FIRST COMMUNITY BANKSHARES INC /VA/ - FORM 10-Q

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EX-32 - EXHIBIT 32 - FIRST COMMUNITY BANKSHARES INC /VA/	ex_126753.htm
EX-31.2 - EXHIBIT 31.2 - FIRST COMMUNITY BANKSHARES INC /VA/	ex_126752.htm
EX-31.1 - EXHIBIT 31.1 - FIRST COMMUNITY BANKSHARES INC /VA/	ex_126751.htm

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

FORM 10-Q

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

For the quarterly period ended September 30, 2018
or

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

Commission file number: 000-19297

		FIRST COMMUNITY BANKSHARES, INC.
		(Exact name of registrant as specified in its charter)

Virginia					55-0694814
(State or other jurisdiction of incorporation or organization)					(IRS Employer Identification No.)

P.O. Box 989 Bluefield, Virginia					24605-0989
(Address of principal executive offices)					(Zip Code)

			(276) 326-9000
			(Registrant’s telephone number, including area code)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ☐	Accelerated filer ☑
	Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐
		Emerging growth company ☐

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. ☐

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

As of October 26, 2018, there were 16,285,370 shares outstanding of the registrant’s Common Stock, $1.00 par value.

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FIRST COMMUNITY BANKSHARES, INC.
FORM 10-Q
INDEX

PART I.	FINANCIAL INFORMATION		Page

Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of September 30, 2018 (Unaudited) and December 31, 2017	4
		Condensed Consolidated Statements of Income for the Three and Nine months Ended September 30, 2018 and 2017 (Unaudited)	5
		Condensed Consolidated Statements of Comprehensive Income for the Three and Nine months Ended September 30, 2018 and 2017 (Unaudited)	6
		Condensed Consolidated Statements of Changes in Stockholders’ Equity for the Nine months Ended September 30, 2018 and 2017 (Unaudited)	7
		Condensed Consolidated Statements of Cash Flows for the Nine months Ended September 30, 2018 and 2017 (Unaudited)	8
		Notes to Condensed Consolidated Financial Statements (Unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		38
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		53
Item 4.	Controls and Procedures		54

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		54
Item 1A.	Risk Factors		54
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		54
Item 3.	Defaults Upon Senior Securities		55
Item 4.	Mine Safety Disclosures		55
Item 5.	Other Information		55
Item 6.	Exhibits		55

Signatures			57

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Forward-looking statements in filings with the Securities and Exchange Commission, including this Quarterly Report on Form 10-Q and the accompanying Exhibits, filings incorporated by reference, reports to shareholders, and other communications that represent the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates, and intentions are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions that are difficult to predict. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” and other similar expressions identify forward-looking statements. The following factors, among others, could cause financial performance to differ materially from that expressed in such forward-looking statements:

●

the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations;

●

the effects of, and changes in, trade, monetary, and fiscal policies and laws, including interest rate policies of the Federal Reserve System;

●

inflation, interest rate, market and monetary fluctuations;

●

timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;

●

the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa;

●

the impact of changes in financial services laws and regulations, including laws about taxes, banking, securities, and insurance, and the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act;

●

the impact of the U.S. Department of the Treasury and federal banking regulators’ continued implementation of programs to address capital and liquidity in the banking system;

●

further, future, and proposed rules, including those that are part of the process outlined in the Basel Committee on Banking Supervision’s “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems,” which require banking institutions to increase levels of capital;

●

technological changes;

●

the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;

●

the growth and profitability of noninterest, or fee, income being less than expected;

●

unanticipated regulatory or judicial proceedings;

●

changes in consumer spending and saving habits; and

●

the Company’s success at managing the risks mentioned above.

This list of important factors is not exclusive. If one or more of the factors affecting these forward-looking statements proves incorrect, actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking statements contained in this Quarterly Report on Form 10-Q and other reports we file with the Securities and Exchange Commission. Therefore, the Company cautions you not to place undue reliance on forward-looking information and statements. The Company does not intend to update any forward-looking statements, whether written or oral, to reflect changes. These cautionary statements expressly qualify all forward-looking statements that apply to the Company including the risk factors presented in Part II, Item 1A, “Risk Factors,” of this report and Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

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PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

FIRST COMMUNITY BANKSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30,			December 31,
	2018			2017⁽¹⁾
(Amounts in thousands, except share and per share data)	(Unaudited)
Assets
Cash and due from banks	$	44,719		$	37,115
Federal funds sold		27,965			119,891
Interest-bearing deposits in banks		995			945
Total cash and cash equivalents		73,679			157,951
Debt securities available for sale		163,593			165,525
Debt securities held to maturity		25,047			25,149
Loans held for investment, net of unearned income (including covered loans of $20,483 and $27,948)		1,790,909			1,817,184
Allowance for loan losses		(18,256	)		(19,276	)
Loans held for investment, net		1,772,653			1,797,908
FDIC indemnification asset		5,653			7,161
Premises and equipment, net		45,537			48,126
Other real estate owned (including covered OREO of $44 and $105)		4,798			2,514
Interest receivable		5,374			5,778
Goodwill		94,287			95,779
Other intangible assets		5,366			6,151
Other assets		73,701			76,418
Total assets	$	2,269,688		$	2,388,460

Liabilities
Deposits
Noninterest-bearing	$	463,945		$	454,143
Interest-bearing		1,411,906			1,475,748
Total deposits		1,875,851			1,929,891
Securities sold under agreements to repurchase		30,151			30,086
FHLB borrowings		-			50,000
Interest, taxes, and other liabilities		25,284			27,769
Total liabilities		1,931,286			2,037,746

Stockholders' equity
Preferred stock, undesignated par value; 1,000,000 shares authorized; Series A Noncumulative Convertible Preferred Stock, $0.01 par value; 25,000 shares authorized; none outstanding		-			-
Common stock, $1 par value; 50,000,000 shares authorized; 21,381,779 shares issued at September 30, 2018, and December 31, 2017; 4,991,277 and 4,383,553 shares in treasury at September 30, 2018, and December 31, 2017, respectively		21,382			21,382
Additional paid-in capital		229,182			228,750
Retained earnings		189,902			180,543
Treasury stock, at cost		(99,247	)		(79,121	)
Accumulated other comprehensive loss		(2,817	)		(840	)
Total stockholders' equity		338,402			350,714
Total liabilities and stockholders' equity	$	2,269,688		$	2,388,460

(1) Derived from audited financial statements

See Notes to Condensed Consolidated Financial Statements.

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FIRST COMMUNITY BANKSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Amounts in thousands, except share and per share data)	2018			2017			2018			2017
Interest income
Interest and fees on loans	$	22,556		$	22,694		$	67,733		$	67,435
Interest on securities -- taxable		666			341			1,704			1,157
Interest on securities -- tax-exempt		706			739			2,133			2,299
Interest on deposits in banks		358			275			1,343			655
Total interest income		24,286			24,049			72,913			71,546
Interest expense
Interest on deposits		1,269			1,275			3,847			3,674
Interest on short-term borrowings		204			213			606			634
Interest on long-term debt		488			511			1,494			1,753
Total interest expense		1,961			1,999			5,947			6,061
Net interest income		22,325			22,050			66,966			65,485
Provision for loan losses		495			730			1,485			2,156
Net interest income after provision for loan losses		21,830			21,320			65,481			63,329
Noninterest income
Wealth management		791			758			2,408			2,339
Service charges on deposits		3,803			3,605			10,883			10,078
Other service charges and fees		1,925			1,709			5,716			5,156
Insurance commissions		299			306			966			1,004
Net loss on sale of securities		(618	)		-			(618	)		(657	)
Net FDIC indemnification asset amortization		(645	)		(268	)		(1,602	)		(3,186	)
Other operating income		964			593			2,393			2,336
Total noninterest income		6,519			6,703			20,146			17,070
Noninterest expense
Salaries and employee benefits		8,983			9,001			27,417			26,771
Occupancy expense		1,075			1,082			3,408			3,671
Furniture and equipment expense		985			1,133			2,976			3,311
Service fees		1,134			705			2,813			2,645
Advertising and public relations		478			551			1,461			1,700
Professional fees		337			339			1,074			1,978
Amortization of intangibles		261			266			785			790
FDIC premiums and assessments		234			227			697			698
Loss on extinguishment of debt		1,096			-			1,096			-
Goodwill impairment		1,492			-			1,492			-
Other operating expense		2,056			3,173			9,188			8,655
Total noninterest expense		18,131			16,477			52,407			50,219
Income before income taxes		10,218			11,546			33,220			30,180
Income tax expense		1,118			3,894			6,186			9,908
Net income		9,100			7,652			27,034			20,272

Earnings per common share
Basic	$	0.55		$	0.45		$	1.62		$	1.19
Diluted		0.55			0.45			1.61			1.19
Cash dividends per common share		0.21			0.18			1.05			0.50
Weighted average shares outstanding
Basic		16,512,823			17,005,654			16,717,704			17,005,350
Diluted		16,612,416			17,082,729			16,810,425			17,076,958

See Notes to Condensed Consolidated Financial Statements.

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FIRST COMMUNITY BANKSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2018			2017			2018			2017
(Amounts in thousands)
Net income	$	9,100		$	7,652		$	27,034		$	20,272
Other comprehensive income, before tax
Available-for-sale debt securities:
Change in net unrealized (losses) gains on debt securities without other-than-temporary impairment		(983	)		(169	)		(3,426	)		2,127
Reclassification adjustment for net losses recognized in net income		618			-			618			657
Net unrealized (losses) gains on available-for-sale debt securities		(365	)		(169	)		(2,808	)		2,784
Employee benefit plans:
Net actuarial (loss) gain		(1	)		(1	)		91			133
Reclassification adjustment for amortization of prior service cost and net actuarial loss recognized in net income		72			65			214			194
Net unrealized gains on employee benefit plans		71			64			305			327
Other comprehensive (loss) income, before tax		(294	)		(105	)		(2,503	)		3,111
Income tax (benefit) expense		(62	)		(39	)		(526	)		1,167
Other comprehensive (loss) income, net of tax		(232	)		(66	)		(1,977	)		1,944
Total comprehensive income	$	8,868		$	7,586		$	25,057		$	22,216

See Notes to Condensed Consolidated Financial Statements.

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FIRST COMMUNITY BANKSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)

														Accumulated
					Additional									Other
	Preferred		Common		Paid-in			Retained			Treasury			Comprehensive
	Stock		Stock		Capital			Earnings			Stock			Income (Loss)			Total
(Amounts in thousands, except share and per share data)
Balance January 1, 2017	$	-	$	21,382	$	228,142		$	170,377		$	(78,833	)	$	(2,011	)	$	339,057
Net income		-		-		-			20,272			-			-			20,272
Other comprehensive income		-		-		-			-			-			1,944			1,944
Common dividends declared -- $0.50 per share		-		-		-			(8,504	)		-			-			(8,504	)
Equity-based compensation expense		-		-		250			-			387			-			637
Common stock options exercised -- 8,036 shares		-		-		6			-			145			-			151
Issuance of treasury stock to 401(k) plan -- 12,834 shares		-		-		112			-			231			-			343
Purchase of treasury shares -- 50,118 shares at $25.20 per share		-		-		-			-			(1,263	)		-			(1,263	)
Balance September 30, 2017	$	-	$	21,382	$	228,510		$	182,145		$	(79,333	)	$	(67	)	$	352,637

Balance January 1, 2018	$	-	$	21,382	$	228,750		$	180,543		$	(79,121	)	$	(840	)	$	350,714
Net income		-		-		-			27,034			-			-			27,034
Other comprehensive loss		-		-		-			-			-			(1,977	)		(1,977	)
Common dividends declared -- $0.57 per share		-		-		-			(9,541	)		-			-			(9,541	)
Special common dividend declared -- $0.48 per share		-		-		-			(8,134	)		-			-			(8,134	)
Equity-based compensation expense		-		-		345			-			602			-			947
Common stock options exercised -- 18,979 shares		-		-		(41	)		-			362			-			321
Issuance of treasury stock to 401(k) plan -- 10,543 shares		-		-		128			-			197			-			325
Purchase of treasury shares -- 670,016 shares at $31.77 per share		-		-		-			-			(21,287	)		-			(21,287	)
Balance September 30, 2018	$	-	$	21,382	$	229,182		$	189,902		$	(99,247	)	$	(2,817	)	$	338,402

See Notes to Condensed Consolidated Financial Statements.

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FIRST COMMUNITY BANKSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Nine Months Ended
	September 30,
(Amounts in thousands)	2018			2017
Operating activities
Net income	$	27,034		$	20,272
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses		1,485			2,156
Depreciation and amortization of premises and equipment		2,221			2,688
Amortization (accretion) of premiums on investments, net		26			63
Amortization of FDIC indemnification asset, net		1,602			3,186
Amortization of intangible assets		785			790
Goodwill impairment		1,492			-
Accretion on acquired loans		(4,257	)		(4,257	)
Equity-based compensation expense		947			637
Issuance of treasury stock to 401(k) plan		325			343
(Gain) loss on sale of premises and equipment, net		(8	)		13
Loss on sale of other real estate owned		833			940
Loss on sale of securities		618			657
Loss on extinguishment of debt		1,096			-
Decrease in accrued interest receivable		404			397
Decrease (increase) in other operating activities		2,543			(4,647	)
Net cash provided by operating activities		37,146			23,238
Investing activities
Proceeds from sale of securities available for sale		8,937			12,273
Proceeds from maturities, prepayments, and calls of securities available for sale		57,056			18,022
Proceeds from maturities and calls of securities held to maturity		-			21,840
Payments to acquire securities available for sale		(67,355	)		(36,966	)
Proceeds from loans, net		23,929			17,304
Proceeds from bank owned life insurance		458			2,639
(Redemption of) proceeds from FHLB stock, net		(2,122	)		694
(Payments to) proceeds from the FDIC		(117	)		1,701
Proceeds from sale of premises and equipment		507			29
Payments to acquire premises and equipment		(1,076	)		(2,028	)
Proceeds from sale of other real estate owned		981			2,130
Net cash provided by investing activities		21,198			37,638
Financing activities
Increase in noninterest-bearing deposits, net		9,802			25,235
Decrease in interest-bearing deposits, net		(63,842	)		(2,753	)
Proceeds from (repayments of) securities sold under agreements to repurchase, net		65			(14,222	)
Repayments of FHLB and other borrowings, net		(50,000	)		(30,708	)
Proceeds from stock options exercised		321			151
Payments for repurchase of treasury stock		(21,287	)		(1,263	)
Payments of common dividends		(17,675	)		(8,504	)
Net cash used in financing activities		(142,616	)		(32,064	)
Net (decrease) increase in cash and cash equivalents		(84,272	)		28,812
Cash and cash equivalents at beginning of period		157,951			76,307
Cash and cash equivalents at end of period	$	73,679		$	105,119

Supplemental disclosure -- cash flow information
Cash paid for interest	$	6,447		$	6,257
Cash paid for income taxes		4,800			12,942

Supplemental transactions -- noncash items
Transfer of loans to other real estate owned		4,135			1,282
Loans originated to finance other real estate owned		92			-
(Increase) decrease in accumulated other comprehensive loss		(1,977	)		1,944

See Notes to Condensed Consolidated Financial Statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Basis of Presentation

General

First Community Bankshares, Inc. (the “Company”), a financial holding company, was incorporated under the laws of the Commonwealth of Virginia in 2018. The Company is the successor to First Community Bancshares, Inc., a Nevada corporation, pursuant to an Agreement and Plan of Reincorporation and Merger, the sole purpose of which was to change the Company’s state of incorporation from Nevada to Virginia. The reincorporation was completed on October 2, 2018. The Company’s principal executive office is located at One Community Place, Bluefield, Virginia. The Company provides banking products and services to individual and commercial customers through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia-chartered banking institution founded in 1874. The Bank operates as First Community Bank in Virginia, West Virginia, and North Carolina and People’s Community Bank, a Division of First Community Bank, in Tennessee. The Bank provides insurance services through its wholly owned subsidiary First Community Insurance Services (“FCIS”) and offers wealth management and investment advice through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

On September 17, 2018, the Company announced its intention to sell its remaining insurance agency assets to Bankers Insurance, LLC (“BI”) of Glen Allen, Virginia in exchange for an equity interest in BI. The sale, which closed October 1, 2018, strategically allows the Company to continue offering insurance products to its customers through a larger, more diversified insurance agency. In connection with the decision to divest the insurance agency assets, the Company recognized a one-time goodwill impairment charge of $1.49 million during the third quarter of 2018. The Company used the fair value of the equity interest in BI as the basis for determining the goodwill impairment.

Principles of Consolidation

The Company’s accounting and reporting policies conform with U.S. generally accepted accounting principles (“GAAP”) and prevailing practices in the banking industry. The consolidated financial statements include all accounts of the Company and its wholly owned subsidiaries and eliminate all intercompany balances and transactions. The Company operates in one business segment, Community Banking, which consists of all operations, including commercial and consumer banking, lending activities, wealth management, and insurance services. Operating results for interim periods are not necessarily indicative of results that may be expected for other interim periods or for the full year. In management’s opinion, the accompanying unaudited interim condensed consolidated financial statements contain all necessary adjustments, including normal recurring accruals, and disclosures for a fair presentation.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”), as filed with the Securities and Exchange Commission (the “SEC”) on March 5, 2018. The condensed consolidated balance sheet as of December 31, 2017, has been derived from the audited consolidated financial statements.

Reclassifications

Certain amounts reported in prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on the Company’s results of operations, financial position, or net cash flow.

Use of Estimates

Preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that require the most subjective or complex judgments relate to fair value measurements, investment securities, the allowance for loan losses, goodwill and other intangible assets, and income taxes. A discussion of the Company’s application of critical accounting estimates is included in “Critical Accounting Estimates” in Item 2 of this report.

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Significant Accounting Policies

A complete and detailed description of the Company’s significant accounting policies is included in Note 1, “Basis of Presentation,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2018, and in Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of the Company’s 2017 Form 10-K.

Recent Accounting Standards

Standards Adopted in 2018

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updated (“ASU”) 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The Company adopted ASU 2017-09 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements.

In March 2017, the FASB issued ASU 2017-08, “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Securities.” This ASU amends the amortization period for certain purchased callable debt securities. The Company early adopted ASU 2017-08 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements since securities held at a premium were already being amortized to the earliest call date.

In March 2017, the FASB issued ASU 2017-07, “Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” This ASU intends to improve the presentation of net periodic pension cost and net periodic postretirement benefit costs in the income statement and to narrow the amounts eligible for capitalization in assets. The Company adopted ASU 2017-07 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the standard, the Company reclassified the non-service components of the net periodic benefit costs from salaries and employee benefits to other expense on a retrospective basis, which totaled $136 thousand for the three months ended September 30, 2017, and $407 thousand for the nine months ended September 30, 2017.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” This ASU requires that a statement of cash flows explains the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted ASU 2016-18 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” This ASU makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The update should be applied on a retrospective basis, if practicable. The Company adopted ASU 2016-15 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the standard, the Company reclassified proceeds from bank owned life insurance from operating activities to investing activities on a retrospective basis, which totaled $2.64 million for the nine months ended September 30, 2017.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU significantly revises how entities account and disclose financial assets and liabilities. The guidance (1) requires most equity investments to be measured at fair value with changes in fair value recognized in net income; (2) simplifies the impairment assessment of equity investments without a readily determinable fair value; (3) eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet; (4) requires public business entities to use exit price notion, rather than entry prices, when measuring fair value of financial instruments for disclosure purposes; (5) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements; (6) requires separate presentation in other comprehensive income of the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; and (7) states that a valuation allowance on deferred tax assets related to available-for-sale securities should be evaluated in combination with other deferred tax assets. In February 2018, the FASB issued ASU 2018-03, which included technical corrections and improvements to clarify the guidance in ASU 2016-01. The Company adopted ASU 2016-01 in the first quarter of 2018. The adoption of the standard did not have a material effect on the Company’s financial statements. In accordance with the prospective application of the standard, the Company measured the fair value of loans using an exit price notion as of March 31, 2018. For additional information, see Note 13, “Fair Value” to the Condensed Consolidated Financial Statements of this report.

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In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” This ASU’s core principle is that an entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under existing guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers” deferring the effective date of ASU 2014-09 for the Company until fiscal years beginning after December 15, 2017, with early adoption permitted for fiscal years beginning after December 15, 2016. The Company adopted Topic 606, and related updates, in the first quarter of 2018 using the modified retrospective method. The Company’s primary source of revenue is interest income, which is excluded from the scope of this guidance; however, the Company evaluated the impact on other income; which includes fees for services, commissions on sales, and various deposit service charges; revenue contracts; and disclosures and determined that no cumulative-effect adjustment to retained earnings was necessary. The adoption of the standard did not have a material effect on the Company’s financial statements.

Revenue Recognition

Accounting Standards Codification Topic 606 (“ASC 606”), “Revenue from Contracts with Customers,” establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the Company's contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.

The great majority of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans, letters of credit, and derivatives and investment securities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Descriptions of the Company’s revenue-generating activities that are within the scope of ASC 606, which are discussed below, are presented in the Company’s consolidated statements of income as components of noninterest income.

Wealth management. Wealth management income represents monthly fees due from wealth management customers as consideration for managing the customers' assets. Wealth management and trust services include custody of assets, investment management, escrow services, fees for trust services and similar fiduciary activities. Revenue is recognized when the performance obligation is completed each month, which is generally the time that payment is received. Income also includes fees received from a third party broker-dealer as part of a revenue-sharing agreement for fees earned from customers that are referred to the third party. These fees are paid to the Company by the third party on a quarterly basis and recognized ratably throughout the quarter as the performance obligation is satisfied.

Service charges on deposits and other service charges and fees. Service charges on deposits and other service charges and fees represent general service fees for account maintenance and activity and transaction-based fees that consist of transaction-based revenue, time-based revenue (service period), item-based revenue, or some other individual attribute-based revenue. Revenue is recognized when the performance obligation is completed, which is generally monthly for account maintenance services or when a transaction has been completed. Payment for such performance obligations is generally received at the time the performance obligations are satisfied. Other service charges and fees include interchange income from debit and credit card transaction fees. In accordance with the adoption of ASC 606, the Company reclassified interchange expense, which was previously a component of noninterest expense, to net against interchange income on a retrospective basis, which totaled $432 thousand for the three months ended September 30, 2017, and $1.23 million for the nine months ended September 30, 2017.

Other operating income. Other operating income consists primarily of third-party incentive payments, income on life insurance contracts, and dividends received, which are not subject to the requirements of ASC 606.

Standards Not Yet Adopted

In July 2018, the FASB issued ASU 2018-09, “Codification Improvements.” This ASU makes changes to a variety of topics to clarify, correct errors in, or make minor improvements to the Accounting Standards Codification. The majority of the amendments in ASU 2018-09 will be effective for the Company for fiscal years beginning after December 15, 2018. The Company expects to adopt ASU 2018-09 in the first quarter of 2019. The Company is evaluating the impact of the standard and does not expect the guidance to have a material effect on its financial statements.

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In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” This ASU intends to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements and simplify the application of hedge accounting guidance. ASU 2017-12 will be effective for the Company for fiscal years beginning after December 15, 2018. The Company expects to adopt ASU 2017-12 in the first quarter of 2019. The Company is evaluating the impact of the standard and does not expect the guidance to have a material effect on its financial statements.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This ASU intends to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. This ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, the update amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective for the Company for fiscal years beginning after December 15, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. The Company expects to adopt ASU 2016-13 in the first quarter of 2020 and recognize a cumulative adjustment to retained earnings as of the beginning of the year of adoption. The Company is evaluating the impact of the standard.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” This ASU increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requiring more disclosures related to leasing transactions. In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842, Leases,” which updates narrow aspects of the guidance issued in ASU 2016-02. ASU 2016-02 will be effective for the Company for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company expects to adopt ASU 2016-02 in the first quarter of 2019. The Company leases certain banking offices under lease agreements it classifies as operating leases. The Company is evaluating the impact of the standard and expects an increase in assets and liabilities; however, the Company does not expect the guidance to have a material effect on its financial statements or resulting operations.

The Company does not expect other recent accounting standards issued by the FASB or other standards-setting bodies to have a material impact on the consolidated financial statements.

Note 2. Debt Securities

The following tables present the amortized cost and fair value of available-for-sale debt securities, including gross unrealized gains and losses, as of the dates indicated:

	September 30, 2018
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
(Amounts in thousands)
U.S. Agency securities	$	1,137	$	4	$	-		$	1,141
U.S. Treasury securities		29,910		-		(22	)		29,888
Municipal securities		97,857		766		(1,112	)		97,511
Mortgage-backed Agency securities		36,263		15		(1,225	)		35,053
Total	$	165,167	$	785	$	(2,359	)	$	163,593

	December 31, 2017
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
(Amounts in thousands)
U.S. Agency securities	$	11,289	$	17	$	(10	)	$	11,296
U.S. Treasury securities		19,987		-		(16	)		19,971
Municipal securities		101,552		2,203		(107	)		103,648
Single issue trust preferred securities		9,367		-		(483	)		8,884
Mortgage-backed Agency securities		22,095		46		(415	)		21,726
Total	$	164,290	$	2,266	$	(1,031	)	$	165,525

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The following tables present the amortized cost and fair value of held-to-maturity debt securities, including gross unrealized gains and losses, as of the dates indicated:

	September 30, 2018
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
(Amounts in thousands)
U.S. Agency securities	$	17,900	$	-	$	(53	)	$	17,847
Corporate securities		7,147		-		(15	)		7,132
Total	$	25,047	$	-	$	(68	)	$	24,979

	December 31, 2017
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
(Amounts in thousands)
U.S. Agency securities	$	17,937	$	-	$	(49	)	$	17,888
Corporate securities		7,212		-		(16	)		7,196
Total	$	25,149	$	-	$	(65	)	$	25,084

The following table presents the amortized cost and aggregate fair value of available-for-sale debt securities and held-to-maturity debt securities, by contractual maturity, as of the date indicated. Actual maturities could differ from contractual maturities because issuers may have the right to call or prepay obligations with or without penalties.

	September 30, 2018
	Amortized
(Amounts in thousands)	Cost		Fair Value
Available-for-sale debt securities
Due within one year	$	29,910	$	29,888
Due after one year but within five years		11,547		11,644
Due after five years but within ten years		86,662		86,226
Due after ten years		785		782
		128,904		128,540
Mortgage-backed securities		36,263		35,053
Total debt securities available for sale	$	165,167	$	163,593

Held-to-maturity debt securities
Due within one year	$	25,047	$	24,979
Due after one year but within five years		-		-
Due after five years but within ten years		-		-
Due after ten years		-		-
Total debt securities held to maturity	$	25,047	$	24,979

The following tables present the fair values and unrealized losses for available-for-sale debt securities in a continuous unrealized loss position for less than 12 months and for 12 months or longer as of the dates indicated:

	September 30, 2018
	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
(Amounts in thousands)
U.S. Treasury securities	$	29,888	$	(22	)	$	-	$	-		$	29,888	$	(22	)
Municipal securities		26,034		(720	)		6,938		(392	)		32,972		(1,112	)
Mortgage-backed Agency securities		20,213		(369	)		13,062		(856	)		33,275		(1,225	)
Total	$	76,135	$	(1,111	)	$	20,000	$	(1,248	)	$	96,135	$	(2,359	)

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	December 31, 2017
	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
(Amounts in thousands)
U.S. Agency securities	$	10,054	$	(10	)	$	-	$	-		$	10,054	$	(10	)
U.S. Treasury securities		19,972		(16	)		-		-			19,972		(16	)
Municipal securities		8,047		(55	)		2,314		(52	)		10,361		(107	)
Single issue trust preferred securities		-		-			8,884		(483	)		8,884		(483	)
Mortgage-backed Agency securities		4,276		(25	)		14,069		(390	)		18,345		(415	)
Total	$	42,349	$	(106	)	$	25,267	$	(925	)	$	67,616	$	(1,031	)

The following tables present the fair values and unrealized losses for held-to-maturity debt securities in a continuous unrealized loss position for less than 12 months and for 12 months or longer as of the dates indicated:

	September 30, 2018
	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
(Amounts in thousands)
U.S. Agency securities	$	14,104	$	(41	)	$	3,743	$	(12	)	$	17,847	$	(53	)
Corporate securities		3,746		(5	)		3,386		(10	)		7,132		(15	)
Total	$	17,850	$	(46	)	$	7,129	$	(22	)	$	24,979	$	(68	)

	December 31, 2017
	Less than 12 Months					12 Months or Longer				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
	Value		Losses			Value		Losses		Value		Losses
(Amounts in thousands)
U.S. Agency securities	$	17,888	$	(49	)	$	-	$	-	$	17,888	$	(49	)
Corporate securities		7,196		(16	)		-		-		7,196		(16	)
Total	$	25,084	$	(65	)	$	-	$	-	$	25,084	$	(65	)

There were 116 individual debt securities in an unrealized loss position as of September 30, 2018, and their combined depreciation in value represented 1.29% of the debt securities portfolio. There were 45 individual debt securities in an unrealized loss position as of December 31, 2017, and their combined depreciation in value represented 0.57% of the debt securities portfolio.

The Company reviews its investment portfolio quarterly for indications of other-than-temporary impairment (“OTTI”). The initial indicator of OTTI for debt securities is a decline in fair value below book value and the severity and duration of the decline. The credit-related OTTI is recognized as a charge to noninterest income and the noncredit-related OTTI is recognized in other comprehensive income (“OCI”). During the three and nine months ended September 30, 2018 and 2017, the Company incurred no OTTI charges on debt securities. Temporary impairment on debt securities is primarily related to changes in benchmark interest rates, changes in pricing in the credit markets, and other current economic factors.

The following table presents gross realized gains and losses from the sale of available-for-sale debt securities for the periods indicated:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2018			2017		2018			2017
(Amounts in thousands)
Gross realized gains	$	-		$	-	$	-		$	-
Gross realized losses		(618	)		-		(618	)		(657	)
Net loss on sale of securities	$	(618	)	$	-	$	(618	)	$	(657	)

The carrying amount of securities pledged for various purposes totaled $37.79 million as of September 30, 2018, and $51.34 million as of December 31, 2017.

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Note 3. Loans

The Company groups loans held for investment into three segments (commercial loans, consumer real estate loans, and consumer and other loans) with each segment divided into various classes. Covered loans are those loans acquired in Federal Deposit Insurance Corporation (“FDIC”) assisted transactions that are covered by loss share agreements. Customer overdrafts reclassified as loans totaled $1.83 million as of September 30, 2018, and $1.71 million as of December 31, 2017. Deferred loan fees, net of loan costs, totaled $4.64 million as of September 30, 2018, and $4.44 million as of December 31, 2017. For information about off-balance sheet financing, see Note 14, “Litigation, Commitments, and Contingencies,” to the Condensed Consolidated Financial Statements of this report.

The following table presents loans, net of unearned income, with the non-covered portfolio by loan class, as of the dates indicated:

	September 30, 2018					December 31, 2017
(Amounts in thousands)	Amount		Percent			Amount		Percent
Non-covered loans held for investment
Commercial loans
Construction, development, and other land	$	62,657		3.50	%	$	60,017		3.30	%
Commercial and industrial		105,603		5.90	%		92,188		5.07	%
Multi-family residential		112,710		6.29	%		125,202		6.89	%
Single family non-owner occupied		142,591		7.96	%		141,670		7.80	%
Non-farm, non-residential		606,800		33.88	%		616,633		33.93	%
Agricultural		9,016		0.50	%		7,035		0.39	%
Farmland		20,872		1.17	%		25,649		1.41	%
Total commercial loans		1,060,249		59.20	%		1,068,394		58.79	%
Consumer real estate loans
Home equity lines		96,819		5.41	%		103,205		5.68	%
Single family owner occupied		520,363		29.05	%		502,686		27.66	%
Owner occupied construction		17,889		1.00	%		39,178		2.16	%
Total consumer real estate loans		635,071		35.46	%		645,069		35.50	%
Consumer and other loans
Consumer loans		69,974		3.91	%		70,772		3.89	%
Other		5,132		0.29	%		5,001		0.28	%
Total consumer and other loans		75,106		4.20	%		75,773		4.17	%
Total non-covered loans		1,770,426		98.86	%		1,789,236		98.46	%
Total covered loans		20,483		1.14	%		27,948		1.54	%
Total loans held for investment, net of unearned income	$	1,790,909		100.00	%	$	1,817,184		100.00	%

The following table presents the covered loan portfolio, by loan class, as of the dates indicated:

	September 30, 2018		December 31, 2017
(Amounts in thousands)
Covered loans
Commercial loans
Construction, development, and other land	$	35	$	39
Single family non-owner occupied		245		284
Non-farm, non-residential		7		9
Total commercial loans		287		332
Consumer real estate loans
Home equity lines		16,804		23,720
Single family owner occupied		3,392		3,896
Total consumer real estate loans		20,196		27,616
Total covered loans	$	20,483	$	27,948

The Company identifies certain purchased loans as impaired when fair values are established at acquisition and groups those purchased credit impaired (“PCI”) loans into loan pools with common risk characteristics. The Company estimates cash flows to be collected on PCI loans and discounts those cash flows at a market rate of interest.

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The following table presents the recorded investment and contractual unpaid principal balance of PCI loans, by acquisition, as of the dates indicated:

	September 30, 2018				December 31, 2017
(Amounts in thousands)	Recorded Investment		Unpaid Principal Balance		Recorded Investment		Unpaid Principal Balance
PCI Loans, by acquisition
Peoples	$	5,420	$	7,546	$	5,278	$	8,111
Waccamaw		7,354		22,930		12,176		31,335
Other acquired		899		925		986		1,012
Total PCI Loans	$	13,673	$	31,401	$	18,440	$	40,458

The following table presents the changes in the accretable yield on PCI loans, by acquisition, during the periods indicated:

	Peoples			Waccamaw			Total
(Amounts in thousands)
Balance January 1, 2017	$	4,392		$	21,834		$	26,226
Accretion		(969	)		(4,690	)		(5,659	)
Reclassifications from nonaccretable difference⁽¹⁾		782			2,525			3,307
Other changes, net		(375	)		(311	)		(686	)
Balance September 30, 2017	$	3,830		$	19,358		$	23,188

Balance January 1, 2018	$	3,388		$	19,465		$	22,853
Accretion		(986	)		(4,157	)		(5,143	)
Reclassifications (to) from nonaccretable difference⁽¹⁾		(5	)		1,416			1,411
Other changes, net		354			(302	)		52
Balance September 30, 2018	$	2,751		$	16,422		$	19,173

____________________________________________________________________________________________________________________________________________________________

(1) Represents changes attributable to expected loss assumptions

Note 4. Credit Quality

The Company uses a risk grading matrix to assign a risk grade to each loan in its portfolio. Loan risk ratings may be upgraded or downgraded to reflect current information identified during the loan review process. The general characteristics of each risk grade are as follows:

●

Pass -- This grade is assigned to loans with acceptable credit quality and risk. The Company further segments this grade based on borrower characteristics that include capital strength, earnings stability, liquidity, leverage, and industry conditions.

●

Special Mention -- This grade is assigned to loans that require an above average degree of supervision and attention. These loans have the characteristics of an asset with acceptable credit quality and risk; however, adverse economic or financial conditions exist that create potential weaknesses deserving of management’s close attention. If potential weaknesses are not corrected, the prospect of repayment may worsen.

●

Substandard -- This grade is assigned to loans that have well defined weaknesses that may make payment default, or principal exposure, possible. These loans will likely be dependent on collateral liquidation, secondary repayment sources, or events outside the normal course of business to meet repayment terms.

●

Doubtful -- This grade is assigned to loans that have the weaknesses inherent in substandard loans; however, the weaknesses are so severe that collection or liquidation in full is unlikely based on current facts, conditions, and values. Due to certain specific pending factors, the amount of loss cannot yet be determined.

●

Loss -- This grade is assigned to loans that will be charged off or charged down when payments, including the timing and value of payments, are uncertain. This risk grade does not imply that the asset has no recovery or salvage value, but simply means that it is not practical or desirable to defer writing off, either all or a portion of, the loan balance even though partial recovery may be realized in the future.

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The following tables present the recorded investment of the loan portfolio, by loan class and credit quality, as of the dates indicated. Losses on covered loans are generally reimbursable by the FDIC at the applicable loss share percentage, 80%; therefore, covered loans are disclosed separately.

	September 30, 2018
			Special
(Amounts in thousands)	Pass		Mention		Substandard		Doubtful		Loss		Total
Non-covered loans
Commercial loans
Construction, development, and other land	$	60,665	$	800	$	1,192	$	-	$	-	$	62,657
Commercial and industrial		102,590		2,187		826		-		-		105,603
Multi-family residential		106,488		4,077		2,145		-		-		112,710
Single family non-owner occupied		133,820		4,500		4,271		-		-		142,591
Non-farm, non-residential		588,273		8,556		9,825		146		-		606,800
Agricultural		8,716		198		102		-		-		9,016
Farmland		18,427		626		1,819		-		-		20,872
Consumer real estate loans
Home equity lines		94,401		648		1,770		-		-		96,819
Single family owner occupied		491,179		4,562		24,622		-		-		520,363
Owner occupied construction		17,588		-		301		-		-		17,889
Consumer and other loans
Consumer loans		69,611		5		354		-		4		69,974
Other		5,132		-		-		-		-		5,132
Total non-covered loans		1,696,890		26,159		47,227		146		4		1,770,426
Covered loans
Commercial loans
Construction, development, and other land		-		35		-		-		-		35
Single family non-owner occupied		230		-		15		-		-		245
Non-farm, non-residential		-		-		7		-		-		7
Consumer real estate loans
Home equity lines		9,864		6,329		611		-		-		16,804
Single family owner occupied		2,610		372		410		-		-		3,392
Total covered loans		12,704		6,736		1,043		-		-		20,483
Total loans	$	1,709,594	$	32,895	$	48,270	$	146	$	4	$	1,790,909

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	December 31, 2017
			Special
(Amounts in thousands)	Pass		Mention		Substandard		Doubtful		Loss		Total
Non-covered loans
Commercial loans
Construction, development, and other land	$	57,768	$	1,367	$	882	$	-	$	-	$	60,017
Commercial and industrial		87,181		3,721		1,286		-		-		92,188
Multi-family residential		118,509		5,663		1,030		-		-		125,202
Single family non-owner occupied		130,689		7,271		3,710		-		-		141,670
Non-farm, non-residential		596,616		12,493		7,351		173		-		616,633
Agricultural		6,639		294		102		-		-		7,035
Farmland		22,875		210		2,564		-		-		25,649
Consumer real estate loans
Home equity lines		100,833		618		1,754		-		-		103,205
Single family owner occupied		471,382		5,480		25,824		-		-		502,686
Owner occupied construction		38,947		-		231		-		-		39,178
Consumer and other loans
Consumer loans		70,448		13		311		-		-		70,772
Other		5,001		-		-		-		-		5,001
Total non-covered loans		1,706,888		37,130		45,045		173		-		1,789,236
Covered loans
Commercial loans
Construction, development, and other land		1		38		-		-		-		39
Single family non-owner occupied		265		-		19		-		-		284
Non-farm, non-residential		-		-		9		-		-		9
Consumer real estate loans
Home equity lines		11,338		11,685		697		-		-		23,720
Single family owner occupied		2,996		411		489		-		-		3,896
Total covered loans		14,600		12,134		1,214		-		-		27,948
Total loans	$	1,721,488	$	49,264	$	46,259	$	173	$	-	$	1,817,184

The Company identifies loans for potential impairment through a variety of means, including, but not limited to, ongoing loan review, renewal processes, delinquency data, market communications, and public information. If the Company determines that it is probable all principal and interest amounts contractually due will not be collected, the loan is generally deemed impaired.

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The following table presents the recorded investment, unpaid principal balance, and related allowance for loan losses for impaired loans, excluding PCI loans, as of the dates indicated:

	September 30, 2018						December 31, 2017
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
(Amounts in thousands)	Investment		Balance		Allowance		Investment		Balance		Allowance
Impaired loans with no related allowance
Commercial loans
Construction, development, and other land	$	903	$	918	$	-	$	727	$	988	$	-
Commercial and industrial		300		321		-		315		1,142		-
Multi-family residential		1,380		1,445		-		499		1,010		-
Single family non-owner occupied		2,448		2,782		-		2,042		3,521		-
Non-farm, non-residential		3,859		4,759		-		3,022		5,955		-
Agricultural		102		107		-		102		107		-
Farmland		1,404		1,478		-		395		414		-
Consumer real estate loans
Home equity lines		1,451		1,589		-		1,621		1,770		-
Single family owner occupied		14,963		17,868		-		16,633		18,964		-
Owner occupied construction		227		227		-		231		231		-
Consumer and other loans
Consumer loans		203		209		-		141		144		-
Total impaired loans with no allowance		27,240		31,703		-		25,728		34,246		-

Impaired loans with a related allowance
Commercial loans
Commercial and industrial		-		-		-		343		343		270
Multi-family residential		536		536		235		-		-		-
Single family non-owner occupied		842		842		238		446		446		62
Non-farm, non-residential		-		-		-		262		263		15
Farmland		410		418		158		936		974		233
Consumer real estate loans
Home equity lines		65		68		66		-		-		-
Single family owner occupied		4,907		4,951		1,017		5,586		5,606		1,978
Total impaired loans with an allowance		6,760		6,815		1,714		7,573		7,632		2,558
Total impaired loans⁽¹⁾	$	34,000	$	38,518	$	1,714	$	33,301	$	41,878	$	2,558

________________________________________________________________________________________________

(1)

Total impaired loans include loans totaling $25.42 million as of September 30, 2018, and $20.13 million as of December 31, 2017, that do not meet the Company's evaluation threshold for individual impairment and are therefore collectively evaluated for impairment. During the first quarter of 2018, the Company changed the threshold for quarterly reviews of individual loans that are deemed to be impaired from $250 thousand to $500 thousand or greater.

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The following table presents the average recorded investment and interest income recognized on impaired loans, excluding PCI loans, for the periods indicated:

	Three Months Ended September 30,								Nine Months Ended September 30,
	2018				2017				2018				2017
(Amounts in thousands)	Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment
Impaired loans with no related allowance:
Commercial loans
Construction, development, and other land	$	-	$	910	$	32	$	907	$	14	$	950	$	32	$	309
Commercial and industrial		3		311		5		754		6		378		8		468
Multi-family residential		5		1,402		-		509		15		832		3		474
Single family non-owner occupied		8		2,529		11		3,304		56		2,599		88		3,313
Non-farm, non-residential		-		3,926		68		5,244		39		5,028		93		3,766
Agricultural		-		103		4		127		-		187		4		127
Farmland		23		1,425		17		1,003		38		1,066		17		1,004
Consumer real estate loans
Home equity lines		3		1,514		15		1,683		20		1,719		35		1,259
Single family owner occupied		15		15,832		137		17,478		208		15,222		317		15,209
Owner occupied construction		-		229		1		235		6		249		6		234
Consumer and other loans
Consumer loans		-		210		1		62		6		164		3		52
Total impaired loans with no related allowance		57		28,391		291		31,306		408		28,394		606		26,215

Impaired loans with a related allowance:
Commercial loans
Construction, development, and other land		-		-		-		-		-		-		-		143
Commercial and industrial		-		-		50		2,516		-		-		103		1,727
Multi-family residential		-		541		-		-		-		271		-		-
Single family non-owner occupied		-		849		8		778		7		644		21		488
Non-farm, non-residential		-		-		-		872		-		770		15		964
Farmland		-		413		-		413		-		409		-		275
Consumer real estate loans
Home equity lines		1		67		-		-		3		69		-		139
Single family owner occupied		35		4,999		24		3,814		126		5,838		92		4,527
Owner occupied construction		-		-		-		-		-		-		-		1
Total impaired loans with a related allowance		36		6,869		82		8,393		136		8,001		231		8,264
Total impaired loans	$	93	$	35,260	$	373	$	39,699	$	544	$	36,395	$	837	$	34,479

There were no impaired PCI loan pools as of September 30, 2018, or December 31, 2017. The following table provides information on impaired PCI loan pools for the dates indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
(Amounts in thousands)
Interest income recognized	$	-	$	-	$	-	$	20
Average recorded investment		-		-		-		705

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The Company generally places a loan on nonaccrual status when it is 90 days or more past due. PCI loans are generally not classified as nonaccrual due to the accrual of interest income under the accretion method of accounting. The following table presents nonaccrual loans, by loan class, as of the dates indicated:

	September 30, 2018						December 31, 2017
(Amounts in thousands)	Non-covered		Covered		Total		Non-covered		Covered		Total
Commercial loans
Construction, development, and other land	$	485	$	-	$	485	$	-	$	-	$	-
Commercial and industrial		284		-		284		211		-		211
Multi-family residential		1,861		-		1,861		498		-		498
Single family non-owner occupied		1,328		15		1,343		851		19		870
Non-farm, non-residential		3,960		-		3,960		2,448		-		2,448
Agricultural		102		-		102		102		-		102
Farmland		1,055		-		1,055		805		-		805
Consumer real estate loans
Home equity lines		758		277		1,035		882		306		1,188
Single family owner occupied		10,574		38		10,612		13,108		17		13,125
Consumer and other loans
Consumer loans		135		-		135		92		-		92
Total nonaccrual loans	$	20,542	$	330	$	20,872	$	18,997	$	342	$	19,339

The following tables present the aging of past due loans, by loan class, as of the dates indicated. Nonaccrual loans 30 days or more past due are included in the applicable delinquency category. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. Non-covered accruing loans contractually past due 90 days or more totaled $46 thousand as of September 30, 2018, compared to $1 thousand as of December 31, 2017.

	September 30, 2018
	30 - 59 Days		60 - 89 Days		90+ Days		Total		Current		Total
(Amounts in thousands)	Past Due		Past Due		Past Due		Past Due		Loans		Loans
Non-covered loans
Commercial loans
Construction, development, and other land	$	87	$	-	$	478	$	565	$	62,092	$	62,657
Commercial and industrial		174		260		216		650		104,953		105,603
Multi-family residential		148		-		1,515		1,663		111,047		112,710
Single family non-owner occupied		762		281		881		1,924		140,667		142,591
Non-farm, non-residential		795		74		2,559		3,428		603,372		606,800
Agricultural		-		-		-		-		9,016		9,016
Farmland		201		321		410		932		19,940		20,872
Consumer real estate loans
Home equity lines		379		199		499		1,077		95,742		96,819
Single family owner occupied		3,247		1,802		3,938		8,987		511,376		520,363
Owner occupied construction		90		-		-		90		17,799		17,889
Consumer and other loans
Consumer loans		484		169		117		770		69,204		69,974
Other		-		-		-		-		5,132		5,132
Total non-covered loans		6,367		3,106		10,613		20,086		1,750,340		1,770,426
Covered loans
Commercial loans
Construction, development, and other land		-		-		-		-		35		35
Single family non-owner occupied		-		-		-		-		245		245
Non-farm, non-residential		-		-		-		-		7		7
Consumer real estate loans
Home equity lines		184		239		26		449		16,355		16,804
Single family owner occupied		59		-		30		89		3,303		3,392
Total covered loans		243		239		56		538		19,945		20,483
Total loans	$	6,610	$	3,345	$	10,669	$	20,624	$	1,770,285	$	1,790,909

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	December 31, 2017
	30 - 59 Days		60 - 89 Days		90+ Days		Total		Current		Total
(Amounts in thousands)	Past Due		Past Due		Past Due		Past Due		Loans		Loans
Non-covered loans
Commercial loans
Construction, development, and other land	$	20	$	365	$	-	$	385	$	59,632	$	60,017
Commercial and industrial		232		40		142		414		91,774		92,188
Multi-family residential		544		-		185		729		124,473		125,202
Single family non-owner occupied		223		302		331		856		140,814		141,670
Non-farm, non-residential		2,433		383		1,536		4,352		612,281		616,633
Agricultural		123		-		-		123		6,912		7,035
Farmland		113		-		692		805		24,844		25,649
Consumer real estate loans
Home equity lines		226		198		485		909		102,296		103,205
Single family owner occupied		6,959		2,418		8,186		17,563		485,123		502,686
Owner occupied construction		326		79		-		405		38,773		39,178
Consumer and other loans
Consumer loans		439		97		17		553		70,219		70,772
Other		-		-		-		-		5,001		5,001
Total non-covered loans		11,638		3,882		11,574		27,094		1,762,142		1,789,236
Covered loans
Commercial loans
Construction, development, and other land		-		-		-		-		39		39
Single family non-owner occupied		-		-		-		-		284		284
Non-farm, non-residential		-		-		-		-		9		9
Consumer real estate loans
Home equity lines		402		-		173		575		23,145		23,720
Single family owner occupied		70		-		-		70		3,826		3,896
Total covered loans		472		-		173		645		27,303		27,948
Total loans	$	12,110	$	3,882	$	11,747	$	27,739	$	1,789,445	$	1,817,184

The Company may make concessions in interest rates, loan terms and/or amortization terms when restructuring loans for borrowers experiencing financial difficulty. Restructured loans in excess of $250 thousand are evaluated for a specific reserve based on either the collateral or net present value method, whichever is most applicable. Restructured loans under $250 thousand are subject to the reserve calculation at the historical loss rate for classified loans. Certain TDRs are classified as nonperforming at the time of restructuring and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. PCI loans are generally not considered TDRs as long as the loans remain in the assigned loan pool. No covered loans were recorded as TDRs as of September 30, 2018, or December 31, 2017.

The following table presents loans modified as TDRs, by loan class and accrual status, as of the dates indicated:

	September 30, 2018						December 31, 2017
(Amounts in thousands)	Nonaccrual⁽¹⁾		Accruing		Total		Nonaccrual⁽¹⁾		Accruing		Total
Commercial loans
Single family non-owner occupied	$	332	$	311	$	643	$	364	$	528	$	892
Non-farm, non-residential		-		315		315		-		295		295
Consumer real estate loans
Home equity lines		-		130		130		-		145		145
Single family owner occupied		1,881		6,124		8,005		1,565		6,496		8,061
Owner occupied construction		-		227		227		-		233		233
Consumer and other loans
Consumer loans		-		35		35		-		37		37
Total TDRs	$	2,213	$	7,142	$	9,355	$	1,929	$	7,734	$	9,663

Allowance for loan losses related to TDRs					$	632					$	642

__________________________________________________________________________________

(1)	Nonaccrual TDRs are included in total nonaccrual loans disclosed in the nonaccrual table above.

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The following table presents interest income recognized on TDRs for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
(Amounts in thousands)
Interest income recognized	$	73	$	74	$	207	$	159

The following tables present loans modified as TDRs, by type of concession made and loan class, that were restructured during the periods indicated:

	Three Months Ended September 30,
	2018						2017
(Amounts in thousands)	Total Contracts		Pre-modification Recorded Investment		Post-modification Recorded Investment⁽¹⁾		Total Contracts		Pre-modification Recorded Investment		Post-modification Recorded Investment⁽¹⁾
Below market interest rate
Single family owner occupied		1	$	11	$	11		-	$	-	$	-
Below market interest rate and extended payment term
Single family owner occupied		-		-		-		1		42		42
Total		1	$	11	$	11		1	$	42	$	42

________________________________________________________________________

(1) Represents the loan balance immediately following modification

	Nine Months Ended September 30,
	2018						2017
(Amounts in thousands)	Total Contracts		Pre-modification Recorded Investment		Post-modification Recorded Investment⁽¹⁾		Total Contracts		Pre-modification Recorded Investment		Post-modification Recorded Investment⁽¹⁾
Below market interest rate
Single family owner occupied		1	$	11	$	11		-	$	-	$	-
Below market interest rate and extended payment term
Single family owner occupied		1		41		41		3		141		141
Total		2	$	52	$	52		3	$	141	$	141

________________________________________________________________________

(1) Represents the loan balance immediately following modification

There were no payment defaults on loans modified as TDRs that were restructured within the previous 12 months as of September 30, 2018 or 2017.

The following table provides information about other real estate owned (“OREO”), which consists of properties acquired through foreclosure, as of the dates indicated:

	September 30, 2018		December 31, 2017
(Amounts in thousands)
Non-covered OREO	$	4,754	$	2,409
Covered OREO		44		105
Total OREO	$	4,798	$	2,514

Non-covered OREO secured by residential real estate	$	3,331	$	2,209
Residential real estate loans in the foreclosure process⁽¹⁾		7,129		9,921


(1)	The recorded investment in consumer mortgage loans collateralized by residential real estate that are in the process of foreclosure according to local requirements of the applicable jurisdiction

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Note 5. Allowance for Loan Losses

The following tables present the changes in the allowance for loan losses, by loan segment, during the periods indicated. There was no allowance related to PCI loans as of September 30, 2018, or December 31, 2017.

	Three Months Ended September 30, 2018
(Amounts in thousands)	Commercial			Consumer Real Estate			Consumer and Other			Total Allowance
Total allowance
Beginning balance	$	10,902		$	7,867		$	814		$	19,583
(Recovery of) provision for loan losses charged to operations		(300	)		376			419			495
Charge-offs		(201	)		(1,598	)		(378	)		(2,177	)
Recoveries		88			187			80			355
Net charge-offs		(113	)		(1,411	)		(298	)		(1,822	)
Ending balance	$	10,489		$	6,832		$	935		$	18,256

	Three Months Ended September 30, 2017
(Amounts in thousands)	Commercial			Consumer Real Estate			Consumer and Other			Total Allowance
Allowance, excluding PCI
Beginning balance	$	12,283		$	5,802		$	793		$	18,878
Provision for loan losses charged to operations		358			75			305			738
Charge-offs		(207	)		(137	)		(373	)		(717	)
Recoveries		170			67			70			307
Net charge-offs		(37	)		(70	)		(303	)		(410	)
Ending balance	$	12,604		$	5,807		$	795		$	19,206

PCI allowance
Beginning balance	$	-		$	8		$	-		$	8
Recovery of loan losses		-			(8	)		-			(8	)
Benefit attributable to the FDIC indemnification asset		-			-			-			-
Recovery of loan losses charged to operations		-			(8	)		-			(8	)
Recovery of loan losses recorded through the FDIC indemnification asset		-			-			-			-
Ending balance	$	-		$	-		$	-		$	-

Total allowance
Beginning balance	$	12,283		$	5,810		$	793		$	18,886
Provision for loan losses		358			67			305			730
Benefit attributable to the FDIC indemnification asset		-			-			-			-
Provision for loan losses charged to operations		358			67			305			730
Recovery of loan losses recorded through the FDIC indemnification asset		-			-			-			-
Charge-offs		(207	)		(137	)		(373	)		(717	)
Recoveries		170			67			70			307
Net charge-offs		(37	)		(70	)		(303	)		(410	)
Ending balance	$	12,604		$	5,807		$	795		$	19,206

Table of Contents

	Nine Months Ended September 30, 2018
(Amounts in thousands)	Commercial			Consumer Real Estate			Consumer and Other			Total Allowance
Total allowance
Beginning balance	$	11,672		$	6,810		$	794		$	19,276
(Recovery of) provision for loan losses charged to operations		(1,025	)		1,519			991			1,485
Charge-offs		(670	)		(1,853	)		(1,102	)		(3,625	)
Recoveries		512			356			252			1,120
Net charge-offs		(158	)		(1,497	)		(850	)		(2,505	)
Ending balance	$	10,489		$	6,832		$	935		$	18,256

	Nine Months Ended September 30, 2017
(Amounts in thousands)	Commercial			Consumer Real Estate			Consumer and Other			Total Allowance
Allowance, excluding PCI
Beginning balance	$	11,690		$	5,487		$	759		$	17,936
Provision for loan losses charged to operations		822			561			785			2,168
Charge-offs		(493	)		(535	)		(948	)		(1,976	)
Recoveries		585			294			199			1,078
Net recoveries (charge-offs)		92			(241	)		(749	)		(898	)
Ending balance	$	12,604		$	5,807		$	795		$	19,206

PCI allowance
Beginning balance	$	-		$	12		$	-		$	12
Recovery of loan losses		-			(12	)		-			(12	)
Benefit attributable to the FDIC indemnification asset		-			-			-			-
Recovery of loan losses charged to operations		-			(12	)		-			(12	)
Recovery of loan losses recorded through the FDIC indemnification asset		-			-			-			-
Ending balance	$	-		$	-		$	-		$	-

Total allowance
Beginning balance	$	11,690		$	5,499		$	759		$	17,948
Provision for loan losses		822			549			785			2,156
Benefit attributable to the FDIC indemnification asset		-			-			-			-
Provision for loan losses charged to operations		822			549			785			2,156
Recovery of loan losses recorded through the FDIC indemnification asset		-			-			-			-
Charge-offs		(493	)		(535	)		(948	)		(1,976	)
Recoveries		585			294			199			1,078
Net recoveries (charge-offs)		92			(241	)		(749	)		(898	)
Ending balance	$	12,604		$	5,807		$	795		$	19,206

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The following tables present the allowance for loan losses and recorded investment in loans evaluated for impairment, excluding PCI loans, by loan class, as of the dates indicated:

	September 30, 2018
(Amounts in thousands)	Loans Individually Evaluated for Impairment		Allowance for Loans Individually Evaluated		Loans Collectively Evaluated for Impairment		Allowance for Loans Collectively Evaluated
Commercial loans
Construction, development, and other land	$	-	$	-	$	62,053	$	394
Commercial and industrial		-		-		105,597		587
Multi-family residential		536		235		112,174		987
Single family non-owner occupied		842		238		139,958		6,296
Non-farm, non-residential		582		-		602,017		1,363
Agricultural		-		-		9,016		89
Farmland		925		158		19,947		142
Total commercial loans		2,885		631		1,050,762		9,858
Consumer real estate loans
Home equity lines		65		66		107,452		687
Single family owner occupied		5,627		1,017		517,450		4,938
Owner occupied construction		-		-		17,889		124
Total consumer real estate loans		5,692		1,083		642,791		5,749
Consumer and other loans
Consumer loans		-		-		69,974		935
Other		-		-		5,132		-
Total consumer and other loans		-		-		75,106		935
Total loans, excluding PCI loans	$	8,577	$	1,714	$	1,768,659	$	16,542

	December 31, 2017
(Amounts in thousands)	Loans Individually Evaluated for Impairment		Allowance for Loans Individually Evaluated		Loans Collectively Evaluated for Impairment		Allowance for Loans Collectively Evaluated
Commercial loans
Construction, development, and other land	$	-	$	-	$	59,386	$	830
Commercial and industrial		343		270		91,845		492
Multi-family residential		-		-		125,202		1,094
Single family non-owner occupied		770		62		139,093		1,914
Non-farm, non-residential		1,367		15		611,477		6,582
Agricultural		-		-		7,035		51
Farmland		1,219		233		24,430		129
Total commercial loans		3,699		580		1,058,468		11,092
Consumer real estate loans
Home equity lines		-		-		115,807		803
Single family owner occupied		9,471		1,978		496,348		3,732
Owner occupied construction		-		-		39,178		297
Total consumer real estate loans		9,471		1,978		651,333		4,832
Consumer and other loans
Consumer loans		-		-		70,772		794
Other		-		-		5,001		-
Total consumer and other loans		-		-		75,773		794
Total loans, excluding PCI loans	$	13,170	$	2,558	$	1,785,574	$	16,718

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The following table presents the recorded investment in PCI loans and the allowance for loan losses on PCI loans, by loan pool, as of the dates indicated:

	September 30, 2018				December 31, 2017
(Amounts in thousands)	Recorded Investment		Allowance for Loan Pools With Impairment		Recorded Investment		Allowance for Loan Pools With Impairment
Commercial loans
Waccamaw commercial	$	426	$	-	$	64	$	-
Peoples commercial		4,476		-		4,279		-
Other		899		-		986		-
Total commercial loans		5,801		-		5,329		-
Consumer real estate loans
Waccamaw serviced home equity lines		6,106		-		11,118		-
Waccamaw residential		822		-		994		-
Peoples residential		944		-		999		-
Total consumer real estate loans		7,872		-		13,111		-
Total PCI loans	$	13,673	$	-	$	18,440	$	-

Management believed the allowance was adequate to absorb probable loan losses inherent in the loan portfolio as of September 30, 2018.

Note 6. FDIC Indemnification Asset

In connection with the FDIC-assisted acquisition of Waccamaw Bank (“Waccamaw”) in 2012, the Company entered into loss share agreements with the FDIC that covered $20.48 million of loans and $44 thousand of OREO as of September 30, 2018, compared to $27.95 million of loans and $105 thousand of OREO as of December 31, 2017. Under the loss share agreements, the FDIC agrees to cover 80% of most loan and foreclosed real estate losses and reimburse certain expenses incurred in relation to these covered assets. Loss share coverage expired June 30, 2017, for commercial loans, with recoveries continuing until June 30, 2019. Loss share coverage will expire June 30, 2022, for single family loans. The Company’s consolidated statements of income include the expense on covered assets net of estimated reimbursements. The following table presents the changes in the FDIC indemnification asset during the periods indicated:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
(Amounts in thousands)
Beginning balance	$	6,390		$	8,159		$	7,161		$	12,173
Increase in estimated losses on covered OREO		-			4			-			71
Reimbursable expenses (to) from the FDIC		(2	)		47			(23	)		108
Net amortization		(645	)		(268	)		(1,602	)		(3,186	)
(Reimbursements from) payments to the FDIC		(90	)		(477	)		117			(1,701	)
Ending balance	$	5,653		$	7,465		$	5,653		$	7,465

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Note 7. Deposits

The following table presents the components of deposits as of the dates indicated:

	September 30, 2018		December 31, 2017
(Amounts in thousands)
Noninterest-bearing demand deposits	$	463,945	$	454,143
Interest-bearing deposits:
Interest-bearing demand deposits		459,376		465,407
Money market accounts		151,436		170,731
Savings deposits		343,685		342,064
Certificates of deposit		339,523		374,373
Individual retirement accounts		117,886		123,173
Total interest-bearing deposits		1,411,906		1,475,748
Total deposits	$	1,875,851	$	1,929,891

Note 8. Borrowings

The following table presents the components of borrowings as of the dates indicated:

	September 30, 2018					December 31, 2017
(Amounts in thousands)	Balance		Weighted Average Rate			Balance		Weighted Average Rate
Short-term borrowings
Retail repurchase agreements	$	5,151		0.10	%	$	5,086		0.07	%
Long-term borrowings
Wholesale repurchase agreement		25,000		3.18	%		25,000		3.18	%
FHLB advances		-					50,000		4.00	%
Total borrowings	$	30,151				$	80,086

Repurchase agreements are secured by certain securities that remain under the Company’s control during the terms of the agreements. The following schedule presents the contractual maturities of repurchase agreements, by type of collateral pledged, as of September 30, 2018:

	Overnight and Continuous		Up to 30 Days		30 - 90 Days		Greater than 90 Days		Total
(Amounts in thousands)
U.S. Agency securities	$	-	$	-	$	-	$	14,447	$	14,447
Municipal securities		3,645		-		-		524		4,169
Mortgage-backed Agency securities		1,429		-		-		10,106		11,535
Total	$	5,074	$	-	$	-	$	25,077	$	30,151

As of September 30, 2018, long-term borrowings consisted of a wholesale repurchase agreement that matures in 2019 with a weighted average maturity of 0.41 years. During the third quarter of 2018, the Company prepaid its remaining $50 million FHLB convertible advance and incurred a loss on the extinguishment of the debt of $1.10 million. The prepayment was funded with cash and cash equivalents on hand, as well as the sale of the Company’s remaining single issue trust preferred investment securities.

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Unused borrowing capacity with the FHLB totaled $411.31 million, net of FHLB letters of credit of $143.68 million, as of September 30, 2018. As of September 30, 2018, the Company pledged $879.41 million in qualifying loans to secure the FHLB letters of credit, which provide an attractive alternative to pledging securities for public unit deposits.

The Company maintains a $15.00 million unsecured, committed line of credit with an unrelated financial institution with an interest rate of one-month LIBOR plus 2.00% that matures in April 2019. There was no outstanding balance on the line as of September 30, 2018, or December 31, 2017.

Note 9. Derivative Instruments and Hedging Activities

Generally, derivative instruments help the Company manage exposure to market risk and meet customer financing needs. Market risk represents the possibility that fluctuations in external factors such as interest rates, market-driven loan rates, prices, or other economic factors will adversely affect economic value or net interest income.

As of September 30, 2018, the Company’s derivative instruments consisted of three interest rate swap agreements. The Company uses interest rate swap contracts to modify its exposure to interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. These instruments are used to convert these fixed rate loans to an effective floating rate. If the LIBOR rate falls below the loan’s stated fixed rate for a given period, the Company will owe the floating rate payer the notional amount times the difference between LIBOR and the stated fixed rate. If LIBOR is above the stated rate for a given period, the Company will receive payments based on the notional amount times the difference between LIBOR and the stated fixed rate. The Company’s interest rate swaps qualify as fair value hedging instruments; therefore, fair value changes in the derivative and hedged item attributable to the hedged risk are recognized in earnings in the same period. The fair value hedges were effective as of September 30, 2018. The following table presents the notional, or contractual, amounts and fair values of derivative instruments as of the dates indicated:

	September 30, 2018						December 31, 2017
	Notional or		Fair Value				Notional or		Fair Value
(Amounts in thousands)	Contractual Amount		Derivative Assets		Derivative Liabilities		Contractual Amount		Derivative Assets		Derivative Liabilities
Derivatives designated as hedges
Interest rate swaps	$	5,567	$	145	$	-	$	5,813	$	-	$	90
Total derivatives	$	5,567	$	145	$	-	$	5,813	$	-	$	90

The following table presents the effect of derivative and hedging activity, if applicable, on the consolidated statements of income for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,				Income Statement
(Amounts in thousands)	2018		2017		2018		2017		Location
Derivatives designated as hedges
Interest rate swaps	$	6	$	23	$	27	$	64	Interest and fees on loans
Total derivative expense	$	6	$	23	$	27	$	64

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Note 10. Employee Benefit Plans

The Company maintains two nonqualified domestic, noncontributory defined benefit plans (the “Benefit Plans”) for key members of senior management and non-management directors. The Company’s unfunded Benefit Plans include the Supplemental Executive Retention Plan and the Directors’ Supplemental Retirement Plan. The following table presents the components of net periodic pension cost and the effect on the consolidated statements of income for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,				Income Statement
	2018		2017		2018		2017		Location
(Amounts in thousands)
Service cost	$	61	$	57	$	184	$	173	Salaries and employee benefits
Interest cost		90		93		269		279	Other expense
Amortization of prior service cost		57		57		171		171	Other expense
Amortization of losses		15		8		43		23	Other expense
Net periodic cost	$	223	$	215	$	667	$	646

Note 11. Earnings per Share

The following table presents the calculation of basic and diluted earnings per common share for the periods indicated:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017
(Amounts in thousands, except share and per share data)
Net income	$	9,100	$	7,652	$	27,034	$	20,272
Weighted average common shares outstanding, basic		16,512,823		17,005,654		16,717,704		17,005,350
Dilutive effect of potential common shares
Stock options		65,910		49,739		63,898		50,140
Restricted stock		33,683		27,336		28,823		21,468
Total dilutive effect of potential common shares		99,593		77,075		92,721		71,608
Weighted average common shares outstanding, diluted		16,612,416		17,082,729		16,810,425		17,076,958

Basic earnings per common share	$	0.55	$	0.45	$	1.62	$	1.19
Diluted earnings per common share		0.55		0.45		1.61		1.19

Antidilutive potential common shares
Stock options		-		71,592		-		71,592
Restricted stock		4,263		-		2,011		4,276
Total potential antidilutive shares		4,263		71,592		2,011		75,868

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Note 12. Accumulated Other Comprehensive Income (Loss)

The following tables present the changes in accumulated other comprehensive income (“AOCI”), net of tax and by component, during the periods indicated:

	Three Months Ended September 30, 2018
	Unrealized Gains (Losses) on Available- for-Sale Securities			Employee Benefit Plans			Total
(Amounts in thousands)
Beginning balance	$	(955	)	$	(1,630	)	$	(2,585	)
Other comprehensive loss before reclassifications		(776	)		(1	)		(777	)
Reclassified from AOCI		488			57			545
Other comprehensive (loss) income, net		(288	)		56			(232	)
Ending balance	$	(1,243	)	$	(1,574	)	$	(2,817	)

	Three Months Ended September 30, 2017
	Unrealized Gains (Losses) on Available- for-Sale Securities			Employee Benefit Plans			Total
(Amounts in thousands)
Beginning balance	$	1,302		$	(1,303	)	$	(1	)
Other comprehensive loss before reclassifications		(106	)		(1	)		(107	)
Reclassified from AOCI		-			41			41
Other comprehensive (loss) income, net		(106	)		40			(66	)
Ending balance	$	1,196		$	(1,263	)	$	(67	)

	Nine Months Ended September 30, 2018
	Unrealized Gains (Losses) on Available- for-Sale Securities			Employee Benefit Plans			Total
(Amounts in thousands)
Beginning balance	$	975		$	(1,815	)	$	(840	)
Other comprehensive (loss) income before reclassifications		(2,706	)		72			(2,634	)
Reclassified from AOCI		488			169			657
Other comprehensive (loss) income, net		(2,218	)		241			(1,977	)
Ending balance	$	(1,243	)	$	(1,574	)	$	(2,817	)

	Nine Months Ended September 30, 2017
	Unrealized Gains (Losses) on Available- for-Sale Securities			Employee Benefit Plans			Total
(Amounts in thousands)
Beginning balance	$	(544	)	$	(1,467	)	$	(2,011	)
Other comprehensive income before reclassifications		1,329			83			1,412
Reclassified from AOCI		411			121			532
Other comprehensive income, net		1,740			204			1,944
Ending balance	$	1,196		$	(1,263	)	$	(67	)

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The following table presents reclassifications out of AOCI, by component, during the periods indicated:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,				Income Statement
(Amounts in thousands)	2018		2017		2018		2017		Line Item Affected
Available-for-sale securities
Loss recognized	$	618	$	-	$	618	$	657	Net loss on sale of securities
Reclassified out of AOCI, before tax		618		-		618		657	Income before income taxes
Income tax expense		130		-		130		246	Income tax expense
Reclassified out of AOCI, net of tax		488		-		488		411	Net income
Employee benefit plans
Amortization of prior service cost	$	57	$	57	$	171	$	171	(1)
Amortization of net actuarial benefit cost		15		8		43		23	(1)
Reclassified out of AOCI, before tax		72		65		214		194	Income before income taxes
Income tax expense		15		24		45		73	Income tax expense
Reclassified out of AOCI, net of tax		57		41		169		121	Net income
Total reclassified out of AOCI, net of tax	$	545	$	41	$	657	$	532	Net income


(1)	Amortization is included in net periodic pension cost. See Note 10, "Employee Benefit Plans."

Note 13. Fair Value

Financial Instruments Measured at Fair Value

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The fair value hierarchy ranks the inputs used in measuring fair value as follows:

●

Level 1 – Observable, unadjusted quoted prices in active markets

●

Level 2 – Inputs other than quoted prices included in Level 1 that are directly or indirectly observable for the asset or liability

●

Level 3 – Unobservable inputs with little or no market activity that require the Company to use reasonable inputs and assumptions

The Company uses fair value measurements to record adjustments to certain financial assets and liabilities on a recurring basis. The Company may be required to record certain assets at fair value on a nonrecurring basis in specific circumstances, such as evidence of impairment. Methodologies used to determine fair value might be highly subjective and judgmental in nature; therefore, valuations may not be precise. If the Company determines that a valuation technique change is necessary, the change is assumed to have occurred at the end of the respective reporting period. The following discussion describes the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments under the valuation hierarchy.

Assets and Liabilities Reported at Fair Value on a Recurring Basis

Available-for-Sale Debt Securities. Debt securities available for sale are reported at fair value on a recurring basis. The fair value of Level 1 securities is based on quoted market prices in active markets, if available. If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are primarily derived from or corroborated by observable market data. Level 2 securities use fair value measurements from independent pricing services obtained by the Company. These fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and bond terms and conditions. The Company’s Level 2 securities include U.S. Agency and Treasury securities, municipal securities, single issue trust preferred securities, and mortgage-backed securities. Securities are based on Level 3 inputs when there is limited activity or less transparency to the valuation inputs. In the absence of observable or corroborated market data, internally developed estimates that incorporate market-based assumptions are used when such information is available.

Fair value models may be required when trading activity has declined significantly or does not exist, prices are not current, or pricing variations are significant. For Level 3 securities, the Company obtains the cash flow of specific securities from third parties that use modeling software to determine cash flows based on market participant data and knowledge of the structures of each individual security. The fair values of Level 3 securities are determined by applying proper market observable discount rates to the cash flow derived from third-party models. Discount rates are developed by determining credit spreads above a benchmark rate, such as LIBOR, and adding premiums for illiquidity, which are based on a comparison of initial issuance spread to LIBOR versus a financial sector curve for recently issued debt to LIBOR. Securities with increased uncertainty about the receipt of cash flows are discounted at higher rates due to the addition of a deal specific credit premium based on assumptions about the performance of the underlying collateral. Finally, internal fair value model pricing and external pricing observations are combined by assigning weights to each pricing observation. Pricing is reviewed for reasonableness based on the direction of specific markets and the general economic indicators.

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Equity Securities. Equity securities are recorded at fair value on a recurring basis and included in other assets in the consolidated balance sheets. The Company uses Level 1 inputs to value equity securities that are traded in active markets. Equity securities that are not actively traded are classified in Level 2.

Loans Held for Investment. Loans held for investment are reported at fair value using the exit price notion, which is derived from third-party models. Loans related to fair value hedges are recorded at fair value on a recurring basis.

Deferred Compensation Assets and Liabilities. Securities held for trading purposes are recorded at fair value on a recurring basis and included in other assets in the consolidated balance sheets. These securities include assets related to employee deferred compensation plans, which are generally invested in Level 1 equity securities. The liability associated with these deferred compensation plans is carried at the fair value of the obligation to the employee, which corresponds to the fair value of the invested assets.

Derivative Assets and Liabilities. Derivatives are recorded at fair value on a recurring basis. The Company obtains dealer quotes, Level 2 inputs, based on observable data to value derivatives.

The following tables summarize financial assets and liabilities recorded at fair value on a recurring basis, by the level of valuation inputs in the fair value hierarchy, as of the dates indicated:

	September 30, 2018
	Total		Fair Value Measurements Using
(Amounts in thousands)	Fair Value		Level 1		Level 2		Level 3
Available-for-sale debt securities
U.S. Agency securities	$	1,141	$	-	$	1,141	$	-
U.S. Treasury securities		29,888		-		29,888		-
Municipal securities		97,511		-		97,511		-
Mortgage-backed Agency securities		35,053		-		35,053		-
Total available-for-sale debt securities		163,593		-		163,593		-
Equity securities		55		55		-		-
Fair value loans		5,730		-		-		5,730
Deferred compensation assets		3,779		3,779		-		-
Derivative assets		145		-		145		-
Deferred compensation liabilities		3,779		3,779		-		-

	December 31, 2017
	Total		Fair Value Measurements Using
(Amounts in thousands)	Fair Value		Level 1		Level 2		Level 3
Available-for-sale debt securities
U.S. Agency securities	$	11,296	$	-	$	11,296	$	-
U.S. Treasury securities		19,971		-		19,971		-
Municipal securities		103,648		-		103,648		-
Single issue trust preferred securities		8,884		-		8,884		-
Mortgage-backed Agency securities		21,726		-		21,726		-
Total available-for-sale debt securities		165,525		-		165,525		-
Equity securities		55		55		-		-
Fair value loans		5,739		-		5,739		-
Deferred compensation assets		4,002		4,002		-		-
Deferred compensation liabilities		4,002		4,002		-		-
Derivative liabilities		90		-		90		-

Beginning in 2018, the Company measured the fair value of loans held for investment using an exit price notion in according with the adoption of ASU 2016-01. Prior to 2018, loans held for investment were reported at fair value using discounted future cash flows that apply current interest rates for loans with similar terms and borrower credit quality. As a result of using the exit price, certain loans were transferred from Level 2 into Level 3 of the fair value hierarchy during the nine months ended September 30, 2018. No transfers into or out of Level 3 of the fair value hierarchy occurred during the nine months ended September 30, 2017.

Assets Measured at Fair Value on a Nonrecurring Basis

Impaired Loans. Impaired loans are recorded at fair value on a nonrecurring basis when repayment is expected solely from the sale of the loan’s collateral. Fair value is based on appraised value adjusted for customized discounting criteria, Level 3 inputs.

The Company maintains an active and robust problem credit identification system. The impairment review includes obtaining third-party collateral valuations to help management identify potential credit impairment and determine the amount of impairment to record. The Company’s Special Assets staff manages and monitors all impaired loans. Internal collateral valuations are generally performed within two to four weeks of identifying the initial potential impairment. The internal valuation compares the original appraisal to current local real estate market conditions and considers experience and expected liquidation costs. The Company typically receives a third-party valuation within thirty to forty-five days of completing the internal valuation. When a third-party valuation is received, it is reviewed for reasonableness. Once the valuation is reviewed and accepted, discounts are applied to fair market value, based on, but not limited to, our historical liquidation experience for like collateral, resulting in an estimated net realizable value. The estimated net realizable value is compared to the outstanding loan balance to determine the appropriate amount of specific impairment reserve.

Specific reserves are generally recorded for impaired loans while third-party valuations are in process and for impaired loans that continue to make some form of payment. While waiting to receive the third-party appraisal, the Company regularly reviews the relationship to identify any potential adverse developments and begins the tasks necessary to gain control of the collateral and prepare it for liquidation, including, but not limited to, engagement of counsel, inspection of collateral, and continued communication with the borrower. Generally, the only difference between the current appraised value, less liquidation costs, and the carrying amount of the loan, less the specific reserve, is any downward adjustment to the appraised value that the Company deems appropriate, such as the costs to sell the property. Impaired loans that do not meet certain criteria and do not have a specific reserve have typically been written down through partial charge-offs to net realizable value. Based on prior experience, the Company rarely returns loans to performing status after they have been partially charged off. Credits identified as impaired move quickly through the process towards ultimate resolution, except in cases involving bankruptcy and various state judicial processes that may extend the time for ultimate resolution.

OREO. OREO is recorded at fair value on a nonrecurring basis using Level 3 inputs. The Company calculates the fair value of OREO from current or prior appraisals that have been adjusted for valuation declines, estimated selling costs, and other proprietary qualitative adjustments that are deemed necessary.

The following tables present assets measured at fair value on a nonrecurring basis, by the level of valuation inputs in the fair value hierarchy, as of the dates indicated:

	September 30, 2018
	Total		Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
(Amounts in thousands)
Impaired loans, non-covered	$	5,046	$	-	$	-	$	5,046
OREO, non-covered		4,624		-		-		4,624
OREO, covered		32		-		-		32

	December 31, 2017
	Total		Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
(Amounts in thousands)
Impaired loans, non-covered	$	5,015	$	-	$	-	$	5,015
OREO, non-covered		2,359		-		-		2,359
OREO, covered		105		-		-		105

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Quantitative Information about Level 3 Fair Value Measurements

The following table provides quantitative information for assets measured at fair value on a nonrecurring basis using Level 3 valuation inputs as of the dates indicated:

	Valuation	Unobservable	Discount Range (Weighted Average
	Technique	Input	September 30, 2018					December 31, 2017

Impaired loans, non-covered	Discounted appraisals⁽¹⁾	Appraisal adjustments⁽²⁾		6%	to	100%	(25%)		6%	to	79%	(34%)
OREO, non-covered	Discounted appraisals⁽¹⁾	Appraisal adjustments⁽²⁾		10%	to	56%	(19%)		8%	to	47%	(32%)
OREO, covered	Discounted appraisals⁽¹⁾	Appraisal adjustments⁽²⁾				49%	(49%)		0%	to	65%	(52%)

(1)		Fair value is generally based on appraisals of the underlying collateral.
(2)		Appraisals may be adjusted by management for customized discounting criteria, estimated sales costs, and proprietary qualitative adjustments.

Fair Value of Financial Instruments

The Company uses various methodologies and assumptions to estimate the fair value of certain financial instruments. A description of valuation methodologies used for instruments not previously discussed is as follows:

Cash and Cash Equivalents. Cash and cash equivalents are reported at their carrying amount, which is considered a reasonable estimate due to the short-term nature of these instruments.

Held-to-Maturity Debt Securities. Securities held to maturity are reported at fair value using quoted market prices or dealer quotes.

FDIC Indemnification Asset. The FDIC indemnification asset is reported at fair value using discounted future cash flows that apply current discount rates.

Accrued Interest Receivable/Payable. Accrued interest receivable/payable is reported at its carrying amount, which is considered a reasonable estimate due to the short-term nature of these instruments.

Deposits and Securities Sold Under Agreements to Repurchase. Deposits and repurchase agreements with fixed maturities and rates are reported at fair value using discounted future cash flows that apply interest rates available in the market for instruments with similar characteristics and maturities.

FHLB and Other Borrowings. FHLB and other borrowings are reported at fair value using discounted future cash flows that apply interest rates available to the Company for borrowings with similar characteristics and maturities. Trust preferred obligations are reported at fair value using current credit spreads in the market for similar issues.

Off-Balance Sheet Instruments. The Company believes that fair values of unfunded commitments to extend credit, standby letters of credit, and financial guarantees are not meaningful; therefore, off-balance sheet instruments are not addressed in the fair value disclosures. The Company believes it is not feasible or practical to accurately disclose the fair values of off-balance sheet instruments due to the uncertainty and difficulty in assessing the likelihood and timing of advancing available proceeds, the lack of an established market for these instruments, and the diversity in fee structures. For additional information about the unfunded, contractual value of off-balance sheet financial instruments, see Note 14, “Litigation, Commitments, and Contingencies,” to the Condensed Consolidated Financial Statements of this report.

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The following tables present the carrying amounts and fair values of financial instruments, by the level of valuation inputs in the fair value hierarchy, as of the dates indicated:

	September 30, 2018
	Carrying				Fair Value Measurements Using
(Amounts in thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	73,679	$	73,679	$	73,679	$	-	$	-
Debt securities available for sale		163,593		163,593		-		163,593		-
Debt securities held to maturity		25,047		24,979		-		24,979		-
Equity securities		55		55		55		-		-
Loans held for investment, net of allowance		1,772,653		1,733,638		-		-		1,733,638
FDIC indemnification asset		5,653		2,892		-		-		2,892
Interest receivable		5,374		5,374		-		5,374		-
Derivative financial assets		145		145		-		145		-
Deferred compensation assets		3,779		3,779		3,779		-		-

Liabilities
Time deposits		457,409		457,409		-		457,409		-
Securities sold under agreements to repurchase		30,151		30,223		-		30,223		-
Interest payable		603		603		-		603		-
Deferred compensation liabilities		3,779		3,779		3,779		-		-

	December 31, 2017
	Carrying				Fair Value Measurements Using
(Amounts in thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	157,951	$	157,951	$	157,951	$	-	$	-
Debt securities available for sale		165,525		165,525		-		165,525		-
Debt securities held to maturity		25,149		25,084		-		25,084		-
Equity securities		55		55		55		-		-
Loans held for investment, net of allowance		1,797,908		1,760,606		-		5,739		1,754,867
FDIC indemnification asset		7,161		3,927		-		-		3,927
Interest receivable		5,778		5,778		-		5,778		-
Deferred compensation assets		4,002		4,002		4,002		-		-

Liabilities
Demand deposits		454,143		454,143		-		454,143		-
Interest-bearing demand deposits		465,407		465,407		-		465,407		-
Savings deposits		512,795		512,795		-		512,795		-
Time deposits		497,546		490,628		-		490,628		-
Securities sold under agreements to repurchase		30,086		30,449		-		30,449		-
Interest payable		1,104		1,104		-		1,104		-
FHLB and other borrowings		50,000		52,702		-		52,702		-
Derivative financial liabilities		90		90		-		90		-
Deferred compensation liabilities		4,002		4,002		4,002		-		-

Note 14. Litigation, Commitments, and Contingencies

Litigation

In the normal course of business, the Company is a defendant in various legal actions and asserted claims. While the Company and its legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, the Company believes the resolution of these actions, singly or in the aggregate, should not have a material adverse effect on its financial condition, results of operations, or cash flows.

Commitments and Contingencies

The Company is a 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, standby letters of credit, and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized in the consolidated balance sheets. The contractual amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments. If the other party to a financial instrument does not perform, the Company’s credit loss exposure is the same as the contractual amount of the instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn on, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of each customer on a case-by-case basis. Collateral may include accounts receivable, inventory, property, plant and equipment, and income producing commercial properties. The Company maintains a reserve for the risk inherent in unfunded lending commitments, which is included in other liabilities in the consolidated balance sheets.

Standby letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit to customers. The amount of collateral obtained, if deemed necessary, to secure the customer’s performance under certain letters of credit is based on management’s credit evaluation of the customer.

The following table presents the off-balance sheet financial instruments as of the dates indicated:

	September 30, 2018		December 31, 2017
(Amounts in thousands)
Commitments to extend credit	$	213,313	$	243,147
Standby letters of credit and financial guarantees⁽¹⁾		148,731		131,587
Total off-balance sheet risk		362,044		374,734

Reserve for unfunded commitments	$	66	$	66

(1) Includes FHLB letters of credit

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2017 (the “2017 Form 10-K”). Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

Executive Overview

First Community Bankshares, Inc. (the “Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia chartered bank institution. As of September 30, 2018, the Bank operated 44 branches as First Community Bank in Virginia, West Virginia, and North Carolina and as People’s Community Bank, a Division of First Community Bank, in Tennessee. As of September 30, 2018, full-time equivalent employees, calculated using the number of hours worked, totaled 530. Our primary source of earnings is net interest income, the difference between interest earned on assets and interest paid on liabilities, which is supplemented by fees for services, commissions on sales, and various deposit service charges. We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network and, to a lesser extent, retail and wholesale repurchase agreements and Federal Home Loan Bank (“FHLB”) borrowings. We invest our funds primarily in loans to retail and commercial customers and various investment securities. Our common stock is traded on the NASDAQ Global Select Market under the symbol, FCBC.

The Bank offers trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). The Trust Division manages inter vivos trusts and trusts under will, develops and administers employee benefit and individual retirement plans, and manages and settles estates. Fiduciary fees for these services are charged on a schedule related to the size, nature, and complexity of the account. Revenues consist primarily of investment advisory fees and commissions on assets under management and administration. As of September 30, 2018, the Trust Division and FCWM managed and administered $1.04 billion in combined assets under various fee-based arrangements as fiduciary or agent.

The Bank offers insurance products and services through its wholly owned subsidiary First Community Insurance Services (“FCIS”). FCIS provides in-branch commercial and insurance services in West Virginia. Revenues are primarily derived from commissions paid by issuing companies on the sale of policies. As of September 30, 2018, FCIS operated 3 in-branch locations.

Acquisitions and Divestitures

On October 2, 2018, we completed our Plan of Reincorporation and Merger changing our corporate domicile from Nevada to Virginia, along with a slight revision in the spelling of our name from First Community Bancshares, Inc. to First Community Bankshares, Inc.

Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with generally accepted accounting principles (“GAAP”) in the U.S. and conform to general practices within the banking industry. Our financial position and results of operations may require management to make significant estimates and assumptions that have a material impact on our financial condition or operating performance. Due to the level of subjectivity and the susceptibility of such matters to change, actual results could differ significantly from management’s assumptions and estimates. Estimates, assumptions, and judgments, which are periodically evaluated, are based on historical experience and other factors, including expectations of future events believed reasonable under the circumstances. These estimates are generally necessary when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve, or when an asset or liability needs recorded based on the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices, when available, or third-party sources. When quoted prices or third-party information is not available, management estimates valuation adjustments primarily through the use of financial modeling techniques and appraisal estimates.

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Our accounting policies are fundamental in understanding MD&A and the disclosures presented in Item 1, “Financial Statements,” of this report. Our accounting policies are described in detail in Note 1, “Basis of Presentation,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2018, and in Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of our 2017 Form 10-K. Our critical accounting estimates are detailed in the “Critical Accounting Estimates” section in Part II, Item 7 of our 2017 Form 10-K.

Performance Overview

Highlights of our results of operations for the three and nine months ended September 30, 2018, and financial condition as of September 30, 2018, include the following:

●

We recognized a one-time goodwill impairment of $1.49 million in connection with the decision to divest our remaining insurance agency assets.

●

We prepaid our remaining $50 million of FHLB debt and incurred a loss on the extinguishment of the debt of $1.10 million.

●

The divestiture of the remaining insurance agency assets and reduction of FHLB debt, in conjunction with the sale of our remaining trust preferred securities culminates a 5-year plan to return our balance sheet and business model to a traditional, simplified, and de-risked community bank.

●

We finalized our 2017 tax returns and deferred tax asset revaluation charge originally taken in the fourth quarter of 2017, which resulted in a reduction in income tax expense of approximately $1.67 million.

●

Net income increased $1.45 million, or 18.92%, to $9.10 million in the third quarter of 2018 compared to the same quarter of 2017 and $6.76 million, or 33.36%, to $27.03 million for the first nine months of 2018 compared to the same period of 2017.

●

Diluted earnings per share increased $0.10, or 22.22%, to $0.55 in the third quarter of 2018 compared to the same quarter of 2017 and $0.42, or 35.29%, to $1.61 in the first nine months of 2018 compared to the same period of 2017.

●

Return on average assets improved 26 basis points to 1.55% and return on average equity improved 198 basis points to 10.59% in the third quarter of 2018 compared to the same quarter of 2017. Return on average assets improved 39 basis points to 1.53% and return on average equity improved 272 basis points to 10.52% for the first nine months of 2018 compared to the same period of 2017.

●

Net interest margin increased 10 basis points to 4.36% in the third quarter of 2018 compared to the same quarter of 2017 and 10 basis points to 4.35% for the first nine months of 2018 compared to the same period of 2017.

●

The Company repurchased 195,776 common shares during the third quarter of 2018. Year to date, the Company has repurchased 670,016 common shares for $21.29 million compared to 50,118 shares during the same period of 2017.

●

The Company and its subsidiary bank both significantly exceed regulatory “well capitalized” targets as of September 30, 2018.

Results of Operations

Net Income

The following table presents the changes in net income and related information for the periods indicated:

	Three Months Ended						Three Months Ended						Nine Months Ended						Nine Months Ended
	September 30,						Increase						September 30,						Increase
(Amounts in thousands, except per	2018			2017			(Decrease)			% Change			2018			2017			(Decrease)			% Change
share data)
Net income	$	9,100		$	7,652		$	1,448			18.92	%	$	27,034		$	20,272		$	6,762			33.36	%

Basic earnings per common share		0.55			0.45			0.10			22.22	%		1.62			1.19			0.43			36.13	%
Diluted earnings per common share		0.55			0.45			0.10			22.22	%		1.61			1.19			0.42			35.29	%

Return on average assets		1.55	%		1.29	%		0.26	%		20.16	%		1.53	%		1.14	%		0.39	%		34.21	%
Return on average common equity		10.59	%		8.61	%		1.98	%		23.00	%		10.52	%		7.80	%		2.72	%		34.87	%

Three-Month Comparison. Net income increased in the third quarter of 2018 due to a decrease in income tax and an increase in net interest income offset by an increase in noninterest expense.

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Nine-Month Comparison. Net income increased in the first nine months of 2018 due to a decrease in income taxes and increases in noninterest and net interest income offset by an increase in noninterest expense.

Net Interest Income

Net interest income, our largest contributor to earnings, is analyzed on a fully taxable equivalent (“FTE”) basis, a non-GAAP financial measure. For additional information, see “Non-GAAP Financial Measures” below. The following tables present the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

	Three Months Ended September 30,
	2018							2017
	Average				Average Yield/			Average				Average Yield/
(Amounts in thousands)	Balance		Interest⁽¹⁾		Rate⁽¹⁾			Balance		Interest⁽¹⁾		Rate⁽²⁾
Assets
Earning assets
Loans⁽²⁾⁽³⁾	$	1,792,284	$	22,632		5.01	%	$	1,843,612	$	22,765		4.90	%
Securities available for sale		188,975		1,647		3.46	%		157,038		1,373		3.47	%
Securities held to maturity		25,064		105		1.66	%		25,199		106		1.67	%
Interest-bearing deposits		66,137		358		2.15	%		73,802		275		1.48	%
Total earning assets		2,072,460		24,742		4.74	%		2,099,651		24,519		4.63	%
Other assets		253,199							258,763
Total assets	$	2,325,659						$	2,358,414

Liabilities and stockholders' equity
Interest-bearing deposits
Demand deposits	$	459,759	$	39		0.03	%	$	384,594	$	48		0.05	%
Savings deposits		502,255		85		0.07	%		518,355		84		0.06	%
Time deposits		463,885		1,145		0.98	%		509,251		1,143		0.89	%
Total interest-bearing deposits		1,425,899		1,269		0.35	%		1,412,200		1,275		0.36	%
Borrowings
Retail repurchase agreements		3,455		1		0.11	%		58,194		10		0.07	%
Wholesale repurchase agreements		25,000		203		3.22	%		25,000		203		3.22	%
FHLB advances and other borrowings		47,826		488		4.05	%		50,000		511		4.05	%
Total borrowings		76,281		692		3.60	%		133,194		724		2.16	%
Total interest-bearing liabilities		1,502,180		1,961		0.52	%		1,545,394		1,999		0.51	%
Noninterest-bearing demand deposits		454,126							440,227
Other liabilities		28,430							20,101
Total liabilities		1,984,736							2,005,722
Stockholders' equity		340,923							352,692
Total liabilities and stockholders' equity	$	2,325,659						$	2,358,414
Net interest income, FTE			$	22,781						$	22,520
Net interest rate spread						4.22	%						4.12	%
Net interest margin						4.36	%						4.26	%


(1)		FTE basis based on the federal statutory rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018
(2)		Interest on loans included non-cash purchase accounting accretion of $1.05 million and $1.38 million for the three months ended September 30, 2018 and 2017, respectively.
(3)		Nonaccrual loans are included in average balances; however, no related interest income is recorded during the period of nonaccrual.

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	Nine Months Ended September 30,
	2018							2017
	Average				Average Yield/			Average				Average Yield/
(Amounts in thousands)	Balance		Interest⁽¹⁾		Rate⁽¹⁾			Balance		Interest⁽¹⁾		Rate⁽²⁾
Assets
Earning assets
Loans⁽²⁾⁽³⁾	$	1,797,689	$	67,954		5.05	%	$	1,841,981	$	67,645		4.91	%
Securities available for sale		181,630		4,672		3.44	%		162,198		4,312		3.55	%
Securities held to maturity		25,098		314		1.67	%		35,578		382		1.44	%
Interest-bearing deposits		97,623		1,343		1.84	%		66,069		655		1.33	%
Total earning assets		2,102,040		74,283		4.72	%		2,105,826		72,994		4.63	%
Other assets		252,797							264,333
Total assets	$	2,354,837						$	2,370,159

Liabilities and stockholders' equity
Interest-bearing deposits
Demand deposits	$	469,081	$	206		0.06	%	$	384,265	$	162		0.06	%
Savings deposits		512,897		250		0.07	%		523,219		253		0.06	%
Time deposits		478,265		3,391		0.95	%		513,072		3,259		0.85	%
Total interest-bearing deposits		1,460,243		3,847		0.35	%		1,420,556		3,674		0.35	%
Borrowings
Federal funds purchased		-		-		-			2		-		0.00	%
Retail repurchase agreements		3,836		3		0.10	%		61,951		31		0.07	%
Wholesale repurchase agreements		25,000		603		3.22	%		25,000		602		3.22	%
FHLB advances and other borrowings		49,267		1,494		4.05	%		57,357		1,754		4.09	%
Total borrowings		78,103		2,100		3.59	%		144,310		2,387		2.21	%
Total interest-bearing liabilities		1,538,346		5,947		0.52	%		1,564,866		6,061		0.52	%
Noninterest-bearing demand deposits		444,672							435,825
Other liabilities		28,257							21,905
Total liabilities		2,011,275							2,022,596
Stockholders' equity		343,562							347,563
Total liabilities and stockholders' equity	$	2,354,837						$	2,370,159
Net interest income, FTE			$	68,336						$	66,933
Net interest rate spread						4.20	%						4.11	%
Net interest margin						4.35	%						4.25	%


(1)		FTE basis based on the federal statutory rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018
(2)		Interest on loans included non-cash purchase accounting accretion income of $4.26 million for the nine months ended September 30, 2018 and 2017.
(3)		Nonaccrual loans are included in average balances; however, no related interest income is recorded during the period of nonaccrual.

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The following table presents the impact to net interest income on a FTE basis due to changes in volume (average volume times the prior year’s average rate), rate (average rate times the prior year’s average volume), and rate/volume (average volume times the change in average rate), for the periods indicated:

	Three Months Ended												Nine Months Ended
	September 30, 2018 Compared to 2017												September 30, 2018 Compared to 2017
	Dollar Increase (Decrease) due to												Dollar Increase (Decrease) due to
							Rate/												Rate/
(Amounts in thousands)	Volume			Rate			Volume			Total			Volume			Rate			Volume			Total
Interest earned on⁽¹⁾
Loans	$	(1,881	)	$	1,529		$	219		$	(133	)	$	(1,627	)	$	1,983		$	(47	)	$	309
Securities available-for-sale		829			(13	)		(542	)		274			517			(140	)		(17	)		360
Securities held-to-maturity		(2	)		(1	)		2			(1	)		(113	)		63			(18	)		(68	)
Interest-bearing deposits with other banks		(85	)		369			(201	)		83			313			254			121			688
Total interest earning assets		(1,139	)		1,884			(522	)		223			(910	)		2,160			39			1,289

Interest paid on⁽¹⁾
Demand deposits		52			(167	)		65			(50	)		66			(132	)		(29	)		(95	)
Savings deposits		(4	)		133			(87	)		42			(2	)		141			(3	)		136
Time deposits		(302	)		338			(34	)		2			(221	)		379			(26	)		132
Retail repurchase agreements		(28	)		20			(1	)		(9	)		(29	)		17			(16	)		(28	)
Wholesale repurchase agreements		-			-			-			-			-			1			-			1
FHLB advances and other borrowings		(66	)		(2	)		45			(23	)		(247	)		(15	)		2			(260	)
Total interest-bearing liabilities		(348	)		322			(12	)		(38	)		(433	)		391			(72	)		(114	)

Change in net interest income⁽¹⁾	$	(791	)	$	1,562		$	(510	)	$	261		$	(477	)	$	1,769		$	111		$	1,403

(1)

FTE basis based on the federal statutory rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018

Three-Month Comparison. Net interest income comprised 77.40% of total net interest and noninterest income in the third quarter of 2018 compared to 76.69% in the same quarter of 2017. Net interest income on a GAAP basis increased $275 thousand, or 1.25%, compared to an increase of $261 thousand, or 1.16%, on a FTE basis. The net interest margin on a FTE basis increased 10 basis points and the net interest spread on a FTE basis increased 10 basis points. Excluding the impact from non-cash purchase accounting accretion income, the net interest margin increased 16 basis points, or 4.00%, to 4.16% compared to 4.00% in the same quarter of 2017.

Average earning assets decreased $27.19 million, or 1.30%, primarily due to a decrease in average loans offset by an increase in available-for-sale securities. The yield on earning assets increased 11 basis points as the yields on loans and interest-bearing deposits increased. Average loans decreased $51.33 million, or 2.78%, and the average loan to deposit ratio decreased to 95.33% from 99.52% in the same quarter of 2017. Non-cash accretion income decreased $324 thousand, or 23.53%, due to continued acquired portfolio attrition.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $43.21 million, or 2.80%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities increased 1 basis point. Average borrowings decreased $56.91 million, or 42.73%, largely due to a $54.74 million, or 94.06%, decrease in average retail repurchase agreements and a $2.17 million, or 4.35%, decrease in average FHLB advances. Average interest-bearing deposits increased $13.70 million, or 0.97%, which was driven by a $75.17 million, or 19.54%, increase in average interest-bearing demand deposits offset by a $45.37 million, or 8.91%, decrease in average time deposits, and a $16.10 million, or 3.11%, decrease in average savings deposits, which include money market and savings accounts.

Nine-Month Comparison. Net interest income comprised 76.87% of total net interest and noninterest income in the first nine months of 2018 compared to 79.32% in the same period of 2017. Net interest income on a GAAP basis increased $1.48 million, or 2.26%, compared to an increase of $1.40 million, or 2.10%, on a FTE basis. The net interest margin on a FTE basis increased 10 basis points and the net interest spread on a FTE basis increased 9 basis points. Excluding the impact from non-cash purchase accounting accretion income, the net interest margin increased 10 basis points, or 2.51%, to 4.08% compared to 3.98% in the same period of 2017.

Average earning assets decreased $3.79 million, or 0.18%, primarily due to a decrease in average loans offset by increases in interest-bearing deposits and available-for-sale securities. The yield on earning assets increased 9 basis points and the yield on loans increased 14 basis points. Average loans decreased $44.29 million, or 2.40%, and the average loan to deposit ratio decreased to 94.37% from 99.22% in the same period of 2017. Non-cash accretion income remained steady at $4.26 million.

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Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, decreased $26.52 million, or 1.69%, primarily due to a decline in average borrowings. The yield on interest-bearing liabilities remained unchanged at 52 basis points. Average borrowings decreased $66.21 million, or 45.88%, largely due to a $58.12 million, or 93.81%, decrease in average retail repurchase agreements and an $8.09 million, or 14.10%, decrease in average FHLB advances. Average interest-bearing deposits increased $39.69 million, or 2.79%, which was driven by an $84.82 million, or 22.07%, increase in average interest-bearing demand deposits offset by a $34.81 million, or 6.78%, decrease in average time deposits, and a $10.32 million, or 1.97%, decrease in average savings deposits, which include money market and savings accounts.

Provision for Loan Losses

Three-Month Comparison. The provision charged to operations decreased $235 thousand, or 32.19%, to $495 thousand in the third quarter of 2018 compared to the same quarter of 2017, which was attributed to the non-PCI provision. For additional information, see “Allowance for Loan Losses” in the “Financial Condition” section below.

Nine-Month Comparison. The provision charged to operations decreased $671 thousand, or 31.12%, to $1.49 million in the first nine months of 2018 compared to the same period of 2017, which was attributed to the non-PCI provision.

Noninterest Income

The following table presents the components of, and changes in, noninterest income for the periods indicated:

	Three Months Ended						Three Months Ended						Nine Months Ended						Nine Months Ended
	September 30,						Increase						September 30,						Increase
	2018			2017			(Decrease)			% Change			2018			2017			(Decrease)			% Change
(Amounts in thousands)
Wealth management	$	791		$	758		$	33			4.35	%	$	2,408		$	2,339		$	69			2.95	%
Service charges on deposits		3,803			3,605			198			5.49	%		10,883			10,078			805			7.99	%
Other service charges and fees		1,925			1,709			216			12.64	%		5,716			5,156			560			10.86	%
Insurance commissions		299			306			(7	)		-2.29	%		966			1,004			(38	)		-3.78	%
Net loss on sale of securities		(618	)		-			(618	)		-			(618	)		(657	)		39			-5.94	%
Net FDIC indemnification asset amortization		(645	)		(268	)		(377	)		140.67	%		(1,602	)		(3,186	)		1,584			-49.72	%
Other operating income		964			593			371			62.56	%		2,393			2,336			57			2.44	%
Total noninterest income	$	6,519		$	6,703		$	(184	)		-2.75	%	$	20,146		$	17,070		$	3,076			18.02	%

Three-Month Comparison. Noninterest income comprised 22.60% of total net interest and noninterest income in the third quarter of 2018 compared to 23.31% in the same quarter of 2017. Noninterest income decreased $184 thousand, or 2.75%, primarily due to the net loss on the sale of securities and the increase in net negative amortization related to the FDIC indemnification asset. Service charges on deposits and other service charges and fees increased $414 thousand, or 7.79%, primarily from increases in checking account fees and a $162 thousand, or 12.62%, increase in net interchange income. Other operating income increased primarily due to certain third-party incentive payments associated with debit cards and demand deposit accounts. Excluding the impact from sales of securities and net FDIC and indemnification asset amortization, noninterest income increased $811 thousand, or 11.63%, to $7.78 million in the third quarter of 2018, from $6.97 million in the same quarter of 2017.

Nine-Month Comparison. Noninterest income comprised 23.13% of total net interest and noninterest income in the first nine months of 2018 compared to 20.68% in the same period of 2017. Noninterest income increased $3.08 million, or 18.02%, primarily due to the decrease in net negative amortization related to the FDIC indemnification asset as loss share coverage expired June 30, 2017, for commercial loans. Service charges on deposits and other service charges and fees increased $1.37 million, or 8.96%, primarily from increases in checking account fees and a $432 thousand, or 11.34%, increase in net interchange income. Other operating income increased primarily due to certain third-party incentive payments associated with debit cards offset by the recognition of $459 thousand in death proceeds from bank owned life insurance in the first nine months of 2017. Excluding the impact from sales of securities, net FDIC indemnification asset amortization, and bank owned life insurance proceeds, noninterest income increased $1.78 million, or 8.70%, to $22.23 million in the first nine months of 2018, from $20.45 million in the same period of 2017.

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Noninterest Expense

The following table presents the components of, and changes in, noninterest expense for the periods indicated:

	Three Months Ended				Three Months Ended						Nine Months Ended				Nine Months Ended
	September 30,				Increase						September 30,				Increase
	2018		2017		(Decrease)			% Change			2018		2017		(Decrease)			% Change
(Amounts in thousands)
Salaries and employee benefits	$	8,983	$	9,001	$	(18	)		-0.20	%	$	27,417	$	26,771	$	646			2.41	%
Occupancy expense		1,075		1,082		(7	)		-0.65	%		3,408		3,671		(263	)		-7.16	%
Furniture and equipment expense		985		1,133		(148	)		-13.06	%		2,976		3,311		(335	)		-10.12	%
Service fees		1,134		705		429			60.85	%		2,813		2,645		168			6.35	%
Advertising and public relations		478		551		(73	)		-13.25	%		1,461		1,700		(239	)		-14.06	%
Professional fees		337		339		(2	)		-0.59	%		1,074		1,978		(904	)		-45.70	%
Amortization of intangibles		261		266		(5	)		-1.88	%		785		790		(5	)		-0.63	%
FDIC premiums and assessments		234		227		7			3.08	%		697		698		(1	)		-0.14	%
Loss on extinguishment of debt		1,096		-		1,096			-			1,096		-		1,096			-
Goodwill impairment		1,492		-		1,492			-			1,492		-		1,492			-
Other operating expense		2,056		3,173		(1,117	)		-35.20	%		9,188		8,655		533			6.16	%
Total noninterest expense	$	18,131	$	16,477	$	1,654			10.04	%	$	52,407	$	50,219	$	2,188			4.36	%

Three-Month Comparison. Noninterest expense increased $1.65 million, or 10.04%, in the third quarter of 2018 compared to the same quarter of 2017, which was largely due to the one-time $1.49 million goodwill impairment associated with the decision to divest the remaining insurance agency assets and the $1.10 million prepayment penalty related to the remaining FHLB advances. These increases were offset by a decrease in other operating expense, which included a $576 thousand decrease in the net loss on sales and expenses related to other real estate owned (“OREO”) to $71 thousand from $647 thousand in the third quarter of 2017 and a $508 thousand net reduction in accrued franchise tax.

Nine-Month Comparison. Noninterest expense increased $2.19 million, or 4.36%, in the first nine months of 2018 compared to the same period of 2017, which was largely due to the one-time goodwill impairment and the FHLB prepayment penalty offset by a decrease in professional fees, which were largely due to a reduction in legal fees. The increase in other operating expense included a $910 thousand increase in property write-downs offset by a $203 thousand decrease in the net loss on sales and expenses related to OREO to $985 thousand in the first nine months of 2018 from $1.19 million in the first nine months of 2017.

Income Tax Expense

The Tax Cuts and Jobs Act (“Tax Reform Act”) was enacted on December 22, 2017. Among other things, the new law establishes a new, flat corporate federal statutory income tax rate of 21%; eliminates the corporate alternative minimum tax and allows the use of any such carryforwards to offset regular tax liability for any taxable year; limits the deduction for net interest expense incurred by U.S. corporations; allows businesses to immediately expense the cost of new investments in certain qualified depreciable assets for tax purposes; eliminates or reduces certain deductions related to meals and entertainment expenses; modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee; and limits the deductibility of deposit insurance premiums. As a result of the Tax Reform Act, we recognized tax expense totaling $6.55 million during the fourth quarter of 2017 related to the revaluation of our deferred tax balances, which included provisional estimates primarily related to certain purchase accounting, indemnification asset, intangible, and depreciation items. During the third quarter of 2018, we recorded a $1.67 million reduction in tax expense related to the completion of the deferred tax asset revaluation analysis and the finalization of our 2017 tax returns.

Three-Month Comparison. The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent differences and available tax credits. Permanent differences are income and expense items excluded by law in the calculation of taxable income. The Company’s most significant permanent differences generally include interest income on municipal securities and increases in the cash surrender value of life insurance policies. The Tax Reform Act enacted on December 22, 2017, reduced our federal statutory income tax rate from 35% to 21% beginning January 1, 2018. Income tax expense decreased $2.78 million, or 71.29%, and the effective tax rate decreased to 10.94% in the third quarter of 2018 from 33.73% in the same quarter of 2017 primarily due to the enactment of the Tax Reform Act and the completion of the deferred tax asset revaluation, which resulted in a $1.67 million reduction in tax expense.

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Nine-Month Comparison. Income tax expense decreased $3.72 million, or 37.57%, and the effective tax rate decreased to 18.62% in the third quarter of 2018 from 32.83% in the same quarter of 2017 primarily due to the enactment of the Tax Reform Act and the deferred tax asset revaluation as discussed above.

Non-GAAP Financial Measures

In addition to financial statements prepared in accordance with GAAP, we use certain non-GAAP financial measures that management believes provide investors with important information useful in understanding our operational performance and comparing our financial measures with other financial institutions. The non-GAAP financial measure presented in this report includes net interest income on a FTE basis. We believe FTE basis is the preferred industry measurement of net interest income and provides better comparability between taxable and tax exempt amounts. We use this non-GAAP financial measure to monitor net interest income performance and to manage the composition of our balance sheet. The FTE basis adjusts for the tax benefits of income from certain tax exempt loans and investments using the federal statutory rate of 21% beginning January 1, 2018, and 35% prior to January 1, 2018. While we believe certain non-GAAP financial measures enhance understanding of our business and performance, they are supplemental and not a substitute for, or more important than, financial measures prepared on a GAAP basis. Our non-GAAP financial measures may not be comparable to those reported by other financial institutions. The reconciliations of non-GAAP to GAAP measures are presented below.

The following table reconciles net interest income and margin, as presented in our consolidated statements of income, to net interest income on a FTE basis for the periods indicated:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
(Amounts in thousands)
Net interest income, GAAP	$	22,325		$	22,050		$	66,966		$	65,485
FTE adjustment⁽¹⁾		456			470			1,370			1,448
Net interest income, FTE		22,781			22,520			68,336			66,933

Net interest margin, GAAP		4.27	%		4.17	%		4.26	%		4.16	%
FTE adjustment⁽¹⁾		0.09	%		0.09	%		0.09	%		0.09	%
Net interest margin, FTE		4.36	%		4.26	%		4.35	%		4.25	%


(1)	FTE basis based on the federal statutory rate of 21% for periods after January 1, 2018, and 35% for periods prior to January 1, 2018

Financial Condition

Total assets as of September 30, 2018, decreased $118.77 million, or 4.97%, to $2.27 billion from $2.39 billion as of December 31, 2017. Total liabilities as of September 30, 2018, decreased $106.46 million, or 5.22%, to $1.93 billion from $2.04 billion as of December 31, 2017.

Investment Securities

Our investment securities are used to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements.

Available-for-sale debt securities as of September 30, 2018, decreased $1.93 million, or 1.17%, compared to December 31, 2017, and included the sale of our remaining single issue trust preferred securities. The market value of debt securities available for sale as a percentage of amortized cost was 99.05% as of September 30, 2018, compared to 100.75% as of December 31, 2017. Held-to-maturity debt securities as of September 30, 2018, decreased $102 thousand, or 0.41%, compared to December 31, 2017. The market value of debt securities held to maturity as a percentage of amortized cost was 99.73% as of September 30, 2018, compared to 99.74% as of December 31, 2017.

Investment securities are reviewed quarterly for possible other-than-temporary impairment (“OTTI”) charges. We recognized no OTTI charges in earnings associated with debt securities for the three months ended September 30, 2018 or 2017. For additional information, see Note 2, “Debt Securities,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

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Loans Held for Investment

Loans held for investment, our largest component of interest income, are grouped into commercial, consumer real estate, and consumer and other loan segments. Each segment is divided into various loan classes based on collateral or purpose. Certain loans acquired in FDIC-assisted transactions are covered under loss share agreements (“covered loans”). Total loans held for investment, net of unearned income, as of September 30, 2018, decreased $26.28 million, or 1.45%, compared to December 31, 2017, primarily due to an $18.81 million, or 1.05%, decrease in non-covered loans, which was driven by declines in owner occupied construction; multi-family residential; and non-farm, non-residential segments. Covered loans decreased $7.47 million, or 26.71%, as the covered Waccamaw portfolio continues to pay down. For additional information, see Note 3, “Loans,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table presents loans, net of unearned income, with non-covered loans by loan class as of the dates indicated:

	September 30, 2018					December 31, 2017					September 30, 2017
(Amounts in thousands)	Amount		Percent			Amount		Percent			Amount		Percent
Non-covered loans held for investment
Commercial loans
Construction, development, and other land	$	62,657		3.50	%	$	60,017		3.30	%	$	72,952		3.97	%
Commercial and industrial		105,603		5.90	%		92,188		5.07	%		90,184		4.91	%
Multi-family residential		112,710		6.29	%		125,202		6.89	%		125,997		6.86	%
Single family non-owner occupied		142,591		7.96	%		141,670		7.80	%		143,213		7.79	%
Non-farm, non-residential		606,800		33.88	%		616,633		33.93	%		613,380		33.38	%
Agricultural		9,016		0.50	%		7,035		0.39	%		6,096		0.33	%
Farmland		20,872		1.17	%		25,649		1.41	%		27,897		1.52	%
Total commercial loans		1,060,249		59.20	%		1,068,394		58.79	%		1,079,719		58.76	%
Consumer real estate loans
Home equity lines		96,819		5.41	%		103,205		5.68	%		102,888		5.60	%
Single family owner occupied		520,363		29.05	%		502,686		27.66	%		501,242		27.27	%
Owner occupied construction		17,889		1.00	%		39,178		2.16	%		47,034		2.56	%
Total consumer real estate loans		635,071		35.46	%		645,069		35.50	%		651,164		35.43	%
Consumer and other loans
Consumer loans		69,974		3.91	%		70,772		3.89	%		70,695		3.85	%
Other		5,132		0.29	%		5,001		0.28	%		4,856		0.26	%
Total consumer and other loans		75,106		4.20	%		75,773		4.17	%		75,551		4.11	%
Total non-covered loans		1,770,426		98.86	%		1,789,236		98.46	%		1,806,434		98.30	%
Total covered loans		20,483		1.14	%		27,948		1.54	%		31,287		1.70	%
Total loans held for investment, net of unearned income		1,790,909		100.00	%		1,817,184		100.00	%		1,837,721		100.00	%
Less: allowance for loan losses		18,256					19,276					19,206
Total loans held for investment, net of unearned income and allowance	$	1,772,653				$	1,797,908				$	1,818,515

The following table presents covered loans, by loan class, as of the dates indicated:

	September 30, 2018					December 31, 2017					September 30, 2017
(Amounts in thousands)	Amount		Percent			Amount		Percent			Amount		Percent
Commercial loans
Construction, development, and other land	$	35		0.17	%	$	39		0.14	%	$	40		0.13	%
Single family non-owner occupied		245		1.20	%		284		1.02	%		292		0.93	%
Non-farm, non-residential		7		0.03	%		9		0.03	%		10		0.03	%
Total commercial loans		287		1.40	%		332		1.19	%		342		1.09	%
Consumer real estate loans
Home equity lines		16,804		82.04	%		23,720		84.87	%		26,850		85.82	%
Single family owner occupied		3,392		16.56	%		3,896		13.94	%		4,095		13.09	%
Total consumer real estate loans		20,196		98.60	%		27,616		98.81	%		30,945		98.91	%
Total covered loans	$	20,483		100.00	%	$	27,948		100.00	%	$	31,287		100.00	%

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Risk Elements

We seek to mitigate credit risk by following specific underwriting practices and by ongoing monitoring of our loan portfolio. Our underwriting practices include the analysis of borrowers’ prior credit histories, financial statements, tax returns, and cash flow projections; valuation of collateral based on independent appraisers’ reports; and verification of liquid assets. We believe our underwriting criteria are appropriate for the various loan types we offer; however, losses may occur that exceed the reserves established in our allowance for loan losses. We track certain credit quality indicators that include: trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, nonperforming loans, and general economic conditions. The Company’s loan review function generally analyzes all commercial loan relationships greater than $4.00 million annually and at various times during the year. Smaller commercial and retail loans are sampled for review during the year.

Nonperforming assets consist of nonaccrual loans, accrual loans contractually past due 90 days or more, unseasoned troubled debt restructurings (“TDRs”), and OREO. Ongoing activity in the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification due to changing economic conditions, borrower financial capacity, or resolution efforts. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. For additional information, see Note 4, “Credit Quality,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

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The following table presents the components of nonperforming assets and related information as of the periods indicated:

	September 30, 2018			December 31, 2017			September 30, 2017
(Amounts in thousands)
Non-covered nonperforming
Nonaccrual loans	$	20,542		$	18,997		$	18,942
Accruing loans past due 90 days or more		46			1			-
TDRs⁽¹⁾		200			120			141
Total nonperforming loans		20,788			19,118			19,083
Non-covered OREO		4,754			2,409			3,543
Total non-covered nonperforming assets	$	25,542		$	21,527		$	22,626

Covered nonperforming
Nonaccrual loans	$	330		$	342		$	420
Total nonperforming loans		330			342			420
Covered OREO		44			105			54
Total covered nonperforming assets	$	374		$	447		$	474

Total nonperforming
Nonaccrual loans	$	20,872		$	19,339		$	19,362
Accruing loans past due 90 days or more		46			1			-
TDRs⁽¹⁾		200			120			141
Total nonperforming loans		21,118			19,460			19,503
OREO		4,798			2,514			3,597
Total nonperforming assets	$	25,916		$	21,974		$	23,100

Additional Information
Performing TDRs⁽²⁾	$	6,942		$	7,614		$	8,101
Total TDRs⁽³⁾		7,142			7,734			8,242

Non-covered ratios
Nonperforming loans to total loans		1.17	%		1.07	%		1.06	%
Nonperforming assets to total assets		1.14	%		0.91	%		0.97	%
Non-PCI allowance to nonperforming loans		87.82	%		100.83	%		100.64	%
Non-PCI allowance to total loans		1.03	%		1.08	%		1.06	%

Total ratios
Nonperforming loans to total loans		1.18	%		1.07	%		1.06	%
Nonperforming assets to total assets		1.14	%		0.92	%		0.97	%
Allowance for loan losses to nonperforming loans		86.45	%		99.05	%		98.48	%
Allowance for loan losses to total loans		1.02	%		1.06	%		1.05	%


(1)		TDRs restructured within the past six months and nonperforming TDRs exclude nonaccrual TDRs of $550 thousand, $169 thousand, and $15 thousand for the periods ended September 30, 2018, December 31, 2017, and September 30, 2017, respectively.
(2)		TDRs with six months or more of satisfactory payment performance exclude nonaccrual TDRs of $1.66 million, $1.76 million, and $1.50 million for the periods ended September 30, 2018, December 31, 2017, and September 30, 2017, respectively.
(3)		Total TDRs exclude nonaccrual TDRs of $2.21 million, $1.93 million, and $1.52 million for the periods ended September 30, 2018, December 31, 2017, and September 30, 2017, respectively.

Non-covered nonperforming assets as of September 30, 2018, increased $4.02 million, or 18.65%, from December 31, 2017, primarily due to an increase in non-covered nonaccrual loans and non-covered OREO. Non-covered nonaccrual loans as of September 30, 2018, increased $1.55 million, or 8.13%, from December 31, 2017. As of September 30, 2018, non-covered nonaccrual loans were largely attributed to single family owner occupied (51.48%) and non-farm, non-residential (19.28%) loans. As of September 30, 2018, approximately $1.84 million, or 8.94%, of non-covered nonaccrual loans were attributed to performing loans acquired in business combinations. Certain loans included in the nonaccrual category have been written down to estimated realizable value or assigned specific reserves in the allowance for loan losses based on management’s estimate of loss at ultimate resolution.

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Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $27.28 million as of September 30, 2018, a decrease of $3.43 million, or 11.17%, compared to $30.71 million as of December 31, 2017. Non-covered delinquent loans as a percent of total non-covered loans totaled 1.54% as of September 30, 2018, which includes past due loans (0.38%) and nonaccrual loans (1.16%).

When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, or amortization terms. Certain TDRs are classified as nonperforming when modified and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. Accruing TDRs as of September 30, 2018, decreased $592 thousand, or 7.65%, to $7.14 million from December 31, 2017. Unseasoned and nonperforming accruing TDRs as of September 30, 2018, increased $80 thousand to $200 thousand compared to December 31, 2017. Unseasoned and nonperforming accruing TDRs as a percent of total accruing TDRs totaled 2.80% as of September 30, 2018, compared to 1.55% as of December 31, 2017. Specific reserves on TDRs totaled $632 thousand as of September 30, 2018, compared to $642 thousand as of December 31, 2017.

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, increased $2.35 million, or 97.34%, as of September 30, 2018, compared to December 31, 2017, and consisted of 21 properties with an average holding period of 8 months. The net loss on the sale of OREO totaled $63 thousand for the three months ended September 30, 2018, compared to $522 thousand for the same period of the prior year and $838 thousand for the nine months ended September 30, 2018, compared to $943 thousand for the same period of the prior year. The following table presents the changes in OREO during the periods indicated:

	Nine Months Ended September 30,
	2018									2017
	Non-covered			Covered			Total			Non-covered			Covered			Total
(Amounts in thousands)
Beginning balance	$	2,409		$	105		$	2,514		$	5,109		$	276		$	5,385
Additions		4,135			-			4,135			1,256			26			1,282
Disposals		(1,224	)		(55	)		(1,279	)		(2,169	)		(218	)		(2,387	)
Valuation adjustments		(566	)		(6	)		(572	)		(653	)		(30	)		(683	)
Ending balance	$	4,754		$	44		$	4,798		$	3,543		$	54		$	3,597

Allowance for Loan Losses

The allowance for loan losses is maintained at a level management deems sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and recoveries of prior loan charge-offs and decreased by loans charged off. The provision for loan losses is calculated and charged to expense to bring the allowance to an appropriate level using a systematic process of measurement that requires significant judgments and estimates. As of September 30, 2018, our qualitative risk factors reflect a stable risk of loan losses due to consistent asset quality metrics and relatively stable business and economic conditions in our primary market areas. The loan portfolio is continually monitored for deterioration in credit, which may result in the need to increase the allowance for loan losses in future periods. Management considered the allowance adequate as of September 30, 2018; however, no assurance can be made that additions to the allowance will not be required in future periods. For additional information, see Note 5, “Allowance for Loan Losses,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The allowance for loan losses as of September 30, 2018, decreased $1.02 million, or 5.29%, from December 31, 2017. The decrease was largely attributed to an $844 thousand decrease in specific reserves on impaired loans. The non-PCI allowance as a percent of non-covered loans totaled 1.03% as of September 30, 2018, compared to 1.08% as of December 31, 2017. PCI loans were aggregated into five loan pools as of September 30, 2018, and December 31, 2017: Waccamaw commercial, Waccamaw serviced home equity lines, Waccamaw residential, Peoples Bank of Virginia (“Peoples”) commercial, and Peoples residential. The cash flow analysis identified no impaired PCI loan pools as of September 30, 2018, or December 31, 2017. Net charge-offs increased $1.41 million for the three months ended September 30, 2018, compared to the same period of the prior year, and $1.61 million for the nine months ended September 30, 2018, compared to the same period of the prior year. The increase in net charge-offs was driven by one loan relationship in the single family owner occupied segment that was fully reserved.

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The following table presents the changes in the allowance for loan losses, by loan class, during the periods indicated:

	Three Months Ended September 30,
	2018								2017
	Non-PCI Portfolio			PCI Portfolio		Total			Non-PCI Portfolio			PCI Portfolio			Total
(Amounts in thousands)
Beginning balance	$	19,583		$	-	$	19,583		$	18,878		$	8		$	18,886
Provision for (recovery of) loan losses charged to operations		495			-		495			738			(8	)		730
Charge-offs		(2,177	)		-		(2,177	)		(717	)		-			(717	)
Recoveries		355			-		355			307			-			307
Net charge-offs		(1,822	)		-		(1,822	)		(410	)		-			(410	)
Ending balance	$	18,256		$	-	$	18,256		$	19,206		$	-		$	19,206

	Nine Months Ended September 30,
	2018								2017
	Non-PCI Portfolio			PCI Portfolio		Total			Non-PCI Portfolio			PCI Portfolio			Total
(Amounts in thousands)
Beginning balance	$	19,276		$	-	$	19,276		$	17,936		$	12		$	17,948
Provision for (recovery of) loan losses charged to operations		1,485			-		1,485			2,168			(12	)		2,156
Charge-offs		(3,625	)		-		(3,625	)		(1,976	)		-			(1,976	)
Recoveries		1,120			-		1,120			1,078			-			1,078
Net charge-offs		(2,505	)		-		(2,505	)		(898	)		-			(898	)
Ending balance	$	18,256		$	-	$	18,256		$	19,206		$	-		$	19,206

Deposits

Total deposits as of September 30, 2018, decreased $54.04 million, or 2.80%, compared to December 31, 2017. Time deposits, which consist of certificates of deposit and individual retirement accounts, decreased $40.14 million; savings deposits, which consist of money market accounts and savings accounts, decreased $17.67 million; and interest-bearing demand deposits decreased $6.03 million while noninterest-bearing demand deposits increased $9.80 million as of September 30, 2018, compared to December 31, 2017.

Borrowings

Total borrowings as of September 30, 2018, decreased $49.94 million, or 62.35%, compared to December 31, 2017. Short-term borrowings, which consist of retail repurchase agreements, increased $65 thousand, or 1.28%, while the weighted average rate increased 3 basis points to 0.10% as of September 30, 2018, compared to December 31, 2017. Long-term borrowings consisted of a wholesale repurchase agreement that totaled $25.00 million with a weighted average contractual rate of 3.18% as of September 30, 2018, and December 31, 2017. During the third quarter of 2018, we prepaid our remaining $50.00 million FHLB convertible advance and incurred a prepayment penalty of $1.10 million. The prepayment was funded with cash and equivalents on hand, as well as the proceeds from the sale of single issue trust preferred investment securities, and is anticipated to result in annualized net pre-tax savings of approximately $800 thousand.

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Liquidity and Capital Resources

Liquidity

Liquidity is a measure of our ability to convert assets to cash or raise cash to meet financial obligations. We believe that liquidity management should encompass an overall balance sheet approach that draws together all sources and uses of liquidity. Poor or inadequate liquidity risk management may result in a funding deficit that could have a material impact on our operations. We maintain a liquidity risk management policy and contingency funding policy (“Liquidity Plan”) to detect potential liquidity issues and protect our depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”) of the Board of Directors. ALCO reviews liquidity risk exposure and policies related to liquidity management; ensures that systems and internal controls are consistent with liquidity policies; and provides accurate reports about liquidity needs, sources, and compliance. The Liquidity Plan involves ongoing monitoring and estimation of potentially credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows during a funding crisis. The liquidity model incorporates various funding crisis scenarios and a specific action plan is formulated, and activated, when a financial shock that affects our normal funding activities is identified. Generally, the plan will reflect a strategy of replacing liability outflows with alternative liabilities, rather than balance sheet asset liquidity, to the extent that significant premiums can be avoided. If alternative liabilities are not available, outflows will be met through liquidation of balance sheet assets, including unpledged securities.

As a financial holding company, the Company’s primary source of liquidity is dividends received from the Bank, which are subject to certain regulatory limitations. Other sources of liquidity include cash, investment securities, and borrowings. As of September 30, 2018, the Company’s cash reserves totaled $21.24 million and availability on an unsecured, committed line of credit with an unrelated financial institution totaled $15.00 million. There was no outstanding balance on the line of credit as of September 30, 2018. The Company’s cash reserves and investments provide adequate working capital to meet obligations, projected dividends to shareholders, and anticipated debt repayments for the next twelve months.

In addition to cash on hand and deposits with other financial institutions, we rely on customer deposits, cash flows from loans and investment securities, and lines of credit from the FHLB and the Federal Reserve Bank (“FRB”) Discount Window to meet potential liquidity demands. These sources of liquidity are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Secondary sources of liquidity include approved lines of credit with correspondent banks and unpledged available-for-sale securities. As of September 30, 2018, our unencumbered cash totaled $73.68 million, unused borrowing capacity from the FHLB totaled $411.31 million, available credit from the FRB Discount Window totaled $6.00 million, available lines from correspondent banks totaled $90.00 million, and unpledged available-for-sale securities totaled $125.80 million.

Cash Flows

The following table summarizes the components of cash flow for the periods indicated:

	Nine Months Ended September 30,
	2018			2017
(Amounts in thousands)
Net cash provided by operating activities	$	37,146		$	23,238
Net cash provided by investing activities		21,198			37,638
Net cash used in financing activities		(142,616	)		(32,064	)
Net (decrease) increase in cash and cash equivalents		(84,272	)		28,812
Cash and cash equivalents, beginning balance		157,951			76,307
Cash and cash equivalents, ending balance	$	73,679		$	105,119

Cash and cash equivalents decreased $84.27 million for the nine months ended September 30, 2018, compared to an increase of $28.81 million for the same period of the prior year. The decrease was primarily due to a $110.55 million increase in net cash used in financing activities due to a net decrease in deposit accounts, the repayment of FHLB borrowings, an increase in cash dividends, and an increase in the repurchase of treasury stock. Net cash provided by investing activities decreased $16.44 million largely due to the purchase of available for sale securities. Net cash provided by operating activities increased $13.91 million primarily due to an increase in net income and a decrease in other operating activities.

Capital Resources

We are committed to effectively managing our capital to protect our depositors, creditors, and shareholders. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our operations. Total stockholders’ equity as of September 30, 2018, decreased $12.31 million, or 3.51%, to $338.40 million from $350.71 million as of December 31, 2017. The change in stockholders’ equity was largely due to the repurchase of 670,016 shares of our common stock totaling $21.29 million and dividends declared on our common stock of $17.68 million, which includes a one-time special dividend totaling $8.13 million, offset by net income of $27.03 million. Accumulated other comprehensive loss increased $1.98 million to $2.82 million as of September 30, 2018, compared to December 31, 2017, primarily due to net unrealized losses on securities. In accordance with current regulatory guidelines, accumulated other comprehensive income/(loss) is largely excluded from stockholders' equity in the calculation of our capital ratios. Our book value per common share increased $0.02, or 0.10%, to $20.65 as of September 30, 2018, from $20.63 as of December 31, 2017.

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Capital Adequacy Requirements

Risk-based capital guidelines, issued by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. Our current risk-based capital requirements, based on the international capital standards known as Basel III, became effective on January 1, 2015, subject to a four-year phase-in period. Basel III’s capital conservation buffer became effective on January 1, 2016, at 0.625%, and will be phased in over a four-year period (increasing by an additional 0.625% each year until it reaches 2.5% on January 1, 2019). A description of the Basel III capital rules is included in Part I, Item 1 of the 2017 Form 10-K. Our current required capital ratios are as follows:

●

4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 5.75% including the capital conservation buffer)

●

6.0% Tier 1 capital to risk-weighted assets (effectively 7.25% including the capital conservation buffer)

●

8.0% Total capital to risk-weighted assets (effectively 9.25% including the capital conservation buffer)

●

4.0% Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”)

The following table presents our capital ratios as of the dates indicated:

	September 30, 2018						December 31, 2017
	Company			Bank			Company			Bank

Common equity Tier 1 ratio		13.95	%		12.31	%		13.98	%		12.47	%
Tier 1 risk-based capital ratio		13.95	%		12.31	%		13.98	%		12.47	%
Total risk-based capital ratio		15.01	%		13.37	%		15.06	%		13.55	%
Tier 1 leverage ratio		10.85	%		9.56	%		11.06	%		9.84	%

Our risk-based capital ratios as of September 30, 2018, decreased from December 31, 2017, due to a decrease in Tier 1 and total risk-based capital. As of September 30, 2018, we continued to meet all capital adequacy requirements and were classified as well-capitalized under the regulatory framework for prompt corrective action. Management believes there have been no conditions or events since those notifications that would change the Bank’s classification. Additionally, our capital ratios were in excess of the minimum standards under the Basel III capital rules on a fully phased-in basis, if such requirements were in effect, as of September 30, 2018.

Off-Balance Sheet Arrangements

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument. The following table presents our off-balance sheet arrangements as of the dates indicated:

	September 30, 2018		December 31, 2017
(Amounts in thousands)
Commitments to extend credit	$	213,313	$	243,147
Financial letters of credit		250		250
Performance letters of credit⁽¹⁾		148,481		131,337
Total off-balance sheet risk	$	362,044	$	374,734

Reserve for unfunded commitments	$	66	$	66


(1) Includes FHLB letters of credit

Market Risk and Interest Rate Sensitivity

Market risk represents the risk of loss due to adverse changes in current and future cash flows, fair values, earnings, or capital due to movements in interest rates and other factors. Our profitability is largely dependent upon net interest income, which is subject to variation due to changes in the interest rate environment and unbalanced repricing opportunities. We are subject to interest rate risk when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. ALCO reviews our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. ALCO is also responsible for overseeing the formulation and implementation of policies and strategies to improve balance sheet positioning and mitigate the effect of interest rate changes.

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In order to manage our exposure to interest rate risk, we periodically review third-party and internal simulation models that project net interest income at risk, which measures the impact of different interest rate scenarios on net interest income, and the economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing our assets and liabilities at fair value under different interest rate scenarios. Simulation results show the existence and severity of interest rate risk in each scenario based on our current balance sheet position, assumptions about changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and estimated yields earned on assets and rates paid on liabilities. The simulation model provides the best tool available to us and the industry for managing interest rate risk; however, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income due to the use of significant estimates and assumptions. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in our strategies that management might undertake in response to a sudden and sustained rate shock.

During the third quarter of 2018, the Federal Open Market Committee increased the benchmark federal funds rate to a range of 200 to 225 basis points. The following table presents the sensitivity of net interest income from immediate and sustained rate shocks in various interest rate scenarios over a twelve-month period for the periods indicated. Due to the current target rate, we do not reflect a decrease of more than 100 basis points from current rates in our analysis.

	September 30, 2018						December 31, 2017
	Change in			Percent			Change in			Percent
Increase (Decrease) in Basis Points	Net Interest Income			Change			Net Interest Income			Change
(Dollars in thousands)
300	$	(1,036	)		-1.2	%	$	3,759			4.3	%
200		(457	)		-0.5	%		2,756			3.2	%
100		(101	)		-0.1	%		1,535			1.8	%
(100)		(3,714	)		-4.2	%		(4,405	)		-5.1	%

We have established policy limits for tolerance of interest rate risk in various interest rate scenarios and exposure limits to changes in the economic value of equity. As of September 30, 2018, exposure to interest rate risk is within our defined policy limits.

The Company primarily uses derivative instruments to manage exposure to market risk and meet customer financing needs. As of September 30, 2018, we maintained interest rate swap agreements with notional amounts totaling $5.57 million to modify our exposure to interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. The fair values of the swap agreements, which are accounted for as fair value hedges, were recorded as a derivative asset totaling $145 thousand as of September 30, 2018, and a derivative liability totaling $90 thousand as of December 31, 2017. For additional information, see Note 9, “Derivative Instruments and Hedging Activities,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

Inflation and Changing Prices

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on businesses with large investments in property, plant, and inventory is generally more significant than the effect on financial institutions. The U.S. inflation rate continues to be relatively stable, and management believes that any changes in inflation will not be material to our financial performance.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

The information required in this item is incorporated by reference to “Market Risk and Interest Rate Sensitivity” in Item 1 of this report.

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

In connection with this report, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures under the Exchange Act Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of September 30, 2018, our disclosure controls and procedures were effective.

Disclosure controls and procedures are our Company’s controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions about required disclosure.

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

Changes in Internal Control over Financial Reporting

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended September 30, 2018, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION

ITEM 1.

Legal Proceedings

We are currently a defendant in various legal actions and asserted claims in the normal course of business. Although we are unable to assess the ultimate outcome of each matter with certainty, we believe that the resolution of these actions should not have a material adverse effect on our financial position, results of operations, or cash flows.

ITEM 1A.

Risk Factors

Our risk factors discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. If any of the risks occur and the market price of our common stock declines significantly, individuals may lose all, or part, of their investment in our Company. Individuals should carefully consider our risk factors and information included, or incorporated by reference, in this report before making an investment decision. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, the following risk factors are not intended to be an exhaustive list of all risks we face. There have been no material changes to the risk factors included in Part I, Item 1A, “Risk Factors,” of our 2017 Form 10-K.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

(a)	Not Applicable

(b)	Not Applicable

(c)	Issuer Purchases of Equity Securities

We repurchased 195,776 shares of our common stock during the third quarter of 2018 compared to 39,516 shares during the same quarter of 2017 and 670,016 shares during the first nine months of 2018 compared to 50,118 shares during the same period of 2017.

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The following table provides information about purchases of our common stock made by us or on our behalf by any affiliated purchaser, as defined in Rule 10b-18(a)(3) under the Exchange Act, during the periods indicated:

	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Plan		Maximum Number of Shares that May Yet be Purchased Under the Plan⁽¹⁾

July 1-31, 2018		6,000	$	32.96		6,000		1,786,979
August 1-31, 2018		98,650		33.38		98,650		1,696,958
September 1-30, 2018		91,126		33.82		91,126		1,608,723
Total		195,776	$	33.57		195,776


(1)		On June 27, 2018, our Board of Directors increased the number of shares authorized under the stock repurchase plan by 1,600,000 shares. Our stock repurchase plan, as amended, authorizes the purchase and retention of up to 6,600,000 shares. The plan has no expiration date and is currently in effect. No determination has been made to terminate the plan or to cease making purchases. We held 4,991,277 shares in treasury as of September 30, 2018.

ITEM 3.

Defaults Upon Senior Securities

None.

ITEM 4.

Mine Safety Disclosures

None.

ITEM 5.

Other Information

None.

ITEM 6.

Exhibits

2.1	Agreement and Plan of Reincorporation and Merger between First Community Bancshares, Inc. and First Community Bankshares, Inc., incorporated by reference to Appendix A of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2018, filed on March 13, 2018
3.1	Articles of Incorporation of First Community Bankshares, Inc., incorporated by reference to Appendix B of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2018, filed on March 13, 2018
3.2	Bylaws of First Community Bankshares, Inc., incorporated by reference to Exhibit 3.2 of the Current Report on Form 8-K dated and filed October 2, 2018
4.1	Description of First Community Bankshares, Inc. Common Stock, incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K dated and filed October 2, 2018
4.2	Form of First Community Bankshares, Inc. Common Stock Certificate, incorporated by reference to Exhibit 4.2 of the Current Report on Form 8-K dated and filed October 2, 2018
10.1.1**	First Community Bancshares, Inc. 1999 Stock Option Plan, incorporated by reference to Exhibit 10.1 of the Annual Report on Form 10-K/A for the period ended December 31, 1999, filed on April 13, 2000
10.1.2**	Amendment One to the First Community Bancshares, Inc. 1999 Stock Option Plan, incorporated by reference to Exhibit 10.1.1 of the Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed on May 7, 2004
10.2**	First Community Bancshares, Inc. 1999 Stock Option Agreement, incorporated by reference to Exhibit 10.5 of the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002
10.3**	First Community Bancshares, Inc. 2001 Nonqualified Director Stock Option Agreement, incorporated by reference to Exhibit 10.4 of the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed on August 14, 2002
10.4**	First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan, incorporated by reference to Annex B of the Definitive Proxy Statement on Form DEF 14A dated April 27, 2004, filed on March 15, 2004
10.5**	First Community Bancshares, Inc. 2004 Omnibus Stock Option Plan Stock Award Agreement, incorporated by reference to Exhibit 10.13 of the Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed on August 6, 2004

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10.6**	First Community Bancshares, Inc. 2012 Omnibus Equity Compensation Plan, incorporated by reference to Appendix B of the Definitive Proxy Statement on Form DEF 14A dated April 24, 2012, filed on March 7, 2012
10.7**	First Community Bancshares, Inc. 2012 Omnibus Equity Compensation Plan Restricted Stock Grant Agreement, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K dated and filed May 28, 2013
10.8**	First Community Bancshares, Inc. Life Insurance Endorsement Method Split Dollar Plan and Agreement, incorporated by reference to Exhibit 10.5 of the Annual Report on Form 10-K/A for the period ended December 31, 1999, filed on April 13, 2000
10.9.1**	First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated December 30, 2008, filed on January 5, 2009
10.9.2**	Amendment #1 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010
10.9.3**	Amendment #2 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated February 21, 2013, filed on February 25, 2013
10.9.4**	Amendment #3 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016
10.9.5**	Amendment #4 to the First Community Bancshares, Inc. and Affiliates Executive Retention Plan, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on February 28, 2017
10.10**	Amended and Restated Deferred Compensation Plan for Directors of First Community Bancshares, Inc. and Affiliates, incorporated by reference to Exhibit 99.2 of the Current Report on Form 8-K dated August 22, 2006, filed on August 23, 2006
10.11.1**	First Community Bancshares, Inc. Amended and Restated Nonqualified Supplemental Cash or Deferred Retirement Plan, incorporated by reference to Exhibit 99.1 of the Current Report on Form 8-K dated August 22, 2006, filed on August 23, 2006
10.11.2**	Amendment #2 to the First Community Bancshares, Inc. Amended and Restated Nonqualified Supplemental Cash or Deferred Retirement Plan, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on February 28, 2017
10.12.1**	First Community Bancshares, Inc. Supplemental Directors Retirement Plan, as amended and restated, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated December 16, 2010, filed on December 17, 2010
10.12.2**	Amendment #2 to the First Community Bancshares, Inc. Supplemental Directors Retirement Plan, as amended and restated, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated May 24, 2016, filed on May 31, 2016
10.13**	Employment Agreement between First Community Bancshares, Inc. and David D. Brown, incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K dated and filed on April 16, 2015
10.14**	Employment Agreement between First Community Bancshares, Inc. and E. Stephen Lilly, incorporated by reference to Exhibit 10.5 of the Current Report on Form 8-K dated and filed on April 16, 2015
10.15**	Employment Agreement between First Community Bancshares, Inc. and Gary R. Mills, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K dated and filed on April 16, 2015
10.16**	Employment Agreement between First Community Bancshares, Inc. and William P. Stafford, II, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K dated and filed on April 16, 2015
10.17**	Employment Agreement between First Community Bank and Mark R. Evans, incorporated by reference to Exhibit 2.1 of the Current Report on Form 8-K dated April 2, 2009, filed on April 3, 2009
11	Statement Regarding Computation of Earnings per Share, incorporated by reference to Note 11 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report
31.1*	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32*	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101***	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of September 30, 2018, (Unaudited) and December 31, 2017; (ii) Condensed Consolidated Statements of Income (Unaudited) for the three and nine months ended September 30, 2018 and 2017 ; (iii) Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the three and nine months ended September 30, 2018 and 2017; (iv) Condensed Consolidated Statements of Stockholders' Equity (Unaudited) for the nine months ended September 30, 2018 and 2017; (v) Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2018 and 2017; and (vi) Notes to Condensed Consolidated Financial Statements (Unaudited).

(1)	On October 2, 2018, First Community Bancshares, Inc., a Nevada corporation, merged with and into First Community Bankshares, Inc., a Virginia corporation, pursuant to an Agreement and Plan of Reincorporation and Merger (the “Merger”) with First Community Bankshares, Inc. continuing as the surviving corporation.
*	Filed herewith

**	Indicates a management contract or compensation plan or agreement. These contracts, plans, or agreements were assumed by First Community Bankshares, Inc. in connection with the Merger.

***	Submitted electronically herewith

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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, on the 2^nd day of November, 2018.

		First Community Bankshares, Inc. (Registrant)


		/s/ William P. Stafford, II

		William P. Stafford, II
		Chief Executive Officer
		(Principal Executive Officer)




		/s/ David D. Brown

		David D. Brown
		Chief Financial Officer
		(Principal Accounting Officer)

FIRST COMMUNITY BANKSHARES INC /VA/ - FORM 10-Q - November 2, 2018

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FIRST COMMUNITY BANKSHARES INC /VA/ Reports