CAROLINA FINANCIAL CORP - FORM 10-Q

Attached files

file	filename
EX-32 - CAROLINA FINANCIAL CORP	e00584_ex32.htm
EX-31.2 - CAROLINA FINANCIAL CORP	e00584_ex31-2.htm
EX-31.1 - CAROLINA FINANCIAL CORP	e00584_ex31-1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2016

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to

Commission file number 001-10897


	Carolina Financial Corporation
(Exact name of registrant as specified in its charter)

Delaware		57-1039673
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


288 Meeting Street, Charleston, South Carolina		29401
(Address of principal executive offices)		(Zip Code)

843-723-7700

(Registrant’s telephone number, including area code)

Not Applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No 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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

	Large accelerated filer	o		Accelerated filer	x
	Non-accelerated filer	o	(Do not check if a smaller reporting company)	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: 12,549,220 shares of common stock, par value $0.01 per share, were issued and outstanding as of November 9, 2016.

TABLE OF CONTENTS


		Page
PART 1 –	FINANCIAL INFORMATION

Item 1.	Financial Statements	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40

Item 3.	Quantitative and Qualitative Disclosure about Market Risks	64

Item 4.	Controls and Procedures	64

PART II -	OTHER INFORMATION	64

Item 1.	Legal Proceedings	64

Item 1A.	Risk Factors	64

Item 2.	Unregistered Sale of Equity Securities and Use of Proceeds	64

Item 3.	Defaults Upon Senior Securities	65

Item 4.	Mine Safety Disclosures	65

Item 5.	Other Information	65

Item 6.	Exhibits	65

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

	September 30, 2016		December 31, 2015
	(Unaudited)		(Audited)
	(In thousands, except share data)
ASSETS
Cash and due from banks	$	9,110		10,206
Interest-bearing cash		29,211		16,421
Cash and cash equivalents		38,321		26,627
Securities available-for-sale (cost of $334,364 at September 30, 2016 and $305,972 at December 31, 2015)		336,918		306,474
Securities held-to-maturity (fair value of $0 at September 30, 2016 and $17,965 at December 31, 2015)		—		17,053
Federal Home Loan Bank stock, at cost		7,438		9,919
Other investments		1,801		1,760
Derivative assets		3,168		1,945
Loans held for sale		36,686		41,774
Loans receivable, net of allowance for loan losses of $10,340 at September 30, 2016 and $10,141 at December 31, 2015		1,122,889		912,582
Premises and equipment, net		35,086		32,562
Accrued interest receivable		4,813		4,333
Real estate acquired through foreclosure, net		2,843		2,374
Deferred tax assets, net		8,285		5,273
Mortgage servicing rights		13,556		11,433
Cash value life insurance		28,772		28,082
Core deposit intangible		3,771		2,961
Goodwill		4,266		—
Other assets		5,236		4,517
Total assets	$	1,653,849		1,409,669

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Noninterest-bearing deposits	$	267,892		163,054
Interest-bearing deposits		1,044,384		868,474
Total deposits		1,312,276		1,031,528
Short-term borrowed funds		87,500		120,000
Long-term debt		68,465		103,465
Derivative liabilities		2,708		306
Drafts outstanding		3,965		2,154
Advances from borrowers for insurance and taxes		2,614		641
Accrued interest payable		346		333
Reserve for mortgage repurchase losses		3,130		3,876
Dividends payable to stockholders		376		361
Accrued expenses and other liabilities		12,138		7,146
Total liabilities		1,493,518		1,269,810
Commitments and contingencies
Stockholders’ equity:
Preferred stock, par value $.01; 1,000,000 shares authorized at September 30, 2016 and December 31, 2015; no shares issued or outstanding		—		—
Common stock, par value $.01; 25,000,000 and 15,000,000 shares authorized at September 30, 2016 and December 31, 2015 respectively; 12,546,220 and 12,023,557 issued and outstanding at September 30, 2016 and December 31, 2015, respectively		125		120
Additional paid-in capital		65,862		56,418
Retained earnings		93,819		82,859
Accumulated other comprehensive income, net of tax		525		462
Total stockholders’ equity		160,331		139,859
Total liabilities and stockholders’ equity	$	1,653,849		1,409,669

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(In thousands, except share data)
Interest income
Loans	$	13,826			10,345			36,791			30,273
Investment securities		2,264			2,058			6,835			6,031
Dividends from Federal Home Loan Bank stock		83			93			288			238
Federal funds sold		3			—			5			—
Other interest income		32			16			92			60
Total interest income		16,208			12,512			44,011			36,602
Interest expense
Deposits		1,570			1,122			4,449			3,094
Short-term borrowed funds		124			75			320			217
Long-term debt		558			426			1,743			1,391
Total interest expense		2,252			1,623			6,512			4,702
Net interest income		13,956			10,889			37,499			31,900
Provision for loan losses		—			—			—			—
Net interest income after provision for loan losses		13,956			10,889			37,499			31,900
Noninterest income
Mortgage banking income		5,605			4,753			12,967			13,874
Deposit service charges		953			915			2,712			2,638
Net loss on extinguishment of debt		(118	)		—			(174	)		(1,215	)
Net gain on sale of securities		111			1,017			641			1,459
Fair value adjustments on interest rate swaps		99			(1,246	)		(408	)		(1,253	)
Net increase in cash value life insurance		226			172			684			530
Mortgage loan servicing income		1,437			1,330			4,238			3,956
Other		560			381			1,728			1,187
Total noninterest income		8,873			7,322			22,388			21,176
Noninterest expense
Salaries and employee benefits		8,481			7,204			23,306			21,453
Occupancy and equipment		2,067			1,821			5,836			5,332
Marketing and public relations		374			378			1,144			1,147
FDIC insurance		180			190			527			540
Recovery of mortgage loan repurchase losses		(250	)		(250	)		(750	)		(750	)
Legal expense		80			97			185			347
Other real estate expense, net		(96	)		4			(37	)		114
Mortgage subservicing expense		462			418			1,353			1,236
Amortization of mortgage servicing rights		586			515			1,659			1,460
Merger related expenses		—			—			2,985			—
Other		2,006			2,004			5,759			6,084
Total noninterest expense		13,890			12,381			41,967			36,963
Income before income taxes		8,939			5,830			17,920			16,113
Income tax expense		2,998			1,949			5,500			5,302
Net income	$	5,941			3,881			12,420			10,811
Earnings per common share:
Basic	$	0.48			0.41			1.04			1.15
Diluted	$	0.47			0.40			1.02			1.13
Weighted average common shares outstanding:
Basic		12,327,921			9,463,722			11,995,477			9,421,042
Diluted		12,535,551			9,674,994			12,201,721			9,595,991

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	For the Three Months						For the Nine Months
	September 30,						September 30,
	2016			2015			2016			2015
				(In thousands)

Net income	$	5,941			3,881			12,420			10,811

Other comprehensive income (loss), net of tax:
Unrealized gain (losses) on securities		(1,021	)		1,150			1,678			(834	)
Tax effect		368			(414	)		(604	)		300

Reclassification adjustment for gains included in earnings		(111	)		(1,017	)		(641	)		(1,459	)
Tax effect		40			366			231			525

Unrealized gain (loss) on interest rate swaps designated as cash flow hedges		288			—			(1,963	)		—
Tax effect		(104	)		—			707			—

Transfer from held-to-maturity to available-for-sale securities		—			—			1,023			1,604
Tax effect		—			—			(368	)		(577	)

Accretion of unrealized losses on held-to-maturity securities previously recognized in other comprehensive income		—			—			—			175
Tax effect		—			—			—			(63	)

Other comprehensive income (loss), net of tax		(540	)		85			63			(329	)

Comprehensive income	$	5,401			3,966			12,483			10,482

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015

(Unaudited)

													Accumulated
							Additional						Other
	Common Stock						Paid-in			Retained			Comprehensive
	Shares			Amount			Capital			Earnings			Income (Loss)			Total
	(In thousands, except share data)

Balance, December 31, 2014		9,717,043		$	97			23,194			69,625			784			93,700
Stock awards		39,291			1			(1	)		—			—			—
Vested stock awards surrendered in cashless exercise		(6,567	)		—			(40	)		(41	)		—			(81	)
Stock options exercised		13,616			—			70			—			—			70
Excess tax benefit in connection with equity awards		—			—			189			—			—			189
Stock-based compensation expense, net		—			—			661			—			—			661
Net income		—			—			—			10,811			—			10,811
Dividends declared to stockholders		—			—			—			(781	)		—			(781	)
Other comprehensive loss, net of tax		—			—			—			—			(329	)		(329	)
Balance, September 30, 2015		9,763,383		$	98			24,073			79,614			455			104,240

Balance, December 31, 2015		12,023,557		$	120			56,418			82,859			462			139,859
Stock awards		36,056			1			—			—			—			1
Vested stock awards surrendered in cashless exercise		(25,663	)		(1	)		(112	)		(346	)		—			(459	)
Stock options exercised		3,360			—			27			—			—			27
Stock issued - Congaree Bancshares, Inc. merger		508,910			5			8,545			—			—			8,550
Excess tax benefit in connection with equity awards		—			—			15			—			—			15
Stock-based compensation expense, net		—			—			969			—			—			969
Net income		—			—			—			12,420			—			12,420
Dividends declared to stockholders		—			—			—			(1,114	)		—			(1,114	)
Other comprehensive income, net of tax		—			—			—			—			63			63
Balance, September 30, 2016		12,546,220		$	125			65,862			93,819			525			160,331

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Nine Months
	Ended September 30
	2016			2015
	(In thousands)
Cash flows from operating activities:
Net income	$	12,420			10,811
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of unearned discount/premiums on investments, net		2,723			2,377
Accretion of deferred loan fees		(484	)		(645	)
Accretion of acquired loans		(471	)		—
Amortization of core deposit intangibles		294			257
Gain on sale of available-for-sale securities, net		(641	)		(1,459	)
Mortgage banking income		(12,967	)		(13,874	)
Originations of loans held for sale		(713,675	)		(820,109	)
Proceeds from sale of loans held for sale		731,730			841,880
Loss on extinguishment of debt		174			1,215
Provision for mortgage loan repurchase losses		(750	)		(750	)
Mortgage loan losses paid, net of recoveries		4			(161	)
Fair value adjustments on interest rate swaps		408			1,253
Stock-based compensation		969			661
Increase in cash surrender value of bank owned life insurance		(684	)		(530	)
Depreciation		1,457			1,318
(Gain) loss on disposals of premises and equipment		(1	)		8
(Gain) loss on sale of real estate acquired through foreclosure		(48	)		3
Originations of mortgage servicing rights		(3,782	)		(2,358	)
Amortization of mortgage servicing rights		1,659			1,460
(Increase) decrease in:
Accrued interest receivable		(194	)		(472	)
Other assets		(2,375	)		429
Increase (decrease) in:
Accrued interest payable		(9	)		(8	)
Dividends payable to stockholders		15			50
Accrued expenses and other liabilities		4,373			(1,992	)
Cash flows provided by operating activities		20,145			19,364

Continued

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

(Unaudited)

	For the Nine Months
	Ended September 30
	2016			2015
	(In thousands)
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases	$	(115,990	)		(189,117	)
Maturities, payments and calls		41,735			38,876
Proceeds from sales		69,896			94,638
Activity in held-to-maturity securities:
Purchases		—			(497	)
Maturities, payments and calls		—			199
Increase in other investments		(21	)		(967	)
Decrease (increase) in Federal Home Loan Bank stock		2,830			(2,389	)
Increase in loans receivable, net		(135,637	)		(80,942	)
Purchase of premises and equipment		(1,231	)		(2,403	)
Proceeds from disposals of premises and equipment		1			34
Proceeds from sale of real estate acquired through foreclosure		1,925			1,684
Purchase of bank owned life insurance		(25	)		(25	)
Distribution of bank owned life insurance		—			175
Acquisition of Congaree Bancshares, Inc.		3,668			—
Cash flows used in investing activities		(132,849	)		(140,734	)

Cash flows from financing activities:
Net increase in deposit accounts		191,423			69,761
Net (decrease) increase in Federal Home Loan Bank advances		(70,174	)		54,285
Principal repayment of subordinated debt		—			(1,575	)
Net increase (decrease) in drafts outstanding		1,811			(663	)
Net increase in advances from borrowers for insurance and taxes		1,973			1,027
Cash dividends paid on common stock		(1,083	)		(781	)
Net increase in excess tax benefit in connection with equity awards		421			189
Proceeds from exercise of stock options		27			70
Cash flows provided by financing activities		124,398			122,313
Net increase in cash and cash equivalents		11,694			943
Cash and cash equivalents, beginning of period		26,627			21,147
Cash and cash equivalents, end of period	$	38,321			22,090

Supplemental disclosure:
Cash paid for:
Interest on deposits and borrowed funds	$	6,499			4,710
Income taxes paid, net of refunds		3,795			4,261

Noncash investing and financing activities:
Transfer of loans receivable to real estate acquired through foreclosure	$	886			1,192
Transfer of held-to-maturity securities to available-for-sale securities		16,955			12,652

Acquisitions:
Assets acquired	$	104,221			—
Liabilities assumed		92,203			—
Net assets		12,018			—

Goodwill and fair value acquisition adjustments		4,266			—

See accompanying notes to consolidated financial statements.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Carolina Financial Corporation (“Carolina Financial” or the “Company”), incorporated under the laws of the State of Delaware, is a bank holding company with one wholly-owned subsidiary, CresCom Bank (the “Bank”). CresCom Bank operates two wholly-owned subsidiaries, Crescent Mortgage Company and Carolina Services Corporation of Charleston (“Carolina Services”). The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. In consolidation, all material intercompany accounts and transactions have been eliminated. The results of operations of the businesses acquired in transactions accounted for as purchases are included only from the dates of acquisition. All majority-owned subsidiaries are consolidated unless control is temporary or does not rest with the Company.

At September 30, 2016 and December 31, 2015, statutory business trusts (“Trusts”) created by the Company had outstanding trust preferred securities with an aggregate par value of $15,000,000. The principal assets of the Trusts are $15,465,000 of the Company’s subordinated debentures with identical rates of interest and maturities as the trust preferred securities. The Trusts have issued $465,000 of common securities to the Company and are included in other investments in the accompanying consolidated balance sheets. The Trusts are not consolidated subsidiaries of the Company.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“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 the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 as filed with the Securities and Exchange Commission on March 14, 2016. There have been no significant changes to the accounting policies as disclosed in the Company’s Form 10-K.

Management’s Estimates

The financial statements are prepared in accordance with GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. 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, including valuation for impaired loans, the valuation of real estate acquired in connection with foreclosure or in satisfaction of loans, the valuation of securities, the valuation of derivative instruments, the valuation of assets acquired and liabilities assumed in business combinations, the valuation of mortgage servicing rights, the determination of the reserve for mortgage loan repurchase losses, asserted and unasserted legal claims and deferred tax assets or liabilities. In connection with the determination of the allowance for loan losses and foreclosed real estate, management obtains independent appraisals for significant properties. Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.

Management uses available information to recognize losses on loans and foreclosed real estate. However, future additions to the allowance may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses and foreclosed real estate. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses and valuation of foreclosed real estate may change materially in the near term.

Earnings Per Share

Basic earnings per share (“EPS”) represents income available to common stockholders divided by the weighted-average number of shares outstanding during the period. Diluted earnings per share reflects additional shares that would have been outstanding if dilutive potential shares had been issued. Potential shares that may be issued by the Company relate solely to outstanding stock options, restricted stock (non-vested shares), restricted stock units (“RSUs”) and warrants, and are determined using the treasury stock method. Under the treasury stock method, the number of incremental shares is determined by assuming the issuance of stock for the outstanding stock options, unvested restricted stock and RSUs, and warrants, reduced by the number of shares assumed to be repurchased from the issuance proceeds, using the average market price for the period of the Company’s stock. Weighted-average shares for the basic and diluted EPS calculations have been reduced by the average number of unvested restricted shares.

On June 22, 2015, the Board of Directors of the Company declared a six-for-five stock split representing a 20% stock dividend to stockholders of record as of July 15, 2015, payable on July 31, 2015.

All share, earnings per share, and per share data have been retroactively adjusted to reflect the stock splits for all periods presented in accordance with GAAP.

Subsequent Events

Subsequent events are material 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. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the statement of financial condition but arose after that date. Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred requiring accrual or disclosure except as follows:

On October 19, 2016, the Board of Directors of Carolina Financial declared a quarterly cash dividend of $0.04, payable on January 11, 2017 to stockholders of record as of December 28, 2016.

On November 8, 2016, Carolina Financial announced the signing of a definitive agreement pursuant to which Carolina Financial will acquire Greer Bancshares Incorporated (“Greer”). in a cash and stock transaction with a total current value of approximately $45.1 million. Subject to the terms and conditions of the agreement, each share of Greer common stock will be converted into the right to receive one of the following: (i) $18.00 in cash, (ii) 0.782 shares of Carolina Financial common stock, or (iii) a combination of cash and Carolina Financial common stock, subject to the limitation that, excluding any dissenting shares, the total merger consideration shall be prorated to 10% cash consideration and 90% stock consideration. The transaction is anticipated to close at the end of the first quarter of 2017, subject to customary closing conditions.

Reclassification

Certain reclassifications of accounts reported for previous periods have been made in these consolidated financial statements. Such reclassifications had no effect on stockholders’ equity or the net income as previously reported.

Recently Issued Accounting Pronouncements

In May 2014 and August 2015, the Financial Accounting Standards Board (“FASB”) issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

In June 2014, the FASB issued guidance which clarifies that performance targets associated with stock compensation should be treated as a performance condition and should not be reflected in the grant date fair value of the stock award. The amendments are effective for the Company for fiscal years that begin after December 15, 2015. The Company applied the guidance to stock awards with performance targets that are outstanding at the start of the first fiscal year in the financial statements and to all stock awards that are granted or modified after the effective date. These amendments did not have a material effect on the financial statements.

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015 with early adoption permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. These amendments did not have a material effect on the financial statements.

In August 2015, the FASB issued amendments to the Interest topic of the Accounting Standards Codification to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements. The amendments were effective upon issuance. The amendments did not have a material effect on the financial statements

In January 2016, the 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 does not expect these amendments to have a material effect on its financial statements.

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

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. In addition to other changes, the guidance changes the accounting for excess tax benefits and tax deficiencies from generally being recognized in additional paid-in capital to recognition as income tax expense or benefit in the period they occur. For public business entities, the amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any entity in any interim or annual period. The Company adopted the new guidance in the second quarter of 2016. As a result, the Company’s income tax expense was reduced by approximately $22,000 and $421,000 for the three and nine months ended September 30, 2016, respectively. These amendments did not a material impact to the Company’s financial position and cash flows.

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. 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 May 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. 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 June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is evaluating the effect that implementation of the new standard will have on its financial position, results of operation and cash flows.

In August 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

NOTE 2 – BUSINESS COMBINATIONS

Acquisition of Congaree Bancshares, Inc.

On June 11, 2016, the Company completed its acquisition of Congaree Bancshares, Inc. (“Congaree”), the holding company for Congaree State Bank, pursuant to the Agreement and Plan of Merger, dated as of January 5, 2016. Under the terms of the merger agreement, each share of Congaree common stock was converted into the right to receive $8.10 in cash or 0.4806 shares of the Company’s common stock, or a combination thereof, subject to certain limitations.

The following table presents a summary of total consideration paid by the Company at the acquisition date (dollars in thousands).

Common stock issued (508,910 shares)	$	8,557
Cash payments to common stockholders		5,724
Preferred shares assumed and redeemed at par		1,564
Fair value of Congaree stock options assumed - paid out in cash		439
Total consideration paid	$	16,284

The following table presents the Congaree assets acquired and liabilities assumed as of June 11, 2016 as well as the related fair value adjustments and determination of goodwill.

	As Reported by			Fair Value			As Recorded by the
	Congaree			Adjustments			Company
Assets	(In thousands)
Cash and cash equivalents	$	11,394			—			11,394
Securities		9,453			(59	) (a)		9,394
Loans		78,712			(4,111	) (b)		74,601
Allowance for loan losses		(1,112	)		1,112	(c)		—
Premises and equipment		2,712			38	(d)		2,750
Foreclosed assets		1,710			(250	) (e)		1,460
Core deposit intangible		—			1,104	(f)		1,104
Deferred tax asset		1,813			915	(g)		2,728
Other assets		942			(152	) (h)		790
Total assets acquired	$	105,624			(1,403	)		104,221

Liabilities
Deposits	$	89,227			98	(i)		89,325
Borrowings		2,500			—			2,500
Other liabilities		378			—			378
Total liabilities assumed	$	92,105			98			92,203
Net assets acquired								12,018
Total consideration paid								16,284
Goodwill								4,266

Explanation of fair value adjustments:

(a)

Adjustment reflects opening fair value of securities portfolio, which was established as the new book basis of the portfolio.

(b)

Adjustment reflects the fair value adjustment based on the Company’s third party valuation report.

(c)

Adjustment reflects the elimination of Congaree’s historical allowance for loan losses.

(d)

Adjustment reflects fair value adjustments on acquired branch and administrative offices.

(e)

Adjustment reflects the fair value adjustment based on the Company’s evaluation of the foreclosed assets.

(f)

Adjustment reflects the fair value adjustment to record the estimated core deposit intangible based on the Company’s third party valuation report.

(g)

Adjustment reflects the tax impact of acquisition accounting fair value adjustments.

(h)

Adjustment reflects the fair value adjustment based on the Company’s evaluation of acquired other assets.

(i)

Adjustment reflects the fair value adjustment based on the Company’s third party evaluation report on deposits assumed.

The Congaree acquisition was accounted for under the acquisition method of accounting. The assets and liabilities of Congaree have been recorded at their estimated fair values and added to those of the Company for periods following the merger date. The Company may refine its valuations of acquired Congaree assets and liabilities for up to one year following the merger date.

The Company acquired $104.2 million in assets at fair value, including $74.6 million in loans, $9.4 million in investment securities, and $1.5 million in real estate acquired through foreclosure. The Company also assumed $92.2 million of liabilities at fair value, including $89.3 million of total deposits with a core deposit intangible asset recorded of $1.1 million.

There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with FASB Accounting Standards Codification (“ASC”) 310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20. All loans acquired as part of the transaction were accounted for under ASC 310-20, as a practical expedient, due to the immaterial balances of accruing substandard and nonaccrual loans as of the acquisition date. Nonaccrual and accruing substandard loans acquired totaled $204,000 and $423,000, respectively, as of June 11, 2016.

Supplemental Pro Forma Information

The table below presents supplemental pro forma information as if the Congaree acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2015. Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger. Therefore, the pro forma financial information is not indicative of the results of operations that would have occurred had the transactions been effected on the assumed date. Pre-tax merger-related costs of $3.0 million for the nine months ended September 30, 2016, are included in the Company’s consolidated statements of operations and are not included in the pro forma statements below. Net interest income and net income recorded from the merger date to September 30, 2016 was $1.4 million and $709,000, respectively.

	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
	2016		2015		2016		2015
	(In thousands, except share data)

Net interest income	$	13,956	$	12,185	$	40,017	$	35,706
Net income (a)	$	5,941	$	4,119	$	15,071	$	11,669

Weighted average shares outstanding (b):
Basic		12,327,921		9,973,097		12,296,642		9,930,417
Diluted		12,535,551		10,184,369		12,502,886		10,105,366

Earnings per common share:
Basic	$	0.48	$	0.41	$	1.23	$	1.18
Diluted	$	0.47	$	0.40	$	1.21	$	1.15

(a) Supplemental pro forma net income includes the impact of certain fair value adjustments. In addition, preferred shares were assumed to have been repaid; therefore no preferred dividends were assumed to have been paid. Supplemental pro forma net income does not include assumptions on cost saves or impact of merger related expenses.

(b) Weighted average shares outstanding include the full effect of the common stock issued in connection with the Congaree acquisition as of the earliest reporting date.

NOTE 3 – SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of securities available-for-sale and held-to-maturity at September 30, 2016 and December 31, 2015 follows:

	September 30, 2016									December 31, 2015
			Gross		Gross							Gross		Gross
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
Securities available-for-sale:	(In thousands)
Municipal securities	$	83,102		4,830		(68	)		87,864		60,603		1,885		(13	)		62,475
US government agencies		3,441		—		(11	)		3,430		7,015		81		—			7,096
Collateralized loan obligations		63,421		62		(174	)		63,309		38,957		8		(207	)		38,758
Corporate securities		473		48		—			521
Mortgage-backed securities:
Agency		96,634		1,782		(94	)		98,322		112,608		1,370		(123	)		113,855
Non-agency		76,245		654		(184	)		76,715		75,415		580		(459	)		75,536
Total mortgage-backed securities		172,879		2,436		(278	)		175,037		188,023		1,950		(582	)		189,391
Trust preferred securities		11,048		642		(4,933	)		6,757		11,374		1,145		(3,765	)		8,754
Total	$	334,364		8,018		(5,464	)		336,918		305,972		5,069		(4,567	)		306,474

Securities held-to-maturity:
Municipal securities	$	—		—		—			—		17,053		912		—			17,965

During the second quarter of 2016, the Company tainted its securities held-to-maturity portfolio as a result of a change in the intent to hold these securities until maturity to provide opportunities to maximize its asset utilization. As a result, the securities were moved to available-for-sale resulting in an increase to accumulated other comprehensive income of $655,000.

The amortized cost and fair value of debt securities by contractual maturity at September 30, 2016 follows:

	At September 30, 2016
	Amortized		Fair
	Cost		Value
	(In thousands)
Securities available-for-sale:
Less than one year	$	—		—
One to five years		1,300		1,347
Six to ten years		49,618		50,340
After ten years		283,446		285,231
Total	$	334,364		336,918

The contractual maturity dates of the securities were used for mortgage-backed securities and asset-backed securities. No estimates were made to anticipate principal repayments.

The following table summarizes the gross realized gains and losses from sales of investment securities available-for-sale for the periods indicated.

	For the Three Months					For the Nine Months
	Ended September 30,					Ended September 30,
	2016		2015			2016			2015
	(In thousands)

Proceeds	$	19,024		32,829			69,896			94,638

Realized gains	$	111		1,026			758			1,605
Realized losses		—		(9	)		(117	)		(146	)
Total investment securities gains, net	$	111		1,017			641			1,459

At September 30, 2016, the Company had pledged securities with a market value of $21.7 million of securities for Federal Home Loan Bank (“FHLB”) advances.

At September 30, 2016, the Company has pledged $22.8 million of securities to secure public agency funds.

The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at September 30, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

	At September 30, 2016
	Less than 12 Months							12 Months or Greater							Total
	Amortized		Fair		Unrealized			Amortized		Fair		Unrealized			Amortized		Fair		Unrealized
	Cost		Value		Losses			Cost		Value		Losses			Cost		Value		Losses
	(In thousands)
Available-for-sale:
Municipal securities	$	4,168		4,100		(68	)		—		—		—			4,168		4,100		(68	)
US government agencies		3,441		3,430		(11	)		—		—		—			3,441		3,430		(11	)
Collateralized loan obligations		36,758		36,672		(86	)		12,726		12,638		(88	)		49,484		49,310		(174	)
Mortgage-backed securities:
Agency		3,297		3,267		(30	)		11,066		11,002		(64	)		14,363		14,269		(94	)
Non-agency		4,859		4,777		(82	)		11,421		11,319		(102	)		16,280		16,096		(184	)
Total mortgage-backed securities		8,156		8,044		(112	)		22,487		22,321		(166	)		30,643		30,365		(278	)
Trust preferred securities		1,308		1,046		(262	)		8,688		4,017		(4,671	)		9,996		5,063		(4,933	)
Total	$	53,831		53,292		(539	)		43,901		38,976		(4,925	)		97,732		92,268		(5,464	)

	At December 31, 2015
	Less than 12 Months							12 Months or Greater							Total
	Amortized		Fair		Unrealized			Amortized		Fair		Unrealized			Amortized		Fair		Unrealized
	Cost		Value		Losses			Cost		Value		Losses			Cost		Value		Losses
	(In thousands)
Available-for-sale:
Municipal securities	$	2,579		2,566		(13	)		—		—		—			2,579		2,566		(13	)
Collateralized loan obligations		24,289		24,130		(159	)		9,706		9,658		(48	)		33,995		33,788		(207	)
Mortgage-backed securities:
Agency		22,528		22,416		(112	)		804		793		(11	)		23,332		23,209		(123	)
Non-agency		27,724		27,432		(292	)		12,242		12,075		(167	)		39,966		39,507		(459	)
Total mortgage-backed securities		50,252		49,848		(404	)		13,046		12,868		(178	)		63,298		62,716		(582	)
Trust preferred securities		—		—		—			8,803		5,038		(3,765	)		8,803		5,038		(3,765	)
Total	$	77,120		76,544		(576	)		31,555		27,564		(3,991	)		108,675		104,108		(4,567	)

The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”). Factors considered in the review include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospect of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or a portion may be recognized in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

As of September 30, 2016, trust preferred securities had an amortized cost of $11.0 million and a fair value of $6.8 million. For each trust preferred security, impairment testing is performed on a quarterly basis using a detailed cash flow analysis. The major assumptions used during the quarterly impairment testing are described in the subsequent paragraph.

In 2009, the Company adopted a four year “burst” scenario for its modeled default rates (2010 - 2013) that replicated the default rates for the banking industry from the four peak years of the savings and loan crisis, which then reduced to 0.25% annually. The elevated default rate ended in 2013, and the constant default rate used by the Company is now 0.25% annually. All issuers that are currently in deferral were presumed to be in default. Additionally, all defaults are assumed to have a 15% recovery after two years and 1% of the pool is presumed to prepay annually. If this analysis results in a present value of expected cash flows that is less than the book value of a security (that is, a credit loss exists), OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed used discount rates equal to the credit spread at the time of purchase for each security and then added the current three-month LIBOR forward interest rate curve. Based on the cash flow analysis performed at period end, management believes that there are no additional securities other-than-temporarily impaired at September 30, 2016.

The underlying issuers in the pools were primarily financial institutions and to a lesser extent, insurance companies and real estate investment trusts. The Company owns both senior and mezzanine tranches in pooled trust preferred securities; however, the Company does not own any income notes. The senior and mezzanine tranches of trust preferred collateralized debt obligations generally have some protection from defaults in the form of over-collateralization and excess spread revenues, along with waterfall structures that redirect cash flows in the event certain coverage test requirements are failed. Generally, senior tranches have the greatest protection, with mezzanine tranches subordinated to the senior tranches, and income notes subordinated to the mezzanine tranches.

As of September 30, 2016, $0.7 million of the pooled trust preferred securities were investment grade and $6.1 million were below investment grade. As of December 31, 2015, $0.8 million of the pooled trust preferred securities were investment grade and $8.0 million were below investment grade. In terms of risk-based capital calculation, the Company allocates additional risk-based capital to the below investment grade securities.

As of September 30, 2016, senior tranches represent $0.7 million of the Company’s pooled securities, while mezzanine tranches represented $6.1 million. All of the $6.1 million in mezzanine tranches are still subordinate to senior tranches as the senior notes have not been paid to a zero balance. As of December 31, 2015, senior tranches represent $0.8 million of the Company’s pooled securities, while mezzanine tranches represented $8.0 million. All of the $8.0 million in mezzanine tranches are still subordinate to senior tranches as the senior notes have not been paid to a zero balance.

At September 30, 2016 and December 31, 2015, the Company had 45 individual investments available-for-sale that were in an unrealized loss position. The unrealized losses on the Company’s investments in US government-sponsored agencies, municipal securities, mortgage-backed securities (agency and non-agency), and trust preferred securities summarized above were attributable primarily to changes in interest rates. Management has performed various analyses, including cash flows as needed, and determined that no OTTI expense was necessary during 2016 or 2015.

Management believes that there are no additional securities other-than-temporarily impaired at September 30, 2016. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost. Management continues to monitor these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of the securities may be sold or are other-than-temporarily impaired, which would require a charge to earnings in such periods.

NOTE 4 – DERIVATIVES

In the ordinary course of business, the Company enters into various types of derivative transactions. The Company’s primary uses of derivative instruments are related to the mortgage banking activities. As such, the Company holds derivative instruments, which consist of rate lock agreements related to expected funding of fixed-rate mortgage loans to customers (interest rate lock commitments) and forward commitments to sell mortgage-backed securities and individual fixed-rate mortgage loans. The Company’s objective in obtaining the forward commitments is to mitigate the interest rate risk associated with the interest rate lock commitments and the mortgage loans that are held for sale. Derivative instruments not related to mortgage banking activities primarily relate to interest rate swap agreements.

The derivative positions of the Company at September 30, 2016 and December 31, 2015 are as follows:

	At September 30,				At December 31,
	2016				2015
	Fair		Notional		Fair		Notional
	Value		Value		Value		Value
	(In thousands)
Derivative assets:
Cash flow hedges:
Interest rate swaps	$	—		—		180		30,000
Non-hedging derivatives:
Interest rate swaps		12		5,000		—		—
Mortgage loan interest rate lock commitments		2,583		182,787		1,246		143,318
Mortgage loan forward sales commitments		573		25,002		340		31,513
Mortgage-backed securities forward sales commitments		—		—		179		105,014
Total derivative assets	$	3,168		212,789		1,945		309,845

Derivative liabilities:
Cash flow hedges:
Interest rate swaps	$	1,783		30,000		—		—
Non-hedging derivatives:
Interest rate swaps		724		25,000		306		10,000
Mortgage-backed securities forward sales commitments		201		114,527		—		—
Total derivative liabilities	$	2,708		169,527		306		10,000

Non-Designated Hedges

Derivative Loan Commitments and Forward Sales Commitments

The Company enters into mortgage loan commitments that are also referred to as derivative loan commitments, if the loan that will result from exercise of the commitment will be held for sale upon funding. The Company enters into commitments to fund residential mortgage loans at specified rates and times in the future, with the intention that these loans will subsequently be sold in the secondary market.

Outstanding derivative loan commitments expose the Company to the risk that the price of the loans arising from exercise of the loan commitment might decline from inception of the rate lock to funding of the loan due to increases in mortgage interest rates. If interest rates increase, the value of these loan commitments typically decreases. Conversely, if interest rates decrease, the value of these loan commitments typically increases.

To protect against the price risk inherent in derivative loan commitments, the Company utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments.

With a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay a “pair-off” fee, based on then-current market prices, to the investor to compensate the investor for the shortfall.

With a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded (e.g., on the same day the lender commits to lend funds to a potential borrower). The Company expects that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments.

Derivatives related to these commitments are recorded as either a derivative asset or a derivative liability on the balance sheet and are measured at fair value. Both the interest rate lock commitments and the forward commitments are reported at fair value, with adjustments recorded in current period earnings in mortgage banking income within the noninterest income in the consolidated statements of operations.

Interest Rate Swaps

The Company enters into interest rate swaps that do not meet the hedge accounting requirements and are recorded at fair value as a derivative asset or liability. Interest rate swaps that are not designated as hedges are primarily used to more closely match the interest rate characteristics of assets and liabilities and to mitigate the risks arising from timing mismatches between assets and liabilities including duration mismatches. Fair value changes are recognized in noninterest income as “fair value adjustments on interest rate swaps”.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using certain interest rate derivatives are to add stability to interest expense 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. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

The Company has entered into interest rate swaps to reduce the exposure to variability in interest-related cash outflows attributable to changes in forecasted LIBOR-based FHLB borrowings. These derivative instruments are designated as cash flow hedges. The hedged item is the LIBOR portion of the series of future adjustable rate borrowings over the term of the interest rate swap. Accordingly, changes to the amount of interest payment cash flows for the hedged transactions attributable to a change in credit risk are excluded from our assessment of hedge effectiveness. The Company tests for hedging effectiveness on a quarterly basis. 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. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company has not recorded any hedge ineffectiveness since inception.

Risk Management Objective of Using Derivatives

When using derivatives to hedge fair value and cash flow risks, the Company exposes itself to potential credit risk from the counterparty to the hedging instrument. This credit risk is normally a small percentage of the notional amount and fluctuates as interest rates change. The Company analyzes and approves credit risk for all potential derivative counterparties prior to execution of any derivative transaction. The Company seeks to minimize credit risk by dealing with highly rated counterparties and by obtaining collateralization for exposures above certain predetermined limits. If significant counterparty risk is determined, the Company would adjust the fair value of the derivative recorded asset balance to consider such risk.

NOTE 5 - LOANS RECEIVABLE, NET

Loans receivable, net at September 30, 2016 and December 31, 2015 are summarized by category as follows:

	At September 30,					At December 31,
	2016					2015
			% of Total					% of Total
	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	400,500		35.35	%	$	344,928		37.38	%
Home equity		37,901		3.34	%		23,256		2.52	%
Commercial real estate		432,867		38.20	%		341,658		37.03	%
Construction and development		113,667		10.03	%		91,362		9.90	%
Consumer loans		6,029		0.53	%		5,179		0.56	%
Commercial business loans		142,265		12.55	%		116,340		12.61	%
Total gross loans receivable		1,133,229		100.00	%		922,723		100.00	%
Less:
Allowance for loan losses		10,340					10,141
Total loans receivable, net	$	1,122,889				$	912,582

Included in the loan totals were $129.5 million and $64.1 million in loans acquired through acquisitions at September 30, 2016 and December 31, 2015, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

The composition of gross loans outstanding, net of undisbursed amounts, by rate type is as follows:

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

Variable rate loans	$	443,511	39.14	%	$	397,873	43.12	%
Fixed rate loans		689,718	60.86	%		524,850	56.88	%
Total loans outstanding	$	1,133,229	100.00	%	$	922,723	100.00	%

The following table presents activity in the allowance for loan losses for the period indicated. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

Allowance for loan losses:	For the Three Months Ended September 30, 2016
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated		Total
	(In thousands)
Balance, beginning of period	$	2,706			167			3,393			1,210			30			2,423			368		10,297
Provision for loan losses		(174	)		21			189			(140	)		(1	)		43			62		—
Charge-offs		—			—			—			—			(2	)		(2	)		—		(4	)
Recoveries		9			—			—			4			8			26			—		47
Balance, end of period	$	2,541			188			3,582			1,074			35			2,490			430		10,340

	For the Three Months Ended September 30, 2015
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated		Total
										(In thousands)
Balance, beginning of period	$	3,213			208			3,434			1,072			50			1,891			149		10,017
Provision for loan losses		241			(42	)		(17	)		(241	)		(28	)		53			34		—
Charge-offs		(623	)		—			—			—			(6	)		(26	)		—		(655	)
Recoveries		198			—			100			166			5			58			—		527
Balance, end of period	$	3,029			166			3,517			997			21			1,976			183		9,889

Allowance for loan losses:	For the Nine Months Ended September 30, 2016
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated		Total
	(In thousands)
Balance, beginning of period	$	2,903			151			3,402			1,138			27			2,100			420		10,141
Provision for loan losses		(465	)		37			180			(74	)		16			296			10		—
Charge-offs		(45	)		—			—			—			(31	)		(121	)		—		(197	)
Recoveries		148			—			—			10			23			215			—		396
Balance, end of period	$	2,541			188			3,582			1,074			35			2,490			430		10,340

	For the Nine Months Ended September 30, 2015
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated		Total
	(In thousands)
Balance, beginning of period	$	2,888			221			3,283			1,069			30			1,430			114		9,035
Provision for loan losses		240			(55	)		(116	)		(458	)		(25	)		345			69		—
Charge-offs		(623	)		—			—			(90	)		(9	)		(67	)		—		(789	)
Recoveries		524			—			350			476			25			268			—		1,643
Balance, end of period	$	3,029			166			3,517			997			21			1,976			183		9,889

The following table disaggregates our allowance for loan losses and recorded investment in loans by impairment methodology.

	Loans Secured by Real Estate
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
	family		equity		estate		development		Consumer		business		Unallocated		Total
	(In thousands)
At September 30, 2016:
Allowance for loan losses ending balances:
Individually evaluated for impairment	$	26		29		143		—		—		9		—		207
Collectively evaluated for impairment		2,515		159		3,439		1,074		35		2,481		430		10,133
	$	2,541		188		3,582		1,074		35		2,490		430		10,340

Loans receivable ending balances:
Individually evaluated for impairment	$	2,755		331		5,114		516		33		281		—		9,030
Collectively evaluated for impairment		397,745		37,570		427,753		113,151		5,996		141,984		—		1,124,199
Total loans receivable	$	400,500		37,901		432,867		113,667		6,029		142,265		—		1,133,229

At December 31, 2015:
Allowance for loan losses ending balances:
Individually evaluated for impairment	$	15		—		343		120		—		9		—		487
Collectively evaluated for impairment		2,888		151		3,059		1,018		27		2,091		420		9,654
	$	2,903		151		3,402		1,138		27		2,100		420		10,141

Loans receivable ending balances:
Individually evaluated for impairment	$	3,968		—		12,499		500		65		482		—		17,514
Collectively evaluated for impairment		340,960		23,256		329,159		90,862		5,114		115,858		—		905,209
Total loans receivable	$	344,928		23,256		341,658		91,362		5,179		116,340		—		922,723

The following table presents impaired loans individually evaluated for impairment in the segmented portfolio categories and the corresponding allowance for loan losses as of September 30, 2016 and December 31, 2015. The recorded investment is defined as the original amount of the loan, net of any deferred costs and fees, less any principal reductions and direct charge-offs. Unpaid principal balance includes amounts previously included in charge-offs.

	At September 30, 2016						At December 31, 2015
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
	(In thousands)
With no related allowance recorded:
Loans secured by real estate:
One-to-four family	$	2,207		3,350		—		3,175		5,572		—
Home equity		222		222		—		—		28		—
Commercial real estate		3,867		5,427		—		10,681		11,226		—
Construction and development		516		516		—		25		1,863		—
Consumer loans		33		58		—		65		362		—
Commercial business loans		272		392		—		473		1,668		—
		7,117		9,965		—		14,419		20,719		—

With an allowance recorded:
Loans secured by real estate:
One-to-four family		548		548		26		793		793		15
Home equity		109		109		29		—		—		—
Commercial real estate		1,247		1,247		143		1,818		1,818		343
Construction and development		—		—		—		475		475		120
Consumer loans		—		—		—		—		—		—
Commercial business loans		9		9		9		9		9		9
		1,913		1,913		207		3,095		3,095		487


Total:
Loans secured by real estate:
One-to-four family		2,755		3,898		26		3,968		6,365		15
Home equity		331		331		29		—		28		—
Commercial real estate		5,114		6,674		143		12,499		13,044		343
Construction and development		516		516		—		500		2,338		120
Consumer loans		33		58		—		65		362		—
Commercial business loans		281		401		9		482		1,677		9
	$	9,030		11,878		207		17,514		23,814		487

The following table presents the average recorded investment and interest income recognized on impaired loans individually evaluated for impairment in the segmented portfolio categories for the three months and nine months ended September 30, 2016 and 2015.

	For the Three Months Ended September 30,									For the Nine Months Ended September 30,
	2016				2015					2016				2015
	Average		Interest		Average		Interest			Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income			Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized			Investment		Recognized		Investment		Recognized
	(In thousands)
With no related allowance recorded:
Loans secured by real estate:
One-to-four family	$	2,218		9		3,631		71			2,445		32		3,305		190
Home equity		111		4		—		—			37		5		31		2
Commercial real estate		3,889		61		8,511		120			7,411		289		8,154		303
Construction and development		503		1		6		—			501		1		128		—
Consumer loans		20		9		54		27			29		8		41		28
Commercial business loans		286		4		1,140		25			465		56		1,500		112
		7,027		88		13,342		243			10,888		391		13,159		635

With an allowance recorded:
Loans secured by real estate:
One-to-four family		550		4		315		—			555		14		317		—
Home equity		55		2		—		—			18		2		—		—
Commercial real estate		1,256		—		1,046		(20	)		1,274		—		606		22
Construction and development		—		—		617		(2	)		—		—		257		15
Consumer loans		—		—		9		—			—		—		7		—
Commercial business loans		9		—		3		—			9		—		3		—
		1,870		6		1,990		(22	)		1,856		16		1,190		37

Total:
Loans secured by real estate:
One-to-four family		2,768		13		3,946		71			3,000		46		3,622		190
Home equity		166		6		—		—			55		7		31		2
Commercial real estate		5,145		61		9,557		100			8,685		289		8,760		325
Construction and development		503		1		623		(2	)		501		1		385		15
Consumer loans		20		9		63		27			29		8		48		28
Commercial business loans		295		4		1,143		25			474		56		1,503		112
	$	8,897		94		15,332		221			12,744		407		14,349		672

A loan is considered past due if the required principal and interest payment has not been received as of the due date. The following schedule is an aging of past due loans receivable by portfolio segment as of September 30, 2016 and December 31, 2015.

	At September 30, 2016
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	33		152		900		96		15		111		1,307
60-89 days past due		973		109		—		16		—		5		1,103
90 days or more past due		1,435		222		131		516		14		—		2,318
Total past due		2,441		483		1,031		628		29		116		4,728
Current		398,059		37,418		431,836		113,039		6,000		142,149		1,128,501
Total loans receivable	$	400,500		37,901		432,867		113,667		6,029		142,265		1,133,229

	At December 31, 2015
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	—		—		—		—		1		50		51
60-89 days past due		275		—		182		—		—		—		457
90 days or more past due		1,960		—		235		499		25		—		2,719
Total past due		2,235		—		417		499		26		50		3,227
Current		342,693		23,256		341,241		90,863		5,153		116,290		919,496
Total loans receivable	$	344,928		23,256		341,658		91,362		5,179		116,340		922,723

Loans are generally placed in nonaccrual status when the collection of principal and interest is 90 days or more past due, unless the obligation is both well-secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest payments received while the loan is on nonaccrual are applied to the principal balance. No interest income was recognized on impaired loans subsequent to the nonaccrual status designation. A loan is returned to accrual status when the borrower makes consistent payments according to contractual terms and future payments are reasonably assured.

There were no loans past due 90 days or more and still accruing at September 30, 2016 or December 31, 2015.

The following is a schedule of loans receivable, by portfolio segment, on nonaccrual at September 30, 2016 and December 31, 2015.

	At September 30,		At December 31,
	2016		2015
	(In thousands)
Loans secured by real estate:
One-to-four family	$	1,551		2,032
Home equity		331		—
Commercial real estate		1,732		1,686
Construction and development		516		499
Consumer loans		19		50
Commercial business loans		25		35
	$	4,174		4,302

The Company uses several metrics as credit quality indicators of current or potential risks as part of the ongoing monitoring of credit quality of its loan portfolio. The credit quality indicators are periodically reviewed and updated on a case-by-case basis. The Company uses the following definitions for the internal risk rating grades, listed from the least risk to the highest risk.

Pass: These loans range from minimal credit risk to average, however, still acceptable credit risk.

Special mention: A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.

Substandard: A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable.

The Company uses the following definitions in the tables below:

Nonperforming: Loans on nonaccrual status plus loans greater than 90 days past due still accruing interest.

Performing: All current loans plus loans less than 90 days past due.

The following is a schedule of the credit quality of loans receivable, by portfolio segment, as of September 30, 2016 and December 31, 2015.

	At September 30, 2016
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	397,300		37,078		428,772		112,995		6,001		140,421		1,122,567
Special Mention		1,037		714		2,282		173		18		1,813		6,037
Substandard		2,163		109		1,813		499		10		31		4,625
Total loans receivable	$	400,500		37,901		432,867		113,667		6,029		142,265		1,133,229

Performing	$	398,949		37,570		431,135		113,151		6,010		142,240		1,129,055
Nonperforming:
90 days or more and still accruing		—		—		—		—		—		—		—
Nonaccrual		1,551		331		1,732		516		19		25		4,174
Total nonperforming		1,551		331		1,732		516		19		25		4,174
Total loans receivable	$	400,500		37,901		432,867		113,667		6,029		142,265		1,133,229

	At December 31, 2015
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	342,173		23,256		331,671		90,700		5,131		115,268		908,199
Special Mention		532		—		8,152		172		—		919		9,775
Substandard		2,233		—		1,835		490		48		153		4,759
Total loans receivable	$	344,938		23,256		341,658		91,362		5,179		116,340		922,733


Performing	$	342,906		23,256		339,972		90,863		5,129		116,305		918,431
Nonperforming:
90 days or more and still accruing		—		—		—		—		—		—		—
Nonaccrual		2,032		—		1,686		499		50		35		4,302
Total nonperforming		2,032		—		1,686		499		50		35		4,302
Total loans receivable	$	344,938		23,256		341,658		91,362		5,179		116,340		922,733

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

Troubled Debt Restructurings

At September 30, 2016, there were $6.3 million in loans designated as troubled debt restructurings of which $4.9 million were accruing. At December 31, 2015, there were $14.4 million in loans designated as troubled debt restructurings of which $13.2 million were accruing.

There were no loans designated as troubled debt restructuring during the three months or nine months ended September 30, 2016.

There were no loans designed as troubled debt restructuring during the three months ended September 30, 2015. There was one relationship totaling fourteen loans designated as a troubled debt restructuring during the nine months ended September 30, 2015. All loans within this relationship were designated as troubled debt restructuring due to a change in payment structure. Eleven loans were within the one-to-four family loan segment with a pre-modification and post-modification recorded investment of $749,000. Two loans were within the commercial real estate loan segment with a pre-modification and post-modification recorded investment of $147,000. One loan was within the commercial and industrial loan segment with a pre-modification and post-modification recorded investment of $14,000.

No loans previously restructured in the twelve months prior to September 30, 2016 and 2015 went into default during the three months or nine months ended September 30, 2016 and 2015.

NOTE 6 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE

The following presents summarized activity in real estate acquired through foreclosure for the periods ended September 30, 2016 and December 31, 2015:

	September 30,			December 31,
	2016			2015
	(In thousands)
Balance at beginning of period	$	2,374			3,239
Additions		2,346			1,307
Sales		(1,877	)		(2,172	)
Write downs		—			—
Balance at end of period	$	2,843			2,374

A summary of the composition of real estate acquired through foreclosure follows:

	At September 30,		At December 31,
	2016		2015
	(In thousands)
Real estate loans:
One-to-four family	$	1,413		773
Commercial real estate		—		484
Construction and development		1,430		1,117
	$	2,843		2,374

NOTE 7 - DEPOSITS

Deposits outstanding by type of account at September 30, 2016 and December 31, 2015 are summarized as follows:

	At September 30,		At December 31,
	2016		2015
	(In thousands)
Noninterest-bearing demand accounts	$	267,892		163,054
Interest-bearing demand accounts		195,792		158,581
Savings accounts		47,035		39,147
Money market accounts		299,960		223,906
Certificates of deposit:
Less than $250,000		476,744		428,067
$250,000 or more		24,853		18,773
Total certificates of deposit		501,597		446,840
Total deposits	$	1,312,276		1,031,528

The aggregate amount of brokered certificates of deposit was $101.7 million and $97.1 million at September 30, 2016 and December 31, 2015, respectively. The aggregate amount of institutional certificates of deposit was $49.6 million and $51.5 million at September 30, 2016 and December 31, 2015, respectively. Brokered certificates of deposit and institutional certificates of deposit are included in the table above under certificates of deposit less than $250,000.

The Company has pledged $22.8 million of securities as of September 30, 2016 to secure public agency funds.

NOTE 8 – ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

Current accounting literature requires disclosures about the fair value of all financial instruments whether or not recognized in the balance sheet, for which it is practicable to estimate the value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized through immediate settlement of the instrument. Certain items are specifically excluded from disclosure requirements, including the Company’s stock, premises and equipment, accrued interest receivable and payable and other assets and liabilities.

The fair value of a financial instrument is an amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced sale. Fair values are estimated at a specific point in time based on relevant market information and information about the financial instruments. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.

The Company has used management’s best estimate of fair value based on the above assumptions. Thus the fair values presented may not be the amounts that could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair values presented.

The Company determines the fair value of its financial instruments based on the fair value hierarchy established under ASC 820-10, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the financial instrument’s fair value measurement in its entirety. There are three levels of inputs that may be used to measure fair value. The three levels of inputs of the valuation hierarchy are defined below:

Level 1

Quoted prices (unadjusted) in active markets for identical assets and liabilities for the instrument or security to be valued. Level 1 assets include marketable equity securities as well as U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2

Observable inputs other than Level 1 quoted prices, such as quoted prices for similar assets and liabilities in active markets, quoted prices in markets that are not active, or model-based valuation techniques for which all significant assumptions are derived principally from or corroborated by observable market data. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and derivative contracts whose value is determined by using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. U.S. Government sponsored agency securities, mortgage-backed securities issued by U.S. Government sponsored enterprises and agencies, obligations of states and municipalities, collateralized mortgage obligations issued by U.S. Government sponsored enterprises, and mortgage loans held-for-sale are generally included in this category. Certain private equity investments that invest in publicly traded companies are also considered Level 2 assets.

Level 3

Unobservable inputs that are supported by little, if any, market activity for the asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow models and similar techniques, and may also include the use of market prices of assets or liabilities that are not directly comparable to the subject asset or liability. These methods of valuation may result in a significant portion of the fair value being derived from unobservable assumptions that reflect The Company’s own estimates for assumptions that market participants would use in pricing the asset or liability. This category primarily includes collateral-dependent impaired loans, other real estate, certain equity investments, and certain private equity investments.

Cash and due from banks - The carrying amounts of these financial instruments approximate fair value. All mature within 90 days and present no anticipated credit concerns.

Interest-bearing cash - The carrying amount of these financial instruments approximates fair value.

Securities available-for-sale and securities held to maturity – Fair values for investment securities available-for-sale and securities held to maturity are based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

FHLB stock and other non-marketable equity securities - The carrying amount of these financial instruments approximates fair value.

Mortgage loans held for sale – Mortgage loans held for sale are recorded at either fair value, if elected, or the lower of cost or fair value on an individual loan basis. Origination fees and costs for loans held for sale recorded at lower of cost or market are capitalized in the basis of the loan and are included in the calculation of realized gains and losses upon sale. Origination fees and costs are recognized in earnings at the time of origination for loans held for sale that are recorded at fair value. Fair value is derived from observable current market prices, when available, and includes loan servicing value. When observable market prices are not available, the Company uses judgment and estimates fair value using internal models, in which the Company uses its best estimates of assumptions it believes would be used by market participants in estimating fair value. Mortgage loans held for sale are classified within Level 2 of the valuation hierarchy.

Loans receivable - The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Further adjustments are made to reflect current market conditions. There is no discount for liquidity included in the expected cash flow assumptions. Loans receivable are classified within Level 3 of the valuation hierarchy.

Accrued interest receivable - The carrying value approximates the fair value.

Mortgage servicing rights - The Company initially measures servicing assets and liabilities retained related to the sale of residential loans held for sale (“mortgage servicing rights”) at fair value, if practicable. For subsequent measurement purposes, the Company measures servicing assets and liabilities based on the lower of cost or market.

Deposits - The estimated fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The estimated fair value of fixed maturity certificates of deposits is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturities.

Bank-owned life insurance - The cash surrender value of bank owned life insurance policies held by the Bank approximates fair values of the policies.

Short-term borrowed funds - The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Estimated fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Long-term debt - The estimated fair values of the Company’s long-term debt are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Other Investments – The carrying value approximates the fair value.

Derivative assets and liabilities – The primary use of derivative instruments are related to the mortgage banking activities of the Company. The Company’s wholesale mortgage banking subsidiary enters into interest rate lock commitments related to expected funding of residential mortgage loans at specified times in the future. Interest rate lock commitments that relate to the origination of mortgage loans that will be held-for-sale are considered derivative instruments under applicable accounting guidance. As such, The Company records its interest rate lock commitments and forward loan sales commitments at fair value, determined as the amount that would be required to settle each of these derivative financial instruments at the balance sheet date. In the normal course of business, the mortgage subsidiary enters into contractual interest rate lock commitments to extend credit, if approved, at a fixed interest rate and with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within the time frames established by the mortgage banking subsidiary. Market risk arises if interest rates move adversely between the time of the interest rate lock by the borrower and the sale date of the loan to an investor. To mitigate the effect of the interest rate risk inherent in providing interest rate lock commitments to borrowers, the mortgage banking subsidiary enters into best efforts forward sales contracts with third party investors. The forward sales contracts lock in a price for the sale of loans similar to the specific interest rate lock commitments. Both the interest rate lock commitments to the borrowers and the forward sales contracts to the investors that extend through to the date the loan may close are derivatives, and accordingly, are marked to fair value through earnings. In estimating the fair value of an interest rate lock commitment, the Company assigns a probability to the interest rate lock commitment based on an expectation that it will be exercised and the loan will be funded. The fair value of the interest rate lock commitment is derived from the fair value of related mortgage loans, which is based on observable market data and includes the expected net future cash flows related to servicing of the loans. The fair value of the interest rate lock commitment is also derived from inputs that include guarantee fees negotiated with the agencies and private investors, buy-up and buy-down values provided by the agencies and private investors, and interest rate spreads for the difference between retail and wholesale mortgage rates. Management also applies fall-out ratio assumptions for those interest rate lock commitments for which we do not close a mortgage loan. The fall-out ratio assumptions are based on the mortgage subsidiary’s historical experience, conversion ratios for similar loan commitments, and market conditions. While fall-out tendencies are not exact predictions of which loans will or will not close, historical performance review of loan-level data provides the basis for determining the appropriate hedge ratios. In addition, on a periodic basis, the mortgage banking subsidiary performs analysis of actual rate lock fall-out experience to determine the sensitivity of the mortgage pipeline to interest rate changes from the date of the commitment through loan origination, and then period end, using applicable published mortgage-backed investment security prices. The expected fall-out ratios (or conversely the “pull-through” percentages) are applied to the determined fair value of the unclosed mortgage pipeline in accordance with GAAP. Changes to the fair value of interest rate lock commitments are recognized based on interest rate changes, changes in the probability that the commitment will be exercised, and the passage of time. The fair value of the forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date. These instruments are defined as Level 2 within the valuation hierarchy.

Derivative instruments not related to mortgage banking activities interest rate swap agreements. Fair values for these instruments are based on quoted market prices, when available. As such, the fair value adjustments for derivatives with fair values based on quoted market prices are recurring Level 1.

Commitments to extend credit – The carrying amounts of these commitments are considered to be a reasonable estimate of fair value because the commitments underlying interest rates are based upon current market rates.

Accrued interest payable - The fair value approximates the carrying value.

Off-balance sheet financial instruments – Contract values and fair values for off-balance sheet, credit-related financial instruments are based on estimated fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and counterparties’ credit standing.

The carrying amount and estimated fair value of the Company’s financial instruments at September 30, 2016 and December 31, 2015 are as follows:

	At September 30, 2016
	Carrying		Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial assets:
Cash and due from banks	$	9,110		9,110		9,110		—		—
Interest-bearing cash		29,211		29,211		29,211		—		—
Securities available-for-sale		336,918		336,918		—		336,918		—
Federal Home Loan Bank stock		7,438		7,438		—		—		7,438
Other investments		1,801		1,801		—		—		1,801
Derivative assets		3,168		3,168		12		3,156		—
Loans held for sale		36,686		36,686		—		36,686		—
Loans receivable, net		1,122,889		1,131,403		—		—		1,131,403
Accrued interest receivable		4,813		4,813		—		4,813		—
Mortgage servicing rights		13,556		17,461		—		—		17,461
Cash value life insurance		28,772		28,772		—		28,772		—

Financial liabilities:
Deposits		1,312,276		1,313,429		—		1,313,429		—
Short-term borrowed funds		87,500		87,500		—		87,500		—
Long-term debt		68,465		70,935		—		70,935		—
Derivative liabilities		2,708		2,708		2,507		201		—
Accrued interest payable		346		346		—		346		—

	At December 31, 2015
	Carrying		Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial assets:
Cash and due from banks	$	10,206		10,206		10,206		—		—
Interest-bearing cash		16,421		16,421		16,421		—		—
Securities available-for-sale		306,474		306,474		—		306,474		—
Securities held-to-maturity		17,053		17,965		—		17,965		—
Federal Home Loan Bank stock		9,919		9,919		—		—		9,919
Other investments		3,273		3,273		—		—		3,273
Derivative assets		1,945		1,945		180		1,765		—
Loans held for sale		41,774		41,774		—		41,774		—
Loans receivable, net		912,582		917,043		—		—		917,043
Cash value life insurance		28,082		28,082		—		28,082		—
Accrued interest receivable		4,333		4,333		—		4,333		—
Mortgage servicing rights		11,433		17,564		—		—		17,564

Financial liabilities:
Deposits		1,031,528		1,029,406		—		1,029,406		—
Short-term borrowed funds		120,000		119,880		—		119,880		—
Long-term debt		103,465		105,551		—		105,551		—
Derivative liabilities		306		306		306		—		—
Accrued interest payable		333		333		—		333		—

At September 30, 2016

At December 31, 2015

Notional

Estimated

Notional

Estimated

Amount

Fair Value

Amount

Fair Value

(In thousands)

Off-Balance Sheet Financial Instruments:

Commitments to extend credit

104,795

—

70,365

—

Standby letters of credit

1,516

—

1,357

—

In determining appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to fair value disclosures. At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.

Following is a description of valuation methodologies used for assets recorded at fair value on a recurring and non-recurring basis.

Securities Available-for-Sale

Measurement is on a recurring basis upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. At September 30, 2016 and December 31, 2015, the Company’s investment securities available-for-sale are recurring Level 2.

Mortgage Loans Held for Sale

Mortgage loans held for sale are recorded at either fair value, if elected, or the lower of cost or fair value on an individual loan basis. Origination fees and costs for loans held for sale recorded at lower of cost or market are capitalized in the basis of the loan and are included in the calculation of realized gains and losses upon sale. Origination fees and costs are recognized in earnings at the time of origination for loans held for sale that are recorded at fair value. Fair value is derived from observable current market prices, when available, and includes loan servicing value. When observable market prices are not available, the Company uses judgment and estimates fair value using internal models, in which the Company uses its best estimates of assumptions it believes would be used by market participants in estimating fair value. Mortgage loans held for sale are classified within Level 2 of the valuation hierarchy.

Derivative Assets and Liabilities

The primary use of derivative instruments is related to the mortgage banking activities of the Company. The Company’s wholesale mortgage banking subsidiary enters into interest rate lock commitments related to expected funding of residential mortgage loans at specified times in the future. Interest rate lock commitments that relate to the origination of mortgage loans that will be held-for-sale are considered derivative instruments under applicable accounting guidance. As such, The Company records its interest rate lock commitments and forward loan sales commitments at fair value, determined as the amount that would be required to settle each of these derivative financial instruments at the balance sheet date. In the normal course of business, the mortgage subsidiary enters into contractual interest rate lock commitments to extend credit, if approved, at a fixed interest rate and with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within the time frames established by the mortgage banking subsidiary. Market risk arises if interest rates move adversely between the time of the interest rate lock by the borrower and the sale date of the loan to an investor. To mitigate the effect of the interest rate risk inherent in providing interest rate lock commitments to borrowers, the mortgage banking subsidiary enters into best efforts forward sales contracts with third party investors. The forward sales contracts lock in a price for the sale of loans similar to the specific interest rate lock commitments. Both the interest rate lock commitments to the borrowers and the forward sales contracts to the investors that extend through to the date the loan may close are derivatives, and accordingly, are marked to fair value through earnings. In estimating the fair value of an interest rate lock commitment, the Company assigns a probability to the interest rate lock commitment based on an expectation that it will be exercised and the loan will be funded. The fair value of the interest rate lock commitment is derived from the fair value of related mortgage loans, which is based on observable market data and includes the expected net future cash flows related to servicing of the loans. The fair value of the interest rate lock commitment is also derived from inputs that include guarantee fees negotiated with the agencies and private investors, buy-up and buy-down values provided by the agencies and private investors, and interest rate spreads for the difference between retail and wholesale mortgage rates. Management also applies fall-out ratio assumptions for those interest rate lock commitments for which we do not close a mortgage loan. The fall-out ratio assumptions are based on the mortgage subsidiary’s historical experience, conversion ratios for similar loan commitments, and market conditions. While fall-out tendencies are not exact predictions of which loans will or will not close, historical performance review of loan-level data provides the basis for determining the appropriate hedge ratios. In addition, on a periodic basis, the mortgage banking subsidiary performs analysis of actual rate lock fall-out experience to determine the sensitivity of the mortgage pipeline to interest rate changes from the date of the commitment through loan origination, and then period end, using applicable published mortgage-backed investment security prices. The expected fall-out ratios (or conversely the “pull-through” percentages) are applied to the determined fair value of the unclosed mortgage pipeline in accordance with GAAP. Changes to the fair value of interest rate lock commitments are recognized based on interest rate changes, changes in the probability that the commitment will be exercised, and the passage of time. The fair value of the forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date. These instruments are defined as Level 2 within the valuation hierarchy.

Derivative instruments not related to mortgage banking activities include interest rate swap agreements. Fair values for these instruments are based on quoted market prices, when available. As such, the fair value adjustments for derivatives with fair values based on quoted market prices in an active market are recurring Level 1.

Impaired Loans

Loans that are considered impaired are recorded at fair value on a nonrecurring basis. Once a loan is considered impaired, the fair value is measured using one of several methods, including collateral liquidation value, market value of similar debt and discounted cash flows. Those impaired loans not requiring a specific charge against the allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investment in the loan. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair value of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be Level 3 inputs.

Other Real Estate Owned (“OREO”)

OREO is carried at the lower of carrying value or fair value on a nonrecurring basis. Fair value is based upon independent appraisals or management’s estimation of the collateral and is considered a Level 3 measurement. When the OREO value is based upon a current appraisal or when a current appraisal is not available or there is estimated further impairment, the measurement is considered a Level 3 measurement.

Mortgage Servicing Rights

A mortgage servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans are expected to more than adequately compensate the Company for performing the servicing. The Company initially measures servicing assets and liabilities retained related to the sale of residential loans held for sale (“mortgage servicing rights”) at fair value, if practicable. For subsequent measurement purposes, the Company measures servicing assets and liabilities based on the lower of cost or market on a quarterly basis. The quarterly determination of fair value of servicing rights is provided by a third party and is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.

Assets and liabilities measured at fair value on a recurring basis are as follows as of September 30, 2016 and December 31, 2015:

	Quoted market price		Significant other		Significant other
	in active markets		observable inputs		unobservable inputs
	(Level 1)		(Level 2)		(Level 3)
	(In thousands)
September 30, 2016
Available-for-sale investment securities:
Municipal securities	$	—		87,864		—
US government agencies		—		3,430		—
Collateralized loan obligations		—		63,309		—
Corporate securities		—		521		—
Mortgage-backed securities:
Agency		—		98,322		—
Non-agency		—		76,715		—
Trust Preferred Securities		—		6,757		—
Loans held for sale		—		36,686		—
Derivative assets:
Non-hedging derivatives:
Interest rate swaps		12		—		—
Mortgage loan interest rate lock commitments		—		2,583		—
Mortgage loan forward sales commitments		—		573		—
Derivative liabilities:
Cash flow hedges:
Interest rate swaps		1,783		—		—
Non-hedging derivatives:
Interest rate swaps		724		—		—
Mortgage-backed securities forward sales commitment		—		201		—
Total	$	2,519		376,961		—

December 31, 2015
Available-for-sale investment securities:
Municipal securities	$	—		62,475		—
US government agencies		—		7,096		—
Collateralized loan obligations		—		38,758		—
Mortgage-backed securities:
Agency		—		113,855		—
Non-agency		—		75,536		—
Trust preferred securities		—		8,754		—
Loans held for sale		—		41,774		—
Derivative assets:
Cash flow hedges:
Interest rate swaps		180		—		—
Non-hedging derivatives:
Mortgage loan interest rate lock commitments		—		1,246		—
Mortgage loan forward sales commitments		—		340		—
Mortgage-backed securities forward sales commitment		—		179		—
Derivative liabilities:
Non-hedging derivatives:
Interest rate swaps		306		—		—
Total	$	486		350,013		—

Assets measured at fair value on a nonrecurring basis are as follows as of September 30, 2016 and December 31, 2015:

	Quoted market price		Significant other		Significant other
	in active markets		observable inputs		unobservable inputs
	(Level 1)		(Level 2)		(Level 3)
	(In thousands)
September 30, 2016
Impaired loans:
Loans secured by real estate:
One-to-four family	$	—		—		2,729
Home equity		—		—		302
Commercial real estate		—		—		4,971
Construction and development		—		—		516
Consumer loans		—		—		33
Commercial business loans		—		—		272
Real estate owned:
One-to-four family		—		—		1,413
Construction and development		—		—		1,430
Mortgage servicing rights		—		—		17,461
Total	$	—		—		29,127

December 31, 2015
Impaired loans:
Loans secured by real estate:
One-to-four family	$	—		—		3,953
Commercial real estate		—		—		12,156
Construction and development		—		—		380
Consumer loans		—		—		65
Commercial business loans		—		—		473
Real estate owned:
One-to-four family		—		—		773
Commercial real estate		—		—		484
Construction and development		—		—		1,117
Mortgage servicing rights		—		—		17,564
Total	$	—		—		36,965

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2016 and December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

	September 30, 2016 and December 31, 2015
		Significant	Significant Unobservable
	Valuation Technique	Observable Inputs	Inputs
Impaired Loans	Appraisal Value	Appraisals and or sales of comparable properties	Appraisals discounted 10% to 20% for sales commissions and other holding costs

Real estate owned	Appraisal Value/ Comparison Sales/ Other estimates	Appraisals and or sales of comparable properties	Appraisals discounted 10% to 20% for sales commissions and other holding costs

Mortgage Servicing Rights	Discounted cash flows	Comparable sales	Discount rates ranges 12% - 13% - 2016 and 2015 Prepayment rate 11% - 12% - 2016 Prepayment rate 8% - 9% - 2015

NOTE 9 - EARNINGS PER SHARE

On June 22, 2015, the Board of Directors of the Company declared a six-for-five stock split representing a 20% stock dividend to stockholders of record as of July 15, 2015, payable on July 31, 2015.

All share, earnings per share, and per share data have been retroactively adjusted to reflect the stock splits for all periods presented in accordance with GAAP.

The following is a summary of the reconciliation of weighted average shares outstanding for the three months and nine months ended September 30, 2016 and 2015:

	For the Three Months Ended September 30,
	2016				2015
	Basic		Diluted		Basic		Diluted

Weighted average shares outstanding		12,327,921		12,327,921		9,463,722		9,463,722
Effect of dilutive securities		—		207,630		—		211,272
Weighted average shares outstanding		12,327,921		12,535,551		9,463,722		9,674,994

	For the Nine Months Ended September 30,
	2016				2015
	Basic		Diluted		Basic		Diluted

Weighted average shares outstanding		11,995,477		11,995,477		9,421,042		9,421,042
Effect of dilutive securities		—		206,244		—		174,949
Weighted average shares outstanding		11,995,477		12,201,721		9,421,042		9,595,991

The following is a summary of the reconciliation of shares issued and outstanding and unvested restricted stock awards as of September 30, 2016 and 2015 used to calculate book value per share:

	As of September 30,
	2016			2015

Issued and outstanding shares		12,546,220			9,763,383
Less nonvested restricted stock awards		(216,828	)		(299,606	)
Period end dilutive shares		12,329,392			9,463,777

NOTE 10 – SUPPLEMENTAL SEGMENT INFORMATION

The Company has three reportable segments: community banking, wholesale mortgage banking (“mortgage banking”) and other. The community banking segment includes traditional banking services offered through CresCom Bank as well as the managerial and operational support provided by Carolina Services. The mortgage banking segment provides wholesale mortgage loan origination and servicing offered through Crescent Mortgage Company. The other segment includes parent company financial information and represents an overhead function rather than an operating segment. The parent company’s most significant assets are its net investments in its subsidiaries.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on net income.

The Company accounts for intersegment revenues and expenses as if the revenue/expense transactions were generated to third parties, that is, at current market prices.

The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each segment has different types and levels of credit and interest rate risk.

The following tables present selected financial information for the Company’s reportable business segments for the three months and nine months ended September 30, 2016 and 2015:

	Community			Mortgage
For the Three Months Ended September 30, 2016	Banking			Banking			Other			Eliminations			Total
	(In thousands)
Interest income	$	15,760			435			4			9			16,208
Interest expense		2,102			33			151			(34	)		2,252
Net interest income (expense)		13,658			402			(147	)		43			13,956
Provision for loan losses		(12	)		12			—			—			—
Noninterest income from external customers		2,512			6,361			—			—			8,873
Intersegment noninterest income		242			(9	)		—			(233	)		—
Noninterest expense		9,448			4,254			188			—			13,890
Intersegment noninterest expense		—			240			2			(242	)		—
Income (loss) before income taxes		6,976			2,248			(337	)		52			8,939
Income tax expense (benefit)		2,242			846			(109	)		19			2,998
Net income (loss)	$	4,734			1,402			(228	)		33			5,941

	Community			Mortgage
For the Three Months Ended September 30, 2015	Banking			Banking			Other			Eliminations			Total
	(In thousands)
Interest income	$	11,971			550			4			(13	)		12,512
Interest expense		1,475			37			148			(37	)		1,623
Net interest income (expense)		10,496			513			(144	)		24			10,889
Provision for loan losses		(5	)		5			—			—			—
Noninterest income from external customers		1,670			5,652			—			—			7,322
Intersegment noninterest income		1			8			1,768			(1,777	)		—
Noninterest expense		6,444			3,901			2,036			—			12,381
Intersegment noninterest expense		1,528			241			—			(1,769	)		—
Income (loss) before income taxes		4,200			2,026			(412	)		16			5,830
Income tax expense (benefit)		1,346			753			(156	)		6			1,949
Net income (loss)	$	2,854			1,273			(256	)		10			3,881

	Community			Mortgage
For the Nine Months Ended September 30, 2016	Banking			Banking		Other			Eliminations			Total
	(In thousands)
Interest income	$	42,790			1,133		13			75			44,011
Interest expense		6,066			42		447			(43	)		6,512
Net interest income (expense)		36,724			1,091		(434	)		118			37,499
Provision for loan losses		(12	)		12		—			—			—
Noninterest income from external customers		6,773			15,615		—			—			22,388
Intersegment noninterest income		727			25		—			(752	)		—
Noninterest expense		29,523			11,825		619			—			41,967
Intersegment noninterest expense		—			721		6			(727	)		—
Income (loss) before income taxes		14,713			4,173		(1,059	)		93			17,920
Income tax expense (benefit)		4,404			1,451		(390	)		35			5,500
Net income (loss)	$	10,309			2,722		(669	)		58			12,420

	Community			Mortgage
For the Nine Months September 30, 2015	Banking			Banking		Other			Eliminations			Total
	(In thousands)
Interest income	$	35,139			1,423		12			28			36,602
Interest expense		4,263			89		439			(89	)		4,702
Net interest income (expense)		30,876			1,334		(427	)		117			31,900
Provision for loan losses		(57	)		57		—			—			—
Noninterest income from external customers		4,569			16,605		2			—			21,176
Intersegment noninterest income		3			84		5,304			(5,391	)		—
Noninterest expense		19,019			11,989		5,955			—			36,963
Intersegment noninterest expense		4,584			723		—			(5,307	)		—
Income (loss) before income taxes		11,902			5,254		(1,076	)		33			16,113
Income tax expense (benefit)		3,758			1,947		(416	)		13			5,302
Net income (loss)	$	8,144			3,307		(660	)		20			10,811

The following tables present selected financial information for the Company’s reportable business segments for September 30, 2016 and December 31, 2015:

	Community		Mortgage
At September 30, 2016	Banking		Banking		Other		Eliminations			Total
	(In thousands)
Assets	$	1,649,478		78,440		175,051		(249,120	)		1,653,849
Loans receivable, net		1,112,898		22,528		—		(12,537	)		1,122,889
Loans held for sale		3,346		33,340		—		—			36,686
Deposits		1,318,585		—		—		(6,309	)		1,312,276
Borrowed funds		140,500		11,950		15,465		(11,950	)		155,965

	Community		Mortgage
At December 31, 2015	Banking		Banking		Other		Eliminations			Total
	(In thousands)
Assets	$	1,404,681		75,926		156,774		(227,712	)		1,409,669
Loans receivable, net		908,227		17,783		—		(13,428	)		912,582
Loans held for sale		3,466		38,308		—		—			41,774
Deposits		1,047,671		—		—		(16,143	)		1,031,528
Borrowed funds		208,000		12,748		15,465		(12,748	)		223,465

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

The following discussion reviews our results of operations for the three months and nine months ended September 30, 2016 as compared to the three months and nine months ended September 30, 2015 and assesses our financial condition as of September 30, 2016 as compared to December 31, 2015. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and the related notes and the consolidated financial statements and the related notes for the year ended December 31, 2015 included in our Form 10-K for that period. Results for the three months and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 or any future period.

Cautionary Warning Regarding Forward-Looking Statements

This report, including information included or incorporated by reference in this report, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, the following:

●

our ability to maintain appropriate levels of capital and to comply with our capital ratio requirements;

●

examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets or otherwise impose restrictions or conditions on our operations, including, but not limited to, our ability to acquire or be acquired;

●

changes in economic conditions, either nationally or regionally and especially in our primary market areas, resulting in, among other things, a deterioration in credit quality;

●

changes in interest rates, or changes in regulatory environment resulting in a decline in our mortgage production and a decrease in the profitability of our mortgage banking operations;

●

greater than expected losses due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including, but not limited to, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

●

greater than expected losses due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

●

changes in the amount of our loan portfolio collateralized by real estate and weaknesses in the South Carolina, southeastern North Carolina and national real estate markets;

●

the rate of delinquencies and amount of loans charged-off;

●

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

●

the rate of loan growth in recent or future years;

●

our ability to attract and retain key personnel;

●

our ability to retain our existing customers, including our deposit relationships;

●

significant increases in competitive pressure in the banking and financial services industries;

●

adverse changes in asset quality and resulting credit risk-related losses and expenses;

●

changes in the interest rate environment which could reduce anticipated or actual margins;

●

changes in political conditions or the legislative or regulatory environment, including, but not limited to, the Dodd-Frank Act and regulations adopted thereunder, changes in federal or state tax laws or interpretations thereof by taxing authorities and other governmental initiatives affecting the banking, mortgage banking, and financial service industries;

●

changes occurring in business conditions and inflation;

●

increased funding costs due to market illiquidity, increased competition for funding, or increased regulatory requirements with regard to funding;

●

our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, business and a negative impact on results of operations;

●

changes in deposit flows;

●

changes in technology;

●

changes in monetary and tax policies;

●

changes in accounting policies, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board;

●

loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;

●

our expectations regarding our operating revenues, expenses, effective tax rates and other results of operations;

●

our anticipated capital expenditures and our estimates regarding our capital requirements;

●

our liquidity and working capital requirements;

●

competitive pressures among depository and other financial institutions;

●

the growth rates of the markets in which we compete;

●

our anticipated strategies for growth and sources of new operating revenues;

●

our current and future products, services, applications and functionality and plans to promote them;

●

anticipated trends and challenges in our business and in the markets in which we operate;

●

the evolution of technology affecting our products, services and markets;

●

our ability to retain and hire necessary employees and to staff our operations appropriately;

●

management compensation and the methodology for its determination;

	●	our ability to compete in our industry and innovation by our competitors;
	●	increased cybersecurity risk, including potential business disruptions or financial losses;

●

acquisition integration risks, including potential deposit attrition, higher than expected costs, customer loss and business disruption, including, without limitation, potential difficulties in maintaining relationships with key personnel and other integration related matters, and the inability to identify and successfully negotiate and complete additional combinations with potential merger or acquisition partners or to successfully integrate such businesses into the Company, including the ability to realize the benefits and cost savings from, and limit any unexpected liabilities associated with, any such business combinations;

●

our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business; and

●

estimates and estimate methodologies used in preparing our consolidated financial statements and determining option exercise prices and stock-based compensation.

If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements prove to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. For 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 Form10-K for the year ended December 31, 2015. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q and our other reports filed pursuant to the Securities Exchange Act of 1934. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed, implied or projected by us in the forward-looking statements.

Company Overview

Carolina Financial Corporation (“Carolina Financial” or the “Company”) is a Delaware corporation that was organized in February 1997 to serve as a bank holding company. It operates principally through CresCom Bank, a South Carolina state-chartered bank. CresCom Bank operates Crescent Mortgage Company and Carolina Service Corporation of Charleston as wholly-owned subsidiaries of CresCom Bank. Except where the context otherwise requires, the “Company”, “we”, “us” and “our” refer to Carolina Financial Corporation and its consolidated subsidiaries and the “Bank” refers to CresCom Bank.

CresCom Bank provides a full range of commercial and retail banking financial services designed to meet the financial needs of our customers through its branch network in South Carolina and North Carolina. Crescent Mortgage Company, headquartered in Atlanta, Georgia, is a wholesale mortgage company that provides mortgage banking services in 45 states and partners with community banks, credit unions and mortgage brokers.

Like most community banks, we derive a significant portion of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, both interest-bearing and noninterest-bearing. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowed funds. In order to maximize our net interest income, we must not only manage the volume of these balance sheet items, but also the yields that we earn on our interest-earning assets and the rates that we pay on interest-bearing liabilities.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.

In addition to earning interest on our loans and investments, we derive a portion of our income from Crescent Mortgage Company through mortgage banking income as well as servicing income. We also earn income through fees that we charge to our customers. Likewise, we incur other operating expenses as well.

Economic conditions, competition, and the monetary and fiscal policies of the federal government significantly affect most financial institutions, including the Bank. Lending and deposit activities and fee income generation are influenced by levels of business spending and investment, consumer income, consumer spending and savings, capital market activities, and competition among financial institutions as well as client preferences, interest rate conditions and prevailing market rates on competing products in our market areas.

Recent Events

On October 19, 2016, the Board of Directors of Carolina Financial declared a quarterly cash dividend of $0.04, payable on January 11, 2017 to stockholders of record as of December 28, 2016.

Executive Summary of Operating Results

The following is a summary of the Company’s financial highlights and significant events in the third quarter of 2016:

●

Net income for the third quarter 2016 increased 53.1% to $5.9 million, or $0.47 per diluted share from $3.9 million, or $0.40 per diluted share for the third quarter of 2015.

●

Operating earnings for the third quarter of 2016, which excludes certain non-operating income and expenses, increased 45.8% to $5.9 million, or $0.47 per diluted share, from $4.0 million, or $0.42 per diluted share, from the third quarter of 2015.

●

Loans receivable, excluding acquired loans, grew at an annualized rate of 19.3% or $133.7 million since December 31, 2015 and 24.7% or $66.0 million since June 30, 2016.

●

Nonperforming assets to total assets of 0.42% as of September 30, 2016.

●

Core deposits, excluding acquired deposits, increased $150.0 million since December 31, 2015 and $45.3 million since June 30, 2016.

●

Operating return on average assets of 1.45% and operating return on average equity of 14.95% for the third quarter of 2016 compared to operating return on average assets of 1.22% and operating return on average equity of 15.77% for the third quarter of 2015.

●

System integration related to the acquisition of Congaree Bancshares, Inc. (“Congaree”) was completed during the third quarter of 2016.

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. The Company’s management uses these non-GAAP financial measures, including: (i) operating earnings; (ii) operating earnings per common share (iii) operating return on average assets, (iv) operating return on average equity, (v) core deposits, and (vi) tangible book value.

Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company without regard to transactional activities. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and 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 financial 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.

The following table presents a reconciliation of Non-GAAP performance measures for operating earnings and corresponding ratios:

	For the Three Months Ended						For the Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2016			2015			2016			2015
Operating Earnings:
Income before income taxes	$	8,939			5,830			17,920			16,113
Gain on sale of securities		(111	)		(1,017	)		(641	)		(1,459	)
Net loss on extinguishment of debt		118			—			174			1,215
Fair value adjustments on interest rate swaps		(99	)		1,246			408			1,253
Merger related costs		—			—			2,985			—
Operating earnings before income taxes		8,847			6,059			20,846			17,122
Tax expense (1) (2)		2,967			2,026			6,398			5,634
Operating earnings (Non-GAAP)	$	5,880			4,033			14,448			11,488

Average equity		157,311			102,326			148,134			98,805
Average assets		1,626,717			1,322,382			1,500,819			1,283,183
Operating return on average assets (Non-GAAP)		1.45	%		1.22	%		1.28	%		1.19	%
Operating return on average equity (Non-GAAP)		14.95	%		15.77	%		13.00	%		15.50	%

Weighted average common shares outstanding:
Basic		12,327,921			9,463,772			11,995,477			9,421,042
Diluted		12,535,551			9,674,994			12,201,721			9,595,991
Operating earnings per common share:
Basic (Non-GAAP)	$	0.48			0.43			1.20			1.22
Diluted (Non-GAAP)	$	0.47			0.42			1.18			1.20

As Reported:
Income before income taxes	$	8,939			5,830			17,920			16,113
Tax expense		2,998			1,949			5,500			5,302
Net Income	$	5,941			3,881			12,420			10,811

Average equity		157,311			102,326			148,134			98,805
Average assets		1,626,717			1,322,382			1,500,819			1,283,183
Return on average assets		1.46	%		1.17	%		1.10	%		1.12	%
Return on average equity		15.11	%		15.17	%		11.18	%		14.59	%

Weighted average common shares outstanding:
Basic		12,327,921			9,463,772			11,995,477			9,421,042
Diluted		12,535,551			9,674,994			12,201,721			9,595,991
Earnings per common share:
Basic	$	0.48			0.41			1.04			1.15
Diluted	$	0.47			0.40			1.02			1.13

(1) Tax expense is determined using the effective tax rate reflected in the accompanying income statement for the applicable reporting period.

(2) In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions, including income tax consequences. In addition to other changes, the guidance changes the accounting for excess tax benefits and tax deficiencies from generally being recognized in additional paid-in capital to recognition as income tax expense or benefit in the period they occur. The Company early adopted the new guidance in the second quarter of 2016. As a result, the Company’s income tax expense was reduced by approximately $399,000, or $0.03 per diluted share, in the second quarter of 2016.

The following table presents a reconciliation of Non-GAAP performance measures of core deposits and tangible book value per share.

	At September 30,			At December 31,
	2016			2015

Core deposits:
Noninterest-bearing demand accounts	$	267,892			163,054
Interest-bearing demand accounts		195,792			158,581
Savings accounts		47,035			39,147
Money market accounts		299,960			223,906
Total core deposits (Non-GAAP)		810,679			584,688

Certificates of deposit:
Less than $250,000		476,744			428,067
$250,000 or more		24,853			18,773
Total certificates of deposit		501,597			446,840
Total deposits	$	1,312,276			1,031,528

	At September 30,			At December 31,
	2016			2015

Tangible book value per share:
Total stockholders’ equity	$	160,331			139,859
Less intangible assets		(8,037	)		(2,961	)
Tangible common equity (Non-GAAP)	$	152,294			136,898

Issued and outstanding shares		12,546,220			12,023,557
Less nonvested restricted stock awards		(216,828	)		(285,805	)
Period end dilutive shares		12,329,392			11,737,752

Total stockholders equity	$	160,331			139,859
Divided by period end dilutive shares		12,329,392			11,737,752
Common book value per share	$	13.00			11.92

Tangible common equity (Non-GAAP)	$	152,294			136,898
Divided by period end dilutive shares		12,329,392			11,737,752
Tangible common book value per share (Non-GAAP)	$	12.35			11.66

Critical Accounting Policies

There have been no significant changes to our critical accounting policies from those disclosed in our 2015 Annual Report on Form 10-K. Refer to the notes to our consolidated financial statements in our 2015 Annual Report on Form 10-K for a full disclosure of all critical accounting policies.

Results of Operations

Summary

The Company reported net income for the three months ended September 30, 2016 of $5.9 million, or $0.47 per diluted share, as compared to $3.9 million, or $0.40 per diluted share, for the three months ended September 30, 2015. Net income for the nine months ended September 30, 2016 totaled $12.4 million, or $1.02 per diluted share, compared to net income of $10.8 million, or $1.13 per diluted share. Included in net income for the nine months ended September 30, 2016 were pretax merger related expense of $3.0 million.

The decrease in earnings per share for the nine months ended September 30, 2016 from the nine months ended September 30, 2015 was primarily a result of the following:

●

Merger related expenses incurred from the acquisition of Congaree of $3.0 million for the nine months ended September 30, 2016.

●

Issuance of 508,910 shares of common stock in connection with the acquisition of Congaree during the second quarter.

●

Public offering completed in December 2015 where the Company issued 2,262,296 shares of its common stock for net proceeds of approximately $32.1 million.

Net Interest Income and Margin

Net interest income is a significant component of our net income. Net interest income is the difference between income earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is determined by the yields earned on interest-earning assets, rates paid on interest-bearing liabilities, the relative balances of interest-earning assets and interest-bearing liabilities, the degree of mismatch, and the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities.

Net interest income increased to $14.0 million for the three months ended September 30, 2016 from $10.9 million for the three months ended September 30, 2015. Net interest income increased to $37.5 million for the nine months ended September 30, 2016 from $31.9 million for the nine months ended September 30, 2015. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the three months and nine months ended September 30, 2016 is primarily the result of increased balances of loans receivable.

The growth in loan balances was primarily the result of the following:

●

On June 11, 2016, the Company acquired approximately $74.6 million of loans, net of purchase accounting adjustment as part of the acquisition of Congaree.

●

Residential mortgage – In addition to selling a portion of its production, the Company has retained a portion of its mortgage production. Due to management’s emphasis on growing the Company’s residential mortgage portfolio, loans receivable within the one-to-four family portfolio has increased $101.6 million since September 30, 2015. This growth includes loans acquired in the acquisition of Congaree as well as a purchase of a non-conforming residential loan pool during the fourth quarter of 2015 with a balance of $31.9 million as of September 30, 2016.

●

Commercial lending – during 2014 and 2015, the Company expanded its commercial lending team by hiring additional loan officers in its Charleston and Myrtle Beach markets of South Carolina. The Company also has opened its first branch in the upstate of South Carolina, and a branch in Wilmington, North Carolina. As a result, gross loans receivable within commercial real estate and construction and development increased $126.4 million since September 30, 2015.

●

Syndicated loans – The Company’s primary markets are generally concentrated in real estate lending and have provided limited opportunities to develop a Commercial and Industrial (“C&I”) loan portfolio. However, in order to diversify our lending portfolio, the Company began a syndicated loan program in 2014 to purchase C&I loans originated in other markets to retain in the loan portfolio. These loans typically have terms of seven years and generally are tied to a floating rate index such as LIBOR or prime. To effectively manage this new line of lending, the Company hired an experienced senior lending executive in 2014 with relevant experience to lead and manage this area of the loan portfolio and retained a consulting firm that specializes in syndicated loans. Syndicated loans have grown $9.2 million since September 30, 2015. As of September 30, 2016, the syndicated loan portfolio outstanding was $87.7 million and is grouped within commercial business loans. The Company’s policy currently limits the syndicated loan portfolio not to exceed 75% of the Bank’s Tier 1 regulatory capital. As of September 30, 2016, the Moody’s weighted average credit facility rating of the syndicated loan portfolio was Ba2, with no credit rated less than B2.

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the periods indicated (dollars in thousands). We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments were owned at an original maturity of over one year. Nonaccrual loans are included in earning assets in the following tables. Loan yields reflect the negative impact on our earnings of loans on nonaccrual status. The net capitalized loan costs and fees, which are considered immaterial, are amortized into interest income on loans.

	For The Three Months Ended September 30,
	2016								2015
				Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate

Interest-earning assets:
Loans held for sale	$	32,196			282		3.48	%		43,193			431		3.96	%
Loans receivable, net (1)		1,093,669			13,544		4.93	%		842,578			9,914		4.67	%
Interest-bearing cash		29,989			19		0.25	%		8,056			5		0.25	%
Securities available for sale		345,385			2,264		2.57	%		291,925			1,927		2.58	%
Securities held to maturity		—			—		—			17,149			131		2.99	%
Dividends from non-equitable securities		7,477			83		4.42	%		7,843			93		4.70	%
Other investments		3,201			16		1.96	%		3,633			11		1.20	%
Total interest-earning assets		1,511,917			16,208		4.26	%		1,214,377			12,512		4.09	%
Non-earning assets		114,800								108,005

Total assets	$	1,626,717								1,322,382

Interest-bearing liabilities:
Demand accounts		175,484			64		0.15	%		183,564			47		0.10	%
Money market accounts		298,961			233		0.31	%		228,338			105		0.18	%
Savings accounts		46,875			15		0.13	%		38,707			13		0.13	%
Certificates of deposit		504,492			1,258		0.99	%		407,699			957		0.93	%
Short-term borrowed funds		88,452			124		0.56	%		116,679			75		0.26	%
Long-term debt		68,282			558		3.25	%		57,869			426		2.92	%
Total interest-bearing liabilities		1,182,546			2,252		0.76	%		1,032,856			1,623		0.62	%
Noninterest-bearing deposits		265,755								169,463
Other liabilities		21,105								17,737
Stockholders’ equity		157,311								102,326

Total liabilities and Stockholders’ equity	$	1,626,717								1,322,382

Net interest spread							3.50	%							3.47	%
Net interest margin		3.67	%							3.56	%

Net interest margin (tax-equivalent) (2)		3.75	%							3.66	%
Net interest income					13,956								10,889

(1) Average balances of loans include nonaccrual loans.

(2) The tax-equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.

Our net interest margin was 3.67%, or 3.75% on a tax-equivalent basis, for the three months ended September 30, 2016 compared to 3.56%, or 3.66% on a tax equivalent basis, for the three months ended September 30, 2015. The increase in margin from period to period is the result of a shift to higher yielding earning assets as well as an increase in yield on loans receivable. Average loans receivable comprised 72.3% of earnings assets for the three months ended September 30, 2016 compared to 69.4% for the three months ended September 30, 2015. The increase in yield on loans receivable during the period is the result of accretion income of $399,000 recognized related to the acquisition of Congaree as well as prepayment penalty collected of $92,000.

Our net interest spread, which is not on a tax-equivalent basis, was 3.50% for the three months ended September 30, 2016 as compared to 3.47% for the same period in 2015. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 3 basis point increase in net interest spread is a result of the 17 basis point increase in yield on interest-earning assets offset by a 15 basis point increase in rate paid on interest-bearing liabilities.

	For The Nine Months Ended September 30,
	2016								2015
				Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate

Interest-earning assets:
Loans held for sale	$	27,388			717		3.50	%		40,978			1,181		3.85	%
Loans receivable, net (1)		1,000,780			36,074		4.81	%		811,568			29,092		4.79	%
Interest-bearing cash		29,222			55		0.25	%		15,089			28		0.25	%
Securities available for sale		327,860			6,618		2.65	%		279,704			5,606		2.64	%
Securities held to maturity		9,452			217		3.02	%		20,320			425		2.76	%
Dividends from non-equitable securities		7,740			288		4.97	%		7,486			238		4.25	%
Other investments		2,772			42		1.99	%		2,884			32		1.48	%
Total interest-earning assets		1,405,214			44,011		4.18	%		1,178,029			36,602		4.15	%
Non-earning assets		95,605								105,154

Total assets	$	1,500,819								1,283,183

Interest-bearing liabilities:
Demand accounts		140,092			157		0.15	%		168,134			153		0.12	%
Money market accounts		266,000			574		0.29	%		236,822			328		0.19	%
Savings accounts		43,602			43		0.13	%		38,034			37		0.13	%
Certificates of deposit		484,581			3,675		1.01	%		380,546			2,576		0.91	%
Short-term borrowed funds		84,590			320		0.51	%		115,513			217		0.25	%
Long-term debt		82,586			1,743		2.82	%		51,530			1,391		3.61	%
Total interest-bearing liabilities		1,101,451			6,512		0.79	%		990,579			4,702		0.63	%
Noninterest-bearing deposits		234,243								175,945
Other liabilities		16,991								17,854
Stockholders’ equity		148,134								98,805

Total liabilities and Stockholders’ equity	$	1,500,819								1,283,183

Net interest spread							3.39	%							3.52	%
Net interest margin		3.59	%							3.62	%

Net interest margin (tax-equivalent) (2)		3.67	%							3.71	%
Net interest income					37,499								31,900

(1) Average balances of loans include nonaccrual loans.

(2) The tax-equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.

Our net interest margin was 3.59%, or 3.67% on a tax-equivalent basis, for the nine months ended September 30, 2016 compared to 3.62%, or 3.71% on a tax equivalent basis, for the nine months ended September 30, 2015. The decrease in margin from period to period is the result of the recognition of $460,000 of previously uncollected interest income from the resolution of a non performing asset during the second quarter of 2015 as well as an increase in certificate of deposits during 2016 that has increased the rate paid on interest-bearing liabilities. In addition, the Federal Reserve increased interest rates in December of 2015 which has increased the rate paid on our short term borrowings for 2016.

Our net interest spread, which is not on a tax-equivalent basis, was 3.43% for the nine months ended September 30, 2016 as compared to 3.52% for the same period in 2015. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 9 basis point decrease in net interest spread is a result of the 7 basis point increase in yield on interest-earning assets and a 16 basis point increase in rate paid on interest-bearing liabilities.

Provision for Loan Loss

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

Following is a summary of the activity in the allowance for loan losses during the periods ended September 30, 2016 and 2015.

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(Dollars in thousands)
Balance, beginning of period	$	10,297			10,017			10,141			9,035
Provision for loan losses		—			—			—			—
Loan charge-offs		(4	)		(655	)		(197	)		(789	)
Loan recoveries		47			527			396			1,643
Balance, end of period	$	10,340			9,889			10,340			9,889

The Company experienced net recoveries of $43,000 and net charge offs of $128,000 for the three months ended September 30, 2016 and 2015, respectively. The Company experienced net recoveries of $199,000 and $854,000 for the nine months ended September 30, 2016 and 2015, respectively. Asset quality has remained relatively consistent since year end, with nonperforming assets to total assets slightly decreasing to 0.42% as of September 30, 2016 as compared to 0.47% as of December 31, 2015. No provision expense for loan losses was recorded during 2016 or 2015 primarily due to the net recoveries experienced.

Provision expense is recorded based on our assessment of general loan loss risk as well as asset quality. The allowance for loan losses is management’s estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. Management determines the allowance based on an ongoing evaluation. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. For further discussion regarding the calculation of the allowance, see the “Allowance for Loan Losses” discussion below.

Noninterest Income and Expense

Noninterest income provides us with additional revenues that are significant sources of income. The major components of noninterest income for the three months and nine months ended September 30, 2016 and 2015 are presented below:

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(In thousands)
Noninterest income:
Mortgage banking income	$	5,605			4,753			12,967			13,874
Deposit service charges		953			915			2,712			2,638
Net loss on extinguishment of debt		(118	)		—			(174	)		(1,215	)
Net gain on sale of securities		111			1,017			641			1,459
Fair value adjustments on interest rate swaps		99			(1,246	)		(408	)		(1,253	)
Net increase in cash value life insurance		226			172			684			530
Mortgage loan servicing income		1,437			1,330			4,238			3,956
Other		560			381			1,728			1,187
Total noninterest income	$	8,873			7,322			22,388			21,176

Noninterest income increased $1.6 million to $8.9 million for the three months ended September 30, 2016 from $7.3 million for the three months ended September 30, 2015. The increase in noninterest income primarily relates to the increase in mortgage banking income as a result of margin expansion experienced during the quarter

Noninterest income increased $1.2 million to $22.4 million for the nine months ended September 30, 2016 from $21.2 million for the nine months ended September 30, 2015. The increase in noninterest income primarily relates to the decrease in loss on extinguishment of debt.

The following table provides a break out of mortgage banking income from our retail mortgage team “Community banking” and Crescent Mortgage Company “Wholesale mortgage banking”:

	For the Three Months Ended September 30,
	Loan Originations				Mortgage Banking Income				Margin
	2016		2015		2016		2015		2016			2015
	(Dollars in thousands)
Additional segment information:
Community banking	$	25,633		17,642		680		431		2.65	%		2.44	%
Wholesale mortgage banking		253,485		261,948		4,925		4,322		1.94	%		1.65	%
Total mortgage banking income	$	279,118		279,590		5,605		4,753		2.01	%		1.70	%

	For the Nine Months Ended September 30,
	Loan Originations				Mortgage Banking Income				Margin
	2016		2015		2016		2015		2016			2015
	(Dollars in thousands)
Additional segment information:
Community banking	$	68,263		50,430		1,586	$	1,231		2.32	%		2.44	%
Wholesale mortgage banking		645,412		769,679		11,381		12,643		1.76	%		1.64	%
Total mortgage banking income	$	713,675		820,109		12,967	$	13,874		1.82	%		1.69	%

The percentage of originations attributable to refinances were 35.9% for the third quarter of 2016 compared to 30.3% for the third quarter of 2015.

During the three months ended September 30, 2016 and 2015, the Company recognized net gains on sale of available-for-sale securities of $111,000 and $1.0 million respectively. Net gain on sale of available-for-sale securities were $641,000 and $1.5 million for the nine months ended September 30, 2016 and 2015, respectively.

The fair value adjustment on interest rate swaps increased noninterest income by $99,000 for the three months ended September 30, 2016 compared to an reduction in noninterest income of $1.3 million for three months ended September 30, 2015. The fair value adjustment on interest rate swaps reduced noninterest income by $408,000 and $1.3 million for the nine months ended September 30, 2016 and 2015, respectively. The change in fair value adjustment on interest rate swaps relates to the change in interest rates from period to period. The Company uses standalone interest rate swaps to more closely match the interest rate characteristics of assets and liabilities and to mitigate the risks arising from timing mismatches between assets and liabilities including duration mismatches.

During three months and nine months ended September 30, 2016, the Company incurred loss on extinguishment of debt of $118,000 and $174,000, respectively. Loss on extinguishment of debt was $1.2 million for nine months ended September 30, 2015. There was no loss on extinguishment of debt recorded for the three months ended September 30, 2015.

The following table sets forth for the periods indicated the primary components of noninterest expense:

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(In thousands)
Noninterest expense:
Salaries and employee benefits	$	8,481			7,204			23,306			21,453
Occupancy and equipment		2,067			1,821			5,836			5,332
Marketing and public relations		374			378			1,144			1,147
FDIC insurance		180			190			527			540
Recovery of mortgage loan repurchase losses		(250	)		(250	)		(750	)		(750	)
Legal expense		80			97			185			347
Other real estate expense, net		(96	)		4			(37	)		114
Mortgage subservicing expense		462			418			1,353			1,236
Amortization of mortgage servicing rights		586			515			1,659			1,460
Merger related expenses		—			—			2,985			—
Other		2,006			2,004			5,759			6,084
Total noninterest expense	$	13,890			12,381			41,967			36,963

Noninterest expense represents the largest expense category for the Company. Noninterest expense increased to $13.9 million for the three months ended September 30, 2016 from $12.4 million for the three months ended September 30, 2015. For the nine months ended September 30, 2016, noninterest expense increased to $42.0 million from $37.0 million at September 30, 2015. The increase in noninterest expense for the three months and nine months ended September 30, 2016 is primarily the result of an increase in salaries and employee benefits and occupancy and equipment as well as merger related expense related to the acquisition of Congaree during the second quarter of 2016. Merger related expenses totaled $3.0 million for the nine months ended September 30, 2016. In addition, the Company opened a branch during the first quarter of 2016 in the Wilmington market.

Income Tax Expense

Our effective tax rate was 33.5% for three month period ended September 30, 2016, compared to 33.4% for the three month period ended September 30, 2015. Our effective rate was 30.7% for nine months ended September 30, 2016 compared to 32.9% for the nine months ended September 30, 2015. In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions, including income tax consequences. In addition to other changes, the guidance changes the accounting for excess tax benefits and tax deficiencies from generally being recognized in additional paid-in capital to recognition as income tax expense or benefit in the period they occur. The Company early adopted the new guidance in the second quarter of 2016. As a result, the Company’s income tax expense was reduced by approximately$22,000 and $421,000 for the three and nine months ended September 30, 2016, respectively.

Balance Sheet Review

Securities

Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies and the assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk.

At September 30, 2016, our securities portfolio, excluding FHLB stock and other investments, was $336.9 million or approximately 20.4% of our assets. Our available-for-sale securities portfolio included US agency securities, municipal securities, collateralized loan obligations, mortgage-backed securities (agency and non-agency), and trust preferred securities with a fair value of $336.9 million and an amortized cost of $334.4 million for a net unrealized gain of $2.5 million.

As securities are purchased, they are designated as held-to-maturity or available-for-sale based upon our intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. We do not currently hold, nor have we ever held, any securities that are designated as trading securities.

During the second quarter of 2016, the Company tainted its securities held-to-maturity portfolio as a result of a change in the intent to hold the securities until maturity to provide opportunities to maximize its asset utilization. As a result, the securities were moved to available-for-sale resulting in an increase to accumulated other comprehensive income of $655,000.

Loans by Type

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Gross loans receivable at September 30, 2016 and December 2015 were $1.1 billion and $922.7 million, respectively.

Our loan portfolio consists primarily of loans secured by real estate mortgages. As of September 30, 2016, our loan portfolio included $984.9 million, or 86.9%, of gross loans secured by real estate. As of December 31, 2015, our loan portfolio included $801.2 million, or 86.8%, of gross loans secured by real estate. Substantially all of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. The Bank’s primary markets are generally concentrated in real estate lending. In order to diversify our lending portfolio, the Bank began a syndicated loan program during 2014. As of September 30, 2016, syndicated loans were $87.7 million and are included within commercial business loans in the table below. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types.

As shown in the table below, gross loans receivable increased $210.5 million since December 31, 2015. The increase in loans receivable primarily relates to the $74.6 million in loans acquired, net of purchase accounting adjustments, in the acquisition of Congaree on June 11, 2016 as well as the Bank’s focus on growing residential mortgage and commercial lending.

The following table summarizes loans by type and percent of total at the end of the periods indicated:

	At September 30,					At December 31,
	2016					2015
			% of Total					% of Total
	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	400,500		35.35	%		344,928		37.38	%
Home equity		37,901		3.34	%		23,256		2.52	%
Commercial real estate		432,867		38.20	%		341,658		37.03	%
Construction and development		113,667		10.03	%		91,362		9.90	%
Consumer loans		6,029		0.53	%		5,179		0.56	%
Commercial business loans		142,265		12.55	%		116,340		12.61	%
Total gross loans receivable		1,133,229		100.00	%		922,723		100.00	%
Less:
Allowance for loan losses		10,340					10,141
Total loans receivable, net	$	1,122,889					912,582

Maturities and Sensitivity of Loans to Changes in Interest Rates

The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

The following table summarizes the loan maturity distribution by type and related interest rate characteristics.

	At September 30, 2016
			After one
	One Year		but within		After five
	or Less		five years		years		Total
	(In thousands)
Loans secured by real estate:
One-to-four family	$	17,835		54,643		328,022		400,500
Home equity		7,477		3,696		26,728		37,901
Commercial real estate		22,569		320,705		89,593		432,867
Construction and development		24,440		75,055		14,172		113,667
Consumer loans		1,277		3,929		823		6,029
Commercial business loans		11,968		73,719		56,578		142,265
Total gross loans receivable		85,566		531,747		515,916		1,133,229

Loans maturing - after one year
Variable rate loans							$	393,908
Fixed rate loans								653,755
							$	1,047,663

Nonperforming and Problem Assets

Nonperforming assets include loans on which interest is not being accrued, accruing loans that are 90 days or more delinquent and foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of a borrower’s loan default. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction of principal when received. In general, a nonaccrual loan may be placed back onto accruing status once the borrower has made a minimum of six consecutive payments in accordance with the loan terms. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. As of September 30, 2016 and December 31 2015, we had no loans 90 days past due and still accruing.

Troubled Debt Restructurings (“TDRs”)

The Company designates loan modifications as TDRs when, for economic or legal reasons related to the borrower’s financial difficulties, it grants a concession to the borrower that it would not otherwise consider. Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of modification are initially classified as accruing TDRs at the date of modification, if the note is reasonably assured of repayment and performance is in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the modification date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accrual status when there is economic substance to the restructuring, there is well documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated repayment performance in accordance with the modified terms for a reasonable period of time, generally a minimum of six months.

The following table summarizes nonperforming and problem assets at the end of the periods indicated.

	At September 30,		At December 31,
	2016		2015
	(In thousands)
Loans receivable:
Nonaccrual loans-renegotiated loans	$	1,427		1,136
Nonaccrual loans-other		2,747		3,166
Accruing loans 90 days or more delinquent		—		—
Real estate acquired through foreclosure, net		2,843		2,374
Total Non-Performing Assets	$	7,017		6,676

Problem Assets not included in Non-Performing Assets- Accruing renegotiated loans outstanding	$	4,857		13,212

At September 30, 2016, nonperforming assets were $7.0 million, or 0.42% of total assets. Comparatively, nonperforming assets were $6.7 million, or 0.47% of total assets, at December 31, 2015. Nonperforming loans were 0.37% and 0.47% of gross loans receivable at September 30, 2016 and December 31, 2015, respectively.

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $4.9 million, or 0.43% of gross loans at September 30, 2016, compared to $13.2 million, or 1.43% of gross loans at December 31, 2015. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms. The decrease in potential problem loans since December 31, 2015 is the result of payoffs to other institutions.

Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans at September 30, 2016 and December 31, 2015 are collateralized by real estate. The Bank utilizes third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require the Bank to obtain updated appraisals on an annual basis, either through a new external appraisal or an internal appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. Management believes based on information known and available currently, the probable losses related to problem assets are adequately reserved in the allowance for loan losses.

Credit quality indicators continue to show improvement as the Company experienced reduced loan migrations to nonaccrual status, and lower loss severity on individual problem asset. The Company believes this general trend in reduced loans migrating into nonaccrual status is an indication of improving credit quality in the Company’s overall loan portfolio and a leading indicator of reduced credit losses going forward. Nevertheless, the Company can make no assurances that nonperforming assets will continue to improve in future periods. The Company continues to monitor the loan portfolio and foreclosed assets very carefully and is continually working to reduce its problem assets.

Allowance for Loan Losses

The allowance for loan losses is management’s estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. Management determines the allowance based on an ongoing evaluation. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The allowance consists of specific and general components.

The general component covers nonimpaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by major loan category and is based on the actual loss history trends for the previous 20 quarters. The actual loss experience is supplemented with internal and external qualitative factors as considered necessary at each period and given the facts at the time. These qualitative factors adjust the 20 quarter historical loss rate to recognize the most recent loss results and changes in the economic conditions to ensure the estimated losses in the portfolio are recognized in the period incurred and that the allowance at each balance sheet date is adequate and appropriate in accordance with GAAP. Qualitative factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries for the most recent twelve quarters; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. Impaired loans are evaluated for impairment using the discounted cash flow methodology or based on the net realizable value of the underlying collateral. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. See additional discussion in section “Nonperforming and Problem Assets” above.

While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses could be required that could adversely affect the Bank’s earnings or financial position in future periods.

The allowance for loan losses was $10.3 million, or 0.91% of total loans at September 30, 2016, compared to $10.1 million, or 1.10% of total loans, at December 31, 2015. Included in the loan totals were $129.5 million and $64.1 million in loans acquired through previous branch acquisitions at September 30, 2016 and December 31, 2015, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

The following table summarizes the activity related to our allowance for loan losses for the three months and nine months ended September 30, 2016 and 2015.

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(Dollars in thousands)
Balance, beginning of period	$	10,297			10,017			10,141			9,035
Provision for loan losses		—			—			—			—
Loan charge-offs:
Loans secured by real estate:
One-to-four family		—			(623	)		(45	)		(623	)
Home equity		—			—			—			—
Commercial real estate		—			—			—			—
Construction and development		—			—			—			(90	)
Consumer loans		(2	)		(6	)		(31	)		(9	)
Commercial business loans		(2	)		(26	)		(121	)		(67	)
Total loan charge-offs		(4	)		(655	)		(197	)		(789	)
Loan recoveries:
Loans secured by real estate:
One-to-four family		9			198			148			524
Home equity		—			—			—			—
Commercial real estate		—			100			—			350
Construction and development		4			166			10			476
Consumer loans		8			5			23			25
Commercial business loans		26			58			215			268
Total loan recoveries		47			527			396			1,643
Net loan (charge-offs) recoveries		43			(128	)		199			854
Balance, end of period	$	10,340			9,889			10,340			9,889

Allowance for loan losses as a percentage of loans receivable (end of period)		0.91	%		1.15	%		0.91	%		1.15	%
Net charge-offs (recoveries) to average loans receivable (annualized)		(0.02	)%		0.06	%		(0.04	)%		(0.21	)%

Mortgage Operations

Mortgage Activities and Servicing

Our wholesale mortgage banking operations are conducted through our mortgage origination subsidiary, Crescent Mortgage Company. Mortgage activities involve the purchase of mortgage loans and table funded originations for the purpose of generating gains on sales of loans and fee income on the origination of loans and is included in mortgage banking income in the accompanying consolidated statements of operations. While the Company originates residential one-to-four family loans that are held in its loan portfolio, the majority of new loans are generally sold pursuant to secondary market guidelines through Crescent Mortgage Company. Generally, residential mortgage loans are sold and, depending on the pricing in the marketplace, servicing rights are either sold or retained. The level of loan sale activity and its contribution to the Company’s profitability depends on maintaining a sufficient volume of loan originations and margin. Changes in the level of interest rates and the local economy affect the volume of loans originated by the Company and the amount of loan sales and loan fees earned. Discussion related to the impact and changes within the mortgage operations are provided in “Results of Operations”. Additional segment information is provided in Note 10 under Item 1 “Financial Statements”.

Loan Servicing

We retain the rights to service a portion of the loans we sell on the secondary market, as part of our mortgage banking activities, for which we receive service fee income. These rights are known as mortgage servicing rights, or MSRs, where the owner of the MSR acts on behalf of the mortgage loan owner and has the contractual right to receive a stream of cash flows in exchange for performing specified mortgage servicing functions. These duties typically include, but are not limited to, performing loan administration, collection, and default activities, including the collection and remittance of loan payments, responding to customer inquiries, accounting for principal and interest, holding custodial (impound) funds for the payment of property taxes and insurance premiums, counseling delinquent mortgagors, modifying loans and supervising foreclosures and property dispositions. We subservice the duties and responsibilities obligated to the owner of the MSR to a third party provider for which we pay a fee.

We recognize the rights to service mortgage loans for others as an asset. We initially record the MSR at fair value and subsequently account for the asset at lower of cost or market using the amortization method. Servicing assets are amortized in proportion to, and over the period of, the estimated net servicing income and are carried at amortized cost. A valuation is performed by an independent third party on a quarterly basis to assess the servicing assets for impairment based on the fair value at each reporting date. The fair value of servicing assets is determined by calculating the present value of the estimated net future cash flows consistent with contractually specified servicing fees. This valuation is performed on a disaggregated basis, based on loan type and year of production. Generally, loan servicing becomes more valuable when interest rates rise (as prepayments typically decrease) and less valuable when interest rates decline (as prepayments typically increase). As discussed in detail in notes to the consolidated financial statements, we use an appropriate weighted average constant prepayment rate, discount rate, and other defined assumptions to model the respective cash flows and determine the fair value of the servicing asset at each reporting date.

The Company was servicing $2.2 billion loans for others at September 30, 2016 and $2.1 billion at December 31, 2015. Mortgage servicing rights asset had a balance of $13.6 million and $11.4 million at September 30, 2016 and December 31, 2015, respectively. The economic estimated fair value of the mortgage servicing rights was $17.5 million and $17.6 million at September 30, 2016 and December 31, 2015, respectively. The amortization expense related to the mortgage servicing rights was $587,000 and $515,000 during the three months ended September 30, 2016 and 2015, respectively. The amortization expense related to mortgage servicing rights was $1.7 million and $1.5 million for the nine months ended September 30, 2016 and 2015, respectively.

Below is a roll-forward of activity in the balance of the servicing assets for the three months and nine months ended September 30, 2016 and 2015.

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(In thousands)
MSR beginning balance	$	12,400			10,644			11,433			10,181
Amount capitalized		1,743			950			3,782			2,358
Amount amortized		(587	)		(515	)		(1,659	)		(1,460	)
MSR ending balance	$	13,556			11,079			13,556			11,079

Reserve For Mortgage Repurchase Losses

Loans held for sale have primarily been fixed-rate single-family residential mortgage loans under contracts to be sold in the secondary market. In most cases, loans in this category are sold within 30 days of closing. Buyers generally have recourse to return a purchased loan to the Company under limited circumstances. An estimation of mortgage repurchase losses is reviewed on a quarterly basis. The representations and warranties in our loan sale agreements provide that we repurchase or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application or invalid market value on the collateral property due to deficiencies in the appraisal. In addition to these representations and warranties, our loan sale contracts define a condition in which the borrower defaults during a short period of time, typically 120 days to one year, as an early payment default, or EPD. In the event of an EPD, we are required to return the premium paid by the investor for the loan as well as certain administrative fees, and in some cases repurchase the loan or indemnify the investor. Because the level of mortgage loan repurchase losses depends upon economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of the liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment.

The following table demonstrates the activity for the reserve for mortgage repurchase losses for the three months and nine months ended September 30, 2016 and 2015.

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2016			2015			2016			2015
	(In thousands)
Beginning Balance	$	3,355			4,362			3,876			4,999
Losses paid		—			(25	)		(21	)		(162	)
Recoveries		25			1			25			1
Provision for mortgage repurchase losses		(250	)		(250	)		(750	)		(750	)
Ending balance	$	3,130			4,088			3,130			4,088

For the three and nine months ended September 30, 2016 and 2015, the Company recorded a negative provision for mortgage repurchase losses of $250,000 and $750,000, respectively. The decline in the provision for mortgage loan repurchase losses is related to several factors. The Company sells mortgage loans to various third parties, including government-sponsored entities (“GSEs”), under contractual provisions that include various representations and warranties as previously stated. The Company establishes the reserve for mortgage loan repurchase losses based on a combination of factors, including estimated levels of defects on internal quality assurance, default expectations, historical investor repurchase demand and appeals success rates, reimbursement by correspondent and other third party originators, and projected loss severity. Prior to 2012, there was no expiration date related to representations and warranties as long as the loan sold to the investor was outstanding. As a result, the Company received loan repurchase requests years after the loan was originated and sold to various third parties. In the latter part of 2012, the regulatory framework for certain GSEs changed where, under certain circumstances, the loan repurchase risk was limited for production beginning in January 2013. In addition, in May 2014, additional regulatory changes further limited loan repurchase risk.

As a result, the Company performed an analysis of its reserve for mortgage loan repurchase losses and, based on management’s judgment and interpretation of such regulatory changes, reduced the reserve accordingly. Management will continue to monitor how the GSEs implement the regulatory changes and trends. If such trends continue to be favorable, there is a possibility that additional reductions in this reserve could occur in future periods.

Deposits

We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. At September 30, 2016 deposits totaled $1.3 billion, an increase of $280.7 million from deposits of $1.0 billion at December 31, 2015. The increase in deposits since December 31, 2015 primarily relates to the $89.3 million in deposits assumed with the completion of the acquisition of Congaree on June 11, 2016 as well as continued efforts to increase our core deposits through business development.

Our retail deposits represented $1.2 billion, or 88.5% of total deposits at September 30, 2016, while out-of-market brokered and institutional deposits, represented $151.4 million, or 11.5% of our total deposits. Our retail deposits represented $882.9 million, or 85.6% of total deposits at December 31, 2015, while out-of-market, or brokered deposits and institutional deposits, represented $148.6 million, or 14.4% of our total deposits.

The following table shows the average balance amounts and the average rates paid on deposits held by us.

	For the Nine Months
	Ended September 30,
	2016					2015
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(Dollars in thousands)

Interest-bearing demand accounts	$	140,092		0.15	%		168,134		0.12	%
Money market accounts		266,000		0.29	%		236,822		0.19	%
Savings accounts		43,602		0.13	%		38,034		0.13	%
Certificates of deposit less than $100,000		268,385		0.95	%		230,342		0.88	%
Certificates of deposit of $100,000 or more		216,196		1.09	%		150,204		0.94	%
Total interest-bearing average deposits		934,275					823,536

Noninterest-bearing deposits		234,243					175,945
Total average deposits	$	1,168,518					999,481

The maturity distribution of our time deposits of $100,000 or more is as follows:

	At September 30, 2016
	(In thousands)

Three months or less	$	46,779
Over three through Nine Months		27,188
Over six through twelve months		23,870
Over twelve months		129,689
Total certificates of deposits	$	227,526

Borrowings

The followings table outlines our various sources of short-term borrowed funds during the three months and nine months ended September 30, 2016 and 2015 and the amounts outstanding at the end of each period, the maximum amount for each component during the periods, the average amounts for each period, and the average interest rate that we paid for each borrowings source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown.

				Maximum
			Period	Month		Average for the
	Ending		End	End		Period
	Balance		Rate	Balance		Balance		Rate
	(Dollars in thousands)
At or for the three months ended September 30, 2016
Short-term borrowed funds
Short-term FHLB advances	$	87,500	0.36% - 0.95%		117,500		88,452		0.56	%

Long-term borrowed funds
Long-term FHLB advances, due 2017 through 2021		53,000	0.83%-4.00%		53,000		52,817		3.09	%
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032		5,155	4.00%		5,155		5,155		4.00	%
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034		10,310	3.73%		10,310		10,310		3.81	%

				Maximum
			Period	Month		Average for the
	Ending		End	End		Period
	Balance		Rate	Balance		Balance		Rate
	(Dollars in thousands)
At or for the three months ended September 30, 2015
Short-term borrowed funds
Short-term FHLB advances	$	105,000	0.18% - 0.64%		132,500		116,667		0.26	%
Other short-term borrowings		—	0.00%		—		12		0.73	%

Long-term borrowed funds
Long-term FHLB advances, due 2017 through 2021		53,000	0.76%-4.00%		53,000		42,404		2.62	%
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032		5,155	3.75%		5,155		5,155		3.75	%
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034		10,310	3.34%		10,310		10,310		3.41	%

				Maximum
			Period	Month		Average for the
	Ending		End	End		Period
	Balance		Rate	Balance		Balance		Rate
	(Dollars in thousands)
At or for the nine months ended September 30, 2016
Short-term borrowed funds
Short-term FHLB advances	$	87,500	0.36% - 0.95%		117,500		84,590		0.51	%

Long-term borrowed funds
Long-term FHLB advances, due 2017 through 2021		53,000	0.83%-4.00%		88,000		67,121		2.58	%
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032		5,155	4.00%		5,155		5,155		4.00	%
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034		10,310	3.73%		10,310		10,310		3.74	%

				Maximum
			Period	Month		Average for the
	Ending		End	End		Period
	Balance		Rate	Balance		Balance		Rate
	(Dollars in thousands)
At or for the nine months ended September 30, 2015
Short-term borrowed funds
Short-term FHLB advances	$	105,000	0.18% - 0.64%		147,500		115,346		0.21	%
Subordinated debenture		—	0.00%		300		167		4.89	%
Long-term borrowed funds
Long-term FHLB advances, due 2017 through 2021		53,000	0.76%-4.00%		53,000		35,212		2.67	%
Subordinated debentures, due 2016 through 2020		—	0.00%		1,275		853		1.35	%
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032		5,155	3.75%		5,155		5,155		2.81	%
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034		10,310	3.34%		10,310		10,310		2.52	%

Liquidity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

The Company utilizes borrowing facilities in order to maintain adequate liquidity including: the FHLB of Atlanta, the Federal Reserve Bank (“FRB”), and federal funds purchased. The Company also uses wholesale deposit products, including brokered deposits as well as national certificate of deposit services. Additionally, the Company has certain investment securities classified as available-for-sale that are carried at market value with changes in market value, net of tax, recorded through stockholders’ equity.

Lines of credit with the FHLB of Atlanta are based upon FHLB-approved percentages of Bank assets, but must be supported by appropriate collateral to be available. The Company has pledged first lien residential mortgage, second lien residential mortgage, residential home equity line of credit, commercial mortgage and multifamily mortgage portfolios under blanket lien agreements. At September 30, 2016, the Company had FHLB advances of $140.5 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately $184.8 million.

Lines of credit with the FRB are based on collateral pledged. At September 30, 2016, the Company had lines available with the FRB for $129.5 million. At September 30, 2016, the Company had no FRB advances outstanding.

Capital Resources

The Company and the Bank are subject to various federal and state regulatory requirements, including regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions that if undertaken could have a direct material effect on the Company’s and the Bank’s financial statements.

In 2013, federal bank regulatory agencies issued a final rule that revises 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 (“Basel III”) and certain provisions of the Dodd-Frank Act.

The rule imposes higher risk-based capital and leverage requirements than those in place at the time the rule was issued. Specifically, the rule imposes the following minimum capital requirements:

●

A new Common Equity Tier 1 risk-based capital ratio of 4.5%,

●

A Tier 1 risk-based capital ratio of 6% (increased from the previous 4% requirement),

●

A total risk-based capital ratio of 8% (unchanged from previous requirement),

●

A leverage ratio of 4% and

●

A new supplementary leverage ratio of 3% applicable to advanced approaches banking organizations resulting in a leverage ratio requirement of 7% for such institutions.

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 rule also includes changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital and increased risk-weights (from 0% to up to 600%) for equity exposures.

Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of Common Equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.

The final rule became effective on January 1, 2015, and the requirements in the rule will be fully phased-in by January 1, 2019. While the ultimate impact of the fully phased-in capital standards on the Company and the Bank is being reviewed, we currently do not believe Basel III will have a material impact once fully implemented.

A new capital conservation buffer that was previously established phased in beginning January 1, 2016 at 0.625 percent of risk-weighted assets and will increase each subsequent year by an additional 0.625 percent until reaching its final level of 2.50 percent on January 1, 2019. The Bank had a capital conservation buffer above minimum risk-based capital requirements of at September 30, 2016.

The actual capital amounts and ratios as well as minimum amounts for each regulatory defined category for the Company and the Bank at September 30, 2016 and December 31, 2015 are as follows:

											To Be Well
						Minimum Required					Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)

September 30, 2016
Carolina Financial Corporation
CET1 capital (to risk weighted assets)	$	153,277		12.99	%		53,092		4.50	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		168,277		14.26	%		70,789		6.00	%		N/A		N/A
Total capital (to risk weighted assets)		178,617		15.14	%		94,385		8.00	%		N/A		N/A
Tier 1 capital (to total average assets)		168,277		10.39	%		64,792		4.00	%		N/A		N/A

CresCom Bank
CET1 capital (to risk weighted assets)		163,771		13.89	%		53,046		4.50	%		76,623		6.50	%
Tier 1 capital (to risk weighted assets)		163,771		13.89	%		70,729		6.00	%		94,305		8.00	%
Total capital (to risk weighted assets)		174,111		14.77	%		94,305		8.00	%		117,881		10.00	%
Tier 1 capital (to total average assets)		163,771		10.12	%		64,750		4.00	%		80,937		5.00	%

December 31, 2015
Carolina Financial Corporation
CET1 capital (to risk weighted assets)	$	138,213		13.97	%		44,527		4.50	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		153,213		15.48	%		59,370		6.00	%		N/A		N/A
Total capital (to risk weighted assets)		163,353		16.51	%		79,160		8.00	%		N/A		N/A
Tier 1 capital (to total average assets)		153,213		11.23	%		54,557		4.00	%		N/A		N/A

CresCom Bank
CET1 capital (to risk weighted assets)		139,025		14.08	%		44,442		4.50	%		64,194		6.50	%
Tier 1 capital (to risk weighted assets)		139,025		14.08	%		59,256		6.00	%		79,008		8.00	%
Total capital (to risk weighted assets)		149,165		15.10	%		79,008		8.00	%		98,760		10.00	%
Tier 1 capital (to total average assets)		139,025		10.21	%		54,466		4.00	%		68,082		5.00	%

Off Balance Sheet Arrangements

Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.

At September 30, 2016, we had issued commitments to extend credit and standby letters of credit of approximately $106.3 million through various types of lending arrangements. There were 23 standby letters of credit included in the commitments for $1.5 million. Total fixed rate commitments were $15.3 million and variable rate commitments were $91.0 million.

Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. A significant portion of the unfunded commitments relate to consumer equity lines of credit and commercial lines of credit. Based on historical experience, we anticipate that a portion of these lines of credit will not be funded.

Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings.

Market Risk Management and Interest Rate Risk

The effective management of market risk is essential to achieving the Company’s objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk. The primary objective of managing interest rate risk is to minimize the effect that changes in interest rates have on net income. This is accomplished through active asset and liability management, which requires the strategic pricing of asset and liability accounts and management of appropriate maturity mixes of assets and liabilities. The expected result of these strategies is the development of appropriate maturity and re-pricing opportunities in those accounts to produce consistent net income during periods of changing interest rates. The Bank’s asset/liability management committee, or ALCO, monitors loan, investment and liability portfolios to ensure comprehensive management of interest rate risk. These portfolios are analyzed for proper fixed-rate and variable-rate mixes under various interest rate scenarios. The asset/liability management process is designed to achieve relatively stable net interest margins and assure liquidity by coordinating the volumes, maturities or re-pricing opportunities of interest-earning assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate volume and mix of interest-earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The ALCO meets regularly to review the Company’s interest rate risk and liquidity positions in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to ensure that the potential impact on earnings and liquidity as a result of fluctuations in interest rates is within acceptable standards. The Board of Directors also sets policy guidelines and establishes long-term strategies with respect to interest rate risk exposure and liquidity.

The Company uses interest rate sensitivity analysis to measure the sensitivity of projected net interest income to changes in interest rates. Management monitors the Company’s interest sensitivity by means of a computer model that incorporates current volumes, average rates earned and paid, and scheduled maturities, payments of asset and liability portfolios, together with multiple scenarios of prepayments, repricing opportunities and anticipated volume growth. Interest rate sensitivity analysis shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next 12 months under the current interest rate environment. The resulting change in net interest income reflects the level of sensitivity that net interest income has in relation to changing interest rates.

As of September 30, 2016, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market condition

		Annualized Hypothetical
Interest Rate Scenario		Percentage Change in
Change	Prime Rate	Net Interest Income
0.00%	3.50%	0.0%
1.00%	4.50%	0.7%
2.00%	5.50%	0.5%
3.00%	6.50%	-0.1%

The primary uses of derivative instruments are related to the mortgage banking activities of the Company. As such, the Company holds derivative instruments, which consist of rate lock agreements related to expected funding of fixed-rate mortgage loans to customers (interest rate lock commitments) and forward commitments to sell mortgage-backed securities and individual fixed-rate mortgage loans. The Company’s objective in obtaining the forward commitments is to mitigate the interest rate risk associated with the interest rate lock commitments and the mortgage loans that are held for sale. Derivatives related to these commitments are recorded as either a derivative asset or a derivative liability in the balance sheet and are measured at fair value. Both the interest rate lock commitments and the forward commitments are reported at fair value, with adjustments recorded in current period earnings within the noninterest income of the consolidated statements of operations.

Derivative instruments not related to mortgage banking activities, including financial futures commitments and interest rate swap agreements that do not satisfy the hedge accounting requirements, are recorded at fair value and are classified with resultant changes in fair value being recognized in noninterest income in the consolidated statement of operations.

Accounting, Reporting, and Regulatory Matters

Information regarding recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of the financial information by the Company are included in Note 1 under Part I, Item 1 “Financial Statements”.

Effect of Inflation and Changing Prices

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with GAAP.

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

See Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk Management and Interest Rate Risk, and Liquidity.

Item 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

Management, including our President and Chief Executive Officer and Executive Vice President and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our President and Chief Executive Officer and Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our President and Chief Executive Officer and Executive Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the three months ended September 30, 2016, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

We are a party to claims and lawsuits arising in the ordinary course of business. Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, would have a material adverse impact on the Company’s financial position, results of operations or cash flows.

Item 1A RISK FACTORS.

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A of our Annual Report on Form 10-K for fiscal years ended December 31, 2015, as well as cautionary statements contained in this Form 10-Q, including those under the caption “Cautionary Note Regarding Any Forward-Looking Statements” set forth in Part I, Item 2 of this Form 10-Q, risks and matters described elsewhere in this Form 10-Q and in our other filings with the SEC.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

Not applicable

Item 3. DEFAULTS UPON SENIOR SECURITIES.

Not applicable

Item 4. MINE SAFETY DISCLOSURES.

Not applicable

Item 5. OTHER INFORMATION.

Not applicable

Item 6. EXHIBITS.

The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Index to Exhibits attached hereto and are incorporated herein by reference.

SIGNATURES

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

		CAROLINA FINANCIAL CORPORATION
		Registrant

Date: November 9, 2016		/s/ Jerold L. Rexroad
		Jerold L. Rexroad
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: November 9, 2016		/s/ William A. Gehman, III
		William A. Gehman III
		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

INDEX TO EXHIBITS


Exhibit Number		Description
31.1		Rule 13a-14(a) Certification of the Principal Executive Officer.

31.2		Rule 13a-14(a) Certification of the Principal Financial Officer.

32		Section 1350 Certifications.

101		The following materials from the Quarterly Report on Form 10-Q of Carolina Financial Corporation for the quarter ended September 30, 2016, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements.

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