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EX-32 - CAROLINA FINANCIAL CORPe17260_ex32.htm
EX-31.2 - CAROLINA FINANCIAL CORPe17260_ex31-2.htm
EX-31.1 - CAROLINA FINANCIAL CORPe17260_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 March 31, 2017

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
    Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     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: 16,149,802 shares of common stock, par value $0.01 per share, were issued and outstanding as of May 5, 2017.

 
 

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 47
     
Item 3. Quantitative and Qualitative Disclosure about Market Risks 73
     
Item 4. Controls and Procedures 73
     
PART II -    OTHER INFORMATION 73
     
Item 1. Legal Proceedings 73
     
Item 1A. Risk Factors 73
     
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds 74
     
Item 3. Defaults Upon Senior Securities 74
     
Item 4. Mine Safety Disclosures 74
     
Item 5. Other Information 74
     
Item 6. Exhibits 74
2
 

CAROLINA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
   March 31, 2017   December 31, 2016 
   (Unaudited)   (Audited) 
   (In thousands, except share data) 
ASSETS          
Cash and due from banks  $21,456    9,761 
Interest-bearing cash   36,582    14,591 
Federal funds sold   10,560     
Cash and cash equivalents   68,598    24,352 
Securities available-for-sale (cost of $493,678 at March 31, 2017 and $338,214 at December 31, 2016)   494,130    335,352 
Federal Home Loan Bank stock, at cost   12,478    11,072 
Other investments   2,116    1,768 
Derivative assets   3,226    2,219 
Loans held for sale   21,399    31,569 
Loans receivable, net of allowance for loan losses of $10,715 at March 31, 2017 and $10,688 at December 31, 2016   1,406,295    1,167,578 
Premises and equipment, net   46,544    37,054 
Accrued interest receivable   6,726    5,373 
Real estate acquired through foreclosure, net   1,479    1,179 
Deferred tax assets, net   10,210    8,341 
Mortgage servicing rights   15,792    15,032 
Cash value life insurance   37,938    28,984 
Core deposit intangible   8,005    3,658 
Goodwill   37,287    4,266 
Other assets   9,886    5,939 
Total assets  $2,182,109    1,683,736 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Liabilities:          
Noninterest-bearing deposits  $298,365    229,905 
Interest-bearing deposits   1,309,355    1,028,355 
Total deposits   1,607,720    1,258,260 
Short-term borrowed funds   214,500    203,000 
Long-term debt   55,304    38,465 
Derivative liabilities   682    342 
Drafts outstanding   7,129    6,223 
Advances from borrowers for insurance and taxes   2,037    1,058 
Accrued interest payable   690    327 
Reserve for mortgage repurchase losses   2,583    2,880 
Dividends payable to stockholders   576    502 
Accrued expenses and other liabilities   19,434    9,489 
Total liabilities   1,910,655    1,520,546 
Commitments and contingencies          
Stockholders’ equity:          
Preferred stock, par value $.01; 1,000,000 shares authorized at March 31, 2017 and December 31, 2016; no shares issued or outstanding        
Common stock, par value $.01; 25,000,000 shares authorized at March 31, 2017 and December 31, 2016; 16,185,408 and 12,548,328 issued and outstanding at March 31, 2017 and December 31, 2016, respectively   162    125 
Additional paid-in capital   168,113    66,156 
Retained earnings   102,528    98,451 
Accumulated other comprehensive income (loss), net of tax   651    (1,542)
Total stockholders’ equity   271,454    163,190 
Total liabilities and stockholders’ equity  $2,182,109    1,683,736 
           
See accompanying notes to consolidated financial statements.          

3
 

CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
         
   For the Three Months 
   Ended March 31, 
   2017   2016 
(In thousands, except share data)
Interest income          
Loans  $14,968    11,085 
Investment securities   2,553    2,152 
Dividends from Federal Home Loan Bank stock   101    97 
Federal funds sold   3     
Other interest income   45    26 
Total interest income   17,670    13,360 
Interest expense          
Deposits   1,692    1,367 
Short-term borrowed funds   355    105 
Long-term debt   353    615 
Total interest expense   2,400    2,087 
Net interest income   15,270    11,273 
Provision for loan losses        
Net interest income after provision for loan losses   15,270    11,273 
Noninterest income          
Mortgage banking income   3,608    3,175 
Deposit service charges   858    862 
Net loss on extinguishment of debt       (9)
Net gain on sale of securities   185    417 
Fair value adjustments on interest rate swaps   (58)   (281)
Net increase in cash value life insurance   211    229 
Mortgage loan servicing income   1,566    1,388 
Other   861    495 
Total noninterest income   7,231    6,276 
Noninterest expense          
Salaries and employee benefits   8,609    7,150 
Occupancy and equipment   2,182    1,842 
Marketing and public relations   381    385 
FDIC insurance   100    168 
Recovery of mortgage loan repurchase losses   (225)   (250)
Legal expense   65    49 
Other real estate expense, net   20    20 
Mortgage subservicing expense   486    423 
Amortization of mortgage servicing rights   669    532 
Merger related expenses   1,319    186 
Other   1,980    1,763 
Total noninterest expense   15,586    12,268 
Income before income taxes   6,915    5,281 
Income tax expense   2,011    1,638 
Net income  $4,904    3,643 
Earnings per common share:          
Basic  $0.35    0.31 
Diluted  $0.35    0.30 
Weighted average common shares outstanding:          
Basic   13,919,711    11,746,574 
Diluted   14,139,241    11,978,801 
           

See accompanying notes to consolidated financial statements.

4
 

CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
   For the Three Months 
   March 31, 
   2017   2016 
   (In thousands) 
Net income  $4,904    3,643 
           
Other comprehensive income (loss), net of tax:          
Unrealized gain on securities   3,474    179 
Tax effect   (1,251)   (64)
           
Reclassification adjustment for gains included in earnings   (185)   (417)
Tax effect   67    150 
           
Unrealized gain (loss) on interest rate swaps designated as cash flow hedges   138    (1,490)
Tax effect   (50)   536 
Other comprehensive income (loss), net of tax   2,193    (1,106)
           
Comprehensive income  $7,097    2,537 
           

See accompanying notes to consolidated financial statements.

5
 
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2017 AND 2016
(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, 2015   12,023,557   $120    56,418    82,859    462    139,859 
Stock awards   29,994    1                1 
Vested stock awards surrendered in cashless exercise   (1,936)           (30)       (30)
Excess tax benefit in connection with equity awards           15            15 
Stock-based compensation expense, net           370            370 
Net income               3,643        3,643 
Dividends declared to stockholders               (362)       (362)
Other comprehensive loss, net of tax                   (1,106)   (1,106)
Balance, March 31, 2016   12,051,615   $121    56,803    86,110    (644)   142,390 
                               
Balance, December 31, 2016   12,548,328   $125    66,156    98,451    (1,542)   163,190 
Issuance of common stock, net of offering expenses   1,807,143    18    47,653            47,671 
Stock issued - Greer Bancshares Incorporated acquisition   1,784,831    18    54,063            54,081 
Stock awards   60,031    1    108            109 
Vested stock awards surrendered in cashless exercise   (14,925)       (186)   (251)       (437)
Stock-based compensation expense, net           319            319 
Net income               4,904        4,904 
Dividends declared to stockholders               (576)       (576)
Other comprehensive income, net of tax                   2,193    2,193 
Balance, March 31, 2017   16,185,408   $162    168,113    102,528    651    271,454 
                               

See accompanying notes to consolidated financial statements.

6
 
CAROLINA FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
   For the Three Months 
   Ended March 31, 
   2017   2016 
   (In thousands) 
Cash flows from operating activities:          
Net income  $4,904    3,643 
Adjustments to reconcile net income to net cash provided by operating activities:          
Amortization of unearned discount/premiums on investments, net   834    903 
Accretion of deferred loan fees   (251)   (122)
Accretion of acquired loans   (372)    
Amortization of core deposit intangibles   133    86 
Gain on sale of available-for-sale securities, net   (185)   (417)
Mortgage banking income   (3,608)   (3,175)
Originations of loans held for sale   (195,583)   (204,477)
Proceeds from sale of loans held for sale   209,466    217,622 
Loss on extinguishment of debt       9 
Provision for mortgage loan repurchase losses   (225)   (250)
Mortgage loan losses paid, net of recoveries   (72)   (21)
Fair value adjustments on interest rate swaps   58    281 
Stock-based compensation   319    370 
Increase in cash surrender value of bank owned life insurance   (211)   (229)
Depreciation   568    472 
Loss (gain) on disposals of premises and equipment   3    (1)
Loss on sale of real estate acquired through foreclosure   (6)   (5)
Originations of mortgage servicing rights   (1,429)   (1,045)
Amortization of mortgage servicing rights   669    532 
(Increase) decrease in:          
Accrued interest receivable   (170)   (171)
Other assets   (5,156)   (2,423)
Increase (decrease) in:          
Accrued interest payable   105    17 
Dividends payable to stockholders   74    1 
Accrued expenses and other liabilities   (1,031)   (1,823)
Cash flows provided by operating activities   8,834    9,777 
           
   Continued

7
 

   For the Three Months 
   Ended March 31, 
   2017   2016 
   (In thousands) 
Cash flows from investing activities:          
Activity in available-for-sale securities:          
Purchases  $(85,787)   (55,688)
Maturities, payments and calls   11,877    12,665 
Proceeds from sales   37,697    34,478 
Increase in other investments   (7)   (228)
Decrease in Federal Home Loan Bank stock   189    2,150 
Increase in loans receivable, net   (43,725)   (41,084)
Purchase of premises and equipment   (1,931)   (417)
Proceeds from disposals of premises and equipment       1 
Proceeds from sale of real estate acquired through foreclosure   29    1,288 
Purchase of bank owned life insurance       (25)
Net cash received for acquisitions   37,622     
Cash flows used in investing activities   (44,036)   (46,860)
           
Cash flows from financing activities:          
Net increase in deposit accounts   38,394    96,244 
Net decrease in Federal Home Loan Bank advances   (8,000)   (55,009)
Net increase (decrease) in drafts outstanding   906    (459)
Net increase in advances from borrowers for insurance and taxes   979    333 
Cash dividends paid on common stock   (502)   (361)
Proceeds from issuance of common stock   47,671      
Net increase in excess tax benefit in connection with equity awards       15 
Cash flows provided by financing activities   79,448    40,763 
Net increase in cash and cash equivalents   44,246    3,680 
Cash and cash equivalents, beginning of period   24,352    26,627 
Cash and cash equivalents, end of period  $68,598    30,307 
           
Supplemental disclosure:          
Cash paid for:          
Interest on deposits and borrowed funds  $2,037    2,070 
Income taxes paid, net of refunds   19    1,931 
           
Noncash investing and financing activities:          
Transfer of loans receivable to real estate acquired through foreclosure  $281     

 

See accompanying notes to consolidated financial statements.

8
 

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 March 31, 2017, statutory business trusts (“Trusts”) created or acquried by the Company had outstanding trust preferred securities with a balance of $23.3 million. The principal assets of the Trusts are the Company’s subordinated debentures with identical rates of interest and maturities as the trust preferred securities. The Trusts have issued $806,000 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 notes 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 ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 as filed with the Securities and Exchange Commission on March 10, 2017. 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.

9
 

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.

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:

The Company’s Board of Directors declared a quarterly cash dividend of $0.04 per share payable on its common stock. The cash dividend will be payable on July 6, 2017 to stockholders of record as of June 15, 2017.

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 August 2015, the FASB issued amendments to the Interest topic of the Accounting Standards Codification (“ASC”) 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 ASC 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.

 10 
 

In February 2016, the FASB amended the Leases topic of the ASC 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 ASC 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 become effective as of January 1, 2017. 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. The Company adopted the new guidance in the second quarter of 2016. These amendments did not have a material impact to the Company’s financial position, results of operations, and cash flows.

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC 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 ASC 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 ASC 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.

In October 2016, the FASB amended the Income Taxes topic of the ASC to modify the accounting for intra-entity transfers of assets other than inventory. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 11 
 

In October 2016, the FASB amended the Consolidation topic of the ASC to revise the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The amendments will be effective for the Company for fiscal years beginning after December 15, 2016 including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In November 2016, the FASB amended the Statement of Cash Flows topic of the ASC to clarify how restricted cash is 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. Early adoption is permitted. These amendments did not have a material effect on the Company’s financial statements.

In December 2016, the FASB issued amendments to clarify the ASC, correct unintended application of guidance, and make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments were effective upon issuance (December 14, 2016) for amendments that did not have transition guidance. Amendments that are subject to transition guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. These amendments did not have a material effect on the Company’s financial statements.

In December 2016, the FASB issued technical corrections and improvements to the Revenue from Contracts with Customers Topic of the ASC. These corrections make a limited number of revisions to several pieces of the revenue recognition standard issued in 2014. The effective date and transition requirements for the technical corrections 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 January 2017, the FASB issued guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendment to the Business Combinations Topic is intended to address concerns that the existing definition of a business has been applied too broadly and has resulted in many transactions being recorded as business acquisitions that in substance are more akin to asset acquisitions. The guidance will be effective for the Company for [reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In January 2017, the FASB updated the Accounting Changes and Error Corrections and the Investments—Equity Method and Joint Ventures Topics of the Accounting Standards Codification. The ASU incorporates into the Accounting Standards Codification recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards. The ASU was effective upon issuance. The Company is currently evaluating the impact on additional disclosure requirements as each of the standards is adopted, however it does not expect these amendments to have a material effect on its financial position, results of operations or cash flows.

 

In January 2017, the FASB amended the Goodwill and Other Topic of the Accounting Standards Codification to simplify the accounting for goodwill impairment for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2017, the FASB amended the Other Income Topic of the Accounting Standards Codification to clarify the scope of the guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. 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 2017, the FASB amended the requirements in the Receivables—Nonrefundable Fees and Other Costs Topic of the Accounting Standards Codification related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. 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.

 

12
 

NOTE 2 – BUSINESS COMBINATIONS

Acquisition of Greer Bancshares Incorporated

On March 18, 2017, the Company completed its acquisition of Greer Bancshares Incorporated (“Greer”), the holding company for Greer State Bank, pursuant to the Agreement and Plan of Merger, dated as of November 7, 2016. Under the terms of the merger agreement, each share of Greer common stock was converted into the right to receive $18.00 in cash or 0.782 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 thousand).

Common stock issued (1,784,831 shares at $30.30 per share)  $54,080 
Cash payments to common stockholders   4,565 
Total consideration paid  $58,645 
      

The assets acquired and liabilities assumed from Greer were recorded at their fair value as of the closing date of the merger. Fair values were preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values became available. Goodwill of $33.0 million was initially recorded at the time of the acquisition. The following table summarizes the consideration paid by the Company in the merger with Greer and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date.

13
 
   As Reported   Fair Value   As Recorded by 
March 18, 2017  by Greer   Adjustments   the Company 
  (In thousands)  
Assets   
Cash and cash equivalents  $42,187        42,187 
Investments   121,374        121,374 
Loans receivable   205,209    (10,559) (a)   194,650 
Loans held for sale   105        105 
Allowance for loan losses   (3,198)   3,198  (b)    
Premises and equipment   3,928    4,202  (c)   8,130 
Foreclosed assets   42        42 
Core deposit intangible       4,480  (d)   4,480 
Deferred tax asset, net   3,831    (1,434) (e)   2,397 
Other assets   11,367    (241) (f)   11,126 
Total assets acquired  $384,845    (354)   384,491 
                
Liabilities               
Deposits  $310,866    200  (g)   311,066 
Long-term debt   43,712    (3,510) (h)   40,202 
Accrued expenses and other liabilities   7,086    512  (i)   7,598 
Total liabilities assumed  $361,664    (2,798)   358,866 
Net assets acquired             25,625 
Total consideration paid             58,645 
Goodwill            $33,020 
                

Explanation of fair value adjustments:

(a)Adjustment reflects the fair value adjustment based on the Company’s third party valuation report.
(b)Adjustment reflects the elimination of Greer’s historical allowance for loan losses.
(c)Adjustment reflects fair value adjustments on acquired branch and administrative offices based on third party appraisals.
(d)Adjustment reflects the fair value adjustment to record the estimated core deposit intangible based on the Company’s third party valuation report.
(e)Adjustment reflects the tax impact of acquisition accounting fair value adjustments.
(f)Adjustment reflects the fair value adjustment based on the Company’s evaluation of acquired other assets.
(g)Adjustments reflects the fair value adjustment based on Company’s third party valuation report.
(h)Adjustments reflects the fair value adjustment based on Company’s third party valuation report.
(i)Adjustment reflects the fair value adjustment based on the Company’s evaluation of acquired other liabilities.
   

The following table presents additional information related to the purchased credit impaired (“PCI”) acquired loan portfolio at March 18, 2017 (in thousands):

Contractual principal and interest at acquisition  $37,683 
Nonaccretable difference   7,248 
Expected cash flows at acquisition   30,434 
Accretable yield   4,995 
Basis in PCI loans at acquisition - estimated fair value  $25,439 

14
 

Supplemental Pro Forma Information - Unaudited

 

The table below presents supplemental pro forma information as if the Greer acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2016. 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 $1.3 million for the three months ended March 31, 2017, 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 March 31, 2017 was approximately $520,000 and $403,000, respectively.

   For the Three Months Ended
   March 31,
   2017   2016 
   (In thousands, except share data) 
Net interest income  $17,899   $14,287 
Net income (a)  $6,048   $4,673 
           
Weighted average shares outstanding:          
Basic (b)   15,704,542    13,531,405 
Diluted (b)   15,924,072    13,763,632 
           
Earnings per common share:          
Basic  $0.39   $0.35 
Diluted  $0.38   $0.34 
           

(a) Supplemental pro forma net income includes the impact of certain fair value adjustments. 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 Greer acquisition as of the earliest reporting date.

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 at $16.80 per share)  $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 
15
 

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. There have been no adjustments to initial fair values recorded by the Company for the Congaree acquisition to date.

   As Reported by
Congaree
   Fair Value
Adjustments
   As Recorded by the
Company
 
   (In thousands) 
Assets               
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.
16
 

NOTE 3 – SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of securities available-for-sale at March 31, 2017 and December 31, 2016 follows:

   March 31, 2017   December 31, 2016 
       Gross   Gross           Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value   Cost   Gains   Losses   Value 
               (In thousands)             
Securities available-for-sale:                                           
Municipal securities  $148,946    2,570    (660)   150,856    92,792    1,475    (1,055)   93,212 
US government agencies   35,406    332    (38)   35,700    3,438        (52)   3,386 
Collateralized loan obligations   84,212    188    (63)   84,337    76,202    138    (91)   76,249 
Corporate securities   474    15        489    474    17        491 
Mortgage-backed securities:                                        
Agency   144,592    1,304    (587)   145,309    90,477    995    (486)   90,986 
Non-agency   68,844    431    (257)   69,018    63,628    424    (188)   63,864 
Total mortgage-backed securities   213,436    1,735    (844)   214,327    154,105    1,419    (674)   154,850 
Trust preferred securities   11,204    872    (3,655)   8,421    11,203    545    (4,584)   7,164 
Total  $493,678    5,712    (5,260)   494,130    338,214    3,594    (6,456)   335,352 
                                         

The Company had no held-to-maturity securities as of March 31, 2017 or December 31, 2016. 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 March 31, 2017 follows:

   At March 31, 2017 
   Amortized   Fair 
   Cost   Value 
   (In thousands) 
Securities available-for-sale:          
Less than one year  $302    302 
One to five years   3,667    3,684 
Six to ten years   88,515    88,805 
After ten years   401,194    401,339 
Total  $493,678    494,130 
           

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.

17
 

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 
   Ended March 31, 
   2017   2016 
   (In thousands) 
Proceeds  $37,697    34,478 
           
Realized gains  $ 373    534 
Realized losses   (188)   (117)
Total investment securities gains, net  $185    417 
           

At March 31, 2017, the Company had pledged securities with a market value of $14.9 million for Federal Home Loan Bank (“FHLB”) advances.

At March 31, 2017, the Company has pledged $77.6 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 March 31, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

   At March 31, 2017  
   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  $37,685    37,025    (660)               37,685    37,025    (660)
US government agencies   7,129    7,091    (38)               7,129    7,091    (38)
Collateralized loan obligations   19,500    19,468    (32)   8,500    8,469    (31)   28,000    27,937    (63)
Mortgage-backed securities:                                             
Agency   62,055    61,586    (469)   9,672    9,554    (118)   71,727    71,140    (587)
Non-agency   10,660    10,475    (185)   8,214    8,142    (72)   18,874    18,617    (257)
Total mortgage-backed securities   72,715    72,061    (654)   17,886    17,696    (190)   90,601    89,757    (844)
Trust preferred securities               10,001    6,346    (3,655)   10,001    6,346    (3,655)
Total  $137,029    135,645    (1,384)   36,387    32,511    (3,876)   173,416    168,156    (5,260
18
 
   At December 31, 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  $40,479    39,424    (1,055)               40,479    39,424    (1,055)
US government agencies   3,438    3,386    (52)               3,438    3,386    (52)
Collateralized loan obligations   16,792    16,748    (44)   8,500    8,453    (47)   25,292    25,201    (91)
Mortgage-backed securities:                                             
Agency   33,323    32,960    (363)   10,125    10,002    (123)   43,448    42,962    (486)
Non-agency   9,357    9,240    (117)   8,801    8,730    (71)   18,158    17,970    (188)
Total mortgage-backed securities   42,680    42,200    (480)   18,926    18,732    (194)   61,606    60,932    (674)
Trust preferred securities   1,362    1,112    (250)   8,667    4,333    (4,334)   10,029    5,445    (4,584)
Total  $104,751    102,870    (1,881)   36,093    31,518    (4,575)   140,844    134,388    (6,456
                                              

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 March 31, 2017, trust preferred securities had an amortized cost of $11.2 million and a fair value of $8.4 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.

19
 

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 March 31, 2017.

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.

 

At March 31, 2017 and December 31, 2016, the Company had 96 and 81, respectively, 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 2017 or 2016.

Management believes that there are no additional securities other-than-temporarily impaired at March 31, 2017. 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.

20
 

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 March 31, 2017 and December 31, 2016 are as follows:

   At March 31,   At December 31, 
   2017   2016 
   Fair   Notional   Fair   Notional 
   Value   Value   Value   Value 
   (In thousands) 
Derivative assets:                    
Cash flow hedges:                    
Interest rate swaps  $559    45,000    421    30,000 
Non-hedging derivatives:                    
Interest rate swaps   552    20,000    532    20,000 
Mortgage loan interest rate lock commitments   1,827    136,592    1,113    117,439 
Mortgage loan forward sales commitments   288    15,670    153    94,001 
Total derivative assets  $3,226     217,262    2,219    261,440 
                     
Derivative liabilities:                    
Non-hedging derivatives:                    
Interest rate swaps  $234    10,000    195    10,000 
Mortgage-backed securities forward sales commitments   448    96,000    147    22,784 
Total derivative liabilities  $682    106,000    342    32,784 
                     

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.

21
 

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 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.

22
 

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

We emphasize a range of lending services, including commercial and residential real estate mortgage loans, real estate construction loans, commercial and industrial loans and consumer loans. Our customers are generally individuals and small to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in our market areas. We have focused our lending activities primarily on the professional market, including doctors, dentists, small business to medium-sized owners and commercial real estate developers.

 

Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer lending limits, with approval processes for larger loans, documentation examination, and follow-up procedures for any exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds the maximum senior officer’s lending authority, the loan request will be considered by the management loan committee, or MLC, which is comprised of five members, all of whom are part of the senior management team of the Bank. The MLC meets weekly to approve loans with total loan commitments exceeding $1.5 million. The loan authority of the MLC is equal to two-thirds of the legal lending limit of the Bank which is equivalent to the in-house loan limit. Total credit exposure above the in-house limit requires approval by the majority of the board of directors. We do not make any loans to any director, executive officer of the Bank, or the related interests of each, unless the loan is approved by the full Board of Directors of the Bank and is on terms not more favorable than would be available to a person not affiliated with the Bank.

 

The following is a description of the risk characteristics of the material loan portfolio segments:

 

Residential Mortgage Loans and Home Equity Loans. We generally originate and hold short-term and long-term first mortgages and traditional second mortgage residential real estate loans. Generally, we limit the loan-to-value ratio on our residential real estate loans to 80%. We offer fixed and adjustable rate residential real estate loans with terms of up to 30 years. We also offer a variety of lot loan options to consumers to purchase the lot on which they intend to build their home. The options available depend on whether the borrower intends to begin building within 12 months of the lot purchase or at an undetermined future date. We also offer traditional home equity loans and lines of credit. Our underwriting criteria for, and the risks associated with, home equity loans and lines of credit are generally the same as those for first mortgage loans. Home equity loans typically have terms of 10 years or less. We generally limit the extension of credit to 90% of the available equity of each property, although we may extend up to 100% of the available equity.

 

Commercial Real Estate. Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, generally does not exceed 80%. We also generally require that a borrower’s cash flow exceed 120% of monthly debt service obligations. In order to ensure secondary sources of payment and liquidity to support a loan request, we typically review all of the personal financial statements of the principal owners and require their personal guarantees.

23
 

Real Estate Construction and Development Loans. We offer fixed and adjustable rate residential and commercial construction loan financing to builders and developers and to consumers who wish to build their own home. The term of construction and development loans generally is limited to 18 months, although payments may be structured on a longer amortization basis. Most loans will mature and require payment in full upon the sale of the property. We believe that construction and development loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and usually on the subsequent sale of the property. We attempt to reduce risk associated with construction and development loans by obtaining personal guarantees and by keeping the maximum loan-to-value ratio at or below 65%-80% of the lesser of cost or appraised value, depending on the project type. Generally, we do not have interest reserves built into loan commitments but require periodic cash payments for interest from the borrower’s cash flow.

 

Commercial Loans. We make loans for commercial purposes in various lines of businesses, including the manufacturing industry, service industry, and professional service areas. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the collateral may be difficult to assess and more likely to decrease than real estate. Equipment loans typically will be made for a term of 10 years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Generally, we limit the loan-to-value ratio on these loans to 75% of cost. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange will generally be handled through a correspondent bank as agent for the Bank.

 

The Company’s primary markets are generally concentrated in real estate lending. However, in order to diversify our lending portfolio, the Company purchases nationally syndicated commercial and industrial loans. These loans typically have terms of seven years and are generally tied to a floating rate index such as LIBOR or prime. To effectively manage this line of business, the Company has an experienced senior lending executive with relevant experience to manage this area of this segement of the loan portfolio. In addition, the Company engaged a consulting firm that specializes in syndicated loans to assist in monitoring performance analytics. As of March 31, 2017 and December 31, 2016, there were approximately $80.2 million and $91.5 million in syndicated loans outstanding. Syndicated loans are grouped within commercial business loans below.

 

Consumer Loans. We make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. Consumer loans are underwritten based on the borrower’s income, current debt level, past credit history, and the availability and value of collateral. Consumer rates are both fixed and variable, with negotiable terms. Our installment loans typically amortize over periods up to 72 months. Although we typically require monthly payments of interest and a portion of the principal on our loan products, we will offer consumer loans with a single maturity date when a specific source of repayment is available. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value than real estate.

 

Loans receivable, net at March 31, 2017 and December 31, 2016 are summarized by category as follows:

   At March 31,   At December 31, 
   2017   2016 
       % of Total       % of Total 
   Amount   Loans   Amount   Loans 
   (Dollars in thousands)
Loans secured by real estate:                    
One-to-four family  $472,764    33.36%  $411,399    34.91%
Home equity   52,298    3.69%   36,026    3.06%
Commercial real estate   540,415    38.14%     445,344    37.80%
Construction and development   150,738    10.64%   115,682    9.82%
Consumer loans   10,411    0.73%   5,714    0.48%
Commercial business loans   190,384    13.44%   164,101    13.93%
Total gross loans receivable   1,417,010    100.00   1,178,266    100.00
Less:                    
Allowance for loan losses   10,715         10,688      
Total loans receivable, net  $1,406,295        $1,167,578      
24
 

Included in the loan totals were $303.2 million and $119.4 million in loans acquired through acquisitions at March 31, 2017 and December 31, 2016, 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.

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 ASC 310-30 and are considered purchased credit impaired (“PCI”) loans. 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.

PCI loans are aggregated into pools of loans based on common risk characteristics such as the type of loan, payment status, or collateral type. The Company estimates the amount and timing of expected cash flows for each purchased loan pool and the expected cash flows in excess of the amount paid are recorded as interest income over the remaining life of the pool (accretable yield). The excess of the pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).

Over the life of the loan pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

At March 31, 2017, the outstanding balance and recorded investment of PCI loans was $31.9 million and $25.3 million, respectively. The Company had no PCI loans prior to 2017. The following table presents changes in the value of the accretable yield for PCI loans for three months ended March 31, 2017 (in thousands):

   For the Three Months 
   Ended March 31, 2017 
   (In thousands) 
Accretable yield, beginning of period  $ 
Additions   4,995 
Accretion   (102)
Reclassification from nonaccretable balance, net    
Other changes, net    
Accretable yield, end of period  $4,893 
      

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

   At March 31,   At December 31, 
   2017   2016 
   (Dollars in thousands) 
Variable rate loans  $535,935    37.82%  $455,589    38.67%
Fixed rate loans   881,075    62.18   722,677    61.33%
Total loans outstanding  $1,417,010    100.00  $1,178,266    100.00
25
 

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 March 31, 2017
   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  2,636    197    3,344    1,132    80    2,805    494    10,688 
Provision for loan losses   (114)   39    244    (190)   35    (329)   315     
Charge-offs   (17)               (9)           (26)
Recoveries   1        25    1    4    22        53 
Balance, end of period  $2,506    236    3,613    943    110    2,498    809    10,715 
                                         
   For the Three Months Ended March 31, 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   (98)   1    (37)   90    (2)   66    (20)    
Charge-offs                   (2)           (2)
Recoveries   58            3    6    27        94 
Balance, end of period  $2,863    152    3,365    1,231    29    2,193    400    10,233 
26
 

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 March 31, 2017:                                
Allowance for loan losses ending balances:                                        
Individually evaluated for impairment  $43    54    48            23        168 
Collectively evaluated for impairment   2,463    182    3,565    943    110    2,475    809    10,547 
   $2,506    236    3,613    943    110    2,498    809    10,715 
                                         
Loans receivable ending balances:                                        
Individually evaluated for impairment  $4,460    1,114    5,055    491    19    247        11,386 
Collectively evaluated for impairment   461,515    50,884    523,626    145,506    10,336    188,450        1,380,317 
Purchased Credit-Impaired Loans   6,789    300    11,734    4,741    56    1,687        25,307 
Total loans receivable  $472,764    52,298    540,415    150,738    10,411    190,384        1,417,010 
                                         
At December 31, 2016:                                        
Allowance for loan losses ending balances:                                        
Individually evaluated for impairment  $27    29    92            9        157 
Collectively evaluated for impairment   2,609    168    3,252    1,132    80    2,796    494    10,531 
   $2,636    197    3,344    1,132    80    2,805    494    10,688 
                                         
Loans receivable ending balances:                                        
Individually evaluated for impairment  $4,668    108    5,247    507    24    267        10,821 
Collectively evaluated for impairment   406,731    35,918    440,097    115,175    5,690    163,834        1,167,445 
Total loans receivable  $411,399    36,026    445,344    115,682    5,714    164,101        1,178,266 
27
 

The following table presents impaired loans individually evaluated for impairment in the segmented portfolio categories and the corresponding allowance for loan losses as of March 31, 2017 and December 31, 2016. 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 March 31, 2017   At December 31, 2016 
       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  $3,833   4,073      4,125   4,366    
Home equity   839    839                 
Commercial real estate   4,041    4,041        4,011    4,011     
Construction and development   491    491        507    507     
Consumer loans   19    19        24    24     
Commercial business loans   36    37        258    258     
    9,259    9,500        8,925    9,166     
                               
With an allowance recorded:                              
Loans secured by real estate:                              
One-to-four family   627    627    43    543    543    27 
Home equity   275    275    54    108    108    29 
Commercial real estate   1,014    1,014    48    1,236    1,236    92 
Construction and development                        
Consumer loans                        
Commercial business loans   211    211    23    9    9    9 
    2,127    2,127    168    1,896    1,896    157 
                               
Total:                              
Loans secured by real estate:                              
One-to-four family   4,460    4,700    43    4,668    4,909    27 
Home equity   1,114    1,114    54    108    108    29 
Commercial real estate   5,055    5,055    48    5,247    5,247    92 
Construction and development   491    491        507    507     
Consumer loans   19    19        24    24     
Commercial business loans   247    248    23    267    267    9 
   $11,386    11,627    168    10,821    11,062    157 
28
 

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 ended March 31, 2017 and 2016.

   For the Three Months Ended March 31, 
   2017   2016 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
       (In thousands)     
With no related allowance recorded:                    
Loans secured by real estate:                    
One-to-four family  $3,827   36   3,076   11 
Home equity   541    3         
Commercial real estate   4,070    136    10,753    136 
Construction and development   491        25     
Consumer loans   20    1    65    (4)
Commercial business loans   38    17    318    4 
    8,987    193    14,237    147 
                     
With an allowance recorded:                    
Loans secured by real estate:                    
One-to-four family   597    3    518    5 
Home equity   192    1         
Commercial real estate   1,019    66    1,671     
Construction and development           475     
Consumer loans                
Commercial business loans   217    6    198    (1)
    2,025    76    2,862    4 
                     
Total:                    
Loans secured by real estate:                    
One-to-four family   4,424    39    3,594    16 
Home equity   733    4         
Commercial real estate   5,089    202    12,424    136 
Construction and development   491        500     
Consumer loans   20    1    65    (4)
Commercial business loans   255    23    516    3 
   $11,012    269    17,099    151 
29
 

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 March 31, 2017 and December 31, 2016.

   At March 31, 2017
   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  $1,526   15   1,536   90   181   11   3,359 
60-89 days past due   27    13                    40 
90 days or more past due   3,123    772    135    491    6    623    5,150 
Total past due   4,676    800    1,671    581    187    634    8,549 
Current   468,088    51,498    538,744    150,157    10,224    189,750    1,408,461 
Total loans receivable  $472,764    52,298    540,415    150,738    10,411    190,384    1,417,010 
                                    
   At December 31, 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  $3,864   379   206   62   55   136   4,702 
60-89 days past due   635    497            3        1,135 
90 days or more past due   3,170    108    334    507    26    16    4,161 
Total past due   7,669    984    540    569    84    152    9,998 
Current   403,730    35,042    444,804    115,113    5,630    163,949    1,168,268 
Total loans receivable  $411,399    36,026    445,344    115,682    5,714    164,101    1,178,266 
                                    

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.

30
 

The following is a schedule of loans receivable, by portfolio segment, on nonaccrual at March 31, 2017 and December 31, 2016.

   At March 31,   At December 31, 
   2017   2016 
  (In thousands) 
Loans secured by real estate:    
One-to-four family  $3,098   3,256 
Home equity   772    108 
Commercial real estate   1,546    1,703 
Construction and development   491    507 
Consumer loans   7    27 
Commercial business loans   17    24 
   $5,931    5,625 
           

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.

31
 

The following is a schedule of the credit quality of loans receivable, by portfolio segment, as of March 31, 2017 and December 31, 2016.

   At March 31, 2017
   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  $466,380   50,881   535,087   147,728   10,384   186,113   1,396,573 
Special Mention   1,934    231    2,749    427    20    2,236    7,597 
Substandard   4,450    1,186    2,579    2,583    7    2,035    12,840 
Total loans receivable  $472,764    52,298    540,415    150,738    10,411    190,384    1,417,010 
                                    
Performing  $469,666    51,526    538,869    150,247    10,404    190,367    1,411,079 
Nonperforming:                                   
Nonaccrual   3,098    772    1,546    491    7    17    5,931 
Total nonperforming   3,098    772    1,546    491    7    17    5,931 
Total loans receivable  $472,764    52,298    540,415    150,738    10,411    190,384    1,417,010 

   At December 31,2016
   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  $407,612   35,903   442,323   114,751   5,683   162,235   1,168,507 
Special Mention   438    15    1,318    424    19    1,849    4,063 
Substandard   3,349    108    1,703    507    12    17    5,696 
Total loans receivable  $411,399    36,026    445,344    115,682    5,714    164,101    1,178,266 
                                    
Performing  $408,143    35,918    443,641    115,175    5,687    164,077    1,172,641 
Nonperforming:                                   
Nonaccrual   3,256    108    1,703    507    27    24    5,625 
Total nonperforming   3,256    108    1,703    507    27    24    5,625 
Total loans receivable  $411,399    36,026    445,344    115,682    5,714    164,101    1,178,266 
                                    

As of March 31, 2017, the Company had $911,000 in PCI loans that were 90 days or more and still accuring. There were no loans 90 days or more and still accruing at December 31, 2016.

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.

32
 

Troubled Debt Restructurings

 

At March 31, 2017, there were $6.6 million in loans designated as troubled debt restructurings of which $5.5 million were accruing. At December 31, 2016, there were $6.4 million in loans designated as troubled debt restructurings of which $5.2 million were accruing.

There was one loan with a premodification and post modification balance of $342,000 identified as a troubled debt restructuring during the three months ended March 31, 2017 due to a payment structure change. There were no loans designated as troubled debt restructuring during the three months ended March 31 2016.

No loans previously restructured in the twelve months prior to March 31, 2017 and 2016 went into default during the three months March 31, 2017 and 2016. 

NOTE 6 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE

The following presents summarized activity in real estate acquired through foreclosure for the periods ended March 31, 2017 and December 31, 2016:

   March 31,   December 31, 
   2017   2016 
   (In thousands) 
Balance at beginning of period  $1,179   2,374 
Additions   323    2,630 
Sales   (23)   (3,810)
Write downs       (15)
Balance at end of period  $1,479    1,179 
           

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

   At March 31,   At December 31, 
   2017   2016 
   (In thousands) 
Real estate loans:          
One-to-four family  $239    
Construction and development   1,240    1,179 
   $1,479    1,179 
33
 

NOTE 7 - DEPOSITS

Deposits outstanding by type of account at March 31, 2017 and December 31, 2016 are summarized as follows:

   At March 31,   At December 31, 
   2017   2016 
   (In thousands) 
Noninterest-bearing demand accounts  $298,365   229,905 
Interest-bearing demand accounts   309,961    191,851 
Savings accounts   66,506    48,648 
Money market accounts   363,600    292,639 
Certificates of deposit:          
Less than $250,000   524,836    467,937 
$250,000 or more   44,452    27,280 
Total certificates of deposit   569,288    495,217 
Total deposits  $1,607,720    1,258,260 
           

The aggregate amount of brokered certificates of deposit was $86.2 million and $98.3 million at March 31, 2017 and December 31, 2016, respectively. Brokered certificates of deposit are included in the table above under certificates of deposit less than $250,000. The aggregate amount of institutional certificates of deposit was $49.9 million and $44.3 million at March 31, 2017 and December 31, 2016, respectively.

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.

34
 

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.

35
 

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.

 

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.

36
 

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.

37
 

The carrying amount and estimated fair value of the Company’s financial instruments at March 31, 2017 and December 31, 2016 are as follows:

   At March 31, 2017 
   Carrying   Fair Value 
   Amount   Total   Level 1   Level 2   Level 3 
   (In thousands) 
Financial assets:                        
Cash and due from banks  $21,456   21,456   21,456       
Interest-bearing cash   36,582    36,582    36,582         
Federal funds sold   10,560        10,560         
Securities available-for-sale   494,130    494,130        494,130     
Federal Home Loan Bank stock   12,478    12,478            12,478 
Other investments   2,116    2,116            2,116 
Derivative assets   3,226    3,226    1,111    2,115     
Loans held for sale   21,399    21,399        21,399     
Loans receivable, net   1,406,295    1,407,232            1,407,232 
Accrued interest receivable   6,726    6,726        6,726     
Mortgage servicing rights   15,792    21,933            21,933 
                          
Financial liabilities:                         
Deposits   1,607,720    1,605,218        1,605,218     
Short-term borrowed funds   214,500    213,865        213,865     
Long-term debt   55,304    55,272        55,272     
Derivative liabilities   682    682    234    448     
Accrued interest payable   690    690        690     

 

38
 
   At December 31, 2016 
   Carrying   Fair Value 
   Amount   Total   Level 1   Level 2   Level 3 
   (In thousands) 
Financial assets:                         
Cash and due from banks  $9,761    9,761    9,761         
Interest-bearing cash   14,591    14,591    14,591         
Securities available-for-sale   335,352    335,352        335,352     
Federal Home Loan Bank stock   11,072    11,072            11,072 
Other investments   1,768    1,768            1,768 
Derivative assets   2,219    2,219    953    1,266     
Loans held for sale   31,569    31,569        31,569     
Loans receivable, net   1,167,578    1,173,118            1,173,118 
Accrued interest receivable   5,373    5,373        5,373     
Mortgage servicing rights   15,032    20,961            20,961 
                          
Financial liabilities:                         
Deposits   1,258,260    1,256,119        1,256,119     
Short-term borrowed funds   203,000    202,455        202,455     
Long-term debt   38,465    38,442        38,442     
Derivative liabilities   342    342    195    147     
Accrued interest payable   327    327        327     

 

39
 

   At March 31, 2017   At December 31, 2016 
   Notional   Estimated   Notional   Estimated 
   Amount   Fair Value   Amount   Fair Value 
   (In thousands) 
Off-Balance Sheet Financial Instruments:                       
Commitments to extend credit  $141,082       111,446     
Standby letters of credit   3,521        2,248     
                     

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 March 31, 2017 and December 31, 2016, the Company’s investment securities available-for-sale are recurring Level 2 except for trust preferred securities which are determined to be Level 3.

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.

40
 

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.

41
 

Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2017 and December 31, 2016:

   Quoted
market price
   Significant
other
   Significant
other
 
   in active
markets
   observable
inputs
   unobservable
inputs
 
   (Level 1)   (Level 2)   (Level 3) 
   (In thousands)
March 31, 2017               
Available-for-sale investment securities:               
Municipal securities  $   150,856    
US government agencies       35,700     
Collateralized loan obligations       84,337     
Corporate securities       489     
Mortgage-backed securities:               
Agency       145,309     
Non-agency       69,018     
Trust Preferred Securities       8,421     
Loans held for sale       21,399     
Derivative assets:               
Cash flow hedges:               
Interest rate swaps   559         
Non-hedging derivatives:               
Interest rate swaps   552         
Mortgage loan interest rate lock commitments       1,827     
Mortgage loan forward sales commitments       288     
Derivative liabilities:               
Non-hedging derivatives:               
Interest rate swaps   234         
Mortgage-backed securities forward sales commitments       448     
Total  $1,345    515,092    0 
                
December 31, 2016               
Available-for-sale investment securities:               
Municipal securities  $    93,212     
US government agencies       3,386     
Collateralized loan obligations       76,249     
Corporate securities       491     
Mortgage-backed securities:               
Agency       90,986     
Non-agency       63,864     
Trust preferred securities       7,164     
Loans held for sale       31,569     
Derivative assets:               
Cash flow hedges:               
Interest rate swaps   421         
Non-hedging derivatives:               
Interest rate swaps   532         
Mortgage loan interest rate lock commitments       1,113     
Mortgage loan forward sales commitments       153     
Derivative liabilities:               
Non-hedging derivatives:               
Interest rate swaps   195         
Mortgage-backed securities forward sales commitments       147     
Total  $1,148    368,334    0 
42
 

Assets measured at fair value on a nonrecurring basis are as follows as of March 31, 2017 and December 31, 2016:

   Quoted
market price
   Significant
other
   Significant
other
 
   in active
markets
   observable
inputs
   unobservable
inputs
 
   (Level 1)   (Level 2)   (Level 3) 
   (In thousands) 
March 31, 2017               
Impaired loans:               
Loans secured by real estate:               
One-to-four family  $        4,417 
Home equity           1,060 
Commercial real estate           5,007 
Construction and development           491 
Consumer loans           19 
Commercial business loans           224 
Real estate owned:               
One-to-four family           239 
Construction and development           1,240 
Mortgage servicing rights           21,933 
Total  $        34,630 
                
December 31, 2016               
Impaired loans:               
Loans secured by real estate:               
One-to-four family  $        4,641 
Home equity           79 
Commercial real estate           5,155 
Construction and development           507 
Consumer loans           24 
Commercial business loans           258 
Real estate owned:               
One-to-four family            
Commercial real estate            
Construction and development           1,179 
Mortgage servicing rights           20,961 
Total  $        32,804 
43
 

For Level 3 assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

    March 31, 2017 and December 31, 2016
        Significant   Significant Unobservable
    Valuation Technique   Observable Inputs   Inputs
Impaired Loans   Appraisal Value   Appraisals and or sales of   Appraisals discounted 10% to 20% for
        comparable properties   sales commissions and other holding costs
             
Real estate owned   Appraisal Value/   Appraisals and or sales of   Appraisals discounted 10% to 20% for
    Comparison Sales/   comparable properties   sales commissions and other holding costs
    Other estimates        
             
Mortgage Servicing Rights   Discounted cash flows   Comparable sales   Discount rates 12% - 13% - 2017 and 2016
            Prepayment rate 7% - 8% - 2017 and 2016

NOTE 9 - 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.

The following is a summary of the reconciliation of weighted average shares outstanding for the three months ended March 31, 2017 and 2016:

   For the Three Months Ended March 31, 
   2017   2016 
   Basic   Diluted   Basic   Diluted 
Weighted average shares outstanding   13,919,711    13,919,711    11,746,574    11,746,574 
Effect of dilutive securities       219,530        232,227 
Weighted average shares outstanding   13,919,711    14,139,241    11,746,574    11,978,801 

The following is a summary of the reconciliation of shares issued and outstanding and unvested restricted stock awards as of March 31, 2017 and 2016 used to calculate book value per share:

   As of March 31, 
   2017   2016 
Issued and outstanding shares   16,185,408    12,051,615 
Less nonvested restricted stock awards   (227,439)   (302,028)
Period end dilutive shares   15,957,969    11,749,587 
44
 

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 ended March 31, 2017 and 2016:

   Community   Mortgage             
For the Three Months Ended March 31, 2017  Banking   Banking   Other   Eliminations   Total 
   (In thousands) 
Interest income  $17,257    395    6    12    17,670 
Interest expense   2,218    12    182    (12)   2,400 
Net interest income (expense)   15,039    383    (176)   24    15,270 
Provision for loan losses                    
Noninterest income from external customers   2,419    4,812            7,231 
Intersegment noninterest income   242    34        (276)    
Noninterest expense   11,324    4,053    209        15,586 
Intersegment noninterest expense       240    2    (242)    
Income (loss) before income taxes   6,376    936    (387)   (10)   6,915 
Income tax expense (benefit)   1,867    291    (143)   (4)   2,011 
Net income (loss)  $4,509    645    (244)   (6)   4,904 

 

   Community   Mortgage             
For the Three Months Ended March 31, 2016  Banking   Banking   Other   Eliminations   Total 
   (In thousands) 
Interest income  $12,944    369    5    42    13,360 
Interest expense   1,939    5    148    (5)   2,087 
Net interest income (expense)   11,005    364    (143)   47    11,273 
Provision for loan losses                    
Noninterest income from external customers   2,133    4,143            6,276 
Intersegment noninterest income   243    19        (262)    
Noninterest expense   8,429    3,680    159        12,268 
Intersegment noninterest expense       241    2    (243)    
Income (loss) before income taxes   4,952    605    (304)   28    5,281 
Income tax expense (benefit)   1,539    204    (116)   11    1,638 
Net income (loss)  $3,413    401    (188)   17    3,643 
45
 

The following tables present selected financial information for the Company’s reportable business segments for March 31, 2017 and December 31, 2016:

   Community   Mortgage             
At March 31, 2017  Banking   Banking   Other   Eliminations   Total 
   (In thousands) 
Assets  $2,178,608    70,688    298,319    (365,506)   2,182,109 
Loans receivable, net   1,383,117    27,757        (4,579)   1,406,295 
Loans held for sale   1,302    20,097            21,399 
Deposits   1,620,575            (12,855)   1,607,720 
Borrowed funds   246,500    4,000    23,304    (4,000)   269,804 

   Community   Mortgage             
At December 31, 2016  Banking   Banking   Other   Eliminations   Total 
   (In thousands) 
Assets  $1,678,541    78,315    179,681    (252,801)   1,683,736 
Loans receivable, net   1,151,704    27,433        (11,559)   1,167,578 
Loans held for sale   2,159    29,410            31,569 
Deposits   1,263,030            (4,770)   1,258,260 
Borrowed funds   226,000    10,990    15,465    (10,990)   241,465 

46
 

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 ended March 31, 2017 as compared to the three months ended March 31, 2016 and assesses our financial condition as of March 31, 2017 as compared to December 31, 2016. 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, 2016 included in our Form 10-K for that period. Results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017 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;
47
 
  · 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 FASB;

  · 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 Form 10-K for the year ended December 31, 2016. 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 is a Delaware corporation holding company registered under the Bank Holding Company Act of 1956, as amended. Its primary business is to serve as the holding company to 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 48 states and partners with community banks, credit unions and mortgage brokers.

48
 

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 January 25, 2017, the Company closed a public offering of 1.8 million shares of its common stock with net proceeds of approximately $47.7 million.

On March 18, 2017, the Company closed its acquisition of Greer Bancshares Incorporated, the holding company for Greer State Bank (“Greer”) ,with the operational conversion completed in April 2017.

49
 

Executive Summary of Operating Results

The following is a summary of the Company’s financial highlights and significant events in first quarter of 2017:

·Net income for the first quarter 2017 increased 34.6% to $4.9 million, or $0.35 per diluted share, from $3.6 million, or $0.30 per diluted share for the first quarter of 2016. Included in net income for first quarter 2017 and 2016 were $1.3 million and $186,000 in merger related expenses, respectively.
·Operating earnings for the first quarter of 2017, which excludes certain non-operating income and expenses, increased 56.1% to $5.7 million, or $0.41 per diluted share, from $3.7 million, or $0.31 per diluted share, from the first quarter of 2016.
·Performance ratios first quarter of 2017 compared to first quarter of 2016:
oReturn on average assets improved to 1.11% compared to 1.03%.
oOperating return on average assets improved to 1.30% compared to 1.04%.
oReturn on tangible equity was 9.98% compared to 10.53%.
oOperating return on tangible equity improved to 11.70% compared to 10.65%.
·Loans receivable, excluding Greer loans acquired, grew at an annualized rate of 15.7%, or $46.4 million, since December 31, 2016.
·Allowance for loan losses to non-acquired loans was 0.96% at March 31, 2017 compared to 1.01% at December 31, 2016. Nonperforming assets to total assets were 0.34% at March 31, 2017 compared to 0.40% at December 31, 2016.
·Total deposits, excluding Greer deposits acquired, increased $35.6 million since December 31, 2016. Core deposits, excluding Greer core deposits acquired, increased $26.6 million since December 31, 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 tangible equity, (v) core deposits, (vi) tangible book value and (vii) allowance for loan losses to non-acquired loans.

 

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.  

50
 

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

(Unaudited)                    
(In thousands, except share data)                    
   For the Three Months Ended 
   March 31,   December 31,   September 30,   June 30,   March 31, 
Operating Earnings and Performance Ratios:  2017   2016   2016   2016   2016 
Income before income taxes  $6,915    7,498    8,939    3,700    5,281 
Gain on sale of securities   (185)   (65)   (111)   (113)   (417)
Net loss on extinguishment of debt       1,694    118    47    9 
Fair value adjustments on interest rate swaps   58    (998)   (99)   226    281 
Merger related expenses   1,319    260        2,799    186 
Operating earnings before income taxes   8,107    8,389    8,847    6,659    5,340 
Tax expense (1)   2,358    2,627    2,967    1,555    1,656 
Operating earnings (Non-GAAP)  $5,749    5,762    5,880    5,104    3,684 
                          
Average equity   210,071    160,991    157,311    145,656    141,311 
Average assets   1,768,323    1,651,653    1,626,717    1,482,963    1,412,778 
                          
Average Equity   210,071    160,991    157,311    145,656    141,311 
Less average intangible assets   (13,510)   (7,979)   (8,092)   (3,076)   (2,917)
Average tangible common equity (Non-GAAP)   196,561    153,012    149,219    142,580    138,394 
                          
Operating return on average assets (Non-GAAP)   1.30   1.40%   1.45%   1.38%   1.04%
Operating return on average equity (Non-GAAP)   10.95%   14.32%   14.95%   14.02%   10.43%
Operating return on average tangible equity (Non-GAAP)   11.70%   15.06%   15.76%   14.32%   10.65%
                          
Weighted average common shares outstanding:                         
Basic   13,919,711    12,336,420    12,327,921    11,908,282    11,746,574 
Diluted   14,139,241    12,585,518    12,535,551    12,076,878    11,978,801 
Operating earnings per common share:                         
Basic (Non-GAAP)  $0.41    0.47    0.48    0.43    0.31 
Diluted (Non-GAAP)  $0.41    0.46    0.47    0.42    0.31 
                          
                          
As Reported:                         
Income before income taxes  $6,915    7,498    8,939    3,700    5,281 
Tax expense   2,011    2,348    2,998    864    1,638 
Net Income  $4,904    5,150    5,941    2,836    3,643 
                          
Average equity   210,071    160,991    157,311    145,656    141,311 
Average tangible equity (Non-GAAP)   196,561    153,012    149,219    142,580    138,394 
Average assets   1,768,323    1,651,653    1,626,717    1,482,963    1,412,778 
Return on average assets   1.11%   1.25%   1.46%   0.76%   1.03%
Return on average equity   9.34%   12.80%   15.11%   7.79%   10.31%
Return on average tangible equity (Non-GAAP)   9.98%   13.46%   15.93%   7.96%   10.53%
                          
Weighted average common shares outstanding:                         
Basic   13,919,711    12,336,420    12,327,921    11,908,282    11,746,574 
Diluted   14,139,241    12,585,518    12,535,551    12,076,878    11,978,801 
Earnings per common share:                         
Basic  $0.35    0.42    0.48    0.24    0.31 
Diluted  $0.35    0.41    0.47    0.23    0.30 

  

(1)Tax expense is determined using the effective tax rate reflected in the accompanying income statement for the applicable reporting period.
51
 

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

 

(Unaudited)                    
(In thousands, except share data)                    
   At the Month Ended 
   March 31,   December 31,   September 30,   June 30,   March 31, 
   2017   2016   2016   2016   2016 
Core deposits:                         
Noninterest-bearing demand accounts  $298,365    229,905    267,892    246,811    200,743 
Interest-bearing demand accounts   309,961    191,851    195,792    166,843    147,393 
Savings accounts   66,506    48,648    47,035    46,032    41,596 
Money market accounts   363,600    292,639    299,960    296,968    257,808 
Total core deposits (Non-GAAP)   1,038,432    763,043    810,679    756,654    647,540 
                          
Certificates of deposit:                         
Less than $250,000   524,836    467,937    476,744    480,002    459,789 
$250,000 or more   44,452    27,280    24,853    26,532    20,443 
Total certificates of deposit   569,288    495,217    501,597    506,534    480,232 
Total deposits  $1,607,720    1,258,260    1,312,276    1,263,188    1,127,772 

 

   At the Month Ended 
   March 31,   December 31,   September 30,   June 30,   March 31, 
   2017   2016   2016   2016   2016 
Tangible book value per share:                         
Total stockholders’ equity  $271,454    163,190    160,331    155,017    142,390 
Less intangible assets   (45,292)   (7,924)   (8,037)   (8,150)   (2,875)
Tangible common equity (Non-GAAP)  $226,162    155,266    152,294    146,867    139,515 
                          
Issued and outstanding shares   16,185,408    12,548,328    12,546,220    12,545,282    12,051,615 
Less nonvested restricted stock awards   (227,439)   (211,908)   (216,828)   (219,228)   (302,028)
Period end dilutive shares   15,957,969    12,336,420    12,329,392    12,326,054    11,749,587 
                          
Total stockholders equity  $271,454    163,190    160,331    155,017    142,390 
Divided by period end dilutive shares   15,957,969    12,336,420    12,329,392    12,326,054    11,749,587 
Common book value per share  $17.01    13.23    13.00    12.58    12.12 
                          
Tangible common equity (Non-GAAP)  $226,162    155,266    152,294    146,867    139,515 
Divided by period end dilutive shares   15,957,969    12,336,420    12,329,392    12,326,054    11,749,587 
Tangible common book value per share (Non-GAAP)  $14.17    12.59    12.35    11.92    11.87 

 

   At the Month Ended 
   March 31,   December 31,   September 30,   June 30,   March 31, 
   2017   2016   2016   2016   2016 
Acquired and non-acquired loans:                         
Acquired loans receivable 

$

303,244    119,422    129,505    130,228    61,610 
Non-acquired loans receivable   1,113,766    1,058,844    1,003,724    937,028    902,411 
Total loans receivable 

$

1,417,010    1,178,266    1,133,229    1,067,256    964,021 
% Acquired   21.40%   10.14%   11.43%   12.20%   6.39%
                          
Non-acquired loans 

$

1,113,766    1,058,844    1,003,724    937,028    902,411 
Allowance for loan losses   10,715    10,688    10,340    10,297    10,233 
Allowance for loan losses to non-acquired loans (Non-GAAP)   0.96   1.01%   1.03%   1.10%   1.13%
                          
Total loans receivable  $1,417,010    1,178,266    1,133,229    1,067,256    964,021 
Allowance for loan losses   10,715    10,688    10,340    10,297    10,233 
Allowance for loan losses to total loans receivable   0.76%   0.91%   0.91%   0.96%   1.06%
52
 

Critical Accounting Policies

 

There have been no significant changes to our critical accounting policies from those disclosed in our 2016 Annual Report on Form 10-K. Refer to the notes to our consolidated financial statements in our 2016 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 March 31, 2017 of $4.9 million, or $0.35 per diluted share, as compared to $3.6 million, or $0.30 per diluted share, for the three months ended March 31, 2016. Included in net income for the three months ended March 31, 2017 and 2016 were pretax merger related expenses of $1.3 million and $186,000, respectively.

The increase in earnings per share for the three months ended March 31, 2017 from the three months ended March 31, 2016 was primarily a result of the increase in earnings assets from organic and acquired growth.

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 $15.3 million for the three months ended March 31, 2017 from $11.3 million for the three months ended March 31, 2016. 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 ended March 31, 2017 is primarily the result of increased balances of loans receivable.

53
 

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 adjustments, as part of the acquisition of Congaree. The recorded investment in loans acquired from the Congaree acquisition were $63.9 million as of March 31, 2017.
·On March 18, 2017, the Company acquired approximately $194.7 million of loans, net of purchase accounting adjustments, as part of the acquisition of Greer. The recorded investment in loans acquired from the Greer acquisition were $192.4 million as of March 31, 2017. The recorded investment as of March 31, 2017 for loans acquired in the acquisition of Greer are presented in the following table:

   At March 31, 
   2017 
      % of Total 
   Amount   Loans 
   (Dollars in thousands) 
Loans secured by real estate:          
One-to-four family  $52,536    27.31%
Home equity   17,515    9.10%
Commercial real estate   68,401    35.55%
Construction and development   24,288    12.62%
Consumer loans   4,244    2.21%
Commercial business loans   25,398    13.21%
Total loans receivable, net  $192,382    100.00

·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 $111.4 million since March 31, 2016. This growth includes loans acquired in the acquisition of Congaree and Greer.
·Commercial lending – The Company continues to expand its commercial lending team in throughout its markets. As a result, gross loans receivable within commercial real estate and construction and development increased $238.9 million since March 31, 2016. This growth includes loans acquired in the acquisition of Congaree and Greer.
54
 

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 March 31, 
   2017   2016 
       Interest   Average       Interest   Average 
   Average   Earned/   Yield/   Average   Earned/   Yield/ 
   Balance   Paid   Rate   Balance   Paid   Rate 
Interest-earning assets:                              
Loans held for sale  $17,827    168    3.83   25,454    222    3.51%
Loans receivable, net (1)   1,214,777    14,798    4.95%   935,438    10,863    4.67%
Interest-bearing cash   16,384    32    0.79%   9,737    14    0.58%
Securities available for sale   363,505    2,551    2.81%   314,980    2,022    2.57%
Securities held to maturity               17,026    130    3.05%
Dividends from non-equitable securities   10,046    101    4.09%   8,421    97    4.63%
Other investments   4,124    20    1.94%   3,923    12    1.23%
Total interest-earning assets   1,626,663    17,670    4.42%   1,314,979    13,360    4.09%
Non-earning assets   141,660              97,799           
Total assets  $1,768,323              1,412,778           
                               
Interest-bearing liabilities:                              
Demand accounts   187,178    115    0.25%   136,634    47    0.14%
Money market accounts   305,275    288    0.38%   237,001    137    0.23%
Savings accounts   84,973    21    0.10%   40,741    13    0.13%
Certificates of deposit   478,310    1,268    1.08%   466,336    1,170    1.01%
Short-term borrowed funds   176,525    355    0.82%   92,967    105    0.45%
Long-term debt   30,538    353    4.70%   95,068    615    2.60%
Total interest-bearing liabilities   1,262,799    2,400    0.77%   1,068,747    2,087    0.79%
Noninterest-bearing deposits   275,069              188,739           
Other liabilities   20,384              13,981           
Stockholders’ equity   210,071              141,311           
Total liabilities and                              
Stockholders’ equity  $1,768,323              1,412,778           
Net interest spread             3.65%             3.30%
Net interest margin   3.82%             3.44%          
                               
Net interest margin (tax-equivalent) (2)   3.93             3.53%          
Net interest income       $15,270              11,273      

 

(1) Average balances of loans include nonaccrual loans.
(2) The tax-equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.
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Our net interest margin was 3.82%, or 3.93% on a tax-equivalent basis, for the three months ended March 31, 2017 compared to 3.44%, or 3.53% on a tax equivalent basis, for the three months ended March 31, 2016. 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 75.8% of earnings assets for the three months ended March 31, 2017 compared to 73.1% for the three months ended March 31, 2016. The yield on loans receivable during the period also reflect accretion income of $372,000 recognized.

Our net interest spread, which is not on a tax-equivalent basis, was 3.65% for the three months ended March 31, 2017 as compared to 3.30% for the same period in 2016. 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 35 basis point increase in net interest spread is a result of the 33 basis point increase in yield on interest-earning assets as well as a 2 basis point decrease 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 March 31, 2017 and 2016.

   For the Three Months 
   Ended March 31, 
   2017   2016 
   (Dollars in thousands) 
Balance, beginning of period  $10,688    10,141 
Provision for loan losses        
Loan charge-offs   (26)   (2)
Loan recoveries   53    94 
Balance, end of period  $10,715    10,233 

The Company experienced net recoveries of $27,000 and net charge offs of $92,000 for the three months ended March 31, 2017 and 2016, respectively. Asset quality has remained relatively consistent since year end, with nonperforming assets to total assets slightly decreasing to 0.34% as of March 31, 2017 as compared to 0.40% as of December 31, 2016. No provision expense for loan losses was recorded during the first quarter of 2017 or the year 2016 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.

56
 

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 ended March 31, 2017 and 2016 are presented below:

   For the Three Months 
   Ended March 31, 
   2017   2016 
   (In thousands) 
Noninterest income:          
Mortgage banking income  $3,608    3,175 
Deposit service charges   858    862 
Net loss on extinguishment of debt       (9)
Net gain on sale of securities   185    417 
Fair value adjustments on interest rate swaps   (58)   (281)
Net increase in cash value life insurance   211    229 
Mortgage loan servicing income   1,566    1,388 
Other   861    495 
Total noninterest income  $7,231    6,276 

Noninterest income increased $955,000 to $7.2 million for the three months ended March 31, 2017 from $6.3 million for the three months ended March 31, 2016. The increase in noninterest income primarily relates to the increase in mortgage banking income as a result of margin expansion experienced during the quarter

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

   For the Three Months Ended March 31, 
   Loan Originations   Mortgage Banking Income   Margin 
   2017   2016   2017   2016   2017   2016 
Additional segment information:                 
Community banking  $14,753    17,679    358    420    2.43%   2.38%
Wholesale mortgage banking   180,830    186,798    3,250    2,755    1.80%   1.47%
Total mortgage banking income  $195,583    204,477    3,608    3,175    1.84%   1.55%

 

During the three months ended March 31, 2017 and 2016, the Company recognized net gains on sale of available-for-sale securities of $185,000 and $417,000 respectively.

 

The fair value adjustment on interest rate swaps decreased noninterest income by $58,000 for the three months ended March 31, 2017 compared to a reduction in noninterest income of $281,000 for three months ended March 31, 2016. 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.

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

 

   For the Three Months 
   Ended March 31, 
   2017   2016 
   (In thousands) 
Noninterest expense:          
Salaries and employee benefits  $8,609    7,150 
Occupancy and equipment   2,182    1,842 
Marketing and public relations   381    385 
FDIC insurance   100    168 
Recovery of mortgage loan repurchase losses   (225)   (250)
Legal expense   65    49 
Other real estate expense, net   20    20 
Mortgage subservicing expense   486    423 
Amortization of mortgage servicing rights   669    532 
Merger related expenses   1,319    186 
Other   1,980    1,763 
Total noninterest expense  $15,586    12,268 

Noninterest expense represents the largest expense category for the Company. Noninterest expense increased to $15.6 million for the three months ended March 31, 2017 from $12.3 million for the three months ended March 31, 2016. The increase in noninterest expense for the three months ended March 31, 2017 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 Greer during the first quarter of 2017. Merger related expenses totaled $1.3 million for the three months ended March 31, 2017 as compared to $186,000 for the three months ended March 31, 2016. In addition, the Company opened a second branch in the Wilmington market during the fourth quarter of 2016.

Income Tax Expense

Our effective tax rate was 29.1% for three month period ended March 31, 2017, compared to 31.0% for the three month period ended March 31, 2016. The decrease in the effective tax rate from period to period is primarily attributable to the increase in interest income on municipal securities during 2017. As of March 31, 2017, municipal securities comprised 30.5% of total securities as compared to 27.8% as of March 31, 2016.

58
 

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 March 31, 2017, our securities portfolio, excluding FHLB stock and other investments, was $494.1 million or approximately 22.6% 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 $494.1 million and an amortized cost of $493.7 million for a net unrealized gain of $452,000.

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.

The increase in securities from period to period is attributable to the securities acquired with the acquisition of Greer on March 18, 2017. Securities acquired in the acquisition of Greer were approximately $121.4 million on March 18, 2017. For additional information, see Footnote 2 “Business Combinations” in the accompanying financial statements.

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 March 31, 2017 and December 2016 were $1.4 billion and $1.2 billion, respectively.

Our loan portfolio consists primarily of loans secured by real estate mortgages. As of March 31, 2017, our loan portfolio included $1.2 billion, or 85.8%, of gross loans secured by real estate. As of December 31, 2016, our loan portfolio included $1.0 billion, or 85.6%, 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. 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 $238.7 million since December 31, 2016. The increase in loans receivable primarily relates to the loans acquired in the acquisition of Greer well as the Bank’s focus on growing residential mortgage and commercial lending. The recorded investment in loans acquired in the acquisition of Greer was $192.4 million as of March 31, 2017. For additional information, see the net interest margin discussion above as well as Note 2 “Business Combinations” in the accompanying financial statements.

59
 

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

   At March 31,   At December 31, 
   2017   2016 
       % of Total       % of Total 
   Amount   Loans   Amount   Loans 
       (Dollars in thousands)     
Loans secured by real estate:                    
One-to-four family  $472,764    33.36%  $411,399    34.91%
Home equity   52,298    3.69%   36,026    3.06%
Commercial real estate   540,415    38.14%   445,344    37.80%
Construction and development   150,738    10.64%   115,682    9.82%
Consumer loans   10,411    0.73%   5,714    0.48%
Commercial business loans   190,384    13.44%   164,101    13.93%
Total gross loans receivable   1,417,010    100.00%   1,178,266    100.00%
Less:                    
Allowance for loan losses   10,715         10,688      
Total loans receivable, net  $1,406,295        $1,167,578      

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.

60
 

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

   At March 31, 2017 
       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  $21,906    62,671    388,187    472,764 
Home equity   7,555    5,894    38,849    52,298 
Commercial real estate   53,190    369,002    118,223    540,415 
Construction and development   39,749    90,656    20,333    150,738 
Consumer loans   2,077    6,668    1,666    10,411 
Commercial business loans   19,053    98,283    73,048    190,384 
Total gross loans receivable  $143,530    633,174    640,306    1,417,010 
                     
Loans maturing - after one year                    
Variable rate loans                 $460,172 
Fixed rate loans                  813,308 
                  $1,273,480 

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 March 31, 2017 the Company had $911,000 of PCI loans that were 90 days past due and accruing. At December 31 2016, 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.

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

   At March 31,   At December 31, 
   2017   2016 
   (In thousands) 
Loans receivable:          
Nonaccrual loans-renegotiated loans  $1,167    1,227 
Nonaccrual loans-other   4,764    4,398 
Real estate acquired through foreclosure, net   1,479    1,179 
Total Non-Performing Assets  $7,410    6,804 
           
Problem Assets not included in Non-Performing Assets-Accruing renegotiated loans outstanding  $5,460    5,216 

At March 31, 2017, nonperforming assets were $7.4 million, or 0.34% of total assets. Comparatively, nonperforming assets were $6.8 million, or 0.40% of total assets, at December 31, 2016. Nonperforming loans were 0.42% and 0.48% of gross loans receivable at March 31, 2017 and December 31, 2016, respectively.

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $5.5 million at March 31, 2017, compared to $5.2 million at December 31, 2016. 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.

Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans at March 31, 2017 and December 31, 2016 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 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.

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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 $10.7 million, or 0.96% of non-acquired loans, at March 31, 2017, compared to $10.7 million, or 1.01% of total non-acquired loans, at December 31, 2016. Loans acquired in business combinations were $303.2 million and $119.4 at March 31, 2017 and December 31, 2016, 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 table below shows a reconciliation of acquired and non-acquired loans and allowance for loan losses to non-acquired loans:

   At the Month Ended 
   March 31,   December 31,   September 30,   June 30,   March 31, 
   2017   2016   2016   2016   2016 
Acquired and non-acquired loans:                         
Acquired loans receivable  $303,244    119,422    129,505    130,228    61,610 
Non-acquired loans receivable   1,113,766    1,058,844    1,003,724    937,028    902,411 
Total loans receivable  $1,417,010    1,178,266    1,133,229    1,067,256    964,021 
% Acquired   21.40%     10.14%   11.43%   12.20%   6.39%
                          
Non-acquired loans  $1,113,766    1,058,844    1,003,724    937,028    902,411 
Allowance for loan losses   10,715    10,688    10,340    10,297    10,233 
Allowance for loan losses to non-acquired loans (Non-GAAP)   0.96%   1.01%   1.03%   1.10%   1.13%
                          
Total loans receivable  $1,417,010    1,178,266    1,133,229    1,067,256    964,021 
Allowance for loan losses   10,715    10,688    10,340    10,297    10,233 
Allowance for loan losses to total loans receivable   0.76%   0.91%   0.91%   0.96%   1.06%

The Company experienced net recoveries of $27,000 and $92,000 for the three months ended March 31, 2017 and 2016, respectively. Asset quality has remained relatively consistent since year end, with nonperforming assets to total assets slightly decreasing to 0.34% as of March 31, 2017 as compared to 0.40% as of December 31, 2016. No provision expense for loan losses was recorded during 2017 or 2016 primarily due to the net recoveries experienced.

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The following table summarizes the activity related to our allowance for loan losses for the three months ended March 31, 2017 and 2016.

   For the Three Months 
   Ended March 31, 
   2017   2016 
   (Dollars in thousands) 
Balance, beginning of period  $10,688    10,141 
Provision for loan losses        
Loan charge-offs:          
Loans secured by real estate:          
One-to-four family   (17)    
Home equity        
Commercial real estate        
Construction and development        
Consumer loans   (9)   (2)
Commercial business loans        
Total loan charge-offs   (26)   (2)
Loan recoveries:          
Loans secured by real estate:          
One-to-four family   1    58 
Home equity        
Commercial real estate   25     
Construction and development   1    3 
Consumer loans   4    6 
Commercial business loans   22    27 
Total loan recoveries   53    94 
Net loan (charge-offs) recoveries   27    92 
Balance, end of period  $10,715    10,233 
           
Allowance for loan losses as a percentage of loans receivable (end of period)   0.76%   1.06%
Net charge-offs (recoveries) to average loans receivable (annualized)   (0.01)%    (0.04)%
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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 is provided in “Results of Operations” – Noninterest Income and Expense. Additional segment information is provided in Note 10 “Supplemntal Segment Information” in the accompanying 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 $2.3 billion loans for others at March 31, 2017 and $2.2 billion at December 31, 2016. Mortgage servicing rights asset had a balance of $15.8 million and $15.0 million at March 31, 2017 and December 31, 2016, respectively. The economic estimated fair value of the mortgage servicing rights was $21.9 million and $21.0 million at March 31, 2017 and December 31, 2016, respectively. The amortization expense related to the mortgage servicing rights was $669,000 and $532,000 during the three months ended March 31, 2017 and 2016, respectively.

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Below is a roll-forward of activity in the balance of the servicing assets for the three months ended March 31, 2017 and 2016.

   For the Three Months 
   Ended March 31, 
   2017   2016 
   (In thousands) 
MSR beginning balance  $15,032    11,433 
Amount capitalized   1,429    1,045 
Amount amortized   (669)   (532)
MSR ending balance  $15,792    11,946 

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 ended March 31, 2017 and 2016.

 

   For the Three Months 
   March 31, 
   2017   2016 
   (In thousands) 
Beginning Balance  $2,880    3,876 
Losses paid   (72)   (21)
Recoveries        
Provision for mortgage repurchase losses   (225)   (250)
Ending balance  $2,583    3,605 

For the three ended March 31, 2017 and 2016, the Company recorded a negative provision for mortgage repurchase losses of $225,000 and $250,000, 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.

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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 March 31, 2017 deposits totaled $1.6 billion, an increase of $349.5 million from deposits of $1.3 billion at December 31, 2016. The increase in deposits since December 31, 2016 primarily relates to the $311.1 million in deposits assumed with the completion of the acquisition of Greer on March 18, 2017 as well as continued efforts to increase our core deposits through business development.

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

   For the Three Months 
   Ended March 31, 
   2017    2016 
   Average   Average   Average   Average 
   Balance   Rate   Balance   Rate 
   (Dollars in thousands) 
Interest-bearing demand accounts  $187,178    0.25%   136,634    0.14%
Money market accounts   305,275    0.38%   237,001    0.23%
Savings accounts   84,973    0.10   40,741    0.13%
Certificates of deposit less than $100,000   254,778    0.95%   262,938    0.96%
Certificates of deposit of $100,000 or more   223,532    1.19%   203,398    1.07%
Total interest-bearing average deposits   1,055,736         880,712      
Noninterest-bearing deposits   275,069         188,739      
Total average deposits  $1,330,805         1,069,451      

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

   At March 31, 2017 
   (In thousands) 
Three months or less  $22,745 
Over three through Nine Months   24,354 
Over six through twelve months   79,252 
Over twelve months   152,883 
Total certificates of deposits  $279,234 
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Borrowings

The followings table outlines our various sources of short-term borrowed funds during the three months ended March 31, 2017 and 2016 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 
At or for the three months ended March 31, 2017  (Dollars in thousands) 
Short-term borrowed funds                         
Short-term FHLB advances  $214,500    0.66% - 2.28%    214,500    176,525    0.82%
                          
Long-term borrowed funds                         
Long-term FHLB advances, due 2018 through 2020   32,000    0.69% - 2.71%    32,000    13,894    4.94%
Subordinated debentures, due 2032 through 2037   23,304    2.77% - 4.25%    26,806    16,644    4.36

 

           Maximum         
       Period   Month   Average for the 
   Ending   End   End   Period 
   Balance   Rate   Balance   Balance   Rate 
At or for the three months ended March 31, 2016   (Dollars in thousands) 
Short-term borrowed funds                         
Short-term FHLB advances  $70,000    0.35% - 0.76%    115,000    92,967    0.45%
                          
Long-term borrowed funds                         
Long-term FHLB advances, due 2017 through 2021   83,000    0.63%-4.00%    88,000    79,603    2.35%
Subordinated debentures, due 2032 through 2034   15,465    3.30% - 3.75%    15,465    15,465    3.82%

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.

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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 March 31, 2017, the Company had FHLB advances of $246.5 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately $194.5 million. Lines of credit with the FRB are based on collateral pledged.

Lines of credit with the FRB are based on collateral pledged. At March 31, 2017 the Company had lines available with the FRB for $152.1 million. At March 31, 2017 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.

 

Effective January 2, 2015, the Company and Bank became subject to the regulatory risk-based capital rules adopted by the federal banking agencies implementing Basel III. Under the new capital guidelines, applicable regulatory capital components consist of (1) common equity Tier 1 capital (common stock, including related surplus, and retained earnings, plus limited amounts of minority interest in the form of common stock, net of goodwill and other intangibles (other than mortgage servicing assets), deferred tax assets arising from net operating loss and tax credit carry forwards above certain levels, mortgage servicing rights above certain levels, gain on sale of securitization exposures and certain investments in the capital of unconsolidated financial institutions, and adjusted by unrealized gains or losses on cash flow hedges and accumulated other comprehensive income items (subject to the ability of a non-advanced approaches institution to make a one-time irrevocable election to exclude from regulatory capital most components of AOCI), (2) additional Tier 1 capital (qualifying non-cumulative perpetual preferred stock, including related surplus, plus qualifying Tier 1 minority interest and, in the case of holding companies with less than $15 billion in consolidated assets at December 31, 2009, certain grandfathered trust preferred securities and cumulative perpetual preferred stock in limited amounts, net of mortgage servicing rights, deferred tax assets related to temporary timing differences, and certain investments in financial institutions) and (3) Tier 2 capital (the allowance for loan and lease losses in an amount not exceeding 1.25% of standardized risk-weighted assets, plus qualifying preferred stock, qualifying subordinated debt and qualifying total capital minority interest, net of Tier 2 investments in financial institutions). Total Tier 1 capital, plus Tier 2 capital, constitutes total risk-based capital.

 

The required minimum ratios are as follows:

·Common equity Tier 1 capital ratio (common equity Tier 1 capital to total risk-weighted assets) of 4.5%
·Tier 1 Capital Ratio (Tier 1 capital to total risk-weighted assets) of 6%
·Total capital ratio (total capital to total risk-weighted assets) of 8%; and
·Leverage ratio (Tier 1 capital to average total consolidated assets) of 4%

 

The new capital guidelines also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The phase-in of the capital conservation buffer requirement began on January 1, 2016.

 

The final regulatory capital rules also incorporate these changes in regulatory capital into the prompt corrective action framework, under which the thresholds for “adequately capitalized” banking organizations are equal to the new minimum capital requirements. Under this framework, in order to be considered “well capitalized”, insured depository institutions are required to maintain a Tier 1 leverage ratio of 5%, a common equity Tier 1 risk-based capital measure of 6.5%, a Tier 1 risked-based capital ratio of 8% and a total risk-based capital ratio of 10%.

 

The following table present select information  for the three months ended March 31, 2017 ad 2016.

  

   For the Three Months Ended
March 31,
   2017  2016
Return on average assets   1.11%   1.03%
Return on average equity   9.34%   10.31%
Average equity to average assets ratio   11.88%   10.00%
Dividend Payout ratio   11.75%   9.94%

 

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The actual capital amounts and ratios as well as minimum amounts for each regulatory defined category for the Company and the Bank at March 31, 2017 and December 31, 2016 are as follows:

                           To Be Well 
           Minimum Capital   Minimum Capital   Capitalized Under 
           Required - Basel III   Required - Basel III   Prompt Corrective 
   Actual   Phase-In Schedule    Fully Phased-In   Action Regulations 
   Amount   Ratio   Amount   Ratio   Amount   Ratio   Amount   Ratio 
   (Dollars in thousands) 
March 31, 2017                                        
Carolina Financial Corporation                                        
CET1 capital (to risk weighted assets)  $227,039    14.73%   78,992    5.125%   107,892    7.000   N/A    N/A 
Tier 1 capital (to risk weighted assets)   250,343    16.42   102,112    6.625%   131,012    8.500%   N/A    N/A 
Total capital (to risk weighted assets)   261,058    16.94%   132,939    8.625%   161,838    10.500%   N/A    N/A 
Tier 1 capital (to total average assets)   250,343    14.52%   68,982    4.000%   68,982    4.000%   N/A    N/A 
                                         
CresCom Bank                                        
CET1 capital (to risk weighted assets)   242,961    15.71%   79,258    5.125   108,255    7.000%   100,522    6.50
Tier 1 capital (to risk weighted assets)   242,961    15.71%   102,455    6.625%   131,452    8.500%   123,720    8.00%
Total capital (to risk weighted assets)   253,676    16.40%   133,385    8.625%   162,382    10.500%   154,650    10.00%
Tier 1 capital (to total average assets)   242,961    14.10%   68,911    4.000%   68,911    4.000%   86,139    5.00%
                                         
December 31, 2016                                        
Carolina Financial Corporation                                        
CET1 capital (to risk weighted assets)  $157,876    12.87%   62,859    5.125%   85,857    7.000%   N/A    N/A 
Tier 1 capital (to risk weighted assets)   172,876    14.09%   81,257    6.625%   104,254    8.500%   N/A    N/A 
Total capital (to risk weighted assets)   183,564    14.97%   105,788    8.625%   128,785    10.500%   N/A    N/A 
Tier 1 capital (to total average assets)   172,876    10.49%   65,911    4.000%   65,911    4.000%   N/A    N/A 
                                         
CresCom Bank                                        
CET1 capital (to risk weighted assets)   169,222    13.81%   62,811    5.125%   85,791    7.000%   79,663    6.50%
Tier 1 capital (to risk weighted assets)   169,222    13.81%   81,195    6.625%   104,174    8.500%   98,046    8.00%
Total capital (to risk weighted assets)   179,910    14.68%   105,706    8.625%   128,686    10.500%   122,558    10.00%
Tier 1 capital (to total average assets)   169,222    10.30%   65,701    4.000%   65,701    4.000%   82,126    5.00%
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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 March 31, 2017, we had issued commitments to extend credit and standby letters of credit of approximately $144.6 million through various types of lending arrangements.  There were 47 standby letters of credit included in the commitments for $3.5 million. Total fixed rate commitments were $27.6 million and variable rate commitments were $117.0 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.

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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 March 31, 2017, 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

Interest Rate Scenario  Annualized Hypothetical
Percentage Change in
Change  Prime Rate  Net Interest Income
 0.00%   3.50%   0.0%
 1.00%   4.50%   0.0%
 2.00%   5.50%   -0.1%
 3.00%   6.50%   -0.3%

 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.

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.

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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 “Summary of Significant Accounting Polices” in the accompanying 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 March 31, 2017, 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, 2016, 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.

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

During the three months ended March 31, 2017, the Company issued 1,784,831 shares of common stock in completing the acquisition of Greer Bancshares Incorporated – see Note 2 “Business Combinations” to the accompanying financial statements for additional information. Pursuant to Section 35-1-202(9) of the South Carolina Uniform Securities Act of 2005, the Securities Division of the Office of the Attorney General of the State of South Carolina convened a hearing regarding the transaction on January 11, 2017 and, on January 25, 2017, issued an order concluding that the terms and conditions of the transaction were fair to the shareholders of Greer. Accordingly, the Company relied upon the exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933 to issue the aforementioned shares of common stock in the transaction. There were no other unregistered sales of the Company’s securities during the three months ended March 31, 2017.

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.

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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: May 5, 2017   /s/ Jerold L. Rexroad  
    Jerold L. Rexroad
    President and Chief Executive Officer
    (Principal Executive Officer)
     
Date: May 5, 2017   /s/ William A. Gehman, III  
    William A. Gehman III
    Executive Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer)
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INDEX TO EXHIBITS

 
Exhibit
Number
  Description
2.1   Agreement and Plan of Merger by and between Carolina Financial Corporation, CBAC, Inc., and Congaree Bancshares, Inc., dated January 5, 2016.(1)
     
2.2   Agreement and Plan of Merger by and between Carolina Financial Corporation and Greer Bancshares Incorporated, dated November 7, 2016.(2)
     
4.1   Restated Certificate of Incorporation.(3)
     
4.2   Amendment to the Restated Certificate of Incorporation.(4)
     
4.3   Amended and Restated Bylaws.(5)
     
4.4   Specimen Common Stock Certificate.(6)
     
4.5   See Exhibits 4.1, 4.2, and 4.3 for provisions of the Restated Certificate of Incorporation and Amended and Restated Bylaws which define the rights of the stockholders.
     
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 March 31, 2017, 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.

 

(1) Incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on January 11, 2016.
   
(2) Incorporated by reference to Exhibit 2.2 of the Company’s Registration Statement on Form S-3 filed on December 23, 2016.
   
(3) Incorporated by reference to Exhibit 3.1 of the Company’s Registration Statement on Form S-3 filed on August 31, 2015.
   
(4) Incorporated by reference to Exhibit A of the Company’s Definitive Proxy Statement on Schedule 14A filed on March 31, 2016.
   
(5) Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on May 5, 2016.
   
(6) Incorporated by reference to Exhibit 4.2 of the Company’s Registration Statement on Form 10 filed on February 26, 2014.

 

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