2,248		18		1,901		34		2,255		39
Commercial		312		4		326		5		315		9		326		10
	$	17,885	$	70	$	24,228	$	240	$	17,922	$	229	$	24,282	$	466

Nonperforming Loans

The following table summarizes the balances of nonperforming loans as of June 30, 2016 and December 31, 2015. Certain loans classified as Troubled Debt Restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.

	June 30, 2016		December 31, 2015
	(Dollars in thousands)

One-to four-family residential	$	2,246	$	2,893
Commercial real estate		5,179		3,628
Home equity loans and lines of credit		528		320
Residential construction		—		—
Other construction and land		1,434		384
Commercial		48		55
Consumer		1		—
Non-performing loans	$	9,436	$	7,280

Troubled Debt Restructurings (TDR)

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

	June 30, 2016
	Performing		Nonperforming		Total
	TDRs		TDRs		TDRs
	(Dollars in thousands)

One-to-four family residential	$	3,138	$	211	$	3,349
Commercial real estate		4,451		2,860		7,311
Home equity and lines of credit		213		—		213
Residential construction		—		—		—
Other construction and land		1,490		406		1,896
Commercial		311		11		322

	$	9,603	$	3,488	$	13,091

	December 31, 2015
	Performing		Nonperforming		Total
	TDRs		TDRs		TDRs
	(Dollars in thousands)

One-to-four family residential	$	4,182	$	211	$	4,393
Commercial real estate		5,134		2,922		8,056
Home equity and lines of credit		313		—		313
Residential construction		—		—		—
Other construction and land		1,259		250		1,509
Commercial		318		12		330

	$	11,206	$	3,395	$	14,601

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

	Three Months Ended June 30, 2016						Six Months Ended June 30, 2016
(Dollars in thousands)	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Forgiveness of principal:
Commercial real estate		—	$	—	$	—		—	$	—	$	—
		—	$	—	$	—		—	$	—	$	—

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

There were no TDRs that defaulted during the three month and six month periods ending June 30, 2016 and 2015 and which were modified as TDRs within the previous 12 months.

NOTE 6. REAL ESTATE OWNED

The following tables summarize real estate owned and changes in the valuation allowance for real estate owned as of June 30, 2016 and December 31, 2015 and for the three and six months ended June 30, 2016 and 2015.

	June 30		December 31,
(Dollars in thousands)	2016		2015

Real estate owned, gross	$	6,769	$	6,741
Less: Valuation allowance		1,356		1,372

Real estate owned, net	$	5,413	$	5,369

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in thousands)	2016			2015			2016			2015
Valuation allowance, beginning	$	1,651		$	1,606		$	1,372		$	1,760
Provision charged to expense		166			23			508			91
Reduction due to disposal		(461	)		(71	)		(524	)		(293	)

Valuation allowance, ending	$	1,356		$	1,558		$	1,356		$	1,558

As of June 30, 2016 and December 31, 2015, the Company had $0.3 million and $0.7 million, respectively, in loans secured by residential real estate properties for which formal foreclosure proceedings were in process. As of June 30, 2016 and December 31, 2015, the Company had $1.9 million and $1.4 million, respectively, of residential real estate properties included in real estate owned.

NOTE 7. DEPOSITS

The following table summarizes deposit balances and interest expense by type of deposit as of and for the six months ended June 30, 2016 and 2015 and the year ended December 31, 2015.

	As of and for the								As of and for the Year Ended
	Six Months Ended June 30,								December 31,
	2016				2015				2015
(Dollars in thousands)	Balance		Interest Expense		Balance		Interest Expense		Balance		Interest Expense
Noninterest-bearing demand	$	127,010	$	—	$	95,604	$	—	$	121,062	$	—
Interest-bearing demand		116,648		94		98,447		76		103,198		136
Money Market		236,750		324		171,475		294		180,377		558
Savings		38,057		26		30,043		16		35,838		33
Time Deposits		310,409		1,530		296,968		1,972		276,142		3,607
	$	828,874	$	1,974	$	692,537	$	2,358	$	716,617	$	4,334

NOTE 8. BORROWINGS

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

		June 30, 2016					December 31, 2015
Year of Maturity		Balance		Weighted Average Rate			Balance		Weighted Average Rate
		(Dollars in thousands)
	2016		130,000		0.58	%		130,000		0.49	%
	2017		38,000		0.88	%		8,000		1.23	%
	2018		12,000		0.91	%		2,000		1.25	%
	2019		12,500		1.82	%		12,500		1.82	%
	2020		1,000		1.78	%		1,000		1.78	%
		$	193,500		0.75	%	$	153,500		0.65	%

NOTE 9. Derivative Financial Instruments and Hedging Activities

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposure to business and operational risks through management of its core business activities. The Company manages interest rate risk primarily by managing the amount, sources, and duration of its investment securities portfolio and borrowings and through the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Derivative financial instruments are used to manage differences in the amount, timing, and duration of known or expected cash receipts or payments principally related to loans and borrowings.

The table below presents the fair value of the Company’s derivative financial instruments as of the dates indicated as well as their classification on the consolidated balance sheet (in thousands).

		Fair Value
	Balance Sheet Location	June 30, 2016		December 31, 2015
Designated as hedges:
Cash flow hedge of borrowings - interest rate swap	Other liabilities	$	43	$	—
Total		$	43	$	—

Not designated as hedges:
Mortgage banking - loan commitment	Other assets	$	99	$	30
Mortgage banking - forward sales commitment	Other assets		19		15
Total		$	118	$	45

Derivative contracts that are not accounted for as hedging instruments under ASC 815, Derivatives and Hedging, are related to the Company’s mortgage loan origination activities. Between the time that the Company enters into an interest-rate lock commitment to originate a mortgage loan that is to be held for sale and the time the loan is funded and eventually sold, the Company is subject to the risk of variability in market prices. The Company also enters into forward sale agreements to mitigate risk and to protect the expected gain on the eventual loan sale. This activity is on a matched basis, with a loan sale commitment hedging a specific loan. The commitments to originate mortgage loans and forward loan sales commitments are freestanding derivative instruments. The underlying loans are accounted for under the lower of cost or fair value method and are not reflected in the table above. Fair value adjustment on these derivative instruments are recorded within mortgage banking income in the Consolidated Statement of Income.

The Company’s objectives in using interest rate derivatives are to add stability to net interest revenue and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. At June 30, 2016, the Company had one interest rate swap with a notional amount of $14.0 million that was designated as a cash flow hedge of the interest expense on junior subordinated notes. The swap contract involves the payment of fixed-rate amounts to a counterparty in exchange for the Company receiving variable-rate payments over the four year life of the agreement without exchange of the underlying notional amount.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense when the swaps become effective, as interest payments are made on the Company’s LIBOR based, variable-rate junior subordinated debt.

The table below presents the effect of the Company’s cash flow hedge on the Consolidated Statement of Income (in thousands).

	Amount of Gain(Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion)					Gain(Loss) Reclassified from Accumulated Other Comprehensive Income into Income (Effective Portion)
							For the three and six months ended June 30
	June 30, 2016			December 31, 2015		Location	2016		2015
Interest rate swap	$	(28	)	$	—	Interest Expense	$	1	$	—

The Company may be exposed to credit risk in the event of non-performance by the counterparties to its interest rate derivative agreements. The Company assesses the credit risk of its financial institution counterparties by monitoring publicly available credit rating and financial information. The Company manages dealer credit risk by entering into interest rate derivatives only with primary and highly rated counterparties, the use of ISDA master agreements and counterparty limits. The agreements contain collateral arrangements with the amount of collateral to be posted generally governed by the settlement value of outstanding swaps. The Company does not currently anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.

The Company has agreements with its derivative counterparties that contain a provision in which if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, the Company could also be declared in default on its derivative obligations. Furthermore, certain agreements covering the Company’s derivative instruments contain provisions that require the Company to maintain its status as a well / adequately capitalized institution. These provisions enable the counterparties to the derivative instruments to request immediate payment or require the Company to post additional collateral.

NOTE 10. INCOME TAXES

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

●

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

●

A 3 year cumulative profit;

●

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

●

Significant improvements in asset quality;

●

Resolution of all remaining regulatory orders; and

●

A strong capital position enabling future earnings investments.

As of June 30, 2016 and December 31, 2015, $0.3 million and $0.6 million in valuation allowance related to net deferred tax assets on investment securities remains in accumulated other comprehensive income. This valuation allowance will be recognized as tax expense on a security-by-security basis upon the sale or maturity of the individual securities. The tax expense is expected to be recognized over the remaining life of the securities of approximately 1.5 years.

The components of net deferred taxes as of June 30, 2016 and December 31, 2015 are summarized as follows:

	June 30,		December 31,
	2016		2015
	(Dollars in thousands)
Deferred tax assets:
Federal net operating loss	$	10,445	$	10,750
Allowance for loan losses		3,303		3,557
Deferred compensation and post employment benefits		3,415		3,498
North Carolina net operating loss		698		988
Valuation reserve for other real estate		501		516
Non-accrual interest		325		286
Tax credits and other carryforwards		308		197
Deferred gains		195		154
Unrealized losses on securities		—		697
Loan basis difference		288		—
Deposit premium		209		—
Other		740		421
Gross deferred tax assets		20,427		21,064

Deferred tax liabilities:
Fixed assets		437		499
Loan servicing rights		884		881
Deferred loan costs		908		708
Prepaid expenses		149		146
Unrealized gains on securities		1,700		—
Other		392		—
Total deferred tax liabilities		4,470		2,234

Net deferred tax asset	$	15,957	$	18,830

NOTE 11. EARNINGS PER SHARE

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

(Dollars in thousands, except per share amounts)	For the Three Months Ended June 30, 2016		For the Six Months Ended June 30, 2016
Numerator:
Net income	$	858	$	2,224
Denominator:
Weighted-average common shares outstanding - basic		6,466,665		6,492,209
Effect of dilutive shares		15,414		14,276
Weighted-average common shares outstanding - diluted		6,482,079		6,506,485

Earnings per share - basic	$	0.13	$	0.34
Earnings per share - diluted	$	0.13	$	0.34

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

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

For the three and six months ended June 30, 2016, all of the 411,500 outstanding stock options remain anti-dilutive and have not been included in calculating diluted earnings per share. There were no stock options outstanding during the six months ended June 30, 2015.

For the three and six months ended June 30, 2016, all of the 178,300 outstanding restricted stock units were dilutive and included in calculating diluted earnings per share. There were no restricted stock units outstanding during the six months ended June 30, 2015.

NOTE 12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the components of accumulated other comprehensive income and changes in those components as of and for the three and six months ended June 30, 2016 and 2015.

	Three Months Ended June 30, 2016
	Available for Sale Securities			Held to Maturity Securities Transferred from AFS			Deferred Tax Valuation Allowance on Investment Securities			Cash flow hedge			Total
	(Dollars in thousands)
Balance, beginning of period	$	1,394		$	(295	)	$	(378	)	$	—		$	721

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities		—			—			94			—			94
Change in net unrealized holding gains and losses on securities available for sale		3,049			—			—			—			3,049
Reclassification adjustment for net securities gains realized in net income		(429	)		—			—			—			(429	)
Amortization of unrealized gains and losses on securities transferred to held to maturity		—			139			—			—			139
Change in unrealized holding loss on cash flow hedge		—			—			—			(43	)		(43	)
Income tax effect		(984	)		(55	)		—			15			(1,024	)

Balance, end of period	$	3,030		$	(211	)	$	(284	)	$	(28	)	$	2,507

	Three Months Ended June 30, 2015
	(Dollars in thousands)
Balance, beginning of period	$	910		$	(1,135	)	$	(139	)	$	—		$	(364	)

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

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

	Six Months Ended June 30, 2016
	Available for Sale Securities			Held to Maturity Securities Transferred from AFS			Deferred Tax Valuation Allowance on Investment Securities			Cash flow hedge			Total
	(Dollars in thousands)
Balance, beginning of period	$	(594	)	$	(563	)	$	(579	)	$	—		$	(1,736	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities		—			—			295			—			295
Change in net unrealized holding gains and losses on securities available for sale		6,504			—			—			—			6,504
Reclassification adjustment for net securities gains realized in net income		(698	)		—			—			—			(698	)
Amortization of unrealized gains and losses on securities transferred to held to maturity		—			570			—			—			570
Change in unrealized holding loss on cash flow hedge		—			—			—			(43	)		(43	)
Income tax effect		(2,182	)		(218	)		—			15			(2,385	)

Balance, end of period	$	3,030		$	(211	)	$	(284	)	$	(28	)	$	2,507

	Six Months Ended June 30, 2015
	(Dollars in thousands)
Balance, beginning of period	$	(236	)	$	(1,165	)	$	(868	)	$	—		$	(2,269	)

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

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

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2016		2015		2016		2015
	(Dollars in thousands)				(Dollars in thousands)

Gain on sale of investments, net	$	429	$	123	$	698	$	287
Tax effect		—		—		—		—
Impact, net of tax		429		123		698		287


Interest income - taxable securities		139		493		570		542
Tax effect		—		—		—		—
Impact, net of tax		139		493		570		542

Total reclassifications, net of tax	$	568	$	616	$	1,268	$	829

NOTE 13. COMMITMENTS AND CONTINGENCIES

To accommodate the financial needs of its customers, the Company makes commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family dwellings, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.

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

	June 30, 2016
	(Dollars in thousands)
Lines of credit	$	94,239
Standby letters of credit		826

	$	95,065

As of June 30, 2016, the Company had outstanding commitments to originate loans as follows:

	June 30, 2016
	Amount		Range of Rates
	(Dollar in thousands)

Fixed	$	24,280	2.75% to 7.99%
Variable		27,706	3.50% to 6.49%

	$	51,986

The allowance for unfunded commitments was $0.1 million at June 30, 2016 and December 31, 2015.

The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to Fannie Mae and maintained a reserve of $0.3 million as of June 30, 2016 and December 31, 2015.

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

NOTE 14. FAIR VALUE DISCLOSURES

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

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

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

●

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

●

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

●

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

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

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

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

Securities Available for Sale

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

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

Trading securities represent investments in exchange traded mutual funds which are valued by reference to quoted market prices and considered a Level 1 security.

Loan Servicing Rights

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

Derivative Instruments

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

Interest rate swaps are valued by a third party using significant assumptions that are observable in the market and can be corroborated by market data. The Company classifies interest rate swaps as Level 2.

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

Loans Held for Sale

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

Impaired Loans

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

Real Estate Owned

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

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

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

Cash and Cash Equivalents

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

Securities Held to Maturity

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

Loans

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

Bank Owned Life Insurance

Fair values approximate net cash surrender values.

Other Investments, at cost

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

Deposits

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

Advances from the FHLB

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

Junior Subordinated Notes

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

Other Borrowings

Accrued Interest Receivable and Payable

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

Loan Commitments

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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

	June 30, 2016
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Trading account assets - mutual funds	$	4,991	$	—	$	—	$	4,991
Securities available for sale:
U.S. government agencies		—		13,234		—		13,234
Municipal securities		—		97,641		—		97,641
Mortgage-backed securities		—		170,971		—		170,971
U.S. Treasury securities		1,557		—		—		1,557
Corporate debt securities		—		7,312		—		7,312
Mutual funds		619		—		—		619
		7,167		289,158		—		296,325

Loan servicing rights		—		—		2,392		2,392
Forward sales commitments		—		—		19		19
Interest rate lock commitments		—		—		99		99

Total assets	$	7,167	$	289,158	$	2,510	$	298,835

Derivative liabilities	$	—	$	43	$	—	$	43

	December 31, 2015
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Trading account assets	$	4,714	$	—	$	—	$	4,714
Securities available for sale:
U.S. government agencies		—		25,720		—		25,720
Municipal securities		—		39,858		—		39,858
Mortgage-backed securities		—		171,174		—		171,174
U.S. Treasury securities		1,510		—		—		1,510
Mutual funds		600		—		—		600
		6,824		236,752		—		243,576

Loan servicing rights		—		—		2,344		2,344
Forward sales commitments		—		—		16		16
Interest rate lock commitments		—		—		30		30

Total assets	$	6,824	$	236,752	$	2,390	$	245,966

There were no liabilities measured on a recurring basis at December 31, 2015.

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
	(Dollars in thousands)
Balance at beginning of period	$	2,478		$	2,368		$	2,390		$	2,248

Loan servicing right activity, included in servicing income, net Capitalization from loans sold		131			83			259			216
Fair value adjustment		(138	)		(157	)		(212	)		(245	)

Mortgage derivative gains (losses) included in Other income		39			(118	)		73			(43	)

Balance at end of period	$	2,510		$	2,176		$	2,510		$	2,176

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The table below presents information about certain assets and liabilities measured at fair value on a nonrecurring basis. There were no loans held for sale carried at fair value at either June 30, 2016 or December 31, 2015.

	June 30, 2016
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential	$	—	$	—	$	3,055	$	3,055
Commercial real estate		—		—		8,178		8,178
Home equity loans and lines of credit		—		—		679		679
Other construction and land		—		—		999		999

Real estate owned:
One-to four family residential		—		—		1,958		1,958
Commercial real estate		—		—		1,008		1,008
Other construction and land		—		—		2,447		2,447

Total assets	$	—	$	—	$	18,324	$	18,324

	December 31, 2015
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential	$	—	$	—	$	4,163	$	4,163
Commercial real estate		—		—		7,226		7,226
Home equity loans and lines of credit		—		—		213		213
Other construction and land		—		—		658		658

Real estate owned:
One-to four family residential		—		—		1,384		1,384
Commercial real estate		—		—		1,123		1,123
Other construction and land		—		—		2,862		2,862

Total assets	$	—	$	—	$	17,629	$	17,629

There were no liabilities measured at fair value on a nonrecurring basis as of June 30, 2016 or December 31, 2015.

Impaired loans totaling $4.6 million and $5.2 million at June 30, 2016 and December 31, 2015, respectively, were measured using the present value of expected future cash flows. These impaired loans were not deemed to be measured at fair value on a nonrecurring basis.

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at June 30, 2016.

	Valuation Technique	Unobservable Input	General Range

Impaired loans	Discounted Appraisals	Collateral discounts and estimated selling cost	0 – 30%
Real estate owned	Discounted Appraisals	Collateral discounts and estimated selling cost	0 – 30%
Loan servicing rights	Discounted Cash Flows	Prepayment speed	5 - 35%
		Discount rate	12% - 14%
Forward sales commitments and interest rate lock commitments	Change in market price of underlying loan	Value of underlying loan	101 - 108%

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

			Fair Value Measurements at June 30, 2016
	Carrying
(Dollars in thousands)	Amount		Total		Level 1		Level 2		Level 3
Assets:
Cash and equivalents	$	57,945	$	57,945	$	57,945	$	—	$	—
Trading securities		4,991		4,991		4,991		—		—
Securities available for sale		291,334		291,334		2,176		289,158		—
Securities held to maturity		30,907		31,970		1,002		30,968		—
Loans held for sale		7,300		8,011		—		8,011		—
Loans receivable, net		721,461		714,929		—		—		714,929
Other investments, at cost		10,798		10,798		—		10,798		—
Interest receivable		4,260		4,260		—		4,260		—
Bank owned life insurance		21,059		21,059		—		21,059		—
Loan servicing rights		2,392		2,392		—		—		2,392
Forward sales commitments		19		19		—		—		19
Interest rate lock commitments		99		99		—		—		99

Liabilities:
Demand deposits	$	518,465		518,465	$	—	$	518,465	$	—
Time deposits		310,409		311,243		—		—		311,243
Federal Home Loan Bank advances		193,500		193,946		—		193,946		—
Junior subordinated debentures		14,433		14,433		—		14,433		—
Other borrowings		2,675		2,853		—		—		2,853
Accrued interest payable		265		265		—		265		—
Interest rate swap		43		43		—		43		—

			Fair Value Measurements at December 31, 2015
	Carrying
(Dollars in thousands)	Amount		Total		Level 1		Level 2		Level 3
Assets:
Cash and equivalents	$	40,650	$	40,650	$	40,650	$	—	$	—
Trading securities		4,714		4,714		4,714		—		—
Securities available for sale		238,862		238,862		2,110		236,752		—
Securities held to maturity		41,164		41,812		995		40,817		—
Loans held for sale		8,348		8,952		—		8,952		—
Loans receivable, net		624,072		620,516		—		—		620,516
Other investments, at cost		8,834		8,834		—		8,834		—
Interest receivable		3,554		3,554		—		3,554		—
Bank owned life insurance		20,858		20,858		—		20,858		—
Loan servicing rights		2,344		2,344		—		—		2,344
Forward sales commitments		16		16		—		—		16
Interest rate lock commitments		30		30		—		—		30

Liabilities:
Demand deposits	$	440,475		440,475	$	—	$	440,475	$	—
Time deposits		276,142		275,403		—		—		275,403
Federal Home Loan Bank advances		153,500		153,441		—		153,441		—
Junior subordinated debentures		14,433		14,433		—		14,433		—
Accrued interest payable		213		213		—		213		—

NOTE 15. SHARE REPURCHASES

The following table summarizes share repurchase activity through June 30, 2016:

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2016 to January 31, 2016		—	$	—		—		—
February 1, 2016 to February 29, 2016		40,621	$	17.04		40,621		286,697
March 1, 2016 to March 31, 2016		33,382	$	17.70		33,382		253,315
April 1, 2016 to April 30, 2016		5,997	$	17.65		5,997		247,318
May 1, 2016 to May 31, 2016		—	$	—		—		247,318
June 1, 2016 to June 30, 2016		—	$	—		—		247,318
Total year-to-date 2016		80,000	$	17.42		80,000		247,318

NOTE 16. SUBSEQUENT EVENTS

On July 23, 2013, North Carolina Governor Pat McCrory signed a major tax reform bill into law that lowered the North Carolina corporate income tax rate among other things. Specifically, the corporate income tax rate was reduced from 6.9% to 6% in 2014 and to 5% in 2015. The rate was to be further reduced to 4% during the 2016 tax year and to 3% for post-2016 tax years provided that specified revenue growth targets are reached. Based on state income tax revenues announced by the North Carolina Governor’s Office on August 2, 2016, the revenue target for the fiscal year ended June 30, 2016 was met, resulting in a reduction of the state income tax rate to 3% effective January 1, 2017. The Company treated this announcement as a subsequent event and recorded a $0.3 million reduction in the net deferred tax asset as of June 30, 2016. As such, these financial results differ from the earnings reported on Form 8-K dated July 21, 2016.

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

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

	●		statements of our goals, intentions and expectations;
	●		statements regarding our business plans, prospects, growth and operating strategies;
	●		statements regarding the asset quality of our loan and investment portfolios; and
	●		estimates of our risks and future costs and benefits.

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

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

	●		the occurrence of an ownership change under applicable tax rules that could limit our ability to utilize losses to offset future taxable income;
	●		general economic conditions, either nationally or in our market areas, that are worse than expected;
	●		credit quality deterioration as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;
	●		the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
	●		weaknesses in the real estate market affect the value of real estate serving as collateral for loans in our portfolio
	●		competition among depository and other financial institutions;
	●		inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
	●		adverse changes in the securities markets;
	●		changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
	●		increased cybersecurity risk, including potential business disruptions or financial losses;
	●		our ability to enter new markets successfully and capitalize on growth opportunities;
	●		our ability to successfully integrate acquired entities;
	●		changes in consumer spending, borrowing and savings habits;
	●		changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board (“FASB”), the Securities and Exchange Commission (“SEC”) and the Public Company Accounting Oversight Board (“PCAOB”);
	●		changes in our key personnel, and our compensation and benefit plans;
	●		changes in our financial condition or results of operations that reduce capital available to pay dividends or buy back shares;
	●		changes in the financial condition or future prospects of issuers of securities that we own; and
	●		other risks and uncertainties detailed in this Quarterly Report on Form 10-Q and, from time to time, in our other filings with the SEC.

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

Critical Accounting Policies and Estimates

Our critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of June 30, 2016 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K. Due to recent acquisition activity, we have added the following acquisition accounting policy:

We determined that fair value of our acquired assets and liabilities in accordance with accounting requirements for fair value measurement and acquisition transactions as promulgated in FASB Accounting Standards Codification (“ASC”) Subtopic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30), ASC Topic 805, Business Combinations(ASC 805), and ASC Topic 820, Fair Value Measurements and Disclosures. The determination of the initial fair values on loans and other real estate purchased in an acquisition require significant judgment and complexity. All identifiable assets acquired, including loans, are recorded at fair value. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in ASC Topic No. 820. These fair value estimates associated with the purchased loans include estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.

Where a loan exhibits evidence of credit deterioration since origination and it is probable at the acquisition date that we will not collect all principal and interest payments in accordance with the terms of the loan agreement, we account for the loan under ASC 310-30, as a purchased credit impaired loan. Purchased-credit impaired loans were not material related to the Old Town Bank acquisition.

The Jumpstart Our Business Startups Act (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of June 30, 2016 and December 31, 2015, there was not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance.

Overview

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

We provide a full range of financial services through offices located in Cherokee, Henderson, Jackson, Macon, Polk, Haywood and Transylvania counties in North Carolina and Anderson, Greenville, and Spartanburg counties in South Carolina. We provide full service retail and commercial banking products as well as wealth management services through a third party.

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

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

Recent Events

On April 1, 2016, the Company completed its acquisition of Old Town Bank (“Old Town”) of Waynesville, North Carolina, which was merged with and into Entegra Bank. The Company will continue to operate Old Town’s office under the Old Town name until a system conversion is completed in August 2016.

Shareholders of Old Town received a cash payment equal to $11.05 in exchange for each share of Old Town common stock held immediately prior to the effective time of the merger. The aggregate merger consideration paid by the Company was approximately $13.5 million, which included a $0.7 million payment for the cash-out of in-the-money stock options. The Company did not issue any shares of its common stock in connection with the merger.

The acquisition added approximately $110.2 million to the Company’s assets, including $65.0 million of loans, $88.7 million of deposits, and $1.7 million of goodwill and intangibles.

Strategic Plan

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

●

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

●

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

●

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

●

Maximizing our capital leverage through organic and acquired asset growth; and

●

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

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

Earnings Summary

Net income for the three months ended June 30, 2016 was $0.9 million compared to $17.1 million for the same period in 2015. The decrease in net income was the result of increases in compensation and benefits of $0.4 million and merger expenses of $1.8 million related to the Old Town acquisition. This decrease was partially offset by a $2.1 million increase in net interest income and an increase of $1.0 million in noninterest income during the 2016 period, as compared to the same period in 2015. In addition, the decrease in net income for the quarter was primarily the result of a non-cash income tax benefit resulting from the $17.6 million reversal of substantially all of the valuation allowance on the Company’s net deferred tax offset by a FHLB advance prepayment penalty of $1.8 million in the same period in 2015.

Net income for the six months ended June 30, 2016 was $2.2 million compared to $19.7 million for the same period in 2015. The increase in net income for the six month period was primarily a result of the non-cash income tax benefit mentioned above and a negative provision for loan losses of $1.5 million in the same period in 2015. These items were partially offset by an increase in net interest income of $3.4 million and an increase in noninterest income of $1.3 million partially offset by an increase in noninterest expense of $1.8 million during the six months ending June 30, 2016 as compared to the same period in 2015.

Net interest income increased $2.1 million, or 31.7%, to $8.7 million for the three months ended June 30, 2016 compared to $6.6 million for the same period in 2015. Net interest income increased $3.4 million, or 26.2%, to $16.4 million for the six months ended June 30, 2016 compared to $13.0 million for the same period in 2015. The increase in net interest income was primarily due to higher volumes in the loan and investment portfolios as well as a decrease in the rate paid on advances and deposits. Net interest margin for the three and six months ended June 30, 2016 improved to 3.33% and 3.28%, respectively, compared to 3.06% and 3.05% for the same periods in 2015.

We recorded no provision for loan losses for the three and six month periods ended June 30, 2016 compared to a provision for loan losses of $0 and $(1.5 million) in the comparable 2015 periods. The Company continues to experience a minimal level of net charge-offs and low levels of non-performing assets.

Non-GAAP Financial Measures

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

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
	(Dollars in thousands)						(Dollars in thousands)

Core Noninterest Expense
Noninterest expense (GAAP)	$	9,313		$	8,181		$	16,592		$	14,757
FHLB prepayment penalty		—			(1,762	)		—			(1,762	)
Merger-related expenses		(1,771	)		—			(1,916	)		—
Core noninterest expense (Non-GAAP)	$	7,542		$	6,419		$	14,676		$	12,995

Core Net Income
Net income (GAAP)	$	858		$	17,105		$	2,224		$	19,720
FHLB prepayment penalty		—			1,762			—			1,762
Negative provision for loan losses		—			—			—			(1,500	)
Merger-related expenses		1,151			—			1,245			—
Adjust actual income tax benefit to 35% estimated effective tax rate (1)		—			(18,017	)		—			(18,290	)
Core net income (Non-GAAP)	$	2,009		$	850		$	3,469		$	1,692

Core Diluted Earnings Per Share
Diluted earnings per share (GAAP)	$	0.13		$	2.61		$	0.34		$	3.01
FHLB prepayment penalty		—			0.27			—			0.27
Negative provision for loan losses		—			—			—			(0.23	)
Merger-related expenses		0.18			—			0.19			—
Adjust actual income tax benefit to 35% estimated effective tax rate (1)		—			(2.75	)		—			(2.79	)
Core diluted earnings per share (Non-GAAP)	$	0.31		$	0.13		$	0.53		$	0.26

Core Return on Average Assets
Return on Average Assets (GAAP)		0.29	%		7.39	%		0.40	%		4.35	%
FHLB prepayment penalty		—			0.76	%		—			0.39	%
Negative provision for loan losses		—			—			—			-0.33	%
Merger-related expenses		0.39	%		—			0.23	%		—
Adjust actual income tax benefit to 35% estimated effective tax rate (1)		—			-7.78	%		—			-4.04	%
Core Return on Average Assets (Non-GAAP)		0.69	%		0.37	%		0.63	%		0.37	%

Core Return on Average Equity
Return on Average Equity (GAAP)		2.56	%		61.45	%		3.32	%		35.97	%
FHLB prepayment penalty		—			6.33	%		—			3.21	%
Negative provision for loan losses		—			—			—			-2.74	%
Merger-related expenses		3.43	%		—			1.86	%		—
Adjust actual income tax benefit to 35% estimated effective tax rate (1)		—			-64.73	%		—			-33.35	%
Core Return on Average Equity (Non-GAAP)		5.98	%		3.05	%		5.19	%		3.09	%

Core Efficiency Ratio
Efficiency ratio		85.86	%		105.88	%		81.55	%		94.61	%
Merger-related expenses		-16.33	%		—			-9.42	%		—
Effect to adjust for FHLB prepayment penalty		—			-22.81	%		—			-11.30	%
Core Efficiency Ratio (Non-GAAP)		69.53	%		83.07	%		72.13	%		83.31	%

	As Of
	June 30, 2016			December 31, 2015
	(Dollars in thousands, except share data)
Tangible Book Value Per Share
Book Value (GAAP)		136,974			131,469
Goodwill and intangibles		(2,931	)		(1,301	)
Book Value (Tangible)		134,043			130,168
Outstanding shares		6,466,375			6,546,375
Tangible Book Value Per Share		20.73			19.88

(1) - The Company maintained a valuation allowance on a portion of its net deferred tax asset during a portion of 2015 and therefore did not recognize a normal income tax provision. Core results have been adjusted to reflect income tax expense to an estimated 35% effective tax rate after the other adjustments have been applied.

Financial Condition At June 30, 2016 and December 31, 2015

Total assets increased $161.2 million, or 15.6%, to $1.19 billion at June 30, 2016 from $1.03 billion at December 31, 2015, primarily as a result of the addition of $110.2 million in assets related to the Old Town acquisition in the second quarter of 2016, and increases in loan activity and investment purchases.

Loans increased $97.4 million, or 15.6%, to $721.5 million at June 30, 2016, which included $65.0 million of loans related to the Old Town acquisition. Loan balances excluding those acquired in the Old Town acquisition have grown at an annualized pace of 10.4% since December 31, 2015 and have been primarily concentrated in commercial real estate and consumer and industrial loans.

The Company also increased its investment portfolio by $42.2 million from December 31, 2015 to June 30, 2016 in order to better leverage its capital. FHLB advances, which increased $40.0 million, or 26.1%, from December 31, 2015 to June 30, 2016, were utilized to fund the investment purchases.

Core deposits increased $75.0 million, or 17.0%, to $515.5 million at June 30, 2016 from $440.5 million at December 31, 2015, including $40.6 million of core deposits related to the Old Town acquisition. Retail and wholesale certificates of deposit and brokered money market deposits increased $37.3 million, or 13.5%, to $313.4 million at June 30, 2016 from $276.1 million at December 31, 2015, primarily due to the acquisition of $48.1 million of time deposits in the Old Town acquisition. Core deposits now represent 62% of the Company’s deposit portfolio compared to 61% at December 31, 2015 and 55% at December 31, 2014.

Total equity increased $5.5 million, or 4.2%, to $137.0 million at June 30, 2016 compared to $131.5 million at December 31, 2015. This increase was primarily attributable to $2.2 million of net income and a $4.2 million improvement in the market value of investment securities, partially offset by $1.4 million of share repurchases. The Company intends to selectively utilize share repurchases to supplement shareholder returns, but not at the expense of building long term value. Notwithstanding the $0.55 per share dilution arising from the Old Town acquisition, tangible book value per share increased $0.85, or 4.20%, to $20.73 at June 30, 2016 from $19.88 at December 31, 2105.

Cash and Cash Equivalents

Total cash and cash equivalents increased $17.3 million, or 42.5%, to $57.9 million at June 30, 2016 from $40.7 million at December 31, 2015.

Investment Securities

During the fourth quarter of 2015, the Company funded a trading account which is held in a Rabbi trust to generate returns that seek to offset changes in liabilities of certain deferred compensation agreements.

The following table presents the holdings of our trading account as of June 30, 2016 and December 31, 2015:

	June 30, 2016		December 31, 2015
	(Dollars in thousands)

Cash	$	—	$	4,714
Mutual funds		4,991		—
	$	4,991	$	4,714

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

	At June 30,				At December 31,
	2016				2015
	Amortized Cost		Fair value		Amortized Cost		Fair value
	(Dollars in thousands)
Investment securities available-for-sale:
U.S. Government and agency securities:
U.S. Government and agency obligations	$	13,100	$	13,234	$	25,633	$	25,720
U.S. Treasury Notes & Bonds		1,499		1,557		1,500		1,510
Municipal obligations		94,766		97,641		39,751		39,858
Mortgage-backed securities:
U.S. Government agency		85,180		86,171		112,857		112,010
SBA securities		38,285		38,311		47,768		47,582
Collateralized mortgage obligations		45,841		46,489		11,702		11,582
Corporate debt securities		7,198		7,312		—		—
Mutual funds		609		619		602		600

Total securities available-for-sale	$	286,478	$	291,334	$	239,813	$	238,862

Available-for-sale investment securities increased $52.5 million, or 22.0%, to $291.3 million at June 30, 2016 from $238.9 million at December 31, 2015. We continue to grow our investment portfolio as we seek to better leverage our capital.

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

	At June 30,				At December 31,
	2016				2015
	Amortized Cost		Fair value		Amortized Cost		Fair value
	(Dollars in thousands)
Investment securities held-to-maturity:
U.S. Government and agency securities:
U.S. Government and agency obligations	$	1,002	$	1,008	$	5,729	$	5,706
U.S. Government structured agency obligations		2,723		3,006		10,148		10,793
U.S. Treasury Notes & Bonds		—		—		1,002		995
Municipal tax exempt		7,890		8,307		7,641		7,825
Municipal taxable		4,735		4,836		4,787		4,709
Collateralized mortgage obligations		4,531		4,602		4,834		4,776
Corporate debt securities		10,026		10,211		7,023		7,008

Total securities held-to-maturity	$	30,907	$	31,970	$	41,164	$	41,812

Held-to-maturity investment securities decreased $10.3 million, or 24.9%, to $30.9 million at June 30, 2016 from $41.2 million at December 31, 2015 as a result of several structured agency securities being called.

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

Loans

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

	At June 30,						At December 31,
	2016						2015
	Amount			Percent			Amount			Percent
	(Dollars in thousands)
Real estate loans:
One- to four-family residential	$	268,699			37.1	%	$	248,633			39.7	%
Commercial		276,371			38.1			214,413			34.2
Home equity loans and lines of credit		51,675			7.1			53,446			8.5
Residential construction		14,270			2.0			7,848			1.3
Other construction and land		52,576			7.3			57,316			9.1
Commercial		55,530			7.7			41,046			6.6
Consumer		5,098			0.7			3,639			0.6
Total loans, gross	$	724,219			100.0	%	$	626,341			100.0	%

Less:
Deferred loan fees, net		(1,152	)					(1,388	)
Unamortized premium		467						557
Unamortized discount		(2,073	)					(1,438	)

Total loans, net	$	721,461					$	624,072

Percentage of total assets		60.5	%					60.5	%

Net loans increased $97.4 million, or 15.6%, to $721.5 million at June 30, 2016 from $624.1 million at December 31, 2015 primarily as the result of the Old Town acquisition. In addition, we have continued to experience moderate loan demand and maintain a strong pipeline going into the third quarter. We believe that economic conditions in our primary market areas are strong and present opportunities for continued growth. The amount of commercial real estate and commercial loans as a percentage of total loans continues to increase as we continue to shift our lending focus to these loan types as we develop stronger commercial relationships in all of our markets.

Delinquent Loans

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

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

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

The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. We have no loans past due 90 days and over that are still accruing interest as of June 30, 2016 or December 31, 2015.

	Delinquent loans
	30-59 Days			60-89 Days			90 Days and over			Total
	(Dollars in thousands)
At June 30, 2016
Real estate loans:
One- to four-family residential	$	3,914		$	2,787		$	1,866		$	8,567
Commercial		2,811			478			3,079			6,368
Home equity loans and lines of credit		201			195			530			926
Residential construction		224			218			—			442
Other construction and land		1,600			19			1,387			3,006
Commercial		132			82			239			453
Consumer		16			1			1			18
Total loans	$	8,898		$	3,780		$	7,102		$	19,780
% of total loans, net		1.25	%		0.53	%		1.00	%		2.77	%

At December 31, 2015
Real estate loans:
One- to four-family residential	$	5,610		$	1,260		$	1,205		$	8,075
Commercial		1,585			—			605			2,190
Home equity loans and lines of credit		369			38			322			729
One- to four-family residential construction		—			—			—			—
Other construction and land		208			397			138			743
Commercial		625			—			—			625
Consumer		12			4			—			16
Total loans	$	8,409		$	1,699		$	2,270		$	12,378
% of total loans, net		1.37	%		0.27	%		0.37	%		2.01	%

Delinquent loans increased $7.4 million, or 59.7%, to $19.8 million at June 30, 2016 from $12.4 million at December 31, 2015. This increase was due in part to the assumption of $2.3 million of delinquent loans in the Old Town acquisition. Despite the current year increase, our level of delinquent loans remains low. In July 2016, delinquent loans were reduced by $2.6 million as the result of early payoffs.

Non-Performing Assets

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

	June 30,			December 31,
	2016			2015
	(Dollars in thousands)
Non-accrual loans:
Real estate loans:
One- to four-family residential	$	2,246		$	2,893
Commercial		5,179			3,628
Home equity loans and lines of credit		528			320
Residential construction		—			—
Other construction and land		1,434			384
Commercial		48			55
Consumer		1			—

Total non-performing loans		9,436			7,280

REO:
One- to four-family residential		1,958			1,384
Commercial real estate		1,008			1,123
Residential construction		—			—
Other construction and land		2,447			2,862

Total foreclosed real estate		5,413			5,369

Total non-performing assets	$	14,849		$	12,649


Troubled debt restructurings still accruing	$	9,603		$	11,206


Ratios:
Non-performing loans to total loans		1.31	%		1.17	%
Non-performing assets to total assets		1.24	%		1.23	%

Non-performing loans increased $2.2 million, or 29.7%, to $9.4 million at June 30, 2016 from $7.3 million at December 31, 2015. The increase in non-performing loans was primarily attributable due to the addition of a single $1.7 million hospitality loan, for which no loss is expected.

REO remained unchanged at $5.4 million at June 30, 2016 compared to December 31, 2015.

Classification of Loans

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

	At June 30,			At December 31,
	2016			2015
	(Dollars in thousands)

Classified loans:
Substandard	$	22,013		$	17,478
Doubtful		—			—
Loss		—			—

Total classified loans:		22,013			17,478
As a % of total loans, net		3.05	%		2.80	%

Special mention		19,918			19,195

Total criticized loans	$	41,931		$	36,673
As a % of total loans, net		5.81	%		5.88	%

Total classified loans increased $4.5 million, or 25.9%, to $22.0 million at June 30, 2016 from $17.5 million at December 31, 2015. Total criticized loans increased $5.3 million, or 14.3%, to $41.9 million at June 30, 2016 from $36.7 million at December 31, 2015. These increases were primarily attributable to the Old Town Bank acquisition, which increase total classified loans by $2.0 million and total criticized loans by $2.8 million. Management continues to dedicate significant resources to monitoring and resolving classified and criticized loans.

Allowance for Loan Losses

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

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

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. Prior to the first quarter of 2015, we more heavily weighted the most recent four quarters than the least recent four quarters. Beginning in the first quarter of 2015, we no longer weight any quarters to calculate our average loss rates. This change in weighting did not have a material impact on our allowance for loan losses methodology. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.25% to 11%.

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

●

Non-accrual and classified loans

●

Collateral values

●

Loan concentrations

●

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

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

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

	As of or for the Three Months Ended June 30,						As of or for the Six Months Ended June 30,
	2016			2015			2016			2015
	( Dollars in thousands)						( Dollars in thousands)
Balance at beginning of period	$	9,498		$	9,611		$	9,461		$	11,072

Charge-offs:
Real Estate:
One- to four-family residential		52			19			98			238
Commercial		431			15			431			45
Home equity loans and lines of credit		93			260			130			369
Residential construction		—			—			—			—
Other construction and land		120			67			437			86
Commercial		10			1			10			1
Consumer		16			7			26			20
Total charge-offs		722			369			1,132			759

Recoveries:
Real Estate:
One- to four-family residential		6			13			29			122
Commercial		2			75			2			167
Home equity loans and lines of credit		21			2			134			25
Residential construction		32			2			32			2
Other construction and land		7			47			84			166
Commercial		4			3			122			10
Consumer		92			67			208			146
Total recoveries		164			209			611			638

Net charge-offs		558			160			521			121

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

Balance at end of period	$	8,940		$	9,451		$	8,940		$	9,451

Ratios:
Net charge-offs to average loans outstanding		0.16	%		0.06	%		0.15	%		0.04	%
Allowance to non-performing loans at period end		94.65	%		76.53	%		94.65	%		76.53	%
Allowance to total loans at period end		1.24	%		1.62	%		1.24	%		1.62	%

We have continued to experience limited charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of non-performing loans remained strong at 94.65% at June 30, 2016 compared to 76.53% at June 30, 2015 and 129.96% at December 31, 2015.

Real Estate Owned (REO)

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

	June 30,		December 31,
	2016		2015
	(Dollars in thousands)

One- to four-family residential	$	1,958	$	1,384
Commercial real estate		1,008		1,123
Residential construction		—		—
Other construction and land		2,447		2,862
Total	$	5,413	$	5,369

	Three Months Ended June 30,						Six Months Ended June 30,
	2016			2015			2016			2015
	(Dollars in thousands)						(Dollars in thousands)
Balance, beginning of period	$	5,430		$	4,917		$	5,369		$	4,425
Additions		1,088			372			1,596			1,689
Disposals		(939	)		(564	)		(1,044	)		(1,321	)
Writedowns		(166	)		(23	)		(508	)		(91	)
Other		—			8			—			8
Balance, end of period	$	5,413		$	4,710		$	5,413		$	4,710

REO remained unchanged at $5.4 million at June 30, 2016 compared to December 31, 2015. Most of the transfers to real estate owned during the three and six months ended June 30, 2016 were 1-4 family residential properties which are normally sold at a faster pace than other property types. We have experienced a significant decrease in the number and dollar amount of additions to REO, and have had moderate success in liquidating REO. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.

Net Deferred Tax Assets

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

●

Future reversals of existing taxable temporary differences;

●

Future taxable income exclusive of reversing temporary differences and carry forwards;

●

Taxable income in prior carryback years; and

●

Tax planning strategies that would, if necessary, be implemented.

Net deferred tax assets decreased $2.8 million, or 14.9%, to $16.0 million at June 30, 2016 compared to $18.8 million at December 31, 2015. The decrease in net deferred tax assets is mainly attributable to reductions in our federal and state net operating losses and improvement in the net unrealized holding gains/losses on our investment securities.

Deposits

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

	As of					As of
	June 30, 2016					December 31, 2015
	Balance		Percent			Balance		Percent
	(Dollars in thousands)
Deposit type:
Savings accounts	$	38,057		4.6	%	$	35,838		5.0	%
Time deposits		310,409		37.4			276,142		38.5
Money market accounts		236,750		28.6			180,377		25.2
Interest-bearing demand accounts		116,648		14.1			103,198		14.4
Noninterest-bearing demand accounts		127,010		15.3			121,062		16.9

Total deposits	$	828,874		100.0	%	$	716,617		100.0	%

Total deposits increased $112.3 million, or 15.7%, to $828.9 million at June 30, 2016 from $716.6 million at December 31, 2015 primarily as a result of the Old Town acquisition. We continue our efforts to reduce our reliance on time deposits and expand our core deposit relationships which is evidenced by the decrease in time deposits as a percentage of total deposits to 37.4% at June 30, 2016 from 38.5% at December 31, 2015.

FHLB Advances

FHLB advances increased $40.0 million, or 26.1%, to $193.5 million at June 30, 2016 compared to $153.5 million at December 31, 2015. The additional funds were primarily used to invest in investment securities and to provide funding for future cash needs. The advances had a weighted average rate of 0.75% as of June 30, 2016 compared to 0.65% at December 31, 2015.

Junior Subordinated Notes

We had $14.4 million in junior subordinated notes outstanding at June 30, 2016 and December 31, 2015 payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. To add stability to net interest revenue and manage our exposure to interest rate movement, we entered into an interest rate swap in June 2016. The swap contract involves the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the four year life of the contract. The effective interest rate was 3.76% and 3.34% at June 30, 2016 and December 31, 2015, respectively.

Equity

Total equity increased $5.5 million, or 4.2%, to $137.0 million at June 30, 2016 from $131.5 million at December 31, 2015. This increase was the result of $2.2 million of net income for the period, and a $4.2 million improvement in net unrealized holding gains and losses on securities available for sale, which were partially offset by $1.4 million in repurchases of common stock.

Comparison of Operating Results for the Three Months Ended June 30, 2016 and June 30, 2015.

General. Net income for the three months ended June 30, 2016 was $0.9 million compared to $17.1 million for the same period in 2015. The decrease in net income for the quarter was primarily the result of a non-cash income tax benefit resulting from the $17.6 million reversal of substantially all of the valuation allowance on the Company’s net deferred tax asset, partially offset by a FHLB advance prepayment penalty of $1.8 million in same period in 2015. The decrease in net income was also impacted by increases in compensation and benefits of $0.4 million and merger expenses of $1.8 million related to the Old Town acquisition. The decrease was partially offset by a $2.1 million increase in net interest income and an increase of $1.0 million in noninterest income during the 2016 period as compared to the same period in 2015.

Net Interest Income. Net interest income increased $2.1 million, or 31.8%, to $8.7 million for the three months ended June 30, 2016 compared to the same period in 2015. The increase in net interest income for the period was primarily the result of increases in interest and fee income on loans of $1.7 million.

The tax-equivalent net interest margin increased to 3.33% for the quarter ended June 30, 2016 compared to 3.06% for the same period in 2015. The increase was primarily the result of increased yields on taxable investments and decreased rates on deposits and FHLB advances.

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

	For the three Months Ended June 30,
	2016								2015
	Average Outstanding Balance			Interest		Yield/ Rate			Average Outstanding Balance			Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale	$	703,576		$	8,255		4.71	%	$	567,114		$	6,647		4.70	%
Loans, tax exempt (1)		15,753			151		3.84	%		4,616			48		4.35	%
Investments - taxable		263,968			1,422		2.16	%		255,571			1,278		2.01	%
Investment tax exempt (1)		48,722			471		3.88	%		9,054			127		6.01	%
Interest earning deposits		38,086			54		0.57	%		35,102			22		0.25	%
Other investments, at cost		9,566			122		5.12	%		5,942			49		3.31	%

Total interest-earning assets		1,079,671			10,475		3.89	%		877,399			8,172		3.74	%

Noninterest-earning assets		87,193								50,521

Total assets	$	1,166,864							$	927,920

Interest-bearing liabilities:
Savings accounts	$	37,757		$	16		0.17	%	$	29,008		$	8		0.11	%
Time deposits		313,204			769		0.98	%		309,430			961		1.25	%
Money market accounts		237,424			180		0.30	%		175,000			140		0.32	%
Interest bearing transaction accounts		114,069			67		0.24	%		96,118			40		0.17	%
Total interest bearing deposits		702,454			1,032		0.59	%		609,556			1,149		0.76	%

FHLB advances		173,885			319		0.74	%		85,462			183		0.86	%
Junior subordinated debentures		14,433			128		3.56	%		14,433			115		3.20	%
Other borrowings		2,569			30		4.68	%		2,159			26		4.83	%

Total interest-bearing liabilities		893,341			1,509		0.68	%		711,610			1,473		0.83	%

Noninterest-bearing deposits		121,001								91,090

Other non interest bearing liabilities		18,725								13,570

Total liabilities		1,033,067								816,270
Total equity		133,797								111,650

Total liabilities and equity	$	1,166,864							$	927,920


Tax-equivalent net interest income				$	8,966							$	6,699


Net interest-earning assets ⁽²⁾	$	186,330							$	165,789

Average interest-earning assets to interest-bearing liabilities		1.21	%							1.23	%

Tax-equivalent net interest rate spread ⁽³⁾							3.21	%							2.91	%
Tax-equivalent net interest margin ⁽⁴⁾							3.33	%							3.06	%

(1)

Tax exempt loans and investments are calculated giving effect to a 35% federal tax rate.

(2)

Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(3)

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

(4)

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

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

	For the Three Months Ended June 30, 2016 Compared to the Three Months Ended June 30, 2015
	Increase (decrease) due to:
	Volume		Rate			Total
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale (1)	$	1,601	$	7		$	1,608
Loans, tax exempt (2)		108		(6	)		102
Investment - taxable		43		101			144
Investments - tax exempt (2)		408		(64	)		344
Interest-earning deposits		2		30			32
Other investments, at cost		38		35			73

Total interest-earning assets		2,200		103			2,303

Interest-bearing liabilities:
Savings accounts	$	3	$	5		$	8
Time deposits		12		(204	)		(192	)
Money market accounts		48		(8	)		40
Interest bearing transaction accounts		8		19			27
FHLB advances		166		(30	)		136
Junior subordinated debentures		—		13			13
Other borrowings		5		(1	)		4

Total interest-bearing liabilities		242		(206	)		36

Change in tax-equivalent net interest income	$	1,958	$	309		$	2,267

(1)

Non-accrual loans are included in the above analysis.

(2)

Interest income on tax exempt loans and investments are adjusted for based on a 35% federal tax rate

Net interest income before provision for loan losses increased to $8.7 million for the three months ended June 30, 2016, compared to $6.6 million for the same period in 2015. As indicated in the table above $2.0 million of the increase is attributable to increased volume and the remaining $0.3 million improvement in net interest earned is attributable to an improvement in rates.

The increase in tax-equivalent net interest income of $2.0 million related to volume was primarily the result of higher average taxable loan balances, taxable investment balances, and tax exempt investment securities which increased $136.5 million, $8.4 million, and $39.7 million respectively, for the three months ended June 30, 2016 as compared to the same period in 2015 primarily as a result of the Old Town acquisition April 1, 2016. The increase in average loan and investment balances was partially offset by higher average deposits and FHLB advance balances which increased $92.9 million and $88.4 million, respectively, over the same periods. While the average deposit growth was primarily attributable to the Old Town acquisition, the increase in average FHLB advances was a result of a leverage strategy to fund investment purchases.

The increase in tax-equivalent net interest income of $0.3 million related to rate was primarily the result of increased yields on taxable investments, and decreased deposit and FHLB advance rates partially offset by decreased tax exempt investment yields. The decrease in average tax exempt investment yields was offset by the impact of lower average interest bearing deposit yields which decreased 17 basis points to 0.59% in the quarter ended June 30, 2016 as compared to 0.76% in the three months ending June 30, 2015. In addition, a reduction in average rates on FHLB advances from 0.86% during the three months ended June 30, 2015 to 0.74% for the three months ended June 30, 2016 also contributed to the increase in this component of net interest income.

Our tax-equivalent net interest rate spread increased by 30 basis points to 3.21% for the three months ended June 30, 2016 compared to 2.91% for the three months ended June 30, 2015, and our tax-equivalent net interest margin increased 27 basis points to 3.33% for the three months ended June 30, 2016, compared to 3.06% for the three months ended June 30, 2015. The increases in our interest rate spread and margin were primarily a result of decreased rates on deposits and FHLB advances.

Provision for Loan Losses. We did not record a provision for loan losses for the three months ended June 30, 2016 and 2015. Factors contributing to no recorded provision for loan losses were the continued stabilization in asset quality, low charge off amounts, and a continued decline in the overall loss rates used in our allowance for loan losses model.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the three month periods ended June 30, 2016 and 2015:

	Three Months Ended June 30,
	2016		2015			Change
	(Dollars in thousands)
Servicing income, net	$	75	$	19		$	56
Mortgage banking		220		85			135
Gain on sale of SBA loans		284		3			281
Gain on sale of investments, net		429		123			306
Other than temporary impairment on cost method investment		—		(3	)		3
Service charges on deposit accounts		387		317			70
Interchange fees		382		322			60
Bank owned life insurance		94		133			(39	)
Other		228		89			139

Total	$	2,099	$	1,088		$	1,011

The $0.1 million increase in mortgage banking income is primarily due to increased volume.

Gains on sales of SBA loans increased $0.3 million as a result of a larger balance of SBA loans being sold during the 2016 period as we continue to increase our SBA lending efforts.

Net gains on sales of investments increased $0.3 million for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 due a significant decrease in interest rates which provided favorable market conditions.

Service charges on deposit accounts and interchange fees both increased $0.1 million as a result of increased core deposit accounts and the acquisition of approximately $88.7 million in deposits from Old Town that occurred on April 1, 2016.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the three months ended June 30, 2016 and 2015:

	2016		2015		Change
	(Dollars in thousands)

Compensation and employee benefits	$	4,257	$	3,817	$	440
Net occupancy		835		731		104
Federal Home Loan Bank prepayment penalty		—		1,762		(1,762	)
Marketing and advertising		302		85		217
Federal deposit insurance		184		279		(95	)
Professional and advisory		293		261		32
Data processing		400		282		118
Merger-related expenses		1,771		—		1,771
Net cost of operation of real estate owned		210		116		94
Other		1,061		848		213

Total noninterest expenses	$	9,313	$	8,181	$	1,132

Compensation and employee benefits increased by $0.4 million, or 11.5%, for the three months ended June 30, 2016 compared to the three months ended June 30, 2015. This additional expense is related to increases in our number of employees primarily as a result of the addition of three new branches, the Old Town Bank acquisition, annual raises, employee benefits, incentives and commissions.

Marketing and advertising expenses increased $0.2 million for the three months ended June 30, 2016 compared to the same period in 2015 due primarily to increased advertising related to the Old Town acquisition.

Merger-related expenses were $1.8 million for the three months ended June 30, 2016 compared to none during the 2015 period. The expenses during the period related to both the acquisition of two branches in December 2015 and the whole bank acquisition of Old Town which closed on April 1, 2016.

The net cost of operation of real estate owned increased $0.1 million, or 81.0%, for the three months ended June 30, 2016 compared to the three months ended June 30, 2015. The increase primarily relates to the additional holding costs related to the Old Town acquired real estate owned.

Other noninterest expense increased $0.3 million, or 25.1%, for the three months ended June 30, 2016 compared to the same period in 2015 primarily as the result of increases in directors stock-based benefits of $0.1 million as part of the 2015 Long-term Stock Incentive Plan and telecommunication expense of $0.2 million.

Income Taxes. We recorded $0.7 million of income tax expense for the three months ended June 30, 2016, compared to $17.6 million income tax benefit in the same period of 2015 discussed above. We remain focused on reducing our effective tax rate through further investments in tax-free municipal securities, BOLI and affordable housing tax credits.

We continue to be in a net operating loss position for federal and state income tax purposes and do not have a material current tax liability or receivable.

Comparison of Operating Results for the Six Months Ended June 30, 2016 and June 30, 2015.

General. Net income decreased $17.5 million to $2.2 million for the six months ended June 30, 2016, compared to net income of $19.7 million for the six months ended June 30, 2015. The decrease in net income for the six months ended June 30, 2016, was primarily the result of a non-cash income tax benefit resulting from the $17.4 million reversal of substantially all of the valuation allowance on the Company’s net deferred tax asset, partially offset by a FHLB advance prepayment penalty of $1.8 million in same period in 2015. Increases in compensation of $0.8 million and merger-related expenses of $1.9 million also contributed to the decline in net income in 2016. These increases were primarily related to the Old Town acquisition, but were more than offset by increases in net interest income of $3.4 million, service charges on deposits and interchange fees of $0.2 million, and $0.1 million, respectively, also mainly attributable to the Old Town transaction.

Net Interest Income. Net interest income before provision for loan losses increased to $16.4 million for the six months ended June 30, 2016, compared to $13.0 million for the same period in 2015. The increase in net interest income was primarily the result of an increase of $2.4 million of interest and fees on loans combined with declines in interest expense on deposits of $0.4 million during the six months ended June 30, 2016 as compared to the same period in 2015.

The tax-equivalent net interest margin increased to 3.28% for the six months ended June 30, 2016 compared to 3.05% for the same period in 2015. This increase was primarily the result of increased yields on taxable loans and investments combined with declines in time deposit and FHLB advance rates for the six months ended June 30, 2016, compared to the six months ended June 30, 2015.

	For the Six Months Ended June 30,
	2016								2015
	Average Outstanding Balance			Interest		Yield/ Rate			Average Outstanding Balance			Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale	$	668,318		$	15,461		4.64	%	$	558,488		$	13,117		4.74	%
Loans, tax exempt (1)		11,147			220		3.96	%		4,073			88		4.35	%
Investments - taxable		263,925			2,880		2.19	%		250,422			2,514		2.02	%
Investment tax exempt (1)		31,586			691		4.39	%		7,829			233		6.01	%
Interest earning deposits		35,977			90		0.50	%		38,633			46		0.24	%
Other investments, at cost		9,058			227		5.03	%		5,424			107		3.98	%

Total interest-earning assets		1,020,011			19,569		3.85	%		864,869			16,105		3.76	%

Noninterest-earning assets		85,553								49,462

Total assets	$	1,105,564							$	914,331

Interest-bearing liabilities:
Savings accounts	$	36,688		$	26		0.14	%	$	28,480		$	16		0.11	%
Time deposits		292,979			1,523		1.04	%		313,992			1,972		1.27	%
Money market accounts		213,379			331		0.31	%		176,469			294		0.34	%
Interest bearing transaction accounts		108,387			94		0.17	%		93,365			76		0.16	%
Total interest bearing deposits		651,433			1,974		0.61	%		612,306			2,358		0.78	%

FHLB advances		165,066			594		0.72	%		72,811			388		1.07	%
Junior subordinated debentures		14,433			254		3.53	%		14,433			227		3.17	%
Other borrowings		2,394			56		4.69	%		1,980			52		5.30	%

Total interest-bearing liabilities		833,326			2,878		0.69	%		701,530			3,025		0.87	%

Noninterest-bearing deposits		121,001								88,561

Other non interest bearing liabilities		17,440								13,681

Total liabilities		971,767								803,772
Total equity		133,797								110,559

Total liabilities and equity	$	1,105,564							$	914,331

Tax-equivalent net interest income				$	16,691							$	13,080

Net interest-earning assets ⁽²⁾	$	186,685							$	163,339

Average interest-earning assets to interest-bearing liabilities		1.22	%							1.23	%

Tax-equivalent net interest rate spread ⁽³⁾							3.15	%							2.89	%
Tax-equivalent net interest margin ⁽⁴⁾							3.28	%							3.05	%

(1)

Tax exempt loans and investments are calculated giving effect to a 35% federal tax rate.

(2)

Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(3)

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

(4)

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

	For the Six Months Ended June 30, 2016 Compared to the Six Months Ended June 30, 2015
	Increase (decrease) due to:
	Volume			Rate			Total
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale (1)	$	2,618		$	(274	)	$	2,344
Loans, tax exempt (2)		140			(8	)		132
Investment - taxable		155			211			366
Investments - tax exempt (2)		537			(79	)		458
Interest-earning deposits		(3	)		47			44
Other investments, at cost		86			34			120

Total interest-earning assets		3,533			(69	)		3,464

Interest-bearing liabilities:
Savings accounts	$	5		$	5		$	10
Time deposits		(115	)		(334	)		(449	)
Money market accounts		60			(23	)		37
Interest bearing transaction accounts		13			5			18
FHLB advances		367			(161	)		206
Junior subordinated debentures		—			27			27
Other borrowings		10			(6	)		4

Total interest-bearing liabilities		340			(487	)		(147	)

Change in tax-equivalent net interest income	$	3,193		$	418		$	3,611

(1)

Non-accrual loans are included in the above analysis.

(2)

Interest income on tax exempt loans and investments are adjusted for based on a 35% federal tax rate

Net interest income before provision for loan losses increased to $16.4 million for the six months ended June 30, 2016, compared to $14.5 million for the same period in 2015. As indicated in the table above, $3.2 million of the increase is attributable to increased volume, and the remaining $0.4 million improvement is the result of improved rates mainly for time deposits and FHLB advances.

The increase in tax-equivalent net interest income of $3.2 million related to volume was primarily the result of higher average loan and tax exempt investment balances which increased $109.8 million and $23.8 million, respectively, for the six months ended June 30, 2016 as compared to the same period in 2015. The increase in average loan and investment balances was partially offset by higher average FHLB advance balances which increased $92.3 million over the same periods.

The increase in tax-equivalent net interest income of $0.4 million related to rate was primarily the result of reduced rates on time deposits and FHLB advances of 23 basis points and 35 basis points, respectively. The reduced rates on average loans of 10 basis points for the six months period ending June 30, 2016 compared to the same period in 2015 was partially offset by an increased rate on average taxable investments of 17 basis points for the same period.

Our tax-equivalent net interest rate spread increased by 26 basis points to 3.15% for the six months ended June 30, 2016 compared to 2.89% for the six months ended June 30, 2015. Our tax-equivalent net interest margin increased 23 basis points to 3.28% for the six months ended June 30, 2016, compared to 3.05% for the six months ended June 30, 2015. As mentioned above, the increases in our interest rate spread and margin were primarily a result of the increases in taxable investment yields and reduced rate on time deposits and FHLB advances.

Provision for Loan Losses. The Company continues to experience a low level of net charge-offs and non-performing assets. As such, no provision for loan losses was recorded for the six month period ended June 30, 2016. The reversal of the provision for loan losses for the same period in 2015 was the result of improved asset quality and reduced loss rates during the period.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the six month periods ended June 30, 2016 and 2015:

	Six Months Ended June 30,
	2016		2015			Change
	(Dollars in thousands)
Servicing income, net	$	191	$	105		$	86
Mortgage banking		360		340			20
Gain on sale of SBA loans		618		214			404
Gain on sale of investments, net		698		287			411
Other than temporary impairment on cost method investment		—		(3	)		3
Service charges on deposit accounts		781		615			166
Interchange fees		724		600			124
Bank owned life insurance		201		262			(61	)
Other		401		207			194

Total	$	3,974	$	2,627		$	1,347

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

Gains on sales of SBA loans increased $0.4 million as a result of a larger balance of SBA loans being sold during the 2016 period as we continue to increase our SBA lending efforts.

Net gains on sales of investments increased $0.4 million for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 due to a significant drop in interest rates which provided for favorable market conditions for sales.

Service charges on deposit accounts and interchange fees increased $0.2 million and $0.1 million, respectively, for the six months ended June 30, 2016, compared to the same period in 2015 primarily as a result of a focus on core deposits.

Other noninterest income increased $0.2 million for the six months ended June 30, 2016, compared to the same period in 2015 primarily as a result of increases in trading securities revenue.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the six months ended June 30, 2016 and 2015:

	Six Months Ended June 30,
	2016		2015		Change
	(Dollars in thousands)

Compensation and employee benefits	$	8,267	$	7,514	$	753
Net occupancy		1,651		1,433		218
Federal Home Loan Bank prepayment penalty		—		1,762		(1,762	)
Marketing and advertising		502		237		265
Federal deposit insurance		360		563		(203	)
Professional and advisory		505		511		(6	)
Data processing		751		562		189
Merger-related expenses		1,916		—		1,916
Net cost of operation of real estate owned		496		332		164
Other		2,144		1,843		301

Total noninterest expenses	$	16,592	$	14,757	$	1,835

Compensation and employee benefits increased $0.8 million, or 10.0%, for the six months ended June 30, 2016 as compared to the same period in 2015. This additional expense is related to increases in our number of employees primarily as a result of the addition of three new branches and the Old Town acquisition, annual raises, employee benefits, incentives and commissions.

During the second quarter of 2015, we prepaid a $15.0 million FHLB advance and incurred a prepayment penalty of $1.8 million.

Marketing and advertising expenses increased $0.3 million for the six months ended June 30, 2016 as compared to the same period in 2015. The increase is primarily the result of rebranding costs related to the Old Town acquisition.

FDIC deposit insurance decreased $0.2 million, or 36.1%, for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 as a result of a reduction in our assessment rates due to an improving risk profile.

Merger-related expenses of $1.9 million related primarily to the Old Town acquisition on April 1, 2016.

Other noninterest expense increased $0.7 million, or 35.2%, for the three months ended June 30, 2016 compared to the same period in 2015 primarily as the result of increases in directors stock-based benefits of $0.1 million as part of the 2015 Long-term Stock Incentive Plan, telecommunication expense of $0.1 million, and data processing expense of $0.2 million.

Income Taxes. We recorded a $1.5 million income tax expense for the six months ended June 30, 2016 compared to a $17.4 million income tax benefit for the six months ended June 30, 2015. As mentioned above, the reversal of $17.6 million in deferred tax asset valuation allowance resulted in the tax benefit for the six months ended June 30, 2015. We continue to be in a net operating loss position for federal and state income tax purposes and do not have a material current tax liability or receivable.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, proceeds from the sale of loans originated for sale, and principal repayments and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee, under the direction of our Chief Financial Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2016.

We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and FRB interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At June 30, 2016, cash and cash equivalents totaled $57.9 million. Included in this total was $43.6 million held at FRB and $2.3 million held at the FHLB in interest-earning accounts.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements. The following summarizes the most significant sources and uses of liquidity during the six months ended June 30, 2016 and 2015:

	Six Months Ended June 30,
	2016			2015
	(Dollars in thousands)
Operating activities:
Loans originated for sale	$	(14,897	)	$	(14,950	)
Proceeds from loans originated for sale		16,923			16,630

Investing activities:
Purchases of investments	$	(103,802	)	$	(90,592	)
Maturities and principal repayments of investments		25,510			31,890
Sales of investments		74,959			25,707
Net increase in loans		(33,452	)		(25,339	)
Purchase of loans		—			(20,369	)
Net cash paid in business combinations		(5,912	)		—

Financing activities:
Net increase (decrease) in deposits	$	23,026		$	(11,264	)
Proceeds from FHLB advances		40,000			100,500
Repayment of FHLB advances		9,025			(40,000	)
Repurchase of common stock		(1,390	)		—

At June 30, 2016, we had $52.0 million in outstanding commitments to originate loans. In addition to commitments to originate loans, we had $94.2 million in unused lines of credit.

Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of June 30, 2016.

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

Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have borrowing agreements with the FHLB and the FRB discount window. The following summarizes our borrowing capacity as of June 30, 2016:

	Total		Used		Unused
(Dollars in thousands)	Capacity		Capacity		Capacity

FHLB	$	207,638	$	193,500	$	14,138
Unpledged Marketable Securities		322,241		128,273		193,968
FRB		40,876		—		40,876
	$	570,755	$	321,773	$	248,982

In addition to the amounts noted in the table above, we have the ability to pledge additional loans and increase our borrowing capacity with the FHLB.

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

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

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

Beginning on January 1, 2016, the Company and its subsidiary bank must maintain a capital conservation buffer to avoid restrictions on capital distributions or discretionary bonus payments. This buffer must consist solely of Common Equity Tier 1 Capital, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital) in addition to the minimum risk-based capital requirements. The capital conservation buffer required for 2016 is common equity equal to .625% of risk-weighted assets and will increase by .625% per year until reaching 2.5% beginning January 1, 2019.

The tables below summarize capital ratios and related information in accordance with Basel III as measured at June 30, 2016 and pre-existing rules at December 31, 2015.

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

	Actual					For Capital Adequacy Purposes					To Be Well- Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of June 30, 2016:
Tier 1 Leverage Capital	$	133,223		11.56	%	$	46,114		>4	%	$	57,642		>5	%
Common Equity Tier 1 Capital	$	133,223		17.06	%	$	35,133		>4.5	%	$	50,747		>6.5	%
Tier 1 Risk-based Capital	$	133,223		17.06	%	$	46,844		>6	%	$	62,458		>8	%
Total Risk-based Capital	$	142,248		18.22	%	$	62,458		>8	%	$	78,073		>10	%

As of December 31, 2015:
Tier 1 Leverage Capital	$	118,251		12.05	%	$	39,270		>4	%	$	49,087		>5	%
Common Equity Tier 1 Capital	$	118,251		18.07	%	$	29,443		>4.5	%	$	42,529		>6.5	%
Tier 1 Risk-based Capital	$	118,251		18.07	%	$	39,257		>6	%	$	52,343		>8	%
Total Risk-based Capital	$	126,524		19.34	%	$	52,343		>8	%	$	65,429		>10	%

The Company exceeded its regulatory capital ratios at June 30, 2016 and December 31, 2015, as set forth in the following table:

	Actual					For Capital Adequacy Purposes
(Dollars in thousands)	Amount		Ratio			Amount		Ratio
As of June 30, 2016:
Tier I Leverage Capital	$	136,548		11.84	%	$	46,135		>4	%
Common Equity Tier 1 Capital	$	126,053		16.13	%	$	35,171		>4.5	%
Tier I Risk-based Capital	$	145,572		17.47	%	$	46,895		>6	%
Total Risk Based Capital	$	145,572		18.63	%	$	62,527		>8	%

As of December 31, 2015:
Tier I Leverage Capital	$	136,063		13.85	%	$	39,291		>4	%
Common Equity Tier 1 Capital	$	128,007		19.55	%	$	29,468		>4.5	%
Tier I Risk-based Capital	$	136,063		20.78	%	$	39,291		>6	%
Total Risk Based Capital	$	144,343		22.04	%	$	52,388		>8	%

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

One of the primary ways we manage interest rate risk is by selling the majority of our long-term fixed rate mortgages into the secondary markets, and obtaining commitments to sell at locked-in interest rates prior to issuing a loan commitment. From a funding perspective, we expect to satisfy the majority of our future requirements with retail deposit growth, including checking and savings accounts, money market accounts and certificates of deposit generated within our primary markets. If our funding needs exceed our deposits, we will utilize our excess funding capacity with the FHLB and the FRB.

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

●

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

●

limited the fixed rate period on loans within our portfolio;

●

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

●

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

●

increased our level of variable-rate investments and loans;

●

utilized FHLB advances for positioning; and

●

engaged in an interest rate swap to hedge interest expense related to the junior subordinated debt.

Economic Value of Equity (EVE)

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

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

Net Interest Income

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

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

	June 30, 2016						December 31, 2015
Change in Interest Rates (basis points)	% Change in Pretax Net Interest Income			% Change in Economic Value of Equity			% Change in Pretax Net Interest Income			% Change in Economic Value of Equity
+400		4.7			(4.6	)		4.9			(14.5	)
+300		3.5			(3.7	)		3.5			(11.6	)
+200		2.2			(2.9	)		2.0			(9.1	)
+100		0.8			(2.2	)		0.8			(5.9	)
-		—			—			—			—
-100		(4.8	)		3.5			(2.5	)		10.7

The results from the rate shock analysis on NII are consistent with having a slightly asset sensitive balance sheet. Having an asset sensitive balance sheet means assets will reprice at a faster pace than liabilities during the short-term horizon. The implications of an asset sensitive balance sheet will differ depending upon the change in market rates. For example, with an asset sensitive balance sheet in a declining interest rate environment, the interest rate on assets will decrease at a faster pace than liabilities. This situation generally results in a decrease in NII and operating income. Conversely, with an asset sensitive balance sheet in a rising interest rate environment, the interest rate on assets will increase at a faster pace than liabilities. This situation generally results in an increase in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 2.2% increase in NII as of June 30, 2016 as compared to a 2.0% increase in NII as of December 31, 2015, suggesting that the Company’s exposure to the benefit of rising interest rates has increased slightly since December 31, 2015. The Company generally seeks to remain neutral to the impact of changes in interest rates by maximizing current earnings while balancing the risk of changes in interest rates.

The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has decreased from December 31, 2015 to June 30, 2016. For example, as indicated in the table above, a 200 basis point increase in rates would result in a 2.9% in EVE as of June 30, 2016 as compared to a 9.1% decrease in EVE as of December 31, 2015.

Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of June 30, 2016. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that as of June 30, 2016, the end of the period covered by this Quarterly Report on Form 10-Q, the Company maintained effective disclosure controls and procedures.

Changes in Internal Control over Financial Reporting

There have been no changes to the Company’s internal controls over financial reporting that occurred during the quarter ended June 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not involved in any material pending legal proceedings. In the ordinary course of operations, we are often involved in legal proceedings. In the opinion of management, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the quarter ended June 30, 2016.

Item 1A. Risk Factors

There have been no material changes to the risk factors that we have previously disclosed in the “Risk Factors” section in our 2015 Annual Report on Form 10-K as filed with the SEC on March 15, 2016.

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

On January 28, 2016, the Company announced that the Board of Directors had authorized the repurchase of up to 327,318 shares of the Company’s common stock through January 27, 2017. The authorization represented approximately 5% of the Company’s shares outstanding as of December 31, 2015. There is no guarantee as to the number of shares that will be repurchased. The stock repurchase program may be extended, suspended, or discontinued at any time without notice at the Company’s discretion.

The table below sets forth information regarding the Company’s common stock repurchases during the six months ended June 2016:

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1, 2016 to January 31, 2016		—	$	—		—		—
February 1, 2016 to February 29, 2016		40,621	$	17.04		40,621		286,697
March 1, 2016 to March 31, 2016		33,382	$	17.70		33,382		253,315
April 1, 2016 to April 30, 2016		5,997	$	17.65		5,997		247,318
May 1, 2016 to May 31, 2016		—	$	—		—		247,318
June 1, 2016 to June 30, 2016		—	$	—		—		247,318
Total year-to-date 2016		80,000	$	17.42		80,000		247,318

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits


Exhibit No.	Description

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

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

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

3.3	Articles of Amendment of Entegra Financial Corp., incorporated by reference to Exhibit 3.1 of the Current report on Form 8-k, filed with the SEC on November 16, 2014. (SEC File No. 001-35302)

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

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

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

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

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

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

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

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

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

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


10.10	Entegra Financial Corp. 2015 Long-Term Stock Incentive Plan incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on May 21, 2015. (SEC File No. 001-35302)

10.11	Tax Benefits Preservation Plan, dated as of November 16, 2015, incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K, filed with the SEC on November 16, 2015. (SEC File No. 001-35302)

10.12	Macon Bank, Inc. Long-Term Capital Appreciation Plan, as amended and restated, dated December 15, 2004, incorporated by reference to Exhibit 10.12 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016. (SEC File No. 001-35302)

10.13	First Amendment to the Macon Bank, Inc. Amended and Restated Long-Term Capital Appreciation Plan, dated December 10, 2008, incorporated by reference to Exhibit 10.13 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016. (SEC File No. 001-35302)

10.14	Second Amendment to the Macon Bank, Inc. Amended and Restated Long-Term Capital Appreciation Plan, dated March 16, 2011, incorporated by reference to Exhibit 10.14 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016. (SEC File No. 001-35302)

10.15	Third Amendment to the Macon Bank, Inc. Amended and Restated long-Term Capital Appreciation Plan, dated February 26, 2015, incorporated by reference to Exhibit 10.15 of the Annual Report on Form 10-K, filed with the SEC on March 15, 2016. (SEC File No. 001-35302)

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

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

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

101	Financial Statements filed in XBRL format.

*	Management contract or compensatory plan, contract or arrangement.

SIGNATURES

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

Date: August 8, 2016	Entegra Financial Corp.

(Registrant)

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

EXHIBIT INDEX

Exhibit No.	Description

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

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

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

101	Financial Statements filed in XBRL format.

Entegra Financial Corp. - FORM 10-Q - August 8, 2016

Attached files

Entegra Financial Corp. Reports