10-K 1 e18072_enfc-10k.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

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

 

For the fiscal year ended:

December 31, 2017

Commission File Number: 001-35302

Entegra Financial Corp.

(Exact name of Registrant as specified in its Charter)

   
North Carolina 45-2460660
(State of Incorporation) (I.R.S. Employer Identification No.)
   
14 One Center Court,  
Franklin, North Carolina 28734
(Address of principal executive offices) (Zip Code)

(828) 524-7000

(Registrant’s telephone number, including area code)

 

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

 

Title of each class

 

Name of each exchange on which registered

Common stock, no par value per share   NASDAQ Global Market

 

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 in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

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

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o Accelerated filer x Non-accelerated filer o Smaller reporting company o Emerging growth company x

 

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

 

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

 

As of June 30, 2017, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $141.9 million. On March 9, 2018, 6,888,415 shares of the issuer’s common stock (no par value), were issued and outstanding.

 

Documents Incorporated by Reference:

Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 17, 2018. Part III (Portions of Items 10-14)
 
 

TABLE OF CONTENTS

    Page No.
PART I    
Item 1. Business   3
Item 1A. Risk Factors   20
Item 1 B. Unresolved Staff Comments    31
Item 2. Properties    31
Item 3. Legal Proceedings    31
Item 4. Mine Safety Disclosures    31
PART II    
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    32
Item 6. Selected Financial Data   34 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations    36
Item 8. Financial Statements and Supplementary Data    74
Consolidated Balance Sheets    75
Consolidated Statements of Operations    76
Consolidated Statements of Comprehensive Income    77
Consolidated Statements of Changes in Shareholders’ Equity    78
Consolidated Statements of Cash Flows    79
Notes to Consolidated Financial Statements    81
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure    139
Item 9A. Controls and Procedures    139
Item 9B. Other Information    139
PART III    
Item 10. Directors, Executive Officers and Corporate Governance    140
Item 11. Executive Compensation    140
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    140
Item 13. Certain Relationships and Related Transactions, and Director Independence    140
Item 14. Principal Accounting Fees and Services    140
PART IV    
Item 15. Exhibits, Financial Statement Schedules    141
SIGNATURES    
 
 

CAUTIONARY STATEMENT REGARDING

FORWARD-LOOKING STATEMENTS

This report, including information included or incorporated by reference in this document, contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking 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,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” 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 materially from those anticipated in our forward-looking statements include, without limitation:

·We may not be able to utilize all of our deferred tax asset;
·Our ability to realize our deferred tax asset and deduct certain future losses could be limited if we experience an ownership change as defined in the Code;
·We may not be able to implement aspects of our growth strategy;
·Future expansion involves risks;
·New bank office facilities and other facilities may not be profitable;
·Acquisition of assets and assumption of liabilities may expose us to intangible asset risk, which could impact our results of operations and financial condition;
·The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand;
·We may need additional access to capital, which we may be unable to obtain on attractive terms or at all;
·Our estimate for losses in our loan portfolio may be inadequate, which would cause our results of operations and financial condition to be adversely affected;
·Our commercial real estate loans generally carry greater credit risk than one-to-four family residential mortgage loans;
·Our concentration of construction financing may expose us to a greater risk of loss and hurt our earnings and profitability;
·Repayment of our commercial business loans is primarily dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value;
·Our level of home equity loans and lines of credit lending may expose us to increased credit risk;
·We continue to hold and acquire other real estate, which has led to operating expenses and vulnerability to additional declines in real property values;
·A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business;
·Concentration of collateral in our primary market area may increase the risk of increased non-performing assets;
·Income from secondary mortgage market operations is volatile, and we may incur losses with respect to our secondary mortgage market operations that could negatively affect our earnings;
·We rely on the mortgage secondary market for some of our liquidity;
·Future changes in interest rates could reduce our profits;
·Strong competition within our market areas may limit our growth and profitability;
·Our stock-based benefit plan will increase our costs, which will reduce our income;
·The implementation of stock-based benefit plans may dilute your ownership interest;
·We are subject to extensive regulation and oversight, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory action;
·Financial reform legislation enacted by Congress and resulting regulations have increased and are expected to continue to increase our costs of operations;
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·We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations;
·We are subject to more stringent capital requirements, which may adversely impact our return on equity, require us to raise additional capital, or constrain us from paying dividends or repurchasing shares;
·We depend on our management team to implement our business strategy and execute successful operations and we could be harmed by the loss of their services;
·The fair value of our investments could decline;
·Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows;
·Changes in accounting standards could affect reported earnings;
·We are subject to environmental liability risk associated with our lending activities;
·A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses;
·We are party to various lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained;
·Our stock price may be volatile, which could result in losses to our shareholders and litigation against us;
·The trading volume in our common stock is lower than that of other larger companies; future sales of our stock by our shareholders or the perception that those sales could occur may cause our stock price to decline;
·There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock;
·We may issue additional debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in the event of liquidation, which could negatively affect the value of our common stock;
·Negative public opinion surrounding our company and the financial institutions industry generally could damage our reputation and adversely impact our earnings; and
·Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business.

Because of these and other risks and uncertainties, our actual future results may be materially different from the results indicated by any forward-looking statements. For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of this Annual Report on Form 10-K. In addition, our past results of operations do not necessarily indicate our future results. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We undertake no obligation to update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

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Part I

Item 1. Business

 

General

 

Entegra Financial Corp. (“Entegra” or the “Company”), headquartered in Franklin, North Carolina, was incorporated on May 31, 2011 to be the holding company for Entegra Bank (the “Bank”). On September 30, 2014, the mutual to stock conversion was completed and the Bank became the wholly owned subsidiary of the Company. Also on that date, the Company sold and issued 6,546,375 shares of its common stock at a price of $10.00 per share, through which the Company received net offering proceeds of $63.7 million.

 

The Company has one non-bank subsidiary, Macon Capital Trust I (“Macon Trust”), a Delaware statutory trust, formed to facilitate the issuance of trust preferred securities. Macon Trust is not consolidated in the Company’s financial statements.

 

Entegra Bank is a North Carolina chartered commercial bank founded in 1922. Our business consists primarily of accepting deposits from individuals and small businesses and investing those deposits, together with funds generated from operations and borrowings, primarily in loans secured by real estate, including commercial real estate loans, one-to-four family residential loans, construction loans, and home equity loans and lines of credit. We also originate commercial business loans and invest in investment securities. Through our mortgage loan production operations we originate loans for sale in the secondary markets to Fannie Mae and others, generally retaining the servicing rights in order to generate servicing income, supplement our core deposits with escrow deposits and maintain relationships with local borrowers. We offer a variety of deposit accounts, including savings accounts, certificates of deposit, money market accounts, commercial and regular checking accounts, and individual retirement accounts.

 

The Bank has one wholly-owned subsidiary, Entegra Services, Inc., which holds investment securities. The subsidiary had no assets as of December 31, 2017.

 

Market Area

 

The Bank was organized as a mutual savings and loan association, or “thrift,” for the primary purpose of promoting home ownership through mortgage lending, financed by locally gathered deposits. Surviving the Great Depression of the 1930’s, we remained a single-office bank until we opened a second office in downtown Murphy, North Carolina in 1981. Between 1993 and 2002, we added eight more branches in North Carolina, including a second office in Franklin, one in each of Highlands, Brevard, Sylva, Cashiers and Arden, and two in Hendersonville. In 2007, we opened two more branches in Columbus and Saluda, North Carolina. During 2015, we opened a branch in Greenville, South Carolina and acquired two branches in Anderson and Chesnee, South Carolina. In 2016, we acquired a branch and a loan production office in Waynesville and Asheville, North Carolina, respectively and opened a loan production office in Clemson, South Carolina. In February 2017, we acquired two branches in Jasper, Georgia and in October 2017 acquired a branch and loan production office in Gainesville and Duluth, Georgia, respectively.

 

As of December 31, 2017, we had 18 branches and three loan production offices located throughout the western North Carolina counties of Buncombe, Cherokee, Haywood, Henderson, Jackson, Macon, Polk and Transylvania, the Upstate South Carolina counties of Anderson, Greenville, Pickens, and Spartanburg, and the northern Georgia counties of Gwinnett, Hall and Pickens which we consider our primary market area. We also regularly extend loans to customers located in neighboring counties, including Clay, Rutherford and Swain in North Carolina; Fannin, Rabun, Towns and Union in Georgia; and Cherokee and Oconee, in South Carolina, which we consider our secondary market area.

 

The primary economic drivers of our primary market area in North Carolina are tourism and a vacation and retirement home industry. This area has numerous small- to mid-sized businesses, which are our primary business customers. These businesses include agricultural producers, artisans and specialty craft manufacturers, small industrial manufacturers, and a variety of service oriented industries. The largest employers in Macon County include Drake Software, a national tax software provider, based in Franklin.

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Our primary market area in South Carolina is economically diverse with major industries including the automobile industry, health and pharmaceuticals, manufacturing, and academic institutions. Located adjacent to major transportation corridors such as Interstates 85 and 26 and centrally located between Charlotte, North Carolina and Atlanta, Georgia, the Upstate South Carolina market is consistently recognized nationally as an area for business growth and relocation.

 

Our primary market area in northern Georgia includes one of the 50 fastest growing metro areas in the U.S., is home to more than 300 manufacturing and processing companies and is known as the business hub for northeast Georgia. Located at the foothills of the Blue Ridge Mountains, Gainesville is the 19th largest city in the state while Jasper is known as the Marble Capital of Georgia.

 

Unemployment data is one of the most significant indicators of the economic health in our market areas and is monitored by management on a regular basis. As reflected in the table below, the unemployment rate in each of the counties in our primary market area was elevated subsequent to the Great Recession, but have significantly improved since 2013.

 

   Unemployment Rate (1) 
   December 31, 
County  2017   2016   2015   2014   2013 
North Carolina:                         
Macon   4.4%   5.1%   5.6%   7.3%   11.1%
Henderson   3.8    4.1    4.0    4.9    7.2 
Haywood   3.9    4.5    4.7    5.0    6.2 
Jackson   4.6    5.1    4.7    5.8    9.6 
Polk   4.2    4.4    4.0    4.6    7.8 
Transylvania   4.4    4.9    5.6    6.6    10.1 
Cherokee   5.4    5.4    7.2    9.0    12.8 
Buncome   3.4    3.8    3.9    4.0    4.8 
                          
South Carolina:                         
Anderson   3.9    3.7    4.6    5.8    5.5 
Greenville   3.6    3.5    4.3    5.2    4.9 
Spartanburg   3.9    3.8    4.9    6.0    6.0 
                          
Georgia:                         
Gwinnett   3.8    4.6    4.7    5.2    6.0 
Hall   3.5    4.2    4.4    4.9    5.9 
Pickens   3.9    4.7    4.8    5.5    7.1 
                          
(1) - Unemployment rate per the United States Department of Labor 

Competition

 

The banking business is highly competitive. We have significant competition in our primary and secondary market areas. We compete with commercial banks, savings institutions, finance companies, credit unions and other financial services companies. Many of our larger commercial bank competitors have greater name recognition and offer certain services that we do not. However, we believe that our long-time presence in our primary market area and focus on superior service distinguish us from our competitors, many of whom operate under different names or are under different leadership as a consequence of the effects of the recent recession and a series of mergers and acquisitions.

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Market Share

 

As of June 30, 2017, the most recent date for which market data is available, total deposits in the Bank’s North Carolina primary market area, Cherokee, Haywood, Henderson, Jackson, Macon, Polk and Transylvania counties, were over $5.5 billion. At June 30, 2017, our deposits represented 14.4% of the market ranking us second in deposit market share within our North Carolina primary market area.

 

As of June 30, 2017, total deposits in the Bank’s South Carolina primary market area, Anderson, Greenville, and Spartanburg counties, were over $19.6 billion. As of June 30, 2017, our $64.9 million of deposits held at South Carolina branches represented less than 1.0% of total deposits in this market.

 

As of June 30, 2017, total deposits in the Bank’s northern Georgia primary market area of Pickens county, were over $0.9 million. At June 30, 2017, our deposits represented 21.48% of the market ranking us second in deposit market share within our northern Georgia primary market area.

 

Employees

 

At December 31, 2017, we had a total of 272 employees, of which 257 were full-time and 15 were part-time, all of whom were compensated by the Bank. None of our employees are represented by a collective bargaining unit, and we have not recently experienced any type of strike or labor dispute. We consider our relationship with our employees to be good.

 

Acquisition Activities

 

During the year ended December 31, 2017, we continued to successfully execute our key strategic initiatives. Building on our acquisition of two South Carolina branches from Arthur State Bank in December, 2015, we completed our first whole bank acquisition in the second quarter of 2016 when we acquired Old Town Bank of Waynesville, North Carolina. In February 2017, we acquired two branches in Jasper, Georgia from another financial institution followed by a whole bank acquisition, Chattahoochee Bank of Georgia in Gainesville, Georgia, in October 2017.

 

Lending Activities

 

Our primary lending activities are the origination of commercial real estate loans, one-to-four family residential mortgage loans, other construction and land loans, commercial business loans and home equity loans and lines of credit. Our largest category of loans is commercial real estate followed by one-to-four family, and other construction and land loans. At December 31, 2017, our top 25 relationships represented a lending exposure of $167.0 million with the largest single relationship totaling $16.8 million. These loans are primarily for commercial business purposes and collateralized by real estate, primarily commercial, and construction and land development loans.

 

Commercial Real Estate Loans. At December 31, 2017, $453.7 million, or 45.0% of our loan portfolio consisted of commercial real estate loans. Properties securing our commercial real estate loans primarily comprise business owner-occupied properties, small office buildings and office suites, and income-producing real estate.

 

In the underwriting of commercial real estate loans, we generally lend up to the lesser of 80% of the appraised value or purchase price of the property. We base our decision to lend primarily on the economic viability of the property and the credit-worthiness of the borrower. In evaluating a proposed commercial real estate loan, we emphasize the ratio of the property’s projected net cash flow to the loan’s debt service requirement (generally requiring a preferred ratio of 1.25x), computed after deduction for an appropriate vacancy factor and reasonable expenses. Individuals owning 20% or more of the business and/or real estate are generally required to sign the note as co-borrowers or provide personal guarantees. We require title insurance, fire and extended coverage casualty insurance, and, if appropriate, flood insurance, in order to protect our security interest in the underlying property. Almost all of our commercial real estate loans are generated internally by our loan officers.

 

One-to–Four Family Residential Mortgage Loans. At December 31, 2017, $304.1 million, or 30.1% of our loan portfolio consisted of one-to-four family residential mortgage loans. We offer fixed-rate and adjustable-rate residential mortgage loans with maturities generally up to 30 years. We generally sell 30-year fixed rate loans in the secondary market.

 

Our one-to-four family residential mortgage loans originated for sale are underwritten according to Fannie Mae underwriting guidelines. We refer to loans that conform to such guidelines as “conforming loans.” We originate both fixed and adjustable rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Office of Federal Housing Enterprise Oversight, which increased from $417,000 in 2016 to $424,100 in 2017 for single-family homes. Loans in excess of the maximum conforming loan limit (referred to as “jumbo loans”) may be originated for retention in our loan portfolio. We generally underwrite jumbo loans in the same manner as conforming loans.

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We originate loans with loan-to-value ratios in excess of 80% for sale into the secondary market. We require private mortgage insurance for loans with loan-to-value ratios in excess of 80%.

 

We generally retain the servicing rights on loans sold in the secondary market in order to generate cash flow, supplement our core deposits with escrow deposits, and maintain relationships with local borrowers.

 

Other than loans for the construction of one-to-four family residential mortgage loans (described under “—One-to Four-Family Residential Construction, Other Construction and Land, and Consumer Loans”) and home equity loans and lines of credit (described under “—Home Equity Loans and Lines of Credit”), presently we do not offer “interest only” mortgage loans (where the borrower pays only interest for an initial period, after which the loan converts to a fully amortizing loan) on one-to-four family residential properties.

 

We do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower may pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan.

 

Home Equity Loans and Lines of Credit. At December 31, 2017, $50.0 million, or 4.9% of our loan portfolio, consisted of home equity loans and lines of credit. In addition to traditional one-to-four family residential mortgage loans, we offer home equity loans and lines of credit that are secured by the borrower’s primary or secondary residence. Our home equity loans and lines of credit are currently originated with fixed or adjustable rates of interest. Home equity loans and lines of credit are generally underwritten with the same criteria that we use to underwrite one-to-four family residential mortgage loans. For a borrower’s primary residence, home equity loans and lines of credit may be underwritten with a loan-to-value ratio of 80% when combined with the principal balance of the existing mortgage loan, while the maximum loan-to-value ratio on secondary residences is 70% when combined with the principal balance of the existing mortgage loan. We require appraisals or internally prepared real estate evaluations on home equity loans and lines of credit. At the time we close a home equity loan or line of credit, we record a deed of trust to perfect our security interest in the underlying collateral.

 

Commercial Loans. At December 31, 2017, $56.9 million, or 5.6% of our loan portfolio, consisted of commercial loans. We make various types of secured and unsecured commercial loans to customers in our market areas in order to provide customers with working capital and for other general business purposes. The terms of these loans generally range from less than one year to a maximum of 10 years. These loans bear either a fixed interest rate or an interest rate linked to a variable market index. We seek to originate loans to small to medium sized businesses with principal balances between $150,000 and $750,000; however, we also originate government-guaranteed Small Business Administration, or SBA, loans with higher balances with the intent of selling the guaranteed portion into the secondary market. From time to time, we also purchase the guaranteed portion of SBA loans in the secondary market to supplement our commercial loan originations.

 

Commercial credit decisions are based upon our credit assessment of each applicant. We evaluate the applicant’s ability to repay in accordance with the proposed terms of the loan and assess the risks involved. Individuals owning 20% or more of the business and/or real estate are generally required to sign the note as co-borrowers or provide personal guarantees. In addition to evaluating the applicant’s financial statements, we consider the adequacy of the primary and secondary sources of repayment for the loan. Credit agency reports of the applicant’s personal credit history supplement our analysis of the applicant’s creditworthiness. In addition, collateral supporting a secured transaction is analyzed to determine its marketability. Commercial business loans generally have higher interest rates than residential loans of similar duration because they have a higher risk of default with repayment generally depending on the successful operation of the borrower’s business and the sufficiency of any collateral.

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One-to-Four Family Residential Construction, Other Construction and Land, and Consumer Loans. At December 31, 2017, $37.1 million, or 3.7% of our loan portfolio consisted of one-to-four family residential construction loans. Other construction and land loans comprised $101.4 million, or 10.1% of our loan portfolio. Consumer loans totaled $5.7 million, or 0.6% of our loan portfolio, and included automobile and other consumer loans. We make construction loans to owner-occupiers of residential properties, and to businesses for commercial properties. In the past, we made loans to developers for speculative residential construction; however, following the recession we have limited our speculative construction lending. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction, but are generally limited to an 80% loan-to-value ratio based on the appraised value upon completion. Repayment of construction loans on non-residential properties is normally attributable to rental income, income from the borrower’s operating entity or the sale of the property. Repayment of loans on income-producing property is normally scheduled following completion of construction, when permanent financing is obtained. We typically provide permanent mortgage financing on our construction loans for income-producing property. Construction loans are interest-only during the construction period, which typically does not exceed 12 months, and convert to permanent, fully-amortizing financing following the completion of construction.

 

Generally, before making a commitment to fund a construction loan, we require an appraisal of the property by a state-certified or state-licensed appraiser. We review and inspect properties before disbursement of funds during the term of the construction loan.

 

At December 31, 2017, our largest other construction and land loan had a principal balance of $5.0 million and was secured by a first mortgage on single family residential real estate, as well as additional residential building lots. At December 31, 2017, this loan was performing in accordance with its terms.

 

Loan Originations, Purchases, Sales, Participations and Servicing. All residential loans that we originate are underwritten pursuant to our policies and procedures, which incorporate standard Fannie Mae underwriting guidelines, as applicable. We originate both adjustable rate and fixed rate loans. Our loan origination and sales activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand. Most of our one-to-four family residential mortgage loans are originated by our loan officers.

 

Historically, we have sold most of our 15-year and longer residential loans to Fannie Mae or non-government purchasers. During the years ended December 31, 2017, 2016, and 2015, we sold $43.0 million, $34.5 million, and $29.0 million, respectively, of conforming residential loans, primarily with terms of 15 years and longer. We sell our loans with the servicing rights retained on residential mortgage loans, and have no immediate plans to change this practice.

 

At December 31, 2017, we were servicing residential loans owned by third parties with an aggregate principal balance of $240.6 million. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We retain a portion of the interest paid by the borrower on the loans we service as consideration for performing these servicing activities.

 

At December 31, 2017, we were servicing SBA loans having a gross loan amount of $39.7 million, of which the unguaranteed portion of $9.9 million has been retained by us and the guaranteed portion of $29.8 million has been sold in the secondary market.

 

At December 31, 2017, we were servicing commercial loan participations having a gross loan amount of $32.0 million, of which $25.5 million was retained by us and $6.5 million was owned by our co-participants.

 

From time to time, we have participated in loans originated by other financial institutions that service and remit payments to us. At December 31, 2017, the unpaid balance of these loans was $22.7 million.

 

Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by the board of directors of the Bank (“Bank Board”). The loan approval process is intended to assess the borrower’s ability to repay the loan and value of the collateral that will secure the loan. To assess the borrower’s ability to repay, we review the borrower’s employment and credit history and information on the historical and projected income and expenses of the borrower.

 

Our policies and loan approval limits are established by the Bank Board. Loans in amounts up to individual loan authority limits set annually by management and the Bank Board can be approved by designated individual officers or officers acting together pursuant to our loan policy. Relationships in excess of these amounts require the approval of the Officers Loan Committee, Executive Loan Committee, or Directors Loan Committee within the authority limits set by the Bank Board. The Bank Board may approve loans up to the internal loans-to-one-borrower policy limit of $16.0 million, which is below the Bank’s regulatory loans-to-one-borrower limit of $22.1 million as of December 31, 2017.

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We require appraisals or internally prepared evaluations of all real property securing one-to-four family residential and commercial real estate loans and home equity loans and lines of credit. All appraisers are state-licensed or state-certified, and our practice is to have local appraisers approved on an annual basis by the Bank Board. Internal evaluations are prepared only by individuals possessing the necessary skill and experience to meet regulatory competency requirements. Evaluations are reviewed by staff who report directly to the Chief Risk Officer to ensure independence from the loan production process.

 

Investments

 

The Bank’s Asset/Liability Management Committee (“ALCO”) is primarily responsible, subject to the ultimate approval of the Bank Board, for implementing our investment policy. The general investment strategies are developed and authorized by the ALCO Committee, which includes several members of the Bank Board. The ALCO Committee is responsible for the execution of specific investment actions by our Chief Financial Officer, Chief Accounting Officer or Chief Executive Officer, for all sales, purchases, or trades executed in the investment portfolio. All our investment transactions are periodically reported to the ALCO Committee. The investment policy is reviewed annually by the ALCO Committee. The overall objectives of our investment policy are to maintain a portfolio of high quality and diversified investments to maximize interest income over the long term and to minimize risk, to provide collateral for borrowings, to provide additional earnings when loan production is low, and, when appropriate, to reduce our tax liability. The policy dictates that investment decisions give consideration to the safety of principal, liquidity requirements and interest rate risk management.

 

Our current investment policy permits investments that meet certain quality guidelines in direct U.S. Government obligations and securities, U.S. Government agencies, municipal securities, mortgage-backed securities, collateralized mortgage and loan obligations, corporate issues, certain commercial paper, agency structured notes, trust preferred securities, subordinated debt, and bank owned life insurance. We only hold securities classified as “trading” in a Rabbi Trust established to generate returns that will fund the cost of certain deferred compensation agreements. In accordance with Accounting Standards Codification (“ASC”) Topic 802-10-35-01 investment securities “available-for-sale” are recorded at fair value on a recurring basis and investment securities “held-to-maturity” are held at amortized cost. Fair value measurement is based upon quoted prices of like or similar securities, if available, and these securities are classified as Level 1 or Level 2. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions and are classified as Level 3.

 

We purchase mortgage-backed securities insured or guaranteed by Fannie Mae, Freddie Mac or the Government National Mortgage Association. We invest in quality securities to obtain yields higher than we can receive from holding in overnight cash or other short term cash accounts, and to meet our Asset/Liability objectives which focus on liquidity and interest rate risk in our portfolio as a whole.

 

Sources of Funds

 

General. Deposits traditionally have been our primary source of funds for our investment and lending activities. Our primary outside borrowing source is the Federal Home Loan Bank of Atlanta (“FHLB” or “FHLB of Atlanta”). We have in the past used both brokered deposits and internet generated deposits to fund loan growth and to manage interest rate risk. Our additional sources of funds are scheduled loan payments, maturing investments, loan repayments, security repurchase agreements, retained earnings, income on other earning assets and the proceeds of loan sales.

 

Deposits. We accept deposits primarily from within our primary market area. As noted, we have also used brokered and internet deposits as a source of funds. We rely on our competitive pricing and products, convenient locations and quality customer service to attract and retain deposits. Our branch network is well established in our primary market area. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, certificates of deposit, regular checking accounts, money market accounts and individual retirement accounts.

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Interest rates paid, maturity terms, service fees and withdrawal penalties are revised on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements and our deposit growth goals.

 

Borrowings. Our borrowings consist of advances from the FHLB of Atlanta and a holding company line of credit with a correspondent bank. At December 31, 2017, FHLB advances totaled $223.5 million, or 15.6% of total liabilities. At December 31, 2017, the Company had unused borrowing capacity with the FHLB of $13.9 million based on collateral pledged at that date. The Company had total additional credit availability with FHLB of $202.2 million as of December 31, 2017 if additional collateral was pledged. Advances from the FHLB of Atlanta are secured by our investment in the common stock of the FHLB of Atlanta, securities in our investment portfolio, and approved loans in our one-to-four family residential and commercial loan portfolios. The Company had drawn $5.0 million on the $15.0 million revolving line of credit as of December 31, 2017. The line of credit is secured by the stock of the Bank.

 

Recent Development

 

As of December 31, 2017, the Company had a tax liability of $5.7 million related to the Company’s acquisition of Chattahoochee Bank of Georgia (“Chattahoochee”) in October 2017, which was not otherwise presented in the Company’s earnings release filed with the SEC on January 18, 2018 (the “January Earnings Release”). As a consequence, goodwill increased $5.7 million to $23.9 million, income taxes receivable which is included in other assets decreased $1.4 million, and net tax liabilities which is included in other liabilities increased $4.3 million. Tangible book value per share decreased to $17.90 from $18.72. The Company continues to evaluate potential courses of action with respect to the incurrence of this tax liability.

 

SUPERVISION AND REGULATION

 

Bank holding companies and banks are extensively regulated under both federal and state law. Set forth below is a brief description of certain regulatory requirements that are or will be applicable to us. The description below is limited to certain material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on us. Supervision, regulation and examination by the bank regulatory agencies are intended primarily for the protection of depositors rather than shareholders of banks and bank holding companies. Statutes and regulations which contain wide-ranging proposals for altering the structures, regulations and competitive relationship of financial institutions are introduced regularly. We cannot predict whether, or in what form, any proposed statute or regulation will be adopted or the extent to which our business or the business of the Bank may be affected by such statute or regulation.

 

Holding Company Regulation

 

General. As a bank holding company, Entegra is subject to the Bank Holding Company Act of 1956 (the “BHCA”), and subject to certain regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Under the BHCA, a bank holding company such as Entegra, which does not qualify as a financial holding company, is prohibited from engaging in activities other than banking, managing or controlling banks or other permissible subsidiaries, furnishing services to or performing services for its subsidiaries or engaging in any other activity that the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

 

The BHCA prohibits Entegra from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank, or merging or consolidating with another bank holding company without prior approval of the Federal Reserve. Additionally, the BHCA prohibits Entegra from engaging in, or acquiring ownership or control of more than 5% of the outstanding voting stock of any company engaged in, a non-banking business unless such business is determined by the Federal Reserve to be so closely related to banking as to be properly incident thereto. The BHCA does not place territorial restrictions on the activities of such non-banking related activities.

 

State and federal law restricts the amount of voting stock of a bank or bank holding company that a person may acquire without prior regulatory approval. Pursuant to North Carolina law, no person may directly or indirectly purchase or acquire voting stock of any bank or bank holding company which would result in the change in control of that bank or bank holding company unless the North Carolina Commissioner of Banks (“Commissioner”) approves the proposed acquisition. Under North Carolina law, a person will be deemed to have acquired “control” of a bank or bank holding company if the person directly or indirectly (i) owns, controls or has power to vote 10% or more of the voting stock of the bank or bank holding company, or (ii) otherwise possesses the power to direct or cause the direction of the management and policy of the bank or bank holding company. As a result of Entegra’s ownership of the Bank, Entegra is also registered under the bank holding company laws of North Carolina, and as such is subject to the regulation and supervision of the Commissioner.

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Federal law imposes additional restrictions on acquisitions of stock of banks and bank holding companies. Under the BHCA, and the Change in Bank Control Act of 1978 (the “CBCA”), as amended, and regulations adopted thereunder and under the BHCA, a person or group acting in concert must give advance notice to the applicable banking regulator before directly or indirectly acquiring “control” of a federally-insured bank or bank holding company. Under applicable federal law, control is conclusively deemed to have been acquired upon the acquisition of 25% or more of any class of voting securities of any federally-insured bank or bank holding company. Both the BHCA and CBCA generally create a rebuttable presumption of a change in control if a person or group acquires ownership or control of or the power to vote 10% or more of any class of a bank or bank holding company’s voting securities, and either (i) the bank or bank holding company has a class of outstanding securities that are subject to registration under the Exchange Act, or (ii) no other person will own, control, or have the power to vote a greater percentage of that class of voting securities immediately after the transaction. This presumption can, in certain cases, be rebutted by entering into “passivity commitments” with the Federal Reserve or Federal Deposit Insurance Corporation (“FDIC”), as applicable. Upon receipt of a notice of a change in control, the FDIC or the Federal Reserve, as applicable, may approve or disapprove the acquisition.

 

Prior approval of the Federal Reserve and the Commissioner would be required for any acquisition of control of either Entegra or the Bank by any bank holding company under the BHCA and the North Carolina Bank Holding Company Act (“NCBHCA”), respectively. Control for purposes of the BHCA and the NCBHCA would be based on whether the holding company (i) owns, controls or has power to vote 25% or more of our voting stock or the voting stock of the Bank, (ii) controls the election of a majority of our Board of Directors (the “Board”) or the Bank Board, or (iii) the Federal Reserve or the Commissioner, as applicable, determines that the holding company directly or indirectly exercises a controlling influence over our management or policies or the management or policies of the Bank. As part of such acquisition, the holding company (unless already so registered) would be required to register as a bank holding company under the BHCA and the NCBHCA.

 

There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC’s deposit insurance fund in the event the depository institution becomes in danger of default or is in default. For example, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that has become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary to bring the institution into compliance with all acceptable capital standards as of the time the institution initially fails to comply with such capital restoration plan. Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve under the BHCA also has the authority to require a bank holding company to terminate any activity or to relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

 

In addition, the “cross-guarantee” provisions of the Federal Deposit Insurance Act, as amended, require insured depository institutions under common control to reimburse the FDIC for any loss suffered as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the FDIC’s deposit insurance fund. The FDIC’s claim for damages is superior to claims of shareholders of the insured depository institution or any affiliate but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

 

Capital Adequacy Guidelines for Holding Companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies and banks that are members of the Federal Reserve System and have consolidated assets of $1.0 billion or more. Bank holding companies subject to the Federal Reserve’s capital adequacy guidelines are required to comply with the Federal Reserve’s risk-based capital guidelines. Under these regulations, the minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 9.25%. At least half of the total capital is required to be “tier 1 capital,” principally consisting of common shareholders’ equity, non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets. The remainder (“tier 2 capital”) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the general loan loss allowance.

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In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum tier 1 capital (leverage) ratio, under which a bank holding company must maintain a minimum level of tier 1 capital to average total consolidated assets of at least 3.0% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a tier 1 capital (leverage) ratio of at least 4.0%.

 

In July 2013, the Federal Reserve approved a new rule in implementation of the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule includes new risk-based capital and leverage ratios, which became effective January 1, 2015, and revise the definition of what constitutes “capital” for purposes of calculating those ratios. See “Capital Adequacy Requirements Applicable to the Bank” below.

 

The Company exceeded all applicable minimum capital adequacy guidelines as of December 31, 2017.

 

Dividend and Repurchase Limitations. The Federal Reserve has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, and which expresses the Federal Reserve’s view that a holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Under the prompt corrective action regulations, the Federal Reserve may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

 

Federal Reserve policy also provides that a holding company should inform the Federal Reserve supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred.

  

The Company’s ability to pay dividends or repurchase shares may also be dependent upon its receipt of dividends from the Bank. The Company’s payment of dividends and repurchase of stock will also be subject to the requirements and limitations of North Carolina corporate law.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly changed bank regulation and has affected the lending, investment, trading and operating activities of depository institutions and their holding companies.

 

The Dodd-Frank Act also created a new Consumer Financial Protection Bureau (“CFPB”) with extensive powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, such as the Bank, continue to be examined by their applicable federal bank regulators. The Dodd-Frank Act also gave state attorneys general the ability to enforce applicable federal consumer protection laws.

 

The Dodd-Frank Act broadened the base for FDIC assessments for deposit insurance, permanently increasing the maximum amount of deposit insurance to $250,000 per depositor. The legislation also, among other things, requires originators of certain securitized loans to retain a portion of the credit risk, stipulates regulatory rate-setting for certain debit card interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contains a number of reforms related to mortgage originations. The Dodd-Frank Act increased the ability of shareholders to influence boards of directors by requiring companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments. However, as an “emerging growth company” under the Jumpstart Our Business Startups Act (the “JOBS Act”), we are exempt from the shareholder vote requirement until one year after we cease to be an “emerging growth company.” The legislation also directed the Federal Reserve to promulgate rules prohibiting excessive compensation paid to company executives, regardless of whether the company is publicly traded or not. Many of the provisions of the Dodd-Frank Act are subject to further rulemaking, guidance and interpretation by the applicable federal regulators. We will continue to evaluate the impact of any changes in law and any new regulations promulgated.

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Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act, enacted in 1999 (the “GLB Act”), dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. In doing so, it increased competition in the financial services industry, presenting greater opportunities for our larger competitors who were more able to expand their services and products than smaller, community-oriented financial institutions.

 

USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Act was intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Act on financial institutions of all kinds has been significant and wide ranging. The Act, which was largely extended in 2015 by the USA Freedom Act, contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

 

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, our Chief Executive Officer and Chief Financial Officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission (“SEC”) under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of our Board about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.

 

Federal Securities Laws. The Company filed with the SEC a registration statement under the Securities Act for the registration of the shares of common stock that were issued pursuant to the offering. Upon completion of the offering, the common stock was registered with the SEC under the Exchange Act. The Company is now subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act.

 

The registration under the Securities Act of shares of common stock does not cover the resale of those shares. Shares of common stock purchased by persons who are not the Company’s affiliates may be resold without registration. Shares purchased by the Company’s affiliates are subject to the resale restrictions of Rule 144 under the Securities Act. If the Company meets the current public information requirements of Rule 144 under the Securities Act, each affiliate that complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of our outstanding shares, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, the Company may permit affiliates to have their shares registered for sale under the Securities Act.

 

Emerging Growth Company Status. On April 5, 2012, the JOBS Act was signed into law. The JOBS Act made numerous changes to the federal securities laws to facilitate access to capital markets. Under the JOBS Act, a company with total annual gross revenues of less than $1.0 billion during its most recently completed fiscal year qualifies as an “emerging growth company.” We qualify as an “emerging growth company” and believe that we will continue to qualify as an “emerging growth company” for five years from the completion of our stock offering.

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As an “emerging growth company,” we have elected to use the transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements were made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of December 31, 2017, there is not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance.

 

Subject to certain conditions set forth in the JOBS Act, if, as an “emerging growth company,” we choose to rely on such exemptions we may not be required to, among other things, (i) provide an auditor’s attestation report on our system of internal controls over financial reporting, (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Act, (iii) hold non-binding shareholder votes regarding annual executive compensation or executive compensation payable in connection with a merger or similar corporate transaction, (iv) comply with any requirement that may be adopted by the PCAOB regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis), and (v) disclose certain executive compensation related items such as the correlation between executive compensation and performance and comparisons of the chief executive officer’s compensation to median employee compensation. These exemptions will apply for a period of five years following the completion of our initial public offering or until we are no longer an “emerging growth company,” whichever is earlier.

 

We could remain an “emerging growth company” for up to five years, (October 1, 2019), or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1.0 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1.0 billion in non-convertible debt during the preceding three-year period.

 

Bank Regulation

 

General. The Bank is a North Carolina chartered commercial bank. Its deposits are insured through the FDIC’s deposit insurance fund, and it is subject to supervision and examination by and the regulations and reporting requirements of the Commissioner and the FDIC.

  

As a federally insured depository institution, the Bank is prohibited from engaging as principal in any activity, or acquiring or retaining any equity investment of a type or in an amount, that is not permitted for national banks unless (i) the FDIC determines that the activity or investment would pose no significant risk to the deposit insurance fund, and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.

 

In addition, the Bank is subject to various regulations promulgated by the Federal Reserve including, without limitation, Regulation B (Equal Credit Opportunity), Regulation D (Reserves), Regulation E (Electronic Fund Transfers), Regulation O (Loans to Executive Officers, Directors and Principal Shareholders), Regulation W (Transactions Between Member Banks and Affiliates), Regulation Z (Truth in Lending), and Regulation CC (Availability of Funds).

 

The FDIC and Commissioner have broad powers to enforce laws and regulations applicable to the Bank. Among others, these powers include the ability to assess civil money penalties, to issue cease and desist or removal orders, and to initiate injunctive actions. In general, these enforcement actions may be initiated in response to violations of laws and regulations and the conduct of unsafe and unsound practices.

 

Transactions with Affiliates. Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans-to-one-borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The FDIC has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of directors approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits on the amount a bank can loan to an executive officer.

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Deposit Insurance. The deposit accounts of the Bank are insured by the FDIC’s deposit insurance fund. The Dodd-Frank Act permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor.

 

The FDIC issues regulations and conducts periodic examinations, requires the filing of reports and generally supervises the operations of its insured banks. This supervision and regulation is intended primarily for the protection of depositors. Any insured bank that is not operated in accordance with or does not conform to FDIC regulations, policies and directives may be sanctioned for noncompliance. Civil and criminal proceedings may be instituted against any insured bank or any director, officer or employee of such bank for the violation of applicable laws and regulations, breaches of fiduciary duties or engaging in any unsafe or unsound practice. The FDIC has the authority to terminate insurance of accounts pursuant to procedures established for that purpose.

 

The Bank is subject to insurance assessments imposed by the FDIC. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005. Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings.

 

The Dodd-Frank Act required the FDIC to revise its procedures to base its assessments upon each insured institution’s total assets less tangible equity instead of deposits. The FDIC finalized a rule, effective April 1, 2011, that set the assessment range at 2.5 to 45 basis points of total assets less tangible equity. In 2016, the FDIC adopted a rule increasing the deposit insurance fund’s minimum reserve ratio from 1.15% to 1.35% by September 30, 2020, the cost of which increase is to be borne by depository institutions with total consolidated assets of $10 billion or more.

 

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the FDIC, an insured institution 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 CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions’ records of meeting the credit needs of their communities, using the ratings “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination, which was completed during January 2017.

 

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency 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. 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. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.

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Capital Adequacy Requirements Applicable to the Bank. The Bank is required to comply with the capital adequacy standards established under applicable federal laws and regulations. In addition, the FDIC has promulgated risk-based capital and leverage capital guidelines for determining the adequacy of a bank’s capital, and all applicable capital standards must be satisfied for the Bank to be considered in compliance with the FDIC’s requirements. Under the FDIC’s risk-based capital measure, the minimum ratio (total risk-based capital ratio) of a bank’s total capital to its risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 9.25%. At least half of total capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (tier 1 capital). The remainder may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, a limited amount of loan loss reserves, and net unrealized holding gains on equity securities (tier 2 capital). At December 31, 2017, the Bank’s total risk- based capital ratio and tier 1 risk-based capital ratio were 12.88% and 11.92%, respectively, each was well above the FDIC’s minimum risk-based capital guidelines.

 

Under the FDIC’s leverage capital measure, the minimum ratio (the “tier 1 leverage capital ratio”) of tier 1 capital to total assets is 3.0% for banks that meet certain specified criteria, including having the highest regulatory rating. All other banks generally are required to maintain an additional cushion of 100 to 200 basis points above the stated minimum. The FDIC’s guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets, and the FDIC has indicated that it will consider a bank’s “tangible leverage ratio” (deducting all intangible assets) and other indicia of capital strength in evaluating proposals for expansion or new activities. At December 31, 2017, the Bank’s tier 1 leverage capital ratio was 8.79%, which was well above the FDIC’s minimum leverage capital guidelines.

 

Failure to meet the FDIC’s capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and certain other restrictions on its business. As described below, substantial additional restrictions can be imposed upon FDIC-insured depository institutions that fail to meet applicable capital requirements. See “– Prompt Corrective Action”. The FDIC also considers interest rate risk (arising when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of a bank’s capital adequacy.

 

In July 2013, the Federal Reserve and the FDIC approved revisions to their capital adequacy guidelines and prompt corrective action rules that implement the revised standards of the Basel Committee on Banking Supervision, commonly called Basel III, and address relevant provisions of the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

 

The new rules include new risk-based capital and leverage ratios, which became effective January 1, 2015, and revise the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank are: (i) a new common equity tier 1 capital ratio of 4.5%; (ii) a tier 1 capital ratio of 6.0% (increased from 4.0%); (iii) a total capital ratio of 8.0% (unchanged from prior rules); and (iv) a tier 1 leverage ratio of 4.0% for all institutions. The new rules eliminate the inclusion of certain instruments, such as trust preferred securities, from tier 1 capital. Instruments issued prior to May 19, 2010 are grandfathered for companies with consolidated assets of $15 billion or less. The new rules also established a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity tier 1 capital and will result in the following minimum ratios: (i) a common equity tier 1 capital ratio of 7.0%; (ii) a tier 1 capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions. At December 31, 2017, all of the Company’s and Bank’s capital ratios were well above the capital guidelines.

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Loans to One Borrower. The Bank is subject to the loans to one borrower limits imposed by NC law, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any single borrower outstanding at one time and not fully secured by readily marketable collateral may exceed 15% of the Bank’s capital, as used in the calculation of its risk-based capital ratios, plus those portions of the Bank’s allowance for credit losses, deferred tax assets, and intangible assets that are excluded from the Bank’s capital or the amount permitted for national banks. At December 31, 2017, this limit was $22.1 million. For loans and extensions of credit that are fully secured by readily marketable collateral this limit is increased by an additional 10% of the Bank’s capital or the amount permitted for national banks.

  

Limits on Rates Paid on Deposits and Brokered Deposits. Regulations enacted by the FDIC place limitations on the ability of insured depository institutions to accept, renew or roll-over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions in the depository institution’s normal market area. Under these regulations, “well capitalized” depository institutions may accept, renew or roll-over such deposits without restriction, “adequately capitalized” depository institutions may accept, renew or roll-over such deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates) and “undercapitalized” depository institutions may not accept, renew, or roll-over such deposits. The regulations contemplate that the definitions of “well capitalized,” “adequately capitalized” and “undercapitalized” will be the same as the definitions adopted by the FDIC to implement the corrective action provisions discussed below. See “– Prompt Corrective Action,” below. As of December 31, 2017, the Bank exceeded all of the applicable regulatory capital ratios to be considered “well capitalized” under the regulatory framework for prompt corrective action.

 

FHLB System. The FHLB System provides a central credit facility for member institutions. As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta in an amount at least equal to 0.20% of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta. At December 31, 2017, the Bank was in compliance with these requirements.

 

Reserve Requirements. Pursuant to regulations of the Federal Reserve, all insured depository institutions must maintain average daily reserves against their transaction accounts equal to specified percentages of the balances of such accounts. These percentages are subject to adjustment by the Federal Reserve. Because the Bank’s reserves are required to be maintained in the form of vault cash or in a noninterest-bearing account at a Federal Reserve bank, one effect of the reserve requirement is to reduce the amount of the Bank’s interest-earning assets. At December 31, 2017, the Bank met these reserve requirements.

  

Prompt Corrective Action. Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”). The FDIC is required to take certain mandatory supervisory actions and is authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of any action taken will depend upon the capital category in which an institution is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for an institution that is critically undercapitalized.

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Under the FDIC’s rules implementing the prompt corrective action provisions, an insured, state-chartered commercial bank that (i) has a total risk-based capital ratio of 10.0% or greater, a tier 1 risk-based capital ratio of 8.0% or greater, a common equity tier 1 risk-based ratio of 6.5% or greater, and a leverage capital ratio of 5.0% or greater, and (ii) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is deemed to be “well capitalized.” A bank with a total risk-based capital ratio of 9.25% or greater, a tier 1 risk-based capital ratio of 7.25% or greater, a common equity tier 1 risk-based ratio of 5.75% or greater, and a leverage capital ratio of 4.0% or greater (or 3.0% or greater in the case of an institution with the highest examination rating), is considered to be “adequately capitalized.” A bank that has a total risk-based capital ratio of less than 9.25%, a tier 1 risk-based capital ratio of less than 7.25%, or a leverage capital ratio of less than 4.0% (or 3.0% in the case of an institution with the highest examination rating), is considered to be “undercapitalized.” A bank that has a total risk-based capital ratio of less than 6.0%, a tier 1 risk-based capital ratio of less than 3.0%, a common equity tier 1 risk-based ratio of less than 4.5%, or a leverage capital ratio of less than 3.0%, is considered to be “significantly undercapitalized,” and a bank that has a ratio of tangible equity capital to assets equal to or less than 2.0% is deemed to be “critically undercapitalized.” For purposes of these rules, the term “tangible equity” includes core capital elements counted as tier 1 capital for purposes of the risk-based capital standards (see “Capital Adequacy Requirements Applicable to the Bank” above), plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets (with certain exceptions). A bank may be deemed to be in a capitalization category lower than indicated by its actual capital position if it receives an unsatisfactory examination rating.

 

A bank that is categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing any branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. In addition, the FDIC is given authority with respect to any “undercapitalized” bank to take any of the actions it is required to or may take with respect to a “significantly undercapitalized” bank if it determines that those actions are necessary to carry out the purpose of the law.

 

As of December 31, 2017, the Bank exceeded all of the applicable regulatory capital ratios to be considered “well capitalized” under the regulatory framework for prompt corrective action.

 

Restrictions on Distributions. A North Carolina chartered commercial bank may not make distributions that reduce its capital below its applicable required capital, i.e., if after making such distribution, the bank would become, or if it already is, “undercapitalized. In addition, the Bank is not permitted to declare or pay a cash dividend or repurchase any of its capital stock if the effect thereof would be to cause its net worth to be reduced below the amount required for its liquidation account.

 

Other Federal and North Carolina Regulations. The federal banking agencies, including the FDIC, have developed joint regulations requiring disclosure of contingent assets and liabilities and, to the extent feasible and practicable, supplemental disclosure of the estimated fair market value of assets and liabilities. Additional joint regulations require annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small, well-capitalized institutions and state-chartered institutions examined by state regulators, and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards when such compensation would endanger the insured depository institution or would constitute an unsafe practice.

  

Under NC law, if the Commissioner determines, after notice and hearing, that supervisory control of the bank is necessary to protect the bank’s customers, creditors, or the general public, the Commissioner may issue an order taking supervisory control of the bank.

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TAXATION

 

Federal Taxation

 

General. We are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to us.

 

Method of Accounting. For federal income tax purposes, the Company files a consolidated tax return with the Bank, and reports its income and expenses on the accrual method of accounting and uses a calendar year ending December 31 for filing its consolidated federal income tax returns.

 

Minimum Tax. The Internal Revenue Code of 1986, as amended (the “Code”), imposed an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, referred to as “alternative minimum taxable income.” The alternative minimum tax was payable to the extent alternative minimum taxable income is in excess of an exemption amount. Net operating losses could, in general, offset no more than 90% of alternative minimum taxable income. The Tax Reform and Jobs Act of 2017 (the “Tax Reform”) repealed the alternative minimum tax since the corporate federal tax rate was reduced to 21%. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years or may be refundable. At December 31, 2017, the Company had an alternative minimum tax credit carryforward of approximately $0.7 million.

 

Net Operating Loss Carryovers. Prior to the Tax Reform, generally a financial institution could carry back federal net operating losses to the preceding two taxable years and carry forward to the succeeding 20 taxable years. The newly enacted Tax Reform allows net operating losses generated in 2017 and earlier to offset up to 100% of taxable income. Net operating losses generated in tax years after December 31, 2017, and later can offset up to 80% of taxable income. Generally, there the Tax Reform repeals carryback and provides for an unlimited carryforward of net operating losses generated in tax years after 2017. At December 31, 2017, the Company had a $16.7 million net operating loss carryforward for federal income tax purposes and a $24.1 million net operating loss carryforward for North Carolina income tax purposes. See “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations – Net Deferred Tax Assets”.

 

Corporate Dividends. The Company is able to exclude from its income 100% of the dividends received from the Bank as a member of the same affiliated group of corporations.

 

Audit of Tax Returns. The Company’s federal income tax returns have not been audited in the most recent five-year period. 

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State Taxation

 

The State of North Carolina imposes an income tax on income measured substantially the same as federally taxable income, except that U.S. Government interest is not fully taxable. During the third quarter of 2013, North Carolina reduced its corporate income tax rate from 6.9% to 6.0% effective January 1, 2014, and to 5.0% effective January 1, 2015. The rate was further reduced to 4.0% for the 2016 tax year, to 3.0% effective January 1, 2017 and in the second quarter of 2017 was reduced to 2.5% effective January 1, 2019. Our state income tax returns have not been audited in the most recent five-year period. Under North Carolina law, we are also subject to an annual franchise tax at a rate of 0.15% of equity. The maximum annual franchise tax payable by the holding company is $150,000. There is no comparable maximum franchise tax for the Bank.

 

AVAILABLE INFORMATION

 

We make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports available free of charge on www.entegrabank.com as soon as reasonably practicable after the reports are electronically filed with the SEC. Our Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q are also available our internet website in interactive data format using the eXtensible Business Reporting Language (XBRL), which allows financial statement information to be downloaded directly into spreadsheets, analyzed in a variety of ways using commercial off-the-shelf software and used within investment models in other software formats. Any materials that we file with the SEC may be read and/or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. These filings are also accessible on the SEC’s website at www.sec.gov.

 

Additionally, our corporate governance policies, including the charters of the Executive, Audit and Risk, Compensation, and Corporate Governance and Nominating Committees, the Corporate Governance Guidelines, Code of Business Conduct and Ethics, and Code of Business Conduct and Ethics for Senior Financial Officers may also be found under the “Investor Relations” section of our website. A written copy of the foregoing corporate governance policies is available upon written request.

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Item 1A. Risk Factors

We may not be able to utilize all of our deferred tax asset. As of December 31, 2017, we had a net deferred tax asset of $8.8 million. Our ability to use our deferred tax asset is dependent on our ability to generate future earnings within the operating loss carry-forward periods, which are generally 20 years. Some or all of our deferred tax asset could expire unused if we are unable to generate taxable income in the future sufficient to utilize the deferred tax asset, or we enter into transactions that limit our right to use it. If a material portion of our deferred tax asset expires unused, it could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock. Our ability to realize the deferred tax asset is periodically reviewed and any necessary valuation allowance is adjusted accordingly.

Our ability to realize our deferred tax asset and deduct certain future losses could be limited if we experience an ownership change as defined in the Code. Section 382 of the Code may limit the benefit of both net operating losses incurred to date and future “built-in-losses” which may exist at the time of an “ownership change” for federal income tax purposes. A Section 382 “ownership change” occurs if a shareholder or a group of shareholders who are deemed to own at least 5% of our common stock increase their ownership in aggregate by more than 50% over their lowest ownership percentage within a testing period which is generally a rolling three-year period. If an “ownership change” occurs, Section 382 would impose an annual limit on the amount of losses we can use to reduce our taxable income equal to the product of the total value of our outstanding equity (potentially subject to certain adjustments) immediately prior to the “ownership change” and the federal long-term tax-exempt interest rate in effect for the month of the “ownership change.” A number of special rules apply to calculating this limit.

The relevant calculations under Section 382 are technical and highly complex. Whether an “ownership change” occurs in the future is largely outside of our control, and there can be no assurance that such a change will not occur. If an “ownership change” were to occur, it is possible that the limitations imposed could cause a net increase in our federal income tax liability and cause federal income taxes to be paid earlier than if such limitations were not in effect. An ownership change could also eliminate a portion of the federal tax loss carryforward if the limitation is low and causes our net operating losses to expire unutilized. Any such “ownership change” could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock.

We may not be able to implement aspects of our growth strategy. Our growth strategy contemplates the future expansion of our business and operations both organically and by selective acquisitions of banks and the establishment of banking offices within our market areas and other contiguous markets in the Southeast. Implementing these aspects of our growth strategy depends, in part, on our ability to successfully identify acquisition opportunities and strategic partners that will complement our operating philosophy and to successfully integrate their operations, as well as generate loans and deposits of acceptable risk and expense. To successfully acquire or establish banks or banking offices, we must be able to correctly identify profitable or growing markets, as well as attract the necessary relationships and high caliber banking personnel to make these new banking offices profitable. In addition, we may not be able to identify suitable opportunities for further growth and expansion or, if it does, we may not be able to successfully integrate these new operations into its business.

As consolidation of the financial services industry continues, the competition for suitable acquisition candidates may further increase. We will compete with other financial services companies for acquisition opportunities, and many of these competitors have greater financial resources than us and may be able to pay more for an acquisition than we are able or willing to pay.

We can offer no assurance that we will have opportunities to acquire other financial institutions or acquire or establish any new branches or loan production offices, or that we will be able to negotiate, finance and complete any opportunities available to us.

If we are unable to effectively implement our growth strategies, our business, results of operations and stock price may be materially and adversely affected.

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Future expansion involves risks. Our acquisition of other financial institutions or parts of those institutions, or the establishment of de novo branch offices and loan production offices, involves a number of risks, including the risk that: 

  · We may incur substantial costs in identifying and evaluating potential acquisitions and merger partners, or in evaluating new markets, hiring experienced local managers, and opening new offices;
  · Estimates and judgments used to evaluate credit, operations, management and market risks relating to target institutions may not be accurate;
  · The institutions we acquire may have distressed assets and there can be no assurance that we will be able to realize the value we predict from those assets or that we will make sufficient provisions or have sufficient capital for future losses;
  · We may be required to take writedowns or writeoffs, restructuring and impairment, or other charges related to the institutions we acquire that could have a significant negative effect on our financial condition and results of operations;
  · There may be substantial lag-time between completing an acquisition or opening a new office and generating sufficient assets and deposits to support costs of the expansion;
  · We may not be able to finance an acquisition, or the financing we obtain may have an adverse effect on our results of operations or result in dilution to our existing shareholders;
  · Our management’s attention in negotiating a transaction and integrating the operations and personnel of the combining businesses may be diverted from our existing business and we may not be able to successfully integrate such operations and personnel;
  · If we experience problems with system conversions, financial losses could be sustained from transactions processed incorrectly or not at all;
  · We may not be able to obtain regulatory approval for an acquisition;
  · We may enter new markets where we lack local experience or that introduce new risks to our operations, or that otherwise result in adverse effects on our results of operations;
  · We may introduce new products and services we are not equipped to manage or that introduce new risks to our operations, or that otherwise result in adverse effects on our results of operations;
  · We may incur intangible assets in connection with an acquisition, or the intangible assets we incur may become impaired, which results in adverse short-term effects on our results of operations;
  · We may assume liabilities in connection with an acquisition, including unrecorded liabilities that are not discovered at the time of the transaction, and the repayment of those liabilities may have an adverse effect on our results of operations, financial condition and stock price; or
  · We may lose key employees and customers.

We cannot assure you that we will be able to successfully integrate any banking offices that we acquire into our operations or retain the customers of those offices. If any of these risks occur in connection with our expansion efforts, it may have a material and adverse effect on our results of operations and financial condition.

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New bank office facilities and other facilities may not be profitable. We may not be able to organically expand into new markets that are profitable for our franchise. The costs to start up bank branches and loan production offices in new markets, other than through acquisitions, and the additional costs to operate these facilities would increase our noninterest expense and may decrease our earnings. It may be difficult to adequately and profitably manage our growth through the establishment of bank branches or loan production offices in new markets. In addition, we can provide no assurance that our expansion into any such new markets will successfully attract enough new business to offset the expenses of their operation. If we are not able to do so, our earnings and stock price may be negatively impacted.

Acquisition of assets and assumption of liabilities may expose us to intangible asset risk, which could impact our results of operations and financial condition. In connection with any acquisitions, as required by accounting principles generally accepted in the United States (“GAAP”), we will record assets acquired and liabilities assumed at their fair value, and, as such, acquisitions may result in us recording intangible assets, including deposit intangibles and goodwill. We will perform a goodwill valuation at least annually to test for goodwill impairment by comparing the fair value of our reporting unit with its carrying value. Adverse conditions in its business climate, including a significant decline in future operating cash flows, a significant change in our stock price or market capitalization, or a deviation from our expected growth rate and performance may significantly affect the fair value of our reporting unit and may trigger impairment losses, which could be materially adverse to our results of operations, financial condition and stock price.

The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand. Our growth strategy contemplates that we may expand our business and operations to other contiguous markets in the Southeast through organic growth and selective acquisitions. We intend to primarily target market areas that we believe possess attractive demographic, economic or competitive characteristics. To expand into new markets successfully, we must identify and retain experienced key management members with local expertise and relationships in these markets. Competition for qualified personnel in the markets in which we may expand may be intense, and there may be a limited number of qualified persons with knowledge of and experience in the commercial banking industry in these markets. Even if we identify individuals that we believe could assist it in establishing a presence in a new market, we may be unable to recruit these individuals away from other banks or be unable to do so at a reasonable cost. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy. Our inability to identify, recruit and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition, results of operations and stock price.

We may need additional access to capital, which we may be unable to obtain on attractive terms or at all. We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments, for future growth or to fund losses or additional provision for loan losses in the future. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to it, 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 and our stock price negatively affected.

Our estimate for losses in our loan portfolio may be inadequate, which would cause our results of operations and financial condition to be adversely affected. We maintain an allowance for loan losses, which is a reserve established through a provision for possible loan losses charged to our expenses and represents management’s best estimate of probable losses within our existing portfolio of loans. Our allowance for loan losses amounted to $10.9 million at December 31, 2017, as compared to $9.3 million as of December 31, 2016. The level of the allowance reflects management’s estimates and judgments as to specific credit risks, evaluation of industry concentrations, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio, which have been elevated in light of recent economic conditions. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current credit risks and future trends, all of which may undergo material changes. In addition, bank regulatory agencies review our allowance for loan losses during their periodic examinations, and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs. Any such increases may have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock.

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Our commercial real estate loans generally carry greater credit risk than one-to-four family residential mortgage loans. At December 31, 2017, we had commercial real estate loans of $453.7 million, or 45.0% of total loans. These types of loans generally have higher risk-adjusted returns and shorter maturities than one-to-four family residential mortgage loans. Further, loans secured by commercial real estate properties are generally for larger amounts and involve a greater degree of risk than one-to-four family residential mortgage loans. Also, many of our borrowers have more than one of these types of loans outstanding. 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. Payments on loans secured by these properties are often dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans can be negatively impacted by adverse conditions in the real estate market or the local economy. If loans that are collateralized by commercial real estate become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses which would in turn adversely affect our operating results and financial condition. While we seek to minimize these risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses.

Our concentration of construction financing may expose us to a greater risk of loss and hurt our earnings and profitability. At December 31, 2017, we had other construction and land loans of $101.4 million, or 10.1% of total loans, and one-to-four family residential construction loans of $37.1 million, or 3.7% of total loans outstanding, to finance construction and land development. These loans are dependent on the successful completion of the projects they finance.

Construction financing typically involves a higher degree of credit risk than financing on improved, owner-occupied real estate. Risk of loss on a construction loan is largely dependent upon the accuracy of the initial estimate of the property’s value at completion of construction and the bid price and estimated cost (including interest) of construction. 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 project. If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment. When lending to builders, the cost of construction breakdown is provided by the builder, as well as supported by the appraisal. Although our underwriting criteria are designed to evaluate and minimize the risks of each construction loan, there can be no guarantee that these practices will safeguard against material delinquencies and losses to our operations.

 

Repayment of our commercial business loans is primarily dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types of commercial loans to a variety of small- to medium-sized businesses, and intend to increase our commercial business loan portfolio in the future. The types of commercial loans offered are business lines of credit and term equipment financing. Our commercial business loans are primarily underwritten based on the cash flow of the borrowers and secondarily on the underlying collateral, including real estate. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use. As of December 31, 2017, our commercial business loans totaled $56.9 million, or 5.6% of our total loan portfolio.

Our level of home equity loans and lines of credit lending may expose us to increased credit risk. At December 31, 2017, we had home equity loans and lines of credit of $50.0 million, or 4.9% of total loans. Home equity loans and lines of credit typically involve a greater degree of risk than one-to-four family residential mortgage loans. Equity line lending allows customer to access an amount up to his or her line of credit limit for the term specified in their agreement. At the expiration of the term of an equity line, a customer may have the entire principal balance outstanding as opposed to a one-to-four family residential mortgage loan where the principal is disbursed entirely at closing and amortizes throughout the term of the loan. We cannot predict when and to what extent our customers will access their equity lines. While we seek to minimize this risk in a variety of ways, including attempting to employ conservative underwriting criteria, there can be no assurance that these measures will protect against credit-related losses.

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We continue to hold and acquire other real estate, which has led to operating expenses and vulnerability to additional declines in real property values. We foreclose on and take title to real estate serving as collateral for many of our loans as part of our business. Real estate owned by us and not used in the ordinary course of our operations is referred to as “real estate owned” or “REO.” At December 31, 2017, we had REO with an aggregate book value of $2.6 million. We obtain appraisals prior to taking title to real estate and periodically thereafter. However, in the event of deterioration in real estate prices in our market areas, there can be no assurance that such valuations will reflect the amount which may be paid by a willing purchaser in an arms-length transaction at the time of the final sale. Moreover, we cannot assure investors that the losses associated with REO will not exceed the estimated amounts, which would adversely affect future results of our operations.

The calculation for the adequacy of write-downs of our REO is based on several factors, including the appraised value of the real property, economic conditions in the property’s sub-market, comparable sales, current buyer demand, availability of financing, entitlement and development obligations and costs and historic loss experience. All of these factors have caused significant write-downs in recent years and can change without notice based on market and economic conditions. Since 2007, higher REO balances have led to greater expenses as we have incurred costs to manage and dispose of the properties. We expect that our earnings will continue to be negatively affected by various expenses associated with REO, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments and other expenses associated with property ownership, as well as by the funding costs associated with assets that are utilized in REO. Moreover, our ability to sell REO is affected by public perception that banks are inclined to accept large discounts from market value in order to quickly liquidate properties. Any material decrease in market prices may lead to further REO write-downs, with a corresponding expense in our statement of operations. Further write-downs on REO or an inability to sell REO properties could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock. Furthermore, the management and resolution of non-performing assets, which include REO, increases our costs and requires significant commitments of time from our management and directors, which can be detrimental to the performance of their other responsibilities. The expenses associated with REO and any further property write-downs could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock.

 

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business. A significant portion of our loan portfolio is secured by real estate. As of December 31, 2017, 93.8% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our results of operations, financial condition and the value of our common stock could be adversely affected.

Concentration of collateral in our primary market area may increase the risk of increased non-performing assets. Our primary lending market area consists of: western North Carolina counties of Buncombe, Cherokee, Haywood, Henderson, Jackson, Macon, Polk and Transylvania; Upstate South Carolina counties of Anderson, Greenville, Pickens and Spartanburg; and northern Georgia counties of Gwinnett, Hall and Pickens. At December 31, 2017, approximately $722.3 million, or 71.9%, of our loans were secured by real estate located within our primary area. A decline in real estate values in our primary market area would lower the value of the collateral securing loans on properties in this area, and may increase our level of non-performing assets.

Income from secondary mortgage market operations is volatile, and we may incur losses with respect to our secondary mortgage market operations that could negatively affect our earnings. A key component of our existing business is to sell in the secondary market longer term, conforming fixed-rate residential mortgage loans that we originate, earning non-interest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans tends to fall and may reduce the number of loans we can originate for sale. Weak or deteriorating economic conditions also tend to reduce loan demand. Although we originate, and intend to continue originating, loans on a “best efforts” basis, and we sell, and intend to continue selling, most loans in the secondary market with limited or no recourse, we are required, and will continue to be required, to give customary representations and warranties to the buyers relating to compliance with applicable law. If we breach those representations and warranties, the buyers will be able to require us to repurchase the loans and we may incur a loss on the repurchase that could negatively affect our earnings.

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We rely on the mortgage secondary market for some of our liquidity. In 2017, we sold 36.9% of the mortgage loans we originated in the secondary markets to Fannie Mae and others. We rely on Fannie Mae and others to purchase loans that meet their conforming loan requirements in order to reduce our credit risk and provide funding for additional loans we desire to originate. We cannot provide assurance that these purchasers will not materially limit their purchases of conforming loans due to capital constraints, a change in the criteria for conforming loans or other factors. Additionally, various proposals have been made to reform the U.S. residential mortgage finance market, including the role of Fannie Mae and other agencies. The exact effects of any such reforms are not yet known, but they may limit our ability to sell conforming loans to Fannie Mae and others. If we are unable to continue to sell conforming loans to these agencies, our ability to fund, and thus originate, additional mortgage loans may be adversely affected, which would adversely affect our results of operations.

Future changes in interest rates could reduce our profits. Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:

  ·   the interest income we earn on our interest-earning assets, such as loans and securities; and

  ·   the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.

Timing differences that can result from our interest-earning assets not repricing at the same time as our interest-bearing liabilities can negatively impact our net interest income. In addition, the amount of change in interest-earning assets and interest-bearing liabilities can also vary and present a risk to the amount of net interest margin earned. We generally employ market indexes when making portfolio loans in order to reduce the interest rate risk in our loan portfolio. Those indexes may not move in tandem with changes in rates of our funding sources, depending on market demand. As part of our achieving a balanced earning asset portfolio and earning acceptable yields, we also invest in longer term fixed rate municipal securities and in securities which have issuer callable features. These securities could reduce our net interest income or lengthen the average life during periods of high interest rate volatility. We also employ forecasting models to measure and manage the risk within stated policy guidelines. Notwithstanding these tools and practices, we are not assured that we can reprice our assets commensurately to interest rate changes in our funding sources, particularly during periods of high interest rate volatility. The difference in the timing of repricing our assets and liabilities may result in a decline in our earnings.

Strong competition within our market areas may limit our growth and profitability. Competition in the banking and financial services industry is intense. In our market areas, we compete with credit unions, commercial banks, savings institutions, mortgage brokerage firms, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some of our competitors have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we do, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends upon our continued ability to successfully compete in our market areas. If we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected.

 

The financial services industry could become even more competitive as a result of continuing technological changes and increasing consolidation. Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

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Our stock-based benefit plan will increase our costs, which will reduce our income. We have adopted a stock-based benefit plan through which we can award participants shares of our common stock (at no cost to them), options to purchase shares of our common stock and/or other equity-based compensation. Currently, a total of 654,637 shares of common stock have been reserved for issuance under the plan. Should our shareholders authorize an increase, in the future we may grant additional shares of common stock and stock options in excess of these amounts if an additional stock-based benefit plan is adopted in the future. The stock options and shares of restricted stock granted under our stock-based benefit plan are expensed by us over their vesting period at the fair market value of the shares on the date they are awarded. Accordingly, further grants made under the plan will increase our costs, which will reduce our net income.

The implementation of stock-based benefit plans may dilute your ownership interest. We have adopted a stock-based benefit plan through which we can award participants shares of our common stock (at no cost to them), options to purchase shares of our common stock and/or other equity-based compensation. The stock-based benefit plans may be funded through either open market purchases of shares of common stock and/or from the issuance of authorized but unissued shares of common stock. Our ability to repurchase shares of common stock to fund these plans will be subject to many factors, including, but not limited to, applicable regulatory restrictions on stock repurchases, the availability of stock in the market, the trading price of the stock, our capital levels, alternative uses for our capital and our financial performance If we do not repurchase shares of common stock to fund these plans, then shareholders would experience a reduction in their ownership interest.

We are subject to extensive regulation and oversight, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory action. We are subject to extensive regulation and supervision, including examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on us if they determine, upon conclusion of their examination or otherwise, violations of laws with which we must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, consent orders, civil money penalties and termination of deposit insurance and bank closure. Enforcement actions may be taken regardless of the capital levels of the institutions, and regardless of prior examination findings. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective actions. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions, paying dividends or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. The imposition of regulatory sanctions, including monetary penalties, may have a material impact on our financial condition and results of operations and/or damage our reputation. In addition, compliance with any such action could distract management’s attention from our operations, cause us to incur significant expenses, restrict us from engaging in potentially profitable activities and limit our ability to raise capital.

Financial reform legislation enacted by Congress and resulting regulations have increased and are expected to continue to increase our costs of operations. In 2010, Congress enacted the Dodd-Frank Act. This law has significantly changed the structure of the bank regulatory system and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations. Although many of these regulations have been promulgated, many additional regulations are expected to be issued in 2018 and thereafter.

The Dodd-Frank Act created the CFPB with broad powers to supervise and enforce consumer protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. It also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

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It is difficult to quantify what specific impact the Dodd-Frank Act and related regulations have had on the Bank to date and what impact yet to be written regulations will have on us in the future. However, it is expected that at a minimum these measures will increase our costs of doing business and increase our costs related to regulatory compliance, and may have a significant adverse effect on our lending activities, financial performance and operating flexibility.

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 USA 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 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 Office of Foreign Assets Control (“OFAC”). Federal and state bank regulators also 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 any financial institutions that we 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 any 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.

We are subject to more stringent capital requirements, which may adversely impact our return on equity, require us to raise additional capital, or constrain us from paying dividends or repurchasing shares. In July 2013, the Federal Reserve and the FDIC approved new rules that substantially amended the regulatory risk-based capital rules applicable to the Bank. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.

 

The final rule includes new minimum risk-based capital and leverage ratios, which became effective for the Bank and the Company on January 1, 2015, and revises the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital requirements are: (i) a new common equity tier 1 capital ratio of 4.5%; (ii) a tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a tier 1 leverage ratio of 4%. These rules also establish a “capital conservation buffer” of 2.5%, and will result in the following minimum ratios: (i) a common equity tier 1 capital ratio of 7.0%, (ii) a tier 1 to risk-based assets capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions.

 

In addition to the higher required capital ratios and the new deductions and adjustments, the final rules increase the risk weights for certain assets, meaning that we will have to hold more capital against these assets. For example, commercial real estate loans that do not meet certain new underwriting requirements must be risk-weighted at 150%, rather than the current 100%. There are also new risk weights for unsettled transactions and derivatives.

The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions constraining us from paying dividends or repurchasing shares if we were to be unable to comply with such requirements.

We depend on our management team to implement our business strategy and execute successful operations and we could be harmed by the loss of their services. We are dependent upon the services of our management team. Our strategy and operations are directed by the executive management team. Any loss of the services of our President and Chief Executive Officer or other members of our management team could impact our ability to implement our business strategy, and have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock.

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The fair value of our investments could decline. As of December 31, 2017, all of our investment portfolio was designated as available-for-sale. Unrealized gains and losses in the estimated value of the available-for-sale portfolio must be “marked to market” and reflected as a separate item in shareholders’ equity (net of tax) as accumulated other comprehensive income. Shareholders’ equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. The fair value of our investment portfolio may decline, causing a corresponding decline in shareholders’ equity.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows. Liquidity is essential to our business. Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital, possible acquisitions and other general corporate purposes. An inability to raise funds through deposits, borrowings, securities sold under repurchase agreements, the sale of loans and other sources could have a substantial negative effect on our liquidity. From time to time we rely on deposits obtained through intermediaries, FHLB advances, securities sold under agreements to repurchase and other wholesale funding sources to obtain the funds necessary to manage our balance sheet.

 

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general, including a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry. To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.

Changes in accounting standards could affect reported earnings. The accounting standard setters, including the PCAOB, the FASB, the SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply new or revised guidance retroactively.

The FASB issued the current expected credit losses (CECL) standard which will be effective in 2020, which changes the manner in which the allowance for credit losses is established and evaluated from the concept of incurred losses to that of expected losses. The effect of this change in accounting standard on our financial position and results of operations has not been quantified; however, if it results in a material increase in our allowance and future provisions for credit losses, this could have a material adverse effect on our financial condition and results of operations.

We are subject to environmental liability risk associated with our lending activities. A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock.

 

A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses. We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies; the use of the internet and telecommunications technologies to conduct financial transactions; and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As customer, public, and regulatory expectations regarding operational and information security have increased, our operating systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting, and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunication outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and as described below, cyber-attacks.

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As noted above, our business relies on our digital technologies, computer and email systems, software and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our customers’ or other third parties’ confidential information. Third parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide service or security solutions for our operations, and other unaffiliated third parties could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

While we have disaster recovery and other 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. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As a result, cyber security and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputation damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material effect on our results of operations or financial condition.

We are party to various lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained. From time to time, customers and others make claims and take legal action pertaining to our performance of fiduciary responsibilities. Whether claims and legal actions are legitimate or unfounded, if such claims and legal actions are not resolved in our favor, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Our stock price may be volatile, which could result in losses to our shareholders and litigation against us. Our stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to: actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, our announcement of developments related to our businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and non-traditional competitors, news reports of trends, irrational exuberance on the part of investors, new federal banking regulations, and other issues related to the financial services industry. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of volatility in the market price of its securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from our normal business.

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The trading volume in our common stock is lower than that of other larger companies; future sales of our stock by our shareholders or the perception that those sales could occur may cause our stock price to decline. Although our common stock is listed for trading on the NASDAQ Global Market, the trading volume in our common stock is lower than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the relatively low trading volume of our common stock, significant sales of our common stock in the public market, or the perception that those sales may occur, could cause the trading price of our common stock to decline or to be lower than it otherwise might be in the absence of those sales or perceptions.

There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock. We may issue additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.

 

We may issue additional debt and equity securities or securities convertible into equity securities, any of which may be senior to our common stock as to distributions and in the event of liquidation, which could negatively affect the value of our common stock. In the future, we may issue additional debt or equity securities, including securities convertible into equity securities. In the event of our liquidation, the holders of our debt and preferred securities must be satisfied before any distributions can be made on our common stock. Because our decision to incur debt and issue securities in our future offerings will depend on market conditions and other factors beyond our control, we cannot predict or estimate with certainty the amount, timing or nature of our future offerings and debt financings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future.

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 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.

Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business. Severe weather, natural disasters, acts of war or terrorism, and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. Although management has established disaster recovery plans and procedures, the occurrence of any such event could have a material adverse effect on our future business, results of operations, financial condition and the value of our common stock.

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Item 1B. Unresolved Staff Comments

None

 

Item 2. Properties

 

We operate from our corporate headquarters and, as of December 31, 2017, 18 branches located in our primary market area within western North Carolina, Upstate South Carolina, and northern Georgia. The net book value of our premises, land and equipment was $24.1 million at December 31, 2017. The following table sets forth information with respect to our full-service banking offices and other locations as of December 31, 2017.

  

Banking Center  Location  Year
Established
  Owned/
Leased
  Deposits at
December 31,
2017
(in thousands)
 
Franklin Main  50 West Main Street, Franklin, NC  1922  Owned  $218,948 
Murphy  12 Peachtree Street, Murphy, NC  1981  Owned   54,480 
Franklin Holly Springs Plaza  30 Hyatt Road, Franklin, NC  1993  Owned   49,850 
Highlands  473 Carolina Way, Highlands, NC  1995  Owned   50,583 
Sylva  498 East Main Street, Sylva, NC  1999  Owned   49,881 
Hendersonville—Laurel Park  640 North Main Street, Hendersonville, NC  1996  Owned   69,649 
Brevard Branch  2260 Asheville Highway, Brevard, NC  1997  Owned   52,508 
Hendersonville—Eastside  1617 Spartanburg Highway, Hendersonville, NC  1997  Leased   32,434 
Cashiers Branch  500 U.S. Highway 64, Cashiers, NC  2002  Owned   45,770 
Columbus Branch  160 W. Mill Street, Columbus, NC  2007  Owned   47,995 
Saluda  108 East Main Street, Saluda, NC  2007  Leased   26,961 
Waynesville (1)  2045 S. Main Street, Waynesville, NC  2016  Owned   60,271 
Greenville  501 Roper Mountain Road, Greenville, SC  2015  Owned   15,516 
Anderson (2)  602 North Main Street, Anderson, SC  2015  Owned   23,634 
Chesnee (2)  110 South Alabama Avenue, Chesnee, SC  2015  Owned   36,776 
Jasper Main (3)  100 Mark Whitfield St, Jasper, GA  2017  Owned   155,083 
Jasper Ingles (3)  1449 W Church St, Jasper, GA  2017  Leased   1,554 
Gainesville (4)  643 EE Buter Parkway, Gainesville, GA  2017  Owned   170,284 
            $1,162,177 
Other offices              
Corporate Office and Operations  14 One Center Court, Franklin, NC  2004  Owned    N/A  
Mortgage Processing Office  3640 East 1st Street, Suite 202, Blue Ridge, GA  2013  Leased    N/A  
Loan Production Office  133 Thomas Green Blvd., Suite 200, Clemson, SC  2016  Leased    N/A  
Loan Production Office (1)  1200 Ridgefield Blvd., Suite 258, Asheville, NC  2016  Leased    N/A  
Loan Production Office (4)  6340 Sugarloaf Parkway, Duluth, GA  2017  Leased    N/A  

 

(1) - Acquired on April 1, 2016.
(2) - Acquired on December 11, 2015.
(3) - Acquired on April 1, 2017.
(4) - Acquired on October 1, 2017.

 

Item 3. Legal Proceedings

 

In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

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Part II

 

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

 

Our common stock is listed on the Nasdaq Global Market under the symbol “ENFC.” The common stock was issued at a price of $10.00 per share in connection with the mutual to stock conversion and the initial public offering of our common stock. The common stock commenced trading on the Nasdaq Global Market on October 1, 2014. As of the close of business on March 9, 2018, there were 6,888,415 shares of common stock outstanding held by approximately 429 holders of record.

 

The following table sets forth the high and low closing sales prices of our common stock as reported by the Nasdaq Global Market for the periods indicated.

 

   High   Low 
2017          
First quarter  $24.10   $20.30 
Second quarter   24.25    22.75 
Third quarter   25.00    22.20 
Fourth quarter   30.55    25.00 
           
2016          
First quarter  $18.91   $16.24 
Second quarter   17.83    17.16 
Third quarter   18.43    17.40 
Fourth quarter   20.60    18.00 

The Company did not declare any dividends to its shareholders during the years ended December 31, 2017 or 2016. See Item 1, “Business—Supervision and Regulation,” for more information regarding the restrictions on the Company’s and the Bank’s abilities to pay dividends.

Logo

   Cumulative Total Return (1) 
   10/1/2014 (2)   12/31/2014   12/31/2015   12/31/2016   12/31/2017 
Entegra Financial Corp. (ENFC)  $100   $144   $194   $206   $293 
NASDAQ Composite Index   100    107    113    122    156 
KBW NASDAQ Bank Index   100    105    103    130    151 

(1)Total return includes reinvestment of dividends.
(2) Date of initial public offering.

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The graph and table compare our cumulative total shareholders return on our common stock with the NASDAQ Composite Index and the NASDAQ Bank Index. Returns are calculated on a total return basis, assuming the reinvestment of dividends and assuming that $100 was originally invested on October 1, 2014, the first day our common stock was traded.

The following sets forth information regarding our common stock repurchases during the fourth quarter of 2017.

 

Period  Total Number
of Shares
Purchased
   Average Price
Paid per
Share
   Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs (1)
   Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs (2)
 
October 1, 2017 to October 31, 2017      $        209,750 
November 1, 2017 to November 30, 2017               209,750 
December 1, 2017 to December 31, 2017               209,750 
Total      $        209,750 

 

(1) – On January 28, 2016, we announced the authorization to repurchase up to 327,318 shares of our common stock through January 27, 2017. On February 24, 2017, we announced the extension of the stock repurchase program through February 23, 2018.

(2) - Approximately 117,568 shares were repurchased under the stock repurchase program. The program expired on February 23, 2018 and no additional shares may be repurchased under the program.

 

The following table sets forth certain information regarding shares issuable upon exercise of outstanding options and rights under equity compensation plans, and shares remaining available for future issuance under equity compensation plans, in each case as of December 31, 2017.

 

   Number of Shares
to be Issued
Upon Exercise
of Outstanding
Options, Warrants
and Rights
   Weighted Average
Exercise Price
of Outstanding Options,
Warrants and Rights
   Number of Shares
Remaining Available
for Future Issuance
under Equity
Compensation Plans
(excluding shares
reflected in column (a))
 
Plan Category  (a)   (b)   (c) 
Equity Compensation Plans Approved by Shareholders             38,295 
Stock Options   433,300   $19.11      
Restricted Stock Units   125,200          
Equity Compensation Plans Not Approved by Shareholders            
Total   558,500   $14.83    38,295 
33
 

Item 6. Selected Financial Data

 

The following tables should be read in conjunction with “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8 - Financial Statements and Supplementary Data,” below.

 

(Dollars in thousands, except per share data)  2017   2016   2015   2014   2013 
Selected Financial Condition Data:                    
Total assets  $1,581,449   $1,292,877   $1,031,416   $903,648   $784,893 
Cash and cash equivalents   109,467    43,294    40,650    58,982    34,281 
Investment securities   348,958    403,502    284,740    249,144    176,472 
Loans receivable, net   994,252    735,056    614,611    529,407    507,623 
Bank owned life insurance   32,150    31,347    20,858    20,417    19,961 
Real estate owned   2,568    4,226    5,369    4,425    10,506 
Deposits   1,162,177    830,013    716,617    703,117    684,226 
FHLB advances   223,500    298,500    153,500    60,000    40,000 
Junior subordinated debt   14,433    14,433    14,433    14,433    14,433 
Total equity   151,313    133,068    131,469    107,319    32,518 
                          
Selected Operating Data:                         
Interest income  $50,529   $40,520   $33,144   $32,445   $31,451 
Interest expense   7,684    6,032    5,723    6,573    6,988 
Net interest income   42,845    34,488    27,421    25,872    24,463 
                          
Provision for loan losses   1,897    274    (1,500)   33    4,358 
Net interest income after provision for loan losses   40,948    34,214    28,921    25,839    20,105 
                          
Noninterest income   5,957    7,846    5,795    6,079    6,134 
Noninterest expense   36,798    32,189    27,630    23,767    26,179 
Income before income tax expense (benefit)   10,107    9,871    7,086    8,151    60 
Income tax expense (benefit)   7,528    3,495    (16,739)   2,208    475 
Net income (loss)  $2,579   $6,376   $23,825   $5,943   $(415)
34
 
(Dollars in thousands, except per share data)  2017   2016   2015   2014   2013 
Selected Financial Ratios and Other Data:                         
Performance Ratios:                         
Return on average assets   0.18%   0.55%   2.51%   0.71%   (0.05)%
Return on average equity (1)   1.82    4.71    19.78    10.39    (1.02)
Tax equivalent net interest rate spread   3.25    3.16    2.96    3.19    3.33 
Tax equivalent net interest margin   3.36    3.28    3.11    3.32    3.43 
Efficiency ratio (2)   75.40    76.04    83.18    74.42    85.59 
Noninterest expense to average total assets   2.58    2.76    2.91    2.85    3.37 
Average interest-earning assets to average interest-bearing liabilities   120.19    121.77    123.99    115.89    110.47 
Tangible equity to tangible assets (3)(6)   7.95    10.08    12.64    11.88    4.14 
Average equity to average assets   9.98    11.63    12.71    6.85    5.21 
                          
Asset Quality Ratios:                         
Non-performing loans to total loans (4)   0.48%   0.81%   1.17%   3.10%   2.99%
Non-performing assets to total assets (5)   0.47    0.79    1.23    2.35    3.33 
Allowance for loan losses to non-performing loans   227.86    154.03    129.96    65.98    91.19 
Allowance for loan losses to total loans   1.08    1.25    1.52    2.05    2.73 
Net charge-offs to average loans   0.04    0.06    0.02    0.60    0.93 
Loan loss provision/ net charge-offs   602.22    63.72    (1,351.35)   1.03    87.49 
                          
Capital Ratios (Bank level only):                         
Total capital (to risk-weighted assets)   12.88%   17.43%   19.34%   21.15%   11.97%
Tier I capital (to risk-weighted assets)   11.92    16.33    18.07    19.89    10.70 
Common Equity Tier 1 capital (to risk-weighted assets)   11.92    16.33    18.07     N/A      N/A  
Tier I capital (to average assets)   8.79    11.06    12.05    11.91    7.02 
                          
Capital Ratios (Company):                         
Total capital (to risk-weighted assets)   12.72%   17.72%   22.04%   24.50%   11.79%
Tier I capital (to risk-weighted assets)   11.76    16.62    20.78    23.24    10.52 
Common Equity Tier 1 capital (to risk-weighted assets)   10.57    15.33    19.55     N/A      N/A  
Tier I capital (to average assets)   8.68    11.28    13.85    13.94    6.90 
                          
Per Share Data:                         
Earnings per share - basic  $0.39   $0.98   $3.64   $0.91    N/A 
Earnings per share - diluted   0.39    0.98    3.64    0.91    N/A 
Cash dividends declared                   N/A 
Book value at end of year   22.00    20.57    20.08    16.39    N/A 
Tangible book value at end of year (6)   17.90    20.10    19.88    16.39    N/A 
                          
Other Data:                         
Number of offices   18    15    14    11    11 
Full time equivalent employees   272    239    213    187    185 

 

(1)-Return on average equity for the year ended December 31, 2014 reflects our actual average equity, and would have been adversely impacted had the $63.7 million in net stock offering proceeds been outstanding for the entire year.
(2)-The efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
(3)-Mortgage servicing rights are included in tangible assets and tangible equity.
(4)-Non-performing loans include non-accruing loans.
(5)-Non-performing assets include non-performing loans and REO.
(6)-Non-GAAP measure, see page 38 for a reconciliation of GAAP to non-GAAP measures.
35
 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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

 

The following presents management’s discussion and analysis of the Company’s financial condition and results of operations and should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company.

 

Statements included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations section include financial measures that do not conform to U.S. generally accepted accounting principles, or GAAP and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. This Management’s Discussion and Analysis of Financial Condition and Results of Operations section and the accompanying tables discuss financial measures, such as core net interest income, core noninterest expense, core net income, core return on average assets, core return on average equity, and core efficiency ratio, which are non-GAAP measures. We believe that such non-GAAP measures are useful because they enhance the ability of investors and management to evaluate and compare the Company’s operating results from period to period in a meaningful manner. Non-GAAP measures should not be considered as an alternative to any measure of performance as promulgated under GAAP. Investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the company. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.

36
 

RECONCILIATION OF NON-GAAP MEASURES

  

   Year Ended December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands, except per share data) 
Core Net Interest Income                         
Net Interest income (GAAP)  $42,845   $34,488   $27,421   $25,872   $24,463 
One-time deferred interest and discounts               (1,125)    
Core net interest income (Non-GAAP)  $42,845   $34,488   $27,421   $24,747   $24,463 
                          
Core Noninterest Expense                         
Noninterest expense (GAAP)  $36,798   $32,189   $27,630   $23,767   $26,179 
FHLB prepayment penalty       (118)   (1,762)        
Merger-related expenses   (3,086)   (2,197)   (329)        
Core noninterest expense (Non-GAAP)  $33,712   $29,874   $25,539   $23,767   $26,179 
                          
Core Net Income (Loss)                         
Net income (loss) (GAAP)  $2,579   $6,376   $23,825   $5,943   $(415)
One-time deferred interest and discounts               (1,125)    
Negative provision for loan losses           (1,500)        
FHLB prepayment penalty       77    1,762         
Loss (gain) on sale of investments   716    (790)   (403)   (657)    
Other than temporary impairment of investment securities available for sale   492            76     
Merger-related expenses   2,006    1,428    329         
Deferred tax asset revaluation due to new enacted tax rate of 21%   4,854                 
Adjust actual income tax expense (benefit) to 35% estimated effective tax rate (1)           (19,285)   48    454 
Core net income (Non-GAAP)  $10,647   $7,091   $4,728   $4,285   $39 
                          
Core Diluted Earnings Per Share                         
Diluted earnings per share (GAAP)  $0.39   $0.98   $3.64   $0.91     N/A  
One-time deferred interest and discounts               (0.17)    N/A  
Negative provision for loan losses           (0.23)        N/A  
FHLB prepayment penalty       0.01    0.27         N/A  
Loss (gain) on sale of investments   0.11    (0.13)   (0.06)   (0.10)    
Other than temporary impairment of investment securities available for sale   0.07            0.01     
Merger-related expenses   0.30    0.22    0.05         N/A  
Deferred tax asset revaluation due to new enacted tax rate of 21%   0.73                 
Adjust actual income tax expense (benefit) to 35% estimated effective tax rate (1)           (2.95)        N/A  
Core earnings per share (Non-GAAP)  $1.60   $1.08   $0.72   $0.65     N/A  
                          
Core Return on Average Assets                         
Return on Average Assets (GAAP)   0.18%   0.55%   2.51%   0.71%   -0.05%
Effect to adjust for one-time deferred interest and discounts               (0.13)    
Effect to adjust for negative provision for loan losses           (0.16)        
Effect to adjust for FHLB prepayment penalty       0.01    0.18         
Effect to adjust for loss (gain) on sale of investment securities available for sale   0.05    (0.07)   (0.01)   (0.08)    
Effect to adjust for other than temporary impairment of investment securities available for sale   0.03                 
Effect to adjust for merger-related expenses   0.14    0.12    0.03    0.01     
Effect to adjust for deferred tax asset revaluation due to new enacted tax rate of 21%   0.35                 
Effect to adjust for actual income tax expense (benefit) to 35% effective tax rate           (2.05)       0.05 
Core Return on Average Assets (Non-GAAP)   0.75%   0.61%   0.50%   0.51%   0.00%

37
 

   Year Ended December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands, except per share data) 
                          
Core Return on Tangible Average Equity (2)                         
Return on Average Equity (GAAP)   1.82%   4.71%   19.78%   10.39%   -1.02%
Effect to adjust for one-time deferred interest and discounts               (1.97)    
Effect to adjust for negative provision for loan losses           (1.24)        
Effect to adjust for FHLB prepayment penalty       0.06    1.46         
Effect to adjust for loss (gain) on sale of investment securities available for sale   0.50    (0.58)   (0.03)   (0.11)    
Effect to adjust for other than temporary impairment of investment securities available for sale   0.35            0.01     
Effect to adjust for merger-related expenses   1.41    1.05    0.27         
Effect to adjust for deferred tax asset revaluation due to new enacted tax rate of 21%   3.42                 
Effect to adjust for actual income tax expense (benefit) to 35% effective tax rate           (16.13)   (0.44)   1.12 
Effect to goodwill and intangibles   0.68    0.10    (0.17)   (0.39)    
Core Return on Average Equity (Non-GAAP)   8.18%   5.34%   3.94%   7.49%   -1.02%
                          
Core Efficiency Ratio                         
Efficiency ratio (GAAP)   75.40%   76.04%   83.18%   74.44%   85.59%
Effect to adjust for one-time deferred interest and discounts               2.71     
Effect to adjust for FHLB prepayment penalty       (0.28)   (5.30)        
Effect to adjust for loss (gain) on sale of investment securities available for sale   (2.21)   2.08    0.86    1.70     
Effect to adjust for other than temporary impairment of investment securities available for sale   (1.53)           (0.01)    
Effect to adjust for merger-related expenses   (5.12)   (5.19)   (0.99)        
Core Efficiency Ratio (Non-GAAP)   66.54%   72.65%   77.75%   78.84%   85.59%
                          
Tangible Book Value Per Share                         
Book Value (GAAP)  $151,313   $133,068   $131,469   $107,319    N/A 
Goodwill and intangibles   (28,172)   (3,044)   (1,301)       N/A 
Book Value (Tangible)   123,141    130,024    130,168    107,319    N/A 
Outstanding shares   6,879,191    6,467,550    6,546,375    6,546,375    N/A 
Tangible Book Value Per Share  $17.90   $20.10   $19.88   $16.39    N/A 

 

(1) - The Company maintained a valuation allowance on a portion of its net deferred tax asset during the periods presented and therefore only recognized tax expense (benefit) for adjustments to its tax planning strategies and reversal of valuation allowance on net deferred tax assets. Core net income is reflected to adjust the income tax expense to an estimated 35% effective tax rate after the other adjustments have been applied.  
   
(2) - Core return on average equity and return on average equity for the year ended December 31, 2014 reflects our actual average equity, and would have been adversely impacted had the $63.7 million in net stock offering proceeds raised on September 30, 2014 been outstanding during the entire period.  

 

Recent Development

 

As of December 31, 2017, the Company had a tax liability of $5.7 million related to the Company’s acquisition of Chattahoochee Bank of Georgia (“Chattahoochee”) in October 2017, which was not otherwise presented in the Company’s earnings release filed with the SEC on January 18, 2018 (the “January Earnings Release”). As a consequence, goodwill increased $5.7 million to $23.9 million, income taxes receivable which is included in other assets decreased $1.4 million, and net tax liabilities which is included in other liabilities increased $4.3 million. Tangible book value per share decreased to $17.90 from $18.72. The Company continues to evaluate potential courses of action with respect to the incurrence of this tax liability.

 

38
 

Overview

 

We are a bank holding company with assets of $1.58 billion at December 31, 2017. We provide a full range of financial services through 18 full-service banking offices located in the western North Carolina counties of Cherokee, Haywood, Henderson, Jackson, Macon, Polk and Transylvania, the Upstate South Carolina counties of Anderson, Greenville and Spartanburg, and the Northern Georgia counties of Pickens and Hall. We also operate loan production offices in Asheville, North Carolina, Clemson, South Carolina, and Duluth, Georgia. We provide full service retail and commercial banking products as well as wealth management services through a third party.

 

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

 

Our mission is to become the financial services provider of choice within the markets that we serve. We plan to do this by delivering exceptional service and value.

 

During the year ended December 31, 2017, we continued to successfully execute our key strategic initiatives. Building on our acquisition of two South Carolina branches from Arthur State Bank in December, 2015, we completed our first whole bank acquisition in the second quarter of 2016 when we acquired Old Town Bank of Waynesville, North Carolina. In February 2017, we acquired two branches in Jasper, Georgia from another financial institution followed by a whole bank acquisition, Chattahoochee Bank of Georgia (“Chattahoochee”) in Gainesville, Georgia, in October 2017.

 

Our continued focus will be on loan growth to increase our net interest income, implementing opportunities to increase fee income, improving asset quality and closely monitoring operating expenses. We strive to be well-positioned for changes in both the economy and interest rates, regardless of the timing or direction of these changes. Management regularly assesses our balance sheet, capital, liquidity and operational infrastructure in order to be positioned to take advantage of opportunities for growth as they may arise.

 

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

 

Strategic Plan

 

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

·Building a franchise that will provide above-average shareholder returns;
·Seeking acquisition opportunities that have reasonable earn-back periods and are accretive to return on equity while minimizing book value dilution;
·Building long-term franchise value by diversifying into high growth markets geographically contiguous to our current markets;
·Building deposits in rural markets; and
·Maximizing our capital leverage through organic and acquired asset growth.

  

Critical Accounting Policies

 

We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. Our significant accounting policies are discussed in detail in Note 2 of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company,” we have elected to use the transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of December 31, 2017, there is not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance.

 

We consider the following to be our critical accounting policies.

39
 

Allowance for Loan Losses. We maintain an allowance for loan losses at an amount estimated to equal all credit losses inherent in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Management’s determination of the adequacy of the allowance is based on evaluations, at least quarterly, of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral. Based on our estimate of the level of allowance for loan losses required, we record a provision for loan losses to maintain the allowance for loan losses at an appropriate level.

 

All loan losses are charged to the allowance for loan losses and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which in our judgment deserve current recognition in estimating probable losses. When any loan or portion thereof is classified “doubtful” or “loss,” the loan will be charged down or charged off against the allowance for loan losses. Loans are deemed “doubtful” or “loss” based on a variety of credit, collateral, documentation and other issues. When collateral is foreclosed or repossessed, any principal charge-off related to that transaction, based upon the most current appraisal or evaluation, along with estimated sales expenses is taken at that time.

 

The determination of the allowance for loan losses is based on management’s current judgments about the loan portfolio credit quality and management’s consideration of all known relevant internal and external factors that affect loan collectability, as of the reporting date. We cannot predict with certainty the amount of loan charge-offs that will be incurred. We value impaired loans in our portfolio for specific impairment based primarily on appraised values less selling costs or discounted cash flows. We value non-impaired loans based on our historical loss experience within individual loan types. Qualitative and environmental factors are used to account for trends in economic conditions not captured in historical loss experience. In addition, our various regulatory agencies, as part of their examination processes, periodically review our allowance for loan losses. Such agencies may require that we recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

 

Troubled Debt Restructurings (“TDRs”). In accordance with accounting standards, we classify loans as TDRs when certain modifications are made to the loan terms and concessions are granted to borrowers whom we consider to have a defined financial difficulty. A defined financial difficulty includes a deficient global cash flow coverage ratio, a significant decline in a credit score, defaults with creditors and other increases in the borrower’s risk profile that signify the borrower is experiencing financial difficulty. Our practice is to only restructure loans for borrowers in financial difficulty that have designed a viable business plan to fully pay off all outstanding debt, interest and fees post-restructure either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute its business plan. With respect to TDRs, we grant concessions by reducing the stated interest rate for a specific time period, providing an interest-only period, or extending the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk.

 

From time to time, in the normal course of business, we modify the interest rate and/or the amortization period of performing loans upon the request of the borrower. This is often done for competitive reasons in order to retain the borrower’s business. Where the borrower does not have a defined financial difficulty, such modifications are not classified as TDRs. Also, when we receive a material credit enhancement, such as an additional guarantee, additional collateral or a principal curtailment, in exchange for a concession, we may not classify the modification as a TDR.

 

Impaired loans. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. All TDRs are classified as impaired loans. However, we may also remove a loan from TDR and impaired status if the TDR is subsequently restructured and at the time of the subsequent restructuring the borrower is not experiencing financial difficulties and, under the terms of the subsequent restructuring agreement, no concession has been granted to the borrower.

40
 

We monitor collateral values of collateral-dependent impaired loans and periodically update our determination of the fair value of the collateral. Appraisals and evaluations are performed for collateral-dependent impaired loans at least every 12 to 18 months. In determining the fair value of collateral, market values are discounted to take into account typical selling expenses and closing costs if foreclosure of the property is deemed likely. We generally discount current market values by 10% to reflect the typical selling expenses, inclusive of real estate commissions charged on the sale by brokers in our markets. The discount applied for legal fees varies depending on the nature and anticipated complexity of the foreclosure, with a higher discount applied when the foreclosure is expected to be complex.

 

Evaluations are used predominately for residential-use properties for which market data is readily available or where we have recently liquidated a comparable property in close proximity to the subject real estate. We also use a service comparable to an automated valuation model to support internal evaluations. This service provides subject property and comparable data by compiling public information such as assessed tax values. We generally rely on external appraisers to value more complex income-producing property and other construction and land loans which require discounted cash flow assessments based on more complex market data research than what is normally available to us.

 

We adjust collateral values if we receive market data or evidence from recent sales of similar properties indicating that the appraised value of the collateral exceeds the value we can reasonably expect to receive upon its sale. Adjustments to increase appraised values are not permitted. We use realtors and market data to estimate the potential deficiency when we suspect the fair value of the collateral is less than the outstanding principal balance on a loan and an updated appraisal has not yet been received.

 

Deferred Tax Assets. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date. A valuation allowance is required to be recognized if it is more likely than not that a deferred tax asset will not be realized. The determination as to whether we will be able to realize a deferred tax asset is highly subjective and dependent upon judgments concerning our evaluation of both positive and negative evidence, our forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Positive evidence includes the existence of taxes paid in available carryback years as well as the probability that taxable income will be generated in future periods, while negative evidence includes any cumulative losses in the current year and prior two years and general business and economic trends.

 

Real Estate Owned (“REO”). REO, consisting of properties obtained through foreclosure or through a deed in lieu of foreclosure in satisfaction of loans, is reported at the lower of cost or fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. The cost or fair value is then reduced by estimated selling costs. Management also considers other factors, including changes in absorption rates, length of time a property has been on the market and anticipated sales values, which may result in adjustments to the collateral value estimates. At the time of foreclosure or initial possession of collateral, any excess loan balance over the fair value of the REO is treated as a charge against the allowance for loan losses.

 

Subsequent declines in the fair value of REO below the new cost basis are recorded through valuation adjustments. Significant judgments and complex estimates are required in estimating the fair value of REO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility. In response to market conditions and other economic factors, management may utilize liquidation sales as part of its problem asset disposition strategy. As a result of the significant judgments required in estimating fair value and the variables involved in different methods of disposition, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of REO. Management reviews the value of REO each quarter and adjusts the values as appropriate. Appraisals are obtained no less frequently than every 12 to 18 months. Any subsequent adjustments to the value, gains or losses on sales, and REO expenses are recorded in “Net cost of operation of real estate owned” which is a component of noninterest expense.

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

 

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

 

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

 

Comparison of Financial Condition at December 31, 2017 and 2016

 

Total assets increased $288.6 million, or 22.3%, to $1.58 billion at December 31, 2017 from $1.29 billion at December 31, 2016 as we continued to leverage our capital through acquisitions and organic growth.

 

Total liabilities increased $270.3 million, or 23.3%, to $1.4 billion at December 31, 2017 from $1.2 billion at December 31, 2016, due primarily to the $332.2 million increase in deposits primarily as the result of deposits assumed in the purchase of two branches from Stearns Bank, NA (“Stearns”) and the acquisition of Chattahoochee. The deposit increases were slightly offset by a $75.0 million repayment of FHLB advances.

 

Total equity increased $18.2 million, or 13.7%, to $151.3 million at December 31, 2017 from $133.1 million at December 31, 2016. This increase was primarily attributable to the issuance of approximately 396,000 shares valued at $9.9 million in connection with the Chattahoochee acquisition, $2.6 million of net income, $0.9 million of stock-based compensation expense, and a $5.4 million after tax improvement in the market value of investment securities, partially offset by $0.5 million of share repurchases.

 

Cash and Cash Equivalents

 

Total cash and cash equivalents increased $66.1 million to $109.5 million at December 31, 2017 from $43.3 million at December 31, 2016 primarily as a result of cash received from the sale of approximately $45.0 million of securities classified as available-for-sale in December 2017. We continue to hold adequate levels of liquid and short-term assets.

 

Loans

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

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   December 31, 
   2017   2016   2015   2014   2013 
(Dollars in thousands)  Balance   Percent   Balance   Percent   Balance   Percent   Balance   Percent   Balance   Percent 
Real estate loans:                                                  
One- to four-family residential  $304,107    30.1%  $278,437    37.3%  $248,633    39.7%  $227,209    41.8%  $225,520    43.1%
Commercial   453,725    45.0    292,879    29.0    214,413    28.7    179,435    33.0    155,633    29.7 
Home equity loans and lines of credit   49,877    4.9    50,334    5.0    53,446    7.2    56,561    10.4    56,836    10.9 
Residential construction   37,108    3.7    18,531    1.8    7,848    1.1    7,823    1.4    8,952    1.7 
Other construction and land   101,447    10.0    60,605    8.1    57,316    9.1    50,298    9.3    64,927    12.4 
Commercial   56,939    5.6    41,306    4.1    41,046    5.5    19,135    3.5    8,285    1.6 
Consumer   5,700    0.7    4,594    0.6    3,639    0.5    3,200    0.6    3,654    0.7 
Total loans, gross   1,008,903    100%   746,686    86%   626,341    92%   543,661    100%   523,807    100%
                                                   
Less:  Net deferred loan fees   (1,431)        (923)        (1,388)        (1,695)        (1,933)     
Fair value discount   (2,012)        (857)        (72)                       
Unamortized premium   389         605         557                        
Unamortized discount   (710)        (1,150)        (1,366)        (1,487)              
Total loans, net  $1,005,139        $744,361        $624,072        $540,479        $521,874      
Percentage of total assets   63.6%        57.6%        60.5%        59.8%        66.5%     

In mid-2007, as economic conditions began to deteriorate, management recognized the need to reduce our concentration in higher risk loans, especially other construction and land development loans. Since then we first reduced, and have subsequently monitored the concentration in other construction and land loans. As of December 31, 2017, other construction and land loans had fallen to 10.0% of total loans, compared to 12.4% as of December 31, 2012. Reductions have been achieved through payoffs of maturing loans, controlled loan originations, and foreclosure of non-performing loans. The increase in the 2017 levels of other construction and land loans from 2016 is primarily the result of the Chattahoochee acquisition. The amount of commercial real estate loans as a percentage of total loans continues to increase as we continue to shift our lending focus to these loan types as we develop stronger commercial relationships in all of our markets. The increase in commercial real estate loans to 45.0% as of December 31, 2017 compared to 29.0% at December 31, 2016 is primarily the result of the Chattahoochee acquisition.

  

During 2014, we began to experience moderate growth in loan demand within our primary market area which has continued through 2017. During 2017, net loans increased $260.8 million, or 35.0%, to $1.0 billion at December 31, 2017 compared to $744.4 million at December 31, 2016, positively impacted by the Chattahoochee acquisition which accounted for $159.0 million of loans.

 

Our loan growth has also been enhanced by our new loan production offices in Clemson, SC and Asheville, NC and the hiring of additional commercial lenders. We believe that economic conditions in our primary market area are strong and that improving conditions are contributing to an increase in loan demand.

 

Included in loans receivable and other borrowings at December 31, 2017 are $3.6 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

 

As of December 31, 2017, our largest lending relationship was with a local commercial real estate property developer located in our primary market area. As of December 31, 2017, the borrower had outstanding principal loan balances of $14.2 million. The loans are collateralized primarily by commercial real estate and were performing as of December 31, 2017. The next nine largest lending relationships accounted for 20 loans and had an aggregate principal loan balance of $80.2 million as of December 31, 2017. All of the loans within these nine relationships were performing as of December 31, 2017.

 

Maturities and Sensitivity of Loans to Changes in Interest Rates

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

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   December 31, 2017 
(Dollars in thousands)  One year or less   Over one year
to five years
   Over five years   Total 
Real estate loans:                    
One- to four-family residential  $13,383   $26,139   $263,462   $302,984 
Commercial   130,881    76,633    243,515    451,029 
Home equity loans and lines of credit   7,153    13,638    29,170    49,961 
Residential construction   13,859    3,330    19,955    37,144 
Other construction and land   26,004    17,399    57,765    101,168 
Commercial   19,848    15,196    22,032    57,076 
Consumer   681    3,815    1,281    5,777 
Total loans, gross  $211,809   $156,150   $637,180   $1,005,139 

Longer term one-to-four family residential, construction, commercial real estate, and home equity loans and lines of credit typically carry interest rates which adjust to U.S. Treasury indices or The Wall Street Journal Prime Rate. Longer term one-to-four family residential construction loans represent construction-permanent loans which, upon completion of the construction phase, become one-to-four family residential real estate loans.

 

The following table sets forth the dollar amount of all loans at December 31, 2017 that have contractual maturities after December 31, 2017 and have either fixed interest rates or floating or adjustable interest rates.

 

   December 31, 2017 
(Dollars in thousands)  Fixed   Floating or
adjustable
   Total 
Real estate loans:               
One- to four-family residential  $150,427   $152,557   $302,984 
Commercial   276,275    174,754    451,029 
Home equity loans and lines of credit   20,670    29,291    49,961 
Residential construction   12,962    24,182    37,144 
Other construction and land   57,007    44,161    101,168 
Commercial   34,222    22,854    57,076 
Consumer   5,400    377    5,777 
Total  $556,963   $448,176   $1,005,139 

  

Delinquent Loans

 

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

 

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

 

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

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The following table sets forth certain information with respect to our loan portfolio gross balances of delinquencies at the dates indicated. We had no loans past due 90 days or more that are still accruing interest at December 31, 2017.

 

   Delinquent loans 
   30-59 Days   60-89 Days   90 Days and over   Total 
   (Dollars in thousands) 
At December 31, 2017                    
Real estate loans:                    
One- to four-family residential  $3,957   $599   $565   $5,121 
Commercial   2,094    325    701    3,120 
Home equity loans and lines of credit   307    27    120    454 
One- to four-family residential construction   501            501 
Other construction and land   1,711    20    96    1,827 
Commercial   487    1    91    579 
Consumer   27    25    9    61 
Total loans  $9,084   $997   $1,582   $11,663 
% of total loans, gross   0.90%   0.10%   0.16%   1.16%
                     
At December 31, 2016                    
Real estate loans:                    
One- to four-family residential  $4,931   $1,116   $554   $6,601 
Commercial   1,383    1,800    1,681    4,864 
Home equity loans and lines of credit   126    44    233    403 
One- to four-family residential construction   180            180 
Other construction and land   467        919    1,386 
Commercial   368            368 
Consumer   62    1        63 
Total loans  $7,517   $2,961   $3,387   $13,865 
% of total loans, gross   1.01%   0.40%   0.45%   1.86%
                     
At December 31, 2015                    
Real estate loans:                    
One- to four-family residential  $5,610   $1,260   $1,205   $8,075 
Commercial   1,585        605    2,190 
Home equity loans and lines of credit   369    38    322    729 
One- to four-family residential construction                
Other construction and land   208    397    138    743 
Commercial   625            625 
Consumer   12    4        16 
Total loans  $8,409   $1,699   $2,270   $12,378 
% of total loans, gross   1.35%   0.27%   0.36%   1.98%
                     
At December 31, 2014                    
Real estate loans:                    
One- to four-family residential  $6,298   $448   $2,669   $9,415 
Commercial   2,136    909    1,006    4,051 
Home equity loans and lines of credit   557    528    759    1,844 
One- to four-family residential construction           65    65 
Other construction and land   1,530    964    473    2,967 
Commercial       22        22 
Consumer   247    4    1    252 
Total loans  $10,768   $2,875   $4,973   $18,616 
% of total loans, gross   1.99%   0.53%   0.92%   3.44%
                     
At December 31, 2013                    
Real estate loans:                    
One- to four-family residential  $5,539   $669   $2,587   $8,795 
Commercial   4,746    53    722    5,521 
Home equity loans and lines of credit   313    29    350    692 
One- to four-family residential construction   120            120 
Other construction and land   499    185    970    1,654 
Commercial       35        35 
Consumer   18    9        27 
Total loans  $11,235   $980   $4,629   $16,844 
% of total loans, gross   2.15%   0.19%   0.89%   3.23%
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Total delinquencies as a percentage of loans have decreased from 3.23% at December 31, 2013 to 1.16% at December 31, 2017, representing a decrease of 64.1% over the period. Loans past due 90 days and over and on non-accrual have experienced a greater decline, decreasing from 0.89% at December 31, 2012, to 0.16% at December 31, 2017, a decrease of 82.0% over the period. The decrease in delinquencies is consistent with the improving economic health of our primary market area.

 

Non-Performing Assets

 

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

 

   December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Non-accrual loans:                         
Real estate loans:                         
One- to four-family residential  $1,421   $1,125   $2,893   $5,661   $2,794 
Commercial   2,666    3,536    3,628    7,011    10,212 
Home equity loans and lines of credit   120    250    320    1,347    350 
Residential construction               65     
Other construction and land   464    1,042    384    2,679    2,068 
Commercial   95    41    55    15    190 
Consumer   12    47        2    13 
                          
Total non-performing loans   4,778    6,041    7,280    16,780    15,627 
                          
REO:                         
One- to four-family residential   288    1,336    1,384    220    1,076 
Commercial   544    722    1,123    774    2,988 
Residential construction                   210 
Other construction and land   1,736    2,168    2,862    3,431    6,232 
                          
Total foreclosed real estate   2,568    4,226    5,369    4,425    10,506 
                          
Total non-performing assets  $7,346   $10,267   $12,649   $21,205   $26,133 
                          
Troubled debt restructurings still accruing  $8,952   $9,882   $11,206   $18,760   $23,015 
                          
Ratios:                         
Non-performing loans to total loans   0.47%   0.81%   1.17%   3.10%   2.99%
Non-performing assets to total assets   0.46%   0.79%   1.23%   2.35%   3.33%

Non-performing loans as a percentage of total loans decreased from 2.99% at December 31, 2013, to 0.47% at December 31, 2017, representing a decrease of 84.3% over the period. Similarly, non-performing assets as a percentage of total assets decreased from 3.33% at December 31, 2013, to 0.46% at December 31, 2017, representing a decrease of 86.2% over the period. This decrease in non-performing loans and non-performing assets is due to a combination of the improving economy and the Bank’s successful resolution and disposal of non-performing loans and non-performing assets by means of restructure, foreclosure, deed in lieu of foreclosure and short sales for less than the amount of the indebtedness, in which cases the deficiency is charged-off.

 

Non-performing loans decreased $1.3 million, or 20.9%, to $4.8 million at December 31, 2017 compared to $6.0 million at December 31, 2016. This decrease in non-performing loans is attributable to loan payoffs, transfers to REO, charge-offs, and the return of loans to accrual status upon the determination that ultimate collectability of all amounts contractually due is not in doubt.

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REO decreased $1.7 million, or 39.2%, to $2.6 million at December 31, 2017 from $4.2 million at December 31, 2016. Most of the transfers to REO during 2017 were one-to-four family residential properties which are normally sold at a faster pace than other property types. We have experienced a significant decrease in the number and dollar amount of additions to REO and have had moderate success in liquidating the properties. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.

 

Troubled Debt Restructurings (“TDRs”)

 

In situations where, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession that we would not otherwise consider, for other than an insignificant period of time, the related loan is classified as a TDR. We strive to identify borrowers in financial difficulty early so that we may work with them to modify their loans before they reach nonaccrual status. Modified terms generally include extensions of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar risk characteristics, reductions in contractual interest rates, periods of interest-only payments, and principal deferments. While unusual, there may be instances of forgiveness of loan principal. We individually evaluate all substandard loans that experienced a modification of terms to determine if a TDR has occurred.

 

All TDRs are considered to be impaired loans and are reported as such for the remaining life of the loan, unless the restructuring agreement specifies an interest rate equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk and the ultimate collectability of all amounts contractually due is not in doubt. We may also remove a loan from TDR and impaired status if the TDR is subsequently restructured and at the time of the subsequent restructuring the borrower is not experiencing financial difficulties and, under the terms of the subsequent restructuring agreement, no concession has been granted to the borrower.

 

The following table presents our TDRs by accrual status as of the dates indicated.

 

   December 31, 
(Dollars in thousands)  2017   2016 
TDRs still accruing interest  $8,952   $9,882 
TDRs not accruing interest   1,808    2,782 
Total TDRs  $10,760   $12,664 

 

As noted in the above table, the majority of our borrowers with restructured loans have been able to comply with the revised payment terms for at least six consecutive months, resulting in their respective loans being restored to accrual status.

 

The following table presents details of TDRs made in each of the periods indicated:

 

Year Ended
December 31,
  Modification Type  Number
of TDR
Loans
  Pre-Modification
Recorded
Investment
   Post-Modification
Recorded
Investment
 
      (Dollars in thousands)
2017  Forgiveness of principal  1  $242   $166 
                 
2016  None  0  $   $ 
                 
2015  Forgiveness of principal  1  $1,988   $1,693 
   Extended payment terms  1   833    833 
   Total  2  $2,821   $2,526 

During 2017, we continued to be proactive in working with borrowers to identify potential issues and restructure certain loans to prevent future losses.

47
 

Classification of Loans

 

Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality including “substandard,” “doubtful”, or “loss.” An asset is considered “substandard” if it displays an identifiable weakness without appropriate mitigating factors where there is the distinct possibility that we will sustain some loss if deficiencies are not corrected. “Substandard” loans may include some deterioration in repayment capacity and/or loan-to-value of underlying collateral. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that collection in full is highly questionable or improbable. Assets classified as “loss” are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are designated as “special mention.”

 

We maintain an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at the balance sheet date. We review our asset portfolio no less frequently than quarterly to determine whether any assets require classification in accordance with applicable regulatory guidelines.

 

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

 

   December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Classified loans:                         
Substandard  $9,503   $12,353   $19,196   $31,205   $47,019 
Doubtful                    
Loss                    
                          
Total classified loans   9,503    12,353    19,196    31,205    47,019 
As a % of total loans   0.94%   1.65%   3.08%   5.77%   9.01%
                          
Special mention   12,725    17,158    19,195    31,283    37,670 
                          
Total criticized loans  $22,228   $29,511   $38,391   $62,488   $84,689 
As a % of total loans   2.20%   3.95%   6.15%   11.56%   16.23%

Total classified loans decreased $2.9 million, or 23.1%, to $9.5 million at December 31, 2017 from $12.4 million at December 31, 2016. Total criticized loans decreased $7.3 million, or 24.7%, to $22.2 million at December 31, 2017 from $29.5 million at December 31, 2016. The reductions since 2013 reflect an improving economy and an increasing number of criticized loans being paid off or upgraded as a consequence of improvements in our borrowers’ cash flows and payment performance. Management continues to dedicate significant resources toward monitoring and resolving classified and criticized loans.

 

Management continuously monitors non-performing, classified and past due loans to identify any deterioration in the condition of these loans. As of December 31, 2017, we had not identified any potential problem loans that we did not already classify as non-performing.

 

Allowance for Loan Losses

 

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

48
 

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

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. Prior to the first quarter of 2015, we more heavily weighted the most recent four quarters than the least recent four quarters. Beginning in the first quarter of 2015, we no longer weight any quarters to calculate our average loss rates. This change in weighting did not have a material impact on our allowance for loan losses methodology. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.50% to 5.45%.

 

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

 

  ·   Non-accrual and classified loans

  ·   Collateral values

  ·   Loan concentrations

  ·   Economic conditions – including unemployment rates, home sales, and a regional economic index.

 

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

49
 

The following table presents the activity in and balances of our allowance for loan losses as of and for the periods indicated:

 

   As of or for the Year Ended December 31, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Balance at beginning of period  $9,305   $9,461   $11,072   $14,251   $14,874 
                          
Charge-offs:                         
Real Estate:                         
One- to four-family residential   93    133    536    702    1,283 
Commercial   193    431    52    2,415    2,209 
Home equity loans and lines of credit   268    158    540    598    760 
One- to four-family residential construction                   193 
Other construction and land   289    560    137    566    1,512 
Commercial   68    63    9    133    17 
Consumer   60    201    48    140    675 
Total charge-offs   971    1,546    1,322    4,554    6,649 
                          
Recoveries:                         
Real Estate:                         
One- to four-family residential   118    77    259    193    433 
Commercial   75    173    168    364    125 
Home equity loans and lines of credit   6    224    104    41    22 
One- to four-family residential construction       32    3        111 
Other construction and land   148    130    342    218    539 
Commercial   25    144    32    163    31 
Consumer   284    336    303    363    407 
Total recoveries   656    1,116    1,211    1,342    1,668 
                          
Net charge-offs   315    430    111    3,212    4,981 
                          
Provision for loan losses   1,897    274    (1,500)   33    4,358 
                          
Balance at end of period  $10,887   $9,305   $9,461   $11,072   $14,251 
                          
Ratios:                         
Net charge-offs to average loans outstanding   0.04%   0.06%   0.02%   0.60%   0.93%
Allowance to non-performing loans at period end   227.86%   154.03%   129.96%   65.98%   91.19%
Allowance to total loans at period end   1.08%   1.25%   1.52%   2.05%   2.73%

As indicated in the above table, our net charge-offs to average loans have declined from 0.93% for the year ended December 31, 2013, to 0.04% for the year ended December 31, 2017, representing a decrease of 95.7% over the period. The reduction in net charge-offs is attributable to the continued improvement in quality of our loan portfolio and the continued collection of payments on loans previously charged-off.

 

Our nonperforming loan coverage ratio has continued to increase since 2013. The increase in our coverage ratio is mainly attributable to the reduction in nonperforming loans of $10.8 million, or 69.4%, to $4.8 million at December 31, 2017 from $15.6 million at December 31, 2013.

 

Our allowance as a percentage of total loans decreased to 1.08% at December 31, 2017 from 1.25% at December 31, 2016 primarily as the result of the increase in loans related to the Chattahoochee acquisition. The historical loss rates used in our allowance for loan losses calculation continue to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. The remaining fair value discount on acquired loans was $2.0 million as of December 31, 2017.

 

50
 

Allocation of Allowance for Loan Losses

 

The table below summarizes the allowance for loan losses balance and percent of total loans by loan category.

   December 31, 
   2017   2016   2015   2014   2013 
   Allowance   % of Loans
to Total
Loans
   Allowance   % of Loans
to Total
Loans
   Allowance   % of Loans
to Total
Loans
   Allowance   % of Loans
to Total
Loans
   Allowance   % of Loans
to Total
Loans
 
   (Dollars in thousands) 
Real estate loans:                                                  
One- to four-family residential  $4,018    30.1%  $2,812    37.2%  $2,455    39.7%  $2,983    41.8%  $3,693    43.1%
Commercial   4,364    45.0    3,979    39.3    3,221    34.2    2,717    33.0    4,360    29.7 
Home equity loans and lines of credit   616    4.9    677    6.7    1,097    8.5    1,333    10.4    1,580    10.9 
Residential construction   303    3.7    185    2.5    278    1.3    510    1.4    501    1.7 
Other construction and land   1,025    10.1    848    8.0    1,400    9.1    2,936    9.3    3,516    12.4 
Commercial business   503    5.6    599    5.6    603    6.6    308    3.5    336    1.6 
Consumer   58    0.6    205    0.7    407    0.6    285    0.6    265    0.7 
Total  $10,887    100%  $9,305    100%  $9,461    100%  $11,072    100%  $14,251    100%

We compute our allowance either through a specific allowance to individually impaired loans or through a general allowance applied to homogeneous loans by loan type. The above allocation represents the allocation of the allowance by loan type regardless of specific or general calculations. The largest allocation has been made to one-to-four family, commercial real estate, and other construction and land as a result of the elevated risk in those categories of loans.

 

The table below summarizes balances, charge-offs, and specific allowances related to impaired loans as of the dates indicated.

 

As of December 31,  Recorded
Balance
   Unpaid
Principal
Balance
   Partial
Charge-Offs
   Specific
Allowance
   % of Specific
Allowance & Partial
Charge-off
to Unpaid
Principal
Balance
 
   (Dollars in thousands) 
2017                    
Loans without a valuation allowance  $7,200   $9,601   $2,401   $    25.0%
Loans with a valuation allowance   4,434    4,434        322    7.3 
Total  $11,634   $14,035   $2,401   $322    19.4%
                          
2016                         
Loans without a valuation allowance  $9,770   $11,672   $1,902   $    16.3%
Loans with a valuation allowance   4,536    4,536        584    12.9 
Total  $14,306   $16,208   $1,902   $584    15.3%

As indicated in the above table, during the periods presented, we have consistently maintained between 15.0% and 20.0% of impaired loans in a reserve, either through a direct charge-off or in a specific reserve included as part of the allowance for loan losses. The total dollar amount of impaired loans decreased $2.7 million, or 18.7%, to $11.6 million at December 31, 2017 compared to $14.3 million at December 31, 2016. The decrease in impaired loans is attributable to loan payoffs, transfers to REO, charge-offs, and the return of loans to non-impaired status upon changes to borrowers’ status that ultimate collectability of all amounts contractually due is not in doubt.

51
 

Real Estate Owned (“REO”)

 

The tables below summarize the balances and activity in REO as of the dates and for the periods indicated.

  

   As of December 31, 
   2017   2016 
   (Dollars in thousands) 
One- to four-family residential  $288   $1,336 
Commercial real estate   544    722 
Residential construction        
Other construction and land   1,736    2,168 
Total  $2,568   $4,226 
     
   For the Year Ended December 31, 
   2017   2016 
   (Dollars in thousands) 
Balance, beginning of year  $4,226   $5,369 
Additions   958    748 
Disposals   (2,324)   (2,159)
Writedowns   (292)   (655)
Other - acquired       923 
Balance, end of year  $2,568   $4,226 

As indicated in the above table, the balance in REO has decreased by $1.7 million, or 39.2%, to $2.6 million at December 31, 2017 from a balance of $4.2 million at December 31, 2016. We continue to have success in liquidating the properties. We continue to write-down REO as needed and maintain focus on aggressively disposing of our remaining properties.

 

As of December 31, 2017, our REO property with the largest balance of $1.2 million consisted of approximately 10 acres of commercial land with frontage on US Highway 441 in Franklin, North Carolina. The land is located in close proximity to our corporate office. The property was acquired in September 2009 and currently is under contract.

 

Investment Securities

 

The Company has a trading account which is held in a Rabbi Trust and seeks to generate returns to offset the costs of certain deferred compensation agreements.

 

The following table presents the holdings of our trading account as of December 31 for the periods indicated:

 

   2017   2016 
   (Dollars in thousands) 
Exchange traded mutual funds  $6,095   $5,211 
52
 

The remainder of our investment securities portfolio is classified “available-for-sale”. The Company’s held-to-maturity investment portfolio was transferred to available-for-sale during the third quarter of 2016 in order to provide the Company more flexibility managing its investment portfolio. As a result of the transfer, the Company is prohibited from classifying any investment securities as held-to-maturity for two years from the date of the transfer.

 

On April 28, 2017, the Louisiana Office of Financial Institutions closed First NBC Bank and appointed the FDIC as receiver. The Bank owned $0.7 million par value of subordinated debt issued by the holding company of First NBC Bank with an unrealized loss of $0.1 million prior to the impairment. The Company concluded the investment to be other than temporarily impaired. As such, the financial information for the year ended December 31, 2017 includes other than temporary impairment (“OTTI”) of $0.7 million before tax.

 

The Company sold approximately $45.0 million of tax exempt municipal securities in December 2017, realizing a loss of $1.1 million, in response to the Tax Cuts and Jobs Act of 2017. One tax exempt municipal security that had been identified for sale was not sold until January 2018 resulting in OTTI of $0.1 million based on the established fair value.

 

Available-for-sale securities are carried at fair value. The following table shows the amortized cost and fair value for our available-for-sale investment portfolio at the dates indicated.

 

   December 31, 2017   December 31, 2016 
   Amortized   Fair   Amortized   Fair 
(Dollars in thousands)  Cost   Value   Cost   Value 
U.S. Treasury & Government Agencies  $19,519   $19,518   $14,577   $14,621 
Municipal Securities   94,259    94,863    152,208    146,771 
Mortgage-backed Securities - Guaranteed   141,301    139,760    162,379    160,181 
Mortgage-backed Securities - Non Guaranteed   63,279    63,275    58,967    57,756 
Collateralized Loan Obligations   5,555    5,539         
Corporate bonds   18,925    19,291    18,354    18,358 
Mutual funds   629    617    616    604 
   $343,467   $342,863   $407,101   $398,291 

 

Available-for-sale investment securities decreased $55.4 million, or 13.9%, to $342.9 million at December 31, 2017 from $398.3 million at December 31, 2016. We continue to look for opportunities to re-deploy funds from investments securities to higher yielding loans.

 

In prior years, the Company reclassified certain municipal securities from available-for-sale to held-to-maturity. The difference between the book values and fair values at the date of the transfer continued to be reported in a separate component of accumulated other comprehensive income (loss), and were amortized into income over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a premium. Concurrently, the revised book values of the transferred securities (represented by the market value on the date of transfer) were amortizing back to their par values over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a discount. All held-to-maturity securities were reclassified as available-for-sale and carried at fair value during 2016. At the time of the transfer the remaining unamortized amount in AOCI was offset by the remaining discount of the revised book values.

 

As indicated in the table below, the number and dollar amount of securities in an unrealized loss position for more than 12 consecutive months increased between December 31, 2016 and December 31, 2017. We believe that this increase in the number of securities in an unrealized loss position is due entirely to increases in interest rates from the time that many of these securities were originally purchased over the past few years. We regularly review our investment portfolio for OTTI, and other than the two securities disclosed above, concluded that no OTTI existed during the years ended December 31, 2017 and 2016. In addition, we do not intend to sell the remaining securities, nor is it more likely than not that we would be required to sell these securities, before their anticipated recovery of amortized cost.

53
 

                                     
   12 Months or Less   More Than 12 Months   Total 
   Number of
Securities
   Fair
Value
   Unrealized
Losses
   Number of
Securities
   Fair
Value
   Unrealized
Losses
   Number of
Securities
   Fair
Value
   Unrealized
Losses
 
               (Dollar in Thousands)             
2017   81   $106,996   $832    70   $90,095   $1,604    151   $197,091   $2,436 
2016   240   $300,919   $9,188    15   $17,925   $312    255   $318,844   $9,500 

 

We closely monitor the financial condition of the issuers of our municipal securities. As of December 31, 2017, the fair value of our municipal securities portfolio balance consists of approximately 52.6% of general obligation bonds and 47.4% of revenue bonds. As of December 31, 2017 and 2016, all municipal securities were performing. The table below presents the ratings for our municipal securities by either Standard and Poor’s or Moody’s as of the dates indicated.

 

   December 31, 
   2017   2016 
(Dollars in thousands)  Number of
Securities
   Fair
Value
   Number of
Securities
   Fair
Value
 
AA- or better   95   $92,705    171   $145,661 
BBB+           1    501 
BBB           1    367 
BBB-                
Not Rated   3    2,158    1    242 

 

We also closely monitor the level of credit enhancements within our non guaranteed mortgage-backed securities and our collateralized loan obligation portfolios. The table below presents the credit enhancement included in our portfolio as of the dates indicated.

 

   December 31, 
   2017   2016 
(Dollars in thousands)  Fair
Value
   Credit
Enhancement %
   Fair
Value
   Credit
Enhancement %
 
Mortgage-backed Securities - Non Guaranteed                    
Non-agency Mortgage-backed Securities  $28,893    56.5%  $44,569    46.5%
Agency Mortgage-backed Securities   34,382    11.6%   13,187    10.1%
Collateralized Loan Obligations   5,539    20.95%        
54
 

Investment Portfolio Maturities and Yields

The composition and maturities of the available-for-sale investment securities portfolio at December 31, 2017 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.

   Less than one year   More than one year through five years   More than five years through ten years   More than ten years   Total securities 
(Dollars in thousands)  Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
   Amortized
Cost
   Weighted
Average
Yield
 
U.S. Treasury & Government Agencies  $1,000    0.91%  $1,500    1.87%  $1,000    1.86%  $16,019    2.16%  $19,519    2.06%
Municipal Securities - Taxable           386    2.76%   4,756    3.18%   14,752    3.23%   19,894    3.21%
Municipal Securities - Tax exempt                   1,162    4.23%   73,203    4.56%   74,365    4.55%
Mortgage-backed Securities - Guaranteed   1,203    1.88%   14,950    2.10%   21,337    2.46%   103,811    2.23%   141,301    2.25%
Mortgage-backed Securities - Non Guaranteed           2,967    3.68%   10,517    3.91%   49,795    3.00%   63,279    3.18%
Collateralized Loan Obligations                           5,555    3.53%   5,555    3.53%
Corporate bonds           2,852    5.37%   15,053    5.49%   1,020    5.68%   18,925    5.48%
Mutual funds   629    2.11%                           629    2.11%
Total securities available-for-sale  $2,832    1.59%  $22,655    2.71%  $53,825    3.68%  $264,155    3.11%  $343,467    3.16%

(1) - Tax exempt municipal obligations are shown on a tax equivalent basis using a 35% federal tax rate

Other Investments

 

As of December 31, 2017, we held $12.4 million in other investments accounted for at cost which was a decrease of $2.9 million, or 18.8%, compared to $15.2 million at December 31, 2016. The following table summarizes other investments as of the dates indicated:

   December 31, 
   2017   2016 
   (Dollars in thousands) 
FHLB stock  $10.9   $13.7 
Correspondent banks stock   0.7    0.7 
Certificates of deposit with other banks   0.4    0.4 
Investment in Macon Capital Trust I   0.4    0.4 
Total other investments  $12.4   $15.2 

The amount of FHLB stock required to be owned by the Bank is determined by the amount of FHLB advances outstanding. The decrease in our FHLB stock to $10.9 million at December 31, 2017 compared to $13.7 million at December 31, 2016, was the result of lower FHLB borrowings outstanding which decreased from $298.5 million at December 31, 2016 to $223.5 million at December 31, 2017.

 

Bank Owned Life Insurance (“BOLI”)

 

These policies are recorded at fair value based on cash surrender values provided by a third party administrator. The assets of the separate BOLI account are invested in the PIMCO Mortgage-backed Securities Account which is composed primarily of U.S. Treasury and U.S. Government agency sponsored mortgage-backed securities with a rating of Aaa and repurchase agreements with a rating of P-1. The assets in the general account are invested in six insurance carriers with ratings ranging from A+ to A++. The assets of the hybrid account are invested in two different insurance carriers with ratings ranging from A+ to A++. Certain BOLI holdings were reallocated during 2017 from the separate account to the higher yielding hybrid account as allowed by the individual policies.

55
 

The following table summarizes the composition of BOLI as of the dates indicated:

 

   December 31, 
   2017   2016 
   (Dollars in thousands) 
Separate account  $2,504   $12,548 
General account   18,491    17,944 
Hybrid   11,155    855 
Total  $32,150   $31,347 

 

Net Deferred Tax Assets

 

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

 

·future reversals of existing taxable temporary differences;

 

·future taxable income exclusive of reversing temporary differences and carryforwards;

 

·taxable income in prior carryback years; and

 

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

 

We determined there was no tax valuation allowance required as of December 31, 2017, or 2016.

 

Goodwill

Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as business combinations. Goodwill has an indefinite useful life and is evaluated for impairment annually, or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount of the reporting unit exceeds its fair value.

 

The Company had $23.9 million and $2.1 million of goodwill as of December 31, 2017 and 2016, respectively. The following is a summary of changes in the carrying amounts of goodwill:

 

   Year Ended December 31,
   2017  2016
   Dollars in thousands
Balance at beginning of period  $2,065   $711 
Additions:          
Prior acquisitions measurement period adjustments   63     
Goodwill from  current year acquisitions   21,775    1,354 
Balance at end of period  $23,903   $2,065 

 

As of December 31, 2017, the Company had a tax liability of $5.7 million related to the Chattahoochee acquisition which was not otherwise presented in the Company’s January Earnings Release. As a consequence, goodwill increased $5.7 million to $23.9 million, income taxes receivable which is included in other assets decreased $1.4 million, and net tax liabilities which is included in other liabilities increased $4.3 million. Tangible book value per share decreased to $17.90 from $18.72. The Company continues to evaluate potential courses of action with respect to the incurrence of this tax liability.

 

Deposits

 

The following table presents average deposits by category, percentage of total average deposits and average rates for the periods indicated.

   For the Year Ended December 31, 
   2017   2016   2015 
   Average
Balance
   Percent of
Total
Average
Balance
   Weighted
Average
Rate
   Average
Balance
   Percent of
Total
Average
Balance
   Weighted
Average
Rate
   Average
Balance
   Percent of
Total
Average
Balance
   Weighted
Average
Rate
 
   (Dollars in thousands) 
Deposit type:                                             
Savings accounts  $47,754    4.7%   0.11%  $37,470    4.7%   0.13%  $30,033    4.3%   0.11%
Time deposits   333,664    33.0    0.86    291,930    36.3    1.01    294,148    42.3    1.20 
Brokered CDs   29,621    2.9    1.07    4,526    0.6    1.13    3,836    0.6    1.64 
Money market accounts   270,036    26.7    0.38    227,838    28.3    0.34    174,481    25.1    0.32 
Interest-bearing demand accounts   170,366    16.8    0.13    112,805    14.0    0.14    95,856    13.8    0.14 
Noninterest-bearing demand accounts   161,006    15.9        129,219    16.1        96,251    13.9     
Total deposits  $1,012,447    100.0%   0.44%  $803,788    100.0%   0.49%  $694,605    100.0%   0.62%

 

As indicated in the above table, average deposit balances increased approximately $208.7 million, or 26.0%, for the year ended December 31, 2017 compared to 2016. The increase in total average deposits was mainly attributable to $154.2 million and $166.1 million in deposits assumed from Stearns on April 1, 2017, and Chattahoochee on October 1, 2017, respectively, with the deposits included in our average balances from the date of the acquisition through December 31, 2017.

 

During 2017, we continued to focus on developing lower cost transaction accounts. This strategy assisted with reducing our overall cost of deposits to 44 basis points in 2017 compared to 49 basis points in 2016.

56
 

The following table presents details of the applicable interest rates on our certificates of deposit at the dates indicated.

 

   December 31, 
   2017   2016 
   (Dollars in thousands) 
Interest Rate:          
Less than 1.00%  $158,916   $145,562 
1.00% to 2.00%   190,087    109,296 
2.00% to 3.00%   47,432    34,347 
Greater than 3.00%   300     
Total  $396,735   $289,205 

The following table presents contractual maturities for certificates of deposit in amounts equal to or greater than $100 thousand.

 

   December 31, 2017 
   (Dollars in thousands) 
Three months or less  $53,250 
Over three months through six months   32,017 
Over six months through one year   36,002 
Over one year   103,153 
Total  $224,422 

 

The following table presents contractual maturities for certificates of deposit in amounts equal to or greater than $250 thousand.

 

   December 31, 2017 
   (Dollars in thousands) 
Three months or less  $27,088 
Over three months through six months   8,563 
Over six months through one year   9,260 
Over one year   10,847 
Total  $55,758 

 

Borrowings

 

We have traditionally maintained a balance of borrowings from the FHLB of Atlanta using a combination of fixed and variable borrowings. From time to time, we also borrow overnight funds from the FHLB of Atlanta, but had no overnight borrowings outstanding at December 31, 2017. FHLB advances are secured by qualifying one-to-four family permanent and commercial loans, by investment securities, and by a blanket collateral agreement with the FHLB of Atlanta. At December 31, 2017, the Company had unused borrowing capacity with the FHLB of $13.9 million based on collateral pledged at that date. The Company had total additional credit availability with FHLB of $202.2 million as of December 31, 2017 if additional collateral was available and pledged.

57
 

The following tables detail the composition of our FHLB borrowings between fixed and adjustable rate advances as of the dates indicated:

 

  December 31, 2017
  Balance  Type   Rate   Maturity 
  (Dollars in thousands)
$      5,000   Fixed Rate    1.29   1/5/2018 
       20,000   Fixed Rate    1.37%   2/8/2018 
       20,500   Adjustable rate    1.48%   5/24/2018 
       15,000   Adjustable rate    1.60%   3/29/2018 
         5,000   Fixed Rate    1.29%   4/2/2018 
       20,000   Fixed Rate    1.37%   4/16/2018 
       25,000   Fixed Rate    1.36%   5/7/2018 
       50,000   Fixed Rate    1.59%   5/24/2018 
         5,000   Fixed Rate    1.26%   6/5/2018 
         5,000   Fixed Rate    1.39%   6/6/2018 
       10,000   Fixed Rate    0.84%   6/29/2018 
         5,000   Fixed Rate    1.40%   7/2/2018 
         5,000   Fixed Rate    1.38%   7/2/2018 
       10,000   Fixed Rate    1.52%   9/28/2018 
         5,000   Fixed Rate    1.51%   12/31/2018 
         1,000   Fixed Rate    1.62%   5/13/2019 
         2,000   Fixed Rate    1.53%   6/12/2019 
       10,000   Fixed Rate    2.12%   12/30/2019 
         5,000   Fixed Rate    2.12%   12/30/2019 
$     223,500        1.48%     

  

  December 31, 2016
  Balance  Type   Rate   Maturity 
  (Dollars in thousands)
$      5,000   Fixed Rate    0.58%   1/3/2017 
         5,000   Fixed Rate    0.44%   1/3/2017 
       50,000   Fixed Rate    0.49%   1/5/2017 
       30,000   Fixed Rate    0.64%   1/15/2017 
       15,000   Fixed Rate    0.63%   1/17/2017 
       25,000   Fixed Rate    0.64%   1/23/2017 
       20,000   Fixed Rate    0.56%   2/7/2017 
         5,000   Fixed Rate    0.58%   3/28/2017 
       15,000   Adjustable Rate    0.56%   3/29/2017 
         5,000   Fixed Rate    0.80%   3/31/2017 
         5,000   Fixed Rate    0.60%   4/3/2017 
       10,000   Fixed Rate    0.60%   4/6/2017 
         1,000   Fixed Rate    0.87%   5/11/2017 
       20,500   Adjustable Rate    0.73%   5/23/2017 
         5,000   Fixed Rate    0.82%   6/6/2017 
         2,000   Fixed Rate    1.02%   6/12/2017 
         5,000   Fixed Rate    0.76%   6/30/2017 
       25,000   Fixed Rate    0.77%   8/7/2017 
       10,000   Fixed Rate    0.82%   9/28/2017 
       10,000   Fixed Rate    0.77%   12/29/2017 
         5,000   Fixed Rate    0.78%   12/30/2017 
         5,000   Fixed Rate    1.26%   6/5/2018 
       10,000   Fixed Rate    0.84%   6/29/2018 
         5,000   Fixed Rate    1.40%   7/1/2018 
         5,000   Fixed Rate    1.51%   12/31/2018 
$     298,500        0.68%     

58
 

The following table sets forth information concerning balances and interest rates on our FHLB advances as of or for the periods indicated.

 

   As of or for the Year Ended December 31, 
   2017   2016 
   (Dollars in thousands) 
Balance at end of period  $223,500   $298,500 
Average balance during period   236,308    194,662 
Maximum outstanding at any month end   298,500    298,500 
Weighted average interest rate at end of period   1.48%   0.68
Weighted average interest rate during period   1.03%   0.73%

 

FHLB advances decreased $75.0 million, or 25.1%, to $223.5 million at December 31, 2017, from $298.5 million at December 31, 2016. The advances had a weighted average rate of 1.48% as of December 31, 2017 compared to 0.68% at December 31, 2016. The use of FHLB advances as a funding source continues to be a low cost complement to core deposits.

 

To add stability to net interest revenue and manage our exposure to interest rate movement on our adjustable rate FHLB advances, we entered into two FHLB advance interest rate swaps in 2016. The swap contracts involve the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the two year lives of the contracts. The effective interest rates were 0.96% and 1.36% at December 31, 2017 for the adjustable rate advances maturing March 29, 2018 and May 23, 2018, respectively.

 

On September 15, 2017, the Company established a $15.0 million revolving credit loan facility with NexBank SSB. The loan facility, which is secured by Entegra Bank stock, bears interest at LIBOR plus 350 basis points and is intended to be used for general corporate purposes. Unless extended, the loan will mature on September 15, 2020. The Company had drawn $5.0 million on the revolving credit loan facility as of December 31, 2017.

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

 

Junior Subordinated Notes

 

We had $14.4 million in junior subordinated notes outstanding at December 31, 2017 and 2016, payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. To add stability to net interest revenue and manage our exposure to interest rate movement, we entered into an interest rate swap in June 2016. The swap contract involves the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the four year life of the contract. The effective interest rate was 3.76% at December 31, 2017 and 2016. The notes mature on March 30, 2034.

 

Equity

 

Total equity increased $18.2 million, or 13.7%, to $151.3 million at December 31, 2017 from $133.1 million at December 31, 2016. This increase was primarily the result of the issuance of approximately 396,000 shares valued at $9.9 million related to the Chattahoochee acquisition, $2.6 million of net income, $0.9 million of stock-based compensation expense, and a $5.4 million after tax improvement in the market value of investment securities, partially offset by $0.5 million of share repurchases.

59
 

Average Balances and Net Interest Income Analysis

 

Like most financial institutions, net interest income is our primary source of revenue. Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on our interest-earning assets and the rates paid on our interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of the interest-earning assets and interest-bearing liabilities.

 

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

   For the Year Ended December 31, 
   2017   2016   2015 
   Average
Outstanding
Balance
   Interest   Yield/
Rate
   Average
Outstanding
Balance
   Interest   Yield/
Rate
   Average
Outstanding
Balance
   Interest   Yield/
Rate
 
   (Dollars in thousands) 
Interest-earning assets:                                             
Loans, including loans held for sale  $818,431   $38,712    4.73%  $693,743   $32,324    4.65%  $580,106   $27,027    4.66%
Loans, tax exempt (1)   15,945    585    3.67%   13,516    518    3.83%   4,970    214    4.30%
Investments - taxable   291,452    7,025    2.41%   259,036    5,628    2.17%   253,774    5,223    2.06%
Investment tax exempt (1)   118,461    4,795    4.05%   60,685    2,323    3.83%   11,949    574    4.81%
Interest earning deposits   60,823    676    1.11%   41,762    210    0.50%   31,875    75    0.24%
Other investments, at cost   12,766    619    4.85%   10,351    512    4.93%   6,682    299    4.47%