Annual Report (10-k)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2019

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

For the transition period from to

Commission file number 001-10897

Carolina Financial Corporation

(Exact name of registrant as specified in its charter)

Delaware		57-1039673
(State of Incorporation)		(I.R.S. Employer Identification No.)

288 Meeting Street, Charleston, South Carolina		29401
(Address of principal executive offices)		(Zip Code)

(843) 723-7700

(Issuer’s Telephone Number)

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

Title of Each Class		Trading Symbol		Name of each exchange on which registered
Common Stock, $0.01 par value per share		CARO		The Nasdaq Capital Market^®

Securities registered under Section 12(g) of the Exchange 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 x No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes 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, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes x No o

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

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

(Do not check if a smaller reporting company)

Smaller reporting company o

Emerging growth company o

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

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

The aggregate market value of the voting and nonvoting common equity held by non-affiliates of the registrant (computed by reference to the price at which the stock was most recently sold) was $738,763,981 as of the last business day of the registrant’s most recently completed second fiscal quarter.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

Class		Outstanding at February 19, 2020
Common Stock, $.01 par value per share		24,825,817 shares

DOCUMENTS INCORPORATED BY REFERENCE

Some of the information required by Part I and Part III is incorporated by reference from the prospectus and joint proxy statement filed by United Bankshares, Inc. and the registrant on February 13, 2020 pursuant to Rule 424(b) under the Securities Act of 1933 and Rule 14a-6 under the Securities Exchange Act of 1934.

The information required by Part III will be incorporated by reference from either the registrant’s definitive proxy statement which involves the election of directors if such proxy statement is filed not later than 120 days after the end of the fiscal year covered by this report or as an amendment to this report filed not later than the end of such 120-day period.

TABLE OF CONTENTS


		Page
PART 1
Item 1.	Business	3
Item 1A.	Risk Factors	27
Item 1B.	Unresolved Staff Comments	42
Item 2.	Properties	42
Item 3.	Legal Proceedings	42
Item 4.	Mine Safety Disclosures	42

PART II
Item 5.	Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	43
Item 6.	Selected Financial Data	45
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	47
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	79
Item 8.	Financial Statements and Supplementary Data	80
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	160
Item 9A.	Controls and Procedures	160
Item 9B.	Other Information	160

PART III
Item 10.	Directors, Executive Officers and Corporate Governance	161
Item 11.	Executive Compensation	161
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	161
Item 13.	Certain Relationships and Related Transactions, and Director Independence	161
Item 14.	Principal Accounting Fees and Services	161
Item 15.	Exhibits, Financial Statement Schedules	162

EXHIBIT INDEX		163

SIGNATURES		165

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, including information included or incorporated by reference, 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 our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, those described below under “Item 1A- Risk Factors” and the following:

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

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

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

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

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

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

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

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

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

the rate of loan growth in recent or future years;

our ability to attract and retain key personnel;

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

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

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

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

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

	·	increased funding costs due to market illiquidity, increased competition for funding, or increased regulatory requirements with regard to funding;
	·	discontinuation of a published LIBOR rate after 2021 and the impact to our assets and liabilities;

	·	the impact of past and future hurricanes and other natural disasters on our loan portfolio and the economic prospects of our coastal markets;
	·	our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, business and a negative impact on results of operations;

changes in deposit flows;

changes in technology;

changes in monetary and tax policies;

changes in accounting policies, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board ( “PCAOB”) and the Financial Accounting Standards Board (“FASB”);

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

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

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

our liquidity and working capital requirements;

competitive pressures among depository and other financial institutions;

the growth rates of the markets in which we compete;

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

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

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

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

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

management compensation and the methodology for its determination;

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

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

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

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

the matters noted under the heading “Cautionary Statement Regarding Forward-Looking Statements” in the prospectus and joint proxy statement filed by United Bankshares, Inc. and us on February 13, 2020, which is incorporated herein by reference.

If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of this report. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this report. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements.

PART I

Item 1. Business

General Overview

Carolina Financial Corporation is a Delaware corporation that was organized in February 1997 to serve as a bank holding company. In 2017, it applied for, and received, financial holding company status from the Federal Reserve. The Company operates principally through its wholly-owned subsidiary, CresCom Bank, a South Carolina state-chartered bank. CresCom Bank operates Crescent Mortgage Company, Carolina Services Corporation of Charleston (“Carolina Services”), DTFS, Inc., CresCom Leasing, LLC and Western Carolina Holdings, LLC, as wholly-owned subsidiaries of CresCom Bank. Except where the context otherwise requires, the “Company”, “we”, “us” and “our” refer to Carolina Financial Corporation and its consolidated subsidiaries and the “Bank” refers to CresCom Bank.

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

On March 18, 2017, the Company completed its acquisition of Greer Bancshares Incorporated (“Greer”), the holding company for Greer State Bank. The Company issued 1,789,523 shares of its common stock and paid $4.4 million in cash to Greer shareholders. In the transaction, the Company acquired $384.5 million in total assets, loans receivable of $194.6 million and deposits of $311.1 million. In addition, the Company assumed aggregate subordinated debt principal of $11.3 million, which at the date of acquisition had a fair value of $7.5 million.

On November 1, 2017, the Company completed its acquisition of First South Bancorp, Inc., the holding company for First South Bank (“First South”). In the transaction, the Company acquired $1.1 billion in total assets, loans receivable of $759.2 million and deposits of $952.6 million. The Company issued 4,822,540 shares of its common stock to First South shareholders. In addition, the Company assumed aggregate subordinated debt principal of $10.3 million, which at the date of acquisition had a fair value of $8.6 million.

On December 31, 2019, the Company completed its acquisition of Carolina Trust BancShares, Inc., the holding company for Carolina Trust Bank (“Carolina Trust”). In the transaction, the Company acquired $635.0 million of total assets, loans receivable of $481.0 million and deposits of $537.8 million. The Company issued 2,512,543 shares of its common stock to Carolina Trust shareholders. In addition, the Company assumed aggregated subordinated debt principal of $10.0 million, which at the date of acquisition had a fair value of $10.1 million.

As of December 31, 2019, the Company had total assets of $4.7 billion, loans receivable, net of $3.2 billion, total deposits of $3.4 billion, and total stockholders’ equity of $743.4 million.

Our main office is located at 288 Meeting Street, Charleston, South Carolina 29401.

Pending Merger with and into United Bankshares, Inc.

On November 17, 2019, the Company announced the execution of an agreement and plan of merger by and between the Company and United Bankshares, Inc. (“United”), pursuant to which, subject to the terms and conditions set forth therein, the Company will merge with and into United, with United as the surviving corporation of the merger. The agreement provides that at the effective time of the merger, the Bank will merge with and into United Bank, a wholly-owned subsidiary of United Bank, with United Bank as the surviving entity. Pursuant to the merger agreement, each outstanding share of common stock of Carolina Financial will be converted into the right to receive 1.13 shares of United common stock, par value $2.50 per share, resulting in an aggregate transaction value of approximately $1.1 billion.

United’s and United Bank’s existing charters and bylaws will remain in place following the Merger and the Bank Merger.

Pursuant to the merger agreement, as of the effective time of the merger, each outstanding Company stock option, whether vested or unvested as of the date of the merger agreement, shall, at such option holder’s election, (i) vest and convert into an option to acquire United common stock adjusted based on the 1.13 exchange ratio, or (ii) be entitled to receive cash consideration equal to the difference between (a) the option’s exercise price and (b) the volume weighted average trading price over a specified period multiplied by the number of shares of Company common stock subject to such stock option. Also, at the effective time of the merger, each restricted stock grant, restricted stock unit grant or any other award of a share of Carolina Financial common stock subject to vesting, repurchase or other lapse restriction under a Company stock plan (other than a stock option) that is outstanding immediately prior to the effective time of the merger, will fully vest in accordance with the terms of the stock plan and at the election of the holder (i) convert into the right to receive shares of United common stock based on the 1.13 exchange ratio or (ii) convert into cash in an amount equal to the volume weighted average trading price of Company common stock over a specified period multiplied by the shares of Company common stock subject to the stock award. Consummation of the merger is subject to approval of the stockholders of United and Carolina Financial, the receipt of all required regulatory approvals, as well as other customary conditions.

The foregoing description of the merger agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the merger greement, a copy of which is filed as Exhibit 2.1 to this report and is incorporated herein by reference. The merger agreement has been attached as an exhibit to provide investors and security holders with information regarding its terms. It is not intended to provide any other financial information about the Company. The representations, warranties and covenants contained in the merger agreement were made only for purposes of that agreement and as of specific dates, are solely for the benefit of the parties to the merger greement, may be subject to limitations agreed upon by the parties, including being qualified by confidential disclosures made for the purposes of allocating contractual risk between the parties to the merger agreement instead of establishing these matters as facts, and may be subject to standards of materiality applicable to the parties that differ from those applicable to investors. Investors should not rely on the representations, warranties, or covenants or any description thereof as characterizations of the actual state of facts or condition of the Company. Moreover, information concerning the subject matter of the representations, warranties, and covenants may change after the date of the merger agreement, which subsequent information may or may not be fully reflected in public disclosures by the Company.

In connection with entering into the merger agreement, each of the directors of the Company have entered into a support agreement. The support agreements generally require that the stockholder party thereto vote all of his or her shares of the Company’s common stock in favor of the merger and, subject to specified exceptions, prohibit such stockholder from transferring his or her shares of Company common stock prior to the consummation of the merger. The support agreements will terminate upon the earlier of the consummation of the merger and the termination of the merger agreement in accordance with its terms. The foregoing description of the support agreements does not purport to be complete and is qualified in its entirety by reference to the form of support agreement included as Exhibit A to the merger agreement, which is filed as Exhibit 2.1 to this report and incorporated by reference herein.

United has filed a registration statement on Form S-4 with the SEC to register the shares of United’s common stock that will be issued to the Company’s stockholders in connection with the proposed merger. The definitive prospectus of United and joint proxy statement of United and the Company, filed on February 13, 2020 has been provided to the stockholders of each of United and the Company in connection with the proposed merger and is incorporated herein by reference. INVESTORS AND SECURITY HOLDERS ARE URGED TO READ THE REGISTRATION STATEMENT AND THE DEFINITIVE JOINT PROXY STATEMENT-PROSPECTUS (AND ANY OTHER DOCUMENTS FILED WITH THE SEC IN CONNECTION WITH THE PROPOSED MERGER OR INCORPORATED BY REFERENCE INTO THE JOINT PROXY STATEMENT-PROSPECTUS) BECAUSE SUCH DOCUMENTS CONTAIN IMPORTANT INFORMATION REGARDING THE PROPOSED MERGER. Investors and security holders may obtain free copies of these documents and other documents filed with the SEC on its website at www.sec.gov. Investors and security holders may also obtain free copies of the documents filed with the SEC by United on its website at www.ubsi-wv.com and by the Company on its website at www.haveanicebank.com.

This report does not constitute an offer to sell or the solicitation of an offer to buy any securities or a solicitation of any vote or approval. Before making any voting or investment decision, investors and security holders of United and the Company are urged to read carefully the entire registration statement and definitive joint proxy statement-prospectus, including any amendments thereto, because these documents contain important information about the proposed merger. Free copies of these documents may be obtained as described above.

United, the Company and certain of their directors and executive officers may be deemed participants in the solicitation of proxies from the stockholders of each of United and the Company in connection with the proposed merger. Information regarding the directors and executive officers of United and the Company and other persons who may be deemed participants in the solicitation of the stockholders of United or of the Company in connection with the proposed merger is included in the definitive joint proxy statement-prospectus for each of United’s and the Company’s special meeting of stockholders, which has been filed by United and the Company with the SEC. Information about the directors and officers of United and their ownership of United common stock can also be found in United’s definitive proxy statement in connection with its 2018 annual meeting of stockholders, as filed with the SEC on March 29, 2019, and other documents subsequently filed by United with the SEC. Information about the directors and officers of the Company and their ownership of the Company’s common stock can also be found in this Annual Report on Form 10-K, and other documents subsequently filed by the Company with the SEC. Additional information regarding the interests of such participants is included in the definitive prospectus and joint proxy statement and other relevant documents regarding the proposed merger filed with the SEC.

Available Information

We provide our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act on our website at www.haveanicebank.com under the “Investor Relations” section. These filings are made accessible as soon as reasonably practicable after they have been filed electronically with the Securities and Exchange Commission (the “SEC”). These filings are also accessible on the SEC’s website at www.sec.gov. In addition, we make available under the Investor Relations section on our website the following, among other things, (i) Code of Ethics and Whistleblower Policy and (ii) the charters of the Audit, Corporate Governance and Nominating and Compensation and Benefits Committees of our board of directors. These materials are available to the general public on our website free of charge. Printed copies of these materials are also available free of charge to shareholders who request them in writing. Please address your request to: Investor Relations, Attn: William A. Gehman III, Carolina Financial Corporation, 288 Meeting Street, Charleston, South Carolina 29401. Statements of beneficial ownership of equity securities filed by directors, officers, and 10% or greater stockholders under Section 16 of the Exchange Act are also available through our website. The information on our website is not incorporated by reference into this report.

Our Market Area

Our primary market areas are the Coastal, Midlands, and Upstate regions of South Carolina, including the Charleston (Charleston, Dorchester and Berkeley Counties), Myrtle Beach (Horry and Georgetown Counties), Columbia (Richland and Lexington Counties), and the Upstate (Greenville and Spartanburg Counties) market areas. Our primary market areas in North Carolina include Wilmington (New Hanover County), Raleigh-Durham (Durham and Wake Counties), Charlotte-Concord-Gastonia (NC and SC) and the southeastern coastal region of North Carolina (Bladen, Brunswick, Columbus, Cumberland, Duplin and Robeson Counties).

The following table presents, for each of our above-described primary market and reflecting the pro-forma franchise with acquired Carolina Trust branches, the number of branches of CresCom Bank, the approximate amount of deposits in the market areas as of June 30, 2019 and the approximate deposit market share in the market area at June 30, 2019 (the latest date for which such data is available).

	Number of		Deposits		Market
Market Name	Branches		(in millions)		Share
Charleston		8	$	708		4.1	%
Myrtle Beach		8	$	436		4.7	%
Midlands South Carolina		3	$	137		1.6	%
Upstate South Carolina		5	$	315		2.4	%
Inland North Carolina		9	$	320		4.6	%
Coastal North Carolina		4	$	145		6.4	%
Wilmington		3	$	53		0.6	%
Charlotte		12	$	519		3.6	%
Raleigh/Durham		2	$	68		0.1	%
Eastern NC		19	$	627		4.8	%

Our markets in or near Charleston, South Carolina are heavily influenced by the diverse economic mix of the Charleston region. The region is home to the Port of Charleston, one of the busiest container ports along the Southeast and Gulf Coasts, as well as a number of national and international manufacturers, including Boeing South Carolina and Robert Bosch LLC. The region also benefits from a thriving tourism industry. In addition, a number of academic institutions are located within the region, including the Medical University of South Carolina, The Citadel, The College of Charleston, Charleston Southern University, Trident Technical College and The Charleston School of Law. Charleston also hosts military installations for the U.S. Navy, Marine Corps, U.S. Air Force, U.S. Army and U.S. Coast Guard. Data obtained through SNL Financial LC projects population growth in the Charleston-North Charleston MSA of 7.65% from 2020 to 2025.

The Myrtle Beach area, also known as the Grand Strand, is a 60-mile stretch of beaches extending south from the South Carolina/North Carolina state line to Pawley’s Island and is consistently ranked as one of the top vacation destinations in the country. According to data published by the Myrtle Beach Area Chamber of Commerce, Myrtle Beach hosted an estimated over 19 million visitors in 2019 with the economy of the region dominated by the tourism and retail industries. The Myrtle Beach-Conway-North Myrtle Beach MSA is also home to Coastal Carolina University in Conway and Webster University in Myrtle Beach. Data obtained through SNL Financial LC projects population growth in the Myrtle Beach-Conway-North Myrtle Beach MSA of 9.2% from 2020 to 2025.

The Midlands market includes branches in the Columbia, South Carolina market. Columbia, the state capital of South Carolina, is located within Richland County in the center of the state between the Upstate region and the coastal cities of Charleston and Myrtle Beach. Columbia’s central location has contributed greatly to its commercial appeal and growth, and the city benefits from a diverse economy composed of advanced manufacturing, healthcare, technology, shared services, logistics, and energy. The largest employers in the Columbia market area include the U.S. Army’s Fort Jackson, the University of South Carolina, Prisma Health (formerly Palmetto Health Alliance), Blue Cross Blue Shield, and Lexington Medical Center. Data obtained through SNL Financial LC projects population growth in the Columbia MSA of 5.5% from 2020 to 2025.

The Upstate market includes banking locations in the Greenville-Spartanburg market area. Major industries in the Upstate include the automobile industry, which is concentrated primarily along the corridor between Greenville and Spartanburg around the BMW manufacturing facility in Greer, South Carolina. The Greenville Health System and Bon Secours St. Francis Health System represent the healthcare and pharmaceuticals industry in the area. The Upstate is also home to significant private sector and university-based research including research and development facilities for Michelin, Fuji and General Electric and research centers to support the automotive, life sciences, plastics and photonics industries. The Upstate also benefits from being an academic center and is home to collegiate and university education facilities such as Clemson University, Furman University, Presbyterian College, University of South Carolina-Upstate, Anderson University, Lander University, Bob Jones University, Wofford College and Converse College, among others. Data obtained through SNL Financial LC projects population growth in the Greenville-Anderson MSA of 6.1% from 2020 to 2025.

The Raleigh/Durham area is among the most visited of the United States. The largest research park in the United States is situated between Durham and Raleigh and is home to more than 250 companies including IBM, GlaxoSmithKline and Cisco Systems. The area is also home to university and research facilities of Duke University and the University of North Carolina – Chapel Hill. Data obtained through SNL Financial LC projects population growth in the Raleigh-Cary and Durham-Chapel Hill MSAs of 7.7% and 6.2%, respectively, from 2020 to 2025.

Our Wilmington and other markets in southeastern North Carolina are contiguous to South Carolina and the Grand Strand. Wilmington has a diversified economy and is a major resort area and a center for light manufacturing. The city also serves as the retail and medical center for the region. Companies in the Wilmington area produce fiber optic cables for the communications industry, aircraft engine parts, pharmaceuticals, nuclear fuel components and various textile products. According to data published by the Wilmington Chamber of Commerce, major employers in the area include General Electric, PPD, Inc., and Corning, Inc. The area also benefits from the presence of the University of North Carolina-Wilmington, which is also a major employer for the market. Data obtained through SNL Financial LC projects population growth in the Wilmington MSA of 7.1% from 2020 to 2025.

The Charlotte-Concord-Gastonia (NC and SC) market includes branches acquired in the Carolina Trust acquisition that closed on December 31, 2019. The acquisition of Carolina Trust expanded the Company’s footprint to the Charlotte-Concord-Gastonia, NC-SC MSA with 11 banking locations and a loan production office, which complemented the Company’s de novo branch in the Charlotte market. Charlotte is one of the 25 largest cities in the U.S. and is the largest city in North Carolina. Charlotte is home to more than 10 Fortune 1000 companies including Bank of America, Wells Fargo, Belk, Shutterfly, Duke Energy, Lance and Nucor. Data obtained through SNL Financial LC projects population growth in the Charlotte-Concord-Gastonia MSA of 7.0% from 2020 to 2025.

Our markets have experienced steady economic and population growth over the past 10 years, and we expect that the areas, as well as the business and tourism industries needed to support it, will continue to grow.

Competition

The banking business is highly competitive, and we experience competition in our market areas from many other financial institutions. Competition among financial institutions is based on interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services rendered, the convenience of banking facilities, and, in the case of loans to commercial borrowers, relative lending limits. We compete with commercial banks, credit unions, savings institutions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices in our market areas and elsewhere.

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions, such as Bank of America, Wells Fargo, PNC and Truist. These institutions offer some services, including extensive and established branch networks, that we do not provide. In addition, many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks.

Lending Activities

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

Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer lending limits, with approval processes for larger loans, documentation examination, and follow-up procedures for any exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds the maximum senior officer’s lending authority, the loan request will be considered by the management loan committee, or MLC, which is comprised of five members, all of whom are part of the senior management team of the Bank. The MLC meets weekly to approve loans with total loan commitment relationships generally exceeding $2.5 million. The loan authority of the MLC is equal to two-thirds of the legal lending limit of the Bank which is equivalent to the in-house loan limit. Total credit exposure above the in-house limit requires approval by the majority of the board of directors. We do not make any loans to any director, executive officer of the Bank, or the related interests of each, unless the loan is approved by the full Board of Directors of the Bank and is on terms not more favorable than would be available to a person not affiliated with the Bank.

Our lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. This legal lending limit will increase or decrease as the Bank’s level of capital increases or decreases. Based upon the capitalization of the Bank at December 31, 2019, the maximum amount we could lend to one borrower was $89.6 million. However, our internal lending limit without board of director approval at December 31, 2019 was $59.7 million. The board of directors will adjust the internal lending limit as deemed necessary to continue to mitigate risk and serve the Bank’s clients. We are able to sell participations in our larger loans to other financial institutions, which allow us to manage the risk involved in these loans and to meet the lending needs of our clients requiring extensions of credit in excess of these limits.

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

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

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

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

Equipment loans typically will be made for a term of 10 years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Generally, we limit the loan-to-value ratio on these loans to 75% of cost. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange will generally be handled through a correspondent bank as agent for the Bank.

The Company’s primary markets are generally concentrated in real estate lending. However, in order to diversify our lending portfolio, the Company purchases nationally syndicated commercial and industrial loans. These loans typically have terms of seven years and are generally tied to a floating rate index such as LIBOR or prime. To effectively manage this line of business, the Company has an experienced senior lending executive who leads a team with relevant experience to manage this area of this segment of the loan portfolio. In addition, the Company engaged a consulting firm that specializes in syndicated loans to assist in monitoring performance analytics. Syndicated loans are grouped within commercial business loans.

The Bank originates leases, primarily on equipment utilized for business purposes with terms that generally range from 12 to 60 months and include options to purchase the leased equipment at the end of the lease. Most leases provide 100% of the cost of the equipment and are secured by the leased equipment. The Company requires the leased equipment to be insured and that we be listed as a loss payee and named as an additional insured on the insurance policy. We manage credit risk associated with our lease financing loan class based upon the dollar amount of the lease and the level of credit risk. We follow a formal review process that entails analysis of the following factors: equipment value/residual value, exposure levels, jurisdiction risk, industry risk, guarantor requirements, and regulatory compliance. As of December 31, 2019 and December 31, 2018, there were approximately $16.8 million and $23.1 million in lease receivables outstanding. Lease receivables are grouped within commercial business loans.

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

Mortgage Operations

Mortgage Activities and Servicing. Our correspondent/wholesale mortgage banking operations are conducted through our mortgage origination subsidiary, Crescent Mortgage Company. Mortgage activities involve the purchase of mortgage loans and table funded originations for the purpose of generating gains on sales of loans and fee income on the origination of loans and is included in mortgage banking income in the accompanying consolidated statements of operations. While the Company originates residential one-to-four family loans that are held in its loan portfolio, the majority of new loans are generally sold pursuant to third-party market guidelines through Crescent Mortgage Company. Generally, residential mortgage loans are sold and, depending on the pricing in the marketplace, servicing rights are either sold or retained. The level of loan sale activity and its contribution to the Company’s profitability depends on maintaining a sufficient volume of loan originations and margin. Changes in the level of interest rates and the local economy affect the volume of loans originated by the Company and the amount of loan sales and loan fees earned.

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

Deposit Products

We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. At December 31, 2019, deposits totaled $3.4 billion, an increase from deposits of $2.7 billion at December 31, 2018. Excluding the impact of deposits acquired from Carolina Trust, deposits increased $152.4 million since December 31, 2018. The increase in deposits since December 31, 2018 relates to continued efforts to fund our balance sheet growth with core deposits through business development.

Emerging Growth Company

On December 31, 2018, our status as an “emerging growth company”, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), terminated because the market value of our common stock held by non-affiliates exceeded $700 million on June 30, 2018. As an “emerging growth company,” we took advantage of some reduced disclosure and other requirements that were otherwise applicable generally to public companies. With the filing of the 2018 Form 10-K, we began providing the information required from “large accelerated filers” as defined in Rule 12b-2 under the Exchange Act in periodic reports required under the Exchange Act. As a result, the information that we provided to our stockholders prior to the 2018 Form 10-K may be different from the information provided by other public reporting companies.

Employees

As of February 20, 2020, we had 880 total employees, including 836 full-time employees.

SUPERVISION AND REGULATION

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws and regulations generally are intended to protect consumers and depositors and not stockholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic control or new federal or state legislation may have on our business and earnings in the future.

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of those laws and regulations on our operations. It is intended only to briefly summarize some material provisions.

Recent Legislative and Regulatory Initiatives

Banking statutes, regulations and policies are continually under review by Congress, state legislatures and federal and state regulatory agencies. In addition to laws and regulations, state and federal bank regulatory agencies may issue policy statements, interpretive letters and similar written guidance applicable to the Company and its subsidiaries. Any change in the statutes, regulations and regulatory policies applicable to us, including changes in their interpretation or implementation, could have a material effect on our business and organization.

Both the scope of the laws and regulations and the intensity of supervision to which we are subject have increased in recent years in response to the financial crisis, as well as other factors such as technological and market changes. Regulatory enforcement and fines have also increased across the banking and financial services sector. Many of these changes have occurred as a result of the Dodd-Frank Act and its implementing regulations, most of which are now in place. The Company expects that its business will remain subject to extensive regulation and supervision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act which was signed into law in 2010 (the “Dodd-Frank Act”), among other things, changes the oversight and supervision of financial institutions, includes new minimum capital requirements, creates a new federal agency to regulate consumer financial products and services and implements changes to corporate governance and compensation practices. The Dodd-Frank Act is focused in large part on the financial services industry, and contains a number of provisions that will affect us, including:

Minimum Leverage and Risk-Based Capital Requirements. Under the Dodd-Frank Act, the Federal banking agencies are required to establish minimum leverage and risk-based capital requirements on a consolidated basis for all insured depository institutions and bank holding companies, which can be no less than the currently applicable leverage and risk-based capital requirements for depository institutions. As a result, the Bank will be subject to at least the same capital requirements and must include the same components in regulatory capital.

Deposit Insurance Modifications. The Dodd-Frank Act modified the FDIC’s assessment base upon which deposit insurance premiums are calculated. The new assessment base equals our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The Dodd-Frank Act also permanently raised the standard maximum insurance amount to $250,000.

Creation of New Governmental Authorities. The Dodd-Frank Act created various new governmental authorities such as the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (the “CFPB”), an independent regulatory authority housed within the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The CFPB has broad authority to regulate the offering and provision of consumer financial products. The CFPB officially came into being on July 21, 2011, and rulemaking authority for a range of consumer financial protection laws (such as the Truth in Lending Act, the Electronic Funds Transfer Act and the Real Estate Settlement Procedures Act, among others) transferred from the Federal Reserve and other federal regulators to the CFPB on that date. The Dodd-Frank Act gives the CFPB authority to supervise and examine depository institutions with more than $10 billion in assets for compliance with these federal consumer laws. The authority to supervise and examine depository institutions with $10 billion or less in assets for compliance with federal consumer laws will remain largely with those institutions’ primary regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. The CFPB also has supervisory and examination authority over certain nonbank institutions that offer consumer financial products. The Dodd-Frank Act identifies a number of covered nonbank institutions, and also authorizes the CFPB to identify additional institutions that will be subject to its jurisdiction. Accordingly, the CFPB may participate in examinations of the Bank, which currently has assets of less than $10 billion, and could supervise and examine our other direct or indirect subsidiaries that offer consumer financial products or services. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB, and state attorneys general are permitted to enforce consumer protection rules adopted by the CFPB against certain institutions.

The Dodd-Frank Act also authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” On January 10, 2013, the CFPB published final rules to, among other things, specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. Since then the CFPB made certain modifications to these rules. The rules extend the requirement that creditors verify and document a borrower’s “income and assets” to include all “information” that creditors rely on in determining repayment ability. The rules also provide further examples of third-party documents that may be relied on for such verification, such as government records and check-cashing or funds-transfer service receipts. The rules took effect January 10, 2014. The rules also define “qualified mortgages,” imposing both underwriting standards - for example, a borrower’s debt-to-income ratio may not exceed 43% - and limits on the terms of their loans. Points and fees are subject to a relatively stringent cap, and the terms include a wide array of payments that may be made in the course of closing a loan. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.

Executive Compensation and Corporate Governance Requirements. The Dodd-Frank Act requires public companies to include, at least once every three years, a separate non-binding “say on pay” vote in their proxy statement by which stockholders may vote on the compensation of the company’s named executive officers. In addition, if such companies are involved in a merger, acquisition, or consolidation, or if they propose to sell or dispose of all or substantially all of their assets, stockholders have a right to an advisory vote on any golden parachute arrangements in connection with such transaction (frequently referred to as “say-on-golden parachute” vote). Other provisions of the Dodd-Frank Act may impact our corporate governance. For instance, the Dodd-Frank Act requires the SEC to adopt rules:

	·	prohibiting the listing of any equity security of a company that does not have an independent compensation committee; and
	·	requiring all exchange-traded companies to adopt claw-back policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements.

The Dodd-Frank Act also authorizes the SEC to issue rules allowing stockholders to include their own nominations for directors in a company’s proxy solicitation materials. Many provisions of the Dodd-Frank Act require the adoption of additional rules to implement the changes. In addition, the Dodd-Frank Act mandates multiple studies that could result in additional legislative action. Governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.

Regulatory Capital Requirements

Regulatory capital rules released by the federal bank regulatory agencies in July 2013 and fully-phased in as of January 1, 2019, referred to as Basel III, impose higher minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. We collectively refer to these organizations herein as “covered” banking organizations. In certain respects, the rules impose more stringent requirements on “advanced approaches” banking organizations—those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime.

Specifically, we are required to maintain the following minimum capital levels:

	·	a Common Equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%;
	·	a Tier 1 risk-based capital ratio of 6%;
	·	a total risk-based capital ratio of 8%; and
	·	a leverage ratio of 4%.

Under Basel III, Tier 1 capital is redefined to include two components: CET1 capital and additional Tier 1 capital. The new and highest form of capital, CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily comprised of non-cumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities. The rules permit bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital, but not in CET1 capital, subject to certain restrictions. Tier 2 capital generally includes the allowance for loan losses up to 1.25% of risk-weighted assets, qualifying preferred stock, subordinated debt and qualifying Tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial institution. Cumulative perpetual preferred stock is included only in Tier 2 capital. Accumulated other comprehensive income (“AOCI”) is presumptively included in CET1 capital and often would operate to reduce this category of capital. The rules provided for a one-time opportunity at the end of the first quarter of 2015 for covered banking organization to opt-out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (CET1 capital, Tier 1 capital and total capital). The capital conservation buffer was phased in incrementally over time, becoming fully effective on January 1, 2019, and consists of an additional amount of common equity equal to 2.5% of risk-based assets.

On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the upcoming implementation of a new credit impairment model, the Current Expected Credit Loss, or CECL model, and accounting standard under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) reduce the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. We expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginning of the first quarter of 2020, the first reporting period in which the new standard is effective.

In November 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 8%, off-balance-sheet exposures of 25% or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed “qualifying community banking organizations” and are eligible to opt into the “community bank leverage ratio framework.” A qualifying community banking organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater-than-9% leverage ratio requirement, is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We do not have any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.

Volcker Rule

Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds.” Proprietary trading includes the purchase or sale of principal of any security, derivative, commodity future, or option on any such instrument for the purpose of benefitting from short-term price movements or realizing short-term profits. In December 2013, our primary federal regulators, the Federal Reserve and the FDIC, together with other federal banking agencies and the SEC and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule.

Exceptions apply, however. Trading in U.S. Treasuries, obligations or other instruments issued by a government sponsored enterprise, state or municipal obligations, or obligations of the FDIC is permitted. A banking entity also may trade for the purpose of managing its liquidity, provided that it has a bona fide liquidity management plan. Trading activities as agent, broker or custodian; through a deferred compensation or pension plan; as trustee or fiduciary on behalf of customers; in order to satisfy a debt previously contracted; or in repurchase and securities lending agreements are permitted. Additionally, the Volcker Rule permits banking entities to engage in trading that takes the form of risk-mitigating hedging activities.

The covered funds that a banking entity may not sponsor or hold an ownership interest in are, with certain exceptions, funds that are exempt from registration under the Investment Company Act of 1940 because they either have 100 or fewer investors or are owned exclusively by “qualified investors” (generally, high net worth individuals or entities). Wholly-owned subsidiaries, joint ventures and acquisition vehicles, foreign pension or retirement funds, insurance company separate accounts (including bank-owned life insurance), public welfare investment funds, and entities formed by the FDIC for the purpose of disposing of assets are not covered funds, and a bank may invest in them. Most securitizations also are not treated as covered funds.

As issued on December 10, 2013, the regulation treated collateralized debt obligations backed by trust preferred securities as covered funds and accordingly subject to divestiture. In an interim final rule issued on January 14, 2014, the agencies exempted collateralized debt obligations, or CDOs, issued before May 19, 2010, that were backed by trust preferred securities issued before the same date by a bank with total consolidated assets of less than $15 billion or by a mutual holding company, and that the bank holding the CDO interest had purchased before December 10, 2013, from the Volcker Rule prohibition. This exemption does not extend to CDOs backed by trust-preferred securities issued by an insurance company.

Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law. The Tax Act includes a number of provisions that impact us, including the following:

Tax Rate. The Tax Act replaces the graduated corporate tax rates applicable under prior law, which imposed a maximum tax rate of 35%, with a reduced 21% flat tax rate. Although the reduced tax rate generally should be favorable to us by resulting in increased earnings and capital, it will decrease the value of our existing deferred tax assets. Generally accepted accounting principles (“GAAP”) require that the impact of the provisions of the Tax Act be accounted for in the period of enactment. Accordingly, the Company’s net income for the year ended December 31, 2017 was reduced by approximately $239,000, primarily due to a lower valuation of deferred income taxes. See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation – Results of Operations – Income Tax Expense.”

Employee Compensation. A “publicly held corporation” is not permitted to deduct compensation in excess of $1 million per year paid to certain employees. The Tax Act eliminates certain exceptions to the $1 million limit applicable under prior to law related to performance-based compensation, such as equity grants and cash bonuses that are paid only on the attainment of performance goals. As a result, our ability to deduct certain compensation that may be paid to our most highly compensated employees will now be limited.

Business Asset Expensing. The Tax Act allows taxpayers immediately to expense the entire cost (instead of only 50%, as under prior law) of certain depreciable tangible property and real property improvements acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain property). This 100% “bonus” depreciation is phased out proportionately for property placed in service on or after January 1, 2023 and before January 1, 2027 (with an additional year for certain property).

Interest Expense. The Tax Act limits a taxpayer’s annual deduction of business interest expense to the sum of (i) business interest income and (ii) 30% of “adjusted taxable income,” defined as a business’s taxable income without taking into account business interest income or expense, net operating losses, and, for 2018 through 2021, depreciation, amortization and depletion. Because we generate significant amounts of net interest income, we do not expect to be impacted by this limitation.

Proposed Legislation and Regulatory Action

From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material effect on the business of the Company.

On May 24, 2018, President Trump signed into law the “Economic Growth, Regulatory Relief and Consumer Protection Act” (the “Regulatory Relief Act”), which amends parts of the Dodd-Frank Act, as well as other laws that involve regulation of the financial industry. While the Regulatory Relief Act keeps in place fundamental aspects of the Dodd-Frank Act’s regulatory framework, it does change the regulatory framework for depository institutions with assets under $10 billion, such as the Bank, and for large depository institutions with assets over $50 billion. The legislation includes a number of provisions which are favorable to bank holding companies with total consolidated assets of less than $10 billion, such as the Company, and also makes changes to consumer mortgage and credit reporting regulations and to the authorities of the agencies that regulate the financial industry. A number of the provisions included in the Regulatory Relief Act require the federal banking agencies to either promulgate regulations or amend existing regulations, and it will likely take some time for these agencies to implement the necessary changes.

The following is a brief summary of select provisions of the Regulatory Relief Act.

Modified Process for Designating Systemically Important Financial Institutions. The Regulatory Relief Act changes which bank holding companies will be designated as a systemically important financial institution (“SIFI”). Prior to passage of the Regulatory Relief Act, all bank holding companies with assets exceeding $50 billion were automatically designated as SIFIs and were subject to the enhanced prudential standards (“EPS”) of the Dodd-Frank Act, which required these bank holding companies to undergo special stress tests, develop resolution plans, and maintain certain levels of liquidity and financial capacity to absorb losses. The Regulatory Relief Act raised the $50 billion SIFI threshold to $250 billion, but staggered the application of this change for certain institutions, based on size. Upon enactment, bank holding companies with total consolidated assets of less than $100 billion are no longer subject to the EPS of the Dodd-Frank Act. Bank holding companies with total consolidated assets of more than $100 billion but less than $250 billion will no longer be subject to such requirements, beginning 18 months after the date of enactment. Because the Regulatory Relief Act does not amend the regulations that the federal banking agencies have promulgated to implement the EPS, it will likely take some time for these agencies to amend their regulations to account for the new thresholds included in the Regulatory Relief Act.

Many of the changes in the Regulatory Relief Act amend provisions of Dodd-Frank Act that apply at the bank holding company level, but not to subsidiary national banks or other insured depository institutions. The Office of the Comptroller of the Currency, or the OCC, and the FDIC have adopted their own counterparts to some EPS for the bank subsidiaries that they regulate, including recovery and resolution planning. The OCC and the FDIC will need to address whether they intend to take similar measures under their regulations and guidance to align asset thresholds with what is reflected in the Regulatory Relief Act.

Provisions that are Favorable to Regional Banks. There are a number of provisions in the Regulatory Relief Act that will have a favorable impact on community banks such as the Bank. These are briefly referenced below.

Elimination of Company-Run Stress Tests. The Regulatory Relief Act exempts all banking organizations with less than $250 billion in total consolidated assets from the current requirement to conduct company-run stress tests.

Increase in Asset Threshold for Requirement to Establish a Risk Committee. The Regulatory Relief Act raises the asset threshold for the requirement that a publicly-traded bank holding company establish a risk committee from $10 billion to $50 billion or more in total consolidated assets.

Short Form Call Reports. The Regulatory Relief Act requires the federal banking agencies to promulgate regulations allowing an insured depository institution with less than $5 billion in total consolidated assets (and that satisfies such other criteria as determined to be appropriate by the agencies) to submit a short-form call report for its first and third quarters of a calendar year.

Consumer Protection Enhancements. The Regulatory Relief Act includes various provisions to address consumer protection challenges facing the credit reporting industry and borrowers in certain credit markets, specifically markets including active duty service members, veterans, and student loan borrowers. The Regulatory Relief Act subjects credit reporting agencies to additional requirements, including requirements to generally provide fraud alerts for consumer files for at least one year and to allow consumers to place security freezes on their credit reports. The Regulatory Relief Act also allows consumers to request that information related to a default on a qualified private student loan be removed from a credit report if the borrower satisfies the requirements of a loan rehabilitation program offered by a private lender. The Regulatory Relief Act prohibits lenders from declaring automatic default in the case of death or bankruptcy of the co-signer of a student loan and requires lenders to release cosigners from obligations related to a student loan in the event of the death of the student borrower. In addition, credit reporting agencies will be required to exclude certain medical debt from veterans’ credit reports.

Carolina Financial Corporation

The Company owns 100% of the outstanding capital stock of the Bank, and therefore is required to be and is registered as a bank holding company under the federal Bank Holding Company Act of 1956 (the “BHCA”). As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Federal Reserve under the BHCA and its regulations promulgated thereunder. Moreover, as a bank holding company of a bank located in South Carolina, the Company also is subject to the South Carolina Banking and Branching Efficiency Act.

Permitted Activities. Under the BHCA, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

	·	banking or managing or controlling banks;
	·	furnishing services to or performing services for our subsidiaries; and
	·	any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

	·	factoring accounts receivable;
	·	making, acquiring, brokering or servicing loans and usual related activities;
	·	leasing personal or real property;
	·	operating a non-bank depository institution, such as a savings association;
	·	trust company functions;
	·	financial and investment advisory activities;
	·	conducting discount securities brokerage activities;
	·	underwriting and dealing in government obligations and money market instruments;
	·	providing specified management consulting and counseling activities;
	·	performing selected data processing services and support services;
	·	acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
	·	performing selected insurance underwriting activities.

A bank holding company that meets specified conditions, including that its depository institutions subsidiaries are “well capitalized” and “well managed,” can opt to become a “financial holding company.” On June 20, 2017, an election submitted by the Company to become a financial holding company was declared effective by the Federal Reserve Bank of Richmond. As a financial holding company, we are now permitted to engage in a broader array of activities that are financial in nature or incidental or complimentary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

Change in Control. Two statutes, the BHCA and the Change in Bank Control Act (the “CBCA”), together with regulations promulgated under them, require some form of regulatory review before any company may acquire “control” of a bank or a bank holding company. Under the BHCA, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the management or policies of a bank or bank holding company. In guidance issued in 2008, the Federal Reserve has stated that it would not expect control to exist if a person acquires, in aggregate, less than 33% of the total equity of a bank or bank holding company (voting and nonvoting equity), provided such person’s ownership does not include 15% or more of any class of voting securities. Prior Federal Reserve approval is necessary before an entity acquires sufficient control to become a bank holding company. Natural persons, certain non-business trusts, and other entities are not treated as companies (or bank holding companies), and their acquisitions are not subject to review under the BHCA. State laws generally, including South Carolina law, require state approval before an acquirer may become the holding company of a state bank.

Under the CBCA, a person or company is required to file a notice with the Federal Reserve if it will, as a result of the transaction, own or control 10% or more of any class of voting securities or direct the management or policies of a bank or bank holding company and either if the bank or bank holding company has registered securities or if the acquirer would be the largest holder of that class of voting securities after the acquisition. For a change in control at the holding company level, both the Federal Reserve and the subsidiary bank’s primary federal regulator must approve the change in control; at the bank level, only the bank’s primary federal regulator is involved. Transactions subject to the BHCA are exempt from CBCA requirements. For state banks, state laws, including that of South Carolina, typically require approval by the state bank regulator as well.

Source of Strength. There are a number of obligations and restrictions imposed by law and regulatory policy on bank holding companies with regard to their depository institution subsidiaries that are designed to minimize potential loss to depositors and to the FDIC insurance funds in the event that the depository institution becomes in danger of defaulting under its obligations to repay deposits. In accordance with Federal Reserve policy, the Company is required to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which it might not otherwise do so. Under the Federal Deposit Insurance Corporate Improvement Act of 1991, or FDICIA, to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” within 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 (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of a bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.

In addition, the “cross guarantee” provisions of the Federal Deposit Insurance Act, (“FDIA”), require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC 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’s claim for damages is superior to claims of stockholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholder. This provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the assets of the Bank.

Further, any capital loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

Capital Requirements. The Federal Reserve imposes certain capital requirements on the bank holding company under the BHCA, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described below under “CresCom Bank.” Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

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

In addition, since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it, which is also subject to regulatory restrictions as described below in “CresCom Bank – Dividends.”

South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions (the “SCBFI”). We are not required to obtain the approval of the SCBFI prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must obtain approval from the SCBFI prior to engaging in the acquisition of branches, a South Carolina state chartered bank, or another South Carolina bank holding company.

CresCom Bank

The Bank’s primary federal regulator is the FDIC. In addition, the Bank is regulated and examined by the SCBFI. Deposits in the Bank are insured by the FDIC up to a maximum amount of $250,000 per depositor, per ownership category, pursuant to the provisions of the Dodd-Frank Act.

The SCBFI and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

	·	security devices and procedures;
	·	adequacy of capitalization and loss reserves;
	·	loans;
	·	investments;
	·	borrowings;
	·	deposits;
	·	mergers;
	·	issuances of securities;
	·	payment of dividends;
	·	interest rates payable on deposits;
	·	interest rates or fees chargeable on loans;
	·	establishment of branches;
	·	corporate reorganizations;
	·	maintenance of books and records; and
	·	adequacy of staff training to carry on safe lending and deposit gathering practices.

These agencies, and the federal and state laws applicable to the Bank’s operations, extensively regulate various aspects of our banking business, including among other things, permissible types and amounts of loans, investments, and other activities, capital adequacy, branching, interest rates on loans and deposits, maintenance of reserves and the safety and soundness of our banking practices. See additional discussion related to Basel III above.

All insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate federal banking agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

	·	internal controls;
	·	information systems and audit systems;
	·	loan documentation;
	·	credit underwriting;
	·	interest rate risk exposure; and
	·	asset quality.

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

	·	Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a CET 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.
	·	Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has a CET 1 risk-based capital ratio of 4.5% or greater, and (iv) has a leverage ratio of 4% or greater.
	·	Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a CET 1 risk-based capital ratio of less than 4.5%, or (iv) has a leverage ratio of less than 4%.
	·	Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a CET 1 risk-based capital ratio of less than 3%, or (iv) has a leverage ratio of less than 3%.
	·	Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

If the applicable federal regulator determines, after notice and an opportunity for hearing, that the institution is in an unsafe or unsound condition, the regulator is authorized to reclassify the institution to the next lower capital category.

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

If a bank is not well capitalized, it cannot accept brokered deposits without prior regulatory approval. In addition, a bank that is not well capitalized cannot offer an effective yield in excess of 75 basis points over interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area. Moreover, the FDIC generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be categorized as undercapitalized. Undercapitalized institutions are subject to growth limitations (an undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action) and are required to submit a capital restoration plan. The agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with the capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of an amount equal to 5.0% of the depository institution’s total assets at the time it became categorized as undercapitalized or the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is categorized as significantly undercapitalized.

Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

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

As of December 31, 2019, the Bank was deemed to be “well capitalized.”

Standards for Safety and Soundness. The Federal Deposit Insurance Act also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards. These 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. Under the regulations, if the FDIC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

Regulatory Examination. The FDIC also requires the Bank to prepare annual reports on the Bank’s financial condition and to conduct an annual audit of its financial affairs in compliance with its minimum standards and procedures.

Transactions with Affiliates and Insiders. The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.

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

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates.

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal stockholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the time for comparable transactions with unrelated third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

On December 27, 2019, the federal banking agencies issued an interagency statement explaining that such agencies will provide temporary relief from enforcement action against bank or asset managers, which become principal shareholders of banks, with respect to certain extensions of credit by banks that otherwise would violate Regulation O, provided the asset managers and banks satisfy certain conditions designed to ensure that there is a lack of control by the asset manager over the bank. This temporary relief will apply while the Federal Reserve, in consultation with the other federal banking agencies, considers whether to amend Regulation O.

Dividends. The Company’s principal source of cash flow, including cash flow to pay dividends to its stockholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company. As a South Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by the SCBFI, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the SCBFI. The FDIC also has the authority under federal law to enjoin a bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances.

Branching. Federal legislation permits out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks. The Dodd-Frank Act removed previous state law restrictions on de novo interstate branching in various states in which we operate. This change effectively permits out-of-state banks to open de novo branches in states where the laws of such state would permit a bank chartered by that state to open a de novo branch.

Anti-Tying Restrictions. Under amendments to the BHCA and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

Community Reinvestment Act. The Bank is subject to certain requirements and reporting obligations under the Community Reinvestment Act, (or “CRA”), which requires federal banking regulators to evaluate the record of the Bank in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. The CRA further requires these criteria to be considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our Bank. On May 21, 2018, the “as of” date of its most recent examination, the Bank received a “satisfactory” CRA rating.

The Gramm-Leach-Bliley Act, (or “GLBA”), made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made available to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a satisfactory CRA rating in its latest CRA examination.

In December 2019, the FDIC and the Office of the Comptroller of the Currency proposed changes to the regulations implementing the CRA, which, if adopted will result in changes to the current CRA framework. The Federal Reserve did not join the proposal.

Financial Subsidiaries. Under the GLBA, subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible. The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the bank’s assets and tangible equity for purposes of calculating the bank’s capital adequacy. In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.

Consumer Protection Regulations. Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:

	·	the Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
	·	the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
	·	the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
	·	the Community Reinvestment Act, encourages banks to help meet the credit needs of their entire community, including low- and moderate-income areas consistent with safe and sound lending practices;
	·	the Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act and Regulation V, as well as the rules and regulations of the FDIC, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;
	·	the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

	·	the Real Estate Settlement Procedures Act and Regulation X, which governs aspects of the settlement process for residential mortgage loans.
	·	the Military Lending Act and Service Members Civil Relief Act both protect active duty members and their families from certain lending practices in consumer credit and provide meaningful benefits for Service Members; and
	·	the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

The deposit operations of the Bank also are subject to:

	·	the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
	·	the Electronic Funds Transfer Act and Regulation E, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
	·	the Expedited Funds Availability Act, Regulation CC, establishes time limits the bank must follow for making check deposits available for withdrawal or transfer; and
	·	the Truth in Savings Act and Regulation DD, which requires depositary institutions to provide certain consumer disclosures.

Anti-Money Laundering. As a financial institution, the Bank must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, as described below. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing cease and desist orders and money penalty sanctions against institutions that have not complied with these requirements.

USA PATRIOT Act/Bank Secrecy Act. The USA PATRIOT Act, amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the U.S. Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. The rule was further enhanced in 2018 by requiring the identification of beneficial owners of each legal entity customer. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

The Office of Foreign Assets Control, (or “OFAC”), which is a division of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify OFAC. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Privacy, Data Security and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law.

Recent cyber-attacks against banks and other institutions that resulted in unauthorized access to confidential customer information have prompted the Federal banking agencies to issue several warnings and extensive guidance on cyber security. The agencies are likely to devote more resources to this part of their safety and soundness examination than they have in the past.

In addition, pursuant to the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) and the implementing regulations of the federal banking agencies and Federal Trade Commission, the Bank is required to have in place an “identity theft red flags” program to detect, prevent and mitigate identity theft. The Bank has implemented an identity theft red flags program designed to meet the requirements of the FACT Act and the joint final rules. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.

Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies. The Federal Open Market Committee raised the target range for the federal funds rate by 25 basis points each on March 16, 2017, June 15, 2017 and December 14, 2017. During 2018, the rate was increased by 25 basis points each on March 22, June 14, September 27 and December 20. During 2019, the rate was decreased by 25 basis points each on August 1, September 19 and October 31. The potential for further changes in the federal funds rate depends on the economic outlook.

Insurance of Accounts and Regulation by the FDIC. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the bank’s regulatory authority an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

As an FDIC-insured bank, the Bank must pay deposit insurance assessments to the FDIC based on its average total assets minus its average tangible equity. The Bank’s assessment rates are currently based on its risk classification (i.e., the level of risk it poses to the FDIC’s deposit insurance fund). Institutions classified as higher risk pay assessments at higher rates than institutions that pose a lower risk. In addition, following the fourth consecutive quarter (and any applicable phase-in period) where an institution’s total consolidated assets equal or exceed $10 billion, the FDIC will use a performance score and a loss-severity score to calculate an initial assessment rate. In calculating these scores, the FDIC uses an institution’s capital level and regulatory supervisory ratings and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The FDIC also has the ability to make discretionary adjustments to the total score based upon significant risk factors that are not adequately captured in the calculations. In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances.

The FDIC has raised assessment rates and imposed special assessments on certain institutions during recent years to raise funds. Under the Dodd-Frank Act, the minimum designated reserve ratio for the deposit insurance fund is 1.35% of the estimated total amount of insured deposits. In October 2010, the FDIC adopted a restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.

In addition, FDIC insured institutions are required to pay a Financing Corporation (“FICO”) assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s, which expired between 2017 and 2019. The final FICO assessment was collected in March 2019.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

Incentive Compensation. The Dodd-Frank Act requires the federal bank regulators and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal stockholder with excessive compensation, fees, or benefits that could lead to a material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, which reflected the guidance previously issued in June 2010 by the bank regulators. However, the 2011 proposal was replaced with a new proposal in May 2016, which makes explicit that the involvement of risk management and control personnel includes not only compliance, risk management and internal audit, but also legal, human resources, accounting, financial reporting and finance roles responsible for identifying, measuring, monitoring or controlling risk-taking.

In June 2010, the Federal Reserve, the FDIC and the OCC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any one industry or segment. A concentration in commercial real estate is one example of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans, represent 300% or more of an institution’s total risk-based capital and the outstanding balance of the commercial real estate loan portfolio has increased by 50% or more in the preceding three years or (ii) construction and land development loans exceed 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. On December 18, 2015, the federal banking agencies issued a statement to reinforce prudent risk-management practices related to commercial real estate lending, having observed substantial growth in many commercial real estate asset and lending markets, increased competitive pressures, rising commercial real estate concentrations in banks, and an easing of commercial real estate underwriting standards. The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management practices to identify, measure, monitor and manage the risks arising from commercial real estate lending. In addition, FDIC-insured institutions must maintain capital commensurate with the level and nature of their commercial real estate concentration risk.

Based on the Bank’s loan portfolio as of December 31, 2019, the Bank did not exceed the 300% or the 100% guidelines for commercial real estate loans.

Item 1A. Risk Factors

Our business is subject to certain risks, including those described below. If any of the events described in the following risk factors actually occurs then our business, results of operations and financial condition could be materially adversely affected. More detailed information concerning these risks is contained in other sections of this report, including “Part I, Item 1: Business”, “Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part I, “Cautionary Note Regarding Forward-Looking Statements.”

In addition to general investment risks and the other information contained in this Item 1A and elsewhere in this report, stockholders and investors should consider the matters described under the heading “Risk Factors” in the prospectus and joint proxy statement filed by United Bankshares, Inc. and us on February 13, 2020, which is incorporated herein by reference.

Risks Related to Our Business

Our business may be adversely affected by economic conditions.

Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment in the primary markets where we operate and in the United States as a whole. Unlike larger banks that are more geographically diversified, we are a regional bank that provides banking and financial services to customers primarily in South Carolina, Charlotte, and eastern North Carolina. The economic conditions in these local markets may be different from, and in some instances worse than, the economic conditions in the United States as a whole. Some elements of the business environment that affect our financial performance include short-term and long-term interest rates, the prevailing yield curve, inflation and price levels, monetary and trade policy, unemployment and the strength of the domestic economy and the local economy in the markets in which we operate. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters; or a combination of these or other factors. While economic conditions in our local markets in South Carolina and North Carolina have improved since the end of the economic recession, However, there are continuing concerns related to, among other things, the level of United States government debt and fiscal actions that may be taken to address that debt, depressed oil prices and trade disputes and related tariffs that may have a destabilizing effect on financial markets. There can be no assurance that current economic conditions will continue or improve, and economic conditions could worsen. Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing and saving habits. A return of recessionary conditions or other negative developments in the domestic or international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.

Changes in U.S. trade policies and other factors beyond our control, including the imposition of tariffs and retaliatory tariffs and the impacts of epidemics or pandemics, may adversely impact our business, financial condition and results of operations.

There have been changes and discussions with respect to U.S. trade policies, legislation, treaties and tariffs, including trade policies and tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by such countries. Tariffs and retaliatory tariffs have been imposed, and additional tariffs and retaliation tariffs have been proposed. Such tariffs, retaliatory tariffs or other trade restrictions on products and materials that our customers import or export could cause the prices of our customers’ products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues, financial results and ability to service debt; which, in turn, could adversely affect our financial condition and results of operations. In addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate our business, results of operations and financial condition could be materially and adversely impacted in the future. It remains unclear what the U.S. Administration or foreign governments will or will not do with respect to tariffs already imposed, additional tariffs that may be imposed, or international trade agreements and policies. On January 26, 2020, President Trump signed a new trade deal between the United States, Canada and Mexico to replace the North American Free Trade Agreement. The full impact of this agreement on us, our customers and on the economic conditions in our primary banking markets is currently unknown. In addition, coronavirus and concerns regarding the extent to which it may spread have affected, and may increasingly affect, international trade (including supply chains and export levels), travel, employee productivity and other economic activities. A trade war or other governmental action related to tariffs or international trade agreements or policies, as well as coronavirus or other potential epidemics or pandemics, have the potential to negatively impact ours and/or our customers’ costs, demand for our customers' products, and/or the U.S. economy or certain sectors thereof and, thus, adversely affect our business, financial condition, and results of operations.

Our mortgage banking profitability could be significantly reduced if we are not able to originate and resell a high volume of mortgage loans.

Mortgage production, especially refinancing activity, typically declines in a rising interest rate environment. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking business depends in large part upon our ability to aggregate a high volume of loans and sell them in the third-party market at a gain. Thus, in addition to our dependence on the interest rate environment, we are dependent upon (i) the existence of an active third-party market and (ii) our ability to profitably sell loans or securities into that market. As our level of mortgage production declines, the profitability from our mortgage operations will depend upon our ability to reduce our costs commensurate with the reduction of revenue from our mortgage operations.

Our ability to originate and sell mortgage loans readily is dependent upon the availability of an active third-party market for single-family mortgage loans, which in turn depends in part upon the continuation of programs currently offered by the government sponsored entities, or GSEs, and other institutional and non-institutional investors. These entities account for a substantial portion of the third-party market in residential mortgage loans. Because the largest participants in the third-party market are government-sponsored enterprises whose activities are governed by federal law, any future changes in laws that significantly affect the activity of the GSEs could, in turn, adversely affect our operations. In September 2008, the GSEs were placed into conservatorship by the U.S. government. Although to date the conservatorship has not had a significant or adverse effect on our operations, it remains unclear whether these events or further changes would significantly and adversely affect our operations. The government and others have provided options to reform the GSEs, but the results of any such reform, and their impact on us, are difficult to predict. To date, no reform proposal has been enacted. In addition, our ability to sell mortgage loans readily is dependent upon our ability to remain eligible for the programs offered by the GSEs and other institutional and non-institutional investors. Our ability to remain eligible to originate and securitize government insured loans may also depend on having an acceptable peer-relative delinquency ratio for Federal Housing Authority, or FHA, loans and maintaining a delinquency rate with respect to Ginnie Mae pools that are below Ginnie Mae guidelines.

Any significant impairment of our eligibility with any of the GSEs would materially adversely affect our operations. Further, the criteria for loans to be accepted under such programs may be changed from time-to-time by the sponsoring entity which could result in a lower volume of corresponding loan originations. The profitability of participating in specific programs may vary depending on a number of factors, including our administrative costs of originating and purchasing qualifying loans and our costs of meeting such criteria.

An increase in our nonperforming assets would adversely impact our earnings.

Our nonperforming assets may increase in future periods. Nonperforming assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or investments or on real estate owned. We must establish an allowance for loan losses that reserves for losses inherent in the loan portfolio that are both probable and reasonably estimable through current period provisions for loan losses, which are recorded as a charge to income. From time to time, we also write down the other real estate owned portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to the other real estate owned. Further, the resolution of nonperforming assets requires the active involvement of management, which can distract them from our overall supervision of operations and other income-producing activities.

We could record other-than-temporary impairment on our securities portfolio. In addition, we may not receive full future interest payments on these securities.

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

At December 31, 2019, the Company had 79 individual securities available-for-sale in an unrealized loss position. The Company believes, based on OTTI evaluations, that the deterioration in the value of these securities is attributable primarily to changes in interest rates. Management believes that there are no securities other-than-temporarily impaired at December 31, 2019. The Company does not intend to sell these securities, and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost. Management continues to monitor these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of the securities may be sold or are other-than-temporarily impaired, which would require a charge to earnings in such periods.

A number of factors or combinations of factors could require us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to our securities portfolio constitutes additional impairment that is other than temporary, which could result in material losses to us. These factors include, but are not limited to, a continued failure by an issuer to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value. In addition, the fair values of securities could decline if the overall economy and the financial condition of some of the issuers continue to deteriorate and there remains limited liquidity for these securities.

We may not be able to continue to support the realization of our deferred tax asset.

We calculate income taxes in accordance with the FASB Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, which requires the use of the asset and liability method. In accordance with this, we regularly assess available positive and negative evidence to determine whether it is more likely than not that our deferred tax asset balances will be recovered from reversals of deferred tax liabilities, potential utilization of net operating loss carrybacks, tax planning strategies and future taxable income. At December 31, 2019, our net deferred tax asset was $2.5 million. We recognized the deferred tax asset because management believes, based on earnings and detailed financial projections, that it is more likely than not that we will have sufficient future earnings to utilize this asset to offset future income tax liabilities. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it requires the future occurrence of circumstances that cannot be predicted with certainty. There can be no assurance that we will achieve sufficient future taxable income as the basis for the ultimate realization of our deferred tax asset and therefore we may have to establish a full or partial valuation allowance at some point in the future. If we determine that a valuation allowance is necessary, this would require us to incur a charge to operations that would adversely affect our capital position. There is no assurance that we will be able to continue to recognize any, or all, of the deferred tax asset for regulatory capital purposes.

We may be terminated as a servicer of mortgage loans, be required to repurchase a mortgage loan or reimburse investors for credit losses on a mortgage loan, or incur costs, liabilities, fines and other sanctions if we fail to satisfy our servicing obligations, including our obligations with respect to mortgage loan foreclosure actions.

We act as servicer for approximately $3.6 billion of mortgage loans owned by third parties as of December 31, 2019. As a servicer for those loans we have certain contractual obligations, including foreclosing on defaulted mortgage loans or, to the extent applicable, considering alternatives to foreclosure such as loan modifications or short sales. If we commit a material breach of our obligations as servicer, we may be subject to termination as servicer if the breach is not cured within a specified period of time following notice, causing us to lose servicing income.

In some cases, we may be contractually obligated to repurchase a mortgage loan or reimburse the investor for credit losses incurred on the loan as a remedy for servicing errors with respect to the loan. If we have increased repurchase obligations because of claims that we did not satisfy our obligations as a servicer, or increased loss severity on such repurchases, we may have a significant reduction to net servicing income within our mortgage banking noninterest income. We may incur costs if we are required to, or if we elect to, re-execute or re-file documents or take other action in our capacity as a servicer in connection with pending or completed foreclosures. We may incur litigation costs if the validity of a foreclosure action is challenged by a borrower. If a court were to overturn a foreclosure because of errors or deficiencies in the foreclosure process, we may have liability to the borrower and/or to any title insurer of the property sold in foreclosure if the required process was not followed. These costs and liabilities may not be legally or otherwise reimbursable to us. In addition, if certain documents required for a foreclosure action are missing or defective, we could be obligated to cure the defect or repurchase the loan. We may incur liability to securitization investors relating to delays or deficiencies in our processing of mortgage assignments or other documents necessary to comply with state law governing foreclosures. The fair value of our mortgage servicing rights may be negatively affected to the extent our servicing costs increase because of higher foreclosure costs. We may be subject to fines and other sanctions imposed by federal or state regulators as a result of actual or perceived deficiencies in our foreclosure practices or in the foreclosure practices of other mortgage loan servicers. Any of these actions may harm our reputation or negatively affect our home lending or servicing business.

We may be required to repurchase mortgage loans or indemnify buyers against losses in some circumstances, which could harm liquidity, results of operations and financial condition.

When mortgage loans are sold, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to purchasers, guarantors and insurers, including the government sponsored enterprises, about the mortgage loans and the manner in which they were originated. Whole loan sale agreements require repurchase or substitute mortgage loans, or indemnification of buyers against losses, in the event we breach these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of early payment default of the borrower on a mortgage loan. With respect to loans that are originated through our broker or correspondent channels, the remedies available against the originating broker or correspondent, if any, may not be as broad as the remedies available to purchasers, guarantors and insurers of mortgage loans against us. We face further risk that the originating broker or correspondent, if any, may not have financial capacity to perform remedies that otherwise may be available. Therefore, if a purchaser, guarantor or insurer enforces its remedies against us, we may not be able to recover losses from the originating broker or correspondent. If repurchase and indemnity demands increase and such demands are valid claims and are in excess of our provision for potential losses, our liquidity, results of operations and financial condition may be adversely affected.

If we fail to effectively manage credit risk and interest rate risk, our business and financial condition will suffer.

We must effectively manage credit risk. There are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting and guidelines, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers and risks resulting from uncertainties as to the future value of collateral. There is no assurance that our credit risk monitoring and loan approval procedures are or will be adequate or will reduce the inherent risks associated with lending. Our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of our loan portfolio. Any failure to manage such credit risks may adversely affect our business, financial condition, and results of operations.

We must also effectively manage interest rate risk. Because mortgage loans typically have much longer maturities than deposits or other types of funding, rising interest rates can raise the cost of funding relative to the value of the mortgage loan. We manage this risk in part by holding adjustable rate mortgages in portfolios and through other means. Conversely, the value of our mortgage servicing assets may fall when interest rates fall, as borrowers refinance into lower rate loans. Given current rates, material reductions in rates may not be probable, but as rates rise, then the risk increases. There can be no assurance that we will successfully manage the lending and servicing businesses through all future interest-rate environments.

New accounting standards will require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The measure of our allowance for loan losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, has issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become effective for the calendar year beginning January 1, 2020. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will affect how we determine our allowance for loan losses and may require us to significantly increase our allowance. The Company’s preliminary evaluation indicates that adoption of the CECL model is expected to impact the Company’s consolidated financial statements, in particular the level of the reserve for credit losses over the contractual life of the loans. In addition, the guidance eliminates the current guidance for purchased credit impaired loans, and requires an increase in the allowance for loan losses and an increase in the recorded investment of purchased credit impaired loans for the nonaccretable difference.

We expect the adoption of ASU 2016-13 to result in the recognition of an incremental allowance for loan and lease losses of approximately $5.2 million as of the adoption date. Approximately $1.8 million of the incremental amount is expected to be related to the increase in the allowance for loan and lease losses related to purchased credit deteriorated loans (the “gross up”), which offsets loan marks at the adoption date. The cumulative-effect adjustment to retained earnings is expected to be approximately $2.6 million and the increase in the deferred tax asset is expected to be approximately $0.8 million. The Company does not expect any incremental allowance for credit losses on available-for-sale securities at adoption, primarily as the impairment was determined to not be credit related. The adoption of ASU 2016-13 is not expected to have a significant impact on our regulatory capital ratios.

While the guidance changes the measurement of the allowance, it does not change the credit risk of the Company’s lending and securities portfolios or the ultimate losses in those portfolios. Future adjustments to the allowance under ASU 2016-13 will depend upon the nature and characteristics of the Company’s loan portfolio, the macroeconomic conditions and other management judgments. As a result, the magnitude of any such future adjustments are difficult to predict.

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. 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 primary 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 earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which could be exacerbated by potential climate change and may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

We have a concentration of credit exposure in commercial real estate and challenges faced by the commercial real estate market could adversely affect our business, financial condition, and results of operations.

As of December 31, 2019, we had approximately $1.4 billion in loans outstanding to borrowers whereby the collateral securing the loan was commercial real estate, representing approximately 43.2% of our total loans outstanding as of that date. Approximately 30.2%, or $421.8 million, of this real estate are owner-occupied properties. Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our level of nonperforming loans. An increase in nonperforming loans could result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement more stringent underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures.

Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.

At December 31, 2019, commercial business loans comprised 14.5% of our total loan portfolio. Our commercial business loans are originated primarily based on the identified cash flow and general liquidity of the borrower and secondarily on the underlying collateral provided by the borrower and/or repayment capacity of any guarantor. The borrower’s cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectable and inventories may be obsolete or of limited use. In addition, business assets may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral value provided by the borrower and liquidity of the guarantor.

Further downturns or a slower recovery in the real estate markets in our primary market areas could significantly adversely impact our business.

Our primary market areas are the Coastal, Midlands, and Upstate regions of South Carolina, including the Charleston (Charleston, Dorchester and Berkeley Counties), Myrtle Beach (Horry and Georgetown Counties), Columbia (Richland and Lexington Counties), and the Upstate (Greenville and Spartanburg Counties) market areas. Our primary market areas in North Carolina include Wilmington (New Hanover County), Raleigh-Durham (Durham and Wake Counties), Charlotte-Concord-Gastonia (NC and SC) and the surrounding southeastern coastal region of North Carolina (Bladen, Brunswick, Columbus, Cumberland, Duplin and Robeson Counties).

The Company’s primary markets are heavily influenced the military, the medical industry, national and international industries, tourism, retirement living, retail and real estate. If economic conditions were to deteriorate in these markets, the industries in our markets could suffer, which could impact our business. The real estate markets experienced a significant decline in these markets in recent years and, if these economic drivers were to experience further downturns or recover more slowly than expected, real estate in the Company’s markets may experience further declines. If real estate values in our markets decline, the collateral for these loans will provide less security. As a result, the borrower’s ability to pay, or the Company’s ability to recover on defaulted loans by selling the underlying collateral, would be diminished.

Our focus on lending to small to mid-sized community-based businesses may increase our credit risk.

Most of our commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the markets in which we operate negatively impact this important customer sector, our results of operations and financial condition and the value of our common stock may be adversely affected. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. Furthermore, the deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could have a material adverse effect on our financial condition and results of operations.

We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract customers.

The banking business is highly competitive, and we experience competition in our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not provide. There is a risk that we will not be able to compete successfully with other financial institutions in our markets, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.

The accuracy of our financial statements and related disclosures could be affected if the judgments, assumptions or estimates used in our critical accounting policies are inaccurate.

The preparation of financial statements and related disclosure in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are included in the section captioned “Part II - Management’s Discussion and Analysis of Results of Operations and Financial Condition”, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures.

Our funding sources may prove insufficient to replace deposits and support future growth.

We rely on customer deposits, including brokered deposits, advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) and the Federal Reserve, and other borrowings to fund operations. Although the Company has historically been able to replace maturing deposits and advances, if desired, no assurance can be given that we would be able to replace such funds in the future if the financial condition of the FHLB or programs sponsored by the Federal Reserve, regulatory restrictions on brokered deposits or regulatory restrictions on the pricing of local deposits or other market conditions were to change. In addition, certain borrowing sources are on a secured basis. The FHLB has become more restrictive on the types of collateral it will accept and the amount of borrowings allowed on acceptable collateral. Due to changes applied by rating agencies on bonds, changes in collateral requirements or deteriorating loan quality, outstanding borrowings could be required to be repaid, incurring prepayment penalties. Our financial flexibility will be severely constrained if we are unable to maintain access to funding at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future operations, our revenues may not increase proportionally to cover these costs. In addition, Crescent Mortgage Company may fund mortgage loans held for sale through a line of credit with the Bank. A decline in economic conditions could affect Crescent Mortgage Company’s ability to fund loans held for sale.

Our operating results may fluctuate based upon the results of our mortgage subsidiary, Crescent Mortgage Company.

There are a number of items that could adversely affect the volumes and margin of the Company’s mortgage banking operations. These include, but are not limited to, the Federal Reserve’s monetary policy including its quantitative easing program, aggressively low rates, reduction in prices paid by the mortgage banking aggregators, aggressive competition, the housing market recovery, the status and financial condition of the FNMA and FHLMC, potential changes in FNMA and FHLMC lending guidelines and programs, proposed changes in the FHA lending requirements, extensive regulatory changes and liquidity. Should these factors significantly impact production of mortgages, it is likely that the Company’s earnings would be adversely affected.

Our mortgage subsidiary’s operations are exposed to significant repurchase risk.

Crescent Mortgage Company is exposed to significant repurchase risk on mortgage loan production related to potential reimbursements for loans sold to third parties for borrower fraud, underwriting and documentation issues, early defaults and prepayments of sold loans. If the Company experiences significant losses related to repurchase risk, it is possible that the reserve established for such exposure is not adequate. The Company continues to receive repurchase requests. The Company evaluates each request and provides estimated reserves as necessary. We believe that the reserve related to repurchase risk is adequate to absorb probable losses; however, we cannot predict these losses or whether our reserve will be adequate. Any of these occurrences could materially and adversely affect our business, financial condition and profitability.

The value of our loan servicing portfolio may become impaired in the future.

As of December 31, 2019, the Company serviced approximately $3.6 billion of loans. At that date, our mortgage loan servicing rights were recorded as an asset with a carrying value of $25.9 million, including a temporary impairment of $3.1 million. We expect that our loan servicing portfolio will increase in the future. If interest rates decline and the actual and expected mortgage loan prepayment rates increase or other factors that cause a reduction of the valuation of our mortgage servicing asset, the Company could incur additional impairment of its mortgage loan servicing asset.

Hurricanes and other natural disasters may adversely affect loan portfolios and operations and increase the cost of doing business.

The Company operates in markets that are susceptible to hurricanes and other natural disasters. Large-scale natural disasters may significantly affect loan portfolios by damaging properties pledged as collateral, affecting the economies our borrowers live in, and by impairing the ability of the borrower to repay their loans.

Changes in prevailing interest rates may reduce our profitability.

Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Depending on the terms and maturities of our assets and liabilities, we believe it is more likely than not a significant change in interest rates could have a material adverse effect on our profitability. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer.

We are dependent on key individuals, and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.

Jerold L. Rexroad, the Company’s President and Chief Executive Officer, has extensive and long-standing ties within our primary markets. Mr. Rexroad has substantial experience in banking operations, correspondent/wholesale mortgage operations, investment securities, and mergers and acquisitions. The services of Mr. Rexroad would be difficult to replace and our business and development could be materially and adversely affected.

David L. Morrow, the Bank’s Chief Executive Officer, also has extensive and long-standing ties within our primary markets and substantial commercial lending experience within our Charleston and Myrtle Beach markets. The services of Mr. Morrow would be difficult to replace and our business and development could be materially and adversely affected.

Fowler C. Williams, Crescent Mortgage Company’s President and Chief Executive Officer, has extensive knowledge and long-standing ties with the mortgage industry. The services of Mr. Williams would be difficult to replace and our wholesale mortgage company results could be materially and adversely affected.

M.J. Huggins, III, the Company’s Executive Vice President and Secretary, and the Bank’s President, has extensive and long-standing ties within our primary markets and substantial commercial and retail lending experience. The services of Mr. Huggins would be difficult to replace and our business and development could be materially and adversely affected.

Our success also depends, in part, on our continued ability to attract and retain experienced commercial and mortgage loan officers, as well as other management personnel. Competition for personnel is intense, and we may not be successful in attracting or retaining qualified personnel. Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our business strategy and seriously harm our business, results of operations, and financial condition.

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

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. The Company is subject to Federal Reserve Board regulation, and our Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC, and by the SCBFI. Our Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against us under these laws could have a material adverse effect on our results of operations.

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

We may be subject to more stringent capital requirements in the future.

We are subject to regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time, the regulators change these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other regulatory requirements, we or our subsidiaries may be restricted in the types of activities we may conduct and we may be prohibited from taking certain capital actions, such as paying dividends and repurchasing or redeeming capital securities.

In particular, the capital requirements applicable to us under the Basel III rules become fully phased-in on January 1, 2019. We are now required to satisfy additional, more stringent, capital adequacy standards than we had in the past. While we expect to meet the requirements of the Basel III rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial condition and results of operations. In addition, these requirements could have a negative impact on our ability to lend, grow deposit balances, make acquisitions or make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower our return on equity.

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

The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (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 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 Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient we would be subject to liability, including fines and regulatory actions, such as restrictions on our ability to pay dividends, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. Since 2013, the CFPB has issued several rules on mortgage lending, notably a rule requiring all home mortgage lenders to determine a borrower’s ability to repay the loan. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected from liability to a borrower for failing to make the necessary determinations. In either case, we may find it necessary to tighten our mortgage loan underwriting standards in response to the CFPB rules, which may constrain our ability to make loans consistent with our business strategies. It is our policy not to make predatory loans and to determine borrowers’ ability to repay, but the law and related rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

We may be exposed to difficulties in combining the operations of acquired businesses into our own operations, which may prevent us from achieving the expected benefits from our merger and acquisition activities.

We may not be able to fully achieve the strategic objectives and operating efficiencies that we anticipate in our merger and acquisition activities. Inherent uncertainties exist in integrating the operations of an acquired business. In addition, the markets and industries in which we and our potential merger and acquisition targets operate are highly competitive. We may lose customers or the customers of acquired entities as a result of an acquisition. We may also lose key personnel from the acquired entity as a result of an acquisition. We may not discover all known and unknown factors when examining a company for acquisition during the due diligence period. These factors could produce unintended and unexpected consequences for us. Undiscovered factors as a result of an acquisition could bring civil, criminal, and financial liabilities against us, our management, and the management of those entities we acquire. In addition, if difficulties arise with respect to the integration process, the economic benefits expected to result from acquisitions might not occur. Failure to successfully integrate businesses that we acquire could have an adverse effect on our profitability, return on equity, return on assets, or our ability to implement our strategy, any of which in turn could have a material adverse effect on our business, financial condition and results of operations. These factors could contribute to our not achieving the expected benefits from our mergers and acquisitions within desired time frames, if at all.

We are subject to losses due to errors, omissions or fraudulent behavior by our employees, clients, counterparties or other third parties.

We are exposed to many types of operational risk, including the risk of fraud by employees and third parties, clerical recordkeeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially and adversely affected if employees, clients, counterparties or other third parties caused an operational breakdown or failure, either as a result of human error, fraudulent manipulation or purposeful damage to any of our operations or systems.

In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information, which we do not independently verify. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.

Our ability to pay cash dividends is limited, and we may be unable to pay future dividends even if we desire to do so.

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

Our ability to pay cash dividends may be limited by regulatory restrictions, by our Bank’s ability to pay cash dividends to the Company and by our need to maintain sufficient capital to support our operations. As a South Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by the SCBFI, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the SCBFI. If our Bank is not permitted to pay cash dividends to the Company, it is unlikely that we would be able to pay cash dividends on our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our board of directors. Although we have historically paid cash dividends on our common stock, we are not required to do so and our board of directors could reduce or eliminate our common stock dividend in the future.

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, and 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.

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 clients 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.

Negative public opinion surrounding our Company and the financial institutions industry generally could damage our reputation and adversely impact our earnings and our ability to make loans or to acquire deposits.

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.

Uncertainty relating to the London Inter-bank Offered Rate, or LIBOR, calculation process and potential phasing out of LIBOR may adversely affect us.

On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, or other securities or financial arrangements, given LIBOR’s role in determining market interest rates globally. The Federal Reserve Board, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing the U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities (“SOFR”). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains traction as a LIBOR replacement tool remains in question, although some transactions using SOFR have been completed in 2019, and the future of LIBOR remains uncertain as this time. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and securities in our portfolio. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may experience significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.

From time to time we are, or may become, involved in lawsuits, legal proceedings, information-gatherings, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.

Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, involved in or the subject of lawsuits and other legal proceedings and information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions, restrictions on the way we conduct our business or reputational harm.

Risks Related to Our Common Stock

Our stock price may be volatile, which could result in losses to our investors and litigation against us.

Several factors could cause our stock 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.

Future sales of our stock by our stockholders or the perception that those sales could occur may cause our stock price to decline.

Although our common stock is listed on the Nasdaq Capital Market under the symbol “CARO,” 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.

Economic and other circumstances may require us to raise capital at times or in amounts that are unfavorable to us. If we have to issue shares of common stock, they will dilute the percentage ownership interest of existing stockholders and may dilute the book value per share of our common stock and adversely affect the terms on which we may obtain additional capital.

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments or to strengthen our capital position. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control and our financial performance. We cannot provide assurance that such financing will be available to us on acceptable terms or at all, or if we do raise additional capital that it will not be dilutive to existing stockholders.

If we determine, for any reason, that we need to raise capital, our board generally has the authority, without action by or vote of the stockholders, to issue all or part of any authorized but unissued shares of stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. Additionally, we are not restricted from issuing 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 price 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 from the perception that such sales could occur. Any issuance of additional shares of stock will dilute the percentage ownership interest of our stockholders and may dilute the book value per share of our common stock. Shares we issue in connection with any such offering will increase the total number of shares and may dilute the economic and voting ownership interest of our existing stockholders.

Our board of directors may issue shares of preferred stock that would adversely affect the rights of our common stockholders.

Our authorized capital stock includes 1,000,000 shares of preferred stock of which no preferred shares are issued and outstanding. Our board of directors, in its sole discretion, may designate and issue one or more series of preferred stock from the authorized and unissued shares of preferred stock. Subject to limitations imposed by law or our certificate of incorporation, our board of directors is empowered to determine:

	·	the designation of, and the number of, shares constituting each series of preferred stock;
	·	the dividend rate for each series;
	·	the terms and conditions of any voting, conversion and exchange rights for each series;
	·	the amounts payable on each series on redemption or our liquidation, dissolution or winding-up;
	·	the provisions of any sinking fund for the redemption or purchase of shares of any series; and
	·	the preferences and the relative rights among the series of preferred stock.

We could issue preferred stock with voting and conversion rights that could adversely affect the voting power of the shares of our common stock and with preferences over the common stock with respect to dividends and in liquidation.

Our securities are not FDIC insured.

Our securities, including our common stock, are not savings or deposit accounts or other obligations of the Bank, are not insured by the Deposit Insurance Fund, the FDIC or any other governmental agency and are subject to investment risk, including the possible loss of principal.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our main office is located at 288 Meeting Street, Charleston, South Carolina 29401-1575. Including our main office, the Bank operates 73 full service branches and one loan production office located in South Carolina and North Carolina. In addition to our main office, branches, and loan production offices, we also operate the Bank’s retail mortgage division headquartered in Myrtle Beach, South Carolina, Crescent Mortgage Company, the Bank’s correspondent/wholesale mortgage subsidiary, headquartered in Atlanta, Georgia, and Carolina Services Corporation of Charleston, located in Charleston, South Carolina.

The Bank owns 38 of the branch offices, plus eight additional branch offices for which the land is leased and the building is owned. The remaining offices are subject to leases. The Company also owns the building occupied by the Bank’s retail mortgage division. For each property that we lease, we believe that, based upon current market conditions, upon expiration of the lease we will be able to extend the lease on satisfactory terms or relocate to another acceptable location. We believe these premises will be adequate for present and anticipated needs and that we have adequate insurance to cover our owned and leased premises. For additional information relating to the Company’s premises, equipment and lease commitments, see Note 7 - Premises and Equipment, net and Note 14 - Commitments and Contingencies Including Leases to our audited consolidated financial statements included elsewhere in this report.

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.

None.

PART II

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

As of February 10, 2020, there were approximately 2,901 stockholders of record of our common stock. Our common stock was listed on the NASDAQ Capital Market on July 1, 2014. Under the Stock Symbol “CARO.”

We are authorized to pay dividends as declared by our board of directors, provided that no such distribution results in our insolvency on a going concern or balance sheet basis. Future dividends will be subject to board approval. As we are a legal entity separate and distinct from the Bank, our principal source of funds with which we can pay dividends to our shareholders is dividends we receive from the Bank. For that reason, our ability to pay dividends is subject to the limitations that apply to the Bank. For more information on restrictions on payments of dividends, see Note 20 - Capital Requirements and Other Restrictions included in Part II, Item 8 – Financial Statements and Supplementary Data.

(LINE GRAPH)

	Period Ending
Index	12/31/14		12/31/15		12/31/16		12/31/17		12/31/18		12/31/19
Carolina Financial Corporation		100.00		155.59		267.81		324.78		260.41		384.09
NASDAQ Composite Index		100.00		106.96		116.45		150.96		146.67		200.49
SNL Southeast Bank Index		100.00		98.44		130.68		161.65		133.56		188.08

Prepared by S&P Global Market Intelligence, a division of S&P Global Inc.

The performance graph above compares the Company’s cumulative total return from December 31, 2014 through December 31, 2019 with the NASDAQ Composite and the SNL Southeast Bank Index, a banking industry performance index for the Southeastern United States. The Company was listed on the NASDAQ exchange on July 1, 2014. Returns are shown on a total return basis, assuming the reinvestment of dividends and a beginning stock index value of $100 per share. The value of the Company’s common stock as shown in the graph is based on published prices for the transactions in the Company’s common stock.

Issuer Purchases of Equity Securities

2019 Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number (or Approximate Dollar Value) of Shares that may yet be Purchased Under the Plans or Programs
January 1 - January 31		104,936	$	31.87		104,936	$	16,274,800
February 1 - February 28		11,936		34.74		11,936		15,860,092
March 1 - March 31		11,726		34.03		11,726		15,461,071
April 1 - April 30		3,810		34.99		3,810		15,327,759
May 1 - May 31		7,575		34.58		7,575		15,065,816
June 1 - June 30		18,520		34.10		18,520		14,434,284
July 1 - July 31		18,093		34.52		18,093		13,809,714
August 1 - August 31		23,742		34.00		23,742		13,002,486
September 1 - September 30		4,972		34.30		4,972		12,831,946
October 1 - October 31		9,462		34.77		9,462		12,502,953
November 1 - November 30		—		—		—		12,502,953
December 1 - December 31		—		—		—		12,502,953
		214,772				214,772

Item 6. Selected Financial Data


	For The Years Ended December 31,
	2019		2018		2017		2016		2015
	(In thousands)
Operating Data:

Interest income	$	177,116		161,058		95,087		60,914		49,604
Interest expense		37,866		27,248		13,253		8,753		6,604
Net interest income		139,250		133,810		81,834		52,161		43,000
Provision for loan losses		2,580		2,059		779		—		—
Net interest income after provision for loan losses		136,670		131,751		81,055		52,161		43,000
Noninterest income		47,110		39,896		33,916		29,297		27,679
Noninterest expense		103,092		109,208		73,445		56,040		49,199
Income before income taxes		80,688		62,439		41,526		25,418		21,480
Income tax expense		17,948		12,769		12,961		7,848		7,060
Net income	$	62,740		49,670		28,565		17,570		14,420

	At December 31,
	2019		2018		2017		2016		2015
	(In thousands)
Balance Sheet Data:

Total assets	$	4,708,873		3,790,748		3,519,017		1,683,736		1,409,669
Interest-bearing cash		91,792		33,276		55,998		14,591		16,421
Securities available-for-sale		879,235		842,801		743,239		335,352		306,474
Securities held-to-maturity		—		—		—		—		17,053
Federal Home Loan Bank stock		23,280		21,696		19,065		11,072		9,919
Loans held for sale		31,282		16,972		35,292		31,569		41,774
Loans receivable, net		3,211,416		2,509,873		2,308,050		1,167,578		912,582
Allowance for loan losses		16,521		14,463		11,478		10,688		10,141
Deposits		3,408,361		2,718,193		2,604,929		1,258,260		1,031,528
Short-term borrowed funds		437,700		405,500		340,500		203,000		120,000
Long-term debt		54,875		59,436		72,259		38,465		103,465
Stockholders’ equity		743,440		575,285		475,381		163,190		139,859


	For The Years Ended December 31,
	2019			2018			2017			2016			2015
	(Dollars in thousands)
Selected Average Balances:

Total assets	$	3,893,831			3,629,490			2,306,667			1,537,654			1,303,402
Loans receivable		2,624,667			2,388,856			1,526,109			1,035,115			827,787
Deposits		2,818,592			2,697,908			1,761,087			1,197,688			1,012,659
Stockholders’ equity		605,629			526,701			280,877			151,285			101,896

Performance Ratios:

Return on average equity		10.36	%		9.43	%		10.17	%		11.61	%		14.15	%
Return on average assets		1.61	%		1.37	%		1.24	%		1.14	%		1.11	%
Average earning assets to average total assets		90.00	%		89.62	%		90.98	%		93.56	%		91.42	%
Average loans receivable to average deposits		93.12	%		88.54	%		86.66	%		86.43	%		81.74	%
Average equity to average assets		15.55	%		14.51	%		12.18	%		9.84	%		7.82	%
Net interest margin		3.97	%		4.11	%		3.90	%		3.63	%		3.59	%
Net interest margin - tax equivalent (1)		4.02	%		4.15	%		4.02	%		3.71	%		3.68	%
Net recoveries (charge-offs) to average loans receivable		(0.02	)%		0.04	%		—			0.05	%		0.13	%
Non-performing assets to total loans receivable		0.85	%		0.53	%		0.30	%		0.58	%		0.72	%
Non-performing assets to total assets		0.58	%		0.35	%		0.20	%		0.40	%		0.47	%
Non-performing loans to total loans		0.78	%		0.47	%		0.17	%		0.48	%		0.47	%
Allowance for loan losses as a percentage of gross loans receivable (end of period) (2)		0.51	%		0.57	%		0.49	%		0.91	%		1.10	%
Allowance for loan losses as a percentage of nonperforming loans		65.44	%		123.13	%		291.84	%		190.01	%		235.73	%

	At or For The Years Ended December 31,
	2019			2018			2017			2016			2015
Per Share Data:

Book value (end of period) (3)	$	30.14			25.83			22.76			13.23			11.92
Basic earnings		2.83			2.28			1.75			1.45			1.51
Diluted earnings		2.80			2.26			1.73			1.42			1.48

Average common shares - basic		22,168,082			21,756,595			16,317,501			12,080,128			9,537,358
Average common shares - diluted		22,385,127			21,972,857			16,550,357			12,352,246			9,718,356

(1)	The tax equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.

(2)	Included in loans receivable are approximately $989.5 million, $686.4 million, and $952.2 million in acquired loans at December 31, 2019, 2018 and 2017, respectively.

(3)

Book value is calculated using outstanding common shares less unvested restricted shares.

On June 22, 2015, the Board of Directors of the Company declared a six-for-five stock split representing a 20% stock dividend to stockholders of record as of July 15, 2015, payable on July 31, 2015.

All share, earnings per share, and per share data have been retroactively adjusted to reflect these stock splits for all periods presented in accordance with generally accepted accounting principles.

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

The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.

We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.

Company Overview

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

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

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

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

Pending Merger with and into United Bankshares, Inc.

On November 17, 2019, the Company announced the execution of an agreement and plan of merger by and between the Company and United Bankshares, Inc., (“United”) pursuant to which, subject to the terms and conditions set forth therein, the Company will merge with and into United, with United as the surviving corporation of the merger. The merger agreement provides that at the effective time of the merger, the Bank will merge with and into United Bank, a wholly-owned subsidiary of United Bank, with United Bank as the surviving entity. Consummation of the merger is subject to approval of the stockholders of United and Carolina Financial, the receipt of all required regulatory approvals, as well as other customary conditions. Pursuant to the merger agreement, each outstanding share of common stock of Carolina Financial will be converted into the right to receive 1.13 shares of United common stock, par value $2.50 per share, resulting in an aggregate transaction value of approximately $1.1 billion. The foregoing description of the merger agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the merger greement, a copy of which is filed as Exhibit 2.1 to this report and is incorporated herein by reference. United has filed a registration statement on Form S-4 with the SEC to register the shares of United’s common stock that will be issued to the Company’s stockholders in connection with the proposed merger. The definitive prospectus of United and joint proxy statement of United and the Company, filed on February 13, 2020 has been provided to the stockholders of each of United and the Company in connection with the proposed merger and is incorporated herein by reference. See “Part I, Item 1 – “Pending Merger with and into United Bankshares, Inc.”

Executive Summary of Operating Results

The following is a summary of the Company’s financial highlights and significant events in 2019:

The Company reported net income for the year ended December 31, 2019 of $62.7 million or $2.80 per diluted share, as compared to $49.7 million, or $2.26 per diluted share, for the year ended December 31, 2018.

Accretion income from acquired loans was $7.6 million for the year ended December 31, 2019 compared to $9.8 million for the year ended December 31, 2018. Provision for loan losses during the years ended December 31, 2019 and 2018 was $2.6 million and $2.1 million, respectively.

Operating earnings for the year ended December 31, 2019, which exclude certain non-operating income and expenses, increased to $67.6 million, or $3.02 per diluted share compared to $62.8 million, or $2.86 per diluted share, for the same period of 2018.

Included in net income for the year ended December 31, 2019 was a fair value loss on interest rate swaps of $3.7 million, a temporary impairment of mortgage servicing rights of $3.1 million, a gain on sale of securities of $3.9 million, a loss on early extinguishment of debt of approximately $178,000 and merger-related expenses of $2.8 million.

Included in net income for the year ended December 31, 2018 was a fair value loss on interest rate swaps of approximately $340,000, a loss on sale of securities of $1.9 million and merger-related expenses of $15.2 million.

	·	On December 31, 2019, the Company closed its acquisition of Carolina Trust BancShares, Inc. The acquisition added $481.0 million of loans receivable, gross and $537.8 million of deposits.
	·	Loans receivable, gross grew $703.6 million since December 31, 2018. Excluding the impact of loans acquired from Carolina Trust, loans receivable, gross grew $222.6 million, or 8.8% since December 31, 2018.
	·	Total deposits increased $690.2 million since December 31, 2018. Excluding the impact of deposits acquired from Carolina Trust, deposits increased $152.4 million since December 31, 2018.

Nonperforming assets to total assets were 0.58% as of December 31, 2019 compared to 0.35% as of December 31, 2018. Nonperforming loans were $25.2 million as of December 31, 2019 as compared to $11.7 million at December 31, 2018. The increase in nonperforming loans and the NPA ratio was primarily due to two fully collateralized lending relationships.

The Company reported book value per common share of $30.14 and $25.83 as of December 31, 2019 and 2018, respectively. Tangible book value per common share was $22.00 and $19.36 as of December 31, 2019 and 2018, respectively.

At December 31, 2019, the Company’s regulatory capital ratios exceeded the minimum levels currently required. Stockholders’ equity totaled $743.4 million as of December 31, 2019 compared to $575.3 million at December 31, 2018. Tangible equity to tangible assets at December 31, 2019 was 12.04% compared to 11.83% at December 31, 2018.

On December 3, 2018, the Company announced that the Board of Directors had approved a plan to repurchase up to $25 million in shares of the Company’s common stock through open market and privately negotiated transactions over the next three years. The Company began stock repurchases on December 4, 2018. During 2019, the Company repurchased approximately 215,000 shares at an average price of $33.13. Cumulatively since December 4, 2018, the Company repurchased approximately 390,000 shares at an average price of $32.01.

Operating earnings and related per share measures, as well as core deposits, tangible common equity and tangible book value per common share are non-GAAP financial measures. For reconciliations to the most comparable GAAP measures, see “Non-GAAP Financial Measures” below.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our consolidated financial statements within Item 8 “Financial Statements and Supplementary Data” elsewhere in this report.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations. Management has reviewed and approved these critical accounting policies and discussed them with the audit committee of the Board of Directors.

Non-GAAP Financial Measures

Statements included in this management’s discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company’s management uses these non-GAAP financial measures, including but not limited to, core deposits, tangible book value, operating earnings, allowance for loan losses to non-acquired loans, net interest margin-core and yield on loans receivable-core to evaluate and compare the Company’s operating results from period to period in a meaningful manner.

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

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

	For the Years Ended
	December 31,
	2019			2018			2017
	(Dollars in thousands)
As Reported:
Income before income taxes	$	80,688			62,439			41,526
Tax expense		17,948			12,769			12,961
Net income	$	62,740			49,670			28,565

Average equity	$	605,629			526,701			280,877
Average assets		3,893,831			3,629,490			2,306,667
Return on average assets		1.61	%		1.37	%		1.24	%
Return on average equity		10.36	%		9.43	%		10.17	%

Weighted average common shares outstanding:
Basic		22,168,082			21,756,595			16,317,501
Diluted		22,385,127			21,972,857			16,550,357
Earnings per common share:
Basic	$	2.83			2.28			1.75
Diluted	$	2.80			2.26			1.73

Operating:
Income before income taxes	$	80,688			62,439			41,526
(Gain) loss on sale of securities		(3,891	)		1,946			(933	)
Net loss on extinguishment of debt		178			—			—
Fair value adjustments on interest rate swaps		3,659			340			(382	)
Merger-related costs		2,753			15,216			8,301
Impairment of mortgage servicing rights		3,100			—			—
Operating earnings before income taxes		86,487			79,941			48,512
Tax expense (1)		18,868			17,105			14,706
Operating earnings (Non-GAAP)	$	67,619			62,836			33,806

Average equity	$	605,629			526,701			280,877
Average assets	$	3,893,831			3,629,490			2,306,667
Operating return on average assets (Non-GAAP)		1.74	%		1.73	%		1.47	%
Operating return on average equity (Non-GAAP)		11.17	%		11.93	%		12.04	%

Weighted average common shares outstanding:
Basic		22,168,082			21,756,595			16,317,501
Diluted		22,385,127			21,972,857			16,550,357
Operating earnings per common share:
Basic (Non-GAAP)	$	3.05			2.89			2.07
Diluted (Non-GAAP)	$	3.02			2.86			2.04

(1)

Tax expense is determined using the effective tax rate adjusted to eliminate the impact of the non-operating items.

	At December 31,
	2019			2018
	(Dollars in thousands)
Core deposits:
Noninterest-bearing demand accounts	$	668,616			547,022
Interest-bearing demand accounts		651,577			566,527
Savings accounts		218,786			192,322
Money market accounts		590,916			431,246
Total core deposits (Non-GAAP)		2,129,895			1,737,117

Certificates of deposit:
Less than $250,000		1,159,978			875,749
$250,000 or more		118,488			105,327
Total certificates of deposit		1,278,466			981,076
Total deposits	$	3,408,361			2,718,193

	At December 31,
	2019			2018
	(Dollars in thousands)
Tangible book value per share:
Total stockholders’ equity	$	743,440			575,285
Less intangible assets		(200,880	)		(144,054	)
Tangible common equity (Non-GAAP)	$	542,560			431,231

Issued and outstanding shares		24,777,608			22,387,009
Less nonvested restricted stock awards		(112,549	)		(117,966	)
Period end shares used for tangible book value		24,665,059			22,269,043

Total stockholders’ equity	$	743,440			575,285
Divided by period end shares used for tangible book value		24,665,059			22,269,043
Common book value per share	$	30.14			25.83

Tangible common equity (Non-GAAP)	$	542,560			431,231
Divided by period end shares used for tangible book value		24,665,059			22,269,043
Tangible common book value per share (Non-GAAP)	$	22.00			19.36

Recent Accounting Standards and Pronouncements

For information relating to recent accounting standards and pronouncements, see Note 1 to the audited consolidated financial statements within Item 8 “Financial Statements and Supplementary Data.”

Results of Operations

Summary

2019 compared to 2018

The Company reported net income available to common stockholders of approximately $62.7 million, or $2.80 per diluted share, for the year ended December 31, 2019, compared to $49.7 million, or $2.26 per diluted share for the year ended December 31, 2018. Operating earnings, which exclude certain non-operating income and expenses, for the year ended December 31, 2019 increased 7.6% to $67.6 million, or $3.02 per diluted share, from $62.8 million, or $2.86 per diluted share, for the year ended December 31, 2018. Operating earnings and related per share measures are non-GAAP financial measures. For a reconciliation to the most compared GAAP measure, see “Non-GAAP Financial Measures”.

2018 compared to 2017

The Company reported net income available to common stockholders of approximately $49.7 million, or $2.26 per diluted share, for the year ended December 31, 2018, compared to $28.6 million, or $1.73 per diluted share for the year ended December 31, 2017. Our 2018 and 2017 results include pretax merger related expenses of $15.2 million and $8.3 million, respectively. Operating earnings, which exclude certain non-operating income and expenses, for the year ended December 31, 2018 increased 85.9% to $62.8 million, or $2.86 per diluted share, from $33.8 million, or $2.04 per diluted share, for the year ended December 31, 2017. Operating earnings and related per share measures are non-GAAP financial measures. For a reconciliation to the most compared GAAP measure, see “Non-GAAP Financial Measures”.

Details of the changes in the various components of net income are further discussed below.

Net Interest Income and Margin

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

2019 compared to 2018

For the years ended December 31, 2019 and 2018, our net interest income was $139.3 million and $133.8 million, respectively. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the year ended December 31, 2019 is primarily the result of increased balances of loans receivable as well as higher available-for-sale securities. Average loans receivable increased $235.8 million from 2018 to 2019, primarily attributable to organic loan growth. Average yields on loans receivable, net increased from 5.54% for the year ended December 31, 2018 to 5.60% for the year ended December 31, 2019.

2018 compared to 2017

For the years ended December 31, 2018 and 2017, our net interest income was $133.8 million and $81.8 million, respectively. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the year ended December 31, 2018 is primarily the result of increased balances of loans receivable as well as higher available-for-sale securities. Average loans receivable increased $862.7 million, or 56.5%, from 2017 to 2018, primarily attributable to the Greer and First South acquisitions as well as organic loan growth. Average yields on loans receivable, net increased 0.40% from December 31, 2017 to 5.54% for the year ended December 31, 2018.

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the periods indicated (dollars in thousands). We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. Nonaccrual loans are included in earning assets in the following tables. Loan yields reflect the negative impact on our earnings of loans on nonaccrual status. The net capitalized loan costs and fees, which are considered immaterial, are amortized into interest income on loans.

	For The Years Ended December 31,
	2019								2018								2017
				Interest		Average						Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate			Balance			Paid		Rate
	(Dollars in thousands)
Interest-earning assets:
Loans held for sale	$	24,271			1,039		4.28	%		22,149			963		4.35	%		23,199			885		3.81	%
Loans receivable, net (1)		2,624,667			146,882		5.60	%		2,388,856			132,289		5.54	%		1,526,109			78,415		5.14	%
Interest-bearing cash		21,063			444		2.11	%		25,628			479		1.87	%		31,715			350		1.10	%
Securities available for sale		811,028			27,424		3.38	%		795,100			26,222		3.30	%		504,555			14,836		2.90	%
Federal Home Loan Bank stock		19,739			1,203		6.09	%		17,744			1,004		5.66	%		11,032			496		4.50	%
Other investments		3,490			124		3.55	%		3,437			101		2.94	%		2,108			105		4.98	%
Total interest-earning assets		3,504,258			177,116		5.05	%		3,252,914			161,058		4.95	%		2,098,718			95,087		4.53	%
Noninterest-earning assets		389,573								376,576								207,949

Total assets	$	3,893,831								3,629,490								2,306,667

Interest-bearing liabilities:
Demand accounts		573,745			2,506		0.44	%		564,282			3,121		0.55	%		319,190			817		0.26	%
Money market accounts		442,076			4,647		1.05	%		459,774			3,048		0.66	%		374,770			1,747		0.47	%
Savings accounts		183,843			1,000		0.54	%		201,741			630		0.31	%		89,598			170		0.19	%
Certificates of deposit		1,017,795			18,953		1.86	%		910,433			11,928		1.31	%		622,424			6,653		1.07	%
Short-term borrowed funds		365,429			8,328		2.28	%		316,189			6,064		1.92	%		176,169			1,888		1.07	%
Long-term debt		48,688			2,432		5.00	%		59,465			2,457		4.13	%		58,539			1,978		3.38	%
Total interest-bearing liabilities		2,631,576			37,866		1.44	%		2,511,884			27,248		1.08	%		1,640,690			13,253		0.81	%
Noninterest-bearing deposits		601,133								561,678								355,105
Other liabilities		55,493								29,227								29,995
Stockholders’ equity		605,629								526,701								280,877

Total liabilities and Stockholders’ equity	$	3,893,831								3,629,490								2,306,667

Net interest spread							3.61	%							3.87	%							3.72	%
Net interest margin		3.97	%							4.11	%							3.90	%

Net interest margin (tax-equivalent) (2)		4.02	%							4.15	%							4.02	%
Net interest income				$	139,250								133,810								81,834

(1)	Average balances of loans receivable, net include nonaccrual loans.

(2)	The tax equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.

2019 compared to 2018

Our net interest margin was 3.97%, or 4.02% on a tax-equivalent basis, for the year ended December 31, 2019 compared to 4.11%, or 4.15% on a tax equivalent basis, for the year ended December 31, 2018. The decrease in margin from period to period is the result of an increase in the cost of funds as well as lower purchase accounting accretion. The increase in rates paid on interest-bearing liabilities is primarily due to repricing because of the increases in the prime rate during 2018 in addition to increased competition in our markets for deposits to fund strong loan growth.

The yield on loans receivable during the year ended December 31, 2019 reflects accretion income from loans purchased in acquisitions of $7.6 million (22 bps to NIM) and early payoff fees of approximately $704,000 (2 bps to NIM) compared to accretion income of $9.8 million (32 bps to NIM) and early payoff fees of $1.0 million (3 bps to NIM) for the year ended December 31, 2018. Excluding accretion income from acquired loans and early payoff fees, net interest margin-core (Non-GAAP) for the year ended December 31, 2019 was 3.78% compared to 3.80% for the year ended December 31, 2018.

Our net interest spread, which is not on a tax-equivalent basis, was 3.61% for the year ended December 31, 2019 as compared to 3.87% for the same period in 2018. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 26 basis point decrease in net interest spread is a result of the 10 basis point increase in yield on interest-earning assets as well as a 36 basis point increase in rates paid on interest-bearing liabilities.

2018 compared to 2017

Our net interest margin was 4.11%, or 4.15% on a tax-equivalent basis, for the year ended December 31, 2018 compared to 3.90%, or 4.02% on a tax equivalent basis, for the year ended December 31, 2017. The increase in margin from period to period is the result of a shift to higher yielding earning assets as well as an increase in yield on securities available for sale and loans receivable, net of the increase in cost of funds. Average loans receivable comprised 73.4% of interest earning assets for the year ended December 31, 2018 compared to 72.7% for the year ended December 31, 2017. The yield on loans receivable during the years ended December 31, 2018 and 2017 reflects accretion income from loans purchased in acquisitions of $9.8 million and $4.3 million, respectively.

Our net interest spread, which is not on a tax-equivalent basis, was 3.87% for the year ended December 31, 2018 as compared to 3.72% for the same period in 2017. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 15 basis point increase in net interest spread is a result of the 42 basis point increase in yield on interest-earning assets as well as a 27 basis point increase in rates paid on interest-bearing liabilities.

The increase in the rate realized on loans is primarily the result of variable rate loans repricing as a result of the increases in the prime rate.

Rate/Volume Analysis

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

	For The Years Ended December 31,
	2019 vs. 2018												2018 vs. 2017
	Increase (decrease)									Net			Increase (decrease)									Net
	due to						Rate/			Dollar			due to						Rate/			Dollar
	Volume			Rate			Volume			Change			Volume			Rate			Volume			Change
	(In thousands)
Loans held for sale	$	91			(16	)		1			76			(46	)		118			6			78
Loans receivable, net		13,197			1,534			(138	)		14,593			47,777			9,544			(3,447	)		53,874
Interest-bearing cash		(96	)		50			11			(35	)		(114	)		196			47			129
Securities available-for-sale		539			677			(14	)		1,202			9,582			2,843			(1,039	)		11,386
FHLB stock		122			86			(9	)		199			380			206			(78	)		508
Other investments		2			21			—			23			39			(70	)		27			(4	)
Interest income		13,855			2,352			(149	)		16,058			57,618			12,837			(4,484	)		65,971

Demand accounts	$	41			(667	)		11			(615	)		1,356			1,677			(728	)		2,305
Money market accounts		(186	)		1,716			69			1,599			564			905			(167	)		1,302
Savings accounts		(97	)		426			41			370			350			247			(137	)		460
Certificates of deposit		1,999			5,619			(593	)		7,025			3,773			2,196			(695	)		5,274
Short-term borrowed funds		1,122			1,320			(178	)		2,264			2,685			2,675			(1,185	)		4,175
Long-term debt		(538	)		420			93			(25	)		38			448			(7	)		479
Interest expense	$	2,341			8,834			(557	)		10,618			8,766			8,148			(2,919	)		13,995
Net interest income											5,440												51,976

	For the Years Ended December 31,
	2017 vs. 2016
	Increase (decrease)									Net
	due to						Rate/			Dollar
	Volume			Rate			Volume			Change
	(In thousands)
Loans held for sale	$	(213	)		79			19			(115	)
Loans receivable, net		25,229			4,496			(1,447	)		28,278
Interest-bearing cash		23			270			(18	)		275
Securities available-for-sale		5,206			883			(310	)		5,779
Securities held-to-maturity		—			—			(217	)		(217	)
FHLB stock		141			(27	)		8			122
Other investments		(27	)		62			16			51
Interest income		30,359			5,763			(1,949	)		34,173

Demand accounts	$	429			323			(169	)		583
Money market accounts		466			645			(172	)		939
Savings accounts		85			52			(26	)		111
Certificates of deposit		1,459			415			(91	)		1,783
Short-term borrowed funds		898			917			(436	)		1,379
Long-term debt		(631	)		255			81			(295	)
Interest expense	$	2,706			2,607			(813	)		4,500
Net interest income											29,673

Provision for Loan Loss

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.

Following is a summary of the activity in the allowance for loan losses during the years ended December 31, 2019, 2018 and 2017.

	For the Years Ended
	2019			2018			2017
	(In thousands)
Balance, beginning of period	$	14,463			11,478			10,688
Provision for loan losses		2,580			2,059			779
Loan charge-offs		(1,235	)		(872	)		(272	)
Loan recoveries		713			1,798			283
Balance, end of period	$	16,521			14,463			11,478

2019 compared to 2018

The Company experienced net charge-offs of approximately $522,000 for the year ended December 31, 2019 and net recoveries of $926,000 for the year ended December 31, 2018. Provision for loan losses of $2.6 million was recorded during 2019 primarily driven by organic loan growth. Provision expense for loan losses of $2.1 million was recorded during 2018. The increase in provision expense from the prior year was primarily due to loan growth and reduced recoveries in 2019. Non-performing assets were 0.58% and 0.35% of total assets at December 31, 2019 and 2018, respectively. The increase in the NPA ratio was primarily due to two fully collateralized lending relationships.

2018 compared to 2017

The Company experienced net recoveries of $926,000 for the year ended December 31, 2018 and net recoveries of $11,000 for the year ended December 31, 2017. Nonperforming assets were 0.35% as of December 31, 2018 and 0.20% as of December 31, 2017. Approximately half of the increase related to five purchased non-credit impaired loans with balances in excess of $500,000. Provision for loan losses of $2.1 million was recorded during 2018 primarily driven by organic loan growth and unknown storm related impacts in the third quarter of 2018. Provision expense for loan losses of $779,000 was recorded during 2017.

Noninterest Income and Expense

Noninterest income provides us with additional revenues that are significant sources of income. In 2019, 2018 and 2017, noninterest income comprised 21.0%, 19.8% and 26.3%, respectively, of total interest and noninterest income.

The major components of noninterest income for the Company are listed below:

	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Noninterest income:
Mortgage banking income	$	19,326			15,295			15,140
Deposit service charges		6,814			7,755			4,643
Net loss on extinguishment of debt		(178	)		—			—
Net gain (loss) on sale of securities		3,891			(1,946	)		933
Fair value adjustments on interest rate swaps		(3,659	)		(340	)		382
Net increase in cash value life insurance		1,591			1,530			1,116
Mortgage loan servicing income		10,107			9,052			6,790
Debit card income, net		4,839			4,809			2,308
Other		4,379			3,741			2,604
Total noninterest income	$	47,110			39,896			33,916

2019 compared to 2018

Noninterest income increased to $47.1 million for the year ended December 31, 2019 from $39.9 million for the year ended December 31, 2018. The increase in noninterest income for the year ended December 31, 2019 over the comparable period in 2018 primarily relates to an increase in mortgage banking income due to higher mortgage origination activity and closings as well as gains on sales of securities partially offset by fair value losses on interest rate swaps.

The following table provides a break out of mortgage banking:

	For the Years Ended December 31,
	Loan Originations				Mortgage Banking Income				Margin
	2019		2018		2019		2018		2019			2018
	(Dollars in thousands)
Additional segment information:
Community banking	$	107,452		108,721		2,998		2,352		2.79	%		2.16	%
Wholesale mortgage banking		799,975		744,208		16,328		12,943		2.04	%		1.74	%
Total	$	907,427		852,929		19,326		15,295		2.13	%		1.79	%

Mortgage loan servicing income increased $1.1 million for the year ended December 31, 2019 compared to the year ended December 31, 2018. The increase in mortgage loan servicing income was primarily driven by an increase in loans serviced for the comparative periods particularly servicing acquired in late 2018.

2018 compared to 2017

Noninterest income increased to $39.9 million for the year ended December 31, 2018 from $33.9 million for the year ended December 31, 2017. The increase in noninterest income for the year ended December 31, 2018 over the comparable period in 2017 primarily relates to an increase in mortgage loan servicing income due to higher average balances of serviced loans and an increase in deposit service charges, debit card income and other noninterest income due to organic growth in addition to the impact of the First South and Greer acquisitions in 2017, partially offset by a net loss on sale of securities.

The following table provides a break out of mortgage banking:


	For the Years Ended December 31,
	Loan Originations				Mortgage Banking Income				Margin
	2018		2017		2018		2017		2018			2017
	(Dollars in thousands)
Additional segment information:
Community banking	$	108,721		86,732		2,352		2,009		2.16	%		2.32	%
Wholesale mortgage banking		744,208		824,282		12,943		13,131		1.74	%		1.59	%
Total	$	852,929		911,014		15,295		15,140		1.79	%		1.66	%

Mortgage loan servicing income increased $2.3 million for the year ended December 31, 2018 compared to the year ended December 31, 2017. The increase in mortgage loan servicing income was primarily driven by an increase in loans serviced for the comparative periods.

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

	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Noninterest expense:
Salaries and employee benefits	$	53,822			53,517			37,827
Occupancy and equipment		16,902			15,961			10,347
Marketing and public relations		1,614			1,330			1,417
FDIC insurance		502			1,090			721
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Legal expense		438			422			507
Other real estate expense (income), net		422			(13	)		54
Mortgage subservicing expense		2,872			2,468			1,986
Amortization of mortgage servicing rights		5,721			4,206			2,966
Impairment of mortgage servicing rights		3,100			—			—
Amortization of core deposit intangible		2,910			3,139			1,037
Merger-related expenses		2,753			15,216			8,301
Other		12,436			12,472			9,182
Total noninterest expense	$	103,092			109,208			73,445

2019 compared to 2018

Noninterest expense decreased to $103.1 million for the year ended December 31, 2019 from $109.2 million for the year ended December 31, 2018. The decrease in noninterest expense is primarily the result of a decrease in merger-related expenses year over year. Noninterest expense for the year ended December 31, 2019 also included a temporary impairment of mortgage servicing rights of $3.1 million. The Company does not hedge the mortgage servicing rights positions and the impact of falling long-term interest rates increased prepayment speed assumptions driving down the value of the MSR asset.

2018 compared to 2017

Noninterest expense increased to $109.2 million for the year ended December 31, 2018 from $73.4 million for the year ended December 31, 2017. The increase in noninterest expense is primarily the result of an increase in salaries and employee benefits and occupancy and equipment as well as merger related expenses related to the acquisitions of First South and Greer during 2017. Merger related expenses totaled $15.2 million for the year ended December 31, 2018 as compared to $8.3 million for the year ended December 31, 2017.

Income Tax Expense

2019 compared to 2018

Our effective tax rate was 22.2% for the year ended December 31, 2019, compared to 20.4% for the year ended December 31, 2018. The increase in the effective tax rate from period to period reflects lower interest income on municipal securities, lower tax benefits related to excess stock-based compensation and the impact of certain non-deductible merger related expenses in 2019.

2018 compared to 2017

Our effective tax rate was 20.4% for the year ended December 31, 2018, compared to 31.2% for the year ended December 31, 2017. The decrease in the effective tax rate from period to period reflects a reduction in the federal income tax rate from 35% to 21% as enacted in the 2017 Tax Cuts and Jobs Act on December 22, 2017. In addition to the lower federal tax rate, the decrease in the effective tax rate from period to period reflects an increase in interest income on municipal securities during 2018 and tax benefits related to excess stock-based compensation.

Balance Sheet Review

Investment Securities

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

At December 31, 2019, our securities portfolio, excluding FHLB stock and other investments, was $879.2 million or approximately 18.7% of our assets. Our available-for-sale securities portfolio included municipal securities, US agency securities, collateralized loan obligations, corporate securities, mortgage-backed securities (agency and non-agency), and trust preferred securities with a fair value of $879.2 million and an amortized cost of $868.2 million resulting in a net unrealized gain of $11.0 million.

At December 31, 2019, the Company acquired approximately $50.2 million in available-for-sale securities from Carolina Trust.

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

The amortized costs and the fair value of our investments are as follows:

	At December 31,
	2019				2018				2017
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
	(In thousands)
Securities available-for-sale:
Municipal securities	$	210,810		218,968		212,215		213,714		240,904		247,350
US government agencies		23,968		23,923		24,772		25,277		11,983		12,008
Collateralized loan obligations		301,249		299,982		231,172		230,699		128,080		128,643
Corporate securities		6,940		6,988		6,915		6,960		6,891		7,006
Mortgage-backed securities:
Agency		164,114		166,714		199,518		197,520		243,075		243,595
Non-agency		150,019		151,942		158,803		157,531		94,834		95,125
Total mortgage-backed securities		314,133		318,656		358,321		355,051		337,909		338,720
Trust preferred securities		11,114		10,718		11,066		11,100		11,208		9,512
Total securities available-for-sale	$	868,214		879,235		844,461		842,801		736,975		743,239

The Company uses prices from third party pricing services to estimate the fair value of our investment securities. While we obtain fair value information from multiple sources, we generally obtain one price/quote for each individual security. For securities priced by third party pricing services, we determine the most appropriate and relevant pricing service for each security class and have that vendor provide the price for each security in the class. We record the value provided by the third party pricing service/broker in our consolidated financial statements, subject to our internal price verification procedures, which include periodic comparisons to other brokers and Bloomberg pricing screens.

Contractual maturities and yields on our investments are shown in the following table. Municipal yields were not tax effected in the table below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities available-for-sale are presented at fair value and held-to-maturity securities are presented at amortized cost.


	At December 31, 2019
	Less than 12 Months					One to Five Years					Five to Ten Years					Over Ten Years					Total
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
	(Dollars in thousands)
Securities available-for-sale:
Municipal securities	$	681		2.78	%		6,141		2.59	%		44,003		3.21	%		168,143		3.12	%		218,968		3.13	%
US government agencies		—		—			8,050		2.07	%		13,813		2.45	%		2,060		2.56	%		23,923		2.33	%
Collateralized loan obligations		—		—			—		—			74,430		3.72	%		225,552		3.62	%		299,982		4.20	%
Corporate securities		—		—			6,988		4.28	%		—		—			—		—			6,988		4.28	%
Mortgage-backed securities:
Agency		—		—			1,113		2.76	%		16,831		2.84	%		148,770		2.55	%		166,714		2.58	%
Non-agency		—		—			3		5.38	%		1,366		2.82	%		150,573		3.54	%		151,942		3.53	%
Total mortgage-backed securities		—		—			1,116		2.77	%		18,197		2.84	%		299,343		3.05	%		318,656		3.03	%
Trust preferred securities		—		—			—		—			—		—			10,718		4.10	%		10,718		4.10	%
Total securities available-for-sale	$	681		2.78	%		22,295		2.94	%		150,443		3.35	%		705,816		3.26	%		879,235		3.46	%

For disclosures related to the Company’s evaluation of securities for OTTI, see Note 4 – Securities within Item 8. “Financial Statements and Supplementary Data.”

Non-marketable investments are comprised of the following and are recorded at cost which approximates fair value since no readily available market exists for these securities.

	At December 31,
	2019		2018
	(In thousands)
Community Reinvestment Act fund	$	2,405		2,334
Investment in Trust Preferred subsidiaries		1,116		1,116
Total other investments		3,521		3,450

Federal Home Loan Bank stock, at cost		23,280		21,696
Total non-marketable investments	$	26,801		25,146

Loans by Type

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Gross loans receivable at December 31, 2019 and 2018 were $3.2 billion and $2.5 billion, respectively.

Our loan portfolio consists primarily of loans secured by real estate mortgages. As of December 31, 2019, our loan portfolio included $2.7 billion, or 84.7%, of gross loans secured by real estate. As of December 31, 2018, our loan portfolio included $2.1 billion, or 84.8%, of gross loans secured by real estate. Substantially all of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types.

As shown in the table below, loans receivable, gross grew $703.6 million since December 31, 2018. Excluding the impact of loans acquired from Carolina Trust, loans receivable, gross grew $222.6 million, or 8.8% since December 31, 2018. The growth in loan balances was primarily the result of strong organic growth in both commercial and residential lending.

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


	At December 31,
	2019					2018					2017
			% of Total					% of Total					% of Total
All Loans:	Amount		Loans			Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	785,572		24.34	%		732,717		29.03	%		665,774		28.70	%
Home equity		110,016		3.41	%		83,770		3.32	%		90,141		3.89	%
Commercial real estate		1,394,626		43.20	%		1,034,117		40.96	%		933,820		40.26	%
Construction and development		442,657		13.71	%		290,494		11.51	%		294,793		12.71	%
Consumer loans		26,500		0.82	%		23,845		0.94	%		19,990		0.86	%
Commercial business loans		468,566		14.52	%		359,393		14.24	%		315,010		13.58	%
Total gross loans receivable		3,227,937		100.00	%		2,524,336		100.00	%		2,319,528		100.00	%
Less:
Allowance for loan losses		16,521					14,463					11,478
Total loans receivable, net	$	3,211,416					2,509,873					2,308,050

	At December 31,
	2016					2015
			% of Total					% of Total
	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	411,399		34.91	%		344,928		37.38	%
Home equity		36,026		3.06	%		23,256		2.52	%
Commercial real estate		445,344		37.80	%		341,658		37.03	%
Construction and development		115,682		9.82	%		91,362		9.90	%
Consumer loans		5,714		0.48	%		5,179		0.56	%
Commercial business loans		164,101		13.93	%		116,340		12.61	%
Total gross loans receivable		1,178,266		100.00	%		922,723		100.00	%
Less:
Allowance for loan losses		10,688					10,141
Total loans receivable, net	$	1,167,578					912,582

Maturities and Sensitivity of Loans to Changes in Interest Rates

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

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

	At December 31, 2019
			After one
	One Year		but within		After five
	or Less		five years		years		Total
	(In thousands)
Loans secured by real estate:
One-to-four family	$	43,586		194,817		547,169		785,572
Home equity		12,276		25,520		72,220		110,016
Commercial real estate		176,990		899,643		317,993		1,394,626
Construction and development		123,718		272,749		46,190		442,657
Consumer loans		3,168		11,105		12,227		26,500
Commercial business loans		72,100		293,312		103,154		468,566
Total gross loans receivable	$	431,838		1,697,146		1,098,953		3,227,937

Loans maturing - after one year
Variable rate loans							$	1,007,928
Fixed rate loans								1,788,171
							$	2,796,099

Nonperforming and Problem Assets

Nonperforming assets include loans on which interest is not being accrued, accruing loans that are 90 days or more delinquent and foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of a borrower’s loan default. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction of principal when received. In general, a nonaccrual loan may be placed back onto accruing status once the borrower has made a minimum of six consecutive payments in accordance with the loan terms. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. As of December 31, 2019, and December 31, 2018, the Company had $2.0 million and $0.6 million, respectively, of PCI loans that were 90 days past due and accruing.

Troubled Debt Restructurings (“TDRs”)

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

The following table summarizes nonperforming and problem assets, excluding purchased credit impaired loans, at the end of the periods indicated.

	At December 31,
	2019		2018		2017		2016		2015
	(In thousands)
Loans receivable:
90 days and still accruing	$	—		20		—		—		—
Nonaccrual loans-renegotiated loans		6,636		3,086		1,140		1,227		1,136
Nonaccrual loans-other		18,530		8,635		2,793		4,398		3,166
Real estate acquired through foreclosure, net		2,325		1,534		3,106		1,179		2,374
Total non-performing assets	$	27,491		13,275		7,039		6,804		6,676

Problem assets not included in non-performing assets:
Accruing renegotiated loans outstanding	$	4,473		3,327		5,324		5,216		13,212

At December 31, 2019, nonperforming assets were $27.5 million, or 0.58% of total assets. Comparatively, nonperforming assets were $13.3 million, or 0.35% of total assets, at December 31, 2018. Nonperforming loans were 0.78% and 0.47% of gross loans receivable at December 31, 2019 and December 31, 2018, respectively.

At December 31, 2018, nonperforming assets were $13.3 million, or 0.35% of total assets. Comparatively, nonperforming assets were $7.0 million, or 0.20% of total assets, at December 31, 2017. Nonperforming loans were 0.47% and 0.17% of gross loans receivable at December 31, 2018 and December 31, 2017, respectively.

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $4.5 million at December 31, 2019, compared to $3.3 million at December 31, 2018. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $3.3 million at December 31, 2018, compared to $5.3 million at December 31, 2017. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.

Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans for fiscal years 2019 and 2018 are collateralized by real estate. The Bank utilizes third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require the Bank to obtain updated appraisals on loans greater than $250,000 at a minimum of every 18 months, either through a new external appraisal or an internal appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. Management believes based on information known and available currently, the probable losses related to problem assets are adequately reserved in the allowance for loan losses.

Allowance for Loan Losses

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

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

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

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

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

The allowance for loan losses was $16.5 million, or 0.74% of non-acquired loans, at December 31, 2019, compared to $14.5 million, or 0.79% of total non-acquired loans, at December 31, 2018. Loans acquired in business combinations were $989.5 million and $686.4 million at December 31, 2019 and December 31, 2018, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. At December 31, 2019 and December 31, 2018, acquired non-credit impaired loans had a purchase discount remaining of $9.5 million and $10.9 million, respectively.

The allowance for loan losses was $14.5 million, or 0.79% of non-acquired loans, at December 31, 2018, compared to $11.5 million, or 0.84% of total non-acquired loans, at December 31, 2017. Loans acquired in business combinations were $686.4 million and $952.2 million at December 31, 2018 and December 31, 2017, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. At December 31, 2018 and December 31, 2017, acquired non-credit impaired loans had a purchase discount remaining of $10.9 million and $17.7 million, respectively.

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


	At December 31,
	2019			2018
	(Dollars in thousands)
Acquired and non-acquired loans:
Acquired loans receivable	$	989,534			686,401
Non-acquired loans receivable		2,238,403			1,837,935
Total loans receivable	$	3,227,937			2,524,336
% Acquired		30.66	%		27.19	%

Non-acquired loans	$	2,238,403			1,837,935
Allowance for loan losses		16,521			14,463
Allowance for loan losses to non-acquired loans (Non-GAAP)		0.74	%		0.79	%

Total loans receivable	$	3,227,937			2,524,336
Allowance for loan losses		16,521			14,463
Allowance for loan losses to total loans receivable		0.51	%		0.57	%

The Company experienced net charge-offs of approximately $522,000 for the year ended December 31, 2019 and net recoveries of $926,000 for the year ended December 31, 2018. Provision for loan losses of $2.6 million was recorded during 2019 primarily driven by organic loan growth. Provision expense for loan losses of $2.1 million was recorded during 2018. The increase was primarily due to loan growth and reduced recoveries in 2019. Non-performing assets were 0.58% and 0.35% of total assets at December 31, 2019 and 2018, respectively. The increase in the NPA ratio was primarily due to two fully collateralized lending relationships.

The Company experienced net recoveries of $926,000 for the year ended December 31, 2018 and net recoveries of $11,000 for the year ended December 31, 2017. Nonperforming assets were 0.35% as of December 31, 2018 and 0.20% as of December 31, 2017. Provision expense was $2.1 million and $779,000 for 2018 and 2017, respectively.

The following table summarizes the activity related to our allowance for loan losses for the five years ended December 31, 2019.


	For the Years Ended December 31,
	2019			2018			2017			2016			2015
	(Dollars in thousands)
Balance, beginning of period	$	14,463			11,478			10,688			10,141			9,035
Provision for loan losses		2,580			2,059			779			—			—
Loan charge-offs:
Loans secured by real estate:
One-to-four family		(293	)		(226	)		(253	)		(84	)		(1,050	)
Home equity		(78	)		(31	)		—			—			—
Commercial real estate		(380	)		(86	)		—			—			—
Construction and development		(19	)		(24	)		—			—			(90	)
Consumer loans		(320	)		(308	)		(19	)		(53	)		(20	)
Commercial business loans		(145	)		(197	)		—			(127	)		(70	)
Total loan charge-offs		(1,235	)		(872	)		(272	)		(264	)		(1,230	)
Loan recoveries:
Loans secured by real estate:
One-to-four family		174			142			4			464			576
Home equity		6			7			3			—			150
Commercial real estate		35			77			31			—			350
Construction and development		248			1,112			81			76			479
Consumer loans		165			93			45			24			38
Commercial business loans		85			367			119			247			743
Total loan recoveries		713			1,798			283			811			2,336
Net loan (charge-offs) recoveries		(522	)		926			11			547			1,106
Balance, end of period	$	16,521			14,463			11,478			10,688			10,141

Allowance for loan losses as a percentage of loans receivable (end of period)		0.51	%		0.57	%		0.49	%		0.91	%		1.10	%
Net charge-offs (recoveries) to average loans receivable		0.02	%		(0.04	)%		—			(0.05	)%		(0.13	)%

The following table summarizes an allocation of the allowance for loan losses and the related percentage of loans outstanding in each category for the five years ended December 31, 2019.

	At December 31,
	2019					2018					2017					2016					2015
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
						(Dollars in thousands)
Loans receivable:
One-to-four family	$	3,531		24.34	%		3,540		29.03	%		2,719		28.70	%		2,636		34.91	%		2,903		37.23	%
Home equity		225		3.41	%		203		3.32	%		168		3.89	%		197		3.06	%		151		2.52	%
Commercial real estate		5,746		43.20	%		5,097		40.96	%		3,986		40.26	%		3,344		37.80	%		3,402		37.10	%
Construction and development		2,542		13.71	%		1,969		11.51	%		1,201		12.71	%		1,132		9.82	%		1,138		9.94	%
Consumer loans		392		0.82	%		352		0.94	%		79		0.86	%		80		0.48	%		27		0.56	%
Commercial business loans		3,448		14.52	%		2,940		14.24	%		2,840		13.58	%		2,805		13.93	%		2,100		12.65	%
Unallocated		637		—			362		—			485		—			494		—			420		—
Total	$	16,521		100.00	%		14,463		100.00	%		11,478		100.00	%		10,688		100.00	%		10,141		100.00	%

Mortgage Operations

Mortgage Activities and Servicing

Our wholesale mortgage banking operations are conducted through our mortgage origination subsidiary, Crescent Mortgage Company. Mortgage activities involve the purchase of mortgage loans and table funded originations for the purpose of generating gains on sales of loans and fee income on the origination of loans and is included in mortgage banking income in the accompanying consolidated statements of operations. While the Company originates residential one-to-four family loans that are held in its loan portfolio, the majority of new loans are generally sold pursuant to third party market guidelines through Crescent Mortgage Company. Generally, residential mortgage loans are sold and, depending on the pricing in the marketplace, servicing rights are either sold or retained. The level of loan sale activity and its contribution to the Company’s profitability depends on maintaining a sufficient volume of loan originations and margin. Changes in the level of interest rates and the local economy affect the volume of loans originated by the Company and the amount of loan sales and loan fees earned. Discussion related to the impact and changes within the mortgage operations is provided in “Results of Operations – Noninterest Income and Expense”. Additional segment information is provided in Note 21 - Supplemental Segment Information in the accompanying financial statements.

Loan Servicing

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

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

The Company was servicing $3.6 billion loans for others at December 31, 2019 and $4.0 billion at December 31, 2018. Mortgage servicing rights asset had a balance of $25.9 million and $32.9 million at December 31, 2019 and December 31, 2018, respectively. The midpoint economic estimated fair value of the mortgage servicing rights was $31.4 million and $40.9 million at December 31, 2019 and December 31, 2018, respectively. Amortization expense related to the mortgage servicing rights was $5.7 million and $4.2 million during the years ended December 31, 2019 and 2018, respectively.

Below is a roll-forward of activity in the balance of the servicing assets for the years ended December 31, 2019 and 2018 respectively:


	At December 31,
	2019			2018
	(In thousands)
MSR beginning balance	$	32,933			21,003
Amount capitalized		1,368			6,283
Purchased servicing		461			9,853
Amount amortized		(5,721	)		(4,206	)
MSR Impairment		(3,100	)		—
MSR ending balance	$	25,941			32,933

Reserve for Mortgage Repurchase Losses

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

The following table demonstrates the activity for the mortgage repurchase reserve for the years ended December 31, 2019, 2018, and 2017:

	For the Years Ended
	December 31,
	2019			2018			2017
	(In thousands)

Beginning balance	$	1,292			1,892			2,880
Losses paid		—			—			(88	)
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Ending balance	$	892			1,292			1,892

For the years ended December 31, 2019 and 2018, the Company recorded a recovery for mortgage repurchase losses of $400,000 and $600,000, respectively. The recovery for mortgage loan repurchase losses is related to several factors. The Company sells mortgage loans to various third parties, including government-sponsored entities (“GSEs”), under contractual provisions that include various representations and warranties as previously stated. The Company establishes the reserve for mortgage loan repurchase losses based on a combination of factors, including estimated levels of defects on internal quality assurance, default expectations, historical investor repurchase demand and appeals success rates, reimbursement by correspondent and other third party originators, and projected loss severity. As a result of the Company’s analysis of its reserve for mortgage loan repurchase losses, the reserve was reduced accordingly.

Deposits

We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. At December 31, 2019, deposits totaled $3.4 billion, an increase from deposits of $2.7 billion at December 31, 2018. The increase in deposits since December 31, 2018 relates to deposits acquired from Carolina Trust as well as continued efforts to fund our balance sheet growth with core deposits through business development.

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


	For the Years Ended December 31,
	2019					2018					2017
	Average		Average			Average		Average			Average		Average
	Balance		Rate			Balance		Rate			Balance		Rate
	(Dollars in thousands)

Interest-bearing demand accounts	$	573,745		0.44	%		564,282		0.55	%		319,190		0.26	%
Money market accounts		442,076		1.05	%		459,774		0.66	%		374,770		0.47	%
Savings accounts		183,843		0.54	%		201,741		0.31	%		89,598		0.19	%
Certificates of deposit less than $100,000		523,052		1.83	%		330,815		1.18	%		220,742		0.92	%
Certificates of deposit of $100,000 or more		494,743		1.89	%		579,618		1.38	%		401,682		1.10	%
Total interest-bearing average deposits		2,217,459		1.22	%		2,136,230		0.88	%		1,405,982		0.67	%

Noninterest-bearing deposits		601,133					561,678					355,105
Total average deposits	$	2,818,592					2,697,908					1,761,087

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

	At December 31,
	2019		2018
	(In thousands)

Three months or less	$	143,658		126,653
Over three through six months		235,092		75,425
Over six through twelve months		114,602		110,300
Over twelve months		185,126		160,006
Total certificates of deposits	$	678,478		472,384

Borrowings

The following table outlines our various sources of short-term borrowed funds during the years ended December 31, 2019, 2018 and 2017, and the amounts outstanding at the end of each period, the maximum amount for each component during the periods, the average amounts for each period, and the average interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown. Stated period end rates are contractual rates. The average for the period rates reflect the impact of purchase accounting.

					Maximum
			Contractual		Month		Average for the
	Ending		Period End		End		Period
At or for the year ended December 31, 2019	Balance		Rate		Balance		Balance		Rate⁽¹⁾
	(Dollars in thousands)
Short-term borrowed funds
Short-term FHLB advances	$	437,700		1.66%-2.02%		437,700		365,429		2.28	%

Long-term borrowed funds
Long-term FHLB advances, due 2021 through 2029		12,114		0.88%-2.39%		27,000		16,134		1.82	%
Subordinated debentures, due 2026 through 2037		42,761		3.67%-6.90%		42,761		32,554		6.57	%

			Stated		Maximum
			Period		Month		Average for the
	Ending		End		End		Period
At or for the year ended December 31, 2018	Balance		Rate		Balance		Balance		Rate⁽¹⁾
	(Dollars in thousands)
Short-term borrowed funds
Short-term FHLB advances	$	405,500		1.05%-2.78%		405,500		316,189		1.92	%

Long-term borrowed funds
Long-term FHLB advances, due 2019 through 2020		27,000		1.72%-2.60%		42,500		27,117		1.59	%
Subordinated debentures, due 2032 through 2037		32,436		4.25%-5.75%		32,436		32,348		6.26	%

			Stated		Maximum
			Period		Month		Average for the
	Ending		End		End		Period
At or for the year ended December 31, 2017	Balance		Rate		Balance		Balance		Rate⁽¹⁾
	(Dollars in thousands)
Short-term borrowed funds
Short-term FHLB advances	$	340,500		0.87%-2.71%		340,500		176,169		1.07	%

Long-term borrowed funds
Long-term FHLB advances, due 2019 through 2020		40,000		1.05%-1.98%		52,000		35,357		2.33	%
Subordinated debentures, due 2032 through 2037		32,259		3.11%-4.75%		32,259		23,182		4.97	%

(1) Subordinated debentures average rate for the period reflects the amortization of the related purchase accounting mark, if any.

Liquidity

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

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

Lines of credit with the FHLB of Atlanta are based upon FHLB-approved percentages of Bank assets, but must be supported by appropriate collateral to be available. The Company has pledged first lien residential mortgage, second lien residential mortgage, residential home equity line of credit, commercial mortgage and multifamily mortgage portfolios under blanket lien agreements. At December 31, 2019, the Company had FHLB advances of $449.8 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately $416.1 million.

Lines of credit with the FRB are based on collateral pledged. At December 31, 2019 the Company had lines available with the FRB for $188.3 million. At December 31, 2019 the Company had no FRB advances outstanding.

At December 31 , 2019, the Company had pledged with a market value of $29.8 million of securities for Federal Home Loan Bank advances.

At December 31, 2019, the Company has pledged $141.6 million of securities to secure public agency funds. In addition, the Company has pledged a $15 million letter of credit to secure public agency funds.

Capital Resources

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

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

The required minimum ratios are as follows:

	·	Common equity Tier 1 capital ratio (common equity Tier 1 capital to total risk-weighted assets) of 4.5%

	·	Tier 1 Capital Ratio (Tier 1 capital to total risk-weighted assets) of 6%

	·	Total capital ratio (total capital to total risk-weighted assets) of 8%; and

	·	Leverage ratio (Tier 1 capital to average total consolidated assets) of 4%

The new capital guidelines also provide that all covered banking organizations must maintain a new capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The phase-in of the capital conservation buffer requirement began on January 1, 2016 and became fully phased in as of January 1, 2019.

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

On June 11, 2018, the Company completed the sale of 1.5 million shares of its common stock. The net proceeds of the offering to the Company, after estimated expenses, were approximately $63.0 million.

The actual capital amounts and ratios as well as minimum amounts for each regulatory defined category for the Company and the Bank at December 31, 2019 and 2018 are as follows:


																To Be Well
						Minimum Capital					Minimum Capital					Capitalized Under
						Required - Basel III					Required - Basel III					Prompt Corrective
	Actual					Phase-In Schedule					Fully Phased-In					Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)

December 31, 2019
Carolina Financial Corporation
CET1 capital (to risk weighted assets)	$	534,742		15.10	%		247,915		7.000	%		247,915		7.000	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		566,240		15.99	%		301,040		8.500	%		301,040		8.500	%		N/A		N/A
Total capital (to risk weighted assets)		592,908		16.74	%		371,873		10.500	%		371,873		10.500	%		N/A		N/A
Tier 1 capital (to total average assets)		566,240		15.03	%		150,695		4.000	%		150,695		4.000	%		N/A		N/A

CresCom Bank
CET1 capital (to risk weighted assets)		580,752		16.41	%		247,744		7.000	%		247,744		7.000	%		230,048		6.50	%
Tier 1 capital (to risk weighted assets)		580,752		16.41	%		300,832		8.500	%		300,832		8.500	%		283,136		8.00	%
Total capital (to risk weighted assets)		597,273		16.88	%		371,616		10.500	%		371,616		10.500	%		353,920		10.00	%
Tier 1 capital (to total average assets)		580,752		15.42	%		150,663		4.000	%		150,663		4.000	%		188,329		5.00	%

December 31, 2018
Carolina Financial Corporation
CET1 capital (to risk weighted assets)	$	431,568		15.19	%		181,094		6.375	%		198,848		7.000	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		462,888		16.29	%		223,704		7.875	%		241,459		8.500	%		N/A		N/A
Total capital (to risk weighted assets)		477,351		16.80	%		280,518		9.875	%		298,273		10.500	%		N/A		N/A
Tier 1 capital (to total average assets)		462,888		13.01	%		142,270		4.000	%		142,270		4.000	%		N/A		N/A

CresCom Bank
CET1 capital (to risk weighted assets)		454,181		16.00	%		180,948		6.375	%		198,688		7.000	%		184,496		6.50	%
Tier 1 capital (to risk weighted assets)		454,181		16.00	%		223,524		7.875	%		241,264		8.500	%		227,072		8.00	%
Total capital (to risk weighted assets)		468,644		16.51	%		280,292		9.875	%		298,032		10.500	%		283,840		10.00	%
Tier 1 capital (to total average assets)		454,181		12.76	%		142,392		4.000	%		142,392		4.000	%		177,990		5.00	%

The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the three years ended December 31, 2019, 2018 and 2017.

	For the Years Ended December 31,
	2019			2018			2017

Return on average assets		1.61	%		1.37	%		1.24	%
Return on average equity		10.36	%		9.43	%		10.17	%
Average equity to average assets ratio		15.55	%		14.51	%		12.18	%

The following table provides the amount of dividends and payout ratios (dividends declared divided by net income) for the years ended December 31, 2019, 2018 and 2017.

	For the Years Ended December 31,
	2019			2018			2017
	(Dollars in thousands)

Dividends declared	$	8,021			5,563			2,920
Dividend payout ratios		12.78	%		11.20	%		10.22	%

We retain earnings to have capital sufficient to grow our loan and investment portfolios and to support certain acquisitions or other business expansion opportunities as they arise. The dividend payout ratio is calculated by dividing dividends paid during the year by net income for the year.

Off Balance Sheet Arrangements

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

At December 31, 2019, we had issued commitments to extend credit of approximately $659.1 million through various types of lending arrangements. There were 72 standby letters of credit in the amount of $23.8 million. Total variable rate commitments were $481.8 million and fixed rate commitments were $201.1 million.

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

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

Market Risk Management and Interest Rate Risk

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

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

As of December 31, 2019, the following table summarizes the forecasted impact on net interest income using a base case scenario given downward movements in interest rates of 100 and 200 and upward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the consolidated financial statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market condition.

		Annualized Hypothetical
Interest Rate Scenario		Percentage Change in
Change	Prime Rate	Net Interest Income

(2.00)%	2.75%	(4.10)%
(1.00)%	3.75%	(1.70)%
0.00%	4.75%	0.00%
1.00%	5.75%	0.30%
2.00%	6.75%	0.70%
3.00%	7.75%	0.90%

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

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

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

The derivative positions of the Company at December 31, 2019 and 2018 are as follows:

	At December 31,
	2019				2018
	Fair		Notional		Fair		Notional
	Value		Value		Value		Value
	(In thousands)
Derivative assets:
Cash flow hedges:
Interest rate swaps	$	—		—		1,232		45,000
Non-hedging derivatives:
Interest rate swaps		138		35,000		1,198		50,000
Mortgage loan interest rate lock commitments		1,073		86,819		1,199		76,571
Mortgage loan forward sales commitments		580		26,240		403		13,241
Total derivative assets	$	1,791		148,059		4,032		184,812

Derivative liabilities:
Cash flow hedges:
Interest rate swaps	$	620		45,000		—		—
Non-hedging derivatives:
Interest rate swaps		2,767		40,000		937		50,000
Mortgage-backed securities forward sales commitments		40		61,000		295		52,000
Total derivative liabilities	$	3,427		146,000		1,232		102,000

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

As of December 31, 2019, the Company had three outstanding interest rate derivatives with a notional value of $45.0 million that were designated as cash flow hedges of interest rate risk with a weighted average remaining term of 4.43 years.

As of December 31, 2018, the Company had three outstanding interest rate derivatives with a notional value of $45.0 million that were designated as cash flow hedges of interest rate risk with a weighted average remaining term of 5.43 years.

For cash flow hedges, in the event that the forecasted transaction was no longer probable, the Company would recognize a loss of approximately $600,000 directly into earnings, the current fair value, as of December 31, 2019.

Contractual Obligations

The following table presents payment schedules for certain of our contractual obligations as of December 31, 2019. Operating lease obligations of $23.0 million pertain to banking facilities and equipment. Certain lease agreements include payment of property taxes and insurance and contain various renewal options. Additional information regarding leases is contained in Note 14 of the audited consolidated financial statements. Trust Preferred subordinated debentures reflect the contractual principal owed excluding purchase accounting fair value adjustments.

			Less than		1 to 3		3 to 5		More than
	Total		1 Year		Years		Years		5 Years
	(In thousands)

Advances from FHLB	$	449,814		437,700		8,038		—		4,076
Interest rate swap - cash flow hedge derivative		45,000		—		15,000		30,000		—
Interest rate swap - non-hedging derivative		75,000		30,000		10,000		—		35,000
Subordinated debentures issued to Carolina Financial Capital Trust I, due 2032		5,155		—		—		—		5,155
Subordinated debentures issued to Carolina Financial Capital Trust II, due 2034		10,310		—		—		—		10,310
Subordinated debentures issued to Greer Capital Trust I, due 2034		6,186		—		—		—		6,186
Subordinated debentures issued to Greer Capital Trust II, due 2037		5,155		—		—		—		5,155
Subordinated debentures issued to FSB Preferred Trust I, due 2033		10,310		—		—		—		10,310
Subordinated debentures issued to Carolina Trust, due 2026		10,000		—		—		—		10,000
Operating lease obligations		23,040		2,595		4,113		3,451		12,881
Total	$	639,970		470,295		37,151		33,451		99,073

Accounting, Reporting, and Regulatory Matters

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

Effect of Inflation and Changing Prices

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

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

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk and Interest Rate Sensitivity and – Liquidity and Capital Resources.

Item 8. Financial Statements and Supplementary Data

(LOGO)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Carolina Financial Corporation

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Carolina Financial Corporation and its subsidiary (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes to the consolidated financial statements and schedules (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 2, 2020 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Loan Losses

As described in Note 6 to the Company’s consolidated financial statements, the Company has a gross loan portfolio of $3.2 billion and related allowance for loan losses of $16.5 million as of December 31, 2019. The Company’s allowance for loan losses includes a general reserve, which is determined based on the results of a quantitative and a qualitative analysis of all loans not specifically measured for impairment at the reporting date.

In calculating the allowance for loan losses, the Company calculates a reserve based on historical loss experience determined by major loan category. The actual loss experience is supplemented with internal and external qualitative factors. As such, the estimation of loss is based on significant management judgment, particularly where the Company has not incurred sufficient historical losses and has utilized qualitative factors in forming its estimate. Auditing these complex judgments and assumptions by management involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.

The primary procedures we performed to address this critical audit matter included:

Testing the design and operating effectiveness of controls relating to management’s review of loans, evaluation of historical losses, and the final reserve coverage.

Substantively testing and evaluating the reasonableness of assumptions and sources of data used by management in the allowance for loan losses calculations and in forming the qualitative loss factors by performing retrospective review of historical loan loss experience and analyzing historical data used in developing the assumptions.

Substantively testing the mathematical accuracy and computation of the allowance for loan losses by independently calculating significant elements of the allowance based on relevant source documents and testing completeness and accuracy of data used in the calculation.

Business Combinations

As described in Note 2 to the Company’s consolidated financial statements, the Company had one acquisition during the year ended December 31, 2019, which was the acquisition of Carolina Trust BancShares, Inc. with total consideration paid of approximately $119.5 million. The most material and complex components of the transaction related to the estimated fair values of the assets acquired and liabilities assumed at the acquisition date.

The Company’s determination of fair values of certain identifiable tangible and intangible assets acquired and liabilities assumed is complex and includes the following areas of management’s judgments: (1) application of accounting guidance related to business combinations, (2) significant unobservable inputs and assumptions utilized by management in determining the fair values of certain identifiable tangible and intangible assets acquired and liabilities assumed, and (3) changes in certain assumptions could have a significant impact on the fair values of the identifiable tangible and intangible assets acquired and liabilities assumed. Auditing these elements involves especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters, including the extent of specialized skill or knowledge needed.

The primary procedures we performed to address this critical audit matter included:

Testing the design and operating effectiveness of controls relating to management’s review of the business combination and fair values of acquired assets and liabilities assumed.

Substantively testing and evaluating management’s third-party valuation specialists and evaluating their conclusions regarding fair values of assets acquired and liabilities assumed, including an evaluation of the significant assumptions utilized in their fair value calculations.

Substantively testing the assumptions that were incorporated into the various models used to calculate fair value.

Mortgage Servicing Rights

As described in Note 9 to the Company’s consolidated financial statements, the Company has unpaid principal balances of loans serviced for others of $3.6 billion at December 31, 2019. The Company’s economic estimated fair values of mortgage servicing rights was $31.4 million at December 31, 2019. The Company’s valuation of mortgage servicing rights is a material and complex estimate requiring significant management judgment, specifically as it pertains to the evaluation of potential impairment within the mortgage servicing right portfolio.

Management relies on a third-party valuation specialist to calculate an estimated fair value of their mortgage servicing rights portfolio. The third-party valuation specialist and the valuation process utilizes several significant assumptions to determine an estimated fair value, including net servicing fee, weighted average discount rates, weighted average constant prepayment rates, and a weighted average delinquency rate. Management evaluates the significant assumptions as well as the final value of the portfolio, including any impairment that needs to be recognized. As such, the fair value estimate, and specifically the measure of impairment, is based on significant management judgment. Auditing these complex judgments and assumptions involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.

The primary procedures we performed to address this critical audit matter included:

Testing the design and operating effectiveness of controls relating to management’s review of the mortgage servicing rights portfolio valuation, including the measurement of impairment.

Substantively testing and evaluating the reasonableness of assumptions used by management and the third-party valuation specialist in the mortgage servicing rights portfolio valuation by utilizing Elliott Davis, LLC valuation specialists to evaluate the reasonableness of the key assumptions utilized in the calculation.

Substantively testing the mathematical accuracy and computation of the mortgage servicing rights by independently calculating significant elements of the valuation as determined by management’s third-party valuation specialist.

/s/ Elliott Davis, LLC

We have served as the Company’s auditor since 2010.

Greenville, South Carolina

March 2, 2020

(LOGO)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Carolina Financial Corporation

Opinion on the Internal Control Over Financial Reporting

We have audited Carolina Financial Corporation and Subsidiary’s (the “Company”) internal control over financial reporting as of December 31, 2019 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013 (the “COSO criteria”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019 based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018 and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019 and our report dated March 2, 2020 expressed an unqualified opinion.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Report On Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Elliott Davis, LLC

Greenville, South Carolina

March 2, 2020

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS


	At December 31,
	2019		2018
	(In thousands)
ASSETS
Cash and due from banks	$	41,411		28,857
Interest-bearing cash		91,792		33,276
Cash and cash equivalents		133,203		62,133
Securities available-for-sale (cost of $868,214 at December 31, 2019 and $844,461 at December 31, 2018)		879,235		842,801
Federal Home Loan Bank stock, at cost		23,280		21,696
Other investments		3,521		3,450
Derivative assets		1,791		4,032
Loans held for sale		31,282		16,972
Loans receivable, net of allowance for loan losses of $16,521 at December 31, 2019 and $14,463 at December 31, 2018		3,211,416		2,509,873
Premises and equipment, net		70,702		60,866
Right of use operating lease asset		17,163		—
Accrued interest receivable		14,951		13,494
Real estate acquired through foreclosure, net		2,325		1,534
Deferred tax assets, net		2,463		5,786
Mortgage servicing rights		25,941		32,933
Cash value life insurance		71,267		58,728
Core deposit intangible		16,621		16,462
Goodwill		184,259		127,592
Other assets		19,453		12,396
Total assets	$	4,708,873		3,790,748

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Noninterest-bearing deposits	$	668,616		547,022
Interest-bearing deposits		2,739,745		2,171,171
Total deposits		3,408,361		2,718,193
Short-term borrowed funds		437,700		405,500
Long-term debt		54,875		59,436
Right of use operating lease liability		17,593		—
Derivative liabilities		3,427		1,232
Drafts outstanding		8,193		8,129
Advances from borrowers for insurance and taxes		3,288		4,100
Accrued interest payable		2,450		1,591
Reserve for mortgage repurchase losses		892		1,292
Dividends payable to stockholders		2,227		1,576
Accrued expenses and other liabilities		26,427		14,414
Total liabilities		3,965,433		3,215,463
Stockholders' equity:
Preferred stock, par value $.01; 1,000,000 shares authorized at December 31, 2019 and December 31, 2018; no shares issued or outstanding		—		—
Common stock, par value $.01; 50,000,000 shares authorized at December 31, 2019 and December 31, 2018, respectively; 24,777,608 and 22,387,009 issued and outstanding at December 31, 2019 and December 31, 2018, respectively		248		224
Additional paid-in capital		514,272		408,224
Retained earnings		221,103		167,173
Accumulated other comprehensive income (loss), net of tax		7,817		(336	)
Total stockholders' equity		743,440		575,285
Total liabilities and stockholders' equity	$	4,708,873		3,790,748

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS


	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands, except share data)
Interest income
Loans	$	147,921			133,252			79,300
Investment securities		27,424			26,222			14,941
Dividends from Federal Home Loan Bank stock		1,203			1,004			496
Other interest income		568			580			350
Total interest income		177,116			161,058			95,087
Interest expense
Deposits		27,106			18,727			9,387
Short-term borrowed funds		8,328			6,064			1,888
Long-term debt		2,432			2,457			1,978
Total interest expense		37,866			27,248			13,253
Net interest income		139,250			133,810			81,834
Provision for loan losses		2,580			2,059			779
Net interest income after provision for loan losses		136,670			131,751			81,055
Noninterest income
Mortgage banking income		19,326			15,295			15,140
Deposit service charges		6,814			7,755			4,643
Net loss on extinguishment of debt		(178	)		—			—
Net gain (loss) on sale of securities		3,891			(1,946	)		933
Fair value adjustments on interest rate swaps		(3,659	)		(340	)		382
Net increase in cash value life insurance		1,591			1,530			1,116
Mortgage loan servicing income		10,107			9,052			6,790
Debit card income, net		4,839			4,809			2,308
Other		4,379			3,741			2,604
Total noninterest income		47,110			39,896			33,916
Noninterest expense
Salaries and employee benefits		53,822			53,517			37,827
Occupancy and equipment		16,902			15,961			10,347
Marketing and public relations		1,614			1,330			1,417
FDIC insurance		502			1,090			721
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Legal expense		438			422			507
Other real estate expense (income), net		422			(13	)		54
Mortgage subservicing expense		2,872			2,468			1,986
Amortization of mortgage servicing rights		5,721			4,206			2,966
Impairment of mortgage servicing rights		3,100			—			—
Amortization of core deposit intangible		2,910			3,139			1,037
Merger related expenses		2,753			15,216			8,301
Other		12,436			12,472			9,182
Total noninterest expense		103,092			109,208			73,445
Income before income taxes		80,688			62,439			41,526
Income tax expense		17,948			12,769			12,961
Net income	$	62,740			49,670			28,565

Earnings per common share:
Basic	$	2.83			2.28			1.75
Diluted	$	2.80			2.26			1.73
Dividends declared per common share	$	0.36			0.25			0.17
Weighted average common shares outstanding:
Basic		22,168,082			21,756,595			16,317,501
Diluted		22,385,127			21,972,857			16,550,357

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME


	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)

Net income	$	62,740			49,670			28,565

Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities		16,614			(7,775	)		10,047
Tax effect		(4,154	)		1,944			(3,620	)

Reclassification adjustment for (gain) loss included in earnings		(3,891	)		1,946			(933	)
Tax effect		973			(489	)		334

Unrealized (loss) gain on interest rate swaps designated as cash flow hedges		(1,852	)		588			223
Tax effect		463			(147	)		(80	)
Other comprehensive income (loss), net of tax		8,153			(3,933	)		5,971

Comprehensive income	$	70,893			45,737			34,536

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

													Accumulated
							Additional						Other
	Common Stock						Paid-in			Retained			Comprehensive
	Shares			Amount			Capital			Earnings			Income (Loss)			Total
	(In thousands, except share data)

Balance, December 31, 2016		12,548,328		$	125			66,156			98,451			(1,542	)		163,190
Issuance of common stock, net of offering expenses		1,807,143			18			47,653			—			—			47,671
Stock awards, net of forfeitures		113,768			1			107			—			—			108
Vested stock awards surrendered in cashless exercise		(59,700	)		—			(398	)		(1,391	)		—			(1,789	)
Stock options exercised		600			—			10			—			—			10
Stock issued - Greer Bancshares, Inc. merger		1,789,523			18			54,205			—			—			54,223
Stock issued - First South Bancorp, Inc. merger		4,822,540			48			178,646			—			—			178,694
Stock-based compensation expense, net		—			—			1,658			—			—			1,658
Net income		—			—			—			28,565			—			28,565
Dividends declared to stockholders		—			—			—			(2,920	)		—			(2,920	)
Other comprehensive income, net of tax		—			—			—			—			5,971			5,971
Reclassification of AOCI due to statutory tax rate change		—			—			—			832			(832	)		—

Balance, December 31, 2017		21,022,202			210			348,037			123,537			3,597			475,381
Issuance of common stock, net of offering expenses		1,500,000			15			63,007			—			—			63,022
Stock awards, net of forfeitures		55,255			1			106			—			—			107
Vested stock awards surrendered in cashless exercise		(22,411	)		—			(303	)		(471	)		—			(774	)
Stock options exercised		7,596			—			56			—			—			56
Stock repurchase plan, net of commissions		(175,633	)		(2	)		(5,379	)		—						(5,381	)
Stock-based compensation expense, net		—			—			2,700			—			—			2,700
Net income		—			—			—			49,670			—			49,670
Dividends declared to stockholders		—			—			—			(5,563	)		—			(5,563	)
Other comprehensive loss, net of tax		—			—			—			—			(3,933	)		(3,933	)

Balance, December 31, 2018		22,387,009			224			408,224			167,173			(336	)		575,285
Stock awards, net of forfeitures		58,656			—			124			—			—			124
Vested stock awards surrendered in cashless exercise		(37,670	)		—			(707	)		(789	)		—			(1,496	)
Stock options exercised		71,842			1			960			—			—			961
Stock issued - Carolina Trust BancShares, Inc. merger		2,512,543			25			109,641									109,666
Stock repurchase plan, net of commissions		(214,772	)		(2	)		(7,113	)		—			—			(7,115	)
Stock-based compensation expense, net		—			—			3,143			—			—			3,143
Net income		—			—			—			62,740			—			62,740
Dividends declared to stockholders		—			—			—			(8,021	)		—			(8,021	)
Other comprehensive income, net of tax		—			—			—			—			8,153			8,153
Balance, December 31, 2019		24,777,608		$	248			514,272			221,103			7,817			743,440

See accompanying notes to consolidated financial statements.

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS


	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Cash flows from operating activities:
Net income	$	62,740			49,670			28,565
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Provision for loan losses		2,580			2,059			779
Deferred income tax expense (benefit)		1,553			(1,530	)		8,226
Amortization of unearned discount/premium on investments, net		4,250			4,595			3,856
Accretion of deferred loan fees		(2,656	)		(2,386	)		(1,279	)
Accretion of acquired loans		(7,559	)		(9,846	)		(4,286	)
Amortization of core deposit intangibles		2,910			3,139			1,037
(Gain) loss on sale of available-for-sale securities, net		(3,891	)		1,946			(933	)
Mortgage banking income		(19,326	)		(15,295	)		(15,140	)
Originations of loans held for sale		(907,427	)		(852,929	)		(909,627	)
Proceeds from sale of loans held for sale		912,443			886,544			922,431
Loss on extinguishment of debt		178			—			—
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Mortgage repurchase loan losses paid, net of recoveries		—			—			(88	)
Fair value adjustments on interest rate swaps		3,659			340			(382	)
Stock-based compensation		3,143			2,700			1,658
Increase in cash surrender value of bank owned life insurance		(1,591	)		(1,530	)		(1,116	)
Depreciation		4,359			4,181			2,756
Loss (gain) on disposals of premises and equipment		61			(2	)		23
Loss (gain) on sale of real estate acquired through foreclosure		149			(110	)		(33	)
Write-down of real estate acquired through foreclosure		—			126			—
Purchases of mortgage servicing rights		(461	)		(9,853	)		—
Originations of mortgage servicing rights		(1,368	)		(6,283	)		(6,061	)
Impairment of mortgage servicing rights		3,100			—			—
Amortization of mortgage servicing rights		5,721			4,206			2,966
Decrease (increase) in:
Accrued interest receivable		389			(1,502	)		(6,619	)
Other assets		(5,865	)		10,670			(29,271	)
Increase (decrease) in:
Accrued interest payable		336			465			799
Dividends payable to stockholders		651			525			549
Accrued expenses and other liabilities		126			106			(6,588	)
Cash flows provided by (used in) operating activities		57,784			69,406			(8,678	)

Continued

CAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases	$	(250,572	)		(351,329	)		(345,815	)
Maturities, payments and calls		125,305			105,005			77,781
Proceeds from sales		151,389			135,681			173,727
Increase in Federal Home Loan Bank stock		(117	)		(2,631	)		(6,400	)
Increase in loans receivable, net		(214,221	)		(192,852	)		(182,467	)
Purchases of premises and equipment		(5,703	)		(3,724	)		(7,002	)
Proceeds from disposals of premises and equipment		—			10			—
Proceeds from sale of real estate acquired through foreclosure		1,065			1,840			660
Purchase of bank owned life insurance		—			—			(25	)
Net cash received for acquisitions		72,285			—			122,320
Cash flows (used in) investing activities		(120,569	)		(308,000	)		(167,221	)

Cash flows from financing activities:
Net increase in deposit accounts		152,355			113,264			83,230
Net (decrease) increase in Federal Home Loan Bank advances		(3,178	)		52,177			100,772
Net (decrease) increase in drafts outstanding		(327	)		805			1,101
Net (decrease) increase in advances from borrowers for insurance and taxes		(820	)		1,095			1,947
Cash dividends paid on common stock		(8,021	)		(5,563	)		(2,371	)
Proceeds from exercise of stock options		961			56			10
Proceeds from issuance of common stock		—			63,022			47,671
Cash paid for common stock repurchase		(7,115	)		(5,381	)		—
Net increase in excess tax benefit in connection with equity awards		—			—			439
Cash flows provided by financing activities		133,855			219,475			232,799
Net increase (decrease) in cash and cash equivalents		71,070			(19,119	)		56,900
Cash and cash equivalents, beginning of period		62,133			81,252			24,352
Cash and cash equivalents, end of period	$	133,203			62,133			81,252

Supplemental disclosure:
Cash paid for:
Interest on deposits and borrowed funds	$	37,007			26,783			12,454
Income taxes paid, net of refunds		10,738			6,822			11,521
Noncash investing activities:
Transfer of loans receivable to real estate acquired through foreclosure	$	1,299			285			2,554

Acquisitions:
Assets acquired, net of cash	$	562,711			—			1,356,242
Liabilities assumed		572,161			—			1,345,119
Goodwill		56,667			—			123,325

See accompanying notes to consolidated financial statements.

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

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

At December 31, 2019, statutory business trusts (“Trusts”) created or acquired by the Company had outstanding trust preferred securities with an aggregate par value of $36.0 million. The principal assets of the Trusts are $37.1 million of the Company’s subordinated debentures with identical rates of interest and maturities as the trust preferred securities. The Trusts have issued $1.1 million of common securities to the Company and are included in other investments in the accompanying consolidated balance sheets. The Trusts are not consolidated subsidiaries of the Company.

Management's Estimates

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

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

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

Subsequent Events

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

On January 30, 2020, the Company’s Board of Directors declared a $0.10 dividend per common share payable on April 6, 2020 to stockholders of record as of March 16, 2020.

Cash and Cash Equivalents

Cash and cash equivalents consists of cash and due from banks and interest-bearing cash with banks. Substantially all of the interest-bearing cash at December 31, 2019 and 2018 consists of Federal Reserve Bank of Richmond (“FRB”) and Federal Home Loan Bank of Atlanta (“FHLB”) overnight deposits. Cash and cash equivalents have maturities of three months or less. The Bank is required to maintain average balances on hand or with the FRB. Cash on hand satisfied the reserve requirements at December 31, 2019 and December 31, 2018.

Securities

Investment securities are classified into three categories: (a) Held-to-Maturity – debt securities that the Company has positive intent and ability to hold to maturity, which are reported at amortized cost; (b) Trading – debt and equity securities that are bought and held principally for the purpose of selling them in the near term, which are reported at fair value, with unrealized gains and losses included in earnings; and (c) Available-for-Sale securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income.

The Company determines the category of the investment at the time of purchase. If a security is transferred from available–for-sale to held-to-maturity, the fair value at the time of transfer becomes the held-to-maturity security’s new cost basis. Premiums and discounts on securities are accreted and amortized as an adjustment to interest yield over the estimated life of the security using a method which approximates a level yield. Dividends and interest income are recognized when earned. Unrealized losses on securities, reflecting a decline in value judged by the Company to be other-than-temporary, are charged to income in the consolidated statements of operations.

The cost basis of securities sold is determined by specific identification. Purchases and sales of securities are recorded on a trade date basis.

Loans Held for Sale

The Company’s residential mortgage lending activities for sale in the secondary market are comprised of accepting residential mortgage loan applications, qualifying borrowers to standards established by investors, funding residential mortgage loans and selling mortgage loans to investors under pre-existing commitments. Loans held for sale are recorded at fair value. Origination fees and costs are recognized in earnings at the time of origination for loans held for sale that are recorded at fair value. Fair value is derived from observable current market prices, when available, and includes loan servicing value. When observable market prices are not available, the Company uses judgment and estimates fair value using internal models, in which the Company uses its best estimates of assumptions it believes would be used by market participants in estimating fair value. Adjustments to reflect unrealized gains and losses resulting from changes in fair value and realized gains and losses upon ultimate sale of the loans are classified as mortgage banking income in the consolidated statements of operations.

The Company issues rate lock commitments to borrowers on prices quoted by secondary market investors. Derivatives related to these commitments are recorded as either assets or liabilities in the balance sheet and are measured at fair value. Changes in the fair value of the derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

Derivative Financial Instruments

Derivatives are recognized as either assets or liabilities and are recorded at fair value on the Company’s consolidated balance sheets. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and resulting designation. The Company’s hedging policies permit the use of various derivative financial instruments to manage interest rate risk or to hedge specified assets and liabilities.

To qualify for hedge accounting, derivatives must be highly effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. If derivative instruments are designated as fair value hedges, and such hedges are highly effective, both the change in the fair value of the hedge and the hedged item are included in current earnings. If derivative instruments are designated as cash flow hedges, fair value adjustments related to the effective portion are recorded in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. Ineffective portions of cash flow hedges are reflected in earnings as they occur. Actual cash receipts and/or payments and related accruals on derivatives related to hedges are recorded as adjustments to the interest income or interest expense associated with the hedged item. During the life of the hedge, the Company formally assesses whether derivatives designated as hedging instruments continue to be highly effective in offsetting changes in the fair value or cash flows of hedged items. If it is determined that a hedge has ceased to be highly effective, the Company will discontinue hedge accounting prospectively. At such time, previous adjustments to the carrying value of the hedged item are reversed into current earnings and the derivative instrument is reclassified to a trading position recorded at fair value. For derivatives not designated as hedges, changes in fair value are recognized in earnings, in noninterest income.

For additional discussion related to the determination of fair value related to derivative instruments, see Note 5 - Derivatives.

Loans Receivable, Net

Loans that management has originated and has the intent and ability to hold for the foreseeable future are reported at their outstanding principal balances net of any unearned income, charge-offs, deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. The net amount of nonrefundable loan origination fees, commitment fees and certain direct costs associated with the lending process are deferred and amortized to interest income over the contractual lives of the loans using methods that approximate a level yield. Commercial loans and substantially all installment loans accrue interest on the unpaid balance of the loans.

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral-dependent. When the fair value of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a specific reserve allocation that is a component of the allowance for loan losses. A loan is charged-off against the allowance for loan losses when all meaningful collection efforts have been exhausted and the loan is viewed as uncollectable in the immediate or foreseeable future.

Acquired credit impaired loans are initially recorded at a discount to recognize the difference in the fair value of the loans and the contractual balance. The discount includes a component to recognize the absolute difference between the contractual value and the amount expected to be collected (total cash flow) as well as a component to recognize the net present value of that future amount to be collected. The net present value component is accretable into income and, therefore, generates a yield on all acquired credit impaired loans, regardless of past due status. Therefore, acquired credit impaired loans are considered to be accruing. Acquired credit impaired loans that are greater than 90 days past due are placed into the greater than 90 days past due and still accruing category when analyzing the aging status of the loan portfolio. See Note 6 – Loans Receivable, Net for further detail.

Troubled Debt Restructurings ("TDRs")

Nonperforming Assets

Assets acquired as a result of foreclosure are initially recorded at fair value less estimated selling costs at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Gains and losses on the sale of assets acquired through foreclosure and related revenue and expenses of these assets are included in noninterest expense in other real estate expenses, net.

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. Impaired loans are evaluated for impairment using the discounted cash flow methodology or based on the net realizable value of the underlying collateral. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment.

Factors considered by management in determining impaired loans include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. 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.

If a loan has impairment, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. For collateral-dependent loans, the measurement of impairment is based on the net investment of the loan compared to the fair value of the collateral less estimated selling costs. In most cases, the fair value of the collateral is based on appraised value. When appropriate, the fair value is based on the probable sales price of the collateral when sale of the collateral is imminent or contracted sales price if the collateral is subject to a binding sales contract as of the end of the quarter.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The Company considers the actual loss history experience over the trailing twenty quarters to determine the historical loss experience used in the general component. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries for the most recent twenty quarters; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

Business Combinations and Method of Accounting for Loans Acquired

The Company accounts for its acquisitions under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. As provided for under GAAP, management has up to twelve months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities. Once management has finalized the fair values of acquired assets and assumed liabilities within this twelve month period, management considers such values to be the Day 1 fair values (“Day 1 Fair Values”).

In determining the Day 1 fair values of acquired loans without evidence of credit deterioration at the date of acquisition, management includes (i) no carryover of any previously recorded allowance for loan losses and (ii) an adjustment of the unpaid principal balance to reflect an appropriate market rate of interest, given the risk profile and grade assigned to each loan. This adjustment will be accreted into earnings as a yield adjustment, using the effective yield method, over the remaining life of each loan.

To the extent that current information indicates it is probable that the Company will collect all amounts according to the contractual terms thereof, such loan is not considered impaired. To the extent that current information indicates it is probable that the Company will not be able to collect all amounts according to the contractual terms thereon, such loan is considered impaired and is considered in the determination of the required level of allowance for loan and lease losses.

Subsequent to the acquisition date, increases in cash flows expected to be received on purchased credit impaired loans in excess of the Company’s initial estimates are reclassified from nonaccretable difference to accretable yield and are accreted into interest income on a level-yield basis over the remaining life of the loan. Decreases in cash flows expected to be collected are recognized as impairment through the provision for loan losses.

Goodwill and Core Deposit Intangible

Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. Goodwill is not amortized but instead is subject to review for impairment annually, or more frequently if deemed necessary. Also in connection with business combinations, the Company records core deposit intangibles, representing the value of the acquired core deposit base. Core deposit intangibles are amortized over their estimated useful lives ranging up to 10 years.

Mortgage Servicing Rights, Fees and Costs

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

Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income. The amortization of the mortgage servicing rights is analyzed periodically and is adjusted to reflect changes in prepayment rates and other estimates.

The Company evaluates potential impairment of mortgage servicing rights based on the difference between the carrying amount and current estimated fair value of the servicing rights. In determining impairment, the Company aggregates all servicing rights and stratifies them into tranches based on predominant risk characteristics. If impairment exists, a valuation allowance is established for any excess of amortized cost over the current estimated fair value by a charge to income. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income.

Service fee income is recorded for fees earned for servicing mortgage loans under servicing agreements with the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), Government National Mortgage Association (“GNMA”) and certain private investors. The fees are based on a contractual percentage of the outstanding principal balance of the loans serviced and are recorded in noninterest income. Amortization of mortgage servicing rights and mortgage servicing costs are charged to expense when incurred.

Guarantees

Standby letters of credit obligate the Company to meet certain financial obligations of its customers, under the contractual terms of the agreement, if the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower; however, these standby letters of credit are generally not collateralized. Commitments under standby letters of credit are usually one year or less. At December 31, 2019 and 2018, the Company had recorded no liability for the current carrying amount of the obligation to perform as a guarantor; as such amounts are not considered material.

Premises and Equipment, Net

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the asset’s estimated useful life. Estimated lives range up to forty years for buildings and improvements and up to ten years for furniture, fixtures and equipment. Maintenance and repairs are charged to expense as incurred. Improvements that extend the lives of the respective assets are capitalized. When property or equipment is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the respective accounts and the resulting gain or loss is reflected in income.

Income Taxes

The provision for income taxes is based upon income or loss before taxes for financial statement purposes, adjusted for nontaxable income and nondeductible expenses. Deferred income taxes have been provided when different accounting methods have been used in determining income for income tax purposes and for financial reporting purposes. Deferred tax assets and liabilities are recognized based on future tax consequences attributable to differences arising from the financial statement carrying values of assets and liabilities and their tax bases. In the event of changes in the tax laws, deferred tax assets and liabilities are adjusted in the period of the enactment of those changes, with the cumulative effects included in the current year’s income tax provision.

Positions taken by the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. The benefits of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. The Company believes that its income tax filing positions taken or expected to be taken in its tax returns will more likely than not be sustained upon audit by the taxing authorities and does not anticipate any adjustments that will result in a material adverse impact on the Company’s financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain tax positions have been recorded. The Company’s federal income tax returns were not examined.

Interest and penalties on income tax uncertainties are classified within income tax expense in the statement of operations. There were no significant interest and penalties paid on income tax uncertainties during 2019 or 2018.

It is management’s belief that the realization of the remaining net deferred tax assets is more likely than not. Accordingly, no additional reserve was considered necessary. See Note 13 – Income Taxes for additional information.

Drafts Outstanding

The Company invests excess funds on deposit at other banks (including amounts on deposit for payment of outstanding disbursement checks) on a daily basis in an overnight interest-bearing account. Accordingly, outstanding checks are reported as a liability.

Reserve for Mortgage Loan Repurchase Losses

The Company sells mortgage loans to various third parties, including government-sponsored entities, under contractual provisions that include various representations and warranties that typically cover ownership of the loan, compliance with loan criteria set forth in the applicable agreement, validity of the lien securing the loan, absence of delinquent taxes or liens against the property securing the loan, and similar matters. The Company may be required to repurchase the mortgage loans with identified defects, indemnify the investor or insurer, or reimburse the investor for credit loss incurred on the loan (collectively “repurchase”) in the event of a material breach of such contractual representations or warranties. Risk associated with potential repurchases or other forms of settlement is managed through underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards.

The Company establishes mortgage repurchase reserves related to various representations and warranties that reflect management’s estimate of losses based on a combination of factors. Such factors incorporate estimated levels of defects on internal quality assurance, default expectations, historical investor repurchase demand and appeals success rates, reimbursement by correspondent and other third party originators, changes in the regulatory repurchase framework and projected loss severity. The Company establishes a reserve at the time loans are sold and quarterly updates the reserve estimate during the estimated loan life.

The following table presents activity in the reserve for mortgage loan repurchase losses:


	For the Years Ended
	December 31,
	2019			2018			2017
	(In thousands)

Beginning balance	$	1,292			1,892			2,880
Losses paid		—			—			(88	)
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Ending balance	$	892			1,292			1,892

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Off-Balance-Sheet Financial Instruments

In the ordinary course of business, the Company entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commitments under revolving credit agreements, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded.

Stock Compensation Plans

The Company can issue stock options, restricted stock, and restricted stock units under various plans to directors, officers and other key employees. The Company accounts for its stock compensation plans in accordance with ASC Topics 718 and 505. Under those provisions, the Company has adopted a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized on a straight-line basis over the service period, which is usually the vesting period, taking into account retirement eligibility. As a result, compensation expense relating to stock options and restricted stock is reflected in net income as part of “salaries and employee benefits” on the consolidated statements of operations.

Earnings Per Common Share

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

All share, earnings per share, and per share data have been retroactively adjusted to reflect the stock splits for all periods presented in accordance with GAAP.

Reclassification

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

Recently Adopted Accounting Pronouncements

In July 2019, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2019-07, Codification Updates to SEC Sections (“ASU 2019-07”). ASU 2019-07 updates various Topics of the Accounting Standards Codification (“ASC”) to align the guidance in various SEC sections of the Codification with the requirements of certain SEC final rules. The amendments were effective upon issuance and did not have a material effect on the financial statements.

During the first quarter of 2019, the Company adopted ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 applies a right-of-use (“ROU”) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. The Company has elected to apply the package of practical expedients permitting entities to not reassess: 1) whether any expired or existing contracts are or contain leases; 2) the lease classification for any expired or existing leases; and 3) initial direct costs for any existing leases. Additionally, as provided by ASU 2016-02, the Company has elected not to apply the recognition requirements of ASC 842 to short-term leases, defined as leases with a term of 12 months or less, and to recognize the lease payments in net income on short-term leases on a straight-line basis over the lease term.

The Company adopted the guidance using the modified retrospective approach on January 1, 2019 and elected the practical expedients for transition including the transition option provided in ASU 2018-11, Leases (Topic 842) Targeted Improvements, which allowed us to initially apply the new leases standard at the adoption date. Consequently, the reporting for the comparative periods presented continued to be in accordance with ASC Topic 840, Leases. Therefore, the 2018 financial results and disclosures have not been adjusted.

The Company implemented internal controls as well as lease accounting software to facilitate the preparation of financial information. The Company is largely accounting for existing operating leases consistent with prior guidance except for the incremental balance sheet recognition for leases. There was no cumulative effect adjustment to retained earnings as of January 1, 2019. On January 1, 2019, the Company recorded a ROU operating lease asset and corresponding operating lease liability of $18.4 million and $18.8 million, respectively, on the consolidated balance sheet. The new standard did not have a material impact on the Company’s results of operations or cash flows.

During the first quarter of 2019, the Company adopted ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). ASU 2017-12 amends the requirements of the Derivatives and Hedging Topic of the ASC to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The Company adopted the guidance using the modified retrospective approach on January 1, 2019. The guidance did not have a material effect on the Company’s financial statements, particularly as the Company has not recorded any hedge ineffectiveness since inception.

During the first quarter of 2019, the Company adopted ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Cost (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”). ASU 2017-08 shortens the amortization period for the premium to the earliest call date. The Company adopted the guidance using the modified retrospective approach on January 1, 2019. The guidance did not have a material effect on the Company’s consolidated financial statements.

During the first quarter of 2018, the Company adopted ASU No. 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The amendments included within this standard, which are applied prospectively, require the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using an exit price notion. Prior to adopting the amendments included in the standard, the Company was allowed to measure fair value under an entry price notion. Refer to Note 16—Estimated Fair Value of Financial Instruments for more information.

In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation (Topic 718) (“ASU 2017-09”). ASU 2017-09 provides clarity when applying guidance to a change to the terms or conditions of a share-based payment award. The amendments are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company adopted ASU 2017-09 and its related amendments on its required effective date of January 1, 2018. The amendments have been applied to awards modified on or after the adoption date. The Company has determined that this guidance did not have a material impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) (“ASU 2016-08”). ASU 2016-08 updates the new revenue standard by clarifying the principal versus agent implementation guidance, but does not change the core principle of the new standard. The updates to the principal versus agent guidance: (i) require an entity to determine whether it is a principal or an agent for each distinct good or service (or a distinct bundle of goods or services) to be provided to the customer; (ii) illustrate how an entity that is a principal might apply the control principle to goods, services, or rights to services, when another party is involved in providing goods or services to a customer and (iii) clarify that the purpose of certain specific control indicators is to support or assist in the assessment of whether an entity controls a good or service before it is transferred to the customer, provide more specific guidance on how the indicators should be considered, and clarify that their relevance will vary depending on the facts and circumstances. The Company’s revenue is primarily comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. A description of the Company’s revenue streams accounted for under ASC 606, Revenue from Contracts with Customers follows:

Deposit service charges: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.

Debit card income: The Company earns interchange fees from debit cardholder transactions conducted through payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

The Company has evaluated ASU 2016-08 and 2014-09 and determined that this guidance did not have a material impact on the way the Company currently recognizes revenue or the way it recognizes expenses related to those revenue streams. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Consistent with the modified retrospective approach, the Company did not adjust prior period amounts.

Recently Issued Accounting Pronouncements

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 simplifies accounting for income taxes by removing specific technical exceptions that often produce information investors have a hard time understanding. The amendments also improve consistent application of an simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief (“ASU 2019-05”). ASU 2019-05 provides entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Refer below for further information surrounding the Company’s adoption of Topic 326.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments (“ASU 2019-04”). ASU 2019-04 clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement of financial instruments. The amendments related to credit losses and related to recognition and measurement of financial instruments will be effective for the Company for reporting periods beginning after December 15, 2019. Refer below for further information surrounding the Company’s adoption of these standards. The amendments related to hedging were effective for the Company for interim and annual periods beginning after December 15, 2018. These amendments did not have a material effect on the Company’s financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 amends the Fair Value Measurement Topic of the Accounting Standards Codification. The amendments remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting – Chapter 8: Notes to Financial Statements. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance on this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangible-Goodwill and other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in today’s two-step impairment test under ASC 350 and eliminating Step 2 from the goodwill impairment test. As amended, the goodwill impairment test will consist of one step comparing the fair value of a reporting unit with its carrying amount. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. The guidance is effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those years. The amendments should be adopted prospectively and early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company has determined that this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires entities to utilize a new impairment model known as the current expected credit loss (“CECL”) model to estimate lifetime “expected credit loss” and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in earlier recognition of credit losses. In addition, the guidance eliminates the current guidance for purchased credit impaired loans, and requires an increase in the allowance for loan losses and an increase in the recorded investment of purchased credit impaired loans for the nonaccretable difference. The CECL approach is not applicable to available-for-sale (“AFS”) debt securities; however, ASU 2016-13 prescribes recognition of credit losses on AFS debt securities as an allowance rather than reductions in the amortized cost of the securities. Improvements to estimated credit losses will be recognized immediately in earnings rather than as interest income over time. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and AFS debt securities. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted the standard as of January 1, 2020 via the prescribed modified retrospective approach.

Throughout 2019, the Company worked with an outside consultant and undertook implementation efforts through its cross-functional implementation team. The team had assigned roles and responsibilities, key tasks to complete, and a timeline to be followed. The implementation team met periodically to discuss the latest developments and ensure progress was being made. The team also kept current on evolving interpretations and industry practices related to ASU 2016-13 via webcasts, publications, and conferences. The team has finalized the methodologies to be utilized, as well as the documentation, controls, processes and policies. Full end-to-end parallel runs were completed for the periods ended September 30, 2019 and December 31, 2019.

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

Risks and Uncertainties

In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk, and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or re-price at different speeds, or on a different basis, than its interest-earning assets. Credit risk is the risk of default on the loan portfolio or certain securities that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company. The Company is subject to the regulations of various governmental agencies. These regulations can and do change significantly from period to period. Periodic examinations by the regulatory agencies may subject the Company to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.

100

NOTE 2 – BUSINESS COMBINATIONS

Acquisition of Carolina Trust BancShares, Inc.

On December 31, 2019, the Company acquired all of the common stock of Carolina Trust BancShares, Inc., the holding company for Carolina Trust Bank. Under the terms of the merger agreement, each share of Carolina Trust common stock was converted into 0.300 shares of the Company’s common stock.

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


Common stock issued (2,512,543 shares at $43.23 per share)	$	108,617
Cash payments to common stockholders		9,836
Fair value of Carolina Trust stock options assumed		1,049
Total consideration paid	$	119,502

The assets acquired and liabilities assumed from Carolina Trust were recorded at their fair value as of the closing date of the merger. Fair values were preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values became available. Goodwill of $56.7 million was recorded at the time of the acquisition. The following table summarizes the consideration paid by the Company in the merger with Carolina Trust and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date.


December 31, 2019	As Reported by Carolina Trust			Fair Value Adjustments			As Recorded by the Company
	(In thousands)
Assets
Cash and cash equivalents	$	72,285			—			72,285
Securities available-for-sale		50,234			—			50,234
Federal Home Loan Bank stock		1,467			—			1,467
Loans receivable		484,384			(3,398	)(a)		480,986
Allowance for loan losses		(4,040	)		4,040	(b)		—
Premises and equipment		8,378			175	(c)		8,553
Foreclosed assets		808			(75	)(d)		733
Core deposit intangible		2,314			756	(e)		3,070
Deferred tax asset, net		923			152	(f)		1,075
Other assets		22,301			(5,708	)(g)		16,593
Total assets acquired	$	639,054			(4,058	)		634,996

Liabilities
Deposits	$	536,106			1,706	(h)		537,812
Borrowings		30,036			426	(i)		30,462
Other liabilities		3,888			(1	)(j)		3,887
Total liabilities assumed	$	570,030			2,131			572,161
Net identifiable assets acquired over liabilities assumed								62,835
Total consideration paid								119,502
Goodwill							$	56,667

101

Explanation of fair value adjustments:

(a)

Represents the amount necessary to adjust loans to their fair value due to interest rate and credit factors.

(b)

Reflects the elimination of Carolina Trust's historical allowance for loan losses.

(c)

Reflects fair value adjustments on acquired branch and administrative offices based on the Company's assessment.

(d)

Reflects the impact of acquisition accounting fair value adjustments.

(e)

Reflects the fair value adjustment to record the estimated core deposit intangible based on the Company's assessment.

(f)

Reflects the tax impact of acquisition accounting fair value adjustments.

(g)

Reflects the elimination of Carolina Trust’s historical goodwill.

(h)

Represents the fair value adjustment due to interest rate factors.

(i)

Represents the fair value adjustment due to interest rate factors.

(j)

Reflects the fair value adjustment based on the Company's evaluation of acquired other liabilities.

The table below summarizes the total contractually required principal and interest payments, management’s estimate of expected total cash payments and fair value of loans as of December 31, 2019 for purchased credit impaired (“PCI”) loans. Contractually required principal and interest payments have been adjusted for estimated payments (in thousands).


Contractual principal and interest at acquisition	$	29,408
Nonaccretable difference		3,901
Expected cash flows at acquisition		25,507
Accretable yield		3,040
Basis in PCI loans at acquisition - estimated fair value	$	22,467

102

Supplemental Pro Forma Information

The Company completed its acquisition of Carolina Trust on December 31, 2019. The table below presents unaudited supplemental pro forma information as if Carolina Trust acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2017 and were included for all periods presented. 2017 reflects pro forma results as if the First South and Greer acquisitions had occurred at January 1, 2017. Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger. Therefore, the pro forma financial information is not indicative of the results of operations that would have occurred had the transactions been effected on the assumed date. Pre-tax merger-related costs of $2.8 million, $15.2 million and $8.3 million for the years ended December 31, 2019, 2018 and 2017, respectively, are included in the Company’s Consolidated Statements of Operations and are not included in the pro forma statements below.


	For the Years Ended December 31,
	2019		2018		2017
	(In thousands, except share data)

Net interest income	$	159,952	$	149,585	$	138,345
Net income (a)	$	69,973	$	53,907	$	44,760

Weighted average shares outstanding:
Basic (b)		24,673,741		23,479,256		21,981,940
Diluted (b)		24,890,786		23,720,011		22,237,072

Earnings per common share:
Basic	$	2.84	$	2.30	$	2.04
Diluted	$	2.81	$	2.27	$	2.01

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

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

The Company may refine its valuations of acquired Carolina Trust assets and liabilities for up to one year following the merger date.

Pending Merger with and into United Bankshares, Inc.

On November 17, 2019, the Company announced the execution of an agreement and plan of merger by and between the Company and United Bankshares, Inc., pursuant to which, subject to the terms and conditions set forth therein, the Company will merge with and into United, with United as the surviving corporation of the merger. The agreement provides that at the effective time of the merger, the Bank will merge with and into United Bank, a wholly-owned subsidiary of United Bank, with United Bank as the surviving entity. The transaction is subject to customary regulatory and shareholder approvals.

Pursuant to the merger agreement, each outstanding share of common stock of Carolina Financial will be converted into the right to receive 1.13 shares of United common stock, par value $2.50 per share, resulting in an aggregate transaction value of approximately $1.1 billion, based on closing price of a share of United’s common stock as of that date.

103

NOTE 3 - CORE DEPOSIT INTANGIBLES

In connection with business combinations, the Company records core deposit intangibles, representing the value of the acquired core deposit base. As of December 31, 2019 and 2018, core deposit intangible was $16.6 million and $16.5 million, respectively. The estimated future amortization is subject to change to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful life of the core deposit intangibles.

Amortization expense (in thousands) for core deposit intangible is expected to be as follows.


Year 1	$	3,263
Year 2		2,953
Year 3		2,659
Year 4		2,369
Year 5		2,054
Thereafter		3,323
Total	$	16,621

Amortization expense of $2.9 million, $3.1 million and $1.0 million related to the core deposit intangible was recognized in 2019, 2018 and 2017 respectively.

NOTE 4 - SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of investment securities available-for-sale at December 31, 2019 and 2018 follows:

	At December 31,
	2019									2018
			Gross		Gross							Gross		Gross
	Amortized		Unrealized		Unrealized			Fair		Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value		Cost		Gains		Losses			Value
	(In thousands)
Securities available-for-sale:
Municipal securities	$	210,810		8,332		(174	)		218,968		212,215		2,768		(1,269	)		213,714
US government agencies		23,968		—		(45	)		23,923		24,772		505		—			25,277
Collateralized loan obligations		301,249		28		(1,295	)		299,982		231,172		119		(592	)		230,699
Corporate securities		6,940		48		—			6,988		6,915		69		(24	)		6,960
Mortgage-backed securities:
Agency		164,114		2,845		(245	)		166,714		199,518		427		(2,425	)		197,520
Non-agency		150,019		1,987		(64	)		151,942		158,803		423		(1,695	)		157,531
Total mortgage-backed securities		314,133		4,832		(309	)		318,656		358,321		850		(4,120	)		355,051
Trust preferred securities		11,114		1,518		(1,914	)		10,718		11,066		1,713		(1,679	)		11,100
Total	$	868,214		14,758		(3,737	)		879,235		844,461		6,024		(7,684	)		842,801

104

The amortized cost and fair value of debt securities by contractual maturity at December 31, 2019 follows:

	Amortized		Fair
	Cost		Value
	(In thousands)
Securities available-for-sale:
Less than one year	$	681		681
One to five years		22,199		22,295
Six to ten years		148,848		150,443
After ten years		696,486		705,816
Total	$	868,214		879,235

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

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


	For the Years
	Ended December 31,
	2019			2018
	(In thousands)

Proceeds	$	151,389			135,681

Realized gains		4,155			494
Realized losses		(264	)		(2,440	)
Total investment securities gains (losses), net	$	3,891			(1,946	)

At December 31, 2019, the Company had pledged securities with a market value of $29.8 million as collateral for Federal Home Loan Bank (“FHLB”) advances. At December 31, 2018, the Company had $84.3 million of securities pledged for FHLB advances.

At December 31, 2019, the Company has pledged $141.6 million of securities to secure public agency funds. At December 31, 2018, the Company had pledged securities with a market value of $165.5 million to secure public agency funds.

The following tables summarize gross unrealized losses on investment securities and the fair market value of the related securities at December 31, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

105



	At December 31, 2019
	Less than 12 Months							12 Months or Greater							Total
	Amortized		Fair		Unrealized			Amortized		Fair		Unrealized			Amortized		Fair		Unrealized
	Cost		Value		Losses			Cost		Value		Losses			Cost		Value		Losses
	(In thousands)
Available-for-sale:
Municipal securities	$	20,895		20,721		(174	)		—		—		—			20,895		20,721		(174	)
US government agencies		10,000		9,955		(45	)		—		—		—			10,000		9,955		(45	)
Collateralized loan obligations		101,801		101,504		(297	)		121,478		120,480		(998	)		223,279		221,984		(1,295	)
Corporate securities		—		—		—			—		—		—			—		—		—
Mortgage-backed securities:
Agency		1,947		1,946		(1	)		28,198		27,954		(244	)		30,145		29,900		(245	)
Non-agency		16,141		16,102		(39	)		1,723		1,698		(25	)		17,864		17,800		(64	)
Total mortgage-backed securities		18,088		18,048		(40	)		29,921		29,652		(269	)		48,009		47,700		(309	)
Trust preferred securities		—		—		—			8,112		6,198		(1,914	)		8,112		6,198		(1,914	)
Total	$	150,784		150,228		(556	)		159,511		156,330		(3,181	)		310,295		306,558		(3,737	)

	At December 31, 2018
	Less than 12 Months							12 Months or Greater							Total
	Amortized		Fair		Unrealized			Amortized		Fair		Unrealized			Amortized		Fair		Unrealized
	Cost		Value		Losses			Cost		Value		Losses			Cost		Value		Losses
	(In thousands)
Available-for-sale:
Municipal securities	$	12,395		12,331		(64	)		55,189		53,984		(1,205	)		67,584		66,315		(1,269	)
US government agencies		—		—		—			—		—		—			—		—		—
Collateralized loan obligations		146,913		146,344		(569	)		5,000		4,977		(23	)		151,913		151,321		(592	)
Corporate securities		2,980		2,956		(24	)		—		—		—			2,980		2,956		(24	)
Mortgage-backed securities:
Agency		14,615		14,450		(165	)		120,325		118,065		(2,260	)		134,940		132,515		(2,425	)
Non-agency		71,376		70,709		(667	)		43,138		42,110		(1,028	)		114,514		112,819		(1,695	)
Total mortgage-backed securities		85,991		85,159		(832	)		163,463		160,175		(3,288	)		249,454		245,334		(4,120	)
Trust preferred securities		—		—		—			8,214		6,535		(1,679	)		8,214		6,535		(1,679	)
Total	$	248,279		246,790		(1,489	)		231,866		225,671		(6,195	)		480,145		472,461		(7,684	)

106

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

At December 31, 2019 and December 31, 2018, the Company had 79 and 214, respectively, of individual investments available-for-sale that were in an unrealized loss position. The unrealized losses on the Company’s investments were attributable primarily to changes in interest rates. Management has performed various analyses, including cash flows testing as needed, and determined that no OTTI expense was necessary during 2019 or 2018.

At December 31, 2018 and December 31, 2017, the Company had 214 and 135, respectively, of individual investments available-for-sale that were in an unrealized loss position. The unrealized losses on the Company’s investments were attributable primarily to changes in interest rates. Management has performed various analyses, including cash flows testing as needed, and determined that no OTTI expense was necessary during 2018 or 2017.

The following table presents detail of non-marketable investments at December 31, 2019 and 2018.


	At December 31,
	2019		2018
	(In thousands)
Community Reinvestment Act fund	$	2,405		2,334
Investment in Trust Preferred subsidiaries		1,116		1,116
Other investments		3,521		3,450

Federal Home Loan Bank stock, at cost		23,280		21,696
Total non-marketable Investments	$	26,801		25,146

The Company, as a member of the FHLB, is required to own capital stock in the FHLB based generally upon a membership-based requirement and an activity-based requirement. FHLB capital stock is pledged to secure FHLB advances. No secondary market exists for this stock, and it has no quoted market price. However, redemption through the FHLB of this stock has historically been at par value.

For additional information regarding the investments in statutory business trust, see Note 12 - Long-Term Debt.

NOTE 5 – DERIVATIVES

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

107

The derivative positions of the Company at December 31, 2019 and December 31, 2018 are as follows:

	At December 31,
	2019				2018
	Fair		Notional		Fair		Notional
	Value		Value		Value		Value
	(In thousands)
Derivative assets:
Cash flow hedges:
Interest rate swaps	$	—		—		1,232		45,000
Non-hedging derivatives:
Interest rate swaps		138		35,000		1,198		50,000
Mortgage loan interest rate lock commitments		1,073		86,819		1,199		76,571
Mortgage loan forward sales commitments		580		26,240		403		13,241
Total derivative assets	$	1,791		148,059		4,032		184,812

Derivative liabilities:
Cash flow hedges:
Interest rate swaps	$	620		45,000		—		—
Non-hedging derivatives:
Interest rate swaps		2,767		40,000		937		50,000
Mortgage-backed securities forward sales commitments		40		61,000		295		52,000
Total derivative liabilities	$	3,427		146,000		1,232		102,000

Non-Designated Hedges

Derivative Loan Commitments and Forward Sales Commitments

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

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

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

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

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

108

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

Interest Rate Swaps

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

Cash Flow Hedges of Interest Rate Risk

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

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

Risk Management Objective of Using Derivatives

NOTE 6 - LOANS RECEIVABLE, NET

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

109

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

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

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

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

110

The Bank originates leases, primarily on equipment utilized for business purposes, with terms that generally range from 12 to 60 months and include options to purchase the leased equipment at the end of the lease. Most leases provide 100% of the cost of the equipment and are secured by the leased equipment. The Company requires the leased equipment to be insured and that we be listed as a loss payee and named as an additional insured on the insurance policy. We manage credit risk associated with our lease financing loan class based upon the dollar amount of the lease and the level of credit risk. We follow a formal review process that entails analysis of the following factors: equipment value/residual value, exposure levels, jurisdiction risk, industry risk, guarantor requirements, and regulatory compliance. As of December 31, 2019 and December 31, 2018, there were approximately $16.8 million and $23.1 million in lease receivables outstanding. Lease receivables are grouped within commercial business loans below.

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

111

Loans receivable, net at December 31, 2019 and 2018 are summarized by category as follows:


	At December 31,
	2019					2018
			% of Total					% of Total
All Loans:	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	785,572		24.34	%		732,717		29.03	%
Home equity		110,016		3.41	%		83,770		3.32	%
Commercial real estate		1,394,626		43.20	%		1,034,117		40.96	%
Construction and development		442,657		13.71	%		290,494		11.51	%
Consumer loans		26,500		0.82	%		23,845		0.94	%
Commercial business loans		468,566		14.52	%		359,393		14.24	%
Total gross loans receivable		3,227,937		100.00	%		2,524,336		100.00	%
Less:
Allowance for loan losses		16,521					14,463
Total loans receivable, net	$	3,211,416					2,509,873

112

Loans receivable, net at December 31, 2019 and 2018 for purchased non-credit impaired loans and nonacquired loans are summarized by category as follows:


	At December 31,
	2019					2018
Purchased Non-Credit Impaired Loans			% of Total					% of Total
(ASC 310-20) and Nonacquired Loans:	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	774,638		24.46	%		723,641		29.24	%
Home equity		108,590		3.43	%		83,717		3.38	%
Commercial real estate		1,364,052		43.08	%		1,004,420		40.59	%

Construction and development		437,178		13.81	%		287,673		11.63	%
Consumer loans		26,112		0.82	%		23,792		0.96	%
Commercial business loans		456,112		14.40	%		351,194		14.20	%
Total gross loans receivable		3,166,682		100.00	%		2,474,437		100.00	%
Less:
Allowance for loan losses		16,493					14,463
Total loans receivable, net	$	3,150,189					2,459,974

Loans receivable, net at December 31, 2019 and 2018 for purchased credit impaired loans are summarized by category as follows:


	At December 31,
	2019					2018
Purchased Credit Impaired			% of Total					% of Total
Loans (ASC 310-30):	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	10,934		17.85	%		9,077		18.19	%
Home equity		1,426		2.34	%		53		0.11	%
Commercial real estate		30,574		49.91	%		29,696		59.51	%
Construction and development		5,479		8.94	%		2,821		5.65	%
Consumer loans		388		0.63	%		53		0.11	%
Commercial business loans		12,454		20.33	%		8,199		16.43	%
Total gross loans receivable		61,255		100.00	%		49,899		100.00	%
Less:
Allowance for loan losses		28					—
Total loans receivable, net	$	61,227					49,899

Included in the loan totals, net of purchase discount, were $989.5 million and $686.4 million in loans acquired through acquisitions at December 31, 2019 and December 31, 2018, respectively. At December 31, 2019 and December 31, 2018, the purchase discount on purchased non-credit impaired loans was $9.5 million and $10.9 million, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

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

113

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

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

At December 31, 2019, the outstanding balance and recorded investment of PCI loans was $74.8 million and $61.3 million, respectively. At December 31, 2018, the outstanding balance and recorded investment of PCI loans was $63.7 million and $49.9 million, respectively,

The table below presents changes in the value of PCI loans for the years ended December 31, 2019 and 2018.


	At December 31,
	2019			2018
	(In thousands)
Balance at beginning of period	$	49,899			78,415
Fair value of acquired loans		22,467			—
Net reductions for payments, foreclosures, and accretion		(11,111	)		(28,516	)
Balance at end of period	$	61,255			49,899

The table below presents changes in the value of the accretable yield for PCI loans for the years ended December 31, 2019 and 2018.


	At December 31,
	2019			2018
	(In thousands)

Accretable yield, beginning of period	$	19,908			12,536
Additions		3,040			—
Accretion and interest income		(6,174	)		(6,092	)
Reclassification from nonaccretable balance, net^(a)		1,522			8,147
Other changes, net ^(b)		1,010			5,317
Accretable yield, end of period	$	19,306			19,908

(a)	Reclassifications from the nonaccretable balance in the year ended December 31, 2019 were driven by improvement in credit quality.

(b)	Other changes, net include the impact of changes in expectations of cash flows, which may vary from period to period due to the impact of modifications and changes to prepayment assumptions, as well as the impact of changes in interest rates on variable rate loans.

114

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


	At December 31,
	2019				2018
	(Dollars in thousands)

Variable rate loans	$	1,274,085	39.47	%		942,348	37.33	%
Fixed rate loans		1,953,852	60.53	%		1,581,988	62.67	%
Total loans outstanding	$	3,227,937	100.00	%		2,524,336	100.00	%

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


	At December 31, 2019
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated		Total
	(In thousands)
Allowance for loan losses:
Balance at January 1, 2019	$	3,540			203			5,097			1,969			352			2,940			362		14,463
Provision for loan losses - non PCI loans		105			94			993			344			195			546			275		2,552
Provision for loan losses - PCI loans		5			—			1			—			—			22			—		28
Charge-offs		(293	)		(78	)		(380	)		(19	)		(320	)		(145	)		—		(1,235	)
Recoveries		174			6			35			248			165			85			—		713
Balance at December 31, 2019	$	3,531			225			5,746			2,542			392			3,448			637		16,521

115


	At December 31, 2018
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated			Total
	(In thousands)
Balance at January 1, 2018	$	2,719			168			3,986			1,201			79			2,840			485			11,478
Provision for loan losses		905			59			1,120			(320	)		488			(70	)		(123	)		2,059
Charge-offs		(226	)		(31	)		(86	)		(24	)		(308	)		(197	)		—			(872	)
Recoveries		142			7			77			1,112			93			367			—			1,798
Balance at December 31, 2018	$	3,540			203			5,097			1,969			352			2,940			362			14,463

	At December 31, 2017
	Loans Secured by Real Estate
	One-to-						Commercial			Construction
	four			Home			real			and						Commercial
	family			equity			estate			development			Consumer			business			Unallocated			Total
	(In thousands)
Balance at January 1, 2017	$	2,636			197			3,344			1,132			80			2,805			494			10,688
Provision for loan losses		332			(32	)		611			(12	)		(27	)		(84	)		(9	)		779
Charge-offs		(253	)		—			—			—			(19	)		—			—			(272	)
Recoveries		4			3			31			81			45			119			—			283
Balance at December 31, 2017	$	2,719			168			3,986			1,201			79			2,840			485			11,478

116

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


	Loans Secured by Real Estate
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
	family		equity		estate		development		Consumer		business		Unallocated		Total
	(In thousands)
At December 31, 2019:
Allowance for loan losses ending balances:
Individually evaluated for impairment	$	109		—		2		438		—		259		—		808
Collectively evaluated for impairment		3,417		225		5,743		2,104		392		3,167		637		15,685
Purchased credit impaired		5		—		1		—		—		22		—		28
Total allowance for loan losses	$	3,531		225		5,746		2,542		392		3,448		637		16,521

At December 31, 2019:
Loans receivable ending balances:
Individually evaluated for impairment	$	5,558		98		20,174		3,539		12		5,469		—		34,850
Collectively evaluated for impairment		769,080		108,492		1,343,878		433,639		26,100		450,643		—		3,131,832
Purchased credit impaired		10,934		1,426		30,574		5,479		388		12,454		—		61,255
Total loans receivable	$	785,572		110,016		1,394,626		442,657		26,500		468,566		—		3,227,937

At December 31, 2018:
Allowance for loan losses ending balances:
Individually evaluated for impairment	$	176		—		145		515		—		24		—		860
Collectively evaluated for impairment		3,364		203		4,952		1,454		352		2,916		362		13,603
Total allowance for loan losses	$	3,540		203		5,097		1,969		352		2,940		362		14,463

At December 31, 2018:
Loans receivable ending balances:
Individually evaluated for impairment	$	4,687		249		5,105		1,866		31		2,853		—		14,791
Collectively evaluated for impairment		718,953		83,468		999,316		285,807		23,761		348,341		—		2,459,646
Purchased credit impaired loans		9,077		53		29,696		2,821		53		8,199		—		49,899
Total loans receivable	$	732,717		83,770		1,034,117		290,494		23,845		359,393		—		2,524,336

117

The following table presents impaired loans individually evaluated for impairment in the segmented portfolio categories and the corresponding allowance for loan losses as of December 31, 2019 and December 31, 2018. The recorded investment is defined as the original amount of the loan, net of any deferred costs and fees, less any principal reductions and direct charge-offs. Unpaid principal balance includes amounts previously included in charge-offs.

	At and for the Year Ended December 31, 2019
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(In thousands)
With no related allowance recorded:
Loans secured by real estate:
One-to-four family	$	4,928		4,989		—		3,916		105
Home equity		98		98		—		10		—
Commercial real estate		18,837		19,028		—		7,881		1,414
Construction and development		2,047		2,047		—		690		56
Consumer loans		12		31		—		17		1
Commercial business loans		4,825		4,969		—		2,578		318
		30,747		31,162		—		15,092		1,890

With an allowance recorded:
Loans secured by real estate:
One-to-four family		630		613		109		600		26
Home equity		—		—		—		—		—
Commercial real estate		1,337		1,337		2		1,363		76
Construction and development		1,492		1,492		438		1,297		5
Consumer loans		—		—		—		—		—
Commercial business loans		644		659		259		232		17
		4,103		4,101		808		3,492		124

Total:
Loans secured by real estate:
One-to-four family		5,558		5,602		109		4,516		131
Home equity		98		98		—		10		—
Commercial real estate		20,174		20,365		2		9,244		1,490
Construction and development		3,539		3,539		438		1,987		61
Consumer loans		12		31		—		17		1
Commercial business loans		5,469		5,628		259		2,810		335
	$	34,850		35,263		808		18,584		2,014

118

	At and for the Year Ended December 31, 2018
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(In thousands)
With no related allowance recorded:
Loans secured by real estate:
One-to-four family	$	3,083		3,241		—		1,904		46
Home equity		249		249		—		97		6
Commercial real estate		2,679		2,694		—		2,049		59
Construction and development		323		323		—		274		19
Consumer loans		31		31		—		24		1
Commercial business loans		2,697		2,698		—		983		152
		9,062		9,236		—		5,331		283

With an allowance recorded:
Loans secured by real estate:
One-to-four family		1,604		1,665		176		1,261		43
Home equity		—		—		—		—		—
Commercial real estate		2,426		2,426		145		1,773		98
Construction and development		1,543		1,543		515		1,241		—
Consumer loans		—		—		—		—		—
Commercial business loans		156		156		24		161		9
		5,729		5,790		860		4,436		150

Total:
Loans secured by real estate:
One-to-four family		4,687		4,906		176		3,165		89
Home equity		249		249		—		97		6
Commercial real estate		5,105		5,120		145		3,822		157
Construction and development		1,866		1,866		515		1,515		19
Consumer loans		31		31		—		24		1
Commercial business loans		2,853		2,854		24		1,144		162
	$	14,791		15,026		860		9,767		434

119

	At and for the Year Ended December 31, 2017
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(In thousands)
With no related allowance recorded:
Loans secured by real estate:
One-to-four family	$	2,725		2,846		—		2,134		80
Home equity		—		—		—		—		—
Commercial real estate		3,370		3,370		—		3,355		111
Construction and development		318		318		—		202		17
Consumer loans		26		26		—		18		1
Commercial business loans		113		114		—		41		4
		6,552		6,674		—		5,750		213

With an allowance recorded:
Loans secured by real estate:
One-to-four family		710		710		64		650		22
Home equity		108		108		29		108		—
Commercial real estate		1,441		1,441		—		1,466		82
Construction and development		—		—		—		—		—
Consumer loans		—		—		—		—		—
Commercial business loans		172		172		16		188		10
		2,431		2,431		109		2,412		114

Total:
Loans secured by real estate:
One-to-four family		3,435		3,556		64		2,784		102
Home equity		108		108		29		108		—
Commercial real estate		4,811		4,811		—		4,821		193
Construction and development		318		318		—		202		17
Consumer loans		26		26		—		18		1
Commercial business loans		285		286		16		229		14
	$	8,983		9,105		109		8,162		327

The Company was not committed to advance additional funds in connection with impaired loans as of December 31, 2019, 2018 or 2017.

120

A loan is considered past due if the required principal and interest payment has not been received as of the due date. The following schedule is an aging of past due loans receivable by portfolio segment as of December 31, 2019 and 2018.


	At December 31, 2019
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
All Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	569		352		6,952		215		145		174		8,407
60-89 days past due		1,783		141		642		425		99		502		3,592
90 days or more past due		2,858		98		9,348		1,176		10		239		13,729
Total past due		5,210		591		16,942		1,816		254		915		25,728
Current		780,362		109,425		1,377,684		440,841		26,246		467,651		3,202,209
Total loans receivable	$	785,572		110,016		1,394,626		442,657		26,500		468,566		3,227,937

	At December 31, 2019
Purchased Non-Credit	Real Estate Loans
Impaired Loans	One-to-				Commercial		Construction
(ASC 310-20) and	four		Home		real		and				Commercial
Nonacquired Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	425		352		6,952		193		141		153		8,216
60-89 days past due		1,719		141		144		425		96		397		2,922
90 days or more past due		2,522		98		8,436		459		10		168		11,693
Total past due		4,747		591		15,532		1,077		247		718		22,912
Current		769,891		107,999		1,348,520		436,101		25,865		455,394		3,143,770
Total loans receivable	$	774,638		108,590		1,364,052		437,178		26,112		456,112		3,166,682

	At December 31, 2019
	Real Estate Loans
	One-to-				Commercial		Construction
Purchased Credit Impaired	four		Home		real		and				Commercial
Loans (ASC 310-30):	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	144		—		—		22		4		21		191
60-89 days past due		64		—		498		—		3		105		670
90 days or more past due		255		—		912		717		—		71		1,955
Total past due		463		—		1,410		739		7		197		2,816
Current		10,471		1,426		29,164		4,740		381		12,257		58,439
Total loans receivable	$	10,934		1,426		30,574		5,479		388		12,454		61,255

121


	At December 31, 2018
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
All Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	503		723		1,780		180		296		793		4,275
60-89 days past due		1,677		213		120		588		31		632		3,261
90 days or more past due		4,133		373		3,054		105		117		602		8,384
Total past due		6,313		1,309		4,954		873		444		2,027		15,920
Current		726,404		82,461		1,029,163		289,621		23,401		357,366		2,508,416
Total loans receivable	$	732,717		83,770		1,034,117		290,494		23,845		359,393		2,524,336

	At December 31, 2018
Purchased Non-Credit	Real Estate Loans
Impaired Loans	One-to-				Commercial		Construction
(ASC 310-20) and	four		Home		real		and				Commercial
Nonpurchased Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	378		720		1,037		172		296		793		3,396
60-89 days past due		1,313		213		120		559		31		632		2,868
90 days or more past due		3,686		373		2,895		106		117		602		7,779
Total past due		5,377		1,306		4,052		837		444		2,027		14,043
Current		718,264		82,411		1,000,368		286,836		23,348		349,167		2,460,394
Total loans receivable	$	723,641		83,717		1,004,420		287,673		23,792		351,194		2,474,437

	At December 31, 2018
	Real Estate Loans
	One-to-				Commercial		Construction
Purchased Credit Impaired	four		Home		real		and				Commercial
Loans (ASC 310-30):	family		equity		estate		development		Consumer		business		Total
	(In thousands)
30-59 days past due	$	126		3		743		7		—		—		879
60-89 days past due		364		—		—		30		—		—		394
90 days or more past due		447		—		158		—		—		—		605
Total past due		937		3		901		37		—		—		1,878
Current		8,140		50		28,795		2,784		53		8,199		48,021
Total loans receivable	$	9,077		53		29,696		2,821		53		8,199		49,899

122

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

The following is a schedule of non-PCI loans receivable, by portfolio segment, on nonaccrual at December 31, 2019 and 2018.


	At December 31,
	2019		2018
	(In thousands)
Loans secured by real estate:
One-to-four family	$	4,435		4,471
Home equity		98		454
Commercial real estate		15,783		3,663
Construction and development		3,270		1,675
Consumer loans		6		107
Commercial business loans		1,574		1,351
	$	25,166		11,721

There were no non-PCI loans past due 90 days and still accruing at December 31, 2019. There was one non-PCI loan past due 90 days and still accruing for approximately $20,000 at December 31, 2018.

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

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

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

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

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

The Company uses the following definitions:

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

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

123

The following is a schedule of the credit quality of loans receivable, by portfolio segment, as of December 31, 2019 and 2018.


	At December 31, 2019
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
Total Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	776,545		108,512		1,361,058		434,486		26,015		455,756		3,162,372
Special Mention		1,865		1,334		11,445		4,122		266		7,720		26,752
Substandard		7,162		170		22,123		4,049		219		5,090		38,813
Total loans receivable	$	785,572		110,016		1,394,626		442,657		26,500		468,566		3,227,937

Performing	$	780,882		109,918		1,377,931		438,670		26,494		466,921		3,200,816
Nonperforming:
90 days past due still accruing		255		—		912		717		—		71		1,955
Nonaccrual		4,435		98		15,783		3,270		6		1,574		25,166
Total nonperforming		4,771		98		16,695		3,987		6		1,645		27,121
Total loans receivable	$	785,572		110,016		1,394,626		442,657		26,500		468,566		3,227,937

	At December 31, 2019
Purchased Non-Credit	Real Estate Loans
Impaired Loans	One-to-				Commercial		Construction
(ASC 310-20) and	four		Home		real		and				Commercial
Nonacquired Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	770,068		108,492		1,345,054		432,475		25,996		447,327		3,129,412
Special Mention		—		—		2,601		1,432		102		4,241		8,376
Substandard		4,570		98		16,397		3,271		14		4,544		28,894
Total loans receivable	$	774,638		108,590		1,364,052		437,178		26,112		456,112		3,166,682

Performing	$	770,203		108,492		1,348,269		433,908		26,106		454,538		3,141,516
Nonperforming:
90 days past due still accruing		—		—		—		—		—		—		—
Nonaccrual		4,435		98		15,783		3,270		6		1,574		25,166
Total nonperforming		4,435		98		15,783		3,270		6		1,574		25,166
Total loans receivable	$	774,638		108,590		1,364,052		437,178		26,112		456,112		3,166,682

	At December 31, 2019
	Real Estate Loans
	One-to-				Commercial		Construction
Purchased Credit Impaired	four		Home		real		and				Commercial
Loans (ASC 310-30):	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	6,477		20		16,004		2,011		19		8,429		32,960
Special Mention		1,865		1,334		8,844		2,690		164		3,479		18,376
Substandard		2,592		72		5,726		778		205		546		9,919
Total loans receivable	$	10,934		1,426		30,574		5,479		388		12,454		61,255

Performing	$	10,679		1,426		29,662		4,762		388		12,383		59,300
Nonperforming:
90 days past due still accruing		255		—		912		717		—		71		1,955
Nonaccrual		—		—		—		—		—		—		—
Total nonperforming		255		—		912		717		—		71		1,955
Total loans receivable	$	10,934		1,426		30,574		5,479		388		12,454		61,255

124


	At December 31, 2018
	Real Estate Loans
	One-to-				Commercial		Construction
	four		Home		real		and				Commercial
Total Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	727,921		83,382		1,016,064		287,559		23,613		353,742		2,492,281
Special Mention		417		—		9,914		534		103		2,166		13,134
Substandard		4,379		388		8,139		2,401		129		3,485		18,921
Total loans receivable	$	732,717		83,770		1,034,117		290,494		23,845		359,393		2,524,336

Performing	$	727,799		83,316		1,030,296		288,819		23,718		358,042		2,511,990
Nonperforming:
90 days past due still accruing		447		—		158		—		20		—		625
Nonaccrual		4,471		454		3,663		1,675		107		1,351		11,721
Total nonperforming		4,918		454		3,821		1,675		127		1,351		12,346
Total loans receivable	$	732,717		83,770		1,034,117		290,494		23,845		359,393		2,524,336

	At December 31, 2018
Purchased Non-Credit	Real Estate Loans
Impaired Loans	One-to-				Commercial		Construction
(ASC 310-20) and	four		Home		real		and				Commercial
Nonpurchased Loans:	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	720,177		83,336		995,319		285,927		23,571		346,487		2,454,817
Special Mention		—		—		5,524		71		103		1,379		7,077
Substandard		3,464		381		3,577		1,675		118		3,328		12,543
Total loans receivable	$	723,641		83,717		1,004,420		287,673		23,792		351,194		2,474,437

Performing	$	719,170		83,263		1,000,757		285,998		23,665		349,843		2,462,696
Nonperforming:
90 days past due still accruing		—		—		—		—		20		—		20
Nonaccrual		4,471		454		3,663		1,675		107		1,351		11,721
Total nonperforming		4,471		454		3,663		1,675		127		1,351		11,741
Total loans receivable	$	723,641		83,717		1,004,420		287,673		23,792		351,194		2,474,437

	At December 31, 2018
	Real Estate Loans
	One-to-				Commercial		Construction
Purchased Credit Impaired	four		Home		real		and				Commercial
Loans (ASC 310-30):	family		equity		estate		development		Consumer		business		Total
	(In thousands)
Internal Risk Rating Grades:
Pass	$	7,745		45		20,745		1,632		42		7,255		37,464
Special Mention		418		—		4,390		463		—		787		6,058
Substandard		914		8		4,561		726		11		157		6,377
Total loans receivable	$	9,077		53		29,696		2,821		53		8,199		49,899

Performing	$	8,630		53		29,538		2,821		53		8,199		49,294
Nonperforming:
90 days past due still accruing		447		—		158		—		—		—		605
Nonaccrual		—		—		—		—		—		—		—
Total nonperforming		447		—		158		—		—		—		605
Total loans receivable	$	9,077		53		29,696		2,821		53		8,199		49,899

125

Activity in loans to officers, directors and other related parties for the years ended December 31, 2019 and 2018 is summarized as follows:


	At December 31,
	2019			2018
	(In thousands)

Balance at beginning of year	$	17,691			12,902
New loans		10,435			16,363
Repayments		(9,027	)		(11,574	)
Balance at end of year	$	19,099			17,691

In management’s opinion, related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with an unrelated person and generally do not involve more than the normal risk of collectability.

Loans serviced for the benefit of others under loan participation arrangements amounted to $28.4 million and $37.1 million at December 31, 2019 and 2018, respectively.

Troubled Debt Restructurings

At December 31, 2019, there were $11.1 million in loans designated as troubled debt restructurings of which $4.5 million were accruing. At December 31, 2018, there were $6.4 million in loans designated as troubled debt restructurings of which $3.3 million were accruing.

There was one one-to-four family loan, one construction and development loan, five commercial loans, and five commercial real estate loans designated as a troubled debt restructuring during the year ended December 31, 2019. All loans were designated as a troubled debt restructuring due to a payment structure change. The pre-modification and post-modification recorded investment were $7.0 million.

There was one commercial real estate loan and one construction and development loan designated as a troubled debt restructuring during the year ended December 31, 2018. All loans were designated as a troubled debt restructuring due to an interest rate change. The pre-modification and post-modification recorded investment were $1.7 million.

Four commercial real estate loans restructured in the twelve months prior to December 31, 2019 totaling $1.9 million in principal went into default during the twelve months ended December 31, 2019.

No loans previously restructured in the twelve months prior to December 31, 2018 went into default during the twelve month period ended December 31, 2018.

126

NOTE 7 - PREMISES AND EQUIPMENT, NET

Premises and equipment, net at December 31, 2019 and 2018 consists of the following:


	At December 31,
	2019			2018
	(In thousands)

Land	$	19,166			15,093
Buildings		40,380			34,213
Furniture, fixtures and equipment		32,986			29,674
Construction in process		744			638
Total premises and equipment		93,276			79,618
Less: accumulated depreciation		(22,574	)		(18,752	)
Premises and equipment, net	$	70,702			60,866

Depreciation expense included in operating expenses for the years ended December 31, 2019, 2018, and 2017 amounted to $4.4 million, $4.2 million and $2.8 million and, respectively. There was no interest capitalized during fiscal year 2019 or 2018.

NOTE 8 – REAL ESTATE ACQUIRED THROUGH FORECLOSURE

The following presents summarized activity in real estate acquired through foreclosure for the periods ended December 31, 2019 and December 31, 2018:


	At December 31,
	2019			2018
	(In thousands)

Balance at beginning of period	$	1,534			3,106
Additions		1,299			285
Acquisitions		733			—
Sales and Paydowns		(1,241	)		(1,731	)
Write downs		—			(126	)
Balance at end of period	$	2,325			1,534

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

	At December 31,
	2019		2018
	(In thousands)
Real estate owned:
One-to-four family	$	755		204
Commercial real estate		784		—
Construction and development		786		1,330
Total real estate owned	$	2,325		1,534

As of December 31, 2019, the Company had approximately $11.3 million of loans in the process of foreclosure.

127

NOTE 9 – MORTGAGE SERVICING RIGHTS

Mortgage loans serviced for others are not included in the accompanying Consolidated Balance Sheets. The value of mortgage servicing rights (“MSRs”) is included on the Company’s Consolidated Balance Sheets. The unpaid principal balances of loans serviced for others were $3.6 billion and $4.0 billion, respectively, at December 31, 2019 and 2018.

The midpoint economic estimated fair value range of the mortgage servicing rights was $31.4 million and $40.9 million, respectively, at December 31, 2019 and 2018.

The estimated fair value of servicing rights at December 31, 2019 was determined using a net servicing fee of 0.25%, weighted average discount rates ranging from 10% to 12%, weighted average constant prepayment rates (“CPR”) ranging from 10% to 12%, depending upon the stratification of the specific servicing right, and a weighted average delinquency rate of 1.87%.

The estimated fair value of servicing rights at December 31, 2018 was determined using a net servicing fee of 0.25%, weighted average discount rates ranging from 12% to 13%, weighted average constant prepayment rates (“CPR”) ranging from 6% to 7%, depending upon the stratification of the specific servicing right, and a weighted average delinquency rate of 2.34%.

The following summarizes the activity in mortgage servicing rights, along with the aggregate activity in the related valuation allowances, for the years ended December 31, 2019 and 2018:


	At December 31,
	2019			2018
	(In thousands)
MSR beginning balance	$	32,933			21,003
Amount capitalized		1,368			6,283
Purchased servicing		461			9,853
Amount amortized		(5,721	)		(4,206	)
MSR Impairment		(3,100	)		—
MSR ending balance	$	25,941			32,933


	For the Years Ended
	December 31,
	2019		2018
	(In thousands)
MSR valuation allowance beginning balance	$	—		—
Increase (reduction)		3,100		—
MSR valuation allowance ending balance	$	3,100		—

The Company recorded a $3.1 million temporary impairment of mortgage servicing rights during the year ended December 31, 2019. The Company does not hedge the mortgage servicing rights positions and the impact of falling long-term interest rates increased prepayment speed assumptions reducing the value of the MSR asset. There was no valuation allowance related to the fair value of mortgage servicing rights for the year ended December 31, 2018.

128

Estimated amortization expense is presented below for the following subsequent years ended (in thousands):


Year 1	$	5,580
Year 2		4,164
Year 3		3,905
Year 4		3,554
Year 5		3,259
Thereafter		5,479
Total	$	25,941

The estimated amortization expense is based on current information regarding future loan payments and prepayments. Amortization expense could change in future periods based on changes in the volume of prepayments and economic factors.

At December 31, 2019 and 2018, servicing related impound funds of approximately $43.0 million, and $41.5 million, respectively, representing both principal and interest due investors and escrows received from borrowers, are on deposit in custodial accounts and are included in noninterest-bearing deposits in the accompanying financial statements.

At December 31, 2019 and 2018, the Company had a blanket bond coverage of $10 million and an errors and omissions coverage of $10 million.

NOTE 10 - DEPOSITS

Deposits outstanding by type of account at December 31, 2019 and 2018 are summarized as follows:


	At December 31,
	2019		2018
	(In thousands)

Noninterest-bearing demand accounts	$	668,616		547,022
Interest-bearing demand accounts		651,577		566,527
Savings accounts		218,786		192,322
Money market accounts		590,916		431,246
Certificates of deposit:
Less than $250,000		1,159,978		875,749
$250,000 or more		118,488		105,327
Total certificates of deposit		1,278,466		981,076
Total deposits	$	3,408,361		2,718,193

The aggregate amount of brokered certificates of deposit was $186.3 million and $174.1 million at December 31, 2019 and 2018, respectively. Brokered certificates of deposit are included in the table above under certificates of deposit less than $250,000. The aggregate amount of institutional certificates of deposit was $92.6 million and $39.4 million at December 31, 2019 and 2018, respectively.

129

The amounts and scheduled maturities of certificates of deposit at December 31, 2019 and 2018 are as follows:


	At December 31,
	2019		2018
	(In thousands)

Maturing within one year	$	963,450		684,031
Maturing one through three years		256,335		254,180
Maturing after three years		58,681		42,865
Total certificates of deposit	$	1,278,466		981,076

NOTE 11 – SHORT-TERM BORROWED FUNDS

Short-term borrowed funds at December 31, 2019 and 2018 are summarized as follows:


	At December 31,
	2019				2018
			Stated Interest				Stated Interest
	Balance		Rate		Balance		Rate
	(Dollars in thousands)

Short-term FHLB advances	$	437,700		1.66% - 2.02%		405,500		1.05% - 2.78%
Total short-term borrowed funds	$	437,700				405,500

At December 31, 2019, the Company had FHLB advances of $449.8 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately $416.1 million.

At December 31, 2018, the Company had FHLB advances of $432.5 million outstanding with excess collateral pledged to the FHLB during those periods that would support additional borrowings of approximately $305.1 million.

Lines of credit with the FRB are based on collateral pledged. At December 31, 2019, the Company had lines available with the FRB for $188.3 million. At December 31, 2018, the Company had lines available with the FRB for $226.3 million. At December 31, 2019 and 2018, the Company had no FRB advances outstanding.

130

NOTE 12 – LONG-TERM DEBT

Long-term debt at December 31, 2019 and 2018 are summarized as follows:


	December 31, 2019
			Stated Interest
	Balance		Rate
	(Dollars in thousands)

Long-term FHLB advances, due through 2028	$	12,114		0.88%-2.39%
Subordinated debentures, due 2026 through 2037		42,761		3.67%-6.90%
Total long-term debt	$	54,875


	December 31, 2018
			Stated Interest
	Balance		Rate
	(Dollars in thousands)
Long-term FHLB advances, due through 2020	$	27,000		1.72%-2.60%
Subordinated debentures, due 2032 through 2037		32,436		4.25%-5.75%
Total long-term debt	$	59,436

The following table presents the scheduled repayments of long-term debt as of December 31, 2019.


2020		—
2021		2,000
2022		6,038
2023		—
2024		—
Thereafter		46,837
Total	$	54,875

As of December 31, 2019, there was $4 million of principal amounts callable by the FHLB on advances.

At December 31, 2019, statutory business trusts (“Trusts”) created by the Company or acquired had outstanding trust preferred securities with an aggregate par value of $36.0 million, with a fair value of $31.9 million. The trust preferred securities have stated floating interest rates ranging from 3.67% to 6.90% at December 31, 2019 and maturities ranging from December 31, 2032 to January 30, 2037. The principal assets of the Trusts are $37.1 million of the Company’s subordinated debentures with identical rates of interest and maturities as the trust preferred securities. The Trusts have issued $1.1 million of common securities to the Company.

The trust preferred securities, the assets of the Trusts and the common securities issued by the Trusts are redeemable in whole or in part beginning on or after December 31, 2008, or at any time in whole but not in part from the date of issuance on the occurrence of certain events. The obligations of the Company with respect to the issuance of the trust preferred securities constitutes a full and unconditional guarantee by the Company of the Trusts’ obligations with respect to the trust preferred securities. Subject to certain exceptions and limitations, the Company may elect from time to time to defer subordinated debenture interest payments, which would result in a deferral of distribution payments on the related trust preferred securities.

131

NOTE 13 - INCOME TAXES

The 2017 Tax and Cuts Jobs Act (“2017 Tax Act”) was signed into law by the President on December 22, 2017. The 2017 Tax Act reduced the corporate Federal tax rate from 35% to 21% effective January 1, 2018. Income tax expense for 2017 includes a revaluation of net deferred tax assets in the amount of $239,000, recorded as a result of the enactment of the 2017 Tax Act.

Income tax expense for the years ended December 31, 2019, 2018 and 2017 consists of the following:


	For the Years
	Ended December 31,
	2019		2018			2017
	(In thousands)
Current income tax expense
Federal	$	14,375		12,114			3,764
State		2,020		2,185			971
		16,395		14,299			4,735
Deferred income tax expense (benefit)
Federal		1,141		(1,219	)		7,792
State		412		(311	)		195
Deferred tax revaluation related to the 2017 Tax Act		—		—			239
		1,553		(1,530	)		8,226
Total income tax expense	$	17,948		12,769			12,961

A reconciliation from expected Federal tax expense to actual income tax expense for the years ended December 31, 2019, 2018 and 2017 using the base federal tax rates of 21%, 21% and 35%, respectively follows:


	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Computed federal income taxes	$	16,944			13,112			14,534
State income tax, net of federal benefit		2,090			1,674			758
Tax exempt interest		(1,195	)		(1,378	)		(1,667	)
Stock based compensation		(77	)		(331	)		(1,514	)
Deferred tax revaluation related to the 2017 Tax Act		—			—			239
Other, net		186			(308	)		611
Total income tax expense	$	17,948			12,769			12,961

The FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions, including income tax consequences. In addition to other changes, the guidance changes the accounting for excess tax benefits and tax deficiencies from generally being recognized in additional paid-in capital to recognition as income tax expense or benefit in the period they occur. The Company early adopted the new guidance in the second quarter of 2016. A tax benefit of $0.1 million, $0.3 million and $1.5 million was recorded during the years ended December 31, 2019, 2018 and 2017, respectively, as a result of share awards vesting/exercised.

132

The following is a summary of the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2019 and 2018:


	At December 31,
	2019			2018
	(In thousands)
Deferred tax assets:
Loan loss reserve	$	8,322			8,808
Unrealized loss on available-for-sale securities		—			109
Net operating loss and credit carryforwards		1,813			2,943
Stock based compensation		1,080			808
Other		2,482			823
		13,697			13,491
Valuation allowance		(436	)		(618	)
Total gross deferred tax assets		13,261			12,873
Deferred tax liabilities:
Depreciation		(4,741	)		(3,393	)
Core deposit intangible		(3,013	)		(2,932	)
Goodwill		(295	)		(240	)
Transaction costs		—			—
Unrealized gain on securities available-for-sale		(2,763	)		—
Other		14			(522	)
Total gross deferred tax liabilities		(10,798	)		(7,087	)
Deferred tax assets, net	$	2,463			5,786

Deferred tax assets are recognized for future deductible amounts resulting from differences in the financial statement and tax bases of assets and liabilities and operating loss carry forwards. A valuation allowance is then established to reduce that deferred tax asset to the level that it is “more likely than not” that the tax benefit will be realized. The realization of a deferred tax benefit by the Company depends upon having sufficient taxable income of an appropriate character in the future periods.

A portion of the annual change in the net deferred income tax asset relates to unrealized gains and losses on debt securities and interest rate swaps. The deferred income tax expense (benefit) related to the unrealized gains and losses on debt securities and interest rate swaps of $2.7 million and ($1.8) million for the years ended December 31, 2019 and 2018, respectively, was recorded directly to stockholders’ equity as a component of accumulated other comprehensive income. The balance of the change in the net deferred tax asset of $0.6 million and ($1.5) million for the years ended December 31, 2019 and 2018, respectively, are reflected in the Consolidated Statement of Operations. The valuation allowances relate to state net operating loss and tax credit carry-forwards. It is management’s belief that the realization of the remaining net deferred tax assets is more likely than not. Tax returns for 2016 and subsequent years are subject to examination by taxing authorities. The Company has analyzed the tax positions taken or expected to be taken on its tax returns and concluded it has no liability related to uncertain tax positions in accordance with ASC Topic 740.

The Company has federal net operating losses of $4.0 million and $2.5 million at December 31, 2019 and 2018, respectively. These net operating losses expire at various times beginning in the year of 2028. The Company has state net operating losses of $7.2 million and $10.4 million at December 31, 2019 and 2018, respectively. These net operating losses expire at various times beginning in the year 2028. The Company has AMT credits of $0.4 million and $1.4 million at December 31, 2019 and 2018, respectively. As a result of the Carolina Trust BancShares ownership changes in 2019, the Greer Bancshares and First South Bancorp ownership changes in 2017 and the Congaree Bancshares ownership change in 2016, Section 382 of the Internal Revenue Code places an annual limitation on the amount of federal net operating loss carry-forwards and credit carryforwards which the Company may utilize. The Company expects all Section 382 limited carry-forwards to be realized within the applicable carry-forward periods.

133

NOTE 14 - COMMITMENTS AND CONTINGENCIES INCLUDING LEASES

The Company has entered into agreements to lease certain office facilities, including buildings and land, and equipment under non-cancellable operating lease agreements. Our leases have remaining lease terms of 1 year to 40 years, which include options to extend or terminate the lease. These options to extend or terminate the lease are included in the lease term when it is reasonably certain that the options will be exercised.

In addition to the package of practical expedients, the Company has also elected the practical expedient which allows lessees to make an accounting policy election by underlying class of asset to not separate nonlease components from the associated lease component, and instead account for them all together as part of the applicable lease component.

Operating lease expense was $2.7 million for the year ended December 31, 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $2.5 million for the year ended December 31, 2019. We do not apply the recognition requirements of ASC 842 to short-term leases and recognize the lease payments on a straight-line basis over the lease term. The rate implicit in the lease is not readily determinable for the Company’s leases. Accordingly, the incremental borrowing rate, giving consideration to the FHLB borrowing rate, is based on the information available at commencement date and is used to determine the present value of lease payments.

Supplemental balance sheet information related to operating leases follows:

	At December 31, 2019
Right of use operating lease asset (in millions)	$	17.2
Right of use operating lease liability (in millions)	$	17.6

Weighted average remaining lease term (years)		15.0
Weighted average discount rate		3.4	%

Future minimum lease payments (in thousands), by year and in the aggregate, under non-cancellable operating leases with initial or remaining terms in excess of one year as of December 31, 2019 are as follows:


Year 1	$	2,595
Year 2		2,136
Year 3		1,977
Year 4		1,860
Year 5		1,591
After Year 5		12,881
Total undiscounted payments		23,040
Less: imputed interest		(5,447	)
Present value of lease payments (ROU operating lease liability)	$	17,593

134

Year 1	$	2,537
Year 2		2,332
Year 3		1,950
Year 4		1,868
Year 5		1,738
After Year 5		14,165
Total	$	24,590

The Company’s rental expense for its office facilities for the years ended December 31, 2018 and 2017 totaled $2.4 million and $1.4 million, respectively.

In the course of ordinary business, the Company is, from time to time, named a party to legal actions and proceedings, primarily related to the collection of loans and foreclosed assets. In accordance with generally accepted accounting principles, the Company establishes reserves for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. When loss contingencies are not both probable and estimable, the Company does not establish reserves.

NOTE 15 – STOCK-BASED COMPENSATION

Compensation cost is recognized for stock options and restricted stock awards issued to employees. Compensation cost is measured as the fair value of these awards on their date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used as the fair value of restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards and as the restriction period for restricted stock awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

The Company has adopted a 2013 Equity Incentive Plan under which an aggregate of 1,200,000 shares of common stock have been reserved for issuance by the Company. The plan provides for the grant of stock options, restricted stock and restricted stock unit awards to our officers, employees, directors, advisors, and consultants. The options are granted at an exercise price at least equal to the fair value of the common stock at the date of grant and expire ten years from the date of the grant. The vesting period for both option grants, restricted stock grants, and restricted stock units will vary based on the timing of the grant. Awards that expire without issuance, forfeitures, shares used as partial payment to the Company for the purchase price of the award, or an award settled in cash, including for payroll taxes, are added back to the shares available to be awarded under the Plan. As of December 31, 2019, a total of 173,637 shares were remaining in the plan available to be issued.

In connection with the merger of First South, the Company assumed the obligations of First South under the First South Bancorp, Inc. 2008 Equity Incentive Plan (the “2008 Plan”) and the First South Bancorp, Inc. 1997 Stock Option Plan (the “1997 Plan”). At December 31, 2019, the 2008 Plan had 8,862 stock options outstanding and there are no stock options outstanding for the 1997 Plan. There are no additional shares available to be awarded under the 2008 Plan or the 1997 Plan. All options under the 2008 Plan and 1997 Plan were fully vested at the time of the merger.

In connection with the merger of Carolina Trust, the Company assumed the existing outstanding options from Carolina Trust by reissuing options with the existing terms and conditions. At December 31, 2019, the date of the merger, the stock options awarded from the Company’s 2013 Equity Incentive Plan to employees of Carolina Trust totaled 34,624. All options were fully vested at the time of the merger.

135

The expense recognition of employee stock option, restricted stock awards, and restricted stock units resulted in net expense of approximately $3.1 million, $2.7 million and $1.7 million during the years ended December 31, 2019, 2018 and 2017, respectively.

Information regarding the 2019 grants as well as other relevant disclosure related to the share-based compensation plans of the Company is presented below.

Stock Options

Activity in the Company’s stock option plans is summarized in the following table. All information has been retroactively adjusted for stock splits.


	At and for the Years Ended December 31,
	2019					2018
				Weighted					Weighted
				Average					Average
				Exercise					Exercise
	Shares			Price		Shares			Price
Outstanding at beginning of year		297,431		$	11.12		312,382		$	12.01
Granted		—			—		1,000			40.91
Acquired in a merger		34,624			12.93		—			—
Exercised		(71,842	)		13.37		(7,596	)		18.71
Forfeited or expired		—			—		(8,355	)		40.79
Outstanding at end of year		260,213		$	10.75		297,431		$	11.12

Options exercisable at end of year		249,550		$	9.96		263,114		$	9.48

The aggregate intrinsic value of 260,213 and 297,431 stock options outstanding at December 31, 2019 and 2018 was $8.5 million and $5.5 million, respectively. The aggregate intrinsic value of 249,550 and 263,114 stock options exercisable at December 31, 2019 and 2018 was $8.3 million and $5.3 million, respectively. Intrinsic value represents the amount by which the fair market value of the underlying stock exceeds the exercise price of the stock option.

136

Information pertaining to options outstanding at December 31, 2019 and 2018, is as follows:


	At December 31, 2019
	Options Outstanding						Options Exercisable
			Weighted Avg.		Weighted				Weighted
	Number		Remaining Years		Average		Number		Average
Exercise Prices	Outstanding		Contractual Life		Exercise Price		Outstanding		Exercise Price
$4.17		111,778		3.3	$	4.17		111,778	$	4.17
$7.10		4,397		2.2		7.10		4,397		7.10
$8.54		6,576		4.3		8.54		6,576		8.54
$9.27 - $9.97		2,569		2.1		9.68		2,569		9.68
$10.20 - $10.66		4,794		1.5		10.50		4,794		10.50
$11.03 - $11.58		54,762		4.9		11.48		54,763		11.48
$12.88		2,279		3.4		12.88		2,279		12.88
$15.82 - $16.83		47,908		5.7		16.53		45,908		16.51
$17.17 - $18.13		4,450		4.8		17.54		4,450		17.54
$21.24		1,013		0.2		21.54		1,013		21.54
$30.90		18,687		7.1		30.90		11,023		30.90
$40.91		1,000		8.2		40.91		—		—

		260,213		4.3	$	10.75		249,550	$	9.96

	At December 31, 2018
	Options Outstanding						Options Exercisable
			Weighted Avg.		Weighted				Weighted
	Number		Remaining Years		Average		Number		Average
Exercise Prices	Outstanding		Contractual Life		Exercise Price		Outstanding		Exercise Price
$4.17		124,930		4.3	$	4.17		124,930	$	4.17
$8.14		10,127		3.2		8.14		10,127		8.14
$8.54		6,576		5.3		8.54		6,576		8.54
$9.97 - $10.66		7,596		2.2		10.52		7,596		10.52
$11.58 - $12.88		58,796		6.0		11.66		58,796		11.66
$15.82 - $16.83		54,781		7.0		16.56		36,791		16.54
$20.97 - $21.54		10,635		0.6		21.21		10,635		21.21
$30.90		22,990		8.1		30.90		7,663		30.90
$34.10 - $38.03		—		—		—		—		—
$40.91		1,000		2.2		40.91		—		—
$42.28 - $42.56		—		—		—		—		—
		297,431		5.2	$	11.12		263,114	$	9.48

137

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the option vesting period. The following weighted-average assumptions were used in valuing options issued during 2018. No options were issued during 2019.

	2018
Dividend yield		0.5	%
Expected life		6 years
Expected volatility		44	%
Risk-free interest rate		2.76	%

As of December 31, 2019, there was $19,000 of total unrecognized compensation cost related to non-vested stock option grants under the plans. The cost is expected to be recognized over a weighted-average period of 0.6 years as of December 31, 2019.

Restricted Stock Grants

The Company from time-to-time also grants shares of restricted stock to key employees and non-employee directors. These awards help align the interests of these employees and directors with the interests of the stockholders of the Company by providing economic value directly related to increases in the value of the Company’s stock. These awards typically hold service requirements over various vesting periods. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants.

All restricted stock agreements are conditioned upon continued employment. Termination of employment prior to a vesting date, as described below, would terminate any interest in non-vested shares. Prior to vesting of the shares, as long as employed by the Company, the key employees and non-employee directors will have the right to vote such shares and to receive dividends paid with respect to such shares. All restricted shares will fully vest in the event of change in control of the Company.

138

Nonvested restricted stock for the years ended December 31, 2019 and 2018 is summarized in the following table.


	At and for the Years Ended December 31,
	2019					2018
				Weighted					Weighted
				Average					Average
				Grant- Date					Grant- Date
Restricted stock grants	Shares			Fair Value		Shares			Fair Value
Nonvested at January 1		117,966		$	13.14		134,302		$	8.87
Granted		56,037			33.47		47,039			39.32
Vested		(42,001	)		30.14		(52,925	)		20.85
Forfeited		(19,453	)		30.36		(10,450	)		37.09
Nonvested at December 31		112,549		$	13.94		117,966		$	13.14

The vesting schedule of these shares as of December 31, 2019 is as follows:

	Shares
2020		57,925
2021		28,747
2022		18,525
2023		7,352
2024		—
Thereafter		—
Total		112,549

As of December 31, 2019, there was $3.9 million of total unrecognized compensation cost related to nonvested restricted stock granted under the plans. The cost is expected to be recognized over a weighted-average period of 1.8 years as of December 31, 2019.

Restricted Stock Units

The Company from time-to-time also grants performance restricted stock units (“RSUs”) to key employees. These awards help align the interests of these employees with the interests of the shareholders of the Company by providing economic value directly related to the performance of the Company. Performance RSU grants contain a two year performance period. The Company communicates the specific threshold, target, and maximum performance RSU awards and performance targets to the applicable key employees at the beginning of a performance period. Dividends are not paid in respect to the awards and the holder does not have the right to vote the shares during the performance period. The value of the RSUs awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expenses on a straight-line basis typically over the period the performance target is to be achieved.

139

Nonvested RSUs for the years ended December 31, 2019 and 2018 is summarized in the following table.


	At and For the Years Ended
	December 31, 2019					December 31, 2018
				Weighted					Weighted
				Average					Average
				Grant- Date					Grant- Date
Restricted stock units	Shares			Fair Value		Shares			Fair Value
Nonvested at January 1		21,512		$	38.77		17,273		$	30.90
Granted		23,045			33.87		22,112			38.77
Granted-achievement of 150% target		10,256			38.23		—			—
Vested		(20,512	)		38.77		(17,273	)		30.90
Vested-achievement of 150% target		(10,256	)		38.23		—			—
Forfeited		(1,000	)		38.77		(600	)		38.77
Nonvested at December 31		23,045		$	33.87		21,512		$	38.77

As of December 31, 2019, there was $0.4 million of total unrecognized compensation cost related to nonvested RSUs granted under the plan. This cost is expected to be recognized over a weighted-average period of 1.0 years as of December 31, 2019.

NOTE 16 – ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

Current accounting literature requires disclosures about the fair value of all financial instruments whether or not recognized in the balance sheet, for which it is practicable to estimate the value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized through immediate settlement of the instrument.

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

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

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

140

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

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

Level 3	Unobservable inputs that are supported by little, if any, market activity for the asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow models and similar techniques, and may also include the use of market prices of assets or liabilities that are not directly comparable to the subject asset or liability. These methods of valuation may result in a significant portion of the fair value being derived from unobservable assumptions that reflect the Company’s own estimates for assumptions that market participants would use in pricing the asset or liability. This category primarily includes collateral-dependent impaired loans, other real estate, certain equity investments, and certain private equity investments.

141

Assets and liabilities measured at fair value on a recurring basis are as follows as of December 31, 2019 and December 31, 2018:


	Quoted market		Significant other		Significant other
	price in active		observable inputs		unobservable inputs
	markets (Level 1)		(Level 2)		(Level 3)
	(In thousands)
December 31, 2019
Available-for-sale investment securities:
Municipal securities	$	—		218,968		—
US government agencies		—		23,923		—
Collateralized loan obligations		—		299,982		—
Corporate securities		—		6,988		—
Mortgage-backed securities:
Agency		—		166,714		—
Non-agency		—		151,942		—
Trust preferred securities		—		10,718		—
Loans held for sale		—		31,282		—
Derivative assets:
Non-hedging derivatives:
Interest rate swaps		138		—		—
Mortgage loan interest rate lock commitments		—		1,073		—
Mortgage loan forward sales commitments		—		580		—
Derivative liabilities:
Cash flow hedges
Interest rate swaps		620		—		—
Non-hedging derivatives:
Interest rate swaps		2,767		—		—
Mortgage-backed securities forward sales commitments		—		40		—

December 31, 2018
Available-for-sale investment securities:
Municipal securities	$	—		213,714		—
US government agencies		—		25,277		—
Collateralized loan obligations		—		230,699		—
Corporate securities		—		6,960		—
Mortgage-backed securities:
Agency		—		197,520		—
Non-agency		—		157,531		—
Trust preferred securities		—		11,100		—
Loans held for sale		—		16,972		—
Derivative assets:
Cash flow hedges:
Interest rate swaps		1,232		—		—
Non-hedging derivatives:
Interest rate swaps		1,198		—		—
Mortgage loan interest rate lock commitments		—		1,199		—
Mortgage loan forward sales commitments		—		403		—
Derivative liabilities:
Non-hedging derivatives:
Interest rate swaps		937		—		—
Mortgage-backed securities forward sales commitments		—		295		—

142

Securities Available-for-Sale

Fair values for investment securities available-for-sale are measured on a recurring basis upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. At December 31, 2019 and 2018, the Company’s investment securities available-for-sale are recurring Level 2. During the year ended December 31, 2018, transfers from Level 3 to Level 2 included $11.5 million of trust preferred securities driven by an increase in the observability of certain valuation inputs. All transfers are assumed to occur at the end of the quarterly reporting period in which they occur.

Mortgage Loans Held for Sale

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

Derivative Assets and Liabilities

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

143

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

Assets measured at fair value on a nonrecurring basis are as follows as of December 31, 2019 and December 31, 2018:


	Quoted market price		Significant other		Significant other
	in active markets		observable inputs		unobservable inputs
	(Level 1)		(Level 2)		(Level 3)
	(In thousands)
December 31, 2019
Impaired loans:
Loans secured by real estate:
One-to-four family	$	—		—		5,449
Home equity		—		—		98
Commercial real estate		—		—		20,172
Construction and development		—		—		3,101
Consumer loans		—		—		12
Commercial business loans		—		—		5,210
Real estate owned:
One-to-four family		—		—		755
Commercial real estate		—		—		784
Construction and development		—		—		786
Mortgage servicing rights		—		—		31,410

December 31, 2018
Impaired loans:
Loans secured by real estate:
One-to-four family	$	—		—		4,511
Home equity		—		—		249
Commercial real estate		—		—		4,960
Construction and development		—		—		1,351
Consumer loans		—		—		31
Commercial business loans		—		—		2,829
Real estate owned:
One-to-four family		—		—		204
Construction and development		—		—		1,330
Mortgage servicing rights		—		—		40,880

144

For Level 3 assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2019 and December 31, 2018, the significant unobservable inputs used in the fair value measurements were as follows:


	At December 31, 2019 and December 31, 2018
		Significant	Significant Unobservable
	Valuation Technique	Observable Inputs	Inputs
Impaired loans	Appraisal value	Appraisals and or sales of comparable properties	Appraisals discounted 10% to 20% for sales commissions and other holding costs

Real estate owned	Appraisal value/ Comparison sales	Appraisals and or sales of comparable properties	Appraisals discounted 10% to 20% for sales commissions and other holding costs

Mortgage servicing rights	Discounted cash flows	Comparable sales	Weighted average discount rates
			averaging 10% - 12% in 2019
			Weighted average discount rates
			averaging 12% - 13% in 2018
			Weighted average prepayment rates
			averaging 10% - 12% in 2019
			Weighted average prepayment rates
			averaging 6% - 7% in 2018
			Net servicing fee of 0.25% in each
			period presented
			Weighted average delinquency rates
			averaging 1.87% in 2019
			Weighted average delinquency rates
			averaging 2.34% in 2018

Impaired Loans

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

Other Real Estate Owned (“OREO”)

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

Mortgage Servicing Rights

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

The Company recorded a $3.1 million temporary impairment of mortgage servicing rights in the year ended December 31, 2019. Impairment was recorded in the 2017, 2018 and 2019 tranches. The Company does not hedge the mortgage servicing rights positions and the impact of falling long-term interest rates increased prepayment speed assumptions reducing the value of the MSR asset.

145

The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2019 and December 31, 2018 are as follows:


	At December 31, 2019
	Carrying		Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial assets:
Cash and due from banks	$	41,411		41,411		41,411		—		—
Interest-bearing cash		91,792		91,792		91,792		—		—
Securities available-for-sale		879,235		879,235		—		879,235		—
Federal Home Loan Bank stock, at cost		23,280		23,280		—		—		23,280
Other investments		3,521		3,521		—		—		3,521
Derivative assets		1,791		1,791		138		1,653		—
Loans held for sale		31,282		31,282		—		31,282		—
Loans receivable, net		3,211,416		3,214,179		—		—		3,214,179
Accrued interest receivable		14,951		14,951		—		14,951		—
Real estate acquired through foreclosure		2,325		2,325		—		—		2,325
Mortgage servicing rights		25,941		31,410		—		—		31,410

Financial liabilities:
Deposits		3,408,361		3,413,608		—		3,413,608		—
Short-term borrowed funds		437,700		437,669		—		437,669		—
Long-term debt		54,875		54,215		—		54,215		—
Derivative liabilities		3,427		3,427		3,387		40		—
Drafts outstanding		8,193		8,193		—		8,193		—
Advances from borrowers for insurance and taxes		3,288		3,288		—		3,288		—
Accrued interest payable		2,450		2,450		—		2,450		—
Dividends payable to stockholders		2,227		2,227		—		2,227		—

146


	At December 31, 2018
	Carrying		Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial assets:
Cash and due from banks	$	28,857		28,857		28,857		—		—
Interest-bearing cash		33,276		33,276		33,276		—		—
Securities available-for-sale		842,801		842,801		—		842,801		—
Federal Home Loan Bank stock, at cost		21,696		21,696		—		—		21,696
Other investments		3,450		3,450		—		—		3,450
Derivative assets		4,032		4,032		2,430		1,602		—
Loans held for sale		16,972		16,972		—		16,972		—
Loans receivable, net		2,509,873		2,506,384		—		—		2,506,384
Accrued interest receivable		13,494		13,494		—		13,494		—
Real estate acquired through foreclosure		1,534		1,534		—		—		1,534
Mortgage servicing rights		32,933		40,880		—		—		40,880

Financial liabilities:
Deposits		2,718,193		2,721,885		—		2,721,885		—
Short-term borrowed funds		405,500		405,532		—		405,532		—
Long-term debt		59,436		61,853		—		61,853		—
Derivative liabilities		1,232		1,232		937		295		—
Drafts outstanding		8,129		8,129		—		8,129		—
Advances from borrowers for insurance and taxes		4,100		4,100		—		4,100		—
Accrued interest payable		1,591		1,591		—		1,591		—
Dividends payable to stockholders		1,576		1,576		—		1,576		—

147

At December 31, 2019

At December 31, 2018

Notional

Estimated

Notional

Estimated

Amount

Fair Value

Amount

Fair Value

(In thousands)

Off-Balance Sheet Financial Instruments:

Commitments to extend credit

659,126

—

379,170

—

Standby letters of credit

23,761

—

13,797

—

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

Cash and due from banks

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

Interest-bearing cash

The carrying amount of these financial instruments approximates fair value.

FHLB stock and other investments

The carrying amount of these financial instruments approximates fair value.

Loans receivable

During the first quarter of 2018, the Company adopted ASU 2016-01, “Recognition and Measurement of Financial Assets and Liabilities.” The amendments included within this standard, which were applied prospectively, require the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using an exit price notion. Prior to adopting the amendments included in the standard, the Company was allowed to measure fair value under an entry price notion. The entry price notion previously applied by the Company used a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument. The exit price notion uses the same approach, but also incorporates other factors, such as enhanced credit risk, illiquidity risk and market factors that sometimes exist in exit prices in dislocated markets. The technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures to those used prior to adopting the amendments included in the standard, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied entry price notion. The fair value of the Company’s loan portfolio has always included a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio. For variable rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral.

Accrued interest receivable

The carrying value approximates the fair value.

Deposits

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

148

Short-term borrowed funds

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

Long-term debt

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

Drafts outstanding, advances from borrowers for insurance and taxes and dividends payable to stockholders

The carrying value approximates the fair value.

Accrued interest payable

The fair value approximates the carrying value.

Commitments to extend credit

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

Off-balance sheet financial instruments

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

NOTE 17 - OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK

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

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments as for on-balance sheet instruments. At December 31, 2019 and 2018, the Company had commitments to extend credit in the amount of $659.1 million and $379.2 million, respectively. At December 31, 2019 and 2018, the Company had standby letters of credit in the amount of $23.8 million and $13.8 million, respectively.

Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower and the letters of credit are generally not collateralized. Commitments under standby letters of credit are usually one year or less. At December 31, 2019, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor; as such amounts are not considered material. The maximum potential of undiscounted future payments related to standby letters of credit at December 31, 2019 was approximately $23.8 million.

149

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require a payment of a fee. Since commitments may expire without being drawn upon, the total commitments do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include inventory, property and equipment, residential real estate and income producing commercial properties.

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

The Company’s derivative positions are presented with discussion in Note 5 - Derivatives.

NOTE 18 - EMPLOYEE BENEFIT PLANS

The Company maintains a 401(k) plan that covers substantially all employees of CresCom Bank, Carolina Services (“CFC Participants”) and Crescent Mortgage (“CMC Participants”). Participants may contribute up to the maximum allowed by the regulation. During fiscal 2019 and 2018, the Company matched 75% of an employee’s contribution up to 6.0% of the participant’s compensation of the CFC Participants and the CMC Participants. For the years ended December 31, 2019, 2018 and 2017, the Company made matching contributions of $1.0 million, $1.0 million and $0.8 million, respectively.

NOTE 19 - EARNINGS PER COMMON SHARE

Basic earnings per common share are calculated by dividing net income by the weighted average number of common shares outstanding during the period. Basic earnings per common share exclude the effect of nonvested restricted stock. Diluted earnings per common share is calculated by dividing net income by the weighted average number of common shares outstanding plus the weighted average number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Diluted earnings per common share include the effects of outstanding stock options and restricted stock issued by the Company, if dilutive. The number of additional shares is calculated by assuming that outstanding stock options were exercised and that the proceeds from such exercises and vesting were used to acquire shares of common stock at the average market price during the reporting period.

All share, earnings per share, and per share data have been retroactively adjusted to reflect stock splits for all periods presented in accordance with generally accepted accounting principles.

150

The following is a summary of the reconciliation of average shares outstanding for the years ended December 31, 2019, 2018 and 2017:


	December 31,
	2019				2018				2017
	Basic		Diluted		Basic		Diluted		Basic		Diluted

Weighted average shares outstanding		22,168,082		22,168,082		21,756,595		21,756,595		16,317,501		16,317,501
Effect of dilutive securities		—		217,045		—		216,262		—		232,856
Weighted average shares outstanding		22,168,082		22,385,127		21,756,595		21,972,857		16,317,501		16,550,357

The average market price used in calculating the dilutive securities under the treasury stock method for the years ended December 31, 2019, 2018 and 2017 was $36.16, $38.95 and $32.85 respectively.

For the years ended December 31, 2019, 2018 and 2017, the Company excluded 1,000, 1,000 and 37,802 option shares, respectively, from the calculation of diluted earnings per share during the period because the exercise prices were greater than the average market price of the common shares, and therefore were deemed not to be dilutive.

The following is a summary of the reconciliation of shares issued and outstanding and unvested restricted stock awards as of December 31, 2019, 2018 and 2017 used for computing book value and tangible book value per share:


	As of December 31,
	2019			2018			2017

Issued and outstanding shares		24,777,608			22,387,009			21,022,202
Less nonvested restricted stock awards		(112,549	)		(117,966	)		(134,302	)
Period end dilutive shares		24,665,059			22,269,043			20,887,900

NOTE 20 - CAPITAL REQUIREMENTS AND OTHER RESTRICTIONS

151

The required minimum ratios are as follows:

Common equity Tier 1 capital ratio (common equity Tier 1 capital to total risk-weighted assets) of 4.5%

Tier 1 Capital Ratio (Tier 1 capital to total risk-weighted assets) of 6%

Total capital ratio (total capital to total risk-weighted assets) of 8%; and

Leverage ratio (Tier 1 capital to average total consolidated assets) of 4%

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

The actual capital amounts and ratios as well as minimum amounts for each regulatory defined category for the Company and the Bank at December 31, 2019 and 2018 are as follows:

																To Be Well
						Minimum Capital					Minimum Capital					Capitalized Under
						Required - Basel III					Required - Basel III					Prompt Corrective
	Actual					Phase-In Schedule					Fully Phased-In					Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)

December 31, 2019
Carolina Financial Corporation
CET1 capital (to risk weighted assets)	$	534,742		15.10	%		247,915		7.000	%		247,915		7.000	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		566,240		15.99	%		301,040		8.500	%		301,040		8.500	%		N/A		N/A
Total capital (to risk weighted assets)		592,908		16.74	%		371,873		10.500	%		371,873		10.500	%		N/A		N/A
Tier 1 capital (to total average assets)		566,240		15.03	%		150,695		4.000	%		150,695		4.000	%		N/A		N/A

CresCom Bank
CET1 capital (to risk weighted assets)		580,752		16.41	%		247,744		7.000	%		247,744		7.000	%		230,048		6.50	%
Tier 1 capital (to risk weighted assets)		580,752		16.41	%		300,832		8.500	%		300,832		8.500	%		283,136		8.00	%
Total capital (to risk weighted assets)		597,273		16.88	%		371,616		10.500	%		371,616		10.500	%		353,920		10.00	%
Tier 1 capital (to total average assets)		580,752		15.42	%		150,663		4.000	%		150,663		4.000	%		188,329		5.00	%

152

																To Be Well
						Minimum Capital					Minimum Capital					Capitalized Under
						Required - Basel III					Required - Basel III					Prompt Corrective
	Actual					Phase-In Schedule					Fully Phased-In					Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
						(Dollars in thousands)

December 31, 2018
Carolina Financial Corporation
CET1 capital (to risk weighted assets)	$	431,568		15.19	%		181,094		6.375	%		198,848		7.000	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		462,888		16.29	%		223,704		7.875	%		241,459		8.500	%		N/A		N/A
Total capital (to risk weighted assets)		477,351		16.80	%		280,518		9.875	%		298,273		10.500	%		N/A		N/A
Tier 1 capital (to total average assets)		462,888		13.01	%		142,270		4.000	%		142,270		4.000	%		N/A		N/A

CresCom Bank
CET1 capital (to risk weighted assets)		454,181		16.00	%		180,948		6.375	%		198,688		7.000	%		184,496		6.50	%
Tier 1 capital (to risk weighted assets)		454,181		16.00	%		223,524		7.875	%		241,264		8.500	%		227,072		8.00	%
Total capital (to risk weighted assets)		468,644		16.51	%		280,292		9.875	%		298,032		10.500	%		283,840		10.00	%
Tier 1 capital (to total average assets)		454,181		12.76	%		142,392		4.000	%		142,392		4.000	%		177,990		5.00	%

A South Carolina state bank may not pay dividends from capital. All dividends must be paid out of undivided profits then on hand, after deducting expenses, including reserves for losses and bad debts. Unless otherwise instructed by the South Carolina Board of Financial Institutions, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions. In addition, under the Federal Deposit Insurance Corporation Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. The note may also prevent the payment of a dividend by the Bank if it determines that the payment would be an unsafe and unsound banking practice.

NOTE 21 – SUPPLEMENTAL SEGMENT INFORMATION

The Company has three reportable segments: community banking, wholesale mortgage banking (“mortgage banking”) and other. The community banking segment provides traditional banking services offered through CresCom Bank. The mortgage banking segment provides mortgage loan origination and servicing offered through Crescent Mortgage. The other segment provides managerial and operational support to the other business segments through Carolina Services and Carolina Financial.

153

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

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

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

The following tables present selected financial information for the Company’s reportable business segments for the years ended December 31, 2019, 2018, and 2017:

	Community		Mortgage
For the Year Ended December 31, 2019	Banking		Banking			Other			Eliminations			Total
	(In thousands)
Interest income	$	175,726		1,695			59			(364	)		177,116
Interest expense		35,736		483			2,138			(491	)		37,866
Net interest income (expense)		139,990		1,212			(2,079	)		127			139,250
Provision for (recovery of) loan losses		2,709		(129	)		—			—			2,580
Noninterest income from external customers		21,384		25,652			74			—			47,110
Intersegment noninterest income		966		17			—			(983	)		—
Noninterest expense		77,921		24,004			1,167			—			103,092
Intersegment noninterest expense		—		960			6			(966	)		—
Income (loss) before income taxes		81,710		2,046			(3,178	)		110			80,688
Income tax expense (benefit)		18,328		474			(879	)		25			17,948
Net income (loss)	$	63,382		1,572			(2,299	)		85			62,740

Assets	$	4,707,151		75,719			790,017			(864,014	)		4,708,873
Loans receivable, net		3,202,616		14,266			—			(5,466	)		3,211,416
Loans held for sale		996		30,286			—			—			31,282
Deposits		3,418,646		—			—			(10,285	)		3,408,361
Borrowed funds		449,814		5,100			42,761			(5,100	)		492,575


	Community		Mortgage
For the Year Ended December 31, 2018	Banking		Banking		Other			Eliminations			Total
	(In thousands)
Interest income	$	159,483		1,841		56			(322	)		161,058
Interest expense		25,227		414		2,025			(418	)		27,248
Net interest income (expense)		134,256		1,427		(1,969	)		96			133,810
Provision for loan losses		2,034		25		—			—			2,059
Noninterest income from external customers		18,680		21,106		110			—			39,896
Intersegment noninterest income		966		99		—			(1,065	)		—
Noninterest expense		89,459		18,631		1,117			1			109,208
Intersegment noninterest expense		—		960		6			(966	)		—
Income (loss) before income taxes		62,409		3,016		(2,982	)		(4	)		62,439
Income tax expense (benefit)		12,785		701		(716	)		(1	)		12,769
Net income (loss)	$	49,624		2,315		(2,266	)		(3	)		49,670

Assets	$	3,786,360		84,335		610,167			(690,114	)		3,790,748
Loans receivable, net		2,494,421		30,879		—			(15,427	)		2,509,873
Loans held for sale		1,450		15,522		—			—			16,972
Deposits		2,724,920		—		—			(6,727	)		2,718,193
Borrowed funds		432,500		14,951		32,436			(14,951	)		464,936

154

	Community		Mortgage
For the Year Ended December 31, 2017	Banking		Banking		Other			Eliminations			Total
	(In thousands)
Interest income	$	93,319		1,743		31			(6	)		95,087
Interest expense		12,100		172		1,152			(171	)		13,253
Net interest income (expense)		81,219		1,571		(1,121	)		165			81,834
Provision for loan losses		779		—		—			—			779
Noninterest income from external customers		14,262		19,654		—			—			33,916
Intersegment noninterest income		966		67		—			(1,033	)		—
Noninterest expense		55,900		16,614		931			—			73,445
Intersegment noninterest expense		—		966		1			(967	)		—
Income (loss) before income taxes		39,768		3,712		(2,053	)		99			41,526
Income tax expense (benefit)		12,929		1,262		(1,267	)		37			12,961
Net income (loss)	$	26,839		2,450		(786	)		62			28,565

Assets	$	3,516,551		81,681		503,144			(582,359	)		3,519,017
Loans receivable, net		2,295,316		28,206		—			(15,472	)		2,308,050
Loans held for sale		5,999		29,293		—			—			35,292
Deposits		2,611,106		—		—			(6,177	)		2,604,929
Borrowed funds		380,500		15,000		32,259			(15,000	)		412,759

155

NOTE 22 – SUMMARIZED QUARTERLY INFORMATION (UNAUDITED)


	2019 Quarter Ended (unaudited)
	4th		3rd		2nd		1st
	Quarter		Quarter		Quarter		Quarter
	(In thousands)
Interest income	$	44,386		45,814		44,135		42,781
Interest expense		9,073		9,631		9,852		9,310
Net interest income		35,313		36,183		34,283		33,471
Provision for loan losses		580		620		680		700
Noninterest income		13,291		12,716		11,231		9,871
Noninterest expense		26,559		26,907		25,478		24,147
Income before income taxes		21,465		21,372		19,356		18,495
Income tax expense		4,972		4,744		4,282		3,950
Net income	$	16,493		16,628		15,074		14,545

Earnings per common share:
Basic	$	0.74	$	0.75	$	0.68	$	0.66
Diluted	$	0.74	$	0.74	$	0.67	$	0.65


	2018 Quarter Ended (unaudited)
	4th		3rd		2nd		1st
	Quarter		Quarter		Quarter		Quarter
	(In thousands)
Interest income	$	42,919		40,985		39,477		37,676
Interest expense		8,027		7,102		6,572		5,545
Net interest income		34,892		33,883		32,905		32,131
Provision for loan losses		750		750		559		—
Noninterest income		8,520		10,300		11,027		10,048
Noninterest expense		23,237		24,002		24,371		37,598
Income before income taxes		19,425		19,431		19,002		4,581
Income tax expense		3,981		4,227		4,036		525
Net income	$	15,444		15,204		14,966		4,056

Earnings per common share:
Basic	$	0.69	$	0.67	$	0.70	$	0.19
Diluted	$	0.68	$	0.66	$	0.70	$	0.19

156

NOTE 23 - PARENT COMPANY FINANCIAL INFORMATION

The condensed financial statements for the parent company are presented below:


Carolina Financial Corporation
Condensed Statements of Operations

	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Interest income	$	60			56			31
Total income		60			56			31
Interest expense		2,138			2,025			1,152
General and administrative expenses		1,100			1,013			932
Total expenses		3,238			3,038			2,084
(Loss) before income taxes and equity in undistributed earnings of subsidiaries		(3,178	)		(2,982	)		(2,053	)
Income tax expense (benefit)		(879	)		(716	)		(1,267	)
(Loss) before equity in undistributed earnings of subsidiaries		(2,299	)		(2,266	)		(786	)
Equity in undistributed earnings of CresCom Bank		65,039			51,936			29,351
Total equity in undistributed earnings of subsidiaries		65,039			51,936			29,351
Net income	$	62,740			49,670			28,565

157

Carolina Financial Corporation

Condensed Balance Sheets


	At December 31,
	2019		2018
	(In thousands)
Assets:
Cash and cash equivalents	$	8,499		5,371
Investment in bank subsidiary		790,566		597,899
Investment in unconsolidated statutory business trusts		1,116		1,116
Securities available-for-sale		1		1
Other assets		922		7,047
Total assets	$	801,104		611,434

Liabilities and stockholders' equity:
Accrued expenses and other liabilities	$	14,903		3,713
Long-term debt		42,761		32,436
Stockholders' equity		743,440		575,285
Total liabilities and stockholders' equity	$	801,104		611,434

158

Carolina Financial Corporation
Condensed Statements of Cash Flows


	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Cash flows from operating activities:
Net income	$	62,740			49,670			28,565
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed earnings in subsidiaries		(65,039	)		(51,936	)		(29,351	)
Stock-based compensation		3,143			2,700			1,658
Vested stock awards surrendered in cashless exercise		(1,496	)		(774	)		(1,789	)
Decrease (increase) in other assets		6,452			(5,423	)		1,053
Increase (decrease) in other liabilities		4			1,581			(3,456	)
Net cash provided by (used in) operating activities		5,804			(4,182	)		(3,320	)
Cash flows from investing activities:
Equity contribution in bank subsidiaries		—			(60,000	)		(35,000	)
Sales and maturities of available for sale securities		—			500			—
Sale or repayment of investments to subsidiaries		9,000			12,000			—
Net cash (paid) received from acquisitions		2,375			—			(6,016	)
Net cash provided by (used in) investing activities		11,375			(47,500	)		(41,016	)
Cash flows from financing activities:
Issuance of common stock, net of offering expenses		124			63,022			47,671
Stock options exercised		961			56			10
Stock repurchase plan, net of commission		(7,115	)		(5,381	)		—
Excess tax benefit in connection with equity awards		—			—			439
Cash dividends paid on common stock		(8,021	)		(5,563	)		(2,371	)
Net cash (used in) provided by financing activities		(14,051	)		52,134			45,749
Net increase in cash and cash equivalents		3,128			452			1,413
Cash and cash equivalents, beginning of period		5,371			4,919			3,506
Cash and cash equivalents, end of period	$	8,499			5,371			4,919

159

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation of disclosure controls and procedures. As of the end of the period covered by this Annual Report on Form 10-K, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, were effective as of the end of the period covered by this report.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

As of December 31, 2019, management assessed the effectiveness of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control-Integrated Framework,” issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in 2013. This assessment included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions for the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C) to meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act. Based on the assessment management determined that the Company maintained effective internal control over financial reporting as of December 31, 2019.

Elliott Davis, LLC, the independent, registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2019, and audited the Company’s effectiveness of internal control over financial reporting as of December 31, 2019, as stated in their report, which is included in Item 8 hereof.

Item 9B. Other Information

None

160

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

The information required by this Item of Part III will be be incorporated by reference from either the registrant’s definitive proxy statement which involves the election of directors if such proxy statement is filed not later than 120 days after the end of the fiscal year covered by this report or as an amendment to this report filed not later than the end of such 120-day period.

Item 11. Executive Compensation.

The information required by Part III will be be incorporated by reference from either the registrant’s definitive proxy statement which involves the election of directors if such proxy statement is filed not later than 120 days after the end of the fiscal year covered by this report or as an amendment to this report filed not later than the end of such 120-day period.

The disclosure under the heading “The Merger -- Interests of Certain Carolina Financial Directors and Executive Officers in the Merger” in the prospectus and joint proxy statement filed by United Bankshares, Inc. and us on February 13, 2020, also is incorporated by herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.

Number of securities

Weighted-average

remaining available

to be issued upon

exercise price

for future issuance

exercise of

of outstanding

under equity

outstanding options,

options, warrants

compensation

warrants and rights

and rights

plans

Equity compensation plans approved by security holders

260,213

10.75

173,637

Equity compensation plans not approved by security holders

—

260,213

10.75

173,637

The equity compensation plans included in the table above are the Carolina Financial Corporation 2013 Equity Incentive Plan and the First South Bancorp Inc. 2008 Equity Incentive Plan.

The other information required by this Item of Part III will be be incorporated by reference from either the registrant’s definitive proxy statement which involves the election of directors if such proxy statement is filed not later than 120 days after the end of the fiscal year covered by this report or as an amendment to this report filed not later than the end of such 120-day period.

Item 13. Certain Relationships and Related Transactions.

Item 14. Principal Accounting Fees and Services.

161

Item 15. Exhibits, Financial Statement Schedules

(a) (1)

Financial Statements

The following consolidated financial statements are located in Item 8 of this report.

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2019 and 2018

Consolidated Statements of Operations for the years ended December 31, 2019, 2018, and 2017

Consolidated Statements of Comprehensive Income for the years ended December 31, 2019, 2018, and 2017

Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2019, 2018, and 2017

Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018, and 2017

Notes to the Consolidated Financial Statements

(2)

Financial Statement Schedules

These schedules have been omitted because they are not required, are not applicable or have been included in our consolidated financial statements.

(3)

Exhibits

See the “Exhibit Index” immediately following the signature page of this report.

162

EXHIBIT INDEX

Exhibit
No.		Description
2.1		Agreement and Plan of Merger by and between Carolina Financial Corporation and Greer Bancshares Incorporated, dated November 7, 2016 ⁽¹⁾
2.2		Agreement and Plan of Merger by and between Carolina Financial Corporation, CBAC, Inc., and Congaree Bancshares, Inc., dated January 5, 2016 ⁽¹²⁾
2.3		Agreement and Plan of Merger and Reorganization by and between Carolina Financial Corporation and First South Bancorp, Inc., dated June 9, 2017 ⁽¹³⁾
2.4		Agreement and Plan of Merger by and between United Bankshares, Inc. and Carolina Financial Corporation, dated as of November 17, 2019⁽¹⁵⁾
3.1		Restated Certificate of Incorporation filed on August 31, 2015 ⁽²⁾
3.2		Amendment to the Restated Certificate of Incorporation⁽³⁾
3.3		Amendment to Restated Certificate of Incorporation ⁽¹⁴⁾
3.4		Amended and Restated Bylaws ⁽⁴⁾
4.1		Description of the Company’s Common Stock
4.2		Form of certificate of common stock ⁽⁶⁾
10.1		Amended and Restated Employment Agreement by and between Crescent Bank and M.J. Huggins, III dated as of December 24, 2008 ⁽⁶⁾⁽⁷⁾
10.2		First Amendment to the Amended and Restated Employment Agreement between CresCom Bank and M.J. Huggins, III dated September 21, 2012 ⁽⁶⁾⁽⁷⁾
10.3		Amended and Restated Supplemental Executive Agreement by and between Carolina Financial Corporation and M.J. Huggins, III dated as of December 24, 2008 ⁽⁶⁾⁽⁷⁾
10.4		Amended and Restated Employment Agreement by and between Crescent Bank and David Morrow dated as of December 24, 2008 ⁽⁶⁾⁽⁷⁾
10.5		First Amendment to the Amended and Restated Employment Agreement between CresCom Bank and David Morrow dated as of September 19, 2012 ⁽⁶⁾⁽⁷⁾
10.6		Amended and Restated Supplemental Executive Agreement by and between Carolina Financial Corporation and David Morrow dated as of December 24, 2008 ⁽⁶⁾⁽⁷⁾
10.7		Employment Agreement by and between Carolina Financial Corporation and Jerold L. Rexroad dated as of May 1, 2008 ⁽⁶⁾⁽⁷⁾
10.8		First Amendment to the Employment Agreement between Carolina Financial Corporation and Jerold L. Rexroad dated as of September 19, 2012 ⁽⁶⁾⁽⁷⁾
10.9		Carolina Financial Corporation 2002 Stock Option Plan ⁽⁶⁾⁽⁷⁾
10.10		Carolina Financial Corporation 2006 Recognition and Retention Plan ⁽⁶⁾⁽⁷⁾
10.11		Carolina Financial Corporation 2013 Equity Incentive Plan ⁽⁶⁾⁽⁷⁾
10.12		Form of Carolina Financial Corporation Elite LifeComp Agreement ⁽⁶⁾⁽⁷⁾
10.13		Subservicing Agreement by and between Cenlar FSB and Crescent Mortgage Company dated January 1, 2004 ⁽⁶⁾
10.14		First Amendment to Subservicing Agreement by and between Cenlar FSB and Crescent Mortgage Company dated as of February 19, 2004 ⁽⁶⁾
10.15		Second Amendment to Subservicing Agreement by and between Cenlar FSB and Crescent Mortgage Company dated as of February 1, 2006 ⁽⁶⁾
10.16		Third Amendment to Subservicing Agreement by and between Cenlar FSB and Crescent Mortgage Company dated as of January 1, 2011 ⁽⁶⁾
10.17		Employment Agreement, dated January 21, 2015, by and between Crescent Mortgage Company and Fowler Williams ⁽⁷⁾⁽⁸⁾
10.18		Amendment No. 1 to the Carolina Financial Corporation 2013 Equity Incentive Plan ⁽⁷⁾⁽⁹⁾
10.19		First South Bancorp, Inc. 2008 Equity Incentive Plan, as assumed by the Company ^(7)(10)
10.20		First South Bancorp, Inc. 1997 Stock Option Plan, as amended, as assumed by the Company ^(7)(11)

163

21		Subsidiaries of Carolina Financial Corporation
23		Consent of Independent Registered Public Accounting Firm—Elliott Davis, LLC
31.1		Rule 13a-14(a) Certification of the Chief Executive Officer
31.2		Rule 13a-14(a) Certification of the Chief Financial Officer
32		Section 1350 Certifications

101

The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets as December 31, 2019 and December 31, 2018; (ii) Consolidated Statements of Operations for the years ended December 31, 2019, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2019, 2018 and 2017; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2019, 2018 and 2017; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2019, 2018 and 2017; and (vi) Notes to the Consolidated Financial Statements.

⁽¹⁾	Incorporated by reference from the Company’s Registration Statement on Form S-3 filed on December 23, 2016.
⁽²⁾	Incorporated by reference from the Company’s Registration Statement on Form S-3 filed on August 31, 2015.
⁽³⁾	Incorporated by reference to Exhibit A of the Company’s Definitive Proxy Statement on Schedule 14A filed on March 31, 2016.
⁽⁴⁾	Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on May 5, 2016.
⁽⁵⁾	Incorporated by reference from the Company’s Registration Statement on Form S-4 filed on February 9, 2016.
⁽⁶⁾	Incorporated by reference from the Company’s Registration Statement on Form 10 filed on February 26, 2014.
⁽⁷⁾	Indicates management contracts or compensatory plans or arrangements.
⁽⁸⁾	Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2016 filed on May 9, 2016.
⁽⁹⁾	Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on January 22, 2015.
⁽¹⁰⁾	Incorporated by reference to First South Bancorp, Inc.’s Registration Statement on Form S-8, filed on June 2, 2008 (Registration No. 333-151337).
⁽¹¹⁾	Incorporated by reference to First South Bancorp, Inc.’s Annual Report on Form 10-K for the year ended September 30, 1999, filed on December 27, 1999 (File No. 0-22219).
⁽¹²⁾	Incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on January 11, 2016.
⁽¹³⁾	Incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on June 15, 2017.
⁽¹⁴⁾	Incorporated by reference to Exhibit A of the Company’s Definitive Proxy Statement on Schedule 14A filed on March 29, 2018.
⁽¹⁵⁾	Incorporated be reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on November 18, 2019.

164

SIGNATURES

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	CAROLINA FINANCIAL CORPORATION

Date: March 2, 2020	By:	/s/ Jerold L. Rexroad
		Jerold L. Rexroad
		Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature	Title	Date

/s/ Jerold L. Rexroad	Chief Executive Officer and Director	March 2, 2020
Jerold L. Rexroad	(Principal Executive Officer)

/s/ William A. Gehman, III	Chief Financial Officer	March 2, 2020
William A. Gehman, III	(Principal Financial Officer
	and Principal Accounting Officer)

/s/ Claudius E. Watts IV	Chairman of the Board of Directors	March 2, 2020
Claudius E. Watts IV

/s/ W. Scott Brandon	Director	March 2, 2020
W. Scott Brandon

/s/ Robert G. Clawson, Jr.	Director	March 2, 2020
Robert G. Clawson, Jr.

/s/ Lindsay A. Crisp	Director	March 2, 2020
Lindsay A. Crisp

/s/ Jeffery L. Deal	Director	March 2, 2020
Jeffery L. Deal, M.D.

/s/ Gary M. Griffin	Director	March 2, 2020
Gary M. Griffin

/s/ Frederick N. Holscher	Director	March 2, 2020
Frederick N. Holscher

/s/ Daniel H Isaac, Jr.	Director	March 2, 2020
Daniel H Isaac, Jr.

/s/ Beverly Ladley	Director	March 2, 2020
Beverly Ladley

/s/ Robert M. Moïse	Director	March 2, 2020
Robert M. Moïse, CPA

/s/ David L. Morrow	Director	March 2, 2020
David L. Morrow

/s/ Thompson E. Penney	Director	March 2, 2020
Thompson E. Penney

/s/ Johnathan L. Rhyne, Jr.	Director	March 2, 2020
Johnathan L. Rhyne, Jr.

165

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