10-K 1 form10k.htm ASB BANCORP, INC 10-K 12-31-2016

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K
(Mark one)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
 
OR
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: 001-35279

 
ASB BANCORP, INC.
 
 
(Exact name of registrant as specified in its charter)
 

North Carolina
 
45-2463413
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)

11 Church Street, Asheville, North Carolina
 
28801
(Address of principle executive offices)
 
(Zip code)

 
 (828) 254-7411
 
 
 (Registrant’s telephone number, including area code)
 

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share
 
The NASDAQ Global Market
(Title of each class)
 
(Name of each exchange on which registered)
 
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ☐  No ☒
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐ No ☒
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files) Yes ☒  No ☐
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
 
 
Large accelerated filer
 
Accelerated filer
 
Non-accelerated filer
 
Smaller reporting company
 
(Do not check if a smaller reporting company)
     

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐ No ☒
 
As of June 30, 2016, the aggregate market value of the voting and non-voting common equity held by non-affiliates was $82,676,820.
 
There were 3,788,025 shares of the registrant’s common stock, par value $0.01 per share, issued and outstanding as of February 28, 2017.

Documents Incorporated by Reference:
 
Portions of the proxy statement for the registrant’s 2017 annual meeting of shareholders are incorporated by reference into Part III of this Form 10-K.
 


ASB BANCORP, INC.
FORM 10-K
Table Of Contents
 
Item
 
 Begins On
 Page
     
Part I
     
Item 1.
2
Item 1A.
24
Item 1B.
33
Item 2.
34
Item 3.
35
Item 4.
35
     
Part II
     
Item 5.
35 
Item 6.
38
Item 7.
40 
Item 7A.
74
Item 8.
76
Item 9.
136 
Item 9A.
137
Item 9B.
140
     
Part III
     
Item 10.
140
Item 11.
140
Item 12.
140 
Item 13.
140
Item 14.
140
     
Part IV
     
Item 15.
141
     
 
143

This statement has not been reviewed, or confirmed for accuracy or relevance,
by the Federal Deposit Insurance Corporation.
 
A Caution About Forward-Looking Statements

This Annual Report on Form 10-K, 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:

 
general economic conditions, either nationally or in our primary market area, that are worse than expected;
a decline in real estate values;
changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;
increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits;
legislative, regulatory or supervisory changes that adversely affect our business;
adverse changes in the securities markets;
increased cybersecurity risk, including potential business disruptions or financial losses;
changes in technology;
our ability to attract and retain personnel; and
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board or the Public Company Accounting Oversight Board.
 
 Any of the forward-looking statements that we make in this report and in other public statements we make may later prove incorrect because of inaccurate assumptions, the factors illustrated above or other factors that we cannot foresee. Consequently, no forward-looking statement can be guaranteed.

Additional factors that may affect our results are discussed below in Item 1A. “Risk Factors” and in other reports filed with the Securities and Exchange Commission. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, ASB Bancorp, Inc. does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
 
Part I

Item 1.
Business

General

ASB Bancorp, Inc. – ASB Bancorp, Inc. (“ASB Bancorp” or the “Company”), a North Carolina corporation, was incorporated in May 2011 to be the holding company for Asheville Savings Bank (“Asheville Savings” or the “Bank”) upon the completion of the Bank’s conversion from the mutual to the stock form of ownership on October 11, 2011. Before the completion of the conversion, the Company did not engage in any significant activities other than organizational activities. The Company’s principal business activity is the ownership of the outstanding shares of common stock of the Bank. The Company does not own or lease any real property, but instead uses the premises, equipment and other property of the Bank, with the payment of appropriate rental fees, as required by applicable laws and regulations, under the terms of an expense allocation agreement entered into with the Bank. The Company and the Bank also entered into an income tax allocation agreement that provides for the filing of a consolidated federal income tax return and formalizes procedures for the payment and allocation of federal income taxes between the Company and the Bank.

Asheville Savings Bank – Founded in 1936, the Bank is a North Carolina chartered savings bank headquartered in Asheville, North Carolina. We operate as a community-oriented financial institution offering traditional financial services to consumers and businesses in our primary market area. We attract deposits from the general public and use those funds to originate primarily one-to-four family residential mortgage loans and commercial real estate loans, and, to a lesser extent, home equity loans and lines of credit, consumer loans, construction and land development loans, and commercial and industrial loans. We conduct our lending and deposit activities primarily with individuals and small businesses in our primary market area.

Our primary market area is Asheville, North Carolina and the rest of Buncombe County where we have eight branch offices, as well as Henderson, Madison, McDowell and Transylvania Counties where we have five branch offices.

Availability of Information

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on the Company’s website, http://ir.ashevillesavingsbank.com, as soon as reasonably practicable after the Company electronically files such reports with, or furnishes them to, the Securities and Exchange Commission (the “SEC”). The information on the Company’s website shall not be considered as incorporated by reference into this Annual Report on Form 10-K.

Personnel

At December 31, 2016, the Company had 155 full-time equivalent employees, none of whom is represented by a collective bargaining unit. We believe our relationships with our employees are good.
 
Operating Strategy

Our primary objective is to operate and grow a profitable community-oriented financial institution serving customers in our primary market areas. We seek to achieve this through the adoption of a business strategy to provide superior financial services with honesty and integrity to help our customers and communities prosper by focusing on our core values while achieving sustainable profitability and reasonable returns to our shareholders. We plan to continue our focus on loan growth in 2017.  We employ senior management with substantial experience in consumer and commercial banking to help us diversify our product offerings and expand our consumer and commercial deposit and lending products, while maintaining high asset quality standards. Our operating strategies include the following:

 
profitable growth of our commercial and small business relationships;

 
profitable growth of our residential mortgage banking;

 
increase efficiencies and productivity bank wide; and

 
cultivate a culture of accountability bank wide.

Profitable growth of our commercial and small business relationships.

Our goal is to grow the number and profitability of business relationships across all product lines, which include loans, deposits, cash management/treasury services, payments, investments/wealth management, residential mortgage and non-bank solutions.  This will necessitate a more focused approach to identifying and targeting specific niches/customer segments.  We will gain a better understanding of products, services, and delivery our target customers value, determination of gaps in our offering, and a plan to close those gaps.  We will attain a better alignment of organization structure, talent, delivery, processes, procedures and technology in addition to marketing strategies to promote growth.

Profitable growth of our residential mortgage banking.

Residential mortgage lending remains an important part of our lending activities. We originate fixed and adjustable-rate residential mortgage loans that are retained in our loan portfolio. However, most of the fixed-rate residential mortgage loans that we originate are sold into the secondary market with servicing released as part of our efforts to reduce our interest rate risk. At December 31, 2016, residential mortgage loans totaled $200.6 million, or 33.2% of our total loan portfolio. Increasing the volume and profitability of single family residential mortgages originated and closed will necessitate an alignment of the Bank’s mortgage banking business model in support of growth goals including: people (talent and leadership), products, processes, acquisition relationships, technology, and back office operations in addition to marketing strategies to promote growth.
 
Increase efficiencies and productivity bank wide.

We seek to increase our profitability by improving efficiencies and productivity throughout the Bank.  This necessitates right-sizing the Bank’s cost structure for revenue growth by allocating resources in alignment with our strategic priorities.  This will require a laser-like focus that must be embedded in the culture of the Bank, having infrastructure, processes, procedures, technology and the like that makes it easier, simpler, faster and less expensive to conduct business.  We will continue to monitor and evaluate the Bank’s processes, policies, and technology to make it easy for the customer to do business with the Bank – simpler, faster and easier.  This includes facilitating our teams’ abilities to recognize opportunities, delivering on commitments to customers and aligning our overall cost structure with our operating revenues.

Cultivate a culture of accountability bank wide.

We will continue to create a work environment in which employees are engaged and committed to the vision of the Bank and encouraged and rewarded for performing at their highest potential.  This requires a strong performance management program that provides clear direction and expectations to all employees and focuses on performance, empowering employees to take responsibility that is aligned with our core values. We hold employees accountable for performance and we provide career and professional development opportunities for them.

Market Area

We are headquartered in Asheville, North Carolina, which is the county seat of Buncombe County, North Carolina and consider Buncombe, Madison, McDowell, Henderson and Transylvania Counties in Western North Carolina and the surrounding areas to be our primary market area. Asheville is situated in the Blue Ridge Mountains at the confluence of the Swannanoa River and French Broad River and is known for its natural beauty and scenic surroundings. The nearby Great Smoky Mountains National Park and Blue Ridge Parkway are among the more visited parks in the United States. In addition, the Asheville metropolitan area has a vibrant cultural and arts community that parallels that of many larger cities in the United States. It has been referred to as the “Paris of the South,” and The New York Times calls it a “surprisingly cosmopolitan city.”  It is a place that combines local arts and diversity of a city with a friendly, small town feel. Asheville is home to a number of historical attractions, the most prominent of which is the Biltmore Estate, a historic mansion with gardens and the most visited winery in the nation, drawing more than one million tourists each year.  Due to its scenic location and diverse cultural and historical offerings, the Asheville metropolitan area has become a popular destination for tourists, attracting approximately nine million visitors annually, with a direct economic impact of approximately $1.5 billion to our local economy. In addition, affordable housing prices, combined with the region’s favorable climate, scenic surroundings and cultural attractions, have also made the Asheville metropolitan area an increasingly attractive destination for retirees seeking to relocate from other parts of the United States.  In Spring 2016, Southern Business & Development ranked Asheville among the top three “Best Mid-Markets in the South to Relocate Your Headquarters.” The Asheville area was also ranked as the 23rd “Best Overall Area in the United States for Women Entrepreneurs” by GoodCall, and in May 2016 was ranked 3rd out of 18 of the “World’s Best Cities for Millennials” by Matador.  In February 2015, Top Retirements named the area as number one on the 2015 list of “Best Places to Retire,” noting Asheville’s reputation as a great place to retire makes it the standard that all other retirement towns can aspire to be.  Forbes ranked Asheville 40th for the 2016 rankings of U.S. cities as “Best Places for Business and Careers.”  Originally established as a mountain retreat, Asheville now stands as a hub for technology, business innovation and growth, making it an attractive destination for corporate relocation.
 
The Asheville metropolitan area benefits from a diverse economy, and there is no single employer or industry upon which a significant number of our customers are dependent.  The area has a mix of manufacturing including advanced manufacturing, plastics, metals, textiles, furniture and automotive parts. Agriculture including food processing is a growing segment of the local economy.  Wood product businesses also are prevalent in Western North Carolina.  Biopharmaceutical is also a growing segment of our economy with Jacob Holm and others having a presence in Asheville.  Business services are predominant in the area with financial services, insurance, financial advisors and other professional practices making up a growing and steady part of the economy.  IT/Software is emerging in our economy as well as other Knowledge Based businesses that are attracted to the area due to quality of life and available resources. Asheville is home to more than 16 climate services organizations and the headquarters of National Centers for Environmental Information (NCEI), the world’s largest archive of weather and climate data center of worldwide communication about climate change. The travel and tourism industry as well as entertainment, including performing arts, sports and film production continue to add economic value to the area.  Western North Carolina has a number of manufacturing and technology companies located in the area, including Wilsonart International, Inc., Eaton Corporation, Thermo Fischer Scientific, Plasticard-Locktech International and Arvato Digital Services.  GE Aviation, Linamar Corporation, White Labs Inc., Hi-Wire Brewing, Highland Brewing Company, Wicked Weed Brewing and BorgWarner Inc. are among the companies that expanded in the Asheville area during 2014 and 2015.  Newer industries that moved to the area include American Recycling and brewers New Belgium, Sierra Nevada and Oskar Blues Brewery. The larger breweries and some successful local micro-breweries have spawned new opportunities in the region, which has created jobs and additional exposure for the area.  During 2016, Avadim Technologies, Baldor Electric Company and Burial Beer Co. were among the businesses expanding their facilities in the Asheville area. Furthermore, the region is home to a number of educational organizations, private colleges and large public universities, such as the University of North Carolina at Asheville as well as satellite campuses of Lenoir-Rhyne University, North Carolina State University and Western Carolina University. Mission Health System, a leading employer in the Asheville metropolitan area and the state’s sixth largest health system, has been nationally recognized as one of the nation’s Top 15 Health Systems 2012-2015, the only health system in the nation to receive this recognition four years in a row, and the only health system in North Carolina to achieve Top 15 recognition, and also received the 2016 Culture of Excellence Award.  Mission Health has seven Centers of Excellence:  Cancer, Heart, Mission Children’s Hospital, Neurosciences, Orthopedics, Trauma and Women’s Health.

Over the course of the past year, the tourism industry in the Asheville metropolitan area has improved, which has positively impacted the economy in a number of our local markets, such as Buncombe and Henderson counties, that directly benefit from this industry.  The overall unemployment rate in the Asheville metropolitan area, the lowest in North Carolina, decreased to 4.0% in December 2016 from 4.2% in December 2015, according to statistics published by the State of North Carolina Department of Commerce. Buncombe County also had the lowest county unemployment rate in North Carolina for December 2016 at 3.7%, and for comparative purposes, the reported seasonally adjusted unemployment rates were 5.1% for North Carolina and 4.7% for the United States for December 2016. The Company also considers McDowell County and Transylvania County, which are not included in the unemployment statistics for the Asheville metropolitan area, as part of its primary market area. The December 2016 unemployment rates were 4.6% for McDowell County and 4.9% for Transylvania County according to the State of North Carolina Department of Commerce.

Competition

We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from several financial institutions operating in our primary market area and from other financial service companies such as securities brokerage firms, credit unions and insurance companies. We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2016, which is the most recent date for which deposit market share data is available from the Federal Deposit Insurance Corporation, we held approximately 9.96% of the deposits in Buncombe County, North Carolina, 3.31% of the deposits in
 
Henderson County, North Carolina, 23.79% of the deposits in Madison County, North Carolina, 17.86% of the deposits in McDowell County, North Carolina and 4.57% of the deposits in Transylvania County, North Carolina. This data does not reflect deposits held by credit unions with which we also compete. In addition, banks owned by large national and regional holding companies and other community-based banks also operate in our primary market area. Some of these institutions are larger than us and, therefore, have greater resources.

Our competition for loans comes primarily from financial institutions, including credit unions, in our primary market area and from other financial service providers, such as mortgage companies, mortgage brokers and private investors. Competition for loans also comes from non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.

We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet, and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Competition for deposits and the origination of loans could limit our growth in the future.

Lending Activities

General. The largest component of our loan portfolio is real estate mortgage loans, primarily one-to-four family residential mortgage loans and commercial mortgage loans, and to a lesser extent, revolving mortgage loans (which consist of home equity loans and lines of credit), consumer loans, construction and land development loans, and commercial and industrial loans. We originate loans for investment purposes, although we generally sell our fixed-rate residential mortgage loans into the secondary market with servicing released.

We intend to continue to emphasize residential and commercial mortgage lending, while also concentrating on ways to expand our commercial and industrial lending activities with a focus on serving small businesses and emphasizing relationship banking in our primary market area. We do not offer Alt-A, sub-prime or no-documentation mortgage loans.

One-to-Four Family Residential Loans. At December 31, 2016, we had $200.6 million in one-to-four and multi-family residential loans, which represented 33.2% of our total loan portfolio, of which $200.0 million were performing in accordance with their original terms. Our origination of residential mortgage loans enables borrowers to purchase or refinance existing homes located in our primary market area.

Our residential lending policies and procedures conform to the secondary market guidelines. We offer a mix of adjustable rate mortgage loans and fixed-rate mortgage loans with terms of up to 30 years. Borrower demand for adjustable-rate loans compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to an initially discounted interest rate and loan fees for multi-year adjustable-rate mortgages. The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. We sell most of the fixed-rate mortgages we originate, which reduces our balances of adjustable rate mortgages as they are refinanced into fixed-rate mortgages during periods of low interest rates. We determine the loan fees, interest rates and other provisions of mortgage loans based on our own pricing criteria and competitive market conditions.
 
Interest rates and payments on our adjustable-rate mortgage loans adjust at intervals of one to five years after an initial fixed period that ranges from one to ten years. Interest rates on our adjustable-rate loans generally are indexed to the US Treasury Constant Maturity Index for the applicable periods. However, in some limited situations, these loans are indexed to the one year London Interbank Offered Rate (“LIBOR”).

While one-to-four family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans on a regular basis. We do not offer residential mortgage loans with negative amortization and we currently offer marketable interest-only residential mortgage loans to well qualified borrowers in limited situations.

We do not make owner occupied one-to-four family residential real estate loans with loan-to-value ratios exceeding 95%, unless the loan is federally guaranteed. Loans with loan-to-value ratios in excess of 80% typically require private mortgage insurance. In addition, we do not make non-owner occupied one-to-four family residential real estate loans with loan-to-value ratios exceeding 85% unless we are able to sell the loan on the secondary market. We require all properties securing mortgage loans to be appraised by a board-approved independent appraiser. We also require title insurance on all mortgage loans. Borrowers must obtain hazard insurance, and flood insurance is required for all loans located in flood hazard areas.

At December 31, 2016, our largest residential mortgage loan had an outstanding balance of $3.0 million and was performing in accordance with its original terms.

Commercial Mortgage Loans. We offer fixed- and adjustable-rate mortgage loans secured by non-residential real estate, which we refer to as commercial mortgage loans. At December 31, 2016, commercial mortgage loans totaled $241.1 million, or 39.9% of our total loan portfolio, all of which were performing in accordance with their terms. Our commercial mortgage loans are generally secured by commercial, industrial, manufacturing, small to moderately-sized office, retail, hotel, hospital and church properties located in our primary market area. Although we have historically made commercial mortgage loans that are secured by both owner-occupied and nonowner-occupied properties, we continue to emphasize the origination of commercial mortgage loans that are secured by owner-occupied properties. At December 31, 2016, $76.8 million, or 31.9%, of our commercial real estate loans were secured by owner-occupied properties.

We originate fixed-rate and adjustable-rate commercial mortgage loans, generally with terms of three to five years and payments based on an amortization schedule of up to 30 years, resulting in “balloon” balances at maturity. For our adjustable-rate commercial mortgage loans, interest rates are typically equal either to the prime lending rate as reported in The Wall Street Journal or to LIBOR, plus an applicable margin. Depending upon the interest rate cycle, our adjustable-rate commercial mortgage loans typically provide for interest rate floors. Loans are secured by first mortgages, generally are originated with a maximum loan-to-value ratio of 85% and may require specified debt service coverage ratios depending on the characteristics of the project. Rates and other terms on such loans generally depend on our assessment of credit risk after considering such factors as the borrower’s financial condition, credit history, loan-to-value ratio, debt service coverage ratio and other factors, including whether the property securing the loan will be owner occupied.

At December 31, 2016, our largest commercial mortgage loan relationship consisted of ten loans and one line of credit to five different entities. The loans have personal guarantees from the owners and are secured by nine separate income producing commercial rental properties. The collateral properties range from office and retail to industrial warehouse located in Asheville, North Carolina with a total outstanding balance of $10.6 million.  The loans are performing in accordance to their original loan terms.
 
Construction and Land Development Loans. We have originated construction and land development loans for commercial properties, such as retail shops and office units, and multi-family properties. At December 31, 2016, commercial construction and land development loans totaled $27.8 million, which represented 4.6% of our total loan portfolio, all of which were performing in accordance with their terms. Typically commercial construction loans are for a term of 12 to 24 months with interest payable monthly and are generally followed by a permanent loan with monthly principal and interest payments.  Commercial construction loans generally require a maximum loan-to-value ratio of 80% and land development loans generally require a maximum loan-to-value ratio of 75%.

We also originate residential construction and land development loans for one-to-four family homes.  At December 31, 2016, residential construction and land development loans totaled $20.8 million, which represented 3.4% of our total loan portfolio, all of which were performing in accordance with their terms. Residential construction loans are typically for a term of 12 months with interest payable monthly, and are generally followed by an automatic conversion to a 15-year or 30-year permanent loan with monthly payments of principal and interest.  Residential construction loans are generally made only to homeowners and the repayment of such loans generally comes from the proceeds of a permanent mortgage loan for which a commitment is typically in place when the construction loan is originated.  We generally require a maximum loan-to-value ratio of 80% for all construction loans unless Private Mortgage Insurance is obtained to allow for higher loan-to-value ratios.

Interest rates on all construction loans are generally tied to an index plus an applicable spread and funds are disbursed on a percentage-of-completion basis following an inspection by a third party inspector.

We also selectively originate loans to individuals and developers for the purpose of developing vacant land in our primary market area, typically for building an individual’s future residence or, in the case of a developer, residential subdivisions. Land development loans, which are offered for terms of up to 18 months, are generally indexed either to the prime rate as reported in The Wall Street Journal or to LIBOR, plus an applicable margin. We generally require a maximum loan-to-value ratio of 75% of the discounted market value based upon expected cash flows upon completion of the project. We also originate loans to individuals secured by undeveloped land held for investment purposes. These loans are typically amortized for no more than fifteen years with a three- or five-year balloon payment. At December 31, 2016, our largest commercial land development loan had an outstanding balance of $207,000, which was performing in accordance with its terms.

Revolving Mortgages and Consumer Loans. We offer revolving mortgage loans, which consist of home equity loans and lines of credit, and various consumer loans, including automobile loans and loans secured by deposits. At December 31, 2016, revolving mortgage loans totaled $66.9 million, or 11.1% of our total loan portfolio, of which $66.5 million were performing in accordance with their terms, and consumer loans totaled $22.8 million, or 3.8% of our total loan portfolio, substantially all of which were performing in accordance with their terms. Our revolving mortgage loans consist of both home equity loans with fixed-rate amortizing terms of up to 15 years and adjustable rate lines of credit with interest rates indexed either to the prime rate as published in The Wall Street Journal or to LIBOR, plus or minus an applicable margin. At December 31, 2016, our largest outstanding revolving mortgage loan balance was $714,000, which was performing in accordance with its terms. Consumer loans typically have shorter maturities and higher interest rates than traditional one-to-four family lending. In most cases, we do not originate home equity loans with loan-to-value ratios exceeding 80%, including any first mortgage loan balance. The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. During 2015, we discontinued the indirect origination of automobile loans through local dealers, although we continue to offer loans secured by motor vehicles directly to consumers.
 
Commercial and Industrial Loans. We typically offer commercial and industrial loans to small businesses located in our primary market area. At December 31, 2016, commercial and industrial loans totaled $23.8 million, which represented 3.9% of our total loan portfolio, substantially all of which were performing. Commercial and industrial loans consist of floating rate loans indexed either to the prime rate as published in The Wall Street Journal or to LIBOR, plus an applicable margin and fixed rate loans for terms of up to 10 years, depending on the useful life and type of collateral. Our commercial and industrial loan portfolio consists primarily of loans that are secured by equipment, accounts receivable and inventory, but also includes a smaller amount of unsecured loans for purposes of financing expansion or providing working capital for general business purposes. Key loan terms vary depending on the collateral, the borrower’s financial condition, credit history and other relevant factors. At December 31, 2016, our largest commercial and industrial relationship had an outstanding balance of $5.2 million, was secured by a blanket first lien on all business assets, including accounts receivable, inventory, furniture, fixtures and equipment, in addition to an assignment of insurance on the owner’s life. The loan was performing in accordance with its terms.

Loan Underwriting

Adjustable-Rate Loans. While we anticipate that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, an increased monthly mortgage payment required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.

Commercial Mortgage Loans. Loans secured by commercial real estate generally have larger balances and involve a greater degree of risk than one-to-four family residential mortgage loans. Of primary concern in commercial mortgage lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income producing properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. We apply what we believe to be conservative underwriting standards when originating commercial mortgage loans and seek to limit our exposure to lending concentrations to related borrowers, types of business and geographies, as well as seeking to participate with other banks in both buying and selling larger loans of this nature. Management has hired additional experienced lending officers and credit management personnel over the past several years in order to continue to safely manage this type of lending. To monitor cash flows on income producing properties, we require borrowers and loan guarantors, if any, to provide annual financial statements on commercial real estate loans. In reaching a decision on whether to make a commercial real estate loan, we consider and review a global cash flow analysis of the borrower and consider the net operating income of the property, the borrower’s expertise, credit history and profitability, and the value of the underlying property. An environmental survey is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.
 
Construction and Land Development Loans. Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment if liquidation is required. If we are forced to foreclose on a building before or at completion due to a default, we may be unable to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs. In addition, speculative construction loans, which are loans made to home builders who, at the time of loan origination, have not yet secured an end buyer for the home under construction, typically carry higher risks than those associated with traditional construction loans. These increased risks arise because of the risk that there will be inadequate demand to ensure the sale of the property within an acceptable time. As a result, in addition to the risks associated with traditional construction loans, speculative construction loans carry the added risk that the builder will have to pay the property taxes and other carrying costs of the property until an end buyer is found. Land development loans have substantially similar risks to speculative construction loans. To monitor cash flows on construction properties, we require borrowers and loan guarantors, if any, to provide annual financial statements and, in reaching a decision on whether to make a construction or land development loan, we consider and review a global cash flow analysis of the borrower and consider the borrower’s expertise, credit history and profitability. We also generally disburse funds on a percentage-of-completion basis following an inspection by a third party inspector.

Revolving Mortgages and Consumer Loans. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are secured by assets that depreciate rapidly, such as motor vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. During 2015, we discontinued the indirect origination of automobile loans through local dealers, which resulted in a decline in our consumer loan portfolio.  We continue to offer loans secured by motor vehicles directly to consumers.  In the case of home equity loans, real estate values may be reduced to a level that is insufficient to cover the outstanding loan balance after accounting for the first mortgage loan balance. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

Commercial and Industrial Loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment income or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial and industrial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial and industrial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is generally limited by regulation to 15% of the Bank’s unimpaired capital and surplus.  At December 31, 2016, our regulatory limit on loans to one borrower was $14.1 million. At that date, our largest lending relationship consisted of ten loans and one line of credit to five different entities. The loans have personal guarantees from the owners and are secured by nine separate income producing commercial rental properties. The collateral properties range from office and retail to industrial warehouse located in Asheville, North Carolina with a total outstanding balance of $10.6 million.  The loans are performing in accordance to their original loan terms.
 
Loan Commitments. We typically issue commitments for most loans conditioned upon the occurrence of certain events. Commitments to originate loans are legally binding agreements to lend to our customers. Generally, our loan commitments expire after 45 to 60 days. See note 12 to the consolidated financial statements included in this annual report.

Investment Activities

We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various government-sponsored agencies and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions. Within certain regulatory limits, we also may invest a portion of our assets in other permissible securities. As a member of the Federal Home Loan Bank of Atlanta, we also are required to maintain an investment in Federal Home Loan Bank of Atlanta stock, which is not publicly traded.

At December 31, 2016, our investment portfolio consisted primarily of mortgage-backed securities, U.S. government and agency securities, securities issued by government sponsored enterprises and securities issued by state and local governments. We do not currently invest in trading account securities.

Our investment objectives are: (i) to provide and maintain liquidity within the guidelines of North Carolina banking law and the regulations of the Federal Deposit Insurance Corporation and (ii) to manage interest rate risk. Our Board of Directors has the overall responsibility for the investment portfolio, including approval of the investment policy. Our Chief Executive Officer and our Chief Financial Officer are responsible for implementation of the investment policy and monitoring our investment performance. Our Board of Directors reviews the status of our investment portfolio on a monthly basis.

Deposit Activities and Other Sources of Funds

General. Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.

Deposit Accounts. Deposits are attracted from within our primary market area through the offering of a broad selection of deposit instruments, including noninterest-bearing demand deposits (such as checking accounts), interest-bearing demand accounts (such as NOW and money market accounts), regular savings accounts and certificates of deposit. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, matching deposit and loan products and customer preferences and concerns. We generally review our deposit mix and pricing weekly. Our deposit pricing strategy has typically been to offer competitive rates on all types of deposit products, and to periodically offer special rates in order to attract deposits of a specific type or term.

Borrowings. We use advances from the Federal Home Loan Bank of Atlanta to supplement our investable funds. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank of Atlanta and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate, range of maturities and prepayment penalties. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth, the Federal Home Loan Bank’s assessment of the institution’s creditworthiness, collateral value and level of Federal Home Loan Bank stock ownership. We also utilize securities sold under agreements to repurchase and overnight repurchase agreements to supplement our supply of investable funds and to meet deposit withdrawal requirements.
 
Financial Services

The Bank has an agreement with LPL Financial LLC (“LPL”), a third-party registered broker-dealer, through which the Bank offers its customers, under the brand of Asheville Savings Investment Services, a complete range of nondeposit investment products, including mutual funds, debt, equity and government securities, retirement accounts, insurance products and fixed and variable annuities.  Pursuant to the agreement with LPL, the Bank received fees of $243,000, $217,000 and $268,000 for the years ended December 31, 2016, 2015 and 2014, respectively.

Subsidiaries

The Bank is the Company’s sole wholly owned subsidiary. The Bank has two subsidiaries, Appalachian Financial Services, Inc., which was formed to engage in investment activities and is currently inactive, and Wenoca, Inc., which serves as the Bank’s trustee regarding deeds of trust. Both subsidiaries are organized as North Carolina corporations.

REGULATION AND SUPERVISION

The Bank is a North Carolina chartered savings bank and the wholly owned subsidiary of the Company, which is a North Carolina corporation and registered bank holding company. The Bank’s deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is subject to extensive regulation by the North Carolina Commissioner of Banks (the “NCCoB”), as its chartering agency, and by the FDIC, as its deposit insurer. The Bank is required to file reports with, and is periodically examined by, the FDIC and the NCCoB concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions, including, but not limited to, mergers with or acquisitions of other financial institutions. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of depositors and, for purposes of the FDIC, the protection of the insurance fund. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The Bank is a member of the Federal Home Loan Bank of Atlanta (the “FHLB of Atlanta” or “FHLB”). The Company is regulated as a bank holding company by the Federal Reserve Board (the “FRB”) and the NCCoB. Any change in such regulatory requirements and policies, whether by the North Carolina legislature, the FDIC, the FRB or Congress, could have a material adverse impact on the Company, the Bank and their operations.

Certain regulatory requirements applicable to the Company and the Bank are referred to below or elsewhere herein. This description of statutes and regulations is intended to be a summary of the material provisions of such statutes and regulations and their effects on the Company and the Bank. You are encouraged to reference the actual statutes and regulations for additional information.

Recent Regulatory Reform

Although the financial crisis has now passed, two legislative and regulatory responses – the Dodd-Frank Wall Street Reform and Consumer Protection Act  (the “Dodd-Frank Act”) and the Basel III-based capital rules – will continue to have an impact on our operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Act was signed into law in July 2010. The Dodd-Frank Act impacts financial institutions in numerous ways, including, among others:

 
The creation of a Financial Stability Oversight Council responsible for monitoring and managing systemic risk;
 
 
Granting additional authority to the Federal Reserve to regulate certain types of nonbank financial companies;

 
Granting new authority to the FDIC as liquidator and receiver;

 
Changing the manner in which deposit insurance assessments are made;

 
Requiring regulators to modify capital standards;

 
Establishing the Consumer Financial Protection Bureau (the “CFPB”);

 
Capping interchange fees that banks with total assets of $10 billion or more charge merchants for debit card transactions;

 
Imposing more stringent requirements on mortgage lenders; and

 
Limiting banks’ proprietary trading activities.

There are many provisions in the Dodd-Frank Act mandating regulators to adopt new regulations and conduct studies upon which future regulation may be based. While some have been issued, many remain to be issued. Governmental intervention and new regulations could materially and adversely affect our business, financial condition and results of operations.

Basel Capital Standards

Regulatory capital rules released by the federal bank regulatory agencies in July 2013 to implement capital standards, referred to as Basel III and developed by an international body known as the Basel Committee on Banking Supervision, impose higher minimum capital requirements for bank holding companies and banks. The rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. More stringent requirements are imposed on “advanced approaches” banking organizations ‒ which are organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime.  The new regulatory capital rules began to phase in on January 1, 2015 for the Company and the Bank,  and all of the requirements in the rules will be fully phased in by January 1, 2019.

The rules include certain new and higher risk-based capital and leverage requirements than those previously in place. Specifically, the following minimum capital requirements apply to us:

 
a new common equity Tier 1 risk-based capital ratio of 4.5%;

 
a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);

 
a total risk-based capital ratio of 8% (unchanged from the former requirement); and

 
a leverage ratio of 4% (also unchanged from the former requirement).

Under the rules, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, common equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. The rules permit bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital, but not in common equity Tier 1 capital, subject to certain restrictions. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments
 
that the rules have disqualified from Tier 1 capital treatment.  Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital.  Accumulated other comprehensive income (“AOCI”) is presumptively included in common equity Tier 1 capital and often would operate to reduce this category of capital.  The rules provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We elected to opt out from the inclusion of AOCI in common equity Tier 1 capital.

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets.  As of January 1, 2017, our conservation buffers were 11.04% for common equity Tier 1 capital, 9.54% for Tier 1 capital and 9.77% for total capital.

In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in common equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.

It is management’s belief that, as of December 31, 2016, the Company and the Bank would have met all capital adequacy requirements under the new capital rules on a fully phased-in basis if such requirements were effective at that time.

Volcker Rule

Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds.”  Proprietary trading is, in general, trading in securities on a short-term basis for a banking entity’s own account.  Funds subject to the ownership and sponsorship prohibition are those not required to register with the SEC because they have only accredited investors or no more than 100 investors. In December 2013, the federal banking agencies, together with the SEC and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule.  The Volcker Rule does not have a material effect on our operations as we do not engage in proprietary trading or own or sponsor covered funds.  The Company may incur costs to adopt additional policies and systems to ensure compliance with the Volcker Rule, but any such costs are not expected to be material.

North Carolina Banking Laws and Supervision

General. As a North Carolina savings bank, Asheville Savings is subject to supervision, regulation and examination by the NCCoB and to various North Carolina statutes and regulations which govern, among other things, investment powers, lending and deposit taking activities, borrowings, maintenance of surplus and reserve accounts, distributions of earnings and payment of dividends. In addition, Asheville Savings is also subject to North Carolina consumer protection and civil rights laws and regulations. The approval of the NCCoB is required for a North Carolina savings bank to establish or relocate branches, merge with other financial institutions, organize a holding company, issue stock and undertake certain other activities.
 
Net Worth Requirement. North Carolina law requires that a North Carolina savings bank maintain a net worth of not less than 5% of its total assets. Intangible assets must be deducted from net worth and assets when computing compliance with this requirement.

Investment Activities. Subject to limitation by the NCCoB, North Carolina savings banks may make any loan or investment or engage in any activity that is permitted to federally chartered institutions. In addition to such lending authority, North Carolina savings banks are generally authorized to invest funds in certain statutorily permitted investments, including but not limited to (i) obligations of the United States, or those guaranteed by it; (ii) obligations of the State of North Carolina; (iii) bank demand or time deposits; (iv) stock or obligations of the federal deposit insurance fund or a Federal Home Loan Bank; (v) savings accounts of any savings institution as approved by the board of directors; and (vi) stock or obligations of any agency of the State of North Carolina or of the United States or of any corporation doing business in North Carolina whose principal business is to make education loans. However, a North Carolina savings bank cannot invest more than 15% of its total assets in business, commercial, corporate and agricultural loans, and cannot directly or indirectly acquire or retain any corporate debt security that is not of investment grade.

Loans to One Borrower Limitations. North Carolina law provides state savings banks with broad lending authority. However, subject to certain limited exceptions, no loans and extensions of credit to any borrower outstanding at one time and not fully secured by readily marketable collateral shall exceed 15% of the net worth of the savings bank, as defined. In addition, loans and extensions of credit fully secured by readily marketable collateral may not exceed 10% of the net worth of the savings bank. These limitations do not apply to loans or obligations made: (i) for any purpose otherwise permitted under North Carolina law in an amount not to exceed $500,000; (ii) to develop domestic residential housing units, not to exceed the lesser of $30 million or 30% of the savings bank’s net worth, provided that the purchase price of each single-family dwelling in the development does not exceed $500,000 and the aggregate amount of loans made pursuant to this authority does not exceed 150% of the savings bank’s net worth; or (iii) to finance the sale of real property acquired in satisfaction of debts in an amount up to 50% of the savings bank’s net worth.

Dividends. A North Carolina stock savings bank may not declare or pay a cash dividend on, or repurchase any of, its capital stock if after making such distribution, the institution would become, or if it already is, “undercapitalized” (as such term is defined under applicable law and regulations) or such transaction would reduce the net worth of the institution to an amount which is less than the minimum amount required by applicable federal and state regulations.

Regulatory Enforcement Authority. Any North Carolina savings bank that does not operate in accordance with the regulations, policies and directives of the NCCoB may be subject to sanctions for noncompliance, including revocation of its articles of incorporation. The NCCoB may, under certain circumstances, suspend or remove officers or directors of a state savings bank who have violated the law or conducted the bank’s business in a manner which is unsafe or unsound. Upon finding that a state savings bank has engaged in an unsafe, unsound or discriminatory manner, the NCCoB may issue an order to cease and desist and impose civil monetary penalties on the institution.

Federal Banking Regulations

Capital Requirements.  In July 2013, the federal bank regulatory agencies issued new regulatory capital rules that impose higher minimum capital requirements for banks and bank holding companies.  The new regulatory capital rules, which include  certain new and higher risk-based capital and leverage requirements than those in place, began to phase in on January 1, 2015 for the Company and the Bank, and all of the requirements in the rules will be fully phased in by January 1, 2019.  See “Regulation and Supervision – Basel Capital Standards” for further information.
 
Standards for Safety and Soundness. As required by statute, the federal banking agencies adopted final regulations and Interagency Guidelines Establishing Standards for Safety and Soundness to implement safety and soundness standards. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit system, credit underwriting, loan documentation, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. Most recently, the agencies have established standards for safeguarding customer information. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.

Investment Activities. Since the enactment of Federal Deposit Insurance Corporation Improvement Act (the “FDICIA”), all state-chartered federally insured banks, including savings banks, have generally been limited in their investment activities to principal and equity investments of the type and in the amount authorized for national banks, notwithstanding state law. The FDICIA and the FDIC regulations promulgated thereunder permit exceptions to these limitations. For example, state chartered banks may, with FDIC approval, continue to exercise state authority to invest in common or preferred stocks listed on a national securities exchange or the Nasdaq Global Market and in the shares of an investment company registered under the Investment Company Act of 1940, as amended. The maximum permissible investment is 100% of Tier 1 Capital, as specified by the FDIC’s regulations, or the maximum amount permitted by North Carolina law, whichever is less. In addition, the FDIC is authorized to permit such institutions to engage in state authorized activities or investments not permissible for national banks (other than non-subsidiary equity investments) if they meet  all applicable capital requirements and it is determined that such activities or investments do not pose a significant risk to the Deposit Insurance Fund. The FDIC has adopted regulations governing the procedures for institutions seeking approval to engage in such activities or investments. The Gramm-Leach-Bliley Act of 1999 specifies that a non-member bank may control a subsidiary that engages in activities as principal that would only be permitted for a national bank to conduct in a “financial subsidiary” if a bank meets specified conditions and deducts its investment in the subsidiary for regulatory capital purposes.

Prompt Corrective Regulatory Action. As an insured depository institution, the Bank is required to comply the capital requirements promulgated under the Federal Deposit Insurance Act and the prompt corrective action regulations thereunder, which set forth five capital categories, each with specific regulatory consequences.  Under these regulations, the categories are:

 
Well Capitalized –  The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage capital ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

 
Adequately Capitalized –  The institution meets the required minimum level for each relevant capital measure.  No capital distribution may be made that would result in the institution becoming undercapitalized.  An adequately capitalized institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 4.5% or greater, and (iv) has a leverage capital ratio of 4% or greater.

 
Undercapitalized –  The institution fails to meet the required minimum level for any relevant capital measure.  An undercapitalized institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 4.5%, or (iv) has a leverage capital ratio of less than 4%.
 
Significantly Undercapitalized –  The institution is significantly below the required minimum level for any relevant capital measure.  A significantly undercapitalized institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 3%, or (iv) has a leverage capital ratio of less than 3%.

 
Critically Undercapitalized –  The institution fails to meet a critical capital level set by the appropriate federal banking agency.  A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

If the applicable federal regulator determines, after notice and an opportunity for hearing, that the institution is in an unsafe or unsound condition, the regulator is authorized to reclassify the institution to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

If the institution is not well capitalized, it cannot accept brokered deposits without prior FDIC approval. Even if approved, rate restrictions will govern the rate the institution may pay on the brokered deposits. In addition, a bank that is undercapitalized cannot offer an effective yield in excess of 75 basis points over the “national rate” paid on deposits (including brokered deposits, if approval is granted for the bank to accept them) of comparable size and maturity. The “national rate” is defined as a simple average of rates paid by insured depository institutions and branches for which data are available and is published weekly by the FDIC. Institutions subject to the restrictions that believe they are operating in an area where the rates paid on deposits are higher than the “national rate” can use the local market to determine the prevailing rate if they seek and receive a determination from the FDIC that it is operating in a high-rate area. Regardless of the determination, institutions must use the national rate to determine conformance for all deposits outside their market area.

Moreover, if the institution becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the FDIC. The institution also would become subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless it is determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution, that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized.

As of December 31, 2016, the Bank was deemed to be “well capitalized.”

Transactions with Affiliates. The Company is a legal entity separate and distinct from the Bank.  Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.
 
Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit by a bank to any affiliate, including its holding company, and on a bank’s investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of any affiliates of the bank.  Section 23A also applies to derivative transactions, repurchase agreements, and securities lending and borrowing transactions that cause a bank to have credit exposure to an affiliate.  The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.

Section 23B of the Federal Reserve Act, among other things, prohibits a bank from engaging in certain transactions with certain affiliates unless the transactions are on terms and under circumstances, including credit standards, that are substantially the same, or at least as favorable to such bank or its subsidiaries, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies. If there are no comparable transactions, a bank’s (or one of its subsidiaries’) affiliate transaction must be on terms and under circumstances, including credit standards, that in good faith would be offered to, or would apply to, nonaffiliated companies.  These requirements apply to all transactions subject to Section 23A as well as to certain other transactions.

The affiliates of a bank include any holding company of the bank, any other company under common control with the bank (including any company controlled by the same shareholders who control the bank), any subsidiary of the bank that is itself a bank, any company in which the majority of the directors or trustees also constitute a majority of the directors or trustees of the bank or holding company of the bank, any company sponsored and advised on a contractual basis by the bank or an affiliate, and any mutual fund advised by a bank or any of the bank’s affiliates.  Regulation W generally excludes all non-bank subsidiaries of banks from treatment as affiliates, except for subsidiaries engaged in certain nonbank financial activities or to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates.

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Extensions of credit include derivative transactions, repurchase and reverse repurchase agreements, and securities borrowing and lending transactions to the extent that such transactions cause a bank to have credit exposure to an insider.  Any extension of credit to an insider:

 
must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties; and

 
must not involve more than the normal risk of repayment or present other unfavorable features.

In some circumstances, approval of an extension of credit to an insider must be approved by a majority of the disinterested directors. Extensions of credit to any one insider are capped at 10% of a bank’s unimpaired capital and unimpaired surplus, with an additional 10% for loans secured by readily marketable collateral. Extensions of credit to all insiders are capped at 100% of unimpaired capital and unimpaired surplus.

In addition, the Bank may not purchase an asset from or sell an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by the majority of disinterested directors.
 
Enforcement. The FDIC has extensive enforcement authority over insured state-chartered savings banks, including Asheville Savings. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices. The FDIC has authority under federal law to appoint a conservator or receiver for an insured bank under limited circumstances. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state non-member bank if that bank was “critically undercapitalized” on average during the calendar quarter beginning 270 days after the date on which the institution became “critically undercapitalized.” The FDIC may also appoint itself as conservator or receiver for an insured state non-member institution under specific circumstances on the basis of the institution’s financial condition or upon the occurrence of other events, including: (i) insolvency; (ii) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (iii) existence of an unsafe or unsound condition to transact business; and (iv) insufficient capital, or the incurring of losses that will deplete substantially all of the institution’s capital with no reasonable prospect of replenishment without federal assistance.

Insurance of Deposit Accounts. The FDIC insures deposits at FDIC insured financial institutions such as Asheville Savings. Deposit accounts at the Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts.  The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund.

FDIC deposit assessments are currently based on an institution’s average consolidated total assets minus average tangible equity as opposed to total deposits. Since the current base is much larger than the previous base, the FDIC lowered assessment rates so that the total amount of revenue collected from the industry would not be significantly altered. These adjustments are expected to benefit smaller financial institutions, which typically rely more on deposits for funding, and shift more of the burden for supporting the insurance fund to larger institutions, which have greater access to non-deposit sources of funding. The Bank’s 2016 FDIC insurance cost decreased approximately $179,000 primarily as a result of these changes.

Federal Home Loan Bank System. Asheville Savings is a member of the Federal Home Loan Bank System, which consists of eleven regional Federal Home Loan Banks. The FHLB provides a central credit facility primarily for member institutions. Asheville Savings, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. At December 31, 2016, Asheville Savings complied with this requirement with an investment in FHLB of Atlanta stock of $2.8 million.

The Federal Home Loan Banks were required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements, or general results of operations, could reduce or eliminate the dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, our net interest income would likely also be reduced.
 
Community Reinvestment Act. Under the Community Reinvestment Act, as implemented by FDIC regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The Community Reinvestment Act requires the FDIC, in connection with its examination of a savings institution, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution.

The Community Reinvestment Act requires public disclosure of an institution’s rating and requires the Federal Deposit Insurance Corporation to provide a written evaluation of an association’s Community Reinvestment Act performance utilizing a four-tiered descriptive rating system.

Asheville Savings received a “satisfactory” rating as a result of its most recent Community Reinvestment Act assessment.

Other Regulations

Interest and other charges collected or contracted for by Asheville Savings are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:

 
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 
Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 
Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 
Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

 
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 
Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

The operations of Asheville Savings also are subject to, among other things, the:

 
Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 
Electronic Funds Transfer Act and Regulation E promulgated thereunder, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 
Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;
 
 
Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), which significantly expands the responsibilities of financial institutions in preventing the use of the U.S. financial system to fund terrorist activities. Among other provisions, it requires financial institutions operating in the United States to develop new anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control (“OFAC”) Regulations; and

 
The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of personal financial information with unaffiliated third parties.

Federal Reserve System

The FRB regulations require savings institutions to maintain noninterest earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal (“NOW”) and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts greater than $15.2 million and less than $110.2 million; a 10% reserve ratio is assessed on net transaction accounts greater than $110.2 million. The first $15.2 million of otherwise reservable balances (subject to adjustments by the FRB) are exempted from the reserve requirements. The amounts are adjusted annually. Asheville Savings complies with the foregoing requirements.

Holding Company Regulation

The Company is subject to examination, regulation and periodic reporting under the Bank Holding Company Act of 1956, as amended, as administered by the FRB. As a result, prior FRB approval would be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company. In addition to the approval of the FRB, before any bank acquisition can be completed, prior approval may also be required to be obtained from other agencies having supervisory jurisdiction over the bank to be acquired.

A bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of more than 5% of the voting securities of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings and loan association.

The Gramm-Leach-Bliley Act of 1999 authorizes a bank holding company that meets specified conditions, including being “well capitalized” and “well managed,” to opt to become a “financial holding company” and thereby engage in a broader array of financial activities than previously permitted. Such activities can include insurance underwriting and investment banking.

The Company is also subject to the FRB’s capital adequacy guidelines for bank holding companies (on a consolidated basis) substantially similar to those of the FDIC for Asheville Savings.
 
A bank holding company is generally required to give the FRB prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. The FRB has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain other conditions.

The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

Under the Federal Deposit Insurance Act, depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This law would have potential applicability if the Company ever held as a separate subsidiary a depository institution in addition to Asheville Savings.

The Company and the Bank will be affected by the monetary and fiscal policies of various agencies of the United States Government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is impossible for management to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of the Company or the Bank.

The status of the Company as a registered bank holding company under the Bank Holding Company Act will not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.

Federal Securities Laws

The Company’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended. As a result, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934, as amended.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act of 2002, the Company’s principal executive officer and principal financial and accounting officer each are required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange
 
Commission under the Sarbanes-Oxley Act of 2002 have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal controls; they have made certain disclosures to our auditors and the audit committee of the board of directors about our internal controls; and they have included information in our quarterly and annual reports about their evaluation and whether there have been significant changes in our internal controls or in other factors that could significantly affect internal controls.

FEDERAL AND STATE TAXATION

Federal Income Taxation

General. We report our income on a calendar year basis using the accrual method of accounting. The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly our reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. The Bank’s federal income tax returns were examined for 2008, 2009 and 2010. For its 2016 and 2015 calendar years, the Company’s maximum marginal federal income tax rate was 34%.

The Company and the Bank have entered into a tax allocation agreement. Because the Company owns 100% of the issued and outstanding capital stock of the Bank, the Company and the Bank are members of an affiliated group within the meaning of Section 1504(a) of the Internal Revenue Code, of which group the Company is the common parent corporation. As a result of this affiliation, the Bank may be included in the filing of a consolidated federal income tax return with the Company and, if a decision to file a consolidated tax return is made, the parties agree to compensate each other for their individual share of the consolidated tax liability and/or any tax benefits provided by them in the filing of the consolidated federal income tax return.

Bad Debt Reserves. For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for nonqualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and require savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves.

Distributions. If Asheville Savings makes “non-dividend distributions” to the Company, the distributions will be considered to have been made from the Bank’s unrecaptured tax bad debt reserves, including the balance of its reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from the Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in the Bank’s taxable income. Non-dividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank’s current or accumulated earnings and profits will not be so included in the Bank’s taxable income.

The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if Asheville Savings makes a non-dividend distribution to the Company, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. Asheville Savings does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
 
State Taxation

North Carolina. North Carolina imposes corporate income and franchise taxes. North Carolina’s corporate income tax was 4% for 2016 for the portion of a corporation’s net income allocable to the state. If a corporation in North Carolina does business in North Carolina and in one or more other states, North Carolina taxes a fraction of the corporation’s income based on the amount of sales, payroll and property it maintains within North Carolina.  Effective for tax years beginning on or after January 1, 2014, North Carolina’s corporate income tax rate decreased to 6% from 6.9%.  Effective for tax years beginning on or after January 1, 2015, North Carolina’s corporate income tax rate decreased to 5% from 6.%.  Effective for tax years beginning on or after January 1, 2016, North Carolina’s corporate income tax rate decreased to 4% from 5%.  Effective for tax years beginning on or after January 1, 2017, North Carolina’s corporate income tax rate decreased to 3% from 4%.  Reductions in North Carolina’s corporate income tax rates have the effect of reducing income taxes on current taxable income, but such reductions also have the effect of increasing income taxes on deferred tax assets that represent tax deductions deferred to future periods because the Federal income tax benefits from the state income taxes attributable to the deferred deductions are lower.  North Carolina franchise tax is levied on business corporations at the rate of $1.50 per $1,000 of the largest of the following three alternate bases: (i) the amount of the corporation’s capital stock, surplus and undivided profits apportionable to the state; (ii) 55% of the appraised value of the corporation’s property in the state subject to local taxation; or (iii) the book value of the corporation’s real and tangible personal property in the state less any outstanding debt that was created to acquire or improve real property in the state.

Any cash dividends, in excess of a certain exempt amount, that would be paid with respect to ASB Bancorp, Inc. common stock to a shareholder (including a partnership and certain other entities) who is a resident of North Carolina will be subject to the North Carolina income tax. Any distribution by a corporation from earnings according to percentage ownership is considered a dividend, and the definition of a dividend for North Carolina income tax purposes may not be the same as the definition of a dividend for federal income tax purposes. A corporate distribution may be treated as a dividend for North Carolina income tax purposes if it is paid from funds that exceed the corporation’s earned surplus and profits under certain circumstances.

Item 1A.
Risk Factors

Risks Related to Our Business

Significant loan losses could require us to increase our allowance for loan losses through a charge to earnings.

When we loan money we incur the risk that our borrowers will not repay their loans. We provide for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial condition and results of operations. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount recorded in our allowance for loan losses. In addition, we might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. Furthermore, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. Downturns in the national economy and the local economies of the areas in which our loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, our determination as to the amount of our allowance for loan losses is subject to review by our primary regulators, the FDIC and the NCCoB, as part of their examination process, which may result in the establishment of an additional allowance based upon the judgment of the
 
FDIC and/or the NCCoB after a review of the information available at the time of their examination. Our allowance for loan losses amounted to $6.5 million and $6.3 million, or 1.08% and 1.09% of total loans outstanding and 646.64% and 246.82% of nonperforming loans, at December 31, 2016 and 2015, respectively. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would decrease our earnings. In addition, at December 31, 2016, we had 84 loan relationships with outstanding balances that exceeded $1 million, all of which were performing according to their original terms. The deterioration of one or more of these loan relationships could result in a significant increase in our nonperforming loans and our provision for loan losses, which would negatively impact our results of operations.

Our commercial lending activities exposed us to losses in recent recessionary periods and our continued emphasis on commercial lending may expose us to future lending risks.

Our emphasis on commercial mortgage, commercial construction and commercial land development loans exposed us to losses as the recent economic recession has adversely affected many businesses and developers in our market area. We are continuing to emphasize our commercial mortgage and commercial and industrial lending activities.  At December 31, 2016, 31.9% of our commercial real estate loans were secured by owner-occupied properties.

At December 31, 2016, our loan portfolio included $241.1 million, or 39.9% of total loans, of commercial mortgage loans, $27.8 million, or 4.6% of total loans, of commercial construction and land development loans, and $23.8 million, or 3.9% of total loans, of commercial and industrial loans. Commercial mortgage loans, commercial construction and land development loans and commercial and industrial loans generally expose a lender to greater risk of nonpayment and loss than one-to-four family residential mortgage loans because repayment of these loans often depends on the successful operation of the property and the income stream of the borrowers, and in the case of commercial construction and land development loans, the successful completion and sale of the project. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Commercial and industrial loans also expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. In addition, since such loans generally entail greater risk than one-to-four family residential mortgage loans, we may need to increase our allowance for loan losses in the future to account for the likely increase in probable credit losses associated with the growth of such loans. Also, many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan.

A slowing or declining of national and local economic conditions could result in increases in our level of nonperforming loans and/or reduce demand for our products and services, which may negatively impact our financial condition and results of operations.

Our business activities and earnings are affected by general business conditions in the United States and in our primary market area. These conditions include short-term and long-term interest rates, inflation, unemployment levels, monetary supply, consumer confidence and spending, fluctuations in both debt and equity capital markets and the strength of the economy in the United States generally and in our primary market area in particular. In recent years, the national economy has experienced recessionary conditions that have resulted in general economic downturns, with rising unemployment levels, declines in real estate values and an erosion in consumer confidence. Over the course of the past two years, the tourism industry in the Asheville metropolitan area has largely recovered, which positively impacted the economy in a number of our local markets, such as Buncombe and Henderson Counties, that directly benefit from this industry. The overall unemployment rate for December 2016 in the Asheville metropolitan area was the lowest of all metropolitan areas in North Carolina at 4.0% compared to 4.2% in December 2015, 4.0% in December
 
2014, 5.0% in December 2013 and its recessionary high of 10.2% in February 2010.  Buncombe County had the lowest county unemployment rate in North Carolina for December 2016 at 3.7%. Madison County and Transylvania County, which are located in our market area, continued to experience unemployment rates that exceeded the national unemployment rates. As of December 2016, the unemployment rate for Henderson County was 4.1%, Madison County was 4.8%, McDowell County was 4.6%, and Transylvania County was 4.9%, while the national and state unemployment rates were 4.7% and 5.1%, respectively.  In addition, our primary market area is recovering from a softening of the local real estate market, that included reductions in local property values and declines in the local manufacturing industry, which employs many of our borrowers.  While economic conditions and real estate in our primary market areas have improved since the end of the economic recession, economic growth has been slow and uneven, unemployment remains relatively high and concerns still exist over the federal deficit, government spending and economic risks. Future economic downturns, elevated levels of unemployment, declines in the values of real estate, or other events that affect household and/or corporate incomes could impair the ability of our borrowers to repay their loans in accordance with their terms.  Deterioration in local economic conditions could also drive the level of loan losses beyond the level we have provided for in our allowance for loan and lease losses, which could necessitate increasing our provision for loans losses and reduce our earnings. Additionally, the demand for our products and services could be reduced, which would adversely impact our liquidity and the level of revenues we generate.

Declines in real estate values may cause us to incur losses in our portfolio of foreclosed real estate.

Our portfolio of foreclosed real estate includes parcels of unimproved land, land with completed structures and land with structures in various stages of completion.  We may have to incur additional costs to complete certain parcels of our foreclosed properties in order to market and sell the parcels, which may not fully recover upon the sale of the parcel thereby causing us to incur additional losses. In addition, although real estate values in our primary market areas have generally shown signs of improvement, there can be no assurance that this improvement will continue. If our local markets experience declines in the values of real estate, we may have to recognize further write-downs on our foreclosed real estate or incur losses when we sell our foreclosed real estate.

The geographic concentration of our loan portfolio and lending activities makes us vulnerable to a downturn in the local economy.

Nearly all of our loans are secured by real estate or made to businesses in our primary market area, which consists of Buncombe, Madison, McDowell, Henderson and Transylvania Counties in North Carolina and the surrounding areas. This concentration makes us vulnerable to a downturn in the local economy and real estate markets, such as the one that we experienced beginning in the latter half of 2007. Adverse conditions in the local economy such as inflation, unemployment, recession or other factors beyond our control could impact the ability of our borrowers to repay their loans, which could impact our net interest income. Decreases in local real estate values could adversely affect the value of the property used as collateral for our loans, which could cause us to realize a loss in the event of a foreclosure.

Changes in interest rates may hurt our profits and investment securities values.

Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our interest rate spread is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our borrowings. Changes in interest rates could adversely affect our interest rate spread and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our interest rate spread to expand or contract. Our liabilities are shorter in duration than our assets, so they will adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs will rise faster than the yield we earn on our assets,
 
causing our interest rate spread to contract until the yield catches up. Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—will also reduce our interest rate spread. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities are shorter in duration than our assets, when the yield curve flattens or even inverts, we will experience pressure on our interest rate spread as our cost of funds increases relative to the yield we can earn on our assets. In addition, our mortgage banking income is sensitive to changes in interest rates.  During periods of rising and relatively higher interest rates, mortgage originations for purchased homes can decline considerably and refinanced mortgage activity can severely decrease.  During periods of falling and relatively lower interest rates, the opposite effects can occur.

Our business strategy includes moderate growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

Over the long term, we expect to experience growth in our assets, our deposits and the scale of our operations, whether through organic growth or acquisitions. However, achieving our growth targets requires us to successfully execute our business strategies. Our business strategies include continuing to diversify our loan portfolio by increasing our commercial and industrial lending activities and introducing new and competitive deposit products. Our ability to successfully grow will also depend on the continued availability of loan opportunities that meet our stringent underwriting standards. If we do not manage our growth effectively, we may not be able to achieve our business plan, and our business and prospects could be adversely affected.

We are subject to extensive regulation that could restrict our activities, have an adverse impact on our operations, and impose financial requirements or limitations on the conduct of our business.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. The Company is subject to FRB regulation, and our Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC, and by our primary state regulator, the NCCoB. Also, as a member of the FHLB of Atlanta, the Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Our Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against us under these laws could have a material adverse effect on our results of operations.

Regulation by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of our shareholders. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes. The Dodd-Frank Act and other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect us in substantial and unpredictable ways, including, among other things, subjecting us to increased capital requirements, liquidity and risk management requirements, creating additional costs, limiting the types of financial services and products we may offer and/or increasing the ability of non-banks to offer competing financial services and products. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

The final Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could adversely affect our financial condition and operations.
 
In July 2013, the federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by Basel III and certain provisions of the Dodd-Frank Act. This rule substantially amended the regulatory risk-based capital rules applicable to us. The requirements in the rule began to phase in on January 1, 2015 for the Company and the Bank. The requirements in the rule will be fully phased in by January 1, 2019.

The final rule includes certain new and higher risk-based capital and leverage requirements than those previously in place. Specifically, the following minimum capital requirements apply to us:

 
a new common equity Tier 1 risk-based capital ratio of 4.5%;
 
a Tier 1 risk-based capital ratio of 6.0% (increased from the former 4.0% requirement);
 
a total risk-based capital ratio of 8.0% (unchanged from the former requirement); and
 
a leverage ratio of 4.0% (also unchanged from the former requirement).

Under the rule, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, common equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital generally consists of instruments that previously qualified as Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital; except that the rule permits bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 Capital (but not in common equity Tier 1 capital), subject to certain restrictions. Accumulated other comprehensive income (“AOCI”) is presumptively included in common equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We elected to opt out from the inclusion of AOCI in common equity Tier 1 capital.

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2017, we are required to hold a capital conservation buffer of 1.25%, increasing by that amount 0.625% each successive year until 2019.

In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in common equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.

In addition, in the current economic and regulatory environment, bank regulators may impose capital requirements that are more stringent than those required by applicable existing regulations. The application of more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if we are unable to comply with such requirements. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital or additional capital conservation buffers, could result in management modifying our business strategy and could limit our ability to make distributions, including paying dividends or buying back our shares.
 
The federal banking agencies are implementing new liquidity standards that, while not directly applicable to us, could result in our having to lengthen the term of our funding, restructure our business lines by forcing us to seek new sources of liquidity for them, and/or increase our holdings of liquid assets.

In 2014, the federal banking agencies adopted a “liquidity coverage ratio” requirement for bank holding companies with $250 billion or more in total assets or $10 billion or more in on-balance sheet foreign exposures and their subsidiary depository institutions with $10 billion or more in total consolidated assets. The requirement calls for sufficient “high quality liquid assets” to meet liquidity needs for a 30 calendar day liquidity stress scenario.  In 2016, the agencies proposed a net stable funding ratio for these institutions, which imposes a similar requirement over a one-year period. Neither the liquidity coverage standard nor the net stable funding standard apply directly to us, but the substance of the standards  –  adequate liquidity over 30-day and one-year periods  –  may influence the regulators’ assessments of our liquidity. We could be required to reduce our holdings of illiquid assets which could adversely affect our results of operations and financial condition. The United States regulators have not yet proposed a net stable funding ratio requirement.

Increased and/or special FDIC assessments will hurt our earnings.

The recent economic recession caused a high level of bank failures, which dramatically increased FDIC resolution costs and led to a significant reduction in the balance of the deposit insurance fund. As a result, the FDIC significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. If such increases in the base assessment rate occur in the future, our deposit insurance costs may increase thereby negatively impacting our earnings.

Strong competition within our market area could hurt our profits and slow growth.

Although we consider ourselves competitive in our primary market area of Buncombe, Madison, McDowell, Henderson and Transylvania Counties in North Carolina and the surrounding areas, we face intense competition both in making loans and attracting deposits. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.

Our operational or security systems may experience an interruption or breach in security, including as a result of cyber-attacks.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, including as a result of cyber-attacks, could result in failures or disruptions in our client relationship management, deposit, loan, and other systems and also the disclosure or misuse of confidential or proprietary information. While we have systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of client business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
 
Liquidity needs could adversely affect our results of operations and financial condition.

The primary sources of our Bank’s funds are client deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters, which could be exacerbated by potential climate change, and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to clients on alternative investments and general economic conditions. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include FHLB advances, sales of securities and loans, and federal funds lines of credit from correspondent banks, as well as out-of-market time deposits. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if we continue to grow and experience increasing loan demand. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.

We are exposed to a need for additional capital resources for the future and these capital resources may not be available when needed or at all.

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments or to strengthen our capital position. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control and our financial performance. Accordingly, we cannot provide assurance that such financing will be available to us on acceptable terms or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we decide to raise additional equity capital, our current shareholders’ interests could be diluted.

Failure to keep pace with technological change could adversely affect our business.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our clients. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
 
Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits, the related income generated from those deposits and, in the event of branch sales or closures, losses from the sales of premises. The loss of these revenue streams, the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

We depend on the accuracy and completeness of information about clients and counterparties.

In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, we may assume that a customer’s audited financial statements conform to accounting principles generally accepted in the United States of America (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. Our financial condition and results of operations could be negatively impacted to the extent we incorrectly assess the creditworthiness of our borrowers, fail to detect or respond to deterioration in asset quality in a timely manner, or rely on financial statements that do not comply with GAAP or are materially misleading.

The accuracy of our financial statements and related disclosures could be affected because we are exposed to conditions or assumptions different from the judgments, assumptions or estimates used in our critical accounting policies.

The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, included in this document, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that are considered “critical” by us because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, such events or assumptions could have a material impact on our audited consolidated financial statements and related disclosures.
 
We are exposed to the possibility of technology failure and a disruption in our operations may adversely affect our business.

We rely on our computer systems and the technology of outside service providers. Our daily operations depend on the operational effectiveness of their technology. We rely on our systems to accurately track and record our assets and liabilities. If our computer systems or outside technology sources become unreliable, fail, or experience a breach of security, our ability to maintain accurate financial records may be impaired, which could materially affect our business operations and financial condition. In addition, a disruption in our operations resulting from failure of transportation and telecommunication systems, loss of power, interruption of other utilities, natural disaster, fire, global climate changes, computer hacking or viruses, failure of technology, terrorist activity or the domestic and foreign response to such activity or other events outside of our control could have an adverse impact on the financial services industry as a whole and/or on our business. Our business recovery plan may not be adequate and may not prevent significant interruptions of our operations or substantial losses. The increased number of cyber attacks during the past few years has further heightened our attention to this risk. As such, we are in the process of implementing additional security software and assigning persons to monitor and assist with the mitigation of this ever increasing risk.

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

Reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our company and the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and cybersecurity incidents, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (which we refer to as the “Patriot Act”) and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and results of operations.  Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.
 
Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected from liability to a borrower for failing to make the necessary determinations.  We have aligned our underwriting standards with the Ability to Repay and Qualified Mortgage rules and requirements issued by the CFPB.  It is our policy not to make predatory loans and to determine borrowers’ ability to repay in accordance with CFPB standards, but the law and related rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.

We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the Community Reinvestment Act and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.

The Federal Reserve Board may require us to commit capital resources to support the Bank.

The Federal Reserve Board requires a bank holding company to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve Board may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. In addition, the Dodd-Frank Act directs the federal bank regulators to require that all companies that directly or indirectly control an insured depository institution serve as a source of strength for the institution. Under these requirements, in the future, we could be required to provide financial assistance to our Bank if the Bank experiences financial distress.

A capital injection may be required at times when we do not have the resources to provide it, and therefore we may be required to borrow the funds. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely impact the holding company’s cash flows, financial condition, results of operations and prospects.

Item 1B.
Unresolved Staff Comments

None.
 
Item 2.
Properties

We conduct our business through our main office, banking centers and other offices. The following table sets forth certain information relating to these facilities as of December 31, 2016.
 
(Dollars in thousands)
 Year
 Opened
 
Square
Footage
 
 Owned/
 Leased
 
Lease
Expiration
Date
   
Net Book
Value At
December 31,
2016
 
                       
Banking Centers:
                     
Downtown Asheville (Main Office)
 1936
   
23,304
 
 Owned
   
   
$
2,951
 
11 Church Street
                           
Asheville, NC  28801
                           
                             
Black Mountain
 1960
   
3,094
 
 Owned
   
     
225
 
300 West State Street
                           
Black Mountain, NC  28711
                           
                             
Mars Hill
 1974
   
4,046
 
 Owned
   
     
1,151
 
105 North Main Street
                           
Mars Hill, NC  28754
                           
                             
Skyland
 1976
   
2,942
 
 Owned
   
     
546
 
1879 Hendersonville Road
                           
Asheville, NC  28803
                           
                             
East Asheville
 1978
   
2,340
 
 Owned
   
     
113
 
10 South Tunnel Road
                           
Asheville, NC  28805
                           
                             
North Asheville
 1979
   
7,533
 
 Owned
   
     
382
 
778 Merrimon Avenue
                           
Asheville, NC  28804
                           
                             
West Asheville
 1981
   
2,888
 
 Owned
   
     
368
 
1012 Patton Avenue
                           
Asheville, NC  28806
                           
                             
Marion
 1981
   
4,920
 
 Owned
   
     
208
 
162 North Main Street
                           
Marion, NC  28752
                           
                             
Hendersonville
 1992
   
5,276
 
 Owned
   
     
525
 
601 North Main Street
                           
Hendersonville, NC  28792
                           
                             
Brevard
 1995
   
2,288
 
 Owned
   
     
767
 
2 Market Street
                           
Straus Park
                           
Brevard, NC  28712
                           
                             
Reynolds
 2001
   
3,342
 
 Owned
   
     
936
 
5 Olde Eastwood Village Boulevard
                           
US 74 East
                           
Asheville, NC  28803
                           

(Continued on following page)
 
(Continued from previous page)

(Dollars in thousands)
 Year
 Opened
 
Square
Footage
 
 Owned/
 Leased
 
Lease
Expiration
Date
   
Net Book
Value At
December 31,
2016
 
                       
Enka-Candler
 2003
   
3,651
 
 Owned
   
   
$
947
 
907 Smoky Park Highway
                           
Candler, NC  28715
                           
                             
Fletcher
 2008
   
3,625
 
  Lot Leased
  1/31/2027      
811
 
3551 Hendersonville Road
         
 Structure
               
Fletcher, NC  28732
         
 Owned
               
                             
Other Offices:
                           
Operations and Administration
 2003
   
46,000
 
 Leased
  4/30/2017      
234
 
901 Smoky Park Highway
                           
Candler, NC  28715
                           
                             
Commercial Lending
 1998
   
– (1
)
 Owned
   
     
– (1
)
11 Church Street
                           
Asheville, NC  28801
                           


(1)
Square footage and net book value for Commercial Lending are reflected in square footage and net book value for our Main Office located at 11 Church Street, Asheville, North Carolina.

Item 3.
Legal Proceedings

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that, after review with our legal counsel, we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

Item 4.
Mine Safety Disclosures

Not applicable.

Part II

Item 5.
Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock is listed on the Nasdaq Global Market under the symbol “ASBB.” The common stock was issued at a price of $10.00 per share in connection with the Bank’s mutual-to-stock conversion and the initial public offering of the Company’s common stock. The common stock commenced trading on the Nasdaq Global Market on October 12, 2011. As of the close of business on December 31, 2016, there were 3,788,025 shares of common stock outstanding held by 439 holders of record.

The following table sets forth the high and low closing sales prices of the Company’s common stock as reported by the Nasdaq Global Market for the periods indicated.
 
   
Market Price Per Common Share
 
Quarter Ended:
 
High Close
   
Low Close
   
Last Close
 
                   
December 31, 2016
 
$
29.75
   
$
25.75
   
$
29.75
 
September 30, 2016
   
26.45
     
24.62
     
26.25
 
June 30, 2016
   
26.50
     
24.07
     
24.53
 
March 31, 2016
   
26.00
     
24.24
     
24.24
 
                         
December 31, 2015
 
$
27.00
   
$
24.66
   
$
25.96
 
September 30, 2015
   
25.80
     
21.67
     
25.05
 
June 30, 2015
   
21.99
     
20.70
     
21.66
 
March 31, 2015
   
21.42
     
19.43
     
20.50
 
 
The following graph and table provide a comparison of the cumulative total returns for the common stock of the Company, the NASDAQ Composite Index and the SNL Financial Southeastern Bank and Thrift Index for the periods indicated. The graph assumes that an investor originally invested $100 in shares of our common stock at its closing price on October 12, 2011, the first day that our shares were traded. The stock price information below is not necessarily indicative of future price performance.
 
 
   
ASB
Bancorp, Inc.
   
NASDAQ
Composite
   
SNL SE
Thrift Index
 
December 31, 2011
   
100.00
     
100.00
     
100.00
 
December 31, 2012
   
130.94
     
117.45
     
156.85
 
December 31, 2013
   
147.45
     
164.57
     
189.72
 
December 31, 2014
   
183.76
     
188.84
     
202.08
 
December 31, 2015
   
221.86
     
201.98
     
187.77
 
December 31, 2016
   
254.28
     
219.89
     
230.14
 
 
The Company did not declare or pay any dividends to its shareholders during the years ended December 31, 2016 or 2015.  See Item 1, “Business—Regulation and Supervision,” for more information regarding the Company’s and the Bank’s payment of dividends.

On September 19, 2012, the Company authorized the funding of a trust that purchased 223,382 shares of its stock during 2012 to be available for issuance under its 2012 Equity Incentive Plan.  On February 5, 2013, 223,382 restricted stock awards were granted under the Plan.

The Company made no purchases of its common stock during the quarter ended December 31, 2016.

The Company’s 2012 Equity Incentive Plan permits the exchange of shares issued upon the exercise of stock options for the surrender of shares currently held by the grant recipient.  During 2016, the Company received 4,050 shares in exchange for the issuance of 6,600 option shares using this exercise method.
 
Item 6.
Selected Financial Data

The summary financial data presented below for the years ended December 31, 2016, 2015, 2014, 2013 and 2012 are derived in part from the audited consolidated financial statements that appear in this annual report. The following is only a summary and should be read in conjunction with the audited consolidated financial statements and notes included in this annual report.
 
   
December 31,
 
(Dollars in thousands)
 
2016
   
2015
   
2014
   
2013
   
2012
 
                               
Selected Financial Condition Data:
                             
Balances at end of period:
                             
Total assets
 
$
795,823
   
$
782,853
   
$
760,040
   
$
733,026
   
$
749,345
 
Cash and cash equivalents
   
46,724
     
33,401
     
56,858
     
52,791
     
47,390
 
Securities available for sale
   
99,909
     
137,555
     
141,462
     
185,329
     
238,736
 
Securities held to maturity
   
3,672
     
3,809
     
3,999
     
4,241
     
4,649
 
Federal Home Loan Bank stock
   
2,829
     
2,807
     
2,902
     
3,131
     
3,429
 
Loans held for sale
   
7,145
     
7,018
     
5,237
     
4,142
     
9,759
 
Loans receivable, net of deferred fees
   
603,582
     
576,087
     
521,820
     
449,234
     
387,721
 
Allowance for loan losses
   
(6,544
)
   
(6,289
)
   
(5,949
)
   
(7,307
)
   
(8,513
)
Foreclosed real estate
   
5,069
     
5,646
     
8,814
     
14,233
     
19,411
 
Deposits
   
647,623
     
630,904
     
603,379
     
572,786
     
578,299
 
Overnight and short-term borrowings
   
392
     
327
     
660
     
787
     
411
 
Federal Home Loan Bank advances
   
50,000
     
50,000
     
50,000
     
50,000
     
50,000
 
Total equity
   
91,137
     
89,682
     
94,397
     
101,088
     
111,529
 
                                         
Average balances for period:
                                       
Average total assets
   
790,831
     
781,974
     
747,491
     
751,406
     
781,633
 
Average loans
   
601,654
     
557,221
     
476,782
     
421,415
     
418,569
 
Average interest-earning assets
   
755,451
     
746,531
     
708,733
     
706,496
     
749,024
 
Average deposits
   
636,800
     
621,741
     
588,511
     
582,858
     
595,183
 
Average interest-bearing liabilities
   
563,789
     
562,228
     
551,995
     
561,892
     
594,908
 
Average total equity
   
92,102
     
96,308
     
98,981
     
105,941
     
116,208
 

(Dollars in thousands except
 
Year Ended December 31,
 
per share data)
 
2016
   
2015
   
2014
   
2013
   
2012
 
                               
Selected Operating Data:
                             
Interest and dividend income
 
$
27,348
   
$
25,435
   
$
23,502
   
$
22,952
   
$
24,992
 
Interest expense
   
3,444
     
3,485
     
3,536
     
4,194
     
6,492
 
Net interest income
   
23,904
     
21,950
     
19,966
     
18,758
     
18,500
 
Provision for (recovery of) loan losses
   
548
     
361
     
(998
)
   
(681
)
   
1,700
 
Net interest income after provision for (recovery of) loan losses
   
23,356
     
21,589
     
20,964
     
19,439
     
16,800
 
Noninterest income
   
8,756
     
7,509
     
6,333
     
8,034
     
9,456
 
Noninterest expenses
   
30,450
     
23,540
     
23,548
     
25,394
     
25,092
 
Income before income tax provision
   
1,662
     
5,558
     
3,749
     
2,079
     
1,164
 
Income tax provision
   
444
     
1,983
     
1,260
     
625
     
302
 
Net income
 
$
1,218
   
$
3,575
   
$
2,489
   
$
1,454
   
$
862
 
                                         
Selected Data Per Common Share:
                                       
Earnings per share - Basic
 
$
0.35
   
$
0.92
   
$
0.60
   
$
0.31
   
$
0.17
 
Earnings per share - Diluted
   
0.33
     
0.89
     
0.59
     
0.31
     
0.17
 
Tangible book value per share
   
24.06
     
22.50
     
21.56
     
20.06
     
19.97
 
Stock price -  High
   
29.75
     
27.24
     
21.96
     
18.41
     
16.40
 
Low
   
24.07
     
19.29
     
17.15
     
14.91
     
11.40
 
Close
   
29.75
     
25.96
     
21.50
     
17.25
     
15.32
 
 
 
Year Ended December 31,
 
   
2016
   
2015
   
2014
   
2013
   
2012
 
                               
Performance Ratios:
                             
Return on average assets (5)
   
0.15
%
   
0.46
%
   
0.33
%
   
0.19
%
   
0.11
%
Return on average equity (5)
   
1.32
%
   
3.71
%
   
2.51
%
   
1.37
%
   
0.74
%
Yield on average interest-earning assets
   
3.69
%
   
3.47
%
   
3.37
%
   
3.31
%
   
3.37
%
Cost of average interest-bearing liabilities
   
0.61
%
   
0.62
%
   
0.64
%
   
0.75
%
   
1.09
%
Interest rate spread (1)
   
3.08
%
   
2.85
%
   
2.73
%
   
2.56
%
   
2.28
%
Net interest margin (2)
   
3.23
%
   
3.00
%
   
2.87
%
   
2.72
%
   
2.50
%
Noninterest expense to average assets (5)
   
3.85
%
   
3.01
%
   
3.15
%
   
3.38
%
   
3.21
%
Efficiency ratio (3)(5)
   
95.64
%
   
80.18
%
   
88.87
%
   
96.23
%
   
100.45
%
Average interest-earning assets to average interest-bearing liabilities
   
134.00
%
   
132.78
%
   
128.39
%
   
125.74
%
   
125.91
%
Average equity to average assets
   
11.65
%
   
12.32
%
   
13.24
%
   
14.10
%
   
14.87
%
                                         
Capital Ratios:
                                       
Common equity Tier 1 capital (4)
   
15.54
%
   
16.66
%
   
n/a
     
n/a
     
n/a
 
Tier 1 risk-based capital to adjusted average assets (4)
   
11.58
%
   
11.87
%
   
13.17
%
   
14.35
%
   
14.69
%
Tier 1 risk-based capital to risk-weighted assets (4)
   
15.54
%
   
16.66
%
   
19.83
%
   
24.14
%
   
27.72
%
Total risk-based capital to risk-weighted assets (4)
   
16.63
%
   
17.77
%
   
21.01
%
   
25.39
%
   
28.98
%
Capital to assets
   
11.45
%
   
11.46
%
   
12.42
%
   
13.79
%
   
14.88
%
                                         
Asset Quality Ratios:
                                       
Allowance for loan losses as a percent of total loans
   
1.08
%
   
1.09
%
   
1.14
%
   
1.63
%
   
2.20
%
Allowance for loan losses as a percent of nonperforming loans
   
646.64
%
   
246.82
%
   
221.32
%
   
610.44
%
   
739.62
%
Net charge-offs to average loans outstanding during period
   
0.05
%
   
0.00
%
   
0.08
%
   
0.12
%
   
0.91
%
Nonperforming loans as a percent of total loans
   
0.17
%
   
0.44
%
   
0.52
%
   
0.27
%
   
0.30
%
Nonperforming assets as a percent of total assets
   
0.79
%
   
1.06
%
   
1.52
%
   
2.11
%
   
2.75
%
                                         
Other Data:
                                       
Banking centers
   
13
     
13
     
13
     
13
     
13
 
Full-time equivalent employees
   
155
     
152
     
160
     
173
     
168
 
 

(1)
Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost on average interest-bearing liabilities. Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 34%.
(2)
Represents net interest income as a percent of average interest-earning assets. Tax exempt income is reported on a tax equivalent basis using a federal marginal tax rate of 34%.
(3)
Represents noninterest expenses divided by the sum of net interest income on a tax equivalent basis using a federal marginal tax rate of 34% and noninterest income, excluding realized gains and losses on the sale of securities.
(4)
Regulatory capital ratios are based on BASEL III capital standards for 2016 and 2015, and BASEL I capital standards for 2012 through 2014.
(5)
Ratios include the qualified pension plan settlement charges for the year ended December 31, 2016. Excluding the pension plan settlement charges, the ratios for the year ended December 31, 2016 were as follows:

Return on average assets
   
0.76
%
Return on average equity
   
6.56
%
Noninterest expense to average assets
   
2.89
%
Efficiency ratio
   
71.75
%
 
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

The objective of this section is to help readers understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the audited consolidated financial statements and the notes to consolidated financial statements that appear at the end of this annual report.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. The following represent our critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to earnings. Management’s estimates of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impaired loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance monthly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectibility of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the NCCoB, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect our earnings. See notes 1 and 4 included in the consolidated financial statements.

Fair Value of Investments. Securities are characterized as available for sale or held to maturity based on management’s ability and intent regarding such investment at acquisition. On an ongoing basis, management estimates the fair value of its investment securities based on information and assumptions it deems reliable and reasonable, which may be quoted market prices or if quoted market prices are not available, fair values extrapolated from the quoted prices of similar instruments. Based on this information, an assessment must be made as to whether any decline in the fair value of an investment security should be considered as an other than temporary impairment and recorded in noninterest income as a loss on investments. The determination of such impairment is subject to a variety of factors, including management’s judgment and experience. See notes 2 and 13 included in the consolidated financial statements.

Foreclosed Real Estate. The Company’s valuations of its foreclosed real estate involve significant judgments and assumptions by management, which have a material impact on the reported values of foreclosed real estate assets and noninterest expense recorded in the financial statements. The judgments and assumptions used by management are described in “Foreclosed Real Estate” under note 1 included in the consolidated financial statements.
 
Pension Plan. The Company had a noncontributory defined benefit pension plan. This plan was accounted for under the provisions of the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) Topic 715: Compensation-Retirement Benefits (“FASB ASC Topic 715”), which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the benefit obligation. For a pension plan, the benefit obligation is the projected benefit obligation. FASB ASC Topic 715 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. Management must make certain estimates and assumptions when determining the projected benefit obligation. These estimates and assumptions include the expected return on plan assets and the appropriate discount rate to be used in determining the present value of the obligation.  In April 2016, the Bank decided to settle its qualified pension plan liability in November 2016 for all participants.  The settlement was  recognized in the fourth quarter of 2016 when participants received annuities or lump sum payments of their accrued benefit balances.  See note 11 included in the consolidated financial statements regarding the plan termination.

Comparison of Financial Condition at December 31, 2016 and December 31, 2015

General. Total assets increased $12.9 million, or 1.7%, to $795.8 million at December 31, 2016 from $782.9 million at December 31, 2015.  Investment securities decreased $37.8 million, or 26.7%, to $103.6 million at December 31, 2016 from $141.4 million at December 31, 2015 and cash and cash equivalents increased $13.3 million to $46.7 million at December 31, 2016 from $33.4 million at December 31, 2015, primarily due to the redeployment of investment securities to fund loan growth, Company stock repurchases and employer pension plan contributions. Loans receivable, net of deferred fees, increased $27.5 million, or 4.8%, to $603.6 million at December 31, 2016 from $576.1 million at December 31, 2015 as new loan originations exceeded loan repayments, prepayments, and foreclosures.  During 2016, a $10.0 million purchase of bank owned life insurance was completed. Total liabilities increased $11.5 million to $704.7 million at December 31, 2016 from $693.2 million at December 31, 2015. Total deposits increased $16.7 million, or 2.7%, to $647.6 million at December 31, 2016 from $630.9 million at December 31, 2015 primarily as a result of growth in lower cost transaction accounts. Accounts payable and other liabilities decreased $5.2 million, or 44.1%, to $6.7 million at December 31, 2016 from $11.9 million at December 31, 2015.  The decrease in 2016 was primarily attributable to $5.5 reduction in the pension liability as a result of contribution to the qualified pension plan.

Loans. Loan originations totaled $291.5 million for the year ended December 31, 2016 compared to $296.1 million for the year ended December 31, 2015. Residential mortgage loan originations, largely from residential purchase transactions, totaled $85.9 million in 2016 compared to $91.9 million in 2015, while residential construction and land development loan originations totaled $39.9 million in 2016 compared to $32.5 million in 2015. Originations of commercial mortgage, commercial construction and land development, and commercial and industrial loans totaled $87.5 million, $29.7 million and $23.7 million, respectively, for the year ended December 31, 2016 compared to $79.9 million, $23.9 million and $19.3 million, respectively, for the year ended December 31, 2015. Revolving mortgage originations totaled $24.3 million in 2016 compared to $33.0 million in 2015, while consumer loan originations totaled $491,000 in 2016 compared to $15.5 million in 2015.  The decrease in consumer loan originations was mostly because of the discontinuation of originations of indirect automobile financing through dealers during the second quarter of 2015 due to the unprofitability of this activity.  Origination activity was significantly offset by $193.0 million of normal loan repayments and prepayments and $69.8 million in loan sales for the year ended December 31, 2016, compared to $163.8 million and $76.1 million, respectively, for the year ended December 31, 2015.
 
Loan Portfolio Composition

The following table sets forth the composition of our loan portfolio at the dates indicated.

   
December 31,
 
   
2016
   
2015
   
2014
 
(Dollars in thousands)
 
Amount
   
Percent
   
Amount
   
Percent
   
Amount
   
Percent
 
                                     
Commercial:
                                   
Commercial mortgage
 
$
241,125
     
39.93
%
 
$
209,397
     
36.32
%
 
$
201,316
     
38.53
%
Commercial construction and land development
   
27,813
     
4.61
%
   
38,313
     
6.64
%
   
21,661
     
4.14
%
Commercial and industrial
   
23,819
     
3.95
%
   
22,878
     
3.97
%
   
15,872
     
3.04
%
Total
   
292,757
     
48.49
%
   
270,588
     
46.93
%
   
238,849
     
45.71
%
                                                 
Non-commercial:
                                               
Residential mortgage
   
200,590
     
33.22
%
   
186,839
     
32.41
%
   
172,163
     
32.95
%
Residential construction and land development
   
20,801
     
3.44
%
   
16,587
     
2.88
%
   
14,781
     
2.83
%
Revolving mortgage
   
66,870
     
11.07
%
   
66,258
     
11.49
%
   
56,370
     
10.79
%
Consumer
   
22,805
     
3.78
%
   
36,291
     
6.29
%
   
40,363
     
7.72
%
Total
   
311,066
     
51.51
%
   
305,975
     
53.07
%
   
283,677
     
54.29
%
                                                 
Total loans
   
603,823
     
100.00
%
   
576,563
     
100.00
%
   
522,526
     
100.00
%
                                                 
Less:  Net deferred loan origination fees
   
241
             
476
             
706
         
Less:  Allowance for loan losses
   
6,544
             
6,289
             
5,949
         
Loans receivable, net
 
$
597,038
           
$
569,798
           
$
515,871
         

   
December 31,
 
   
2013
   
2012
 
(Dollars in thousands)
 
Amount
   
Percent
   
Amount
   
Percent
 
                         
Commercial:
                       
Commercial mortgage
 
$
171,993
     
38.23
%
 
$
138,804
     
35.76
%
Commercial construction and land development
   
15,593
     
3.47
%
   
5,161
     
1.34
%
Commercial and industrial
   
14,770
     
3.28
%
   
11,093
     
2.86
%
Total
   
202,356
     
44.98
%
   
155,058
     
39.96
%
                                 
Non-commercial:
                               
Residential mortgage
   
161,437
     
35.89
%
   
163,571
     
42.14
%
Residential construction and land development
   
8,759
     
1.95
%
   
3,729
     
0.96
%
Revolving mortgage
   
49,561
     
11.02
%
   
48,221
     
12.42
%
Consumer
   
27,719
     
6.16
%
   
17,552
     
4.52
%
Total
   
247,476
     
55.02
%
   
233,073
     
60.04
%
                                 
Total loans
   
449,832
     
100.00
%
   
388,131
     
100.00
%
                                 
Less:  Net deferred loan origination fees
   
598
             
410
         
Less:  Allowance for loan losses
   
7,307
             
8,513
         
Loans receivable, net
 
$
441,927
           
$
379,208
         
 
Loan Portfolio Maturities

The following tables set forth certain information at December 31, 2016 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The tables do not include any estimate of prepayments that significantly shorten the average life of our loans and may cause our actual repayment experience to differ from that shown below. Demand loans, which are loans having no stated schedule of repayments and no stated maturity, are reported as due in one year or less.

   
December 31, 2016
 
(Dollars in thousands)
 
Commercial
Mortgages
   
Commercial
Construction
And Land
Development
   
Commercial
And
Industrial
   
Total
Commercial
 
                         
Amounts due in:
                       
One year or less
 
$
12,019
   
$
1,667
   
$
2,151
   
$
15,837
 
More than one year through two years
   
22,315
     
2,924
     
6,656
     
31,895
 
More than two years through three years
   
38,439
     
5,548
     
3,069
     
47,056
 
More than three years through five years
   
101,363
     
14,516
     
5,724
     
121,603
 
More than five years through ten years
   
48,306
     
3,158
     
6,219
     
57,683
 
More than ten years through fifteen years
   
18,097
     
-
     
-
     
18,097
 
More than fifteen years
   
586
     
-
     
-
     
586
 
Total
 
$
241,125
   
$
27,813
   
$
23,819
   
$
292,757
 

   
December 31, 2016
 
(Dollars in thousands)
 
Residential
Mortgages
   
Residential
Construction
And Land
Development
   
Revolving
Mortgages
   
Consumer
   
Total Non-
Commercial
   
Total
Loans
 
                                     
Amounts due in:
                                   
One year or less
 
$
2,002
   
$
320
   
$
1,263
   
$
901
   
$
4,486
   
$
20,323
 
More than one year through two years
   
3,665
     
188
     
1,037
     
1,299
     
6,189
     
38,084
 
More than two years through three years
   
3,279
     
183
     
2,261
     
3,871
     
9,594
     
56,650
 
More than three years through five years
   
14,134
     
643
     
7,540
     
13,410
     
35,727
     
157,330
 
More than five years through ten years
   
14,414
     
-
     
15,026
     
3,324
     
32,764
     
90,447
 
More than ten years through fifteen years
   
13,006
     
-
     
39,743
     
-
     
52,749
     
70,846
 
More than fifteen years
   
150,090
     
19,467
      -      
-
     
169,557
     
170,143
 
Total
 
$
200,590
   
$
20,801
   
$
66,870
   
$
22,805
   
$
311,066
   
$
603,823
 
 
Fixed vs. Adjustable Rate Loans

The following table sets forth the dollar amount of all loans at December 31, 2016 that have contractual maturities after December 31, 2017 and have either fixed interest rates or floating or adjustable interest rates. The amounts shown below exclude unearned loan origination fees.
 
   
Due After December 31, 2017
 
(Dollars in thousands)
 
Fixed
Rates
   
Floating Or
Adjustable
Rates
   
Total
 
                   
Commercial:
                 
Commercial mortgage
 
$
171,449
   
$
57,656
   
$
229,105
 
Commercial construction and land development
   
11,189
     
14,958
     
26,147
 
Commercial and industrial
   
12,161
     
9,507
     
21,668
 
Total commercial
   
194,799
     
82,121
     
276,920
 
Non-commercial:
                       
Residential mortgage
   
92,123
     
106,465
     
198,588
 
Residential construction and land development
   
601
     
19,880
     
20,481
 
Revolving mortgage
   
722
     
64,885
     
65,607
 
Consumer
   
21,904
     
-
     
21,904
 
Total non-commercial
   
115,350
     
191,230
     
306,580
 
Total loans receivable
 
$
310,149
   
$
273,351
   
$
583,500
 

Some of our adjustable rate loans contain rate floors that are equal to the initial interest rate on the loan. When market interest rates fall below the rate floor loan rates do not adjust further downward. As market interest rates rise in the future, the interest rates on these loans may rise based on the contract rate (index plus the margin) exceeding the initial interest rate floor; however, contract interest rates will only increase when the index plus margin exceed the imposed rate floor.
 
Loan Activity

The following table shows loans originated, purchased and sold during the periods indicated, including residential mortgage loans intended for sale in the secondary market.
 
   
Year Ended December 31,
 
(Dollars in thousands)
 
2016
   
2015
   
2014
   
2013
   
2012
 
                               
Total loans at beginning of period
 
$
576,816
   
$
521,108
   
$
446,069
   
$
388,967
   
$
428,846
 
Loans originated:
                                       
Commercial:
                                       
Commercial mortgage
   
87,520
     
79,933
     
84,145
     
102,280
     
61,910
 
Construction and land development
   
29,739
     
23,920
     
18,352
     
14,772
     
1,050
 
Commercial and industrial
   
23,672
     
19,306
     
14,782
     
9,698
     
5,853
 
Non-commercial:
                                       
Residential mortgage
   
85,905
     
91,932
     
62,082
     
120,555
     
110,682
 
Construction and land development
   
39,882
     
32,512
     
27,071
     
21,913
     
10,986
 
Revolving mortgage
   
24,314
     
33,041
     
24,962
     
18,683
     
7,107
 
Consumer
   
491
     
15,503
     
29,444
     
25,237
     
9,830
 
Total loans originated
   
291,523
     
296,147
     
260,838
     
313,138
     
207,418
 
                                         
Loans purchased:
                                       
Commercial:
                                       
Commercial mortgage
   
150
     
430
     
110
     
55
     
2,909
 
Total loans purchased
   
150
     
430
     
110
     
55
     
2,909
 
                                         
Total loans originated and purchased
   
291,673
     
296,577
     
260,948
     
313,193
     
210,327
 
                                         
Deduct:
                                       
Loan principal repayments
   
193,102
     
163,775
     
143,863
     
150,027
     
139,879
 
Loan sales
   
69,814
     
76,144
     
42,655
     
105,849
     
90,955
 
Foreclosed loans transferred to foreclosed properties
   
992
     
820
     
281
     
708
     
17,464
 
Charge-offs
   
378
     
476
     
504
     
630
     
3,995
 
Deductions (additions) for other items (1)
   
20
     
(346
)
   
(1,394
)
   
(1,123
)
   
(2,087
)
Net loan activity during the period
   
27,367
     
55,708
     
75,039
     
57,102
     
(39,879
)
Total loans at end of period
 
$
604,183
   
$
576,816
   
$
521,108
   
$
446,069
   
$
388,967
 


(1)
Other items consist of deferred loan fees, the allowance for loan losses and loans in process.

Loan originations come from a number of sources. The primary sources of loan originations are existing customers, walk-in traffic, advertising and referrals from customers. We generally sell in the secondary market long-term fixed-rate residential mortgage loans that we originate. Our decision to sell loans is based on prevailing market interest rate conditions, interest rate management and liquidity needs.
 
Investment Security Portfolio

At December 31, 2016, our securities portfolio consisted of mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation (also known as “Freddie Mac”), the Federal National Mortgage Association (also known as “Fannie Mae”) and the Government National Mortgage Association (also known as “Ginnie Mae”), securities of United States government agencies and corporations, securities of various government sponsored entities and securities of state and local governments. Our securities portfolio is used to invest excess funds for increased yield, manage interest rate risk and as collateralization for public unit deposits.

At December 31, 2016, our securities portfolio represented 13.0% of total assets compared to 18.1% at December 31, 2015, the decrease primarily due to a $27.5 million increase in loans receivable to $603.6 million at December 31, 2016. Securities classified as available for sale were $99.9 million of our securities portfolio at December 31, 2016, while $3.7 million of our securities portfolio was classified as held to maturity. Securities classified as held to maturity are United States government sponsored entity, mortgage-backed and state and local government securities. Total investment securities decreased by $37.8 million, or 26.7%, to $103.6 million at December 31, 2016 from $141.4 million at December 31, 2015, primarily due to the redeployment of investment securities to fund loan growth, Company stock repurchases and employer pension plan contributions. In addition, at December 31, 2016, we had $2.8 million of other investments held at cost, which consisted solely of FHLB of Atlanta common stock.

The following table sets forth the amortized costs and fair values of our investment securities at the dates indicated. For all periods presented, our mortgage-backed and related securities did not include any private label issues or real estate mortgage investment conduits, but do include securities backed by the U.S. Small Business Administration (“SBA”).

   
December 31,
 
   
2016
   
2015
   
2014
 
(Dollars in thousands)
 
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
 
                                     
Securities available for sale:
                               
U.S. government agencies and corporations
 
$
2,096
   
$
2,089
   
$
2,135
   
$
2,114
   
$
2,173
   
$
2,138
 
Mortgage-backed and similar securities
   
45,026
     
44,387
     
68,700
     
68,092
     
95,814
     
95,886
 
State and local government
   
54,583
     
52,670
     
65,542
     
66,591
     
42,535
     
42,692
 
Other equity securities
   
777
     
763
     
760
     
758
     
744
     
746
 
Total available for sale
   
102,482
     
99,909
     
137,137
     
137,555
     
141,266
     
141,462
 
                                                 
Securities held to maturity:
                                               
U.S. government agencies and corporations
   
1,009
     
1,027
     
1,024
     
1,070
     
1,038
     
1,111
 
Mortgage-backed and similar securities
   
223
     
240
     
351
     
376
     
532
     
572
 
State and local government
   
2,440
     
2,608
     
2,434
     
2,640
     
2,429
     
2,680
 
Total held to maturity
   
3,672
     
3,875
     
3,809
     
4,086
     
3,999
     
4,363
 
                                                 
Total securities
 
$
106,154