UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the Quarterly Period Ended March 31, 2017

OR

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

Commission file number 001-10897  

 

Carolina Financial Corporation

(Exact name of registrant as specified in its charter) 

 
Delaware   57-1039673
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
288 Meeting Street, Charleston, South Carolina   29401
(Address of principal executive offices)   (Zip Code)

 

843-723-7700
(Registrant’s telephone number, including area code)

 

Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)

 

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

 

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

 

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

 
Large accelerated filer o Accelerated filer x
Non-accelerated filer o   (Do not check if a smaller reporting company) Smaller Reporting Company o
    Emerging growth company o

 

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

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 16,149,802 shares of common stock, par value $0.01 per share, were issued and outstanding as of May 5, 2017.

 
 

TABLE OF CONTENTS

 

    Page
PART 1 – FINANCIAL INFORMATION  
     
Item 1. Financial Statements 3
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 47
     
Item 3. Quantitative and Qualitative Disclosure about Market Risks 73
     
Item 4. Controls and Procedures 73
     
PART II -     OTHER INFORMATION 73
     
Item 1. Legal Proceedings 73
     
Item 1A. Risk Factors 73
     
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds 74
     
Item 3. Defaults Upon Senior Securities 74
     
Item 4. Mine Safety Disclosures 74
     
Item 5. Other Information 74
     
Item 6. Exhibits 74
2
 

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

3
 

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

See accompanying notes to consolidated financial statements.

4
 

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

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements.

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

7
 

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

 

See accompanying notes to consolidated financial statements.

8
 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

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

At March 31, 2017, statutory business trusts (“Trusts”) created or acquried by the Company had outstanding trust preferred securities with a balance of $23.3 million. The principal assets of the Trusts are the Company’s subordinated debentures with identical rates of interest and maturities as the trust preferred securities. The Trusts have issued $806,000 of common securities to the Company and are included in other investments in the accompanying consolidated balance sheets. The Trusts are not consolidated subsidiaries of the Company.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 as filed with the Securities and Exchange Commission on March 10, 2017. There have been no significant changes to the accounting policies as disclosed in the Company’s Form 10-K.

Management’s Estimates

The financial statements are prepared in accordance with GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, including valuation for impaired loans, the valuation of real estate acquired in connection with foreclosure or in satisfaction of loans, the valuation of securities, the valuation of derivative instruments, the valuation of assets acquired and liabilities assumed in business combinations, the valuation of mortgage servicing rights, the determination of the reserve for mortgage loan repurchase losses, asserted and unasserted legal claims and deferred tax assets or liabilities. In connection with the determination of the allowance for loan losses and foreclosed real estate, management obtains independent appraisals for significant properties. Management must also make estimates in determining the estimated useful lives and methods for depreciating premises and equipment.

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

9
 

Earnings Per Share

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

Subsequent Events

Subsequent events are material events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the statement of financial condition but arose after that date. Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred requiring accrual or disclosure except as follows:

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

Reclassification

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

Recently Issued Accounting Pronouncements

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

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

In January 2016, the FASB amended the Financial Instruments topic of the ASC to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

  10  
 

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

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows become effective as of January 1, 2017. In addition to other changes, the guidance changes the accounting for excess tax benefits and tax deficiencies from generally being recognized in additional paid-in capital to recognition as income tax expense or benefit in the period they occur. For public business entities, the amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company adopted the new guidance in the second quarter of 2016. These amendments did not have a material impact to the Company’s financial position, results of operations, and cash flows.

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is evaluating the effect that implementation of the new standard will have on its financial position, results of operation and cash flows.

In August 2016, the FASB amended the Statement of Cash Flows topic of the ASC to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

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

  11  
 

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

In November 2016, the FASB amended the Statement of Cash Flows topic of the ASC to clarify how restricted cash is presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. Early adoption is permitted. These amendments did not have a material effect on the Company’s financial statements.

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

In December 2016, the FASB issued technical corrections and improvements to the Revenue from Contracts with Customers Topic of the ASC. These corrections make a limited number of revisions to several pieces of the revenue recognition standard issued in 2014. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2017, the FASB issued guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendment to the Business Combinations Topic is intended to address concerns that the existing definition of a business has been applied too broadly and has resulted in many transactions being recorded as business acquisitions that in substance are more akin to asset acquisitions. The guidance will be effective for the Company for [reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

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

 

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

 

In February 2017, the FASB amended the Other Income Topic of the Accounting Standards Codification to clarify the scope of the guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2017, the FASB amended the requirements in the Receivables—Nonrefundable Fees and Other Costs Topic of the Accounting Standards Codification related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements .

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

 

12
 

NOTE 2 – BUSINESS COMBINATIONS

Acquisition of Greer Bancshares Incorporated

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

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

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

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

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

Explanation of fair value adjustments:

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

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

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

14
 

Supplemental Pro Forma Information - Unaudited

 

The table below presents supplemental pro forma information as if the Greer acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2016. Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger. Therefore, the pro forma financial information is not indicative of the results of operations that would have occurred had the transactions been effected on the assumed date. Pre-tax merger-related costs of $1.3 million for the three months ended March 31, 2017, are included in the Company’s consolidated statements of operations and are not included in the pro forma statements below. Net interest income and net income recorded from the merger date to March 31, 2017 was approximately $520,000 and $403,000, respectively.

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

(a) Supplemental pro forma net income includes the impact of certain fair value adjustments. Supplemental pro forma net income does not include assumptions on cost saves or impact of merger related expenses.

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

Acquisition of Congaree Bancshares, Inc.

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

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

Common stock issued (508,910 shares at $16.80 per share)   $ 8,557  
Cash payments to common stockholders     5,724  
Preferred shares assumed and redeemed at par     1,564  
Fair value of Congaree stock options assumed - paid out in cash     439  
Total consideration paid   $ 16,284  
15
 

The following table presents the Congaree assets acquired and liabilities assumed as of June 11, 2016 as well as the related fair value adjustments and determination of goodwill. There have been no adjustments to initial fair values recorded by the Company for the Congaree acquisition to date.

    As Reported by
Congaree 		    Fair Value
Adjustments 		    As Recorded by the
Company 		 
    (In thousands)  
Assets                        
Cash and cash equivalents   $ 11,394       —       11,394  
Securities     9,453       (59 ) (a)     9,394  
Loans     78,712       (4,111 ) (b)     74,601  
Allowance for loan losses     (1,112 )     1,112 (c)     —  
Premises and equipment     2,712       38 (d)     2,750  
Foreclosed assets     1,710       (250 ) (e)     1,460  
Core deposit intangible     —       1,104 (f)     1,104  
Deferred tax asset     1,813       915 (g)     2,728  
Other assets     942       (152 ) (h)     790  
Total assets acquired   $ 105,624       (1,403 )     104,221  
                         
Liabilities                        
Deposits   $ 89,227       98 (i)     89,325  
Borrowings     2,500       —       2,500  
Other liabilities     378       —       378  
Total liabilities assumed   $ 92,105       98       92,203  
Net assets acquired                     12,018  
Total consideration paid                     16,284  
Goodwill                   $ 4,266  
 
Explanation of fair value adjustments:
(a) Adjustment reflects opening fair value of securities portfolio, which was established as the new book basis of the portfolio.
(b) Adjustment reflects the fair value adjustment based on the Company’s third party valuation report.
(c) Adjustment reflects the elimination of Congaree’s historical allowance for loan losses.
(d) Adjustment reflects fair value adjustments on acquired branch and administrative offices.
(e) Adjustment reflects the fair value adjustment based on the Company’s evaluation of the foreclosed assets.
(f) Adjustment reflects the fair value adjustment to record the estimated core deposit intangible based on the Company’s third party valuation report.
(g) Adjustment reflects the tax impact of acquisition accounting fair value adjustments.
(h) Adjustment reflects the fair value adjustment based on the Company’s evaluation of acquired other assets.
(i) Adjustment reflects the fair value adjustment based on the Company’s third party evaluation report on deposits assumed.
16
 

NOTE 3 – SECURITIES

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

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

The Company had no held-to-maturity securities as of March 31, 2017 or December 31, 2016. During the second quarter of 2016, the Company tainted its securities held-to-maturity portfolio as a result of a change in the intent to hold these securities until maturity to provide opportunities to maximize its asset utilization. As a result, the securities were moved to available-for-sale resulting in an increase to accumulated other comprehensive income of $655,000.

The amortized cost and fair value of debt securities by contractual maturity at March 31, 2017 follows:

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

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

17
 

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

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

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

At March 31, 2017, the Company has pledged $77.6 million of securities to secure public agency funds.

The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at March 31, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

    At March 31, 2017  
    Less than 12 Months     12 Months or Greater     Total  
    Amortized     Fair     Unrealized     Amortized     Fair     Unrealized     Amortized     Fair     Unrealized  
    Cost     Value     Losses     Cost     Value     Losses     Cost     Value     Losses  
                      (In thousands)                    
Available-for-sale:                                                                      
Municipal securities   $ 37,685       37,025       (660 )     —       —       —       37,685       37,025       (660 )
US government agencies     7,129       7,091       (38 )     —       —       —       7,129       7,091       (38 )
Collateralized loan obligations     19,500       19,468       (32 )     8,500       8,469       (31 )     28,000       27,937       (63 )
Mortgage-backed securities:                                                                        
Agency     62,055       61,586       (469 )     9,672       9,554       (118 )     71,727       71,140       (587 )
Non-agency     10,660       10,475       (185 )     8,214       8,142       (72 )     18,874       18,617       (257 )
Total mortgage-backed securities     72,715       72,061       (654 )     17,886       17,696       (190 )     90,601       89,757       (844 )
Trust preferred securities     —       —       —       10,001       6,346       (3,655 )     10,001       6,346       (3,655 )
Total   $ 137,029       135,645       (1,384 )     36,387       32,511       (3,876 )     173,416       168,156       (5,260 ) 
18
 
    At December 31, 2016
    Less than 12 Months     12  Months or Greater     Total  
    Amortized     Fair     Unrealized     Amortized     Fair     Unrealized     Amortized     Fair     Unrealized  
    Cost     Value     Losses     Cost     Value     Losses     Cost     Value     Losses  
                      (In thousands)                    
Available-for-sale:                                                                      
Municipal securities   $ 40,479       39,424       (1,055 )     —       —       —       40,479       39,424       (1,055 )
US government agencies     3,438       3,386       (52 )     —       —       —       3,438       3,386       (52 )
Collateralized loan obligations     16,792       16,748       (44 )     8,500       8,453       (47 )     25,292       25,201       (91 )
Mortgage-backed securities:                                                                        
Agency     33,323       32,960       (363 )     10,125       10,002       (123 )     43,448       42,962       (486 )
Non-agency     9,357       9,240       (117 )     8,801       8,730       (71 )     18,158       17,970       (188 )
Total mortgage-backed securities     42,680       42,200       (480 )     18,926       18,732       (194 )     61,606       60,932       (674 )
Trust preferred securities     1,362       1,112       (250 )     8,667       4,333       (4,334 )     10,029       5,445       (4,584 )
Total   $ 104,751       102,870       (1,881 )     36,093       31,518       (4,575 )     140,844       134,388       (6,456 ) 
                                                                         

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

As of March 31, 2017, trust preferred securities had an amortized cost of $11.2 million and a fair value of $8.4 million. For each trust preferred security, impairment testing is performed on a quarterly basis using a detailed cash flow analysis. The major assumptions used during the quarterly impairment testing are described in the subsequent paragraph.

19
 

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

Based on the cash flow analysis performed at period end, management believes that there are no additional securities other-than-temporarily impaired at March 31, 2017.

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

 

At March 31, 2017 and December 31, 2016, the Company had 96 and 81, respectively, individual investments available-for-sale that were in an unrealized loss position. The unrealized losses on the Company’s investments in US government-sponsored agencies, municipal securities, mortgage-backed securities (agency and non-agency), and trust preferred securities summarized above were attributable primarily to changes in interest rates. Management has performed various analyses, including cash flows as needed, and determined that no OTTI expense was necessary during 2017 or 2016.

Management believes that there are no additional securities other-than-temporarily impaired at March 31, 2017. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost. Management continues to monitor these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of the securities may be sold or are other-than-temporarily impaired, which would require a charge to earnings in such periods.

20
 

NOTE 4 – DERIVATIVES

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

The derivative positions of the Company at March 31, 2017 and December 31, 2016 are as follows:

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

Non-Designated Hedges

 

Derivative Loan Commitments and Forward Sales Commitments

 

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

 

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

21
 

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

 

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

 

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

 

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

 

Interest Rate Swaps

 

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

 

Cash Flow Hedges of Interest Rate Risk

 

The Company’s objectives in using certain interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

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

22
 

Risk Management Objective of Using Derivatives

 

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

NOTE 5 - LOANS RECEIVABLE, NET

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

 

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

 

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

 

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

 

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

23
 

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

 

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

 

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

 

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

 

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

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

Included in the loan totals were $303.2 million and $119.4 million in loans acquired through acquisitions at March 31, 2017 and December 31, 2016, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with ASC 310-30 and are considered purchased credit impaired (“PCI”) loans. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20.

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

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

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

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

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

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

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

Allowance for loan losses:   For the Three Months Ended March 31, 2017
    Loans Secured by Real Estate                          
    One-to-           Commercial     Construction                          
    four     Home     real     and           Commercial              
    family     equity     estate     development     Consumer     business     Unallocated     Total  
                      (In thousands)                    
Balance, beginning of period   $  2,636       197       3,344       1,132       80       2,805       494       10,688  
Provision for loan losses     (114 )     39       244       (190 )     35       (329 )     315       —  
Charge-offs     (17 )     —       —       —       (9 )     —       —       (26 )
Recoveries     1       —       25       1       4       22       —       53  
Balance, end of period   $ 2,506       236       3,613       943       110       2,498       809       10,715  
                                                                 
    For the Three Months Ended March 31, 2016  
    Loans Secured by Real Estate                          
    One-to-           Commercial     Construction                          
    four     Home     real     and           Commercial              
    family     equity     estate     development     Consumer     business     Unallocated     Total  
    (In thousands)    
Balance, beginning of period   $ 2,903       151       3,402       1,138       27       2,100       420       10,141  
Provision for loan losses     (98 )     1       (37 )     90       (2 )     66       (20 )     —  
Charge-offs     —       —       —       —       (2 )     —       —       (2 )
Recoveries     58       —       —       3       6       27       —       94  
Balance, end of period   $ 2,863       152       3,365       1,231       29       2,193       400       10,233  
26
 

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

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

The following table presents impaired loans individually evaluated for impairment in the segmented portfolio categories and the corresponding allowance for loan losses as of March 31, 2017 and December 31, 2016. The recorded investment is defined as the original amount of the loan, net of any deferred costs and fees, less any principal reductions and direct charge-offs. Unpaid principal balance includes amounts previously included in charge-offs.

    At March 31, 2017     At December 31, 2016  
          Unpaid                 Unpaid        
    Recorded     Principal     Related     Recorded     Principal     Related  
    Investment     Balance     Allowance     Investment     Balance     Allowance  
    (In thousands)
With no related allowance recorded:                                                
Loans secured by real estate:                                                
One-to-four family   $ 3,833     4,073     —     4,125     4,366     —  
Home equity     839       839       —       —       —       —  
Commercial real estate     4,041       4,041       —       4,011       4,011       —  
Construction and development     491       491       —       507       507       —  
Consumer loans     19       19       —       24       24       —  
Commercial business loans     36       37       —       258       258       —  
      9,259       9,500       —       8,925       9,166       —  
                                                 
With an allowance recorded:                                                
Loans secured by real estate:                                                
One-to-four family     627       627       43       543       543       27  
Home equity     275       275       54       108       108       29  
Commercial real estate     1,014       1,014       48       1,236       1,236       92  
Construction and development     —       —       —       —       —       —  
Consumer loans     —       —       —       —       —       —  
Commercial business loans     211       211       23       9       9       9  
      2,127       2,127       168       1,896       1,896       157  
                                                 
Total:                                                
Loans secured by real estate:                                                
One-to-four family     4,460       4,700       43       4,668       4,909       27  
Home equity     1,114       1,114       54       108       108       29  
Commercial real estate     5,055       5,055       48       5,247       5,247       92  
Construction and development     491       491       —       507       507       —  
Consumer loans     19       19       —       24       24       —  
Commercial business loans     247       248       23       267       267       9  
    $ 11,386       11,627       168       10,821       11,062       157  
28
 

The following table presents the average recorded investment and interest income recognized on impaired loans individually evaluated for impairment in the segmented portfolio categories for the three months ended March 31, 2017 and 2016.

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

A loan is considered past due if the required principal and interest payment has not been received as of the due date. The following schedule is an aging of past due loans receivable by portfolio segment as of March 31, 2017 and December 31, 2016.

    At March 31, 2017
    Real Estate Loans                    
    One-to-           Commercial     Construction                    
    four     Home     real     and           Commercial        
    family     equity     estate     development     Consumer     business     Total  
    (In thousands)
30-59 days past due   $ 1,526     15     1,536     90     181     11     3,359  
60-89 days past due     27       13       —       —       —       —       40  
90 days or more past due     3,123       772       135       491       6       623       5,150  
Total past due     4,676       800       1,671       581       187       634       8,549  
Current     468,088       51,498       538,744       150,157       10,224       189,750       1,408,461  
Total loans receivable   $ 472,764       52,298       540,415       150,738       10,411       190,384       1,417,010  
                                                         
    At December 31, 2016
    Real Estate Loans                    
    One-to-           Commercial     Construction                    
    four     Home     real     and           Commercial        
    family     equity     estate     development     Consumer     business     Total  
    (In thousands)
30-59 days past due   $ 3,864     379     206     62     55     136     4,702  
60-89 days past due     635       497       —       —       3       —       1,135  
90 days or more past due     3,170       108       334       507       26       16       4,161  
Total past due     7,669       984       540       569       84       152       9,998  
Current     403,730       35,042       444,804       115,113       5,630       163,949       1,168,268  
Total loans receivable   $ 411,399       36,026       445,344       115,682       5,714       164,101       1,178,266  
                                                         

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

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

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

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

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

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

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

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

 

The Company uses the following definitions in the tables below:

 

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

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

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

    At March 31, 2017
    Real Estate Loans                    
    One-to-           Commercial Construction                    
    four     Home     real     and           Commercial        
    family     equity     estate     development     Consumer     business     Total  
    (In thousands)
Internal Risk Rating Grades:                                                        
Pass   $ 466,380     50,881     535,087     147,728     10,384     186,113     1,396,573  
Special Mention     1,934       231       2,749       427       20       2,236       7,597  
Substandard     4,450       1,186       2,579       2,583       7       2,035       12,840  
Total loans receivable   $ 472,764       52,298       540,415       150,738       10,411       190,384       1,417,010  
                                                         
Performing   $ 469,666       51,526       538,869       150,247       10,404       190,367       1,411,079  
Nonperforming:                                                        
Nonaccrual     3,098       772       1,546       491       7       17       5,931  
Total nonperforming     3,098       772       1,546       491       7       17       5,931  
Total loans receivable   $ 472,764       52,298       540,415       150,738       10,411       190,384       1,417,010  

    At December 31,2016
    Real Estate Loans                    
    One-to-           Commercial     Construction                    
    four     Home     real     and           Commercial        
    family     equity     estate     development     Consumer     business     Total  
    (In thousands)
Internal Risk Rating Grades:                                          
Pass   $ 407,612     35,903     442,323     114,751     5,683     162,235     1,168,507  
Special Mention     438       15       1,318       424       19       1,849       4,063  
Substandard     3,349       108       1,703       507       12       17       5,696  
Total loans receivable   $ 411,399       36,026       445,344       115,682       5,714       164,101       1,178,266  
                                                         
Performing   $ 408,143       35,918       443,641       115,175       5,687       164,077       1,172,641  
Nonperforming:                                                        
Nonaccrual     3,256       108       1,703       507       27       24       5,625  
Total nonperforming     3,256       108       1,703       507       27       24       5,625  
Total loans receivable   $ 411,399       36,026       445,344       115,682       5,714       164,101       1,178,266  
                                                         

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

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

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Troubled Debt Restructurings

 

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

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

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

NOTE 6 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE

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

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

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

    At March 31,     At December 31,  
    2017     2016  
    (In thousands)  
Real estate loans:                
One-to-four family   $ 239     —  
Construction and development     1,240       1,179  
    $ 1,479       1,179  
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NOTE 7 - DEPOSITS

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

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

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

NOTE 8 – ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

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

 

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

 

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

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

 

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

 

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

 

Level 3

Unobservable inputs that are supported by little, if any, market activity for the asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash

flow models and similar techniques, and may also include the use of market prices of assets or liabilities that are not directly comparable to the subject asset or liability. These methods of valuation may result in a significant portion of the fair value being derived from unobservable assumptions that reflect The Company’s own estimates for assumptions that market participants would use in pricing the asset or liability. This category primarily includes collateral-dependent impaired loans, other real estate, certain equity investments, and certain private equity investments.

 

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

 

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

 

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

 

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

 

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

35
 

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

 

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

 

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

 

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

 

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

 

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

 

Other Investments – The carrying value approximates the fair value.

36
 

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

 

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

 

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

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

 

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

37
 

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

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

 

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

 

39
 

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

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

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

Securities Available-for-Sale  

Measurement is on a recurring basis upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. At March 31, 2017 and December 31, 2016, the Company’s investment securities available-for-sale are recurring Level 2 except for trust preferred securities which are determined to be Level 3.

Mortgage Loans Held for Sale

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

Derivative Assets and Liabilities  

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

40
 

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

Impaired Loans

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

Other Real Estate Owned (“OREO”)

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

Mortgage Servicing Rights

 

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

41
 

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

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

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

    Quoted
market price 		    Significant
other 		    Significant
other 		 
    in active
markets 		    observable
inputs 		    unobservable
inputs 		 
    (Level 1)     (Level 2)     (Level 3)  
    (In thousands)  
March 31, 2017                        
Impaired loans:                        
Loans secured by real estate:                        
One-to-four family   $ —       —       4,417  
Home equity     —       —       1,060  
Commercial real estate     —       —       5,007  
Construction and development     —       —       491  
Consumer loans     —       —       19  
Commercial business loans     —       —       224  
Real estate owned:                        
One-to-four family     —       —       239  
Construction and development     —       —       1,240  
Mortgage servicing rights     —       —       21,933  
Total   $ —       —       34,630  
                         
December 31, 2016                        
Impaired loans:                        
Loans secured by real estate:                        
One-to-four family   $ —       —       4,641  
Home equity     —       —       79  
Commercial real estate     —       —       5,155  
Construction and development     —       —       507  
Consumer loans     —       —       24  
Commercial business loans     —       —       258  
Real estate owned:                        
One-to-four family     —       —       —  
Commercial real estate     —       —       —  
Construction and development     —       —       1,179  
Mortgage servicing rights     —       —       20,961  
Total   $ —       —       32,804  
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For Level 3 assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

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

NOTE 9 - EARNINGS PER SHARE

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

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

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

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

    As of March 31,  
    2017     2016  
Issued and outstanding shares     16,185,408       12,051,615  
Less nonvested restricted stock awards     (227,439 )     (302,028 )
Period end dilutive shares     15,957,969       11,749,587  
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NOTE 10 – SUPPLEMENTAL SEGMENT INFORMATION

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

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

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

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

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

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

 

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

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

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

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

46
 

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

 

The following discussion reviews our results of operations for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016 and assesses our financial condition as of March 31, 2017 as compared to December 31, 2016. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and the related notes and the consolidated financial statements and the related notes for the year ended December 31, 2016 included in our Form 10-K for that period. Results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017 or any future period.

 

Cautionary Warning Regarding Forward-Looking Statements

 

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

 

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

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

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

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

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

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

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

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

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

  · the rate of loan growth in recent or future years;

  · our ability to attract and retain key personnel;

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

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

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

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

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

  · changes occurring in business conditions and inflation;
47
 
  · increased funding costs due to market illiquidity, increased competition for funding, or increased regulatory requirements with regard to funding;

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

  · changes in deposit flows;

  · changes in technology;

  · changes in monetary and tax policies;
  · changes in accounting policies, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the FASB;

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

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

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

  · our liquidity and working capital requirements;

  · competitive pressures among depository and other financial institutions;

  · the growth rates of the markets in which we compete;

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

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

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

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

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

  · management compensation and the methodology for its determination;

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

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

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

 

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

 

If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements prove to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q and our other reports filed pursuant to the Securities Exchange Act of 1934. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed, implied or projected by us in the forward-looking statements.

 

Company Overview

 

 Carolina Financial Corporation is a Delaware corporation holding company registered under the Bank Holding Company Act of 1956, as amended. Its primary business is to serve as the holding company to CresCom Bank, a South Carolina state-chartered bank. CresCom Bank operates Crescent Mortgage Company and Carolina Service Corporation of Charleston as wholly-owned subsidiaries of CresCom Bank. Except where the context otherwise requires, the “Company”, “we”, “us” and “our” refer to Carolina Financial Corporation and its consolidated subsidiaries and the “Bank” refers to CresCom Bank.

 

CresCom Bank provides a full range of commercial and retail banking financial services designed to meet the financial needs of our customers through its branch network in South Carolina and North Carolina. Crescent Mortgage Company, headquartered in Atlanta, Georgia, is a wholesale mortgage company that provides mortgage banking services in 48 states and partners with community banks, credit unions and mortgage brokers.

48
 

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

 

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

 

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

 

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

 

Recent Events

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

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

49
 

Executive Summary of Operating Results

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

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

Non-GAAP Financial Measures

 

Statements included in this management’s discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company’s management uses these non-GAAP financial measures, including: (i) operating earnings; (ii) operating earnings per common share (iii) operating return on average assets, (iv) operating return on average tangible equity, (v) core deposits, (vi) tangible book value and (vii) allowance for loan losses to non-acquired loans.

 

Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company without regard to transactional activities. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.  

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

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

  

(1) Tax expense is determined using the effective tax rate reflected in the accompanying income statement for the applicable reporting period.
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The following table presents a reconciliation of Non-GAAP performance measures of core deposits, tangible book book value per share and acquired and non-acquired loans.

 

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

 

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

 

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

$

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

$

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

$

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

 

There have been no significant changes to our critical accounting policies from those disclosed in our 2016 Annual Report on Form 10-K. Refer to the notes to our consolidated financial statements in our 2016 Annual Report on Form 10-K for a full disclosure of all critical accounting policies.

 

Results of Operations

Summary

The Company reported net income for the three months ended March 31, 2017 of $4.9 million, or $0.35 per diluted share, as compared to $3.6 million, or $0.30 per diluted share, for the three months ended March 31, 2016. Included in net income for the three months ended March 31, 2017 and 2016 were pretax merger related expenses of $1.3 million and $186,000, respectively.

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

Net Interest Income and Margin

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

Net interest income increased to $15.3 million for the three months ended March 31, 2017 from $11.3 million for the three months ended March 31, 2016. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the three months ended March 31, 2017 is primarily the result of increased balances of loans receivable.

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

· On June 11, 2016, the Company acquired approximately $74.6 million of loans, net of purchase accounting adjustments, as part of the acquisition of Congaree. The recorded investment in loans acquired from the Congaree acquisition were $63.9 million as of March 31, 2017.
· On March 18, 2017, the Company acquired approximately $194.7 million of loans, net of purchase accounting adjustments, as part of the acquisition of Greer. The recorded investment in loans acquired from the Greer acquisition were $192.4 million as of March 31, 2017. The recorded investment as of March 31, 2017 for loans acquired in the acquisition of Greer are presented in the following table:

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

· Residential mortgage – In addition to selling a portion of its production, the Company has retained a portion of its mortgage production. Due to management’s emphasis on growing the Company’s residential mortgage portfolio, loans receivable within the one-to-four family portfolio has increased $111.4 million since March 31, 2016. This growth includes loans acquired in the acquisition of Congaree and Greer.
· Commercial lending – The Company continues to expand its commercial lending team in throughout its markets. As a result, gross loans receivable within commercial real estate and construction and development increased $238.9 million since March 31, 2016. This growth includes loans acquired in the acquisition of Congaree and Greer.
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The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the periods indicated (dollars in thousands). We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments were owned at an original maturity of over one year. Nonaccrual loans are included in earning assets in the following tables. Loan yields reflect the negative impact on our earnings of loans on nonaccrual status. The net capitalized loan costs and fees, which are considered immaterial, are amortized into interest income on loans.

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

 

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

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

Provision for Loan Loss

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

Following is a summary of the activity in the allowance for loan losses during the periods ended March 31, 2017 and 2016.

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

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

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

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Noninterest Income and Expense

 

Noninterest income provides us with additional revenues that are significant sources of income. The major components of noninterest income for the three months ended March 31, 2017 and 2016 are presented below:

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

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

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

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

 

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

 

The fair value adjustment on interest rate swaps decreased noninterest income by $58,000 for the three months ended March 31, 2017 compared to a reduction in noninterest income of $281,000 for three months ended March 31, 2016. The change in fair value adjustment on interest rate swaps relates to the change in interest rates from period to period. The Company uses standalone interest rate swaps to more closely match the interest rate characteristics of assets and liabilities and to mitigate the risks arising from timing mismatches between assets and liabilities including duration mismatches.

57
 

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

 

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

Noninterest expense represents the largest expense category for the Company. Noninterest expense increased to $15.6 million for the three months ended March 31, 2017 from $12.3 million for the three months ended March 31, 2016. The increase in noninterest expense for the three months ended March 31, 2017 is primarily the result of an increase in salaries and employee benefits and occupancy and equipment as well as merger related expense related to the acquisition of Greer during the first quarter of 2017. Merger related expenses totaled $1.3 million for the three months ended March 31, 2017 as compared to $186,000 for the three months ended March 31, 2016. In addition, the Company opened a second branch in the Wilmington market during the fourth quarter of 2016.

Income Tax Expense

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

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Balance Sheet Review

 

Securities

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

At March 31, 2017, our securities portfolio, excluding FHLB stock and other investments, was $494.1 million or approximately 22.6% of our assets. Our available-for-sale securities portfolio included US agency securities, municipal securities, collateralized loan obligations, mortgage-backed securities (agency and non-agency), and trust preferred securities with a fair value of $494.1 million and an amortized cost of $493.7 million for a net unrealized gain of $452,000.

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

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

Loans by Type

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Gross loans receivable at March 31, 2017 and December 2016 were $1.4 billion and $1.2 billion, respectively.

Our loan portfolio consists primarily of loans secured by real estate mortgages. As of March 31, 2017, our loan portfolio included $1.2 billion, or 85.8%, of gross loans secured by real estate. As of December 31, 2016, our loan portfolio included $1.0 billion, or 85.6%, of gross loans secured by real estate. Substantially all of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types.

As shown in the table below, gross loans receivable increased $238.7 million since December 31, 2016. The increase in loans receivable primarily relates to the loans acquired in the acquisition of Greer well as the Bank’s focus on growing residential mortgage and commercial lending. The recorded investment in loans acquired in the acquisition of Greer was $192.4 million as of March 31, 2017. For additional information, see the net interest margin discussion above as well as Note 2 “Business Combinations” in the accompanying financial statements.

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

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

Maturities and Sensitivity of Loans to Changes in Interest Rates

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

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

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

Nonperforming and Problem Assets

Nonperforming assets include loans on which interest is not being accrued, accruing loans that are 90 days or more delinquent and foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of a borrower’s loan default. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction of principal when received. In general, a nonaccrual loan may be placed back onto accruing status once the borrower has made a minimum of six consecutive payments in accordance with the loan terms. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. As of March 31, 2017 the Company had $911,000 of PCI loans that were 90 days past due and accruing. At December 31 2016, we had no loans 90 days past due and still accruing.

Troubled Debt Restructurings (“TDRs”)

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

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

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

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

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $5.5 million at March 31, 2017, compared to $5.2 million at December 31, 2016. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.

Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans at March 31, 2017 and December 31, 2016 are collateralized by real estate. The Bank utilizes third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require the Bank to obtain updated appraisals on an annual basis, either through a new external appraisal or an internal appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. Management believes based on information known and available currently, the probable losses related to problem assets are adequately reserved in the allowance for loan losses.

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

Allowance for Loan Losses

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

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

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

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

The allowance for loan losses was $10.7 million, or 0.96% of non-acquired loans, at March 31, 2017, compared to $10.7 million, or 1.01% of total non-acquired loans, at December 31, 2016. Loans acquired in business combinations were $303.2 million and $119.4 at March 31, 2017 and December 31, 2016, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

The table below shows a reconciliation of acquired and non-acquired loans and allowance for loan losses to non-acquired loans:

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

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

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

    For the Three Months  
    Ended March 31,  
    2017     2016  
    (Dollars in thousands)  
Balance, beginning of period   $ 10,688       10,141  
Provision for loan losses     —       —  
Loan charge-offs:                
Loans secured by real estate:                
One-to-four family     (17 )     —  
Home equity     —       —  
Commercial real estate     —       —  
Construction and development     —       —  
Consumer loans     (9 )     (2 )
Commercial business loans     —       —  
Total loan charge-offs     (26 )     (2 )
Loan recoveries:                
Loans secured by real estate:                
One-to-four family     1       58  
Home equity     —       —  
Commercial real estate     25       —  
Construction and development     1       3  
Consumer loans     4       6  
Commercial business loans     22       27  
Total loan recoveries     53       94  
Net loan (charge-offs) recoveries     27       92  
Balance, end of period   $ 10,715       10,233  
                 
Allowance for loan losses as a percentage of loans receivable (end of period)     0.76 %     1.06 %
Net charge-offs (recoveries) to average loans receivable (annualized)     (0.01 )%      (0.04 )%
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Mortgage Operations

Mortgage Activities and Servicing

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

Loan Servicing

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

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

The Company was servicing $2.3 billion loans for others at March 31, 2017 and $2.2 billion at December 31, 2016. Mortgage servicing rights asset had a balance of $15.8 million and $15.0 million at March 31, 2017 and December 31, 2016, respectively. The economic estimated fair value of the mortgage servicing rights was $21.9 million and $21.0 million at March 31, 2017 and December 31, 2016, respectively. The amortization expense related to the mortgage servicing rights was $669,000 and $532,000 during the three months ended March 31, 2017 and 2016, respectively.

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

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

Reserve For Mortgage Repurchase Losses

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

The following table demonstrates the activity for the reserve for mortgage repurchase losses for the three months ended March 31, 2017 and 2016.

 

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

For the three ended March 31, 2017 and 2016, the Company recorded a negative provision for mortgage repurchase losses of $225,000 and $250,000, respectively. The decline in the provision for mortgage loan repurchase losses is related to several factors. The Company sells mortgage loans to various third parties, including government-sponsored entities (“GSEs”), under contractual provisions that include various representations and warranties as previously stated. The Company establishes the reserve for mortgage loan repurchase losses based on a combination of factors, including estimated levels of defects on internal quality assurance, default expectations, historical investor repurchase demand and appeals success rates, reimbursement by correspondent and other third party originators, and projected loss severity. Prior to 2012, there was no expiration date related to representations and warranties as long as the loan sold to the investor was outstanding. As a result, the Company received loan repurchase requests years after the loan was originated and sold to various third parties. In the latter part of 2012, the regulatory framework for certain GSEs changed where, under certain circumstances, the loan repurchase risk was limited for production beginning in January 2013. In addition, in May 2014, additional regulatory changes further limited loan repurchase risk.

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

Deposits

We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. At March 31, 2017 deposits totaled $1.6 billion, an increase of $349.5 million from deposits of $1.3 billion at December 31, 2016. The increase in deposits since December 31, 2016 primarily relates to the $311.1 million in deposits assumed with the completion of the acquisition of Greer on March 18, 2017 as well as continued efforts to increase our core deposits through business development.

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

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

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

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

The followings table outlines our various sources of short-term borrowed funds during the three months ended March 31, 2017 and 2016 and the amounts outstanding at the end of each period, the maximum amount for each component during the periods, the average amounts for each period, and the average interest rate that we paid for each borrowings source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown.

              Maximum              
        Period     Month     Average for the  
    Ending     End     End     Period  
    Balance     Rate     Balance     Balance     Rate  
At or for the three months ended March 31, 2017   (Dollars in thousands)  
Short-term borrowed funds                                        
Short-term FHLB advances   $ 214,500       0.66% - 2.28%       214,500       176,525       0.82 %
                                         
Long-term borrowed funds                                        
Long-term FHLB advances, due 2018 through 2020     32,000       0.69% - 2.71%       32,000       13,894       4.94 %
Subordinated debentures, due 2032 through 2037     23,304       2.77% - 4.25%       26,806       16,644       4.36 % 

 

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

Liquidity

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

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

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Lines of credit with the FHLB of Atlanta are based upon FHLB-approved percentages of Bank assets, but must be supported by appropriate collateral to be available. The Company has pledged first lien residential mortgage, second lien residential mortgage, residential home equity line of credit, commercial mortgage and multifamily mortgage portfolios under blanket lien agreements. At March 31, 2017, the Company had FHLB advances of $246.5 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately $194.5 million. Lines of credit with the FRB are based on collateral pledged.

Lines of credit with the FRB are based on collateral pledged. At March 31, 2017 the Company had lines available with the FRB for $152.1 million. At March 31, 2017 the Company had no FRB advances outstanding.

Capital Resources   

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

 

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

 

The required minimum ratios are as follows:

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

 

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

 

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

 

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

  

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

 

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

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

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

 

At March 31, 2017, we had issued commitments to extend credit and standby letters of credit of approximately $144.6 million through various types of lending arrangements.  There were 47 standby letters of credit included in the commitments for $3.5 million. Total fixed rate commitments were $27.6 million and variable rate commitments were $117.0 million.

 

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

 

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

Market Risk Management and Interest Rate Risk

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

71
 

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

As of March 31, 2017, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market condition

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

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

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

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

72
 

Accounting, Reporting, and Regulatory Matters

Information regarding recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of the financial information by the Company are included in Note 1 “Summary of Significant Accounting Polices” in the accompanying financial statements.

Effect of Inflation and Changing Prices

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

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .

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

Item 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting during the three months ended March 31, 2017, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

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

Item 1A RISK FACTORS.

Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A of our Annual Report on Form 10-K for fiscal years ended December 31, 2016, as well as cautionary statements contained in this Form 10-Q, including those under the caption “Cautionary Note Regarding Any Forward-Looking Statements” set forth in Part I, Item 2 of this Form 10-Q, risks and matters described elsewhere in this Form 10-Q and in our other filings with the SEC.

73
 

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

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

Item 3. DEFAULTS UPON SENIOR SECURITIES.

Not applicable

Item 4. MINE SAFETY DISCLOSURES.

Not applicable

Item 5. OTHER INFORMATION.

Not applicable

Item 6. EXHIBITS.

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

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SIGNATURES

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

 
    CAROLINA FINANCIAL CORPORATION
    Registrant
     
Date: May 5, 2017   /s/ Jerold L. Rexroad  
    Jerold L. Rexroad
    President and Chief Executive Officer
    (Principal Executive Officer)
     
Date: May 5, 2017   /s/ William A. Gehman, III  
    William A. Gehman III
    Executive Vice President and Chief Financial Officer
    (Principal Financial and Accounting Officer)
75
 

INDEX TO EXHIBITS

 
Exhibit
Number 		  Description
2.1   Agreement and Plan of Merger by and between Carolina Financial Corporation, CBAC, Inc., and Congaree Bancshares, Inc., dated January 5, 2016. (1)
     
2.2   Agreement and Plan of Merger by and between Carolina Financial Corporation and Greer Bancshares Incorporated, dated November 7, 2016. (2)
     
4.1   Restated Certificate of Incorporation. (3)
     
4.2   Amendment to the Restated Certificate of Incorporation. (4)
     
4.3   Amended and Restated Bylaws. (5)
     
4.4   Specimen Common Stock Certificate. (6)
     
4.5   See Exhibits 4.1, 4.2, and 4.3 for provisions of the Restated Certificate of Incorporation and Amended and Restated Bylaws which define the rights of the stockholders.
     
31.1   Rule 13a-14(a) Certification of the Principal Executive Officer.  
     
31.2   Rule 13a-14(a) Certification of the Principal Financial Officer.  
     
32   Section 1350 Certifications.
     
101   The following materials from the Quarterly Report on Form 10-Q of Carolina Financial Corporation for the quarter ended March 31, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements.

 

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

 

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