UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

 

For the quarterly period ended:

March 31, 2015

Commission File Number: 001-35302

Entegra Financial Corp.

(Exact name of Registrant as specified in its Charter)

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

(828) 524-7000

(Registrant’s telephone number, including area code)

 

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

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

 

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

 

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

Smaller reporting company x

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On May 8, 2015, 6,546,375 shares of the issuer’s common stock (no par value), were issued and outstanding.

ENTEGRA FINANCIAL CORP. AND SUBSIDIARIES

 

FORM 10-Q

TABLE OF CONTENTS

 

				Page No.
PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements			3
		Consolidated Balance Sheets – March 31, 2015 and December 31, 2014			3
		Consolidated Statements of Income – Three Months Ended March 31, 2015 and 2014			4
		Consolidated Statements of Comprehensive Income – Three Months Ended March 31, 2015 and 2014			5
		Consolidated Statements of Changes in Shareholders’ Equity – Three Months Ended March 31, 2015 and 2014			6
		Consolidated Statements of Cash Flows – Three Months Ended March 31, 2015 and 2014			7
		Notes to Consolidated Financial Statements			9
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			42
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			61
Item 4.		Controls and Procedures			63
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings			64
Item 1A.		Risk Factors			64
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			64
Item 3.		Defaults Upon Senior Securities			64
Item 4.		Mine Safety Disclosures			64
Item 5.		Other Information			64
Item 6.		Exhibits			65
		Signatures			66

Item 1. Financial Statements

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

		March 31, 2015 (Unaudited)				December 31, 2014 (Audited)
Assets
Cash and due from banks		$	6,751			$	7,860
Interest-earning deposits			40,878				51,122
Cash and cash equivalents			47,629				58,982
Investments - available for sale			223,741				219,859
Investments - held to maturity (fair value of $42,486 and $30,890 at March 31, 2015 and December 31, 2014, respectively)			40,723				29,285
Loans held for sale			7,232				10,761
Loans receivable			549,874				540,479
Allowance for loan losses			(9,611	)			(11,072	)
Other investments, at cost			5,498				4,908
Fixed assets, net			15,186				13,004
Real estate owned			4,917				4,425
Interest receivable			3,144				2,925
Bank owned life insurance			20,529				20,417
Net deferred tax asset			1,759				2,089
Real estate held for investment			2,420				2,489
Loan servicing rights			2,232				2,187
Other assets			3,777				2,910
Total assets		$	919,050			$	903,648
Liabilities and Shareholders’ Equity
Liabilities:
Deposits		$	699,783			$	703,117
Federal Home Loan Bank advances			75,000				60,000
Junior subordinated notes			14,433				14,433
Other borrowings			2,086				—
Post employment benefits			9,891				9,759
Accrued interest payable			330				323
Other liabilities			5,688				8,697
Total liabilities			807,211				796,329
Commitments and contingencies (Note 12)
Shareholders’ Equity:
Preferred stock - no par value, 10,000,000 shares authorized; none issued and outstanding			—				—
Common stock - no par value, 50,000,000 shares authorized; 6,546,375 shares issued and outstanding as of March 31, 2015 and December 31, 2014			—				—
Additional paid in capital			63,651				63,651
Retained earnings			48,552				45,937
Accumulated other comprehensive loss			(364	)			(2,269	)
Total shareholders’ equity			111,839				107,319
Total liabilities and shareholders’ equity		$	919,050			$	903,648

 

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

 

		Three Months Ended March 31,
		2015				2014
Interest income:
Interest and fees on loans		$	6,470			$	7,608
Interest on tax exempt loans			26				17
Taxable securities			1,236				979
Tax-exempt securities			70				93
Interest-earning deposits			24				10
Other			58				21
Total interest and dividend income			7,884				8,728
Interest expense:
Deposits			1,209				1,341
Federal Home Loan Bank advances			205				174
Junior subordinated notes			112				123
Other borrowings			26				—
Total interest expense			1,552				1,638
Net interest income			6,332				7,090
Provision for loan losses			(1,500	)			5
Net interest income after provision for loan losses			7,832				7,085
Noninterest income:
Servicing income, net			86				279
Mortgage banking			255				194
Gain on sale of SBA loans			211				74
Gain on sale of investments, net			164				62
Other than temporary impairment on cost method investment			—				(76	)
Service charges on deposit accounts			298				298
Interchange fees			278				250
Bank owned life insurance			129				129
Other			118				164
Total noninterest income			1,539				1,374
Noninterest expenses:
Compensation and employee benefits			3,697				2,947
Net occupancy			702				640
Federal deposit insurance			284				438
Professional and advisory			250				198
Data processing			280				226
Net cost of operation of real estate owned			216				840
Other			1,147				824
Total noninterest expenses			6,576				6,113
Income before taxes			2,795				2,346
Income tax expense			180				255
Net income		$	2,615			$	2,091
Earnings per share - basic and diluted		$	0.40				N/A
Average shares outstanding - basic and diluted			6,546,375				N/A

 

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

 

		Three Months Ended March 31,
		2015				2014
Net income		$	2,615			$	2,091
Other comprehensive income:
Change in unrealized holding gains and losses on securities available for sale			2,020				2,131
Reclassification adjustment for securities gains realized in net income			(164	)			(62	)
Amortization of unrealized loss on securities transferred to held to maturity			49				50
Change in deferred tax valuation allowance attributable to unrealized gains and losses on investment securities available for sale			729				811
Other comprehensive income, before tax			2,634				2,930
Income tax effect related to items of other comprehensive income			(729	)			(811	)
Other comprehensive income, after tax			1,905				2,119
Comprehensive income		$	4,520			$	4,210

 

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

Three Months Ended March 31, 2015 and 2014

(Dollars in thousands)

 

		Common Stock
																		Accumulated
																		Other
										Additional				Retained				Comprehensive
		Shares				Amount				Paid in Capital				Earnings				Loss				Total
Balance, December 31, 2013			—			$	—			$	—			$	39,994			$	(7,476	)		$	32,518
Net income			—				—				—				2,091				—				2,091
Other comprehensive income, net of tax			—				—				—				—				2,119				2,119
Balance, March 31, 2014			—			$	—			$	—			$	42,085			$	(5,357	)		$	36,728
Balance, December 31, 2014			6,546,375			$	—			$	63,651			$	45,937			$	(2,269	)		$	107,319
Net income			—				—				—				2,615				—				2,615
Other comprehensive income, net of tax			—				—				—				—				1,905				1,905
Balance, March 31, 2015			6,546,375			$	—			$	63,651			$	48,552			$	(364	)		$	111,839

 

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

 

		For the Three Months Ended March 31,
		2015				2014
Cash flows from operating activities:
Net income		$	2,615			$	2,091
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and leasehold amortization			251				219
Security amortization, net			400				246
Provision for loan losses			(1,500	)			5
Provision for real estate owned			113				635
Deferred income tax expense			330				255
Net increase (decrease) in deferred loan fees			237				(152	)
Gain on sales of securities available for sale			(164	)			(62	)
Other than temporary impairment on cost method investment			—				76
Income on bank owned life insurance, net			(112	)			(113	)
Mortgage banking income, net			(255	)			(194	)
Gain on sales of SBA loans			(211	)			(74	)
Net realized gain on sale of real estate owned			(24	)			(12	)
Loans originated for sale			(4,703	)			(6,123	)
Proceeds from sale of loans originated for sale			8,698				5,223
Net change in operating assets and liabilities:
Interest receivable			(219	)			(163	)
Loan servicing rights			(45	)			(168	)
Other assets			(862	)			(673	)
Postemployment benefits			132				(184	)
Accrued interest payable			7				3
Other liabilities			742				290
Net cash provided by operating activities		$	5,430			$	1,125

 

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited), continued

(Dollars in thousands)

 

		For the Three Months Ended March 31,
		2015				2014
Cash flows from investing activities:
Activity for investment securities:
Purchases		$	(37,550	)		$	(12,412	)
Maturities/calls and principal repayments			12,132				3,515
Sales			13,197				6,941
Net increase in loans			(216	)			(625	)
Purchase of loans			(13,367	)			—
Proceeds from sale of real estate owned			359				1,449
Purchase of fixed assets			(2,414	)			(237	)
Purchase of other investments, at cost			(740	)			—
Redemptions of other investments, at cost			150				209
Net cash used in investing activities		$	(28,449	)		$	(1,160	)
Cash flows from financing activities:
Net increase (decrease) in deposits		$	(3,674	)		$	453
Net increase in escrow deposits			340				240
Proceeds from FHLB advances			25,000				—
Repayment of FHLB advances			(10,000	)			—
Net cash provided by financing activities		$	11,666			$	693
Increase (decrease) in cash and cash equivalents			(11,353	)			658
Cash and cash equivalents, beginning of period		$	58,982			$	34,316
Cash and cash equivalents, end of period		$	47,629			$	34,974
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest on deposits and other borrowings		$	1,545			$	1,635
Noncash investing and financing activities:
Real estate acquired in satisfaction of mortgage loans		$	1,317			$	614
Loans originated for disposition of real estate owned			422				300
Transfer of investment securities available for sale to held to maturity			—				4,399
Purchased loans and investments to be settled			3,434				—
Participation loans not qualified for sale accounting			2,086				—

 

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

ENTEGRA FINANCIAL CORP. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

 

Organization

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

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

Estimates

 

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

Material estimates that are particularly susceptible to significant change, in the near term, relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate, management obtains independent appraisals for significant properties.

 

Principles of Consolidation

 

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

 

Reclassification

 

Certain amounts in the prior years’ financial statements may have been reclassified to conform to the current year’s presentation. The reclassifications had no significant effect on our results of operations or financial condition as previously reported.

 

Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K, filed with the SEC on March 30, 2015. In the opinion of management, these interim financial statements present fairly, in all material respects, the Company’s consolidated financial position and results of operations for each of the interim periods presented. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for a full year or any future period.

 

Recent Accounting Standards Updates

 

In January 2014, the Financial Accounting Standards Board (“FASB”) amended the Receivables topic of the Accounting Standards Codification. The amendments are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to real estate owned. In addition, the amendments require a creditor to reclassify a collateralized consumer mortgage loan to REO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying its interest in the real estate collateral to the creditor to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. As an emerging growth company, the amendments will be effective for the Company for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. For non-emerging growth companies, the amendments are effective for annual periods, and interim periods within those annual periods beginning after December 15, 2014. Early implementation of the guidance is permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company has adopted the amendments as of March 31, 2015 and the related disclosures are included in Note 6. The amendments did not have a material effect on the Company’s financial statements.

In January 2015, the FASB issued guidance to eliminate from U.S. GAAP the concept of an extraordinary item, which is an event or transaction that is both (1) unusual in nature and (2) infrequently occurring. Under the new guidance, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company will apply the guidance prospectively. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. As an emerging growth company, the amendments will be effective for the Company for fiscal years beginning after December 15, 2015, and interim periods beginning after December 15, 2017. For non-emerging growth companies, the amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption of the guidance is permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2015, the FASB issued guidance that will require debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This update affects disclosures related to debt issuance costs but does not affect existing recognition and measurement guidance for these items. As an emerging growth company, the guidance will be effective for the Company for fiscal years beginning after December 15, 2015, and interim periods beginning after December 15, 2016. For non-emerging growth companies, the guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption of the guidance is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

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

 

NOTE 2. STOCK CONVERSION AND CHANGE IN CORPORATE FORM

On January 23, 2014, the Board of Directors of Macon Bancorp adopted a Plan of Conversion (the “Plan of Conversion”) which provided for the reorganization of Macon Bancorp from a North Carolina chartered mutual holding company into a stock holding company, Entegra Financial Corp., incorporated under the laws of the State of North Carolina (the “Conversion”).

 

In connection with the Conversion, the Company sold 6,546,375 shares of common stock at an offering price of $10.00 per share and received gross sales proceeds of $65.5 million. The Company recognized $1.8 million in reorganization and stock issuance costs as of September 30, 2014 which have been deducted from the gross sales proceeds. Of the $63.7 million in net sales proceeds, $44.6 million, or approximately 70%, was contributed to the capital of the Bank upon completion of the Conversion on September 30, 2014.

Common Stock Offering Summary
(Dollars in thousands)
Gross proceeds		$	65,464
Issuance costs			(1,813	)
Net proceeds		$	63,651
Contributed to bank subsidiary		$	44,581
Retained by the Company			19,070
		$	63,651

 

On September 30, 2014, liquidation accounts were established by the Company and the Bank for the benefit of eligible depositors of the Bank as defined in the Plan of Conversion. Each eligible depositor will have a pro rata interest in the liquidation accounts for each of his or her deposit accounts based upon the proportion that the balance of each such account bears to the balance of all deposit accounts of the Bank as of the dates specified in the Plan of Conversion. The liquidation accounts will be maintained for the benefit of eligible depositors who continue to maintain their deposit accounts in the Bank. The liquidation accounts will be reduced annually to the extent that eligible depositors reduce their qualifying deposits. In the unlikely event of a complete liquidation of the Bank or the Company or both, and only in such event, eligible depositors who continue to maintain accounts will be entitled to receive a distribution from the liquidation accounts before any distribution may be made with respect to common stock. Neither the Company nor the Bank may declare or pay a cash dividend if the effect thereof would cause its equity to be reduced below either the amount required for the liquidation accounts or the regulatory capital requirements imposed by the Company’s or the Bank’s regulators.

 

NOTE 3. INVESTMENT SECURITIES

The amortized cost and estimated fair values of securities available for sale as of March 31, 2015 and December 31, 2014 are summarized as follows:

 

						March 31, 2015
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(Dollars in thousands)
U.S. government agencies		$	44,048			$	459			$	(21	)		$	44,486
Municipal securities			27,541				348				(55	)			27,834
Mortgage-backed securities			148,584				1,163				(460	)			149,287
U.S. Treasury securities			1,500				34				—				1,534
Mutual funds			593				7				—				600
		$	222,266			$	2,011			$	(536	)		$	223,741

						December 31, 2014
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(Dollars in thousands)
U.S. government agencies		$	39,540			$	65			$	(123	)		$	39,482
Municipal securities			25,483				225				(150	)			25,558
Mortgage-backed securities			153,128				643				(1,053	)			152,718
U.S. Treasury securities			1,500				10				—				1,510
Mutual funds			590				1				—				591
		$	220,241			$	944			$	(1,326	)		$	219,859

 

The amortized cost and estimated fair values of securities held to maturity (“HTM”) as of March 31, 2015 and December 31, 2014 are summarized as follows:

						March 31, 2015
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(Dollars in thousands)
U.S. government agencies		$	27,990			$	1,637			$	(62	)		$	29,565
Municipal securities			8,358				197				(22	)			8,533
Mortgage-backed securities			2,975				13				—				2,988
Corporate debt securities			1,400				—				—				1,400
		$	40,723			$	1,847			$	(84	)		$	42,486

 

						December 31, 2014
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(Dollars in thousands)
U.S. government agencies		$	23,193			$	1,420			$		(5)		$	24,608
Municipal securities			4,392				190				—				4,582
Trust preferred securities			1,000				—				—				1,000
Corporate debt securities			700				—				—				700
		$	29,285			$	1,610			$		(5)		$	30,890

 

During the three months ended March 31, 2014, the Bank transferred the following investment securities from available for sale to held to maturity:

 

		At Date of Transfer
		During the Three Months Ended
		March 31, 2014
		(Dollars in thousands)
Book value		$	4,473
Market value			4,399
Unrealized loss		$	74

 

There were no transfers of investment securities from available for sale to held to maturity during the three months ended March 31, 2015.

 

Information pertaining to the activity for the three month periods ended March 31, 2015 and 2014 of unrealized losses related to HTM securities (before the impact of income taxes) previously recognized in accumulated other comprehensive income (“AOCI”) is summarized below:

 

		For the Three Months Ended
		March 31
(Dollars in thousands)		2015				2014
Beginning unrealized loss related to HTM securities previously recognized in AOCI		$	1,887			$	2,012
Additions for transfers to HTM			—				74
Amortization of unrealized losses on HTM securities previously recognized in AOCI			(49	)			(50	)
Ending unrealized loss in AOCI related to HTM securities previously recognized in AOCI		$	1,838			$	2,036

 

Information pertaining to securities with gross unrealized losses at March 31, 2015 and December 31, 2014, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

										March 31, 2015
		Less Than 12 Months								More Than 12 Months								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(Dollars in thousands)
Held to Maturity:
U.S. government agencies		$	3,684			$	62			$	—			$	—			$	3,684			$	62
Municipal securities			2,478				22				—				—				2,478				22
		$	6,162			$	84			$	—			$	—			$	6,162			$	84
Available for Sale:
U.S. government agencies		$	—			$	—			$	2,979			$	21			$	2,979			$	21
Municipal securities			4,285				36				1,988				19				6,273				55
Mortgage-backed securities			26,091				149				23,064				311				49,155				460
		$	30,376			$	185			$	28,031			$	351			$	58,407			$	536

 

										December 31, 2014
		Less Than 12 Months								More Than 12 Months								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(Dollars in thousands)
Held to Maturity:
U.S. government agencies		$	1,995			$	5			$	—			$	—			$	1,995			$	5
		$	1,995			$	5			$	—			$	—			$	1,995			$	5
Available for Sale:
U.S. government agencies		$	14,472			$	15			$	7,893			$	108			$	22,365			$	123
Municipal securities			4,306				49				8,409				101				12,715				150
Mortgage-backed securities			38,563				217				46,204				836				84,767				1,053
		$	57,341			$	281			$	62,506			$	1,045			$	119,847			$	1,326

 

Information pertaining to the number of securities with unrealized losses is detailed in the table below. The Company believes all unrealized losses as of March 31, 2015 and December 31, 2014 represent temporary impairment. The unrealized losses have resulted from temporary changes in the interest rate market and not as a result of credit deterioration. We do not intend to sell and it is not likely that we will be required to sell any of the securities referenced in the table below before recovery of their amortized cost.

		March 31, 2015
		Less Than 12 Months				More Than 12 Months				Total
U.S. government agencies			2				1				3
Municipal securities			13				4				17
Mortgage-backed securities			17				13				30
			32				18				50
			December 31, 2014
			Less Than 12 Months				More Than 12 Months				Total
U.S. government agencies			11				3				14
Municipal securities			9				19				28
Mortgage-backed securities			26				27				53
			46				49				95

 

For the three months ended March 31, 2015 and 2014 the Company had proceeds from sales of securities available for sale and their corresponding gross realized gains and losses as detailed below:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in thousands)
Gross proceeds		$	13,197			$	6,941
Gross realized gains			184				62
Gross realized losses			20				—

 

The Company had securities pledged against deposits of approximately $11.2 million and $10.7 million at March 31, 2015 and December 31, 2014, respectively.

The amortized cost and estimated fair value of investments in debt securities at March 31, 2015, by contractual maturity, is shown below. Mortgage-backed securities have not been scheduled because expected maturities will differ from contractual maturities when borrowers have the right to prepay the obligations.

 

		Available for Sale
		Amortized
		Cost				Fair Value
		(Dollars in thousands)
Over 1 year through 5 years		$	36,166			$	36,477
After 5 years through 10 years			16,183				16,363
Over 10 years			21,333				21,614
			73,682				74,454
Mortgage-backed securities			148,584				149,287
Total		$	222,266			$	223,741
			Held to Maturity
			Amortized
			Cost				Fair Value
			(Dollars in thousands)
After 5 years through 10 years		$	8,355			$	8,306
Over 10 years			29,393				31,192
			37,748				39,498
Mortgage-backed securities			2,975				2,988
Total		$	40,723			$	42,486

NOTE 4. LOANS RECEIVABLE

Loans receivable as of March 31, 2015 and December 31, 2014 are summarized as follows:

 

		March 31, 2015				December 31, 2014
		(Dollars in thousands)
Real estate mortgage loans:
One-to four-family residential		$	225,245			$	227,209
Commercial real estate			175,230				179,435
Home equity loans and lines of credit			55,312				56,561
Residential construction			10,208				7,823
Other construction and land			55,062				50,298
Total real estate loans			521,057				521,326
Commercial and industrial			28,248				19,135
Consumer			3,447				3,200
Total commercial and consumer			31,695				22,335
Loans receivable, gross			552,752				543,661
Less: Net deferred loan fees			(1,566	)			(1,695	)
Unamortized premium			275				—
Unamortized discount			(1,587	)			(1,487	)
Loans receivable, net		$	549,874			$	540,479

 

The Bank had $121.3 million and $117.9 million of loans pledged as collateral to secure funding with the Federal Home Loan Bank of Atlanta (“FHLB”) at March 31, 2015 and December 31, 2014, respectively. The Bank also had $92.3 million and $97.7 million of loans pledged as collateral to secure funding with the Federal Reserve Bank (“FRB”) Discount Window at March 31, 2015 and December 31, 2014, respectively.

 

During January 2014, the Bank purchased the remaining participation balance of certain commercial real estate loans from the Federal Deposit Insurance Corporation (“FDIC”). The Bank had previously purchased a 50% participation in the loans from an institution that was subsequently taken into receivership by the FDIC. At the date of purchase, the outstanding loan balance purchased was $9.3 million and the loans were purchased at a total discount of $2.6 million. The loans were not deemed to be impaired at the time of purchase. Subsequent to the transaction, $2.8 million of the participation balance purchased was repaid, resulting in the Bank recognizing approximately $0.5 million of the initial discount, in addition to recognizing $0.3 million of previously collected but deferred interest. In addition, the Bank restructured a $1.8 million loan in the second quarter of 2014 and recognized $0.2 million of the discount in interest income.

During the three months ended March 31, 2015, the Bank purchased the remaining participation balance of a commercial real estate loan from another community bank. The Bank had previously purchased a 54% participation in the loan from the participating institution. At the date of purchase, the outstanding loan balance purchased was $1.6 million and the loan was purchased at a discount of $0.5 million. The loan was not deemed to be impaired at the time of purchase.

Also during the three months ended March 31, 2015, the Bank purchased $8.2 million in externally sourced loans which were comprised of $1.5 million in commercial SBA guaranteed loans, $4.0 million in commercial and industrial participation loans, and a $2.7 million commercial real estate whole loan purchase.

Included in loans receivable and other borrowings at March 31, 2015 are $2.1 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income.

 

The following tables present the activity related to the discount on purchased loans for the three month periods ended March 31, 2015 and 2014:

 

		For the Three Months Ended
		March 31,
(Dollars in thousands)		2015				2014
Discount on purchased loans, beginning of period		$	1,487			$	—
Additional discount for new purchases			492				2,607
Accretion			(97	)			(95	)
Discount applied to charge-offs			(295	)			—
Interest income recognized for repayments and restructurings			—				(538	)
Discount on purchased loans, end of period		$	1,587			$	1,974

 

NOTE 5. ALLOWANCE FOR LOAN LOSSES

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

 

		Three Months Ended March 31, 2015
		One-to four																Other
		Family				Commercial				Home Equity and				Residential				Construction				Commercial				Consumer				Total
		Residential				Real Estate				Lines of Credit				Construction				and Land
		(Dollars in thousands)
Beginning balance		$	2,983			$	2,717			$	1,333			$	510			$	2,936			$	308			$	285			$	11,072
Provision			(100	)			(416	)			(79	)			(206	)			(1,046	)			281				66				(1,500	)
Charge-offs			219				30				109				—				19				—				13				390
Recoveries			109				92				23				—				119				7				79				429
Ending balance		$	2,773			$	2,363			$	1,168			$	304			$	1,990			$	596			$	417			$	9,611
			Three Months Ended March 31, 2014
			One-to four																Other
			Family				Commercial				Home Equity and				Residential				Construction				Commercial				Consumer				Total
			Residential				Real Estate				Lines of Credit				Construction				and Land
			(Dollars in thousands)
Beginning balance		$	3,693			$	4,360			$	1,580			$	501			$	3,516			$	336			$	265			$	14,251
Provision			(63	)			(401	)			35				23				461				(81	)			31				5
Charge-offs			430				1,794				143				—				343				—				45				2,755
Recoveries			2				285				16				—				78				4				70				455
Ending balance		$	3,202			$	2,450			$	1,488			$	524			$	3,712			$	259			$	321			$	11,956

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

 

		March 31, 2015
		One-to four Family Residential				Commercial Real Estate				Home Equity and Lines of Credit				Residential Construction				Other Construction and Land				Commercial				Consumer				Total
		(Dollars in thousands)
Allowance for loan losses
Individually evaluated for impairment		$	557			$	169			$	93			$	—			$	96			$	2			$	—			$	917
Collectively evaluated for impairment			2,216				2,194				1,075				304				1,894				594				417				8,694
		$	2,773			$	2,363			$	1,168			$	304			$	1,990			$	596			$	417			$	9,611
Loans Receivable
Individually evaluated for impairment		$	8,837			$	16,554			$	900			$	—			$	1,937			$	328			$	—			$	28,556
Collectively evaluated for impairment			216,408				158,676				54,412				10,208				53,125				27,920				3,447				524,196
		$	225,245			$	175,230			$	55,312			$	10,208			$	55,062			$	28,248			$	3,447			$	552,752

 

		December 31, 2014
		One-to four Family Residential				Commercial Real Estate				Home Equity and Lines of Credit				Residential Construction				Other Construction and Land				Commercial				Consumer				Total
		(Dollars in thousands)
Allowance for loan losses
Individually evaluated for impairment		$	719			$	235			$	14			$	—			$	705			$	3			$	—			$	1,676
Collectively evaluated for impairment			2,264				2,482				1,319				510				2,231				305				285				9,396
		$	2,983			$	2,717			$	1,333			$	510			$	2,936			$	308			$	285			$	11,072
Loans Receivable
Individually evaluated for impairment		$	9,912			$	17,828			$	1,686			$	—			$	3,911			$	328			$	—			$	33,665
Collectively evaluated for impairment			217,297				161,607				54,875				7,823				46,387				18,807				3,200				509,996
		$	227,209			$	179,435			$	56,561			$	7,823			$	50,298			$	19,135			$	3,200			$	543,661

 

Portfolio Quality Indicators

 

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

 

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

 

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

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

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

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

·

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

 

Beginning with March 31, 2015 balances, we no longer risk grade consumer purposed loans within all categories for which the individual loan balance is less than $417,00. These loan types provide limited credit information subsequent to origination and therefore may not be properly risk graded within our standard risk grading system. All of our consumer purposed loans are now considered ungraded and will be analyzed on a performing versus non-performing basis. The non-performing ungraded loans will be deemed substandard when determining our classified assets. Consumer purposed loans may include residential loans, home equity loans and lines of credit, residential lot loans, and other consumer loans. This change in risk grading methodology did not have any impact on our allowance for loan losses calculation.

Description of segment and class risks

 

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

 

One-to four family residential

 

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

 

Commercial real estate

 

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

 

Home equity and lines of credit

 

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

 

Residential construction and other construction and land

 

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

Commercial

 

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

 

Consumer

 

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

 

The following tables present the recorded investment in gross loans by loan grade:

 

March 31, 2015
Loan Grade		One-to Four- Family				Commercial Real Estate				Home Equity and Lines of				Residential Construction				Other Construction				Commercial				Consumer				Total
		Residential								Credit								and Land
		(Dollars in thousands)
1		$	—			$	67			$	—			$	—			$	—			$	8,741			$	11			$	8,819
2			—				—				—				—				—				100				—				100
3			11,641				9,527				1,228				646				3,393				483				425				27,343
4			35,646				42,962				2,925				3,413				10,002				7,583				580				103,111
5			33,079				86,164				5,907				2,015				19,481				10,392				93				157,131
6			4,186				20,536				—				571				2,258				453				—				28,004
7			5,412				15,974				500				—				2,992				496				—				25,374
		$	89,964			$	175,230			$	10,560			$	6,645			$	38,126			$	28,248			$	1,109			$	349,882
Ungraded Loan Exposure:
Performing		$	133,187			$	—			$	44,599			$	3,498			$	16,772			$	—			$	2,336			$	200,392
Nonperforming			2,094				—				153				65				164				—				2				2,478
Subtotal		$	135,281			$	—			$	44,752			$	3,563			$	16,936			$	—			$	2,338			$	202,870
Total		$	225,245			$	175,230			$	55,312			$	10,208			$	55,062			$	28,248			$	3,447			$	552,752

December 31, 2014
Loan Grade		One-to Four- Family Residential				Commercial Real Estate				Home Equity and Lines of Credit				Residential Construction				Other Construction and Land				Commercial				Consumer				Total
		(Dollars in thousands)
1		$	—			$	68			$	—			$	—			$	—			$	2,511			$	20			$	2,599
2			—				—				—				—				—				100				—				100
3			63,065				14,356				5,978				690				5,154				483				454				90,180
4			58,948				37,349				10,424				2,327				9,027				2,917				419				121,411
5			44,445				90,397				10,486				3,048				21,024				6,399				179				175,978
6			5,714				21,232				882				574				2,451				429				1				31,283
7			7,400				14,139				1,568				—				5,404				555				—				29,066
		$	179,572			$	177,541			$	29,338			$	6,639			$	43,060			$	13,394			$	1,073			$	450,617
Ungraded Loan Exposure:
Performing		$	46,247			$	1,736			$	26,864			$	1,119			$	7,073			$	5,741			$	2,125			$	90,905
Nonperforming			1,390				158				359				65				165				—				2				2,139
Subtotal		$	47,637			$	1,894			$	27,223			$	1,184			$	7,238			$	5,741			$	2,127			$	93,044
Total		$	227,209			$	179,435			$	56,561			$	7,823			$	50,298			$	19,135			$	3,200			$	543,661

  

Delinquency Analysis of Loans by Class

 

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

		March 31, 2015
		30-59 Days Past Due				60-89 Days Past Due				90 Days and Over Past Due				Total Past Due				Current				Total Loans Receivable
		(Dollars in thousands)
One-to four-family residential		$	5,129			$	—			$	3,010			$	8,139			$	217,106			$	225,245
Commercial real estate			2,648				94				316				3,058				172,172				175,230
Home equity and lines of credit			595				347				638				1,580				53,732				55,312
Residential construction			101				—				65				166				10,042				10,208
Other construction and land			2,015				—				471				2,486				52,576				55,062
Commercial			37				—				—				37				28,211				28,248
Consumer			25				6				2				33				3,414				3,447
Total		$	10,550			$	447			$	4,502			$	15,499			$	537,253			$	552,752
		December 31, 2014
			30-59 Days Past Due				60-89 Days Past Due				90 Days and Over Past Due				Total Past Due				Current				Total Loans Receivable
			(Dollars in thousands)
One-to four-family residential		$	6,298			$	448			$	2,669			$	9,415			$	217,794			$	227,209
Commercial real estate			2,136				909				1,006				4,051				175,384				179,435
Home equity and lines of credit			557				528				759				1,844				54,717				56,561
Residential construction			—				—				65				65				7,758				7,823
Other construction and land			1,530				964				473				2,967				47,331				50,298
Commercial			—				22				—				22				19,113				19,135
Consumer			247				4				1				252				2,948				3,200
Total		$	10,768			$	2,875			$	4,973			$	18,616			$	525,045			$	543,661

Impaired Loans

 

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of March 31, 2015 and December 31, 2014.

 

		March 31, 2015												December 31, 2014
		Recorded Balance				Unpaid Principal Balance				Specific Allowance				Recorded Balance				Unpaid Principal Balance				Specific Allowance
		(Dollars in thousands)
Loans without a valuation allowance
One-to four-family residential		$	5,662			$	5,687			$	—			$	5,943			$	6,096			$	—
Commercial real estate			12,926				14,706				—				14,231				16,515				—
Home equity and lines of credit			713				828				—				1,537				1,912				—
Residential construction			—				—				—				—				—				—
Other construction and land			923				1,370				—				1,901				2,579				—
Commercial			—				—				—				—				—				—
		$	20,224			$	22,591			$	—			$	23,612			$	27,102			$	—
Loans with a valuation allowance
One-to four-family residential		$	3,175			$	3,175			$	557			$	3,969			$	4,028			$	719
Commercial real estate			3,628				3,704				169				3,597				3,745				235
Home equity and lines of credit			187				187				93				149				149				14
Residential construction			—				—				—				—				—				—
Other construction and land			1,014				1,014				96				2,010				2,010				705
Commercial			328				328				2				328				328				3
		$	8,332			$	8,408			$	917			$	10,053			$	10,260			$	1,676
Total
One-to four-family residential		$	8,837			$	8,862			$	557			$	9,912			$	10,124			$	719
Commercial real estate			16,554				18,410				169				17,828				20,260				235
Home equity and lines of credit			900				1,015				93				1,686				2,061				14
Residential construction			—				—				—				—				—				—
Other construction and land			1,937				2,384				96				3,911				4,589				705
Commercial			328				328				2				328				328				3
		$	28,556			$	30,999			$	917			$	33,665			$	37,362			$	1,676

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

 

		Three Months Ended March 31,
		2015								2014
		Average								Average
		Investment in				Interest Income				Investment in				Interest Income
		Impaired Loans				Recognized				Impaired Loans				Recognized
		(Dollars in thousands)
Loans without a valuation allowance
One-to four-family residential		$	5,672			$	51			$	4,960			$	49
Commercial real estate			12,953				120				13,527				128
Home equity and lines of credit			714				2				1,052				14
Residential construction			—				—				—				—
Other construction and land			925				7				6,543				68
Commercial			—				—				19				—
		$	20,264			$	180			$	26,101			$	259
Loans with a valuation allowance
One-to four-family residential		$	3,185			$	27			$	5,564			$	63
Commercial real estate			3,640				39				3,007				33
Home equity and lines of credit			186				1				377				4
Residential construction			—				—				—				—
Other construction and land			1,020				10				1,942				25
Commercial			328				5				339				5
		$	8,359			$	82			$	11,229			$	130
Total
One-to four-family residential		$	8,857			$	78			$	10,524			$	112
Commercial real estate			16,593				159				16,534				161
Home equity and lines of credit			900				3				1,429				18
Residential construction			—				—				—				—
Other construction and land			1,945				17				8,485				93
Commercial			328				5				358				5
		$	28,623			$	262			$	37,330			$	389

 

Nonperforming Loans

 

The following table summarizes the balances of nonperforming loans as of March 31, 2015 and December 31, 2014. Certain loans classified as Troubled Debt Restructurings (“TDRs”) and impaired loans may be on non-accrual status even though they are not contractually delinquent.

 

		March 31, 2015				December 31, 2014
		(Dollars in thousands)
One-to four-family residential		$	5,800			$	5,661
Commercial real estate			5,724				7,011
Home equity loans and lines of credit			651				1,347
Residential construction			65				65
Other construction and land			803				2,679
Commercial			65				15
Consumer			2				2
Non-performing loans		$	13,110			$	16,780

Troubled Debt Restructurings (TDR)

 

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

 

		March 31, 2015
		Performing				Nonperforming				Total
		TDR’s				TDR’s				TDR’s
		(Dollars in thousands)
One-to-four family residential		$	5,051			$	375			$	5,426
Commercial real estate			10,638				5,411				16,049
Home equity and lines of credit			313				—				313
Residential construction			—				—				—
Other construction and land			1,446				491				1,937
Commercial			328				15				343
		$	17,776			$	6,292			$	24,068
		December 31, 2014
		Performing				Nonperforming				Total
		TDR’s				TDR’s				TDR’s
		(Dollars in thousands)
One-to-four family residential		$	5,760			$	715			$	6,475
Commercial real estate			10,710				3,797				14,507
Home equity and lines of credit			443				—				443
Residential construction			—				—				—
Other construction and land			1,519				672				2,191
Commercial			328				16				344
		$	18,760			$	5,200			$	23,960

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

 

		Three Months Ended March 31, 2015
(Dollars in thousands)		Number of Loans				Pre-modification Outstanding Recorded Investment				Post-modification Outstanding Recorded Investment
Forgiveness of principal:
Commercial real estate			1			$	1,988			$	1,693
			1			$	1,988			$	1,693
		Three Months Ended March 31, 2014
(Dollars in thousands)		Number of Loans				Pre-modification Outstanding Recorded Investment				Post-modification Outstanding Recorded Investment
Below market interest rate:
One-to four-family residential			1			$	191			$	151
Home equity loans and lines of credit			1				50				40
			2			$	241			$	191
Extended payment terms:
Other construction and land			1			$	54			$	40
Commercial real estate			4				684				574
Commercial			1				18				18
			6			$	756			$	632

   

There were no TDRs that defaulted during the three month periods ending March 31, 2015 and 2014 and which were modified as TDRs within the previous 12 months.

NOTE 6. REAL ESTATE OWNED

 

The following tables summarize real estate owned and changes in the valuation allowance for real estate owned as of March 31, 2015 and December 31, 2014 and for the three months ended March 31, 2015 and 2014.

 

		March 31,				December 31,
(Dollars in thousands)		2015				2014
Real estate owned, gross		$	6,523			$	6,185
Less: Valuation allowance			1,606				1,760
Real estate owned, net		$	4,917			$	4,425
		Three Months Ended March 31,
(Dollars in thousands)		2015				2014
Valuation allowance, beginning		$	1,760			$	5,560
Provision charged to expense			68				635
Reduction due to disposal			(222	)			(1,076	)
Valuation allowance, ending		$	1,606			$	5,119

 

As of March 31, 2015, the Company had $2.5 million in loans secured by residential real estate properties for which formal foreclosure proceedings were in process. As of March 31, 2015, the Company had $1.1 million of residential real estate properties included in real estate owned.

 

NOTE 7. LOAN SERVICING

 

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage and other loans serviced for others is detailed below. 

 

March 31, 2015				December 31, 2014
(Dollars in thousands)
$	247,577			$	246,348

 

The following summarizes the activity in the balance of loan servicing rights for the three months ended March 31, 2015 and 2014:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in thousands)
Loan servicing rights, beginning of period		$	2,187			$	1,883
Capitalization from loans sold			133				48
Fair value adjustment			(88	)			120
Loan servicing rights, end of period		$	2,232			$	2,051

The Bank held custodial escrow deposits of $0.8 million and $0.6 million for loan servicing accounts at March 31, 2015 and December 31, 2014, respectively.

NOTE 8. DEPOSITS

 

The following table summarizes deposit balances and interest expense by type of deposit as of and for the three months ended March 31, 2015 and 2014 and the year ended December 31, 2014.

 

		As of and for the																As of and for the Year Ended
		Three Months Ended March 31,																December 31,
		2015								2014								2014
						Interest								Interest								Interest
(Dollars in thousands)		Balance				Expense				Balance				Expense				Balance				Expense
Noninterest-bearing demand		$	89,012			$	—			$	70,604			$	—			$	86,110			$	—
Interest-bearing demand			89,845				36				78,710				28				92,877				149
Money Market			175,162				154				182,873				251				178,320				983
Savings			28,278				8				26,153				9				27,591				36
Time Deposits			317,486				1,011				326,339				1,053				318,219				4,193
		$	699,783			$	1,209			$	684,679			$	1,341			$	703,117			$	5,361

NOTE 9. JUNIOR SUBORDINATED DEBT

 

The Company issued $14.4 million of junior subordinated notes to its wholly owned subsidiary, Macon Capital Trust I, to fully and unconditionally guarantee the trust preferred securities issued by the Trust. These notes qualify as Tier I capital for the Company. The notes accrue and pay interest quarterly at a rate per annum, reset quarterly, equal to 90-day LIBOR plus 2.80% (3.07% at March 31, 2015). The notes mature on March 30, 2034.

 

The Company has the right to redeem the notes, in whole or in part, on or after March 30, 2009 at a price equal to 100% of the principal amount plus accrued and unpaid interest. In addition, the Company may redeem the notes in whole (but not in part) upon the occurrence of a capital disqualification event, an investment company event, or a tax event at a specified redemption price as defined in the indenture.

 

The Company also may, at its option, defer the payment of interest on the notes for a period up to 20 consecutive quarters, provided that interest will also accrue on the deferred payments of interest. The Company had previously deferred interest on the notes since December 31, 2010. As of March 31, 2015, the Company was current on all interest payments due.

 

NOTE 10. EARNINGS PER SHARE

 

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

 

		For the Three
		Months Ended March
(Dollars in thousands, except per share amounts)		31, 2015
Numerator:
Net income		$	2,615
Denominator:
Weighted-average common shares outstanding - basic			6,546,375
Effect of dilutive shares			—
Weighted-average common shares outstanding - diluted			6,546,375
Earnings per share - basic		$	0.40
Earnings per share - diluted		$	0.40

NOTE 11. ACCUMLATED OTHER COMPREHENSIVE INCOME

 

The following table summarizes the components of accumulated other comprehensive income and changes in those components as of and for the three months ended March 31, 2015 and 2014.

 

		Three Months Ended March 31, 2015
						Held to Maturity				Deferred Tax
		Available				Securities				Valuation
		for Sale				Transferred				Allowance on
		Securities				from AFS				AFS				Total
		(Dollars in thousands)
Balance, beginning of period		$	(236	)		$	(1,165	)		$	(868	)		$	(2,269	)
Change in deferred tax valuation allowance attributable to net unrealized losses on investment securities available for sale			—				—				729				729
Change in net unrealized holding losses on securities available for sale			2,020				—				—				2,020
Reclassification adjustment for net securities gains realized in net income			(164	)			—				—				(164	)
Transfer of net unrealized loss from available for sale to held to maturity			—				—				—				—
Amortization of unrealized gains and losses on securities transferred to held to maturity			—				49				—				49
Income tax expense			(710	)			(19	)			—				(729	)
Balance, end of period		$	910			$	(1,135	)		$	(139	)		$	(364	)
		Three Months Ended March 31, 2014
		(Dollars in thousands)
Balance, beginning of period		$	(3,374	)		$	(1,242	)		$	(2,860	)		$	(7,476	)
Change in deferred tax valuation allowance attributable to unrealized gains on investment securities available for sale			—				—				811				811
Change in unrealized holding gains on securities available for sale			2,131				—				—				2,131
Reclassification adjustment for net securities gains realized in net income			(62	)			—				—				(62	)
Transfer of net unrealized loss from available for sale to held to maturity			74				(74	)			—				—
Amortization of unrealized gains and losses on securities transferred to held to maturity			—				50				—				50
Income tax expense			(820	)			9				—				(811	)
Balance, end of period		$	(2,051	)		$	(1,257	)		$	(2,049	)		$	(5,357	)

The following table shows the line items in the consolidated Statements of Income affected by amounts reclassified from accumulated other comprehensive income:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in thousands)
Gain on sale of investments, net		$	164			$	62
Tax effect			—				—
Impact, net of tax			164				62
Interest income - taxable securities			49				50
Tax effect			—				—
Impact, net of tax			49				50
Total reclassifications, net of tax		$	213			$	112

NOTE 12. COMMITMENTS AND CONTINGENCIES

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

 

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

 

		March 31, 2015
		(Dollars in thousands)
Lines of credit		$	63,580
Standby letters of credit			804
		$	64,384

 

As of March 31, 2015, the Company had outstanding commitments to originate loans as follows:

 

		March 31, 2015
		Amount				Range of Rates
		(Dollar in thousands)
Fixed		$	10,859			2.990% to 5.380%
Variable			10,937			2.490% to 6.000%
		$	21,796

The allowance for unfunded commitments was $0.1 million at March 31, 2015 and December 31, 2014.

 

The Company is exposed to loss as a result of its obligation for representations and warranties on loans sold to Fannie Mae and maintained a reserve of $0.3 million as of March 31, 2015 and December 31, 2014.

 

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

 

NOTE 13. FAIR VALUE DISCLOSURES

 

We use fair value measurements when recording and disclosing certain financial assets and liabilities. Securities available-for-sale, loan servicing rights and mortgage derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans and real estate owned.

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. In determining fair value, we use various valuation approaches, including market, income and cost approaches. The fair value standard establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability, which is developed, based on market data we have obtained from independent sources. Unobservable inputs reflect our estimate of assumptions that market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

 

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

	·	Level 1: valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.

	·	Level 2: valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.

·

Level 3: valuation is derived from other valuation methodologies, including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

 

Fair value estimates are made at a specific point of time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Company’s entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value also would affect significantly the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

 

Securities

 

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

 

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

 

Loan Servicing Rights

 

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

 

Derivative Instruments

 

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

 

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a nonrecurring basis:

 

Loans Held for Sale

 

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

 

Impaired Loans

 

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

 

Real Estate Owned

 

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

 

In addition to financial instruments recorded at fair value in our financial statements, fair value accounting guidance requires disclosure of the fair value of all of an entity’s assets and liabilities that are considered financial instruments. The majority of our assets and liabilities are considered financial instruments. Many of these instruments lack an available trading market as characterized by a willing buyer and willing seller engaged in an exchange transaction. Also, it is our general practice and intent to hold our financial instruments to maturity and to not engage in trading or sales activities. For fair value disclosure purposes, we substantially utilize the fair value measurement criteria as required and explained above. In cases where quoted fair values are not available, we use present value methods to determine the fair value of our financial instruments.

Following is a description of valuation methodologies used for the disclosure of the fair value of financial instruments not carried at fair value:

 

Cash and Cash Equivalents

 

The carrying amount of such instruments is deemed to be a reasonable estimate of fair value.

 

Loans

 

The fair value of variable rate performing loans is based on carrying values adjusted for credit risk. The fair value of fixed rate performing loans is estimated using discounted cash flow analyses, utilizing interest rates currently being offered for loans with similar terms, adjusted for credit risk. The fair value of nonperforming loans is based on their carrying values less any specific reserve. A prepayment assumption is used to estimate the portion of loans that will be repaid prior to their scheduled maturity. No adjustment has been made for the illiquidity in the market for loans as there is no active market for many of the Company’s loans on which to reasonably base this estimate.

 

Bank Owned Life Insurance

 

Fair values approximate net cash surrender values.

 

Other Investments, at cost

 

No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value. Accordingly, the carrying amount is deemed to be a reasonable estimate of fair value.

 

Deposits

 

The fair values disclosed for demand deposits are equal to the amounts payable on demand at the reporting date. The fair value of certificates of deposit are estimated by discounting the amounts payable at the certificate rates using the rates currently offered for deposits of similar remaining maturities.

 

Advances from the FHLB

 

The fair values disclosed for fixed rate long-term borrowings are determined by discounting their contractual cash flows using current interest rates for long-term borrowings of similar remaining maturities. The carrying amounts of variable rate long-term borrowings approximate their fair values.

 

Junior Subordinated Notes

 

The carrying amount approximates fair value because the debt is variable rate tied to LIBOR.

 

Accrued Interest Receivable and Payable

 

Since these financial instruments will typically be received or paid within three months, the carrying amounts of such instruments are deemed to be a reasonable estimate of fair value.

 

Loan Commitments

 

Estimates of the fair value of these off-balance sheet items are not made because of the short-term nature of these arrangements and the credit standing of the counterparties.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

 

Below is a table that presents information about certain assets and liabilities measured at fair value on a recurring basis:

 

		March 31, 2015
		Level 1				Level 2				Level 3				Total
		(Dollars in thousands)
Securities available for sale:
U.S. government agencies		$	—			$	44,486			$	—			$	44,486
Municipal securities			—				27,834				—				27,834
Mortgage-backed securities			—				149,287				—				149,287
U.S. Treasury securities			1,534				—				—				1,534
Mutual funds			600				—				—				600
			2,134				221,607				—				223,741
Loan servicing rights			—				—				2,232				2,232
Forward sales commitments			—				—				26				26
Interest rate lock commitments			—				—				110				110
Total assets		$	2,134			$	221,607			$	2,368			$	226,109
		December 31, 2014
		Level 1				Level 2				Level 3				Total
		(Dollars in thousands)
Securities available for sale:
U.S. government agencies		$	—			$	39,482			$	—			$	39,482
Municipal securities			—				25,558				—				25,558
Mortgage-backed securities			—				152,718				—				152,718
U.S. Treasury securities			1,510				—				—				1,510
Mutual funds			591				—				—				591
			2,101				217,758				—				219,859
Loan servicing rights			—				—				2,187				2,187
Forward sales commitments			—				—				9				9
Interest rate lock commitments			—				—				52				52
Total assets		$	2,101			$	217,758			$	2,248			$	222,107

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

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in thousands)
Balance at beginning of period		$	2,248			$	1,888
Loan servicing right activity, included in servicing income, net
Capitalization from loans sold			133				48
Fair value adjustment			(88	)			120
Mortgage derivative gains included in Other income			75				15
Balance at end of period		$	2,368			$	2,071

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

 

The table below presents information about certain assets and liabilities measured at fair value on a nonrecurring basis. There were no loans held for sale carried at fair value at either March 31, 2015 or December 31, 2014.

 

		March 31, 2015
		Level 1				Level 2				Level 3				Total
						(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential		$	—			$	—			$	5,962			$	5,962
Commercial real estate			—				—				13,350				13,350
Home equity loans and lines of credit			—				—				713				713
Other construction and land			—				—				923				923
Real estate owned:
One-to four family residential			—				—				1,098				1,098
Commercial real estate			—				—				759				759
Residential contruction			—				—				—				—
Other construction and land			—				—				3,060				3,060
Total assets		$	—			$	—			$	25,865			$	25,865
		December 31, 2014
		Level 1				Level 2				Level 3				Total
						(Dollars in thousands)
Collateral dependent impaired loans:
One-to four family residential		$	—			$	—			$	6,407			$	6,407
Commercial real estate			—				—				14,551				14,551
Home equity loans and lines of credit			—				—				1,456				1,456
Other construction and land			—				—				2,227				2,227
Real estate owned:
One-to four family residential			—				—				220				220
Commercial real estate			—				—				774				774
Residential contruction			—				—				—				—
Other construction and land			—				—				3,431				3,431
Total assets		$	—			$	—			$	29,066			$	29,066

There were no liabilities measured at fair value on a nonrecurring basis as of March 31, 2015 or December 31, 2014.

 

Impaired loans totaling $7.6 million at March 31, 2015 and $9.0 million at December 31, 2014, were measured using the present value of expected future cash flows. These impaired loans were not deemed to be measured at fair value on a nonrecurring basis.

The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at March 31, 2015.

 

		Valuation Technique		Unobservable Input		General Range
Impaired loans		Discounted Appraisals		Collateral discounts and estimated selling cost		0 – 30%
Real estate owned		Discounted Appraisals		Collateral discounts and estimated selling cost		0 – 30%
Loan servicing rights		Discounted Cash Flows		Prepayment speed Discount rate		6 – 25% 8 – 14%
Forward sales commitments and interest rate lock commitments		Change in market price of underlying loan		Value of underlying loan		101 – 107%

 

The approximate carrying and estimated fair value of financial instruments are summarized below:

 

						Fair Value Measurements at March 31, 2015
		Carrying
(Dollars in thousands)		Amount				Total				Level 1				Level 2				Level 3
Assets:
Cash and equivalents		$	47,629			$	47,629			$	47,629			$	—			$	—
Securities available for sale			223,741				223,741				2,134				221,607				—
Securities held to maturity			40,723				42,486				—				42,486				—
Loans held for sale			7,232				7,774				—				7,774				—
Loans receivable, net			549,874				556,055				—				—				556,055
Other investments, at cost			5,498				5,498				—				5,498				—
Interest receivable			3,144				3,144				—				3,144				—
Bank owned life insurance			20,529				20,529				—				20,529				—
Loan servicing rights			2,232				2,232				—				—				2,232
Forward sales commitments			26				26				—				—				26
Interest rate lock commitments			110				110				—				—				110
Liabilities:
Demand deposits		$	382,297			$	382,297			$	—			$	382,297			$	—
Time deposits			317,486				320,803				—				—				320,803
Federal Home Loan Bank advances			75,000				77,039				—				77,039				—
Junior subordinated debentures			14,433				14,433				—				14,433				—
Accrued interest payable			330				330				—				330				—

						Fair Value Measurements at December 31, 2014
		Carrying
(Dollars in thousands)		Amount				Total				Level 1				Level 2				Level 3
Assets:
Cash and equivalents		$	58,982			$	58,982			$	58,982			$	—			$	—
Securities available for sale			219,859				219,859				2,101				217,758				—
Securities held to maturity			29,285				30,890				—				30,890				—
Loans held for sale			10,761				11,501				—				11,501				—
Loans receivable, net			529,407				546,450				—				—				546,450
Other investments, at cost			4,908				4,908				—				4,908				—
Interest receivable			2,925				2,925				—				2,925				—
Bank owned life insurance			20,417				20,417				—				20,417				—
Loan servicing rights			2,187				2,187				—				—				2,187
Forward sales commitments			9				9				—				—				9
Interest rate lock commitments			52				52				—				—				52
Liabilities:
Demand deposits		$	384,898			$	384,898			$	—			$	384,898			$	—
Time deposits			318,219				321,491				—				—				321,491
Federal Home Loan Bank advances			60,000				62,108				—				62,108				—
Junior subordinated debentures			14,433				14,433				—				14,433				—
Accrued interest payable			323				323				—				323				—

NOTE 14. REGULATORY MATTERS

 

The Company and the Bank are subject to various regulatory capital requirements administered by their respective federal and state banking regulators. Failure to satisfy minimum capital requirements may result in certain mandatory and additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.

 

On April 21, 2014, the Bank entered into a memorandum of understanding (the “Bank MOU”) with the FDIC and the North Carolina Commissioner of Banks (the “Commissioner,” and together with the FDIC, the “Bank Supervisory Authorities”), which replaced the consent order entered into in 2012. The Bank MOU seeks to enhance the Bank’s existing practices and procedures in the areas of credit risk management, interest rate risk management, capital levels, and Board oversight. With respect to capital, the Memorandum of Understanding requires the Bank to maintain a Tier 1 capital to average assets (leverage) ratio of at least 8% and a total risk-based capital to total risk-weighted assets ratio of at least 11%.

 

The Company entered into a memorandum of understanding (the “Company MOU”) with the Federal Reserve Bank of Richmond in December 2014 which replaced the written agreement entered into in 2012. The Company MOU requires, among other things, obtaining written approval from the Reserve Bank prior to the payment of dividends by the Company or interest on the Company’s trust preferred securities. In addition, the Company must obtain approval from the Reserve Bank prior to purchasing or redeeming shares of its common stock or incurring any additional indebtedness.

 

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined).

 

In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.

 

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in the Bank’s Tier 1 capital.

The tables below summarize capital ratios and related information in accordance with Basel III as measured at March 31, 2015 and pre-existing rules at December 31, 2014.

 

Following are the required and actual capital amounts and ratios for the Bank:

 

																		To meet the
																		Requirements of the
		Actual								For Capital Adequacy Purposes								Memorandum of Understanding
(Dollars in thousands)		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of March 31, 2015:
Tier 1 Leverage Capital		$	107,513				11.96	%		$	35,967				³4	%		$	71,934				³8	%
Common Equity Tier 1 Capital		$	107,513				18.80	%		$	25,735				³4.5	%			N/A				N/A
Tier 1 Risk-based Capital		$	107,513				18.80	%		$	34,313				³6	%			N/A				N/A
Total Risk-based Capital		$	114,732				20.06	%		$	45,751				³8	%		$	62,908				³11	%
As of December 31, 2014:
Tier 1 Leverage Capital		$	105,556				11.91	%		$	35,440				³4	%		$	70,880				³8	%
Tier 1 Risk-based Capital		$	105,556				19.89	%		$	21,231				³4	%			N/A				N/A
Total Risk-based Capital		$	112,246				21.15	%		$	42,462				³8	%		$	58,386				³11	%

Following are the required and actual capital amounts and ratios for the Company:

										For Capital
		Actual								Adequacy Purposes
(Dollars in thousands)		Amount				Ratio				Amount				Ratio
As of March 31, 2015:
Tier I Leverage Capital		$	125,646				13.97	%		$	35,976				³4	%
Common Equity Tier 1 Capital		$	111,807				19.55	%		$	25,740				³4.5	%
Tier I Risk-based Capital		$	111,807				21.97	%		$	34,321				³6	%
Total Risk Based Capital		$	132,867				23.23	%		$	45,761				³8	%
As of December 31, 2014:
Tier I Leverage Capital		$	123,377				13.94	%		$	35,398				³4	%
Tier I Risk-based Capital		$	123,377				23.24	%		$	21,236				³4	%
Total Risk Based Capital		$	130,067				24.50	%		$	42,472				³8	%

 

NOTE 15. SUBSEQUENT EVENTS

 

On May 5, 2015, the Company prepaid an FHLB advance in the amount of $15 million. As a result, the Company incurred a prepayment penalty of $1.8 million which will be reflected in noninterest expense for the quarter ending June 30, 2015. The advance carried an interest rate equal to 90-day LIBOR plus 2.56% (2.81% at March 31, 2015) which reset quarterly and had a maturity date of April 10, 2020.

The prepaid advance was replaced with a $15 million three month fixed rate advance at a rate of 0.23%. Based on the rate of the new advance, we expect the prepayment to reduce interest expense by $390,000 on an annual basis.

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

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

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

	·		statements of our goals, intentions and expectations;

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

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

·

estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The Company is under no duty to and do not undertake any obligation to update any forward-looking statements after the date of this Quarterly Report on Form 10-Q.

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

 

	·		our failure to comply with the terms of any supervisory regulatory agreements;

	·		the occurrence of an ownership change under applicable tax rules that could limit our ability to utilize losses to offset future taxable income;

	·		general economic conditions, either nationally or in our market areas, that are worse than expected;

	·		credit quality deterioration as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

	·		the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
	·		weaknesses in the real estate market affect the value of real estate serving as collateral for loans in our portfolio
	·		competition among depository and other financial institutions;

	·		inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

	·		adverse changes in the securities markets;

	·		changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

	·		increased cybersecurity risk, including potential business disruptions or financial losses;
	·		our ability to enter new markets successfully and capitalize on growth opportunities;

	·		our ability to successfully integrate acquired entities, if any;

	·		changes in consumer spending, borrowing and savings habits;

	·		changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board (“FASB”), the Securities and Exchange Commission (“SEC”) and the Public Company Accounting Oversight Board (“PCAOB”);

	·		changes in our key personnel, and our compensation and benefit plans;

	·		changes in our financial condition or results of operations that reduce capital available to pay dividends or buyback shares;

	·		changes in the financial condition or future prospects of issuers of securities that we own; and
	·		other risks and uncertainties detailed in this Quarterly Report on Form 10-Q and, from time to time, in our other filings with the SEC.

For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our Annual Report on Form 10-K.

Critical Accounting Policies and Estimates

Our critical accounting policies involving significant judgments and assumptions used in the preparation of the Consolidated Financial Statements as of March 31, 2015 have remained unchanged from the disclosures presented in our Annual Report on Form 10-K.

The Jumpstart Our Business Startups Act (“JOBS Act”) contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of March 31, 2015 and December 31, 2014, there was not a significant difference in the presentation of our financial statements as compared to other public companies as a result of this transition guidance.

 

Overview

 

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

We provide a full range of financial services through offices located in Cherokee, Henderson, Jackson, Macon, Polk and Transylvania counties in North Carolina and a loan production office in Greenville, South Carolina. We provide full service retail and commercial banking products as well as wealth management services through a third party.

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

Our mission is to become the financial services provider of choice within the markets that we serve. We plan to do this by delivering exceptional service and value. Our strategic plan focuses on growth by expanding into contiguous markets with higher growth potential, while diversifying the current loan portfolio.

During the three months ended March 31, 2015, we continued to execute on our key strategic initiatives of stabilizing the loan portfolio and improving asset quality, while growing our earning assets with high quality loans and investments. We strive to be well-positioned for changes in both the economy and interest rates, regardless of the timing or direction of these changes. Management regularly assesses our balance sheet, capital, liquidity and operational infrastructure in order to be positioned to take advantage of opportunities for growth as they may arise.

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

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

Earnings Summary

Net income for the three months ended March 31, 2015 was $2.6 million compared to $2.1 million for the same period in 2014. The increase in net income was primarily related to a reduction in the provision for loan losses which was partially offset by a decrease in net interest income and an increase in noninterest expenses.

Net interest income decreased $0.8 million, or 10.7%, to $6.3 million for the three months ended March 31, 2015 compared to the same period in 2014. The decrease in net interest income for period was primarily the result of the favorable resolution of a commercial loan in the 2014 period, which resulted in the recognition of approximately $0.9 million of deferred interest and discounts.

 

Due to continued improvement in asset quality and significantly reduced charge-off amounts, a negative provision for loan losses of $1.5 million was recognized in 2015 compared to a provision of $5,000 for the 2014 period.

 

Financial Condition At March 31, 2015 and December 31, 2014

 

Total assets increased $15.5 million, or 1.7%, to $919.1 million at March 31, 2015 from $903.6 million at December 31, 2014. This increase in assets was comprised primarily of loans, which increased $9.4 million, or 1.7%, and investment securities, which increased $15.3 million, or 6.2%. The increases in loans and investments were mainly funded by FHLB advances which increased $15.0 million, or 25.0%, and available cash which decreased $11.4 million, or 19.2%.

Total liabilities increased $10.9 million, or 1.4%, to $807.2 million at March 31, 2015 from $796.3 million at December 31, 2014, due primarily to the $15.0 million increase in FHLB advances.

Total equity increased $4.5 million, or 4.2%, to $111.8 million at March 31, 2015 from $107.3 million at December 31, 2014. This increase was the result of $2.6 million of net income for the period and a $1.9 million improvement in net unrealized holding gains and losses on securities available for sale.

Cash and Cash Equivalents

Total cash and cash equivalents decreased $11.4 million, or 19.3%, to $47.6 million at March 31, 2015 from $59.0 million at December 31, 2014 as a result of cash being used to invest in loans and investment securities. We continue to hold higher than normal levels of liquidity due to the current interest rate environment and in anticipation of rising interest rates.

Investment Securities

Our investment securities portfolio is classified as both “available-for-sale” and “held-to-maturity”. Available-for-sale securities are carried at fair value. The following table shows the amortized cost and fair value for our available for sale investment portfolio at the dates indicated.

 

		At March 31,								At December 31,
		2015								2014
		Amortized Cost				Fair value				Amortized Cost				Fair value
		(Dollars in thousands)
Investment securities available-for-sale:
U.S. Government and agency securities:
U.S. Government and agency obligations		$	41,048			$	41,507			$	33,540			$	33,572
U.S. Government structured agency obligations			3,000				2,979				6,000				5,910
U.S. Treasury Notes & Bonds			1,500				1,534				1,500				1,510
Municipal obligations			27,541				27,834				25,483				25,558
Mortgage-backed securities:
U.S. Government agency			115,500				116,146				123,321				123,043
SBA securities			24,405				24,423				20,713				20,652
Collateralized mortgage obligations			8,679				8,718				9,094				9,023
Mutual funds			593				600				590				591
Total securities available-for-sale		$	222,266			$	223,741			$	220,241			$	219,859

 

Available for sale investment securities increased $3.9 million, or 1.8%, to $223.7 million at March 31, 2015 from $219.9 million at December 31, 2014. We continue to invest our excess cash in available for sale investments as loan demand continues at a moderate pace.

Held to maturity investment securities are carried at amortized cost. The following table shows the amortized cost and fair value for our held-to-maturity investment portfolio as of the most recent quarter and year end.

		At March 31,								At December 31,
		2015								2014
		Amortized Cost				Fair value				Amortized Cost				Fair value
		(Dollars in thousands)
Investment securities held-to-maturity:
U.S. Government and agency securities:
U.S. Government and agency obligations		$	3,746			$	3,684			$	2,000			$	1,995
U.S. Government structured agency obligations			24,244				25,881				21,193				22,613
Municipal tax exempt			4,386				4,546				3,805				3,973
Municipal taxable			3,972				3,987				587				609
Collateralized mortgage obligations			2,975				2,988				—				—
Trust preferred securities			—				—				1,000				1,000
Corporate debt securities			1,400				1,400				700				700
Total securities held-to-maturity		$	40,723			$	42,486			$	29,285			$	30,890

 

Held-to-maturity investment securities increased $11.4 million, or 39.1%, to $40.7 million at March 31, 2015 from $29.3 million at December 31, 2014 as a result of the Company purchasing new securities with the intent to minimize the impact of future interest rate changes on accumulated other comprehensive income (loss).

In prior years, the Company reclassified certain municipal securities from available-for-sale to held-to-maturity. The reclassifications will remain in effect until the investments are called or mature. The difference between the book values and fair values at the date of the transfer will continue to be reported in a separate component of accumulated other comprehensive income (loss), and will be amortized into income over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a premium. Concurrently, the revised book values of the transferred securities (represented by the market value on the date of transfer) are being amortized back to their par values over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of a discount.

Loans

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

		At March 31,								At December 31,
		2015								2014
		Amount				Percent				Amount				Percent
		(Dollars in thousands)
Real estate loans:
One- to four-family residential		$	225,245				40.7	%		$	227,209				41.8	%
Commercial			175,230				31.7				179,435				33.0
Home equity loans and lines of credit			55,312				10.0				56,561				10.4
Residential construction			10,208				1.9				7,823				1.4
Other construction and land			55,062				10.0				50,298				9.3
Commercial			28,248				5.1				19,135				3.5
Consumer			3,447				0.6				3,200				0.6
Total loans, gross		$	552,752				100.0	%		$	543,661				100.0	%
Less:
Deferred loan fees, net			(1,566	)							(1,695	)
Unamortized premium			275								—
Unamortized discount			(1,587	)							(1,487	)
Total loans, net		$	549,874							$	540,479
Percentage of total assets			59.8	%							59.8	%

 

Net loans increased by $9.4 million, or 1.7%, to $549.9 million at March 31, 2015 from $540.5 million at December 31, 2014. During the first quarter of 2015, we began to experience an improvement in loan demand which was enhanced by our new loan production office in Greenville, South Carolina. We believe that economic conditions in our primary market area are continuing to improve, albeit at a moderate pace, and that these improving conditions are contributing to an increase in loan demand.

In addition, we purchased $8.2 million in externally sourced loans during the first quarter of 2015 which were comprised of $1.5 million in commercial SBA guaranteed loans, $4.0 million in commercial and industrial participation loans, and a $2.7 million commercial real estate whole loan purchase. We will continue to evaluate opportunities to purchase loans while properly managing our risk, which we believe serves as a valuable supplement to organic loan growth.

 

Included in loans receivable and other borrowings at March 31, 2015 are $2.1 million in participated loans that did not qualify for sale accounting. Interest expense on the other borrowings accrues at the same rate as the interest income recognized on the loans receivable, resulting in no effect to net income. 

Delinquent Loans

 

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

 

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

 

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

 

The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. We have no loans past due 90 days and over that are still accruing interest as of March 31, 2015.

		Delinquent loans
		30-59 Days				60-89 Days				90 Days and over				Total
		(Dollars in thousands)
At March 31, 2015
Real estate loans:
One- to four-family residential		$	5,129			$	—			$	3,010			$	8,139
Commercial			2,648				94				316				3,058
Home equity loans and lines of credit			595				347				638				1,580
One- to four-family residential construction			101				—				65				166
Other construction and land			2,015				—				471				2,486
Commercial			37				—				—				37
Consumer			25				6				2				33
Total loans		$	10,550			$	447			$	4,502			$	15,499
% of total loans, net			1.92	%			0.08	%			0.82	%			2.82	%
At December 31, 2014
Real estate loans:
One- to four-family residential		$	6,298			$	448			$	2,669			$	9,415
Commercial			2,136				909				1,006				4,051
Home equity loans and lines of credit			557				528				759				1,844
One- to four-family residential construction			—				—				65				65
Other construction and land			1,530				964				473				2,967
Commercial			—				22				—				22
Consumer			247				4				1				252
Total loans		$	10,768			$	2,875			$	4,973			$	18,616
% of total loans, net			1.99	%			0.53	%			0.92	%			3.44	%

 

We continue to experience stabilization in our delinquencies compared to prior periods as delinquent loans decreased $3.1 million, or 16.7%, to $15.5 million at March 31, 2015 from $18.6 million at December 31, 2014.

Non-Performing Assets

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

		March 31,				December 31,
		2015				2014
		(Dollars in thousands)
Non-accrual loans:
Real estate loans:
One- to four-family residential		$	5,800			$	5,661
Commercial			5,724				7,011
Home equity loans and lines of credit			651				1,347
Residential construction			65				65
Other construction and land			803				2,679
Commercial			65				15
Consumer			2				2
Total non-performing loans			13,110				16,780
REO:
One- to four-family residential			1,098				220
Commercial real estate			759				774
Residential construction			—				—
Other construction and land			3,060				3,431
Total foreclosed real estate			4,917				4,425
Total non-performing assets		$	18,027			$	21,205
Troubled debt restructurings still accruing		$	17,776			$	18,760
Ratios:
Non-performing loans to total loans			2.38	%			3.10	%
Non-performing assets to total assets			1.96	%			2.35	%

Non-performing loans decreased $3.7 million, or 21.9%, to $13.1 million at March 31, 2015 from $16.8 million at December 31, 2014. Several commercial real estate and other construction and land relationships returned to accrual status during this period upon demonstration of sustained payment performance and cash flow coverage. In addition, $1.3 million of nonaccrual loans at December 31, 2014 were transferred to real estate owned during the first quarter of 2015.

Real estate owned increased $0.5 million, or 11.1%, to $4.9 million at March 31, 2015 from $4.4 million at December 31, 2014. Although real estate owned balances have increased, most of the transfers to real estate owned during the quarter were 1-4 family residential properties which are normally sold at a faster pace than other property types.

The overall decrease in non-performing assets reflects the improving economy in our primary market area which has resulted in fewer foreclosures and problem assets.

Classification of Loans

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

		At March 31,				At December 31,
		2015				2014
		(Dollars in thousands)
Classified loans:
Substandard		$	27,852			$	32,105
Doubtful			—				—
Loss			—				—
Total classified loans:			27,852				32,105
As a % of total loans, net			5.07	%			5.94	%
Special mention			28,004				31,283
Total criticized loans		$	55,856			$	63,388
As a % of total loans, net			10.16	%			11.73	%

 

Total classified loans decreased $4.3 million, or 13.2%, to $27.9 million at March 31, 2015 from $32.1 million at December 31, 2014. Total criticized loans decreased $7.5 million, or 11.9%, to $55.9 million at March 31, 2015 from $63.4 million at December 31, 2014. These reductions reflect an improving economy and an increasing number of criticized loans being paid off or upgraded as a consequence of improvements in our borrowers’ cash flows and payment performance. Management continues to dedicate significant resources to monitoring and resolving classified and criticized loans.

 

Allowance for Loan Losses

 

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

 

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

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes a weighted average loss rate for the last 16 quarters. Prior to the first quarter of 2015, we more heavily weighted the most recent four quarters than the least recent four quarters. Beginning in the first quarter of 2015, we no longer weight any quarters for our average loss rates. This change in weighting did not have a material impact on our allowance for loan losses methodology. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0% to 13%.

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

 

· Non-accrual and classified loans

· Collateral values

· Loan concentrations

· Economic conditions – including unemployment rates, building permits, and a regional economic index.

 

Qualitative reserve adjustment factors as a percentage of historical loss rates range from -10% for a favorable trend to +30% for a highly unfavorable trend. These factors are subject to adjustment as economic and other conditions change.

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

 

		As of or for the Three Months Ended March 31,
		2015				2014
		( Dollars in thousands)
Balance at beginning of period		$	11,072			$	14,251
Charge-offs:
Real Estate:
One- to four-family residential			219				430
Commercial			30				1,794
Home equity loans and lines of credit			109				143
One- to four-family residential construction			—				—
Other construction and land			19				343
Commercial			—				—
Consumer			13				45
Total charge-offs			390				2,755
Recoveries:
Real Estate:
One- to four-family residential			109				2
Commercial			92				285
Home equity loans and lines of credit			23				16
One- to four-family residential construction			—				—
Other construction and land			119				78
Commercial			7				4
Consumer			79				70
Total recoveries			429				455
Net charge-offs (recoveries)			(39	)			2,300
Provision for loan losses			(1,500	)			5
Balance at end of period		$	9,611			$	11,956
Ratios:
Net charge-offs (recoveries) to average loans outstanding			(0.03	)%			1.65	%
Allowance to non-performing loans at period end			73.31	%			132.62	%
Allowance to total loans at period end			1.75	%			2.30	%

 

Net charge-offs/recoveries for the quarter ended March 31, 2015 improved by $2.3 million, to net recoveries of $39 thousand compared to net charge-offs of $2.3 million for the corresponding period in the prior year. We have continued to experience a reduction in charge-off amounts and stable collections of amounts previously charged-off. The overall historical loss rate used in our allowance for loan losses calculation continues to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. Our coverage ratio of non-performing loans remained strong at 73.31% at March 31, 2015 compared to 132.62% at March 31, 2014.

Real Estate Owned (REO)

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

 

		March 31,				December 31,
		2015				2014
		(Dollars in thousands)
One- to four-family residential		$	1,098			$	220
Commercial real estate			759				774
Residential construction			—				—
Other construction and land			3,060				3,431
Total		$	4,917			$	4,425
			Three Months Ended March 31,
			2015				2014
			(Dollars in thousands)
Balance, beginning of period		$	4,425			$	10,506
Additions			1,317				614
Disposals			(757	)			(1,749	)
Writedowns			(68	)			(635	)
Other			—				12
Balance, end of period		$	4,917			$	8,748

Real estate owned increased $0.5 million, or 11.1%, to $4.9 million at March 31, 2015 from $4.4 million at December 31, 2014, as transfers to real estate owned exceed disposals and writedowns during the quarter. Most of the transfers to real estate owned during the quarter were 1-4 family residential properties which are normally sold at a faster pace than other property types. We have experienced a significant decrease in the number and dollar amount of additions to REO, and have had moderate success in liquidating REO. Our policy continues to be to aggressively market REO for sale, including recording write-downs when necessary.

Net Deferred Tax Assets

 

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

 

	·	Future reversals of existing taxable temporary differences;

	·	Future taxable income exclusive of reversing temporary differences and carry forwards;

	·	Taxable income in prior carryback years; and

·

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

 

As a result of the analysis above, we concluded that a valuation allowance was necessary as of March 31, 2015 and December 31, 2014. The recorded balance of net deferred tax assets at March 31, 2015 and December 31, 2014 of $1.8 million and $2.1 million respectively, represents the amount of tax planning strategies available to the Company as of those dates. We maintained a valuation allowance of $18.4 million and $19.8 million against our deferred tax asset as of March 31, 2015 and December 31, 2014, respectively. The tax planning strategies utilized include converting tax free municipal income to taxable income, the intention and ability to hold securities with an unrealized loss, and the ability to create taxable gains on certain insurance policies.

Deposits

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

 

		As of								As of
		March 31, 2015								December 31, 2014
		Balance				Percent				Balance				Percent
		(Dollars in thousands)
Deposit type:
Savings accounts		$	28,278				4.0	%		$	27,591				3.9	%
Time depsosits			308,511				44.1				309,046				44.0
Brokered CDs			8,975				1.3				9,173				1.3
Money market accounts			175,162				25.0				178,320				25.4
Interest-bearing demand accounts			89,845				12.8				92,877				13.2
Noninterest-bearing demand accounts			89,012				12.7				86,110				12.2
Total deposits		$	699,783				100.0	%		$	703,117				100.0	%

 

Total deposits decreased $3.3 million, or 0.5%, to $699.8 million at March 31, 2015 from $703.1 million at December 31, 2014. We continue to let brokered CDs mature without replacement and we expect to completely eliminate all of our brokered CDs by June 2015. We expect the elimination of the remaining brokered CDs outstanding at March 31, 2015 to reduce annual interest expense by $0.3 million.

 

FHLB Advances

FHLB advances increased $15 million to $75 million at March 31, 2015 compared to $60 million at December 31, 2014. The additional funds were used to invest in loans and investment securities and to provide funding for future cash needs. The new advances during the quarter carry a weighted average rate and weighted average original maturity of 36 basis points and 8 months, respectively.

 

Junior Subordinated Notes

We had $14.4 million in junior subordinated notes outstanding at March 31, 2015 and December 31, 2014 payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. The effective interest rate was 3.07% and 3.05% at March 31, 2015 and December 31, 2014, respectively.

We had previously been deferring interest on the notes since December 31, 2010; however, on December 29, 2014, the Company made a payment of $2.1 million representing deferred interest of $2.0 million and a regularly scheduled interest payment due on December 30, 2014. We also notified the trustee of the trust preferred securities that we were ending our deferral of interest payments and intend to continue to make regularly scheduled quarterly interest payments in the future, subject to regulatory approval.

Equity

Total equity increased $4.5 million, or 4.2%, to $111.8 million at March 31, 2015 from $107.3 million at December 31, 2014. This increase was the result of $2.6 million of net income for the period and a $1.9 million improvement in net unrealized holding gains and losses on securities available for sale.

Comparison of Operating Results for the Three Months Ended March 31, 2015 and March 31, 2014.

General. Net income increased $0.5 million, or 25.1%, to $2.6 million for the three months ended March 31, 2015, compared to net income of $2.1 million for the three months ended March 31, 2014. On a pre-tax basis, income increased $0.5 million, or 19.1%, to $2.8 million for the three months ended March 31, 2015 compared to $2.3 million for the three months ended March 31, 2014. These increases were primarily attributable to a negative provision for loan losses of $1.5 million partially offset by a decrease in net interest income of $0.8 million and an increase in noninterest expense of $0.5 million.

Net Interest Income. Net interest income before provision for loan losses decreased to $6.3 million for the three months ended March 31, 2015, compared to $7.1 million for the same period in 2014. The tax-equivalent net interest margin decreased to 3.04% for the quarter ended March 31, 2015 compared to 3.93% for the same period in 2014. The decline in net interest income and margin was primarily the result of the recognition of approximately $0.9 million of deferred interest and discounts recognized during the 2014 period from to the favorable resolution of a commercial loan.

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

		For the Three Months Ended March 31,
		2015												2014
		Average Outstanding Balance				Interest				Yield/ Rate				Average Outstanding Balance				Interest				Yield/ Rate
		(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale		$	549,862			$	6,470				4.77	%		$	526,831			$	7,608				5.86	%
Loans, tax exempt (1)			3,230				39				4.95	%			1,979				26				5.28	%
Investments - taxable			245,274				1,236				2.04	%			174,969				979				2.27	%
Investment tax exempt (1)			6,605				106				6.51	%			8,761				141				6.52	%
Interest earning deposits			42,164				24				0.23	%			20,656				10				0.20	%
Other investments, at cost			4,906				58				4.79	%			3,641				21				2.34	%
Total interest-earning assets			852,041				7,933				3.78	%			736,837				8,785				4.84	%
Noninterest-earning assets			48,700												48,345
Total assets		$	900,741											$	785,182
Interest-bearing liabilities:
Savings accounts		$	27,952			$	8				0.12	%		$	25,833			$	9				0.14	%
Time deposits			318,553				1,011				1.29	%			324,036				1,052				1.32	%
Money market accounts			177,939				154				0.35	%			182,964				251				0.56	%
Interest bearing transaction accounts			90,612				36				0.16	%			78,203				28				0.15	%
Total interest bearing deposits			615,056				1,209				0.80	%			611,036				1,340				0.89	%
FHLB advances			60,161				205				1.38	%			40,006				174				1.76	%
Junior subordinated debentures			14,433				112				3.15	%			14,433				123				3.46	%
Other borrowings			1,801				26				5.85	%			—				—				0.00	%
Total interest-bearing liabilities			691,451				1,552				0.91	%			665,475				1,637				1.00	%
Noninterest-bearing deposits			86,031												70,686
Other non interest bearing liabilities			13,792												12,149
Total liabilities			791,274												748,310
Total equity			109,467												36,872
Total liabilities and equity		$	900,741											$	785,182
Tax-equivalent net interest income						$	6,381											$	7,148
Net interest-earning assets (2)		$	160,590											$	71,362
Average interest-earning assets to interest-bearing liabilities			1.23												1.11
Tax-equivalent net interest rate spread (3)											2.87	%											3.84	%
Tax-equivalent net interest margin (4)											3.04	%											3.93	%

(1) Tax exempt loans and investments are calculated giving effect to a 34% federal tax rate.

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

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

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

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

		For the Three Months Ended March 31, 2015 Compared to the Three Months Ended March 31, 2014
		Increase (decrease) due to:
		Volume				Rate				Total
		(Dollars in thousands)
Interest-earning assets:
Loans, including loans held for sale (1)		$	321			$	(1,459	)		$	(1,138	)
Loans, tax exempt (2)			15				(2	)			13
Investment - taxable			362				(105	)			257
Investments - tax exempt (2)			(35	)			(0	)			(35	)
Interest-earning deposits			12				2				14
Other investments, at cost			9				28				37
Total interest-earning assets			684				(1,536	)			(852	)
Interest-bearing liabilities:
Savings accounts		$	1			$	(2	)		$	(1	)
Time deposits			(18	)			(23	)			(41	)
Money market accounts			(7	)			(90	)			(97	)
Interest bearing transaction accounts			5				3				8
FHLB advances			74				(43	)			31
Junior subordinated debentures			—				(11	)			(11	)
Other borrowings			26				—				26
Total interest-bearing liabilities			81				(166	)			(85	)
Change in tax-equivalent net interest income		$	603			$	(1,370	)		$	(767	)

 

(1) Non-accrual loans are included in the above analysis.
(2) Interest income on tax exempt loans and investments are adjusted for based on a 34% federal tax rate

 

Net interest income before provision for loan losses decreased to $6.3 million for the three months ended March 31, 2015, compared to $7.1 million for the same period in 2014. As indicated in the table above, an increase in net interest earned of $0.6 million attributable to an improvement in volume was more than offset by a $1.4 million reduction in net interest earned attributable to a reduction in rates. The decline related to rate was primarily the result of the recognition of approximately $0.9 million of deferred interest and discounts recognized during the 2014 period from to the favorable resolution of a commercial loan.

The increase in tax-equivalent net interest income of $0.6 million related to volume was primarily the result of higher average loan and taxable investment balances which increased $23.0 million and $70.3 million, respectively, for the three months ended March 31, 2015 as compared to the same period in 2014. The increase in average loan and investment balances was partially offset by higher average FHLB advance balances which increased $20.2 million over the same periods.

The decrease in tax-equivalent net interest income of $1.4 million related to rate was primarily the result of the recognition of approximately $0.9 million of deferred interest and discounts recognized during the 2014 period as mention above. This was also the main factor for the decrease in our loan yields from 5.86% to 4.77% year over year. The decrease in average loan yields was partially offset by the impact of lower average deposit yields which decreased 9 basis points to 0.80% in the quarter ended March 31, 2015 as compared to 0.89% in the three months ending March 31, 2014. In addition, a reduction in average rates on FHLB advances from 1.76% during the three months ended March 31, 2014 to 1.38% for the three months ended March 31, 2015 also contributed to the increase in this component of net interest income.

Our tax-equivalent net interest rate spread decreased by 97 basis points to 2.87% for the three months ended March 31, 2015 compared to 3.84% for the three months ended March 31, 2014, and our tax-equivalent net interest margin decreased 89 basis points to 3.04% for the three months ended March 31, 2015, compared to 3.93% for the three months ended March 31, 2014. As mentioned above, the decreases in our interest rate spread and margin was primarily a result of the $0.9 million of deferred interest and discounts recognized during the 2014 period from to the favorable resolution of a commercial loan.

Provision for Loan Losses. For the three months ended March 31, 2015, we had a negative provision for loan losses was $1.5 million compared to a provision $5,000 for the same period in the prior year. The decrease in the provision for loan losses was the result of improvements in asset quality, significantly reduced charge-off amounts, and a continued reduction in decline in the overall loss rates used in our allowance for loan losses model.

Noninterest Income. The following table summarizes the components of noninterest income and the corresponding change between the three month periods ended March 31, 2015 and 2014:

		Three Months Ended March 31,
		2015				2014				Change
		(Dollars in thousands)
Servicing income (expense), net		$	86			$	279			$	(193	)
Mortgage banking			255				194				61
Gain on sale of SBA loans			211				74				137
Gain on sale of investments, net			164				62				102
Other than temporary impairment on cost method investment			—				(76	)			76
Service charges on deposit accounts			298				298				—
Interchange fees			278				250				28
Bank owned life insurance			129				129				—
Other			118				164				(46	)
Total		$	1,539			$	1,374			$	165

The $0.2 million net decrease in servicing income was primarily the result of the valuation impact of the corresponding loan servicing rights compared to the prior year period.

Gains on the sale of SBA loans increased $0.1 million as a result of a larger balance of SBA loans being sold during the three months ended March 31, 2015 compared to the same period in 2014.

Net gains on sales of investments increased $0.1 million for the three months ended March 31, 2015 compared to the three months ended March 31, 2014. The increase in net gains on sales of investments is due to the sale of investments for gross proceeds of $13.0 million for the three months ended March 31, 2015 compared to $6.9 million for the three months ended March 31, 2014.

Noninterest Expense. The following table summarizes the components of noninterest expense and the corresponding change between the three months ended March 31, 2015 and 2014:

		Three Months Ended March 31,
		2015				2014				Change
		(Dollars in thousands)
Compensation and employee benefits		$	3,697			$	2,947			$	750
Net occupancy			702				640				62
Federal deposit insurance			284				438				(154	)
Professional and advisory			250				198				52
Data processing			280				226				54
Net cost of operation of real estate owned			216				840				(624	)
Other			1,147				824				323
Total noninterest expenses		$	6,576			$	6,113			$	463

Compensation and employee benefits increased by $0.8 million, or 25.5%, for the three months ended March 31, 2015 compared to the three months ended March 31, 2014. This additional expense is related to increases in our number of employees, annual raises, employee benefits, incentives and commissions. The number of our full-time equivalent employees increased to 194 at March 31, 2015, as compared to 184 at March 31, 2014.

FDIC deposit insurance decreased $0.2 million, or 35.2%, for the three months ended March 31, 2015 compared to the three months ended March 31, 2014 as a result of a reduction in our assessment rates due to an improving risk profile.

The net cost of operation of real estate owned decreased $0.6 million, or 74.3%, for the three months ended March 31, 2015 compared to the three months ended March 31, 2014. This reduction reflects decreases in our levels of real estate owned compared to the prior year period along with more stabilized property values.

Income Taxes. We recorded $0.2 million of income tax expense for the three months ended March 31, 2015, reflecting a decrease in our allowable net deferred tax asset based on the available tax planning strategies, compared to $0.3 million in the three months ended March 31, 2014. Several of our tax planning strategies are sensitive to changes in interest rates, and we may be required to further reduce our net deferred tax asset in the future should interest rates materially change. We continue to be in a net operating loss position for federal and state income tax purposes and do not have a material current tax liability or receivable.

Liquidity and Capital Resources

 

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, proceeds from the sale of loans originated for sale, and principal repayments and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee, under the direction of our Chief Operating Officer, is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of March 31, 2015.

 

We regularly monitor and adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows and borrowing maturities, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in FHLB and FRB interest-earning deposits and investment securities and are also used to pay off short-term borrowings. At March 31, 2015, cash and cash equivalents totaled $47.6 million. Included in this total is $24.7 million held at FRB and $26.2 million held at the FHLB in interest-earning accounts.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements. The following summarizes the most significant sources and uses of liquidity during the three months ended March 31, 2015 and 2014:

 

		Three Months Ended March 31,
		2015				2014
		(Dollars in thousands)
Operating activities:
Loans originated for sale		$	(4,703	)		$	(6,123	)
Proceeds from loans originated for sale			8,698				5,223
Investing activities:
Purchases of investments		$	(37,550	)		$	(12,412	)
Maturities and principal repayments of investments			12,132				3,515
Sales of investments			13,197				6,941
Net increase in loans			(216	)			(625	)
Purchase of loans			(13,367	)			—
Proceeds from sales of real estate owned			359				1,449
Purchases of fixed assets			(2,414	)			(237	)
Financing activities:
Net increase (decrease) in deposits		$	(3,674	)		$	453
Proceeds from FHLB advances			25,000				15,000
Repayment of FHLB advances			(10,000	)			—

 

At March 31, 2015, we had $21.8 million in outstanding commitments to originate loans. In addition to commitments to originate loans, we had $63.6 million in unused lines of credit.

 

Depending on market conditions, we may be required to pay higher rates on our deposits or other borrowings than we currently pay on certificates of deposit. Based on historical experience and current market interest rates, we anticipate that following their maturity we will retain a large portion of our retail certificates of deposit with maturities of one year or less as of March 31, 2015.

 

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

 

Liquidity management is both a daily and long-term function of management. If we require more funds than we are able to generate locally, we have borrowing agreements with the FHLB and the FRB discount window. The following summarizes our borrowing capacity as of March 31, 2015:

 

		Total				Used				Unused
		Capacity				Capacity				Capacity
FHLB		$	104,685			$	75,000			$	29,685
Unpledged Marketable Securities			266,227				11,238				254,989
FRB			51,067				—				51,067
		$	421,979			$	86,238			$	335,741

 

In July 2013, federal bank regulatory agencies issued final rules to revise their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (“Basel III”). On January 1, 2015, the Basel III rules became effective and include transition provisions which implement certain portions of the rules through January 1, 2019.

The rule also includes changes in what constitutes regulatory capital, some of which are subject to a transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock are required to be deducted from capital, subject to a transition period. Finally, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a transition period and a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in the Bank’s Tier 1 capital.

 

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based guidelines and framework under prompt corrective action provisions include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. Under the memorandum of understanding which the Bank entered into with the Federal Deposit Insurance Corporation (“FDIC”) and the North Carolina Commissioner of Banks (“NCCOB”) in April 2014 (the “Bank MOU”), the Bank is required to maintain a Tier I leverage capital ratio of not less than 8% and a total risk-based capital ratio of not less than 11%. The Bank met these required capital ratios and was considered “well capitalized” as of March 31, 2015.

 

The tables below summarize capital ratios and related information in accordance with Basel III as measured at March 31, 2015 and pre-existing rules at December 31, 2014.

 

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

																		To meet the
										For Capital								Requirements of the
		Actual								Adequacy Purposes								Memorandum of Understanding
(Dollars in thousands)		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of March 31, 2015:
Tier 1 Leverage Capital		$	107,513				11.96	%		$	35,967				>4	%		$	71,934				>8	%
Common Equity Tier 1 Capital		$	107,513				18.80	%		$	25,735				>4.5	%			N/A				N/A
Tier 1 Risk-based Capital		$	107,513				18.80	%		$	34,313				>6	%			N/A				N/A
Total Risk-based Capital		$	114,732				20.06	%		$	45,751				>8	%		$	62,908				>11	%
As of December 31, 2014:
Tier 1 Leverage Capital		$	105,556				11.91	%		$	35,440				>4	%		$	70,880				>8	%
Tier 1 Risk-based Capital		$	105,556				19.89	%		$	21,231				>4	%			N/A				N/A
Total Risk-based Capital		$	112,246				21.15	%		$	42,462				>8	%		$	58,386				>11	%

The Company exceeded its regulatory capital ratios at March 31, 2015 and December 31, 2014, as set forth in the following table:

										For Capital
		Actual								Adequacy Purposes
(Dollars in thousands)		Amount				Ratio				Amount				Ratio
As of March 31, 2015:
Tier I Leverage Capital		$	125,646				13.97	%		$	35,976				>4	%
Common Equity Tier 1 Capital		$	111,807				19.55	%		$	25,740				>4.5	%
Tier I Risk-based Capital		$	111,807				21.97	%		$	34,321				>6	%
Total Risk Based Capital		$	132,867				23.23	%		$	45,761				>8	%
As of December 31, 2014:
Tier I Leverage Capital		$	123,377				13.94	%		$	35,398				>4	%
Tier I Risk-based Capital		$	123,377				23.24	%		$	21,236				>4	%
Total Risk Based Capital		$	130,067				24.50	%		$	42,472				>8	%

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

 

One of the primary ways we manage interest rate risk is by selling the majority of our long-term fixed rate mortgages into the secondary markets, obtaining commitments to sell at locked-in interest rates prior to issuing a loan commitment. From a funding perspective, we expect to satisfy the majority of our future requirements with retail deposit growth, including checking and savings accounts, money market accounts and certificates of deposit generated within our primary markets. Deposits, exclusive of brokered certificates of deposit, decreased to $690.8 million at March 31, 2015, from $693.9 million at December 31, 2014. Brokered deposits declined $0.2 million to $9.0 million at March 31, 2015 from $9.2 million at December 31, 2014. If our funding needs exceed our deposits, we will utilize our excess funding capacity with the FHLB and the FRB.

 

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

 

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

	·	limited the fixed rate period on loans within our portfolio

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

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

·

utilized FHLB advances for positioning.

 

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

 

Economic Value of Equity (EVE)

 

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

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

 

Net Interest Income

 

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

 

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

 

				March 31, 2015								December 31, 2014
Change in Interest Rates (basis points)				% Change in Pretax Net Interest Income				% Change in Economic Value of Equity				% Change in Pretax Net Interest Income				% Change in Economic Value of Equity
	+400				8.1				(17.4	)			10.6				(15.5	)
	+300				5.6				(14.1	)			7.3				(12.8	)
	+200				3.3				(9.9	)			4.2				(9.3	)
	+100				1.3				(5.3	)			1.6				(5.1	)
	—				—				—				—				—
	-100				(6.2	)			1.3				(6.2	)			1.7

 

The results from the rate shock analysis on NII are consistent with having an asset sensitive balance sheet. Having an asset sensitive balance sheet means assets will reprice at a faster pace than liabilities during the short-term horizon. The implications of an asset sensitive balance sheet will differ depending upon the change in market rates. For example, with an asset sensitive balance sheet in a declining interest rate environment, the interest rate on assets will decrease at a faster pace than liabilities. This situation could result in a decrease in NII and operating income. Conversely, with an asset sensitive balance sheet in a rising interest rate environment, the interest rate on assets will increase at a faster pace than liabilities. This situation could result in an increase in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 3.3% increase in NII as of March 31, 2015 as compared to a 4.2% increase in NII as of December 31, 2014.

 

The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has increased from December 31, 2014 to March 31, 2015. For example, a 200 basis point increase in rates would result in a 9.9% decrease in EVE as of March 31, 2015 as compared to a 9.3% decrease in EVE as of December 31, 2014.

Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, including its Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of March 31, 2015. Based upon that evaluation, the Companys’s Chief Executive Officer and Chief Financial Officer each concluded that as of March 31, 2015, the end of the period covered by this Quarterly Report on Form 10-Q, the Company maintained effective disclosure controls and procedures.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes to the Company’s internal controls over financial reporting that occurred during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

 

We are not involved in any material pending legal proceedings. In the ordinary course of operations, we are often involved in legal proceedings. In the opinion of management, except for the Regulatory Agreements, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the quarter ended March 31, 2015.

 

Item 1A.

Risk Factors

 

There have been no material changes to the risk factors that we have previously disclosed in the “Risk Factors” section in our 2014 Annual Report on Form 10-K as filed with the SEC on March 30, 2015.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Not Applicable

 

Item 3.

Defaults Upon Senior Securities

 

None

 

Item 4.

Mine Safety Disclosures

 

Not Applicable

 

Item 5.

Other Information

 

None

Item 6.

Exhibits

 

Exhibit No.	Description
2	Plan of Conversion, incorporated by reference to Exhibit 2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
3.1	Articles of Incorporation of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.1 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
3.2	Bylaws of Entegra Financial Corp., as amended and restated, incorporated by reference to Exhibit 3.2 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
4	Form of Common Stock Certificate of Entegra Financial Corp., incorporated by reference to Exhibit 4 of the Registration Statement on Form S-1/A, filed with the SEC on June 27, 2014 (SEC File No. 333-194641).
10.1	Employment and Change of Control Agreement, dated as of October 9, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and Roger D. Plemens, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on October 15, 2014 (SEC File No. 001-35302)*
10.2	Employment and Change of Control Agreement, dated as of November 1, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and Ryan M. Scaggs, incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on November 6, 2014 (SEC File No. 001-35302)*
10.3	Employment and Change of Control Agreement, dated as of November 1, 2014, by and among Entegra Financial Corp., Macon Bank, Inc., and David A. Bright, incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K, filed with the SEC on November 6, 2014 (SEC File No. 001-35302)*
10.4	Form of Macon Bank, Inc. Severance and Non-Competition Agreement between Macon Bank, Inc. and each of (i) Carolyn H. Huscusson, (ii) Bobby D. Sanders, II, (iii) Laura W. Clark, and (iv) Marcia J. Ringle, incorporated by reference to Exhibit 10.4 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).*
10.5	Amended and Restated Trust Agreement, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.6 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
10.6	Guarantee Agreement, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.7 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
10.7	Junior Subordinated Indenture, regarding Trust Preferred Securities, dated as of December 30, 2003 incorporated by reference to Exhibit 10.8 of the Registration Statement on Form S-1, filed with the SEC on March 18, 2014 (SEC File No. 333-194641).
10.8	Salary Continuation Agreement between Macon Bank, Inc. and Carolyn H. Huscusson, dated November 6, 2007, incorporated by reference to Exhibit 10.11 of the Registration Statement on Form S-1/A, filed with the SEC on May 14, 2014 (SEC File No. 333-194641).*
10.9	Salary Continuation Agreement between Macon Bank, Inc. and Roger D. Plemens, dated June 23, 2003, incorporated by reference to Exhibit 10.12 of the Registration Statement on Form S-1/A, filed with the SEC on May 14, 2014 (SEC File No. 333-194641).*
31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Financial Statements filed in XBRL format.
*	Management contract or compensatory plan, contract or arrangement.

 

SIGNATURES

 

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

 

Date: May 11, 2015			Entegra Financial Corp.
(Registrant)
	By:		/s/ David A. Bright
	Name:		David A. Bright
	Title:		Chief Financial Officer
			(Authorized Officer)

EXHIBIT INDEX

 

Exhibit No.	Description
31.01	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.02	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.01	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Financial Statements filed in XBRL format.