Entegra Financial Corp. - FORM 10-Q

Attached files

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EX-32.1 - Entegra Financial Corp.	e18432_ex32-1.htm
EX-31.2 - Entegra Financial Corp.	e18432_ex31-2.htm
EX-31.1 - Entegra Financial Corp.	e18432_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended:

September 30, 2018

Commission File Number: 001-35302

Entegra Financial Corp.

(Exact name of registrant as specified in its charter)


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

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

(828) 524-7000

(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Smaller reporting company o

Emerging growth company x

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On November 4, 2018, there were 6,892,888 shares of the issuer’s common stock (no par value) issued and outstanding.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

FORM 10-Q

TABLE OF CONTENTS

		Page No.

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	3
	Consolidated Balance Sheets – September 30, 2018 and December 31, 2017	3
	Consolidated Statements of Income – Three and Nine Months Ended September 30, 2018 and 2017	4
	Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2018 and 2017	5
	Consolidated Statements of Changes in Shareholders’ Equity - Nine Months Ended September 30, 2018 and 2017	6
	Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2018 and 2017	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	49
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	78
Item 4.	Controls and Procedures	80

PART II. OTHER INFORMATION		81

Item 1.	Legal Proceedings	81
Item 1A.	Risk Factors	81
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	81
Item 3.	Defaults Upon Senior Securities	81
Item 4.	Mine Safety Disclosures	81
Item 5.	Other Information	81
Item 6.	Exhibits	82
	Signatures	83

Item 1. Financial Statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

	September 30,			December 31,
	2018			2017
	(Unaudited)
Assets

Cash and due from banks	$	13,309		$	15,534
Interest-earning deposits		103,956			93,933
Cash and cash equivalents		117,265			109,467

Investments - equity securities		6,983			6,095
Investments - available for sale		353,759			342,863
Other investments, at cost		12,039			12,386
Loans held for sale (includes loans at fair value of $1,821 and $0, respectively)		3,970			3,845
Loans receivable		1,068,012			1,005,139
Allowance for loan losses		(11,746	)		(10,887	)
Fixed assets, net		26,605			24,113
Real estate owned		2,818			2,568
Accrued interest receivable		6,158			5,405
Bank owned life insurance		32,738			32,150
Small Business Investment Company holdings		3,609			3,491
Net deferred tax asset		8,672			8,831
Loan servicing rights		2,771			2,756
Goodwill		23,903			23,903
Core deposit intangible		3,750			4,269
Other assets		8,260			5,055

Total assets	$	1,669,566		$	1,581,449

Liabilities and Shareholders’ Equity

Liabilities:
Deposits	$	1,256,032		$	1,162,177
Federal Home Loan Bank advances		213,500			223,500
Junior subordinated notes		14,433			14,433
Other borrowings		9,395			8,623
Post employment benefits		9,887			10,174
Accrued interest payable		1,358			935
Other liabilities		8,231			10,294
Total liabilities		1,512,836			1,430,136

Commitments and contingencies (Note 13)

Shareholders’ Equity:
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding		—			—
Common stock - no par value, 50,000,000 shares authorized; 6,891,672 and 6,879,191 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively		—			—
Common stock held by Rabbi Trust, at cost; 17,672 shares at September 30, 2018 and December 31, 2017		(379	)		(379	)
Additional paid in capital		73,865			72,997
Retained earnings		88,901			78,718
Accumulated other comprehensive loss		(5,657	)		(23	)
Total shareholders’ equity		156,730			151,313

Total liabilities and shareholders’ equity	$	1,669,566		$	1,581,449

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2018		2017			2018			2017
	(Unaudited)		(Unaudited)			(Unaudited)			(Unaudited)
Interest income:
Interest and fees on loans	$	12,621	$	9,175		$	36,981		$	26,686
Interest on tax exempt loans		106		98			290			285
Taxable securities		1,827		1,787			5,173			5,367
Tax-exempt securities		695		817			1,852			2,346
Interest-earning deposits		528		216			1,309			459
Other		201		161			544			478
Total interest income		15,978		12,254			46,149			35,621

Interest expense:
Deposits		2,331		1,114			5,540			3,227
Federal Home Loan Bank advances		1,091		641			2,841			1,713
Junior subordinated notes		141		140			421			418
Other borrowings		123		36			352			100
Total interest expense		3,686		1,931			9,154			5,458

Net interest income		12,292		10,323			36,995			30,163

Provision for loan losses		336		520			1,054			1,160
Net interest income after provision for loan losses		11,956		9,803			35,941			29,003

Noninterest income:
Servicing income, net		180		59			313			312
Mortgage banking		233		207			755			771
Gain on sale of SBA loans		257		290			547			436
Gain (loss) on sale of investments		—		(24	)		(520	)		19
Equity securities gains		191		138			183			445
Other than temporary impairment on available-for-sale securities		—		—			—			(700	)
Service charges on deposit accounts		406		436			1,242			1,239
Interchange fees, net		276		246			795			655
Bank owned life insurance		195		208			589			603
Other		227		215			775			527
Total noninterest income		1,965		1,775			4,679			4,307

Noninterest expenses:
Compensation and employee benefits		5,882		4,937			17,151			14,859
Net occupancy		1,128		974			3,342			2,851
Federal deposit insurance		191		140			618			379
Professional and advisory		413		292			1,023			929
Data processing		532		390			1,607			1,215
Marketing and advertising		227		253			671			727
Merger-related expenses		96		116			564			972
Net cost of operation of real estate owned		59		(121	)		202			94
Other		1,013		999			2,925			2,947
Total noninterest expenses		9,541		7,980			28,103			24,973

Income before taxes		4,380		3,598			12,517			8,337

Income tax expense		857		1,127			2,325			2,464

Net income	$	3,523	$	2,471		$	10,192		$	5,873

Earnings per common share:
Basic	$	0.51	$	0.38		$	1.48		$	0.91
Diluted	$	0.50	$	0.38		$	1.45		$	0.90

Weighted average common shares outstanding:
Basic		6,891,672		6,458,679			6,889,130			6,460,015
Diluted		7,031,150		6,548,530			7,023,714			6,542,261

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017

Net income	$	3,523		$	2,471		$	10,192		$	5,873

Other comprehensive income (loss):
Change in unrealized holding gains and losses on securities available for sale		(2,318	)		973			(8,181	)		6,404
Reclassification adjustment for securities (gains) losses realized in net income		—			24			947			(19	)
Reclassification adjustment for other than temporary impairment realized in net income		—			—			—			79
Change in deferred tax valuation allowance attributable to unrealized gains on investment securities available for sale		—			54			—			163
Change in unrealized holding gains and losses on cash flow hedge		93			25			303			(43	)
Reclassification adjustment for cash flow hedge effectiveness		(149	)		(12	)		(347	)		8
Other comprehensive income (loss), before tax		(2,374	)		1,064			(7,278	)		6,592
Income tax effect related to items of other comprehensive income		538			(372	)		1,635			(2,375	)
Other comprehensive income (loss), after tax		(1,836	)		692			(5,643	)		4,217

Comprehensive income	$	1,687		$	3,163		$	4,549		$	10,090

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

Nine Months Ended September 30, 2018 and 2017

(Dollars in thousands)


	Common Stock					Additional Paid in			Retained			Accumulated Other Comprehensive			Common Stock held by Rabbi
	Shares			Amount		Capital			Earnings			Income (Loss)			Trust			Total
Balance, December 31, 2016		6,467,550		$	—	$	62,664		$	76,139		$	(5,456	)	$	(279	)	$	133,068

Net income		—			—		—			5,873			—			—			5,873
Other comprehensive income, net of tax		—			—		—			—			4,217			—			4,217
Stock compensation expense		—			—		687			—			—			—			687
Vesting of restricted stock units, net of 859 shares surrendered		4,129			—		(19	)		—			—			—			(19	)
Repurchase of common stock		(13,000	)		—		(301	)		—			—			—			(301	)
Balance, September 30, 2017		6,458,679		$	—	$	63,031		$	82,012		$	(1,239	)	$	(279	)	$	143,526

Balance, December 31, 2017		6,879,191		$	—	$	72,997		$	78,718		$	(23	)	$	(379	)	$	151,313

Net income		—			—		—			10,192			—			—			10,192
Other comprehensive income, net of tax		—			—		—			—			(5,643	)		—			(5,643	)
Stock compensation expense		—			—		772			—			—			—			772
Stock options exercised		8,081			—		117			—			—			—			117
Vesting of restricted stock units, net of 740 shares surrendered		4,400			—		(21	)		—			—			—			(21	)
Cumulative effect of change in accounting principle		—			—		—			(9	)		9			—			—
Balance, September 30, 2018		6,891,672		$	—	$	73,865		$	88,901		$	(5,657	)	$	(379	)	$	156,730

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	For the Nine Months Ended September 30,
	2018			2017
Cash flows from operating activities:
Net income	$	10,192		$	5,873
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion		(255	)		(36	)
Investment amortization, net		2,672			3,513
Equity securities income		(183	)		(445	)
Provision for loan losses		1,054			1,160
Provision for real estate owned		83			167
Stock compensation expense		772			687
Deferred tax expense		1,796			2,295
Loss (gain) on sales of investments		520			(19	)
Other than temporary impairment on investments		—			700
Income on bank owned life insurance, net		(589	)		(603	)
Mortgage banking income, net		(755	)		(771	)
Gain on sales of SBA loans		(547	)		(436	)
Net realized gain on sale of real estate owned		(16	)		(215	)
Loans originated for sale		(36,982	)		(35,718	)
Proceeds from sale of loans originated for sale		38,159			36,548
Net change in operating assets and liabilities:
Accrued interest receivable		(753	)		(424	)
Loan servicing rights		(15	)		(110	)
Other assets		(2,954	)		(285	)
Postemployment benefits		(287	)		(66	)
Accrued interest payable		423			339
Other liabilities		(4,233	)		669
Net cash provided by operating activities	$	8,102		$	12,823

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited), continued

(Dollars in thousands)

	For the Nine Months Ended September 30,
	2018			2017
Cash flows from investing activities:
Activity for investment securities available for sale:
Purchases	$	(107,204	)	$	(127,989	)
Maturities/calls and principal repayments		32,832			35,009
Sales		54,174			92,316
Net increase in loans		(62,647	)		(71,578	)
Net cash received in branch acquisition		—			146,750
Proceeds from sale of fixed assets		—			64
Proceeds from sale of real estate owned		410			1,475
Purchase of fixed assets		(3,551	)		(594	)
Purchase of Small Business Investment Company Holdings, at cost		(118	)		(1,435	)
Purchase of other investments, at cost		(78	)		(425	)
Redemption of other investments, at cost		425			3,053
Net cash (used in) provided by investing activities	$	(85,757	)	$	76,646
Cash flows from financing activities:
Net increase in deposits	$	92,614		$	19,384
Net increase in escrow deposits		1,970			1,808
Net increase in other borrowings		773			5,863
Proceeds from FHLB advances		255,500			808,501
Repayment of FHLB advances		(265,500	)		(873,501	)
Cash received upon exercise of stock options		117			—
Cash paid for shares surrendered upon vesting of restricted stock		(21	)		(19	)
Purchase of common stock		—			(301	)
Net cash provided by (used in) financing activities	$	85,453		$	(38,265	)

Increase in cash and cash equivalents		7,798			51,204

Cash and cash equivalents, beginning of period	$	109,467		$	43,294

Cash and cash equivalents, end of period	$	117,265		$	94,498

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest on deposits and other borrowings	$	9,460		$	5,671
Income taxes	$	4,070		$	172

Noncash investing and financing activities:
Real estate acquired in satisfaction of mortgage loans	$	1,502		$	702
Investments to be settled		2,169			—
Loans originated for the disposition of real estate owned		774			1,001
Reclassification for adoption of Accounting Standards Update 2016-01		617			—

Acquisitions
Assets acquired	$	—		$	3,997
Liabilities assumed		—			(154,505	)
Net assets/(liabilities)	$	—		$	(150,508	)

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

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

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

Estimates

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

Material estimates that are particularly susceptible to significant change, in the near term, relate to the determination of the allowance for loan losses, the valuation of acquired loans, separately identifiable intangible assets associated with mergers and acquisitions, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the valuation of deferred tax assets.

Principles of Consolidation

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

Reclassification

Certain amounts in the prior year’s financial statements may have been reclassified to conform to the current year’s presentation. Certain investment securities were reclassified to either collateralized mortgage obligations with guarantees, or collateralized mortgage obligations with no guarantee to better align the investment securities by cash flow attributes. The reclassifications had no effect on our results of operations or financial condition as previously reported.

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the Securities and Exchange Commission’s (the “SEC”) instructions for Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 16, 2018 (the “2017 Form 10-K”). In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

Business Combinations

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

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

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

In addition, acquisition-related costs and restructuring costs are recognized as period expenses as incurred.

Recent Accounting Standards Updates

In February 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-02 Income Statement – Reporting Comprehensive Income (Topic 220: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”) to allow a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the “Tax Reform”). This ASU eliminates the stranded tax effects resulting from the Tax Reform and will improve the usefulness of information reported to financial statement users. The amendment becomes effective for public entities beginning after December 15, 2018. Early adoption of ASU 2018-02 was permitted with amendments applied either in the period of adoption or retrospectively to each period in which the effect of the change in the federal corporate income tax rate is recognized. As election to adopt ASU 2018-02 early was permitted, the Company adopted the standard in December 2017 resulting in an adjustment to 2017 net income of approximately $16,000 through a reduction in income tax expense.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This update expands and refines hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This update also makes certain targeted improvements to simplify the application of hedge accounting guidance and ease the administrative burden of hedge documentation requirements and assessing hedge effectiveness. For public entities, this update is effective for fiscal years beginning after December 15, 2018. For cash flow and net investment hedges existing at the date of adoption, an entity should apply a cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness to AOCI with a corresponding adjustment to the opening balance of retained earnings. The amended presentation and disclosure guidance is required prospectively. The Company elected to adopt this update as of December 31, 2017, with no effect on the Company’s financial statements. See Note 9 for enhanced disclosures.

In March 2017, the FASB issued amendments to ASU 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension cost and Net Periodic Postretirement Benefit Cost. This update was issued primarily to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost in the income statement. The standard became effective for the Company on January 1, 2018, and did not have a material effect on the Company’s financial statements.

In January 2017, the FASB issued amendments to ASU 2017-04 Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This update was issued to simplify how an entity is required to test goodwill impairment. Under amendments to this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The standard becomes effective SEC filers beginning after December 15, 2019. The Company does not expect this update to have a material effect on its financial statements.

In January 2017, the FASB issued amendments to ASU 2017-01 Business Combinations (Topic 80): Clarifying the Definition of a Business. This update was issued to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions of assets or businesses. The standard became effective for the Company on January 1, 2018, and did not have a material effect on the Company’s financial statements.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income 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 entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The adoption of ASU 2016-01 on January 1, 2018 resulted in a cumulative-effect adjustment of $9,000 to retained earnings from AOCI with a zero net effect on total shareholders’ equity as a result of the Company’s investment in equity securities. The adoption of ASU 2016-01 also resulted in separately reporting $0.6 million of equity securities with readily determinable fair value as of January 1, 2018, that were reported as available-for-sale investment securities as of December 31, 2017. In accordance with (5) above, the Company measured the fair value of its loan portfolio as of September 30, 2018 using an exit price notion (see Note 14, Fair Value of Assets and Liabilities).

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. The standard’s core principle is that a company 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 generally will be required to use more judgment and make more estimates than under current 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. Subsequent to the issuance of ASU 2014-09, the FASB issued targeted updates to clarify specific implementation issues including ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Identifying Performance Obligations and Licensing, ASU 2016-12, Narrow-Scope Improvements and Practical Expedients, and ASU 2016-20 Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new guidance did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company determined that the classification of certain debit and credit card related costs should change. These classification changes resulted in a reclassification of $0.2 million and $0.7 million from other noninterest expense to interchange income for the three and nine months ended September 30, 2017, respectively. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the retrospective approach. See Note 15 Revenue Recognition for more information.

In June 2016, the FASB issued amendments to ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in the update require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected thereby providing financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by the reporting entity. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company has formed a cross-functional committee to provide corporate governance over the implementation of this update, has evaluated data sources and made process updates to capture additional relevant data, has identified a service provider to perform the calculation, and continues to attend seminars and forums specific to this update. The Company also engaged the service provider to assist with the implementation of the standard and anticipates preliminary measurement of life of loan credit losses by December 31, 2018. The new calculation will be performed quarterly in 2019 in preparation for the January 1, 2020 effective date.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. GAAP is unclear or does not include specific guidance on how to classify certain transactions in the statement of cash flows. This ASU is intended to reduce diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU 2016-15 became effective for the Company January 1, 2018, and did not have a material impact on the Company’s financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This update requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and lease liabilities. For public entities, this update is effective for fiscal years beginning after December 15, 2018, with modified retrospective application to prior periods presented. The Company has lease agreements, such as branch and office locations, which are currently considered operating leases, and therefore, not recognized on the Company’s consolidated statements of condition. The Company expects the new guidance will require these lease agreements to be recognized on the consolidated statements of condition as a right-of-use asset and a corresponding lease liability, but does not expect this update to have a material impact on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

NOTE 2. ACQUISITIONS

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

Chattahoochee Bank of Georgia

On October 1, 2017, the Bank acquired Chattahoochee Bank of Georgia in Gainesville, Georgia (“Chattahoochee”). In connection with the acquisition, the Bank acquired $189.2 million of assets and assumed $170.6 million of liabilities. Total consideration transferred was $25.4 million of cash and 395,666 shares of the Company’s common stock valued at $9.9 million. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $16.8 million which is deductible over 15 years for tax purposes. There were no loans purchased with evidence of credit impairment.

The purchased assets and assumed liabilities were recorded at their acquisition date fair values and are summarized in the table below:

	As Recorded by		Fair Value			As Recorded by
(Dollars in thousands)	Chattahoochee		Adjustments			the Company
Assets
Cash and cash equivalents	$	22,625	$	—		$	22,625
Loans		159,540		(570	)		158,970
Fixed assets		3,945		(408	)		3,537
Accrued interest receivable		421		—			421
Core deposit intangible		—		2,070			2,070
Deferred tax asset		751		(751	)		—
Other assets		1,579		(8	)		1,571
Total assets acquired	$	188,861	$	333		$	189,194

Liabilities
Deposits	$	165,624	$	472		$	166,096
Accrued Interest payable		102		(14	)		88
Other liabilities		7,790		(3,341	)		4,449
Total liabilities assumed		173,516		(2,883	)		170,633

Excess of assets acquired over liabilities assumed	$	15,345	$	3,216		$	18,561
Consideration transferred
Cash						$	25,448
Common stock issued (395,666 shares)							9,872
Total fair value of consideration transferred							35,320
Goodwill						$	16,759

During March 2018, the Company discovered that the structure of its acquisition of Chattahoochee had resulted in a Federal and state tax liability of approximately $5.7 million. This adjustment has been reflected as an adjustment of goodwill and income taxes receivable and payable as of December 31, 2017.

Stearns Bank, N.A.

On February 24, 2017, the Bank completed its acquisition of two branches from Stearns Bank, N.A. (“Stearns”). In connection with the acquisition, the Bank acquired the bank facilities and certain other assets and assumed $154.2 million of deposits. In consideration of the purchased assets and assumed liabilities, the Bank paid (1) the book value, or approximately $1.0 million, for the branch facilities and certain assets, and (2) a deposit premium of $5.7 million, equal to 3.65% of the average daily deposits for the 30- day period ending the tenth (10^th) business day prior to the acquisition. The excess of net liabilities assumed over the cash received to settle the acquisition resulted in the establishment of $5.0 million of goodwill.

The purchased assets and assumed liabilities were recorded at their acquisition date fair values and are summarized in the table below:

(Dollars in thousands)	As Recorded by Stearns		Fair Value Adjustments		As Recorded by the Company
Assets
Cash and cash equivalents	$	1,258	$	—	$	1,258
Loans		7		—		7
Premises and equipment		950		132		1,082
Core deposit intangible		—		1,650		1,650
Total assets acquired		2,215		1,782		3,997

Liabilities
Deposits	$	153,122	$	1,062	$	154,184
Other liabilities		321		—		321
Total liabilities assumed		153,443		1,062		154,505
Excess of liabilities assumed over assets acquired	$	151,228	$	720	$	150,508
Cash received to settle the acquisition						145,492
Goodwill					$	5,016

NOTE 3. INVESTMENT SECURITIES

The following table presents the holdings of our equity securities as of September 30, 2018 and December 31, 2017:

	September 30,		December 31,
	2018		2017
	(Dollars in thousands)
Mutual funds	$	6,983	$	6,095

Equity securities with a fair value of $6.4 million as of September 30, 2018 are held in a Rabbi Trust and seek to generate returns that will fund the cost of certain deferred compensation agreements. Equity securities with a fair value of $0.6 million as of September 30, 2018 are in a mutual fund that qualifies under the Community Reinvestment Act (“CRA”) as CRA activity. There were gains on equity securities of $0.2 million for both the three and nine months ended September 30, 2018, and gains of $0.1 million and $0.4 million for the three and nine months ended September 30, 2017, respectively. The CRA mutual fund was reclassified as an equity security on January 1, 2018.

The Company’s held-to-maturity (“HTM”) investment portfolio was transferred to available-for-sale (“AFS”) during the third quarter of 2016 in order to provide the Company more flexibility managing its investment portfolio. As a result of the transfer, the Company was prohibited from classifying any investment securities as HTM for two years from the date of the transfer and may resume HTM classification in the fourth quarter of 2018.

In 2008, the Company received 4,301 shares of Class B restricted common stock of Visa, Inc. (the “Visa Class B shares”) as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly-traded Class A common shares. This conversion will not occur until the settlement of certain litigation for which Visa is indemnified by the holders of Visa’s Class B shares. Visa funded an escrow account from its initial public offering to settle these litigation claims. However, should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing the conversion ratio of each restricted Visa Class B share to unrestricted Class A shares. Based on the transfer restriction and the uncertainty of the outcome of the Visa litigation, the 4,301 Visa Class B shares that the Company owned were carried at a zero cost basis. The Company sold the 4,301 Visa Class B shares to another financial institution in the second quarter of 2018 for proceeds of $0.4 million.

On April 28, 2017, the Louisiana Office of Financial Institutions closed First NBC Bank and appointed the FDIC as receiver. The Bank owned $0.7 million par value of subordinated debt issued by the holding company of First NBC Bank with an unrealized loss of $79,000 prior to the impairment. The Company concluded the investment to be other than temporarily impaired. As such, the financial information for the nine months ended September 30, 2017 includes other than temporary impairment of $0.7 million before tax.

The amortized cost and estimated fair values of AFS securities as of September 30, 2018 and December 31, 2017 are summarized as follows:

	September 30, 2018
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)
U.S. Treasury & Government Agencies	$	34,203	$	62	$	(97	)	$	34,168
Municipal Securities		113,158		10		(3,294	)		109,874
Mortgage-backed Securities - Guaranteed		86,354		3		(2,239	)		84,118
Collateralized Mortgage Obligations - Guaranteed		18,711		—		(884	)		17,827
Collateralized Mortgage Obligations - Non Guaranteed		75,576		62		(1,328	)		74,310
Collateralized Loan Obligations		13,035		—		(92	)		12,943
Corporate bonds		20,551		164		(196	)		20,519
	$	361,588	$	301	$	(8,130	)	$	353,759

	December 31, 2017
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(Dollars in thousands)
U.S. Treasury & Government Agencies	$	20,529	$	7	$	(13	)	$	20,523
Municipal Securities		93,250		975		(366	)		93,859
Mortgage-backed Securities - Guaranteed		129,314		112		(1,387	)		128,039
Collateralized Mortgage Obligation - Guaranteed		10,559		—		(257	)		10,302
Collateralized Mortgage Obligation - Non Guaranteed		64,706		323		(336	)		64,693
Collateralized Loan Obligations		5,555		6		(22	)		5,539
Corporate bonds		18,925		409		(43	)		19,291
Mutual funds		629		—		(12	)		617
	$	343,467	$	1,832	$	(2,436	)	$	342,863

Information pertaining to securities with gross unrealized losses at September 30, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is detailed as follows:

	September 30, 2018
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Available-for-Sale:
U.S. Treasury & Government Agencies	$	18,191	$	97	$	—	$	—	$	18,191	$	97
Municipal Securities		74,180		1,987		29,267		1,307		103,447		3,294
Mortgage-backed Securities - Guaranteed		45,557		990		34,114		1,249		79,671		2,239
Collateralized Mortgage Obligations - Guaranteed		3,992		101		11,708		783		15,700		884
Collateralized Mortgage Obligations - Non Guaranteed		49,385		954		18,216		374		67,601		1,328
Collateralized Loan Obligations		11,441		88		1,502		4		12,943		92
Corporate Bonds		6,986		109		2,085		87		9,071		196
	$	209,732	$	4,326	$	96,892	$	3,804	$	306,624	$	8,130

	December 31, 2017
	Less Than 12 Months				More Than 12 Months				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Available-for-Sale:
U.S. Treasury & Government Agencies	$	9,943	$	11	$	998	$	2	$	10,941	$	13
Municipal Securities		11,043		61		22,982		305		34,025		366
Mortgage-backed Securities - Guaranteed		51,185		447		47,637		940		98,822		1,387
Collateralized Mortgage Obligations - Guaranteed		4,139		57		6,163		200		10,302		257
Collateralized Mortgage Obligations - Non Guaranteed		25,862		225		10,654		111		36,516		336
Collateralized loan obligations		3,520		22		—		—		3,520		22
Corporate bonds		1,304		9		1,044		34		2,348		43
Mutual funds		—		—		617		12		617		12
	$	106,996	$	832	$	90,095	$	1,604	$	197,091	$	2,436

Information pertaining to the number of securities with unrealized losses is detailed in the table below. The Company believes all unrealized losses as of September 30, 2018 and December 31, 2017 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

	September 30, 2018
	Less Than 12 Months		More Than 12 Months		Total
U.S. Treasury & Government Agencies		11		—		11
Municipal Securities		69		29		98
Mortgage-backed Securities - Guaranteed		39		28		67
Collateralized Mortgage Obligations - Guaranteed		3		6		9
Collateralized Mortgage Obligations - Non Guaranteed		28		15		43
Collateralized loan obligation		6		1		7
Corporate bonds		10		2		12
		166		81		247

	December 31, 2017
	Less Than 12 Months		More Than 12 Months		Total
U.S. Treasury & Government Agencies		6		1		7
Municipal Securities		11		22		33
Mortgage-backed Securities - Guaranteed		42		34		76
Collateralized Mortgage Obligations - Guaranteed		2		3		5
Collateralized Mortgage Obligations - Non Guaranteed		16		8		24
Collateralized loan obligation		2		—		2
Corporate bonds		2		1		3
Mutual funds		—		1		1
		81		70		151

At September 30, 2018, the Company held 247 investment securities that were in an unrealized loss position, of which 81 had been in unrealized loss positions for over twelve months. Market changes in interest rates and credit spreads may result in temporary unrealized losses as market prices of securities fluctuate. The Company reviews its investment portfolio on a quarterly basis for indications of other than temporary impairment. The severity and duration of impairment and the likelihood of potential recovery of impairment is considered along with the intent and ability to hold any impaired security to maturity or recovery of carrying value. When reviewing the securities in loss positions, pricing is reviewed for deterioration, bond ratings are reviewed for downgrades, and credit enhancement levels are reviewed for erosion.

For the three and nine months ended September 30, 2018 and 2017, the Company received proceeds from sales of securities and corresponding gross realized gains and losses as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
	(Dollars in thousands)				(Dollars in thousands)
AFS
Gross proceeds	$	—	$	55,474	$	54,174	$	92,316
Gross realized gains		—		229		77		352
Gross realized losses		—		253		1,024		333

Visa Class B Restricted Shares
Gross proceeds		—		—		427		—
Gross realized gains		—		—		427		—
Gross realized losses		—		—		—		—

Total
Gross proceeds	$	—	$	55,474	$	54,601	$	92,316
Gross realized gains		—		229		504		352
Gross realized losses		—		253		1,024		333

The Company had securities pledged against deposits and borrowings of approximately $148.8 million and $143.3 million at September 30, 2018 and December 31, 2017, respectively.

The amortized cost and estimated fair value of investments in debt securities at September 30, 2018, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.

	Available-for-Sale
	Amortized Cost		Fair Value
	(Dollars in thousands)
Over 1 year through 5 years	$	7,138	$	7,121
After 5 years through 10 years		25,458		25,207
Over 10 years		148,352		145,176
		180,948		177,504
Mortgage-backed securities		180,640		176,255

Total	$	361,588	$	353,759

NOTE 4. LOANS RECEIVABLE

Loans receivable as of September 30, 2018 and December 31, 2017 are summarized as follows:

	September 30,			December 31,
	2018			2017
	(Dollars in thousands)
Real estate mortgage loans:
One-to-four family residential	$	321,477		$	304,107
Commercial real estate		494,226			453,725
Home equity loans and lines of credit		48,205			49,877
Residential construction		42,322			37,108
Other construction and land		102,000			101,447
Total real estate loans		1,008,230			946,264

Commercial and industrial		55,671			56,939
Consumer		6,797			5,700
Total commercial and consumer		62,468			62,639

Loans receivable, gross		1,070,698			1,008,903

Less: Net deferred loan fees		(1,235	)		(1,431	)
Acquired loans fair value discount		(1,202	)		(2,012	)
Hedged loans basis adjustment (See Note 9)		(263	)		—
Unamortized premium		346			389
Unamortized discount		(332	)		(710	)

Loans receivable, net of deferred fees	$	1,068,012		$	1,005,139

The Bank had $253.3 million and $231.8 million of loans pledged as collateral to secure funding with the Federal Home Loan Bank of Atlanta (“FHLB”) at September 30, 2018 and December 31, 2017, respectively. The Bank also had $108.0 million and $108.3 million of loans pledged as collateral to secure funding availability with the Federal Reserve Bank (“FRB”) Discount Window at September 30, 2018 and December 31, 2017, respectively.

Included in loans receivable and other borrowings at September 30, 2018 are $4.4 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

The following tables present the activity related to the discount on individually purchased loans for the three and nine month periods ended September 30, 2018 and 2017:

	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2018			2017			2018			2017
Discount on purchased loans, beginning of period	$	399		$	956		$	710		$	1,150
Accretion		(67	)		(66	)		(378	)		(260	)
Discount on purchased loans, end of period	$	332		$	890		$	332		$	890

The following table presents the activity related to the fair value discount on loans from business combinations for the three and nine month periods ended September 30, 2018 and 2017:

	For the Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2018			2017			2018			2017
Fair value discount, beginning of period	$	1,395		$	704		$	2,012		$	857
Accretion		(193	)		(217	)		(810	)		(370	)
Fair value discount, end of period	$	1,202		$	487		$	1,202		$	487

NOTE 5. ALLOWANCE FOR LOAN LOSSES

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

	Three Months Ended September 30, 2018
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit			Residential Construction			Other Construction and Land			Commercial			Consumer			Total
	(Dollars in thousands)
Beginning balance	$	3,772		$	4,902		$	552		$	453		$	1,146		$	633		$	67		$	11,525
Provision		33			141			209			12			42			26			(127	)		336
Charge-offs		(6	)		—			(219	)		—			—			(45	)		(17	)		(287	)
Recoveries		1			—			—			1			16			2			152			172
Ending balance	$	3,800		$	5,043		$	542		$	466		$	1,204		$	616		$	75		$	11,746

	Three Months Ended September 30, 2017
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit			Residential Construction			Other Construction and Land			Commercial			Consumer			Total
	(Dollars in thousands)
Beginning balance	$	3,386		$	4,096		$	572		$	248		$	907		$	585		$	140		$	9,934
Provision		320			(80	)		236			(28	)		113			(5	)		(36	)		520
Charge-offs		—			(105	)		(266	)		—			(114	)		—			(18	)		(503	)
Recoveries		2			32			—			—			9			7			56			106
Ending balance	$	3,708		$	3,943		$	542		$	220		$	915		$	587		$	142		$	10,057

	Nine Months Ended September 30, 2018
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit			Residential Construction			Other Construction and Land			Commercial			Consumer			Total
	(Dollars in thousands)
Beginning balance	$	4,018		$	4,364		$	616		$	303		$	1,025		$	503		$	58		$	10,887
Provision		(117	)		711			162			162			136			182			(182	)		1,054
Charge-offs		(116	)		(35	)		(260	)		—			—			(79	)		(75	)		(565	)
Recoveries		15			3			24			1			43			10			274			370
Ending balance	$	3,800		$	5,043		$	542		$	466		$	1,204		$	616		$	75		$	11,746

	Nine Months Ended September 30, 2017
	One-to four Family Residential			Commercial Real Estate			Home Equity and Lines of Credit			Residential Construction			Other Construction and Land			Commercial			Consumer			Total
	(Dollars in thousands)
Beginning balance	$	2,812		$	3,979		$	677		$	185		$	848		$	599		$	205		$	9,305
Provision		875			82			127			35			280			(34	)		(205	)		1,160
Charge-offs		(50	)		(193	)		(267	)		—			(289	)		—			(42	)		(841	)
Recoveries		71			75			5			—			76			22			184			433
Ending balance	$	3,708		$	3,943		$	542		$	220		$	915		$	587		$	142		$	10,057

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

	September 30, 2018
	One-to-four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses
Individually evaluated for impairment	$	78	$	39	$	—	$	—	$	52	$	6	$	—	$	175
Collectively evaluated for impairment		3,722		5,004		542		466		1,152		610		75		11,571
	$	3,800	$	5,043	$	542	$	466	$	1,204	$	616	$	75	$	11,746

Loans Receivable
Individually evaluated for impairment	$	2,922	$	5,679	$	313	$	—	$	1,396	$	279	$	—	$	10,589
Collectively evaluated for impairment		317,534		486,708		48,037		42,354		100,329		55,563		6,898		1,057,423
	$	320,456	$	492,387	$	48,350	$	42,354	$	101,725	$	55,842	$	6,898	$	1,068,012

	December 31, 2017
	One-to-four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses
Individually evaluated for impairment	$	185	$	56	$	—	$	—	$	66	$	15	$	—	$	322
Collectively evaluated for impairment		3,833		4,308		616		303		959		488		58		10,565
	$	4,018	$	4,364	$	616	$	303	$	1,025	$	503	$	58	$	10,887

Loans Receivable
Individually evaluated for impairment	$	3,873	$	5,714	$	313	$	—	$	1,443	$	291	$	—	$	11,634
Collectively evaluated for impairment		299,111		445,315		49,648		37,144		99,725		56,785		5,777		993,505
	$	302,984	$	451,029	$	49,961	$	37,144	$	101,168	$	57,076	$	5,777	$	1,005,139

Portfolio Quality Indicators

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

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

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

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

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

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

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

Description of Segment and Class Risks

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

One-to-four family residential

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

Commercial real estate

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

Home equity and lines of credit

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

Residential construction and other construction and land

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

Commercial

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

Consumer

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

The following tables present the recorded investment in gross loans by loan grade as of the dates indicated:

September 30, 2018
Loan Grade	One-to Four- Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)
1	$	—	$	7,666	$	—	$	—	$	—	$	1,210	$	8	$	8,884
2		—		7,936		—		—		—		1,097		—		9,033
3		32,369		89,749		4,306		11,544		10,487		17,912		283		166,650
4		113,885		274,457		3,494		16,449		57,541		20,553		279		486,658
5		24,471		90,113		588		3,817		19,795		12,392		6		151,182
6		325		7,215		—		1		1,320		321		—		9,182
7		681		5,122		—		—		385		487		—		6,675
	$	171,731	$	482,258	$	8,388	$	31,811	$	89,528	$	53,972	$	576	$	838,264

Ungraded Loan Exposure:

Performing	$	147,910	$	10,106	$	39,850	$	10,543	$	12,134	$	1,870	$	6,321	$	228,734
Nonperforming		815		23		112		—		63		—		1		1,014
Subtotal	$	148,725	$	10,129	$	39,962	$	10,543	$	12,197	$	1,870	$	6,322	$	229,748

Total	$	320,456	$	492,387	$	48,350	$	42,354	$	101,725	$	55,842	$	6,898	$	1,068,012

December 31, 2017
Loan Grade	One-to Four Family Residential		Commercial Real Estate		Home Equity and Lines of Credit		Residential Construction		Other Construction and Land		Commercial		Consumer		Total
	(Dollars in thousands)
1	$	—	$	9,086	$	—	$	—	$	—	$	1,665	$	11	$	10,762
2		1,164		12,360		—		—		904		1,272		—	$	15,700
3		34,593		78,485		5,312		7,262		9,207		15,117		377	$	150,353
4		99,816		249,103		3,901		16,294		57,065		25,137		523	$	451,839
5		22,639		87,745		943		3,111		18,806		13,064		8	$	146,316
6		1,741		8,623		—		—		2,055		306		—	$	12,725
7		2,112		5,371		—		—		425		474		—	$	8,382
	$	162,065	$	450,773	$	10,156	$	26,667	$	88,462	$	57,035	$	919	$	796,077

Ungraded Loan Exposure:

Performing	$	140,013	$	256	$	39,685	$	10,477	$	12,623	$	41	$	4,846	$	207,941
Nonperforming		906		—		120		—		83		—		12		1,121
Subtotal	$	140,919	$	256	$	39,805	$	10,477	$	12,706	$	41	$	4,858	$	209,062

Total	$	302,984	$	451,029	$	49,961	$	37,144	$	101,168	$	57,076	$	5,777	$	1,005,139

Delinquency Analysis of Loans by Class

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

	September 30, 2018
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Over Past Due		Total Past Due		Current		Total Loans Receivable
	(Dollars in thousands)
One-to four family residential	$	3,515	$	410	$	261	$	4,186	$	316,270	$	320,456
Commercial real estate		3,197		—		757		3,954		488,433		492,387
Home equity and lines of credit		235		116		98		449		47,901		48,350
Residential construction		—		—		3		3		42,351		42,354
Other construction and land		331		36		63		430		101,295		101,725
Commercial		48		5		306		359		55,483		55,842
Consumer		5		6		1		12		6,886		6,898
Total	$	7,331	$	573	$	1,489	$	9,393	$	1,058,619	$	1,068,012

	December 31, 2017
	30-59 Days Past Due		60-89 Days Past Due		90 Days and Over Past Due		Total Past Due		Current		Total Loans Receivable
	(Dollars in thousands)
One-to four family residential	$	3,941	$	591	$	562	$	5,094	$	297,890	$	302,984
Commercial real estate		2,093		308		683		3,084		447,945		451,029
Home equity and lines of credit		308		27		120		455		49,506		49,961
Residential construction		501		—		—		501		36,643		37,144
Other construction and land		1,711		21		93		1,825		99,343		101,168
Commercial		488		1		95		584		56,492		57,076
Consumer		27		25		10		62		5,715		5,777
Total	$	9,069	$	973	$	1,563	$	11,605	$	993,534	$	1,005,139

Impaired Loans

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of September 30, 2018 and December 31, 2017.

	September 30, 2018						December 31, 2017
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Recorded Balance		Unpaid Principal Balance		Specific Allowance
	(Dollars in thousands)
Loans without a valuation allowance
One-to-four family residential	$	2,101	$	2,241	$	—	$	2,266	$	2,376	$	—
Commercial real estate		3,596		5,880		—		4,050		6,119		—
Home equity and lines of credit		313		428		—		313		428		—
Other construction and land		565		690		—		571		678		—
	$	6,575	$	9,239	$	—	$	7,200	$	9,601	$	—

Loans with a valuation allowance
One-to-four family residential	$	821	$	821	$	78	$	1,607	$	1,607	$	185
Commercial real estate		2,083		2,083		39		1,664		1,664		56
Other construction and land		831		831		52		872		872		66
Commercial		279		279		6		291		291		15
	$	4,014	$	4,014	$	175	$	4,434	$	4,434	$	322

Total
One-to-four family residential	$	2,922	$	3,062	$	78	$	3,873	$	3,983	$	185
Commercial real estate		5,679		7,963		39		5,714		7,783		56
Home equity and lines of credit		313		428		—		313		428		—
Other construction and land		1,396		1,521		52		1,443		1,550		66
Commercial		279		279		6		291		291		15
	$	10,589	$	13,253	$	175	$	11,634	$	14,035	$	322

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

	Three Months Ended September 30,								Nine Months Ended September 30,
	2018				2017				2018				2017
	Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized
	(Dollars in thousands)								(Dollars in thousands)
Loans without a valuation allowance
One-to-four family residential	$	2,247	$	23	$	3,122	$	18	$	2,264	$	69	$	3,156	$	87
Commercial real estate		4,790		32		6,170		32		5,920		97		6,199		95
Home equity and lines of credit		428		4		328		13		428		13		328		37
Other construction and land		692		6		682		5		695		16		687		15
	$	8,157	$	65	$	10,302	$	68	$	9,307	$	195	$	10,370	$	234

Loans with a valuation allowance
One-to-four family residential	$	825	$	11	$	1,115	$	13	$	831	$	32	$	1,129	$	38
Commercial real estate		2,172		22		1,673		21		2,184		68		1,690		64
Home equity and lines of credit		—		—		100		2		—		—		100		4
Other construction and land		842		11		724		9		854		34		753		28
Commercial		281		5		294		5		285		17		301		16
	$	4,120	$	49	$	3,906	$	50	$	4,154	$	151	$	3,973	$	150

Total
One-to-four family residential	$	3,072	$	34	$	4,237	$	31	$	3,095	$	101	$	4,285	$	125
Commercial real estate		6,962		54		7,843		53		8,104		165		7,889		159
Home equity and lines of credit		428		4		428		15		428		13		428		41
Other construction and land		1,534		17		1,406		14		1,549		50		1,440		43
Commercial		281		5		294		5		285		17		301		16
	$	12,277	$	114	$	14,208	$	118	$	13,461	$	346	$	14,343	$	384

Non-performing Loans

The following table summarizes the balances of non-performing loans as of September 30, 2018 and December 31, 2017. Certain loans classified as Troubled Debt Restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.

	September 30, 2018		December 31, 2017
	(Dollars in thousands)
One-to-four family residential	$	1,214	$	1,421
Commercial real estate		2,404		2,666
Home equity loans and lines of credit		112		120
Other construction and land		260		464
Commercial		306		95
Consumer		1		12
Non-performing loans	$	4,297	$	4,778

Troubled Debt Restructurings (TDR)

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

	September 30, 2018
	Performing		Nonperforming		Total
	TDRs		TDRs		TDRs
	(Dollars in thousands)
One-to-four family residential	$	2,172	$	361	$	2,533
Commercial real estate		3,707		1,511		5,218
Home equity and lines of credit		283		30		313
Other construction and land		1,200		196		1,396
Commercial		279		—		279

	$	7,641	$	2,098	$	9,739

	December 31, 2017
	Performing		Nonperforming		Total
	TDRs		TDRs		TDRs
	(Dollars in thousands)
One-to-four family residential	$	3,452	$	—	$	3,452
Commercial real estate		3,805		1,438		5,243
Home equity and lines of credit		313		—		313
Other construction and land		1,091		370		1,461
Commercial		291		—		291

	$	8,952	$	1,808	$	10,760

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

	Three Months Ended Sept 30, 2018				Nine Months Ended Sept 30, 2018
(Dollars in thousands)	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
Extended payment terms
Commercial real estate		—	$	—		1	$	206

There were no loan modifications that were deemed TDRs at the time of the modification during the three or nine month periods ended September 30, 2017.

There were no TDRs that defaulted during the three month and nine month periods ending September 30, 2018 and 2017 and which were modified as TDRs within the previous 12 months.

NOTE 6. GOODWILL AND OTHER INTANGIBLES

The Company had $23.9 million of goodwill as of September 30, 2018 and December 31, 2017.

The Company’s other intangible assets consist of core deposit intangibles related to acquired core deposits. The following is a summary of gross carrying amounts and accumulated amortization of core deposit intangibles:

	As of and for the Nine Months Ending			As of and for the Year Ending
	September 30,			December 31,
	2018			2017
	Dollars in thousands
Gross balance at beginning of period	$	4,840		$	1,120
Additions from acquisitions		—			3,720
Gross balance at end of period		4,840			4,840
Less accumulated amortization		(1,090	)		(571	)
Core deposit intangible, net	$	3,750		$	4,269

Core deposit intangibles are amortized using the straight-line method over their estimated useful lives of seven years. Estimated amortization expense for core deposit intangibles for each of the next five years is approximately $0.7 million per year.

NOTE 7. DEPOSITS

The following table summarizes deposit balances and interest expense by type of deposit as of and for the nine months ended September 30, 2018 and 2017 and the year ended December 31, 2017.

	As of and for the								As of and for the Year Ended
	Nine Months Ended September 30,								December 31,
	2018				2017				2017
(Dollars in thousands)	Balance		Interest Expense		Balance		Interest Expense		Balance		Interest Expense
Noninterest-bearing demand	$	199,224	$	—	$	160,718	$	—	$	179,457	$	—
Interest-bearing demand		206,967		282		179,398		149		226,718		228
Money Market		372,428		1,687		261,901		703		308,767		1,022
Savings		52,874		44		50,827		39		50,500		53
Time Deposits		424,539		3,527		351,995		2,336		396,735		3,171
	$	1,256,032	$	5,540	$	1,004,839	$	3,227	$	1,162,177	$	4,474

The following table indicates wholesale deposits included in the money market and time deposits amounts above:

	September 30,				December 31,
(Dollars in thousands)	2018		2017		2017
Wholesale money market	$	49,595	$	—	$	2,020
Wholesale time deposits		71,880		35,426		39,105
	$	121,475	$	35,426	$	41,125

NOTE 8. BORROWINGS

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

	September 30, 2018					December 31, 2017
Year of Maturity	Balance		Weighted Average Rate			Balance		Weighted Average Rate
2018	$	115,500		2.16	%	$	205,500		1.43	%
2019		68,000		2.31	%		18,000		2.02	%
2020		30,000		2.78	%		—		—
	$	213,500		2.29	%	$	223,500		1.48	%

The Company has a $15.0 million revolving credit loan facility with NexBank SSB. The loan facility, which is secured by Entegra Bank stock, bears interest at LIBOR plus 350 basis points and is intended to be used for general corporate purposes. The Company had drawn $5.0 million on the revolving credit loan facility as of September 30, 2018 and December 31, 2017.

The Company also had other borrowings of $4.4 million and $3.6 million at September 30, 2018 and December 31, 2017, respectively, which is comprised of participated loans that did not qualify for sale accounting. Interest expense on these other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

Interest Rate Swaps

Risk Management Objective of Interest Rate Swaps

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of certain balance sheet assets and liabilities. In the normal course of business, the Company also uses derivative financial instruments to add stability to interest income or expense and to manage its exposure to movements in interest rates. The Company does not use derivatives for trading or speculative purposes and only enters into transactions that have a qualifying hedging relationship. The Company’s hedging strategies involving interest rate derivatives are classified as either “Fair Value Hedges” or “Cash Flow Hedges,” depending upon the rate characteristic of the hedged item.

Fair Value Hedge: As a result of interest rate fluctuations, fixed-rate assets and liabilities will appreciate or depreciate in fair value. When effectively hedged, this appreciation or depreciation will generally be offset by fluctuations in the fair value of the derivative instruments that are linked to the hedged assets and liabilities. This strategy is referred to as a fair value hedge.

Cash Flow Hedge: Cash flows related to floating-rate assets and liabilities will fluctuate with changes in an underlying rate index. When effectively hedged, the increases or decreases in cash flows related to the floating rate asset or liability will generally be offset by changes in cash flows of the derivative instrument designated as a hedge. This strategy is referred to as a cash flow hedge.

Credit and Collateral Risks for Interest Rate Swaps

The Company manages credit exposure on interest rate swap transactions by entering into a bilateral credit support agreement with each counterparty. The credit support agreements allow for collateralization of exposures beyond specified minimum threshold amounts.

The Company’s agreements with its interest rate swap counterparties contain a provision where if either party defaults on any of its indebtedness, then it could also be declared in default on its derivative obligations. The agreements with derivative counterparties also include provisions that if not met, could result in the Company being declared in default. If the Company were to be declared in default, the counterparty could terminate the derivative positions and the Company and the counterparty would be required to settle their obligations under the agreements. At September 30, 2018, the Company had no derivatives in a net liability position under these agreements.

Mortgage Derivatives

Risk Management Objective of Mortgage Lending Activities

The Company also maintains a risk management program to manage interest rate risk and pricing risk associated with its mortgage lending activities. The risk management program includes the use of forward contracts and other derivatives that are recorded in the financial statements at fair value and are used to offset changes in value of the mortgage inventory due to changes in market interest rates. As a normal part of our operations, we enter into derivative contracts to economically hedge risks associated with overall price risk related to interest rate lock commitments (“IRLCs”) and mortgage loans held-for-sale for which the fair value option has been elected. Fair value changes occur as a result of interest rate movements as well as changes in the value of the associated servicing. Derivative instruments used include forward sales commitments and IRLCs.

Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. It is the Company’s practice to enter into forward commitments for the future delivery of mortgage loans in order to economically hedge the effect of changes in interest rates resulting from IRLCs.

Credit and Collateral Risks for Mortgage Lending Activities

The Company’s underlying risks are primarily related to interest rates and forward sales commitments entered into as part of its mortgage banking activities. Forward sales commitments are contracts for the delayed delivery or net settlement of an underlying instrument, such as a mortgage loan, in which the seller agrees to deliver on a specified future date, either a specified instrument at a specified price or yield or the net cash equivalent of an underlying instrument. These hedges are used to preserve the Company’s position relative to future sales of mortgage loans to third parties in an effort to minimize the volatility of the expected gain on sale from changes in interest rate and the associated pricing changes.

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

	Derivative Assets ⁽¹⁾				Derivative Liabilities ⁽¹⁾
	September 30, 2018		December 31, 2017		September 30, 2018		December 31, 2017
Derivatives designated as hedging instruments:
Interest rate swaps	$	778	$	561	$	—	$	—
Total	$	778	$	561	$	—	$	—

Derivatives not designated as hedging instruments:
Mortgage derivatives	$	30	$	73	$	8	$	—
Total	$	30	$	73	$	8	$	—

⁽¹⁾ All derivative assets are located in “Other assets” on the consolidated balance sheets and all derivative liabilities are located in “Other liabilities” on the consolidated balance sheets.

The table below presents the effect of fair value and cash flow hedge accounting on the consolidated statements of income:

	Three months ended September 30,
	2018					2017
(dollars in thousands)	Interest income			Interest expense		Interest income		Interest expense
Total amounts of income and expense line items presented in the consolidated statements of income	$	15,978		$	3,686	$	12,254	$	1,931
Gain (loss) on fair value hedging relationships
Interest rate swaps:
Hedged items		(182	)		—		—		—
Derivatives designated as hedging instruments		187			—		—		—

Gain (loss) on cash flow hedging relationships
Interest rate swaps:
Amount of gain reclassified from accumulated other comprehensive loss into income		—			149		—		12

	Nine months ended September 30,
	2018					2017
(dollars in thousands)	Interest income			Interest expense		Interest income		Interest expense
Total amounts of income and expense line items presented in the consolidated statements of income	$	46,149		$	9,154	$	35,621	$	5,458
Gain (loss) on fair value hedging relationships
Interest rate swaps:
Hedged items		(263	)		—		—		—
Derivatives designated as hedging instruments		261			—		—		—

Gain (loss) on cash flow hedging relationships
Interest rate swaps:
Amount of gain (loss) reclassified from accumulated other comprehensive loss into income		—			347		—		(8	)

Derivatives Designated as Hedging Instruments

Fair Value Hedges

The Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps, designated as fair value hedges, involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed payments over the life of the agreements without the exchange of the underlying notional amount. The gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in earnings. The Company entered into a pay-fixed/receive-variable interest rate swap in April 2018 with a notional amount of $25.0 million which was designated as a fair value hedge associated with the Company’s fixed rate loan program.

As of September 30, 2018, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges:

(dollars in thousands)	Carrying amount of the hedged assets		Cumulative amount of fair value hedging adjustment included in the carrying amount of the hedged assets
Line item in the balance sheet in which the hedged item is included	September 30, 2018		September 30, 2018
Loans receivable ⁽¹⁾	$	104,267	$	(263	)

⁽¹⁾These amounts include the amortized cost basis of the closed portfolio used to designate the hedging relationship in which the hedged item is the last layer expected to be remaining at the end of the hedging relationship. At September 30, 2018, the amortized cost basis of the closed portfolio used in the the hedging relationship was $104.3 million, the cumulative basis adjustment associated with the hedging relationship was $(0.3) million, and the amount of the designated hedged items was $25.0 million.

As of December 31, 2017, the Company had no interest rate swaps that were designated as fair value hedges.

Cash Flow Hedges

Interest rate swap contracts, designated as cash flow hedges, involve the payment of fixed-rate amounts to a counterparty in exchange for the Company receiving variable-rate payments without exchange of the underlying notional amounts. The Company entered into a new pay-fixed/receive-variable interest rate swap in June 2018 associated with the Company’s junior subordinated debt. The forward starting interest rate swap begins exchanging cash flows in 2020 when the current interest rate swap agreement expires.

The structure of the swap agreements designated as cash flow hedges is described in the table below (dollars in thousands):

Underlyings

Designation

Notional

Payment Provision

Life of Swap Contract

Junior Subordinated Debt

Cash Flow Hedge

14,000

Pay 0.958%/Receive 3 month LIBOR

4 yrs

Junior Subordinated Debt

Cash Flow Hedge

14,000

Pay 3.02%/Receive 3 month LIBOR

3 yrs

FHLB Variable Rate Advance

Cash Flow Hedge

20,500

Pay 1.354%/Receive 3 month LIBOR

2 yrs

The table below presents the effect of the Company’s derivatives in cash flow hedging relationships for the periods presented (dollars in thousands):

		Three months ended September 30,						Nine months ended September 30,
Interest rate swaps	Location	2018			2017			2018			2017
Amount of gain (loss) recognized in AOCI on derivatives	OCI	$	93		$	25		$	303		$	(43	)
Amount of gain (loss) reclassified from AOCI into income	Interest expense		(149	)		(12	)		(347	)		8
Amount of gain (loss) recognized in consolidated statement of comprehensive income		$	(56	)	$	13		$	(44	)	$	(35	)

Derivatives Not Designated as Hedging Instruments

Mortgage Derivatives

Mortgage derivative fair value assets and liabilities are described above. At September 30, 2018 and December 31, 2017, the Company had the following IRLCs and forward commitments for the future delivery of residential mortgage loans.

(Dollars in thousands)	As of September 30, 2018		As of December 31, 2017
Mortgage derivatives
Interest rate lock commitments	$	2,631	$	5,705
Forward sales commitment		5,500		5,705

The table below presents the effect of the Company’s derivatives not designated as hedging instruments for the periods presented:

		Three months ended September 30,						Nine months ended September 30,
Interest rate products	Location	2018			2017			2018			2017
		(Dollars in thousands)
Amount of gain (loss) recognized in income on forward commitments	Noninterest income	$	12		$	12		$	(33	)	$	—
Amount of gain (loss) recognized in income on interest rate lock commitments	Noninterest income		(46	)		(7	)		(17	)		9
Amount of gain (loss) recognized in income on derivatives not designated as hedging instruments		$	(34	)	$	5		$	(50	)	$	9

NOTE 10. INCOME TAXES

The components of net deferred taxes as of September 30, 2018 and December 31, 2017 are summarized as follows:

	September 30,		December 31,
	2018		2017
	(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses	$	2,653	$	2,356
Deferred compensation and post employment benefits		1,972		1,993
Non-accrual interest		237		204
Valuation reserve for other real estate		239		346
North Carolina NOL carryover		332		475
Federal NOL carryover		1,675		3,507
AMT credit carryforward		310		645
Unrealized losses on securities		1,810		149
Loan basis differences		53		77
Deposit premium		—		104
Fixed assets		106		63
Core deposit intangible		111		52
Other		1,740		1,009
Total deferred tax assets		11,238		10,980

Deferred tax liabilities:
Loan servicing rights		641		620
Goodwill		412		126
Core deposit intangible		79		89
Deferred loan costs		953		757
Prepaid expenses		14		31
Unrealized gains on securities		181		377
Derivative instruments		109		128
Other		177		21
Total deferred tax liabilities		2,566		2,149

Net Deferred tax asset	$	8,672	$	8,831

The following table summarizes the amount and expiration dates of the Company’s unused net operating losses as of September 30, 2018:

(Dollars in thousands)	Amount		Expiration Dates
Federal	$	8,041		2031-2036
North Carolina	$	16,006		2026-2029

NOTE 11. EARNINGS PER SHARE

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

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in thousands, except per share amounts)	2018		2017		2018		2017
Numerator:
Net income	$	3,523	$	2,471	$	10,192	$	5,873
Denominator:
Weighted-average common shares outstanding - basic		6,891,672		6,458,679		6,889,130		6,460,015
Effect of dilutive securities:
Stock options		90,580		42,973		92,465		39,165
Restricted stock units		48,898		46,878		42,119		43,081
Weighted-average common shares outstanding - diluted		7,031,150		6,548,530		7,023,714		6,542,261

Earnings per share - basic	$	0.51	$	0.38	$	1.48	$	0.91
Earnings per share - diluted	$	0.50	$	0.38	$	1.45	$	0.90

The following table presents stock options that are not deemed dilutive in calculating diluted earnings per share for the respective periods in the table above:

	Average Stock Price								Anti-dilutive Shares
	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017		2018		2017		2018		2017
Stock options	$	28.25	$	23.26	$	28.44	$	23.11		30,438		3,076		23,721		1,564

NOTE 12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the components of AOCI and changes in those components as of and for the three and nine months ended September 30, 2018 and 2017.

	Three Months Ended September 30, 2018
	Available for Sale Securities			Deferred Tax Valuation Allowance on AFS			Cash Flow Hedge			Total
(Dollars in thousands)
Balance, beginning of period	$	(4,271	)	$	—		$	450		$	(3,821	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale		—			—			—			—
Change in net unrealized holding losses on securities available for sale		(2,318	)		—			—			(2,318	)
Reclassification adjustment for net securities gains realized in net income		—			—			—			—
Change in unrealized holding gains on cash flow hedge		—			—			93			93
Reclassification adjustment for cash flow hedge effectiveness		—			—			(149	)		(149	)
Income tax effect		524			—			14			538

Balance, end of period	$	(6,065	)	$	—		$	408		$	(5,657	)

	Three Months Ended September 30, 2017
(Dollars in thousands)
Balance, beginning of period	$	(2,108	)	$	(93	)	$	270		$	(1,931	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale		—			54			—			54
Change in net unrealized holding losses on securities available for sale		973			—			—			973
Reclassification adjustment for net securities gains realized in net income		24			—			—			24
Change in unrealized holding gains on cash flow hedge		—			—			25			25
Reclassification adjustment for cash flow hedge effectiveness		—			—			(12	)		(12	)
Income tax effect		(367	)		—			(5	)		(372	)

Balance, end of period	$	(1,478	)	$	(39	)	$	278		$	(1,239	)

	Nine Months Ended September 30, 2018
	Available for Sale Securities			Deferred Tax Valuation Allowance on AFS			Cash Flow Hedge			Total
	(Dollars in thousands)
Balance, beginning of period	$	(455	)	$	—		$	432		$	(23	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale		—			—			—			—
Change in net unrealized holding losses on securities available for sale		(8,181	)		—			—			(8,181	)

Reclassification adjustment for net securities gains realized in net income		947			—			—			947
Reclassification adjustment for other than temporary impairment of securities available for sale		—			—			—			—
Change in unrealized holding gains on cash flow hedge		—			—			303			303
Reclassification adjustment for cash flow effectiveness		—			—			(347	)		(347	)
Cumulative effect of change in accounting principle		9			—			—			9
Income tax effect		1,615			—			20			1,635

Balance, end of period	$	(6,065	)	$	—		$	408		$	(5,657	)

	Nine Months Ended September 30, 2017
	(Dollars in thousands)
Balance, beginning of period	$	(5,554	)	$	(202	)	$	300		$	(5,456	)

Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale		—			163			—			163
Change in net unrealized holding losses on securities available for sale		6,404			—			—			6,404
Reclassification adjustment for net securities gains realized in net income		(19	)		—			—			(19	)
Reclassification adjustment for other than temporary impairment of securities available for sale		79			—			—			79
Change in unrealized holding gains on cash flow hedge		—			—			(43	)		(43	)
Reclassification adjustment for cash flow effectiveness		—			—			8			8
Income tax effect		(2,388	)		—			13			(2,375	)

Balance, end of period	$	(1,478	)	$	(39	)	$	278		$	(1,239	)

The following table shows the line items in the Consolidated Statements of Income affected by amounts reclassified from AOCI as of the dates indicated:

	Three Months Ended September 30						Nine Months Ended September 30,
(Dollars in thousands)	2018			2017			2018			2017			Income Statement Line Item Affected
Available-for-sale securities
Gains(losses) recognized	$	—		$	(24	)	$	(947	)	$	19		Gain(loss) on sale of investments, net
Other than temporary impairment		—			—			—			(79	)	Other than temporary impairment of AFS securities
Income tax effect		—			9			213			22		Income tax expense
Reclassified out of AOCI, net of tax		—			(15	)		(734	)		(38	)	Net income

Cash flow hedge
Interest expense		99			—			223			(28	)	Interest expense - FHLB advances
Interest expense		50			12			124			20		Interest expense - Junior subordinated notes
Income tax effect		(33	)		(4	)		(78	)		3		Income tax expense
Reclassified out of AOCI, net of tax		116			8			269			(5	)	Net income

Deferred tax valuation allowance
Recognition of reversal of valuation allowance		—			(54	)		—			(163	)	Income tax expense

Total reclassified out of AOCI, net of tax	$	116		$	(61	)	$	(465	)	$	(206	)	Net income

NOTE 13. COMMITMENTS AND CONTINGENCIES

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

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

	September 30, 2018
	(Dollars in thousands)
Lines of credit	$	173,183
Standby letters of credit		1,478
	$	174,661

As of September 30, 2018, the Company had outstanding commitments to originate loans as follows:

	September 30, 2018
	Amount		Range of Rates
	(Dollar in thousands)
Fixed	$	21,182		4.20% to 12.00%
Variable		10,751		3.50% to 7.75%
	$	31,933

The allowance for unfunded commitments was $0.1 million at September 30, 2018 and December 31, 2017.

The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to Fannie Mae and maintained a reserve of $0.3 million as of September 30, 2018 and December 31, 2017.

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

NOTE 14. FAIR VALUE

Overview

Fair value measurements are determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC Topic 820 (“ASC 820”), Fair Value Measurements and Disclosures establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs classified within Level 3 of the hierarchy).

Fair Value Hierarchy

Level 1

Valuation is based on inputs that are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2

Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, such as interest rates, yield curves observable at commonly quoted intervals, and other market-corroborated inputs.

Level 3

Valuation is generated from techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon models that primarily use, as inputs, observable market-based parameters. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. The Company evaluates fair value measurement inputs on an ongoing basis in order to determine if there is a change of sufficient significance to warrant a transfer between levels. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s valuation process.

Fair Value Option

ASC 820 allows companies to report selected financial assets and liabilities at fair value using the fair value option. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately on the balance sheet. The Company made the election in June 2018, to record mortgage loans held-for-sale at fair value under the fair value option, which allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to hedge them without the burden of complying with the requirements for hedge accounting.

Financial Assets and Financial Liabilities Measured on a Recurring Basis

The Company uses the following methods and assumptions in estimating the fair value of its financial assets and financial liabilities on a recurring basis:

Investment Securities Available-for-Sale

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

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

Also included in securities are corporate bonds which are valued using significant unobservable inputs and are classified as Level 2 or Level 3 based on market information available during the period.

Equity Securities

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

Mortgage Loans Held-for-Sale

Mortgage loans held-for-sale are recorded at fair value on a recurring basis. The estimated fair value is determined using Level 3 inputs based on observable data such as the existing forward commitment terms or the current market value of similar loans.

Loan Servicing Rights

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

Derivative Instruments

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

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

The following tables present financial assets and financial liabilities measured at fair value on a recurring basis at the dates indicated, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value:

	September 30, 2018
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets:
Equity securities	$	6,983	$	—	$	—	$	6,983
Securities available for sale:
U.S. Treasury & Government Agencies		4,881		29,287		—		34,168
Municipal Securities		—		109,874		—		109,874
Mortgage-backed Securities - Guaranteed		—		84,118		—		84,118
Collateralized Mortgage Obligations - Guaranteed		—		17,827		—		17,827
Collateralized Mortgage Obligations - Non Guaranteed		—		74,310		—		74,310
Collateralized Loan Obligations		—		12,943				12,943
Corporate bonds		—		20,026		493		20,519
Total securities available for sale		4,881		348,385		493		353,759

Mortgage loans held for sale		—		—		1,821		1,821
Loan servicing rights		—		—		2,771		2,771
Interest rate swaps		—		778		—		778
Mortgage derivatives		—		—		30		30

Total recurring assets at fair value	$	11,864	$	349,163	$	5,115	$	366,142

Liabilities:
Interest rate swaps	$	—	$	—	$	—	$	—
Mortgage derivatives		—		—		8		8

Total recurring liabilities at fair value	$	—	$	—	$	8	$	8

	December 31, 2017
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Assets
Equity securities	$	6,095	$	—	$	—	$	6,095
Securities available for sale:
U.S. Treasury & Government Agencies		2,496		18,027		—		20,523
Municipal Securities		—		93,859		—		93,859
Mortgage-backed Securities - Guaranteed		—		128,039		—		128,039
Collateralized Mortgage Obligations - Guaranteed		—		10,302		—		10,302
Collateralized Mortgage Obligations - NonGuaranteed		—		64,693		—		64,693
Collateralized Loan Obligations				5,539				5,539
Corporate bonds		—		18,799		492		19,291
Mutual funds		617		—		—		617
Total securities available for sale		3,113		339,258		492		342,863

Loan servicing rights		—		—		2,756		2,756
Interest rate swaps		—		561		—		561
Mortgage derivatives		—		—		73		73

Total assets	$	9,208	$	339,819	$	3,321	$	352,348

There were no liabilities measured at fair value on a recurring basis as of December 31, 2017.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
	(Dollars in thousands)						(Dollars in thousands)
Balance at beginning of period	$	4,404		$	3,836		$	3,321		$	4,807

AFS securities
Fair value adjustment		—			—			—			(4	)
Transfer from (to) Level 2		—			—			—			(1,086	)

Mortgage loans held for sale		651			—			1,821			—

Loan servicing right activity, included in servicing income, net
Capitalization from loans sold		129			154			374			446
Fair value adjustment		(43	)		(158	)		(359	)		(335	)

Mortgage derivative gains(losses) included in other income		(34	)		5			(50	)		9

Balance at end of period	$	5,107		$	3,837		$	5,107		$	3,837

Financial Assets Measured on a Nonrecurring Basis

The Company uses the following methods and assumptions in estimating the fair value of its financial assets on a nonrecurring basis:

SBA Loans Held for Sale

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

Impaired Loans

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

Real Estate Owned

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

Small Business Investment Company Holdings

Small Business Investment Company holdings (“SBIC”) are carried at the lower of cost or cost less a valuation allowance. From time to time, impairment of SBIC is evident as a result of underlying financial review and a valuation allowance is established. SBIC carried at cost less a valuation allowance is classified as Level 3.

The following table presents nonfinancial assets measured at fair value on a nonrecurring basis at the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

	September 30, 2018
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential	$	—	$	—	$	2,101	$	2,101
Commercial real estate		—		—		3,596		3,596
Home equity loans and lines of credit		—		—		313		313
Other construction and land		—		—		565		565

Real estate owned:
One-to-four family residential		—		—		290		290
Commercial real estate		—		—		949		949
Other construction and land		—		—		1,579		1,579

Total assets	$	—	$	—	$	9,393	$	9,393

	December 31, 2017
	Level 1		Level 2		Level 3		Total
	(Dollars in thousands)
Collateral dependent impaired loans:
One-to-four family residential	$	—	$	—	$	2,266	$	2,266
Commercial real estate		—		—		4,050		4,050
Home equity loans and lines of credit		—		—		313		313
Other construction and land		—		—		571		571

Real estate owned:
One-to-four family residential		—		—		288		288
Commercial real estate		—		—		544		544
Other construction and land		—		—		1,736		1,736

Total assets	$	—	$	—	$	9,768	$	9,768

There were no liabilities measured at fair value on a nonrecurring basis as of September 30, 2018 or December 31, 2017.

Impaired loans totaling $4.0 million at September 30, 2018 and $4.4 million at December 31, 2017 were measured using the present value of expected future cash flows. These impaired loans were not deemed to be measured at fair value on a nonrecurring basis.

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at September 30, 2018.

	Valuation Technique	Unobservable Input	General Range

Impaired loans	Discounted Appraisals	Collateral discounts and estimated selling cost		0% - 30%
Real estate owned	Discounted Appraisals	Collateral discounts and estimated selling cost		0% - 30%
Corporate bonds	Discounted Cash Flows	Recent trade pricing		0% -10%
Loan servicing rights	Discounted Cash Flows	Prepayment speed		5% - 35%
		Discount rate		12% - 14%
Mortgage loans held for sale	External pricing model	Recent trade pricing		98% - 101%
Mortgage derivatives	External pricing model	Pull-through rate		78%-100%
SBIC	Indicative value provided by fund	Current operations and financial condition		N/A

Fair Value of Financial Assets and Financial Liabilities

The following table includes the estimated fair value of the Company’s financial assets and financial liabilities at the dates indicated:

			Fair Value Measurements at September 30, 2018
	Carrying
(Dollars in thousands)	Amount		Total		Level 1		Level 2		Level 3
Assets:
Cash and equivalents	$	117,265	$	117,265	$	117,265	$	—	$	—
Equity securities		6,983		6,983		6,983		—		—
Securities available for sale		353,759		353,759		4,881		348,385		493
Loans held for sale		3,970		4,200		—		2,379		1,821
Loans receivable, net		1,068,012		1,041,868		—		—		1,041,868
Other investments, at cost		12,039		12,039		—		12,039		—
Accrued interest receivable		6,158		6,158		—		6,158		—
BOLI		32,738		32,738		—		32,738		—
Loan servicing rights		2,771		2,771		—		—		2,771
Mortgage derivatives		30		30		—		—		30
Interest rate swaps		778		778		—		778		—
SBIC investments		3,609		3,609		—		—		3,609

Liabilities:
Demand deposits	$	831,493	$	831,493	$	—	$	831,493	$	—
Time deposits		424,539		427,112		—		—		427,112
Federal Home Loan Bank advances		213,500		213,668		—		213,668		—
Junior subordinated debentures		14,433		12,577		—		12,577		—
Other borrowings		9,395		9,296		—		9,296		—
Accrued interest payable		1,358		—		—		—		—
Mortgage derivatives		8		8		—		—		8
Interest rate swaps		—		—		—		—		—

			Fair Value Measurements at December 31, 2017
	Carrying
(Dollars in thousands)	Amount		Total		Level 1		Level 2		Level 3
Assets:
Cash and equivalents	$	109,467	$	109,467	$	109,467	$	—	$	—
Equity securities		6,095		6,095		6,095		—		—
Securities available for sale		342,863		342,863		3,113		339,258		492
Loans held for sale		3,845		4,211		—		4,211		—
Loans receivable, net		1,005,139		992,993		—		—		992,993
Other investments, at cost		12,386		12,386		—		12,386		—
Accrued interest receivable		5,405		5,405		—		5,405		—
BOLI		32,150		32,150		—		32,150		—
Loan servicing rights		2,756		2,756		—		—		2,756
Forward sales commitments		28		28		—		—		28
Interest rate lock commitments		45		45		—		—		45
Derivative asset		561		561		—		561		—
SBIC investments		3,491		3,491		—		—		3,491

Liabilities:
Demand deposits	$	765,442	$	765,442	$	—	$	765,442	$	—
Time deposits		396,735		390,806		—		—		390,806
FHLB advances		223,500		223,627		—		223,627		—
Junior subordinated debentures		14,433		14,433		—		14,433		—
Other borrowings		8,623		8,620		—		8,620		—
Accrued interest payable		935		935		—		935		—

NOTE 15. Revenue Recognition

On January 1, 2018, the Company adopted ASU 2014-09 Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified ASC Topic 606. As stated in Note 1 Summary of Significant Accounting Policies, the implementation of the new standard did not have a material impact on the measurement or recognition of revenue. Results for reporting periods beginning after January 1, 2018 are presented under ASC Topic 606, while prior period amounts reflect an offset of $0.2 million and $0.7 million of interchange costs against interchange income for the three and nine months ended September 30, 2017, respectively.

ASC Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. ASC Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of ASC Topic 606. Noninterest revenue streams in-scope of ASC Topic 606 are discussed below.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional-based, and therefore, the Company’s performance obligation is satisfied and related revenue recognized at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

Interchange Fees

Interchange fees are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks, such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or within days of the transaction.

Other

Other noninterest income consists of other recurring revenue streams such as safety deposit box rental fees, revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of ASC Topic 606, for the three and nine months ended September 30, 2018 and 2017.

	Three months ended				Nine months ended
	September 30,				September 30,
(dollars in thousands)	2018		2017		2018		2017
Noninterest income
In-scope of Topic 606:
Service charges on deposit accounts	$	406	$	436	$	1,242	$	1,239
Interchange fees		276		246		795		655
Other		227		215		775		527
Noninterest income (in-scope of Topic 606)		909		897		2,812		2,421
Noninterest income (out-of-scope of Topic 606)		1,056		878		1,867		1,886
Total noninterest income	$	1,965	$	1,775	$	4,679	$	4,307

Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers and therefore, does not experience significant contract balances. As of September 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of ASC Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of ASC Topic 606, the Company did not capitalize any contract acquisition cost.

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

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

statements of our goals, intentions and expectations;

statements regarding our business plans, prospects, growth and operating strategies;

statements regarding the asset quality of our loan and investment portfolios; and

estimates of our risks and future costs and benefits.

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

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

our ability to utilize all of our deferred tax asset and deduct certain future losses, which could be limited if we experience an ownership change as defined in the Internal Revenue Code;

failure to implement aspects of our growth strategy;

challenges arising from attempts to expand into new geographic markets, products or services;

new bank office facilities and other facilities may not be profitable;

acquisition of assets and assumption of liabilities may expose us to intangible asset risk, which could impact our results of operations and financial condition;

the success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand;

access to additional capital, which we may be unable to obtain on attractive terms or at all;

inadequacies in our estimated allowance for loan losses, which would cause our results of operations and financial condition to be adversely affected;

greater credit risk associated with our commercial real estate loans and home equity loans and lines of credit than our one-to-four family residential mortgage loans;

our concentration of construction financing may expose us to a greater risk of loss and hurt our earnings and profitability;

the cash flows of our borrowers, which may be unpredictable, and the collateral securing our loans may fluctuate in value;

we continue to hold and acquire other real estate, which has led to operating expenses and vulnerability to additional declines in real property values;

the occurrence of various events that negatively impact the real estate market, since a significant portion of our loan portfolio is secured by real estate;

concentration of collateral in our primary market areas may increase the risk of increased non-performing assets;

income from secondary mortgage market operations is volatile, and we may incur losses with respect to our secondary mortgage market operations that could negatively affect our earnings;

reliance on the mortgage secondary market for some of our liquidity;

future changes in interest rates, which could reduce our profits;

continued or increasing competition within our market areas may limit our growth and profitability;

increased costs associated with our stock-based benefit plan, which will reduce our income;

extensive regulation and oversight, and, depending upon the findings and determinations of our regulatory authorities, requirements to make adjustments to our business, operations or financial position and potentially result in formal or informal regulatory action;

financial reform legislation enacted by Congress and resulting regulations have increased and are expected to continue to increase our costs of operations;

risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations;

more stringent capital requirements, which may adversely impact our return on equity, require us to raise additional capital, or constrain us from paying dividends or repurchasing shares;

loss of members of our management team or our inability to hire qualified management personnel;

the decline in the fair value of our investments;

liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows;

changes in accounting standards could affect reported earnings;

costs arising from the environmental risks associated with making loans secured by real estate;

a failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses;

outcomes of various lawsuits incidental to our business;

volatility in our stock price, which could result in losses to our shareholders and litigation against us;

negative public opinion surrounding our company and the financial institutions industry generally could damage our reputation and adversely impact our earnings; and

severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business.

For additional information with respect to factors that could cause our actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission (the “SEC”) on March 16, 2018 (the “2017 Form 10-K”).

Critical Accounting Policies and Estimates

Our critical accounting policies involving significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2018 have remained unchanged from the disclosures presented in our 2017 Form 10-K.

The Jumpstart Our Business Startups Act (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies known as “emerging growth companies.” As an “emerging growth company” we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of September 30, 2018, there was not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance. Please refer to Note 1 of this Form 10-Q for more information about our accounting policies and recent accounting updates.

Overview

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

We provide a full range of financial services through offices located throughout the western North Carolina counties of Buncombe, Cherokee, Haywood, Henderson, Jackson, Macon, Polk, and Transylvania, the Upstate South Carolina counties of Anderson, Greenville, Pickens, and Spartanburg and the northern Georgia counties of Gwinnett, Hall and Pickens. We provide full service retail banking, commercial banking, Small Business Administration (“SBA”), mortgage lending and private banking products as well as wealth management services through a third party.

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

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

Strategic Plan

We continue to execute on our strategic plan which involves the following key components:

building a franchise that will provide above-average shareholder returns;

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

building long-term franchise value by diversifying into high growth markets geographically contiguous to our current markets;

focus on relationship banking in our metropolitan markets;

building deposits in rural markets; and

maximizing our capital leverage through organic and acquired asset growth.

The following discussion and analysis is presented on a consolidated basis and focuses on the major components of the Company’s operations and significant changes in its results of operations for the periods presented. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information included in this Form 10-Q and in our 2017 Form 10-K.

Earnings Summary

Net income for the three and nine months ended September 30, 2018 was $3.5 million and $10.2 million, respectively, compared to $2.5 million and $5.9 million for the same periods in 2017, respectively. The increase in net income for the three months ended September 30, 2018 was primarily the result of increases in net interest income and noninterest income of $2.0 million and $0.2 million, respectively, partially offset by an increase in noninterest expense of $1.6 million. The increase in net income for the nine months ended September 30, 2018 was primarily the result of increases in net interest income and noninterest income of $6.8 million and $0.4 million, respectively, partially offset by an increase in noninterest expense of $3.1 million.

Net interest income increased $2.0 million, or 19.1%, to $12.3 million for the three months ended September 30, 2018, compared to $10.3 million for the same period in 2017. Net interest income increased $6.8 million, or 22.7%, to $37.0 million for the nine months ended September 30, 2018, compared to $30.2 million for the same period in 2017. The increase in net interest income was primarily due to higher volumes in the loan portfolio, as well as an increase in the yields earned on cash, taxable investments and loans partially offset by increased deposit balances and the costs of deposits and borrowings. Net interest margin was 3.26% for the three months ended September 30, 2018, compared to 3.30% for the same period in 2017, and 3.38% and 3.32% for the nine months ended September 30, 2018 and 2017, respectively.

Noninterest income increased $0.2 million, or 10.7%, to $2.0 million for the three months ended September 30, 2018, compared to $1.8 million for the same period in 2017. Increases in servicing income, mortgage banking, equity securities gains, and net interchange fees were partially offset by decreases in gains on sale of Small Business Administration (“SBA”) loans and service charges on deposit accounts. The Company recorded a valuation adjustment against its loan servicing rights of $44 thousand and $0.2 million for the three months ended September 30, 2018 and 2017, respectively.

Noninterest income increased $0.4 million, or 8.6%, to $4.7 million for the nine months ended September 30, 2018, compared to $4.3 million for the same period in 2017, primarily as the result of the other than temporary impairment on one investment security of $0.7 million in 2017, compared to realized losses on sale of investments of $0.5 million in 2018. Increases in gains on sale of SBA loans, net interchange fees and income from Small Business Investment Company (“SBIC”) holdings were partially offset by decreases in mortgage banking and equity securities gains. The Company recorded a valuation adjustment against its loan servicing rights of $0.4 million and $0.3 million for the nine months ended September 30, 2018 and 2017, respectively.

Noninterest expense increased $1.5 million, or 19.6%, to $9.5 million for the three months ended September 30, 2018, compared to $8.0 million for the same period in 2017. Noninterest expense increased $3.1 million, or 12.5%, to $28.1 million for the nine months ended September 30, 2018, compared to $25.0 million for the same period in 2017. The increases were primarily related to increased compensation and employee benefits, net occupancy expenses, and data processing expenses, as the 2018 period included the full impact of the Chattahoochee Bank of Georgia acquisition and the branches acquired from Stearns Bank.

Non-GAAP Financial Measures

Statements included in this MD&A include financial measures that do not conform to U.S. generally accepted accounting principles (“GAAP”) and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. This MD&A and the accompanying tables discuss non-GAAP financial measures, such as core noninterest expense, core net income, core return on average assets, core return on tangible average equity, and core efficiency ratio. We believe that such non-GAAP measures are useful because they enhance the ability of investors and management to evaluate and compare the Company’s operating results from period to period in a meaningful manner. Non-GAAP measures should not be considered as an alternative to any measure of performance as promulgated under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.

We analyze our noninterest expense and net income on a non-GAAP basis as detailed and as of the periods indicated in the table below:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
(Dollars in thousands, except per share data)
Adjusted Noninterest Expense
Noninterest expense (GAAP)	$	9,541		$	7,980		$	28,103		$	24,973
Merger-related expenses		(96	)		(116	)		(564	)		(972	)
Adjusted noninterest expense (Non-GAAP)	$	9,445		$	7,864		$	27,539		$	24,001

Adjusted Net Income
Net income (GAAP)	$	3,523		$	2,471		$	10,192		$	5,873
Loss (gain) on sale of investments		—			16			411			(12	)
Other than temporary impairment of investment securities available for sale		—			—			—			455
Merger-related expenses		76			76			446			632
Adjusted net income (Non-GAAP)	$	3,599		$	2,563		$	11,049		$	6,948

Adjusted Diluted Earnings Per Share
Diluted earnings per share (GAAP)	$	0.50		$	0.38		$	1.45		$	0.90
Loss (gain) on sale of investments		—			—			0.06			—
Other than temporary impairment of investment securities available for sale		—			—			—			0.06
Merger-related expenses		0.01			0.01			0.06			0.10
Adjusted diluted earnings per share (Non-GAAP)	$	0.51		$	0.39		$	1.57		$	1.06

Adjusted Return on Average Assets
Return on Average Assets (GAAP)		0.86	%		0.71	%		0.84	%		0.57	%
Gain on sale of investments		0.00	%		0.00	%		0.03	%		—
Other than temporary impairment of investment securities available for sale		0.00	%		0.00	%		0.00	%		0.04	%
Merger-related expenses		0.02	%		0.02	%		0.04	%		0.06	%
Adjusted Return on Average Assets (Non-GAAP)		0.88	%		0.73	%		0.91	%		0.67	%

Adjusted Return on Tangible Average Equity
Return on Average Equity (GAAP)		9.00	%		6.95	%		8.84	%		5.66	%
Loss (gain) on sale of investments		0.00	%		0.04	%		0.36	%		-0.01	%
Other than temporary impairment of investment securities available for sale		0.00	%		0.00	%		0.00	%		0.43	%
Merger-related expenses		0.19	%		0.21	%		0.39	%		0.61	%
Effect of goodwill and intangibles		1.98	%		0.52	%		2.13	%		0.43	%
Adjusted Return on Average Tangible Equity (Non-GAAP)		11.18	%		7.72	%		11.71	%		7.12	%

Adjusted Efficiency Ratio
Efficiency ratio (GAAP)		66.92	%		65.96	%		67.44	%		72.45	%
Gain (loss) on sale of investments		0.00	%		-0.19	%		-1.23	%		0.05	%
Other than temporary impairment of investment securities available for sale		0.00	%		0.00	%		0.00	%		-1.38	%
Merger-related expenses		-0.67	%		-0.90	%		-0.94	%		-2.84	%
Adjusted Efficiency Ratio (Non-GAAP)		66.25	%		64.87	%		65.27	%		68.28	%

	As Of
	September 30, 2018			December 31, 2017
	(Dollars in thousands, except share data)
Tangible Assets
Total Assets	$	1,669,566		$	1,581,449
Goodwill and Intangibles		(27,653	)		(28,172	)
Tangible Assets	$	1,641,913		$	1,553,277

Tangible Book Value Per Share
Book Value (GAAP)	$	156,730		$	151,313
Goodwill and intangibles		(27,653	)		(28,172	)
Book Value (Tangible)	$	129,077		$	123,141
Outstanding shares		6,891,672			6,879,191
Tangible Book Value Per Share	$	18.73		$	17.90

Financial Condition at September 30, 2018 and December 31, 2017

Total assets increased $88.1 million, or an annualized rate of 7.4%, to $1.67 billion at September 30, 2018 from $1.58 billion at December 31, 2017. This increase in assets was primarily due to increases in cash and cash equivalents of $7.8 million, from $109.5 million at December 31, 2017 to $117.3 million at September 30, 2018, increases in investment securities available for sale of $10.9 million, or 3.2%, and loans, which increased $62.9 million, or 6.3%, to $1.07 billion at September 30, 2018 from $1.0 billion at December 31, 2017. Core deposits increased $18.5 million to $781.9 million at September 30, 2018 from $763.4 million at December 31, 2017. Core deposits decreased from 66% of the Company’s deposit portfolio at December 31, 2017 to 62% at September, 30 2018. Retail certificates of deposit decreased $4.9 million to $352.7 million at September 30, 2018 from $357.6 million at December 31, 2017. Wholesale deposits have been a source of funding loan growth and increased $80.3 million to $121.5 million at September 30, 2018 from $41.1 million at December 31, 2017.

Total liabilities increased $82.7 million, or 5.8%, to $1.51 billion at September 30, 2018 from $1.43 billion at December 31, 2017, due primarily to the $93.9 million increase in deposits, partially offset by the $10.0 million decrease in Federal Home Loan Bank (“FHLB”) borrowings and the $2.1 million decrease in other liabilities.

Total shareholders’ equity increased $5.4 million to $156.7 million at September 30, 2018, compared to $151.3 million at December 31, 2017. This increase was primarily attributable to $10.2 million of net income, offset by a $5.6 million after-tax decline in the market value of investment securities available for sale. Tangible book value per share, a non-GAAP measure, increased $0.83 to $18.73 at September 30, 2018 from $17.90 at December 31, 2017.

Investment Securities

The following table presents the holdings of our equity securities as of September 30, 2018 and December 31, 2017:

	September 30, 2018		December 31, 2017
	(Dollars in thousands)
Mutual funds	$	6,983	$	6,095

Equity securities with a fair value of $6.4 million and $6.1 million as of September 30, 2018 and December 31, 2017, respectively, are held in a Rabbi Trust and seek to generate returns that will fund the cost of certain deferred compensation agreements.

Equity securities with a fair value of $0.6 million as of September 30, 2018 are in a mutual fund that qualifies under the Community Reinvestment Act (“CRA”) as CRA activity. The CRA mutual fund was reclassified as an equity security on January 1, 2018.

The remainder of our investment securities portfolio is classified as available-for-sale (“AFS”) and is carried at fair value. The Company’s held-to-maturity (“HTM”) investment portfolio was transferred to AFS during the third quarter of 2016 in order to provide the Company more flexibility managing its investment portfolio. As a result of the transfer, the Company is prohibited from classifying any investment securities as HTM for two years from the date of the transfer and may resume HTM classification in the fourth quarter of 2018.

The following table shows the amortized cost and fair value for our AFS investment portfolio as of the dates indicated:

	September 30, 2018				December 31, 2017
			Estimated				Estimated
	Amortized		Fair		Amortized		Fair
(Dollars in thousands)	Cost		Value		Cost		Value
U.S. Treasury & Government Agencies	$	34,203	$	34,168	$	20,529	$	20,523
Municipal Securities		113,158		109,874		93,250		93,859
Mortgage-backed Securities - Guaranteed		86,354		84,118		129,314		128,039
Collateralized Mortgage Obligations - Guaranteed		18,711		17,827		10,559		10,302
Collateralized Mortgage Obligations - Non Guaranteed		75,576		74,310		64,706		64,693
Collateralized Loan Obligations		13,035		12,943		5,555		5,539
Corporate bonds		20,551		20,519		18,925		19,291
Mutual funds		—		—		629		617
	$	361,588	$	353,759	$	343,467	$	342,863

The following table indicates estimated fair value of investments that are fixed or variable rate as of the dates indicated:

	September 30, 2018						December 31, 2017
	Fixed		Variable				Fixed		Variable
(Dollars in thousands)	Rate		Rate		Total		Rate		Rate		Total
U.S. Treasury & Government Agencies	$	6,246	$	27,922	$	34,168	$	2,496	$	18,027	$	20,523
Municipal Securities		109,874		—		109,874		93,859		—		93,859
Mortgage-backed Securities - Guaranteed		34,229		49,889		84,118		57,281		70,758		128,039
Collateralized Mortgage Obligations - Guaranteed		17,827		—		17,827		10,302		—		10,302
Collateralized Mortgage Obligations - Non Guaranteed		61,306		13,004		74,310		48,128		16,565		64,693
Collateralized Loan Obligations		—		12,943		12,943		—		5,539		5,539
Corporate bonds		7,813		12,706		20,519		7,522		11,769		19,291
Mutual funds		—		—		—		—		617		617
	$	237,295	$	116,464	$	353,759	$	219,588	$	123,275	$	342,863

AFS investment securities increased $10.9 million to $353.8 million at September 30, 2018 from $342.9 million at December 31, 2017. We continue to monitor and decrease our investment portfolio as we continue to build our loan portfolio.

Loans

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

	September 30,						December 31,
	2018						2017
	Amount			Percent			Amount			Percent
	(Dollars in thousands)
Real estate loans:
One-to-four family residential	$	321,477			30.0	%	$	304,107			30.1	%
Commercial		494,226			46.2			453,725			45.0
Home equity loans and lines of credit		48,205			4.5			49,877			4.9
Residential construction		42,322			4.0			37,108			3.7
Other construction and land		102,000			9.5			101,447			10.1
Commercial		55,671			5.2			56,939			5.6
Consumer		6,797			0.7			5,700			0.6
Total loans, gross	$	1,070,698			100.0	%	$	1,008,903			100.0	%

Less:
Deferred loan fees, net		(1,235	)					(1,431	)
Acquired loans fair value discount		(1,202	)					(2,012	)
Hedged loans basis adjustment		(263	)					—
Unamortized premium		346						389
Unamortized discount		(332	)					(710	)

Total loans, net of deferred fees	$	1,068,012					$	1,005,139

Percentage of total assets		64.0	%					63.6	%

Net loans increased $62.9 million, or 6.3%, to $1.07 billion at September 30, 2018 from $1.01 billion at December 31, 2017. Most of our loan growth is concentrated in one-to-four family residential and commercial real estate with increases of $17.4 million, or 5.7%, and $40.5 million, or 8.9%, respectively, as compared to relative balances at December 31, 2017. We believe that economic conditions in our primary market areas are favorable and present opportunities for continued growth.

Delinquent Loans

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

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

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

The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. We have no loans past due 90 days and over that are still accruing interest as of September 30, 2018 or December 31, 2017.


	Delinquent loans
	30-59 Days			60-89 Days			90 Days and over			Total
	(Dollars in thousands)
September 30, 2018
Real estate loans:
One-to-four family residential	$	3,515		$	410		$	261		$	4,186
Commercial		3,197			—			757			3,954
Home equity loans and lines of credit		235			116			98			449
Residential construction		—			—			3			3
Other construction and land		331			36			63			430
Commercial		48			5			306			359
Consumer		5			6			1			12
Total delinquent loans	$	7,331		$	573		$	1,489		$	9,393
% of total loans, net		0.69	%		0.05	%		0.14	%		0.88	%

December 31, 2017
Real estate loans:
One-to-four family residential	$	3,941		$	591		$	562		$	5,094
Commercial		2,093			308			683			3,084
Home equity loans and lines of credit		308			27			120			455
One- to four-family residential construction		501			—			—			501
Other construction and land		1,711			21			93			1,825
Commercial		488			1			95			584
Consumer		27			25			10			62
Total delinquent loans	$	9,069		$	973		$	1,563		$	11,605
% of total loans, net		0.90	%		0.10	%		0.15	%		1.15	%

Delinquent loans decreased $2.2 million to $9.4 million at September 30, 2018 from $11.6 million at December 31, 2017. The decrease in delinquencies was due primarily to collection efforts and the favorable resolution of several relationships.

Non-Performing Assets

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

	September 30,			December 31,
	2018			2017
	(Dollars in thousands)
Non-accrual loans:
Real estate loans:
One-to-four family residential	$	1,214		$	1,421
Commercial		2,404			2,666
Home equity loans and lines of credit		112			120
Other construction and land		260			464
Commercial		306			95
Consumer		1			12

Total non-performing loans		4,297			4,778

REO:
One-to-four family residential		290			288
Commercial real estate		949			544
Other construction and land		1,579			1,736

Total foreclosed real estate		2,818			2,568

Total non-performing assets	$	7,115		$	7,346

Troubled debt restructurings still accruing	$	7,641		$	8,952

Ratios:
Non-performing loans to total loans		0.40	%		0.47	%
Non-performing assets to total assets		0.43	%		0.46	%

Non-performing loans decreased $0.5 million, or 10.0%, to $4.3 million at September 30, 2018 from $4.8 million at December 31, 2017. The decrease in non-performing loans was primarily attributable to the satisfaction of loans through foreclosure.

REO increased $0.2 million, or 9.7%, to $2.8 million at September 30, 2018 from $2.6 million at December 31, 2017 primarily as a result of the addition of one relationship partially offset by the successful liquidation of two large properties.

Classification of Loans

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

	September 30,			December 31,
	2018			2017
	(Dollars in thousands)
Classified loans:
Substandard	$	7,689		$	9,503
Doubtful		—			—
Loss		—			—

Total classified loans:		7,689			9,503
As a % of total loans, net		0.72	%		0.95	%

Special mention		9,182			12,725

Total criticized loans	$	16,871		$	22,228
As a % of total loans, net		1.58	%		2.21	%

Total classified loans decreased $1.8 million to $7.7 million at September 30, 2018 from $9.5 million at December 31, 2017. Total criticized loans decreased $5.4 million, or 24.1%, to $16.9 million at September 30, 2018 from $22.2 million at December 31, 2017. Management continues to dedicate resources to monitoring and resolving classified and criticized loans.

Allowance for Loan Losses

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

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

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.5% to 0.7%.

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

non-accrual and classified loans;

collateral values;

loan concentrations;

	·		economic conditions – including unemployment rates, home sales and prices, and a regional economic index; and
	·		lender risk – personnel changes.

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

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

	As of or for the Three Months Ended September 30,						As of or for the Nine Months Ended September 30,
	2018			2017			2018			2017
	( Dollars in thousands)						( Dollars in thousands)
Balance at beginning of period	$	11,525		$	9,934		$	10,887		$	9,305

Charge-offs:
Real Estate:
One- to four-family residential		(6	)		—			(116	)		(50	)
Commercial		—			(105	)		(35	)		(193	)
Home equity loans and lines of credit		(219	)		(266	)		(260	)		(267	)
Residential construction		—			—			—			—
Other construction and land		—			(114	)		—			(289	)
Commercial		(45	)		—			(79	)		—
Consumer		(17	)		(18	)		(75	)		(42	)
Total charge-offs		(287	)		(503	)		(565	)		(841	)

Recoveries:
Real Estate:
One- to four-family residential		1			2			15			71
Commercial		—			32			3			75
Home equity loans and lines of credit		—			—			24			5
Residential construction		1			—			1			—
Other construction and land		16			9			43			76
Commercial		2			7			10			22
Consumer		152			56			274			184
Total recoveries		172			106			370			433

Net (charge-offs) recoveries		(115	)		(397	)		(195	)		(408	)

Provision for loan losses		336			520			1,054			1,160

Balance at end of period	$	11,746		$	10,057		$	11,746		$	10,057

Ratios:
Net charge-offs to average loans outstanding		0.04	%		0.20	%		0.02	%		0.07	%
Allowance to non-performing loans at period end		273.35	%		179.46	%		273.35	%		179.46	%
Allowance to total loans at period end		1.10	%		1.23	%		1.10	%		1.23	%

Our allowance as a percentage of total loans decreased to 1.10% at September 30, 2018 from 1.23% at September 30, 2017 primarily as the result of the increase in loans related to the Chattahoochee Bank of Georgia (“Chattahoochee”) acquisition. The remaining fair value discount on acquired loans was $1.2 million as of September 30, 2018.

We have continued to experience limited charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of non-performing loans increased to 273.35% at September 30, 2018 compared to 227.86% at December 31, 2017 and 179.46% at September 30, 2017.

REO

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

	September 30,		December 31,
	2018		2017
	(Dollars in thousands)
One- to four-family residential	$	290	$	288
Commercial real estate		949		544
Other construction and land		1,579		1,736
Total	$	2,818	$	2,568

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
	(Dollars in thousands)						(Dollars in thousands)
Balance, beginning of period	$	2,802		$	2,487		$	2,568		$	4,226
Additions		753			465			1,502			702
Disposals		(737	)		(515	)		(1,169	)		(2,324	)
Writedowns		—			—			(83	)		(167	)
Balance, end of period	$	2,818		$	2,437		$	2,818		$	2,437

REO increased $0.2 million, or 9.7%, to $2.8 million at September 30, 2018 from $2.6 million at December 31, 2017. We have experienced a significant decrease in the number and dollar amount of additions to REO, and have had success in liquidating REO. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.

Net Deferred Tax Assets

Deferred income tax assets and liabilities are determined using the asset and liability method and are reported net in the consolidated balance sheets of this Form 10-Q. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rate and laws. When deferred tax assets are recognized, they are subject to a valuation allowance based on management’s judgment as to whether realization is more likely than not. In determining the need for a valuation allowance, we considered the following sources of taxable income:

future reversals of existing taxable temporary differences;

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

taxable income in prior carryback years; and

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

Net deferred tax assets decreased $0.1 million to $8.7 million at September 30, 2018 compared to $8.8 million at December 31, 2017. The decrease in net deferred tax assets is mainly attributable to reduction in our federal and state net operating losses and acquisition related deferred tax items, partially offset by increases in the net unrealized holding losses on our investment securities.

Deposits

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

	September 30, 2018					December 31, 2017
	Balance		Percent			Balance		Percent
	(Dollars in thousands)
Deposit type:
Noninterest-bearing demand accounts	$	199,224		15.9	%	$	179,457		15.4	%
Interest-bearing demand accounts		206,967		16.5			226,718		19.5
Money market accounts - retail		322,833		25.7			306,747		26.4
Money market accounts - wholesale		49,595		3.9			2,020		0.2
Savings accounts		52,874		4.2			50,500		4.3
Time deposits - retail		352,659		28.1			357,629		30.8
Time deposits - wholesale		71,880		5.7			39,106		3.4

Total deposits	$	1,256,032		100.0	%	$	1,162,177		100.0	%

Core deposits increased $18.5 million to $781.9 million at September 30, 2018 from $763.4 million at December 31, 2017. Retail certificates of deposit decreased $4.9 million to $352.7 million at September 30, 2018 from $357.6 million at December 31, 2017. Wholesale deposits have been a source of funding loan growth and increased $80.3 million to $121.5 million at September 30, 2018 from $41.1 million at December 31, 2017. We continue to focus on gathering core deposits, which decreased from 66% of the Company’s deposit portfolio at December 31, 2017 to 62% at September, 30 2018.

FHLB Advances

FHLB advances decreased $10.0 million from $223.5 million at December 31, 2017 to $213.5 million at September 30, 2018. To manage our exposure to interest rate movement, we entered into two interest rate swaps on FHLB advances during 2016. The swap contracts involve the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the two year lives of the contracts ending during the third and fourth quarters of 2018. The effective interest rates of the swapped advances were 0.82% and 1.36% at September 30, 2018 and 0.96% and 1.36% at December 31, 2017.

Other Borrowings

On September 15, 2017, the Company established a $15.0 million revolving credit loan facility with NexBank SSB. The loan facility, which is secured by Entegra Bank stock, bears interest at LIBOR plus 350 basis points and is intended to be used for general corporate purposes. Unless extended, the loan will mature on September 15, 2020. The Company had drawn $5.0 million on the revolving credit loan facility as of September 30, 2018.

The Company also had other borrowings at September 30, 2018 of $4.4 million, which is comprised of participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

Junior Subordinated Notes

We had $14.4 million in junior subordinated notes outstanding at September 30, 2018 and December 31, 2017 payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. To add stability to net interest income and manage our exposure to interest rate movement, we entered into an interest rate swap in September 2016 on the junior subordinated notes. We also entered into a forward starting interest rate swap on our junior subordinated date in June 2018 to begin in 2020 after the current interest rate swap terminates. The swap contracts involve the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the four year life of the current contract and three additional years under the forward starting contract. The effective interest rate on the swapped notes was 3.76% at both September 30, 2018 and at December 31, 2017.

Equity

Total shareholders’ equity increased $5.4 million to $156.7 million at September 30, 2018 compared to $151.3 million at December 31, 2017. This increase was primarily attributable to $10.2 million of net income, offset by a $5.6 million after-tax decline in the market value of investment securities available for sale.

Comparison of Operating Results for the Three Months Ended September 30, 2018 and September 30, 2017.

General. Net income for the three months ended September 30, 2018 was $3.5 million, compared to $2.5 million for the same period in 2017. The increase in net income for the three months ended September 30, 2018 was primarily the result of increases in net interest income and noninterest income of $2.0 million and $0.2 million, respectively, partially offset by an increase in noninterest expense of $1.6 million.

Net Interest Income. Net interest income increased $2.0 million for the three months ended September 30, 2018, compared to the same period in 2017. The increase in net interest income was primarily due to higher volumes in the loan portfolio, as well as an increase in the yields earned on cash, taxable investments and loans partially offset by increased deposit balances and costs of deposits and borrowings. The tax-equivalent net interest margin was 3.26% for the three months ended September 30, 2018, compared to 3.30% for the same period in 2017.

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

	For the Three Months Ended September 30,
	2018								2017
	Average Outstanding Balance			Interest		Yield/ Rate			Average Outstanding Balance			Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale	$	1,050,667		$	12,622		4.77	%	$	788,021		$	9,175		4.62	%
Loans, tax exempt⁽¹⁾		16,757			134		3.18	%		16,607			151		3.60	%
Investments - taxable		248,077			1,827		2.95	%		295,516			1,787		2.42	%
Investment tax exempt⁽¹⁾		94,019			880		3.74	%		124,016			1,257		4.05	%
Interest earning deposits		99,572			528		2.10	%		63,262			216		1.35	%
Other investments, at cost		12,039			201		6.62	%		11,822			161		5.40	%

Total interest-earning assets		1,521,131			16,192		4.22	%		1,299,244			12,747		3.89	%

Noninterest-earning assets		123,662								100,731

Total assets	$	1,644,793							$	1,399,975

Interest-bearing liabilities:
Savings accounts	$	53,287		$	15		0.11	%	$	49,146		$	14		0.11	%
Time deposits		423,419			1,404		1.32	%		358,327			796		0.88	%
Money market accounts		355,057			814		0.91	%		260,804			248		0.38	%
Interest bearing transaction accounts		205,732			98		0.19	%		174,945			56		0.13	%
Total interest bearing deposits		1,037,495			2,331		0.89	%		843,222			1,114		0.52	%

FHLB advances		213,500			1,091		2.00	%		223,826			641		1.14	%
Junior subordinated debentures		14,433			141		3.82	%		14,433			140		3.85	%
Other borrowings		9,399			123		5.19	%		3,652			36		3.91	%

Total interest-bearing liabilities		1,274,827			3,686		1.15	%		1,085,133			1,931		0.71	%

Noninterest-bearing deposits		198,001								157,870

Other non interest bearing liabilities		15,431								14,667

Total liabilities		1,488,259								1,257,670
Total equity		156,534								142,305

Total liabilities and equity	$	1,644,793							$	1,399,975

Tax-equivalent net interest income				$	12,506							$	10,816

Net interest-earning assets⁽²⁾	$	246,304							$	214,111

Average interest-earning assets to interest-bearing liabilities		119.32	%							119.73	%

Tax-equivalent net interest rate spread⁽³⁾							3.08	%							3.19	%
Tax-equivalent net interest margin⁽⁴⁾							3.26	%							3.30	%

(1) Tax exempt loans and investments are calculated giving effect to a 21% federal tax rate in 2018 and a 35% federal tax rate in 2017.

(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

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

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

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

	For the Three Months Ended September 30, 2018
	Compared to the Three Months Ended September 30, 2017
	Increase (decrease) due to:
	Volume			Rate			Total
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale⁽¹⁾	$	3,147		$	300		$	3,447
Loans, tax exempt⁽²⁾		1			(18	)		(16	)
Investment - taxable		(316	)		356			39
Investments - tax exempt⁽²⁾		(287	)		(90	)		(377	)
Interest-earning deposits		159			153			312
Other investments, at cost		3			37			40

Total interest-earning assets		2,707			738			3,445

Interest-bearing liabilities:
Savings accounts		1			—			1
Time deposits		164			444			608
Money market accounts		115			451			566
Interest bearing transaction accounts		11			31			42
FHLB advances		(30	)		480			450
Junior subordinated debentures		—			—			—
Other borrowings		73			15			88

Total interest-bearing liabilities		334			1,421			1,755

Change in tax-equivalent net interest income	$	2,373		$	(683	)	$	1,690

(1) Non-accrual loans are included in the above analysis.

(2) Interest income on tax exempt loans and investments are adjusted for based on a 21% federal tax rate in 2018 and a 35% federal tax rate in 2017.

Net interest income before provision for loan losses increased to $12.3 million for the three months ended September 30, 2018, compared to $10.3 million for the same period in 2017. As indicated in the table above, the increase in tax-equivalent net interest income of $2.4 million attributable to an improvement in volume was partially offset by a $0.7 million decline in net interest income earned attributable to an unfavorable movement in rates.

The increase in tax-equivalent net interest income of $2.4 million related to volume was primarily the result of higher average loan balances which increased $262.8 million for the three months ended September 30, 2108 as compared to the same period in 2017. The increase in average loan balances was partially offset by decreased average investment balances of $77.4 million and higher average deposit balances which increased $194.3 million over the same periods. The average deposit growth was primarily attributable to the Chattahoochee acquisition in October 2017.

The decrease in tax-equivalent net interest income of $0.7 million related to rate was primarily the result of increased costs on money markets, time deposits, and FHLB advances. These increased costs were partially offset by increased yields on taxable loans and taxable investments.

Our tax-equivalent net interest rate spread decreased slightly to 3.08% for the three months ended September 30, 2018, compared to 3.19% for the three months ended September 30, 2017, and our tax-equivalent net interest margin was 3.26% for the three months ended September 30, 2018, compared to 3.30% for the same period in 2017.

Provision for Loan Losses. We recorded a provision for loan losses for the three months ended September 30, 2018 of $0.3 million due to loan growth, compared to $0.5 million for the same period in 2017. We are experiencing continued stabilization in asset quality, low charge off amounts, and a continued decline in the historical loss rates used in our allowance for loan losses model.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the three month periods ended September 30, 2018 and 2017:

	Three Months Ended September 30,
	2018		2017			Change
	(Dollars in thousands)
Servicing income, net	$	180	$	59		$	121
Mortgage banking		233		207			26
Gain on sale of SBA loans		257		290			(33	)
Gain (loss) on sale of investments, net		—		(24	)		24
Equity securities gains		191		138			53
Service charges on deposit accounts		406		436			(30	)
Interchange fees, net		276		246			30
Bank owned life insurance		195		208			(13	)
Other		227		215			12

Total	$	1,965	$	1,775		$	190

Servicing income increased $0.1 million in the three months ended September 30, 2018 compared to the same period in 2017 as a result of an increased valuation adjustment on loan servicing rights.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the three months ended September 30, 2018 and 2017:

	Three Months Ended September 30,
	2018		2017			Change
	(Dollars in thousands)
Compensation and employee benefits	$	5,882	$	4,937		$	945
Net occupancy		1,128		974			154
Federal deposit insurance		191		140			51
Professional and advisory		413		292			121
Data processing		532		390			142
Marketing and advertising		227		253			(26	)
Merger-related expenses		96		116			(20	)
Net cost of operation of REO		59		(121	)		180
Other		1,013		999			14

Total noninterest expenses	$	9,541	$	7,980		$	1,561

Compensation and employee benefits increased $0.9 million, or 19.1%, to $5.9 million for the three months ended September 30, 2018 as compared to $4.9 million for the same period in 2017. This additional expense is related to increases in our number of employees primarily as a result our Chattahoochee acquisition in October 2017, annual raises, employee benefits, incentives and commissions.

The increases in net occupancy and data processing of $0.2 million and $0.1 million, respectively, for the three months ended September 30, 2018 as compared to the same period in 2017, primarily as a result of our Chattahoochee acquisition in October 2017.

Professional and advisory expenses increased $0.1 million for the three months ended September 30, 2018 as compared to the same period in 2017, primarily as the result of engagements related to analyzing and potentially improving banking operations.

The increase in net cost of operation of REO of $0.2 million for the three months ended September 30, 2018 as compared to the same period in 2017 relates primarily to a $0.2 million gain on sale of REO in the third quarter of 2017.

Income Taxes. We recorded $0.9 million of income tax expense for the three months ended September 30, 2018 compared to $1.1 million for the same period in 2017. Income tax expense for the 2018 period benefitted from the newly enacted federal tax rate of 21% compared to a federal tax rate of 35% in 2017. In addition, income tax expense for the three months ending September 30, 2018 and 2017 benefitted from tax-exempt income related to municipal bond investments and BOLI income resulting in effective tax rates of 19.6% and 31.3%, respectively.

We continue to have unutilized net operating losses for federal and state income tax purposes and do not have a material current tax liability or receivable.

Comparison of Operating Results for the Nine Months Ended September 30, 2018 and September 30, 2017.

General. Net income for the nine months ended September 30, 2018 was $10.2 million, compared to $5.9 million for the same period in 2017 The increase in net income for the nine months ended September 30, 2018 was primarily the result of increases in net interest income and noninterest income of $6.8 million and $0.4 million, respectively, partially offset by an increase in noninterest expense of $3.1 million.

Net Interest Income. Net interest income increased $6.8 million, or 22.7%, for the nine months ended September 30, 2018 compared to the same period in 2017. The increase in net interest income was primarily due to higher volumes in the loan portfolio, as well as an increase in the yields earned on cash, taxable investments and loans partially offset by increased deposit balances and costs of deposits and borrowings. The tax-equivalent net interest margin increased to 3.38% for the nine months ended September 30, 2018 as compared to 3.32% for the same period in 2017.

	For the Nine Months Ended September 30,
	2018								2017
	Average Outstanding Balance			Interest		Yield/ Rate			Average Outstanding Balance			Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale	$	1,030,421		$	36,981		4.80	%	$	765,810		$	26,686		4.66	%
Loans, tax exempt⁽¹⁾		15,947			367		3.08	%		15,906			438		3.69	%
Investments - taxable		253,129			5,173		2.72	%		301,823			5,367		2.37	%
Investment tax exempt⁽¹⁾		84,890			2,344		3.68	%		118,008			3,609		4.08	%
Interest earning deposits		91,400			1,309		1.91	%		58,067			459		1.06	%
Other investments, at cost		12,259			544		5.93	%		12,491			478		5.12	%

Total interest-earning assets		1,488,046			46,718		4.20	%		1,272,105			37,037		3.89	%

Noninterest-earning assets		127,331								100,321

Total assets	$	1,615,377							$	1,372,426

Interest-bearing liabilities:
Savings accounts	$	52,222		$	44		0.11	%	$	46,835		$	39		0.11	%
Time deposits		414,802			3,527		1.14	%		349,381			2,335		0.89	%
Money market accounts		335,722			1,687		0.67	%		255,013			704		0.37	%
Interest bearing transaction accounts		208,550			282		0.18	%		159,377			149		0.12	%
Total interest bearing deposits		1,011,296			5,540		0.73	%		810,606			3,227		0.53	%

FHLB advances		219,178			2,841		1.71	%		240,551			1,713		0.95	%
Junior subordinated debentures		14,433			421		3.85	%		14,433			418		3.87	%
Other borrowings		9,113			352		5.16	%		3,165			100		4.22	%

Total interest-bearing liabilities		1,254,020			9,154		0.98	%		1,068,755			5,458		0.68	%

Noninterest-bearing deposits		190,902								151,174

Other non interest bearing liabilities		16,719								14,204

Total liabilities		1,461,641								1,234,133
Total equity		153,736								138,293

Total liabilities and equity	$	1,615,377							$	1,372,426

Tax-equivalent net interest income				$	37,564							$	31,579

Net interest-earning assets⁽²⁾	$	234,026							$	203,350

Average interest-earning assets to interest-bearing liabilities		118.66	%							119.03	%

Tax-equivalent net interest rate spread⁽³⁾							3.22	%							3.21	%
Tax-equivalent net interest margin⁽⁴⁾							3.38	%							3.32	%

(1) Tax exempt loans and investments are calculated giving effect to a 21% federal tax rate in 2018 and a 35% federal tax rate in 2017.

(2) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

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

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

	For the Nine Months Ended September 30, 2018 Compared to the Nine Months Ended September 30, 2017
	Increase (decrease) due to:
	Volume			Rate			Total
	(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale⁽¹⁾	$	9,475		$	820		$	10,295
Loans, tax exempt⁽²⁾		1			(72	)		(71	)
Investment - taxable		(931	)		737			(194	)
Investments - tax exempt⁽²⁾		(939	)		(325	)		(1,264	)
Interest-earning deposits		352			498			850
Other investments, at cost		(9	)		74			65

Total interest-earning assets		7,949			1,732			9,681

Interest-bearing liabilities:
Savings accounts	$	5		$	—		$	5
Time deposits		486			706			1,192
Money market accounts		274			709			983
Interest bearing transaction accounts		55			78			133
FHLB advances		(161	)		1,287			1,126
Junior subordinated debentures		—			—			—
Other borrowings		227			30			257

Total interest-bearing liabilities	$	886		$	2,810		$	3,696

Change in tax-equivalent net interest income	$	7,063			(1,078	)		5,985

Net interest income before provision for loan losses increased to $37.0 million for the nine months ended September 30, 2018, compared to $30.2 million for the same period in 2017. As indicated in the table above, the increase in tax-equivalent net interest income of $7.1 million attributable to an improvement in volume and was partially offset by a $1.1 million decline in net interest income earned attributable to an unfavorable movement in rates.

The increase in tax-equivalent net interest income of $7.1 million related to volume was primarily the result of higher average loan and deposit balances which increased $264.7 million and $33.3 million, respectively, and reduced average FHLB advance balances, which declined $21.3 million, for the nine months ended September 30, 2018, as compared to the same period in 2017. The increase in average loan balances and decline in average FHLB advances was partially offset by decreased average investment balances of $81.8 million, increased average interest bearing deposit balances of $200.7 million, and increases in other borrowings of $6.0 million over the same periods. The average deposit growth was primarily attributable to the Chattahoochee acquisition in October 2017.

The decrease in tax-equivalent net interest income of $1.1 million related to rate was primarily the result of lower yields on tax-exempt investment securities and increased costs on money markets, time deposits, and FHLB advances. These unfavorable rate movements were partially offset by increased yields on taxable loans, taxable investments and deposits.

Our tax-equivalent net interest rate spread increased slightly to 3.22% for the nine months ended September 30, 2018 compared to 3.21% for the nine months ended September 30, 2017. Our tax-equivalent net interest margin increased to 3.38% for the nine months ended September 30, 2018, compared to 3.32% for the same period in 2017.

Provision for Loan Losses. We recorded a provision for loan losses for the nine months ended September 30, 2018 of $1.1 million due to loan growth compared to $1.2 million for the same period in 2017. We are experiencing continued stabilization in asset quality, low charge off amounts, and a continued decline in the historical loss rates used in our allowance for loan losses model.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the nine month periods ended September 30, 2018 and 2017:

	Nine Months Ended September 30,
	2018			2017			Change
	(Dollars in thousands)
Servicing income, net	$	313		$	312		$	1
Mortgage banking		755			771			(16	)
Gain on sale of SBA loans		547			436			111
Gain (loss) on sale of investments, net		(520	)		19			(539	)
Equity securities gains		183			445			(262	)
Other than temporary impairment on AFS		—			(700	)		700
Service charges on deposit accounts		1,242			1,239			3
Interchange fees, net		795			655			140
Bank owned life insurance		589			603			(14	)
Other		775			527			248

Total	$	4,679		$	4,307		$	372

Gains on sales of SBA loans increased $0.1 million as a result of increased volume. We continue to focus on our SBA lending and hired a Director of SBA Lending in January 2018 to lead and enhance our efforts.

Loss on sale of investments for the nine months ended September 30, 2018 compared to gains in the same period in 2017 relate to losses of $0.9 million from an available-for-sale investment portfolio restructure which was partially offset by gain on sale of $0.4 million of Visa Class B shares held with a zero cost basis.

Equity securities gains declined $0.3 million for the nine months ended September 30, 2018, compared to the same period in 2017, due to declines in market valuation.

Other than temporary impairment on AFS securities for the nine months ended September 30, 2017 relates to the full impairment of our investment in subordinated debt issued by the holding company of a bank that subsequently failed.

Interchange fees increased $0.1 million for the nine months ended September 30, 2018, compared to the same period in 2017, primarily as of the Chattahoochee acquisition in October 2017.

Other noninterest income increased $0.2 million for the three months ended September 30, 2018, compared to the same period in 2017, as a result of SBIC earnings.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the nine months ended September 30, 2018 and 2017:

	Nine Months Ended September 30,
	2018		2017		Change
	(Dollars in thousands)
Compensation and employee benefits	$	17,151	$	14,859	$	2,292
Net occupancy		3,342		2,851		491
Federal deposit insurance		618		379		239
Professional and advisory		1,023		929		94
Data processing		1,607		1,215		392
Marketing and advertising		671		727		(56	)
Merger-related expenses		564		972		(408	)
Net cost of operation of REO		202		94		108
Other		2,925		2,947		(22	)

Total noninterest expenses	$	28,103	$	24,973	$	3,130

Compensation and employee benefits increased $2.3 million, or 15.4%, for the nine months ended September 30, 2018 as compared to the same period in 2017. This additional expense is related to increases in our number of employees primarily as a result our Chattahoochee acquisition in October 2017, annual raises, employee benefits, incentives and commissions.

The increases in net occupancy and data processing of $0.5 million and $0.7 million, respectively, for the nine months ended September 30, 2018, as compared to the same period in 2017 primarily as a result of our Chattahoochee acquisition in October 2017.

Federal deposit insurance increased $0.2 million for the nine months ended September 30, 2018, as compared to 2017, due to a reduction in premium credits based on a decline in certain regulatory ratios as a result of acquisition activity.

Net cost of operation of REO increased $0.1 million for the nine months ended September 30, 2018, as compared to 2017, primarily as the result of $0.2 million gain on sale of REO partially offset by a $0.1 million REO write-down.

Income Taxes. We recorded $2.3 million of income tax expense for the nine months ended September 30, 2018, compared to $2.5 million for the same period in 2017. Income tax expense for the 2018 period benefitted from the newly enacted federal tax rate of 21% compared to a federal tax rate of 35% in 2017. In addition, income tax expense for the nine months ending September 30, 2018 and 2017 benefitted from tax-exempt income related to municipal bond investments and BOLI income resulting in effective tax rates of 18.6% and 29.6%, respectively.

We continue to have unutilized net operating losses for federal and state income tax purposes and do not have a material current tax liability or receivable.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, proceeds from the sale of loans originated for sale, and principal repayments and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee (“ALCO”), under the direction of our Chief Financial Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of September 30, 2018.

We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and FRB interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At September 30, 2018, cash and cash equivalents totaled $117.3 million. Included in this total was $91.0 million held at the FRB and $2.1 million held at the FHLB in interest-earning accounts.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our consolidated statements of cash flows included in our unaudited consolidated financial statements of this Form 10-Q. The following summarizes the most significant sources and uses of liquidity during the nine months ended September 30, 2018 and 2017:

	Nine Months Ended September 30,
	2018			2017
	(Dollars in thousands)
Operating activities:
Loans originated for sale	$	(36,982	)	$	(35,718	)
Proceeds from loans originated for sale		38,159			36,548

Investing activities:
Purchases of investments	$	(107,204	)	$	(127,989	)
Maturities and principal repayments of investments		32,832			35,009
Sales of investments		54,174			92,316
Net increase in loans		(62,647	)		(71,578	)
Net cash received in branch acquisition		—			146,750
Proceeds from sale of real estate owned		410			1,475
Purchase of fixed assets		(3,551	)		(594	)
Purchase of SBIC Holdings, at cost		(118	)		(1,435	)
Redemption of other investments, at cost		425			3,053

Financing activities:
Net increase in deposits	$	92,614		$	19,384
Net increase in other borrowings		773			5,863
Proceeds from FHLB advances		255,500			808,501
Repayment of FHLB advances		(265,500	)		(873,501	)

At September 30, 2018, we had $31.9 million in outstanding commitments to originate loans. In addition to commitments to originate loans, we had $174.6 million in unused lines of credit.

Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of September 30, 2018.

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

Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have borrowing agreements with the FHLB and the FRB discount window, and a revolving credit line with NexBank SSB. The following summarizes our borrowing capacity as of September 30, 2018:

	Total		Used		Unused
(Dollars in thousands)	Capacity		Capacity		Capacity
FHLB	$	258,541	$	213,500	$	45,041
Unpledged Marketable Securities		30,360		—		30,360
Fed funds lines		15,000		—		15,000
FRB		46,757		—		46,757
NexBank		15,000		5,000		10,000
	$	365,658	$	218,500	$	147,158

In July 2013, the Board of Governors of the Federal Reserve System and the FDIC issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019. When the Basel III rules are fully phased in on January 1, 2019, the Company and the Bank will be required to maintain a 2.5% capital conservation buffer that is in addition to the minimum required risk-weighted asset ratios and is to absorb losses during periods of economic distress. This capital conservation buffer is comprised entirely of common equity Tier 1 capital.

The Bank is subject to various regulatory capital requirements, including a risk-based guidelines and framework under prompt corrective action provisions that calculate risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories.

Under the Basel III rules: (i) Tier 2 capital is not limited to the amount of Tier 1 capital included in total capital. (ii) mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period, and (iii) common equity Tier 1 capital includes AOCI (which includes all unrealized gains and losses on AFS debt securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, AOCI is not included in the Bank’s Tier 1 capital.

The tables below summarize capital ratios and related information in accordance with the Basel III rules as measured at September 30, 2018 and December 31, 2017.

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

	Actual					For Capital Adequacy Purposes⁽¹⁾				To Be Well- Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio			Amount		Ratio		Amount		Ratio
As of September 30, 2018:
Tier 1 Leverage Capital	$	147,947		9.14	%	$	64,749		>4%	$	80,936		>5%
Common Equity Tier 1 Capital	$	147,947		12.63	%	$	74,703		>6.375%	$	76,168		>6.5%
Tier 1 Risk-based Capital	$	147,947		12.63	%	$	92,780		>7.875%	$	93,745		>8%
Total Risk-based Capital	$	159,794		13.64	%	$	115,716		>9.875%	$	117,181		>10%

As of December 31, 2017:
Tier 1 Leverage Capital	$	136,280		8.79	%	$	61,994		>4%	$	77,492		>5%
Common Equity Tier 1 Capital	$	136,280		11.92	%	$	65,729		>5.75%	$	74,303		>6.5%
Tier 1 Risk-based Capital	$	136,280		11.92	%	$	82,876		>7.25%	$	91,450		>8%
Total Risk-based Capital	$	147,266		12.88	%	$	105,739		>9.25%	$	114,312		>10%

(1)

As of September 30, 2018, includes capital conservation buffer of 1.875%. On a fully phased in basis, effective January 1, 2019, under Basel III, minimum capital ratios to be considered “adequately capitalized” including the capital conservation buffer of 2.5% will be as follows: Tier 1 Leverage Capital – 4.0%; Common Equity Tier 1 Capital – 7.0%; Tier 1 Risk-based Capital – 8.5%; and Total Risk-based Capital – 10.5%.

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

	Actual					For Capital Adequacy Purposes⁽¹⁾
(Dollars in thousands)	Amount		Ratio			Amount		Ratio
As of September 30, 2018:
Tier I Leverage Capital	$	147,195		9.09	%	$	64,789		>4%
Common Equity Tier 1 Capital	$	132,762		11.32	%	$	74,779		>6.375%
Tier I Risk-based Capital	$	147,195		12.55	%	$	92,374		>7.875%
Total Risk Based Capital	$	159,042		13.56	%	$	115,834		>9.875%

As of December 31, 2017:
Tier I Leverage Capital	$	134,470		8.68	%	$	61,967		>4%
Common Equity Tier 1 Capital	$	120,861		10.57	%	$	65,775		>5.75%
Tier I Risk-based Capital	$	134,470		11.76	%	$	82,934		>7.25%
Total Risk Based Capital	$	145,457		12.72	%	$	105,812		>9.25%

(1)

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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

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

•

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

•

limited the fixed rate period on loans within our portfolio;

•

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

•

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

•

engaged in interest rate swap agreements; and

•

utilized FHLB advances for positioning.

We have not conducted speculative hedging activities, such as engaging in futures or options.

Economic Value of Equity (“EVE”)

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

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

Net Interest Income

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

The table below reflects the impact of an immediate increase in interest rates in 100 basis point increments on Pretax Net Interest Income (“NII”) and EVE.

		September 30, 2018						December 31, 2017
Change in Interest Rates (basis points)		% Change in Pretax Net Interest Income			% Change in Economic Value of Equity			% Change in Pretax Net Interest Income			% Change in Economic Value of Equity
	+400		(1.9	)		(2.1	)		(3.5	)		(1.7	)
	+300		(1.2	)		(1.6	)		(2.3	)		(1.5	)
	+200		(0.7	)		(1.2	)		(1.2	)		(1.5	)
	+100		(0.2	)		(1.4	)		(0.4	)		(1.4	)
	—		—			—			—			—
	-100		(2.2	)		4.8			(3.2	)		3.6

The results from the rate shock analysis on NII are consistent with having a slightly liability sensitive balance sheet. Having a liability sensitive balance sheet means liabilities will reprice at a faster pace than assets during the short-term horizon. The implications of a liability sensitive balance sheet will differ depending upon the change in market rates. For example, with a liability sensitive balance sheet in a declining interest rate environment, the interest rate on liabilities will decrease at a faster pace than assets. This situation generally results in an increase in NII and operating income. Conversely, with a liability sensitive balance sheet in a rising interest rate environment, the interest rate on liabilities will increase at a faster pace than liabilities. This situation generally results in a decrease in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 0.7% decrease in NII as of September 30, 2018 as compared to a 1.2% decrease in NII as of December 31, 2017, suggesting that there is no benefit for the Company to net interest income in rising interest rates. The Company generally seeks to remain neutral to the impact of changes in interest rates by maximizing current earnings while balancing the risk of changes in interest rates.

The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has decreased slightly from December 31, 2017 to September 30, 2018. For example, as indicated in the table above, a 200 basis point increase in rates would result in a 1.2% decrease in EVE as of September 30, 2018 as compared to a 1.5% decrease in EVE as of December 31, 2017.

Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2018. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer each concluded that as of September 30, 2018, the end of the period covered by this Form 10-Q, the Company maintained effective disclosure controls and procedures.

Changes in Internal Control over Financial Reporting

There have been no changes to the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of operations, we are often involved in legal proceedings. In the opinion of management, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the quarter ended September 30, 2018.

Item 1A. Risk Factors

There have been no material changes to the risk factors that we have previously disclosed in the “Risk Factors” section in our 2017 Form 10-K as filed with the SEC on March 16, 2018.

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

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit No.	Description

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

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

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

101	Financial Statements filed in XBRL format.

SIGNATURES

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

Date: November 8, 2018	Entegra Financial Corp.

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

EXHIBIT INDEX

Exhibit No.	Description

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

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

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

101	Financial Statements filed in XBRL format.

	* This exhibit is furnished herewith and shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of the Exchange Act.

Entegra Financial Corp. - FORM 10-Q - November 8, 2018

Attached files

Entegra Financial Corp. Reports