FOUR OAKS FINCORP INC - FORM 10-Q

Attached files

file	filename
EX-31.1 - EXHIBIT 31.1 - FOUR OAKS FINCORP INC	fofn9302015ex311.htm
EX-10.3 - EXHIBIT 10.3 - FOUR OAKS FINCORP INC	fofn9302015ex103.htm
EX-31.2 - EXHIBIT 31.2 - FOUR OAKS FINCORP INC	fofn9302015ex312.htm
EX-32.1 - EXHIBIT 32.1 - FOUR OAKS FINCORP INC	fofn9302015ex321.htm
EX-32.2 - EXHIBIT 32.2 - FOUR OAKS FINCORP INC	fofn9302015ex322.htm
EX-10.1 - EXHIBIT 10.1 - FOUR OAKS FINCORP INC	fofn9302015ex101.htm

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 September 30, 2015

Commission File Number 000-22787

FOUR OAKS FINCORP, INC.

(Exact name of registrant as specified in its charter)



NORTH CAROLINA		56-2028446
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification Number)

6114 U.S. 301 SOUTH, FOUR OAKS, NC 27524

(Address of principal executive office, including zip code)

(919) 963-2177

(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. xYES oNO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files) xYES oNO

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



Large accelerated filer o	Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	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):

oYES xNO

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



Common Stock,	33,542,636
par value $1.00 per share	(Number of shares outstanding
(Title of Class)	November 13, 2015)

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TABLE OF CONTENTS		Page No.

Part I.	FINANCIAL INFORMATION

Item 1 -	Financial Statements

	Consolidated Balance Sheets
	September 30, 2015 (Unaudited) and December 31, 2014	3

	Consolidated Statements of Operations (Unaudited)
	Three and Nine Months Ended September 30, 2015 and 2014	4

	Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
	Three and Nine Months Ended September 30, 2015 and 2014	5

	Consolidated Statements of Shareholders’ Equity (Unaudited)
	Nine Months Ended September 30, 2015 and 2014	6

	Consolidated Statements of Cash Flows (Unaudited)
	Nine Months Ended September 30, 2015 and 2014	7

	Notes to Consolidated Financial Statements (Unaudited)	9

Item 2 -	Managements' Discussion and Analysis of Financial Condition and Results of Operations	37

Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	45

Item 4 -	Controls and Procedures	45

Part II.	OTHER INFORMATION

Item 1 -	Legal Proceedings	46

Item1A -	Risk Factors	46

Item 6 -	Exhibits	48

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Part I. FINANCIAL INFORMATION

Item 1 – FINANCIAL STATEMENTS

FOUR OAKS FINCORP, INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)



	September 30, 2015			December 31, 2014
	(Unaudited)			(*)
ASSETS
Cash and due from banks	$	17,543		$	15,519
Interest-earning deposits	30,470			143,008
Cash and cash equivalents	48,013			158,527
CDs held for investment	24,010			27,784
Investment securities available-for-sale, at fair value	71,982			64,211
Investment securities held-to-maturity, at amortized cost	68,992			81,583
Total investment securities	140,974			145,794
Loans held for sale	2,100			2,882
Loans	452,763			452,256
Allowance for loan losses	(10,272		)	(9,377		)
Net loans	442,491			442,879
Accrued interest receivable	1,712			1,627
Bank premises and equipment, net	11,808			11,895
FHLB stock	4,564			4,788
Investment in life insurance	14,733			14,590
Foreclosed assets	2,088			3,782
Deferred tax assets, net	16,480			—
Other assets	5,527			6,248
TOTAL ASSETS	$	714,500		$	820,796

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand	$	131,595		$	251,723
Money market, NOW accounts and savings accounts	181,175			175,731
Time deposits, $100,000 and over	142,325			143,336
Other time deposits	80,669			90,395
Total deposits	535,764			661,185
Borrowings	90,000			90,000
Subordinated debentures	12,372			12,372
Subordinated promissory notes	12,000			12,000
Accrued interest payable	775			1,704
Other liabilities	3,374			2,806
TOTAL LIABILITIES	654,285			780,067
Commitments (Note F)
Shareholders’ equity:
Common stock, $1.00 par value, 80,000,000 shares authorized; 33,542,636 and 32,032,327 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively	33,543			32,032
Additional paid-in capital	31,593			32,520
Accumulated deficit	(5,381		)	(24,579		)
Accumulated other comprehensive income	460			756
Total shareholders' equity	60,215			40,729
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	714,500		$	820,796

(*) Derived from audited consolidated financial statements.

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

-3-

FOUR OAKS FINCORP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(Amounts in thousands, except share data)



	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2015		2014			2015				2014
Interest and dividend income:
Loans, including fees	$	6,365	$	6,374		$	19,013			$	19,074
Taxable investments	842		516			2,467				1,799
Dividends	76		76			242			—	239
Interest-earning deposits	106		173			414				515
Total interest and dividend income	7,389		7,139			22,136				21,627
Interest expense:
Deposits	608		716			1,851				2,173
Borrowings	787		1,025			2,334				3,041
Subordinated debentures	96		50			196				149
Subordinated promissory notes	257		257			763				763
Total interest expense	1,748		2,048			5,144				6,126
Net interest income	5,641		5,091			16,992				15,501
Provision for loan losses	—		7,954			—				7,954
Net interest income after provision for loan losses	5,641		(2,863		)	16,992				7,547
Non-interest income:
Service charges on deposit accounts	401		446			1,198				1,259
Other service charges, commissions and fees	877		732			2,710				2,639
Gains on sale of investment securities available-for-sale, net	209		51			265				265
Gains on sale of loans held for sale	100		—			100				—
Recovery of impairment loss and gain on redemption of equity securities	—		175			—				264
Income from investment in life insurance	45		50			143				157
Indemnification from third party payment processor clients	5		772			348				3,049
Other non-interest income	47		44			140				137
Total non-interest income	1,684		2,270			4,904				7,770
Non-interest expenses:
Salaries	2,892		2,254			8,284				6,709
Employee benefits	454		402			1,546				1,364
Occupancy expenses	328		328			1,019				921
Equipment expenses	163		287			585				918
Professional and consulting fees	562		976			1,944				2,406
FDIC assessments	232		460			611				1,368
Foreclosed asset-related costs, net	80		1,359			341				1,806
Collection expenses	156		143			301				497
Prepayment of FHLB borrowings	—		314			—				314
Other operating expenses	1,632		1,482			4,547				3,836
Total non-interest expense	6,499		8,005			19,178				20,139
Income (loss) before income taxes	826		(8,598		)	2,718				(4,822		)
Income tax expense (benefit)	92		—			(16,480		)		—
Net income (loss)	$	734	$	(8,598	)	$	19,198			$	(4,822	)

Basic net income (loss) per common share	$	0.02	$	(0.42	)	$	0.60			$	(0.38	)
Diluted net income (loss) per common share	$	0.02	$	(0.42	)	$	0.60			$	(0.38	)
Weighted Average Shares Outstanding, Basic	32,135,465		20,696,393			32,089,950				12,584,239
Weighted Average Shares Outstanding, Diluted	32,395,315		20,696,393			32,244,253				12,584,239

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

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FOUR OAKS FINCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(Amounts in thousands)



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2015			2014			2015			2014
Net income (loss)	$	734		$	(8,598	)	$	19,198		$	(4,822	)

Other comprehensive income (loss):
Securities available-for-sale:
Unrealized holding gains (losses) on available-for-sale securities	714			(47		)	15			1,329
Tax effect	—			—			—			—
Reclassification of gains recognized in net income	(209		)	(51		)	(265		)	(265		)
Tax effect	—			—			—			—
Amortization of unrealized losses on investment securities transferred from available-for-sale to held-to-maturity	(15		)	(21		)	(46		)	(73		)
Tax effect	—			—			—			—
Total other comprehensive income (loss)	490			(119		)	(296		)	991

Comprehensive income (loss)	$	1,224		$	(8,717	)	$	18,902		$	(3,831	)

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

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FOUR OAKS FINCORP, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(Amounts in thousands, except share data)



	Common stock			Additional paid-in capital			Accumulated deficit			Accumulated other comprehensive (loss) income			Total shareholders' equity
	Shares	Amount		Additional paid-in capital			Accumulated deficit			Accumulated other comprehensive (loss) income			Total shareholders' equity
BALANCE, DECEMBER 31, 2013	7,977,657	$	7,978	$	34,269		$	(20,390	)	$	(234	)	$	21,623
Net loss	—	—		—			(4,822		)	—			(4,822		)
Other comprehensive income	—	—		—			—			991			991
Stock based compensation	—	—		51			—			—			51
Issuance of common stock	24,045,899	24,046		(1,817		)	—			—			22,229
BALANCE, SEPTEMBER 30, 2014	32,023,556	$	32,024	$	32,503		$	(25,212	)	$	757		$	40,072



	Common stock					Additional paid-in capital			Accumulated deficit			Accumulated other comprehensive income			Total shareholders' equity
	Shares		Amount			Additional paid-in capital			Accumulated deficit			Accumulated other comprehensive income			Total shareholders' equity
BALANCE, DECEMBER 31, 2014	32,032,327		$	32,032		$	32,520		$	(24,579	)	$	756		$	40,729
Net income	—		—			—			19,198			—			19,198
Other comprehensive loss	—		—			—			—			(296		)	(296		)
Stock based compensation	—		—			426			—			—			426
Issuance of common stock	109,309		110			48			—			—			158
Issuance of restricted stock	1,461,000		1,461			(1,461		)	—			—			—
Forfeiture of restricted stock	(60,000	)	(60		)	60			—			—			—
BALANCE, SEPTEMBER 30, 2015	33,542,636		$	33,543		$	31,593		$	(5,381	)	$	460		$	60,215

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

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FOUR OAKS FINCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands)



	Nine Months Ended
	September 30,
	2015			2014
Cash flows from operating activities:
Net income (loss)	$	19,198		$	(4,822	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses	—			7,954
Deferred income tax benefit	(16,480		)	—
Provision for depreciation and amortization	206			649
Net amortization of bond premiums and discounts	896			915
Stock based compensation	426			51
Gain on sale of investment securities	(265		)	(265		)
Loss (gain) on disposition of bank premises and equipment	24			(4		)
Gain on sale of foreclosed assets, net	(34		)	(224		)
Valuation adjustment on foreclosed assets	283			1,680
Earnings on bank-owned life insurance	(143		)	(157		)
Earnings from mortgage banking operations	(476		)	(402		)
Gain on sale of problem loans held for sale	(100		)	—
Originations of mortgage loans held for sale	(22,274		)	(17,227		)
Proceeds from sale of loans held for sale	26,032			16,581
Recovery of impairment loss on redemption of securities	—			(264		)
Changes in assets and liabilities:
Other assets	721			345
Accrued interest receivable	(85		)	90
Other liabilities	568			(1,373		)
Accrued interest payable	(929		)	105
Net cash provided by operating activities	7,568			3,632

Cash flows from investing activities:
Proceeds from sales and calls of investment securities available-for-sale	8,324			22,661
Proceeds from paydowns of investment securities available-for-sale	4,801			888
Proceeds from paydowns of investment securities held-to-maturity	11,965			11,381
Purchases of investment securities available-for-sale	(21,197		)	(7,180		)
Redemption of certificates of deposit	3,774			2,205
Redemption of FHLB stock	224			523
Net (increase) decrease in loans outstanding	(3,181		)	23,424
Purchases of bank premises and equipment	(143		)	(131		)
Proceeds from sales of foreclosed assets	2,614			3,877
Net cash provided by investing activities	7,181			57,648

Cash flows from financing activities:
Net repayments from borrowings	—			(5,000		)
Net (decrease) increase in deposit accounts	(125,421		)	4,192
Proceeds from issuance of common stock	158			22,229
Net cash (used in) provided by financing activities	(125,263		)	21,421

Change in cash and cash equivalents	(110,514		)	82,701
Cash and cash equivalents at beginning of period	158,527			128,629
Cash and cash equivalents at end of period	$	48,013		$	211,330

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FOUR OAKS FINCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands)



	Nine Months Ended
	September 30,
	2015			2014
Supplemental disclosures of cash flow information:
Interest paid on deposits and borrowings	$	6,073		$	6,021
Income taxes paid	—			110

Supplemental disclosures of noncash investing and financing activities:
Unrealized (losses) gains on investment securities available-for-sale	$	(250	)	$	1,231
Amortization of net losses on investment securities transferred to held-to-maturity	(46		)	(73		)
Transfer of loans to foreclosed assets	1,169			1,555
Loans transferred from held for sale to held for investment	109			—
Loans transferred from held for investment to held for sale	2,509			11,189

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

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FOUR OAKS FINCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A - BASIS OF PRESENTATION

In management’s opinion, the financial information contained in the accompanying unaudited consolidated financial statements reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the nine months ended September 30, 2015 and 2014, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts and transactions of Four Oaks Fincorp, Inc., a bank holding company incorporated under the laws of the State of North Carolina (the “Company”), and its wholly-owned subsidiary, Four Oaks Bank & Trust Company (the “Bank”). Operating results for the nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2015.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. This Quarterly Report should be read in conjunction with such Annual Report.

Certain amounts previously presented in the Company's Consolidated Financial Statements for the prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods' Statements of Operations, Comprehensive Income (Loss), or Shareholders' Equity as previously reported.

Recent Accounting Pronouncements

In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The existing recognition and measurement guidance for debt issuance costs are not affected by this update. ASU 2015-03 is effective for annual and interim reporting periods beginning after December 15, 2015. The Company does not believe the adoption of this update will have a material impact on the Company’s consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This update requires management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date the financial statements are issued. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that an entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued. If the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables financial statement users to understand the principal conditions or events that raised substantial doubt, management’s evaluation of the conditions and management’s plans to alleviate the substantial doubt. If substantial doubt exists about an entity’s ability to continue as a going concern, and the substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a going concern. The amendments in this update become effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company does not believe the adoption of this update will have a material impact on the Company’s consolidated financial statements.

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In August 2014, the FASB issued ASU No. 2014-14, Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure. This update addresses classification of government-guaranteed mortgage loans, including those where guarantees are offered by the Federal Housing Administration (“FHA”), the U.S. Department of Housing and Urban Development (“HUD”), and the U.S. Department of Veterans Affairs (“VA”). Although current accounting guidance stipulates proper measurement and classification in situations where a creditor obtains from a debtor, assets in satisfaction of a receivable (such as through foreclosure), current guidance does not specify how to measure and classify foreclosed mortgage loans that are government-guaranteed. Under the provisions of this update, a creditor would derecognize a mortgage loan that has been foreclosed upon, and recognize a separate receivable if the following conditions are met: (1) The loan has a government guarantee that is not separable from the loan before foreclosure, (2) At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim, and (3) At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. The amendments within this update are effective for annual and interim periods beginning after December 15, 2014. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) which supersedes the revenue recognition requirements of Accounting Standards Codification (“ASC”) Topic 605, Revenue Recognition, and most industry-specific guidance on revenue recognition throughout the ASC. The new standard is principles based and provides a five step model to determine when and how revenue is recognized. The core principle of the new standard is that revenue should be recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also requires disclosure of qualitative and quantitative information surrounding the amount, nature, timing and uncertainty of revenues and cash flows arising from contracts with customers. On August 12, 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of the new revenue recognition standard by one year. Based on ASU 2015-14, public organizations would apply the new revenue standard to annual reporting periods beginning after December 15, 2017. Early adoption is permitted, but not before the original effective date (i.e., interim and annual reporting periods beginning after December 15, 2016). The Company is currently evaluating the impact of adoption of the new standard on its consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Receivables–Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This update clarifies that an in-substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. This amendment is effective for annual and interim periods beginning after December 15, 2014. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

Other accounting standards that have been issued 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 and cash flows.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

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NOTE B - NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share represents earnings credited to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options.

Basic and diluted net income (loss) per common share have been computed based upon net income (loss) as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below (amounts in thousands, except share data):



	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2015		2014			2015		2014
Net income (loss) available to common shareholders	$	734	$	(8,598	)	$	19,198	$	(4,822	)

Weighted average number of common shares - basic	32,135,465		20,696,393			32,089,950		12,584,239
Effect of dilutive stock options	17,040		—			15,683		—
Effect of dilutive restricted stock awards	242,810		—			138,620		—
Weighted average number of common shares - dilutive	32,395,315		20,696,393			32,244,253		12,584,239

Basic earnings (loss) per common share	$	0.02	$	(0.42	)	$	0.60	$	(0.38	)
Diluted earnings (loss) per common share	$	0.02	$	(0.42	)	$	0.60	$	(0.38	)
Anti-dilutive awards	155,455		280,982			155,455		280,982

During 2014, 24.0 million shares of common stock were issued in connection with the Company's shareholder rights offering and concurrent private placement standby offering in which a net of $22.2 million of capital was raised. Consequently, the diluted weighted average shares of common stock increased 11.7 million and 19.7 million for the three and nine months ended September 30, 2015 as compared to the same periods in 2014. There are 1,401,000 shares of restricted stock outstanding as of September 30, 2015 that the Company awarded pursuant to the Four Oaks Fincorp, Inc. 2015 Restricted Stock Plan. Of this total, there were 848,000 shares of restricted stock in which performance criteria had not been established and therefore these shares were not considered in the calculation of potentially dilutive shares. Refer to Note I for additional information on the restricted stock grant.

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NOTE C – INVESTMENT SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale and securities held-to-maturity as of September 30, 2015 and December 31, 2014 are as follows (amounts in thousands):



	September 30, 2015
Securities Available-for-Sale:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Taxable municipal securities	$	24,798	$	330	$	163	$	24,965
Mortgage-backed securities
GNMA	13,605		135		—		13,740
FNMA & FHLMC	33,226		86		46		33,266
Equity securities	11		—		—		11
Total	$	71,640	$	551	$	209	$	71,982



	September 30, 2015
Securities Held-to-Maturity:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Taxable municipal securities	$	3,544	$	24	$	—	$	3,568
Mortgage-backed securities
GNMA	62,617		883		86		63,414
FNMA	2,831		59		—		2,890
Total	$	68,992	$	966	$	86	$	69,872



	December 31, 2014
Securities Available-for-Sale:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Taxable municipal securities	$	16,412	$	686	$	20	$	17,078
Mortgage-backed securities
GNMA	16,204		163		103		16,264
FNMA & FHLMC	30,992		—		134		30,858
Equity securities	11		—		—		11
Total	$	63,619	$	849	$	257	$	64,211



	December 31, 2014
Securities Held-to-Maturity:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Taxable municipal securities	$	3,584	$	—	$	28	$	3,556
Mortgage-backed securities
GNMA	74,482		887		244		75,125
FNMA	3,517		44		—		3,561
Total	$	81,583	$	931	$	272	$	82,242

-12-

The following tables show gross unrealized losses and fair values of investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at September 30, 2015 and December 31, 2014 (amounts in thousands).



	September 30, 2015
	Less Than 12 Months					12 Months or More					Total
	# Securities	Fair value		Unrealized losses		# Securities	Fair value		Unrealized losses		Fair value		Unrealized losses
Securities Available-for-Sale:
Taxable municipal securities	11	$	9,989	$	163	—	$	—	$	—	$	9,989	$	163
Mortgage-backed securities
FNMA & FHLMC	6	14,033		46		—	—		—		14,033		46
Total temporarily impaired securities	17	$	24,022	$	209	—	$	—	$	—	$	24,022	$	209



	September 30, 2015
	Less Than 12 Months					12 Months or More					Total
Securities Held-to-Maturity:	# Securities	Fair value		Unrealized losses		# Securities	Fair value		Unrealized losses		Fair value		Unrealized losses
Mortgage-backed securities
GNMA	2	$	3,074	$	10	3	$	5,438	$	76	$	8,512	$	86
Total temporarily impaired securities	2	$	3,074	$	10	3	$	5,438	$	76	$	8,512	$	86



	December 31, 2014
	Less Than 12 Months					12 Months or More					Total
Securities Available-for-Sale:	# Securities	Fair value		Unrealized losses		# Securities	Fair value		Unrealized losses		Fair value		Unrealized losses
Taxable municipal securities	2	$	2,580	$	20	—	$	—	$	—	$	2,580	$	20
Mortgage-backed securities
GNMA	2	7,425		103		—	—		—		7,425		103
FNMA & FHLMC	6	30,858		134		—	—		—		30,858		134
Total temporarily impaired securities	10	$	40,863	$	257	—	$	—	$	—	$	40,863	$	257



	December 31, 2014
	Less Than 12 Months					12 Months or More					Total
Securities Held-to-Maturity:	# Securities	Fair value		Unrealized losses		# Securities	Fair value		Unrealized losses		Fair value		Unrealized losses
Taxable municipal securities	—	$	—	$	—	10	$	3,556	$	28	$	3,556	$	28
Mortgage-backed securities
GNMA	6	7,594		41		6	12,240		203		19,834		244
Total temporarily impaired securities	6	$	7,594	$	41	16	$	15,796	$	231	$	23,390	$	272

-13-

Management evaluates each quarter whether unrealized losses on securities represent impairment that is other than temporary. For debt securities, the Company considers its intent to sell the securities or if it is more likely than not that the Company will be required to sell the securities. If such impairment is identified, based upon the intent to sell or the more likely than not threshold, the carrying amount of the security is reduced to fair value with a charge to earnings. Upon the result of the aforementioned review, management then reviews for potential other than temporary impairment based upon other qualitative factors. In making this evaluation, management considers changes in market rates relative to those available when the security was acquired, changes in market expectations about the timing of cash flows from securities that can be prepaid, performance of the debt security, and changes in the market's perception of the issuer's financial health and the security's credit quality. If determined that a debt security has incurred other than temporary impairment, then the amount of the credit related impairment is determined. If a credit loss is evident, the amount of the credit loss is charged to earnings and the non-credit related impairment is recognized through other comprehensive income.

The unrealized gains and losses on securities at September 30, 2015 resulted from changing market interest rates compared to the yields available at the time the underlying securities were purchased. As of September 30, 2015, there were 5 of 55 Government National Mortgage Association ("GNMA") mortgage-backed securities ("MBS"), 6 of 14 Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC") MBS, and 11 of 40 taxable municipal securities that contained net unrealized losses. Management identified no impairment related to credit quality. For debt securities in an unrealized loss position, the Company does not intend to sell and it is not likely that the Company will be required to sell these securities before the anticipated recovery of the amortized cost basis. As a result, no other than temporary impairment losses were recognized during the three and nine months ended September 30, 2015.

The amortized cost and fair value of available-for-sale and held-to-maturity securities at September 30, 2015 by expected maturities are shown on the following table (amounts in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



	September 30, 2015
Securities Available-for-Sale:	Amortized Cost		Fair Value
Taxable municipal securities:
Due after ten years	$	24,798	$	24,965
Total taxable municipal securities	24,798		24,965

Mortgage-backed securities - GNMA/FNMA & FHLMC:
Due after ten years	46,831		47,006
Total mortgage-backed securities - GNMA/FNMA & FHLMC	46,831		47,006

Other securities:
Equity securities	11		11
Total other securities	11		11

Total available-for-sale securities	$	71,640	$	71,982

Securities Held-to-Maturity:
Taxable municipal securities:
Due within one year	$	101	$	101
Due after one year through five years	1,600		1,608
Due after five years through ten years	1,843		1,859
Total taxable municipal securities	3,544		3,568

Mortgage-backed securities - GNMA/FNMA:
Due after five years through ten years	7,105		7,307
Due after ten years	58,343		58,997
Total mortgage-backed securities - GNMA/FNMA	65,448		66,304

Total held-to-maturity securities	$	68,992	$	69,872

-14-

Securities with a carrying value of approximately $86.7 million and $101.8 million at September 30, 2015 and December 31, 2014, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. Sales and calls of securities available-for-sale for the nine months ended September 30, 2015 and 2014 of $8.3 million and $22.7 million generated net realized gains of $265,000 for each respective period, and no gross realized losses for either period. Sales and calls of securities available-for-sale for the three months ended September 30, 2015 and 2014 of $4.7 million and $2.7 million generated net realized gains of $209,000 and $51,000, respectively, and no gross realized losses for either period.

-15-

NOTE D – LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures, which are reviewed on a regular basis. Each class of loans is subject to risks that could have an adverse impact on the credit quality of the loan portfolio. Loans are primarily made in the Company's market area in North Carolina, principally Johnston County, and parts of Wake, Harnett, Duplin, Sampson, and Moore counties. There have been no significant changes to the loan class definitions outlined in the Company's Annual Report on Form 10-K for the year ended December 31, 2014.

During the third quarter of 2014, the Company transferred loans from held for investment to held for sale in anticipation of loan sales as a result of the Company's previously disclosed asset resolution plan (the "Asset Resolution Plan"). These loans are not included in the tables within Note D; however, additional details about these loans have been added to provide information on the credit quality of these assets.

The classification of loan segments as of September 30, 2015 and December 31, 2014 are summarized as follows (amounts in thousands):



	September 30, 2015			December 31, 2014
Commercial and industrial	$	23,804		$	24,286
Commercial construction and land development	50,469			53,642
Commercial real estate	206,548			200,510
Residential construction	31,577			28,130
Residential mortgage	130,588			135,022
Consumer	6,256			7,248
Consumer credit cards	2,140			2,276
Business credit cards	1,299			1,251
Other	832			499
Gross loans	453,513			452,864
Less:
Net deferred loan fees	(750		)	(608		)
Net loans before allowance	452,763			452,256
Allowance for loan losses	(10,272		)	(9,377		)
Total net loans	$	442,491		$	442,879

Loans held for sale	$	2,100		$	2,882

-16-

Allowance for Loan Losses and Recorded Investment in Loans

The allowance for loan losses represents management’s estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. Management evaluates the adequacy of this allowance on at least a quarterly basis, which includes a review of loans both specifically and collectively evaluated for impairment.

The following tables are an analysis of the allowance for loan losses by loan segment as of and for the three and nine months ended September 30, 2015 and 2014 and as of and for the twelve months ended December 31, 2014 (amounts in thousands). These tables do not include loans classified as held for sale.



	Three Months Ended
	September 30, 2015
				Real Estate
Allowances for loan losses:	Commercial and Industrial			Commercial Construction and Land Development			Commercial Real Estate			Residential Construction		Residential Mortgage			Consumer			Other			Totals
Balance, beginning of period	$	153		$	5,306		$	2,669		$	318	$	1,224		$	112		$	30		$	9,812

Provision for loan losses	(102		)	(209		)	(210		)	79		409			(18		)	51			—

Loans charged-off	—			(160		)	7			—		(261		)	(38		)	(28		)	(480		)
Recoveries	73			590			198			—		44			35			—			940
Net recoveries (charge-offs)	73			430			205			—		(217		)	(3		)	(28		)	460

Balance, end of period	$	124		$	5,527		$	2,664		$	397	$	1,416		$	91		$	53		$	10,272



	Nine Months Ended
	September 30, 2015
				Real Estate
Allowances for loan losses:	Commercial and Industrial			Commercial Construction and Land Development			Commercial Real Estate			Residential Construction			Residential Mortgage			Consumer			Other			Totals
Balance, beginning of period	$	119		$	5,105		$	2,382		$	436		$	1,206		$	89		$	40		$	9,377

Provision for loan losses	(161		)	(493		)	93			(39		)	469			50			81			—

Loans charged-off	(47		)	(179		)	(199		)	—			(426		)	(136		)	(70		)	(1,057		)
Recoveries	213			1,094			388			—			167			88			2			1,952
Net recoveries (charge-offs)	166			915			189			—			(259		)	(48		)	(68		)	895

Balance, end of period	$	124		$	5,527		$	2,664		$	397		$	1,416		$	91		$	53		$	10,272
Ending balance: individually evaluated for impairment	$	—		$	494		$	111		$	—		$	—		$	3		$	—		$	608
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	124		$	5,033		$	2,553		$	397		$	1,416		$	88		$	53		$	9,664

Loans:
Balance, end of period	$	25,103		$	50,469		$	206,548		$	31,577		$	130,588		$	8,396		$	832		$	453,513
Ending balance: individually evaluated for impairment	$	—		$	2,357		$	3,427		$	437		$	1,778		$	3		$	12		$	8,014
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	25,103		$	48,112		$	203,121		$	31,140		$	128,810		$	8,393		$	820		$	445,499

⁽¹⁾ At September 30, 2015, there were $416,000 in impaired loans collectively evaluated for impairment with $34,000 in reserves established.

-17-



	Three Months Ended
	September 30, 2014
				Real Estate
Allowances for loan losses:	Commercial and Industrial			Commercial Construction and Land Development			Commercial Real Estate			Residential Construction		Residential Mortgage			Consumer			Other		Totals
Balance, beginning of period	$	389		$	5,567		$	2,241		$	620	$	1,945		$	169		$	15	$	10,946

Provision for loan losses	135			2,282			2,139			23		3,407			(32		)	—		7,954

Loans charged-off	(436		)	(2,779		)	(2,529		)	—		(4,177		)	(25		)	—		(9,946		)
Recoveries	49			113			43			—		123			64			1		393
Net (charge-offs) recoveries	(387		)	(2,666		)	(2,486		)	—		(4,054		)	39			1		(9,553		)

Balance, end of period	$	137		$	5,183		$	1,894		$	643	$	1,298		$	176		$	16	$	9,347



	Nine Months Ended
	September 30, 2014
				Real Estate
Allowances for loan losses:	Commercial and Industrial			Commercial Construction and Land Development			Commercial Real Estate			Residential Construction			Residential Mortgage			Consumer			Other			Totals
Balance, beginning of period	$	487		$	5,037		$	2,981		$	713		$	2,146		$	188		$	38		$	11,590

Provision for loan losses	(53		)	2,945			1,727			101			3,257			21			(44		)	7,954

Loans charged-off	(460		)	(3,096		)	(3,019		)	(171		)	(4,417		)	(114		)	—			(11,277		)
Recoveries	163			297			205			—			312			81			22			1,080
Net (charge-offs) recoveries	(297		)	(2,799		)	(2,814		)	(171		)	(4,105		)	(33		)	22			(10,197		)

Balance, end of period	$	137		$	5,183		$	1,894		$	643		$	1,298		$	176		$	16		$	9,347
Ending balance: individually evaluated for impairment	$	—		$	528		$	6		$	—		$	—		$	—		$	—		$	534
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	137		$	4,655		$	1,888		$	643		$	1,298		$	176		$	16		$	8,813

Loans:
Balance, end of period	$	25,584		$	53,009		$	192,202		$	31,161		$	135,120		$	9,297		$	522		$	446,895
Ending balance: individually evaluated for impairment	$	—		$	5,504		$	4,946		$	—		$	2,844		$	8		$	—		$	13,302
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	25,584		$	47,505		$	187,256		$	31,161		$	132,276		$	9,289		$	522		$	433,593

⁽¹⁾ At September 30, 2014, there were no impaired loans collectively evaluated for impairment with $0 in reserves established.

-18-



	Twelve Months Ended
	December 31, 2014
				Real Estate
Allowances for loan losses:	Commercial and Industrial			Commercial Construction and Land Development			Commercial Real Estate			Residential Construction			Residential Mortgage			Consumer			Other			Totals
Balance, beginning of period	$	487		$	5,037		$	2,981		$	713		$	2,146		$	188		$	38		$	11,590

Provision for loan losses	(84		)	2,778			2,382			(106		)	3,041			(36		)	(21		)	7,954

Loans charged-off	(492		)	(3,107		)	(3,315		)	(171		)	(4,847		)	(183		)	—			(12,115		)
Recoveries	208			397			334			—			866			120			23			1,948
Net (charge-offs) recoveries	(284		)	(2,710		)	(2,981		)	(171		)	(3,981		)	(63		)	23			(10,167		)

Balance, end of period	$	119		$	5,105		$	2,382		$	436		$	1,206		$	89		$	40		$	9,377
Ending balance: individually evaluated for impairment	$	—		$	516		$	4		$	—		$	—		$	4		$	—		$	524
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	119		$	4,589		$	2,378		$	436		$	1,206		$	85		$	40		$	8,853

Loans:
Balance, end of period	$	25,537		$	53,642		$	200,510		$	28,130		$	135,022		$	9,524		$	499		$	452,864
Ending balance: individually evaluated for impairment	$	—		$	6,678		$	3,801		$	—		$	2,030		$	471		$	—		$	12,980
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	25,537		$	46,964		$	196,709		$	28,130		$	132,992		$	9,053		$	499		$	439,884

⁽¹⁾ At December 31, 2014, there were $436,000 in impaired loans collectively evaluated for impairment with $139,000 in reserves established.

-19-

Credit Risk

The Company uses an internal grading system to assign the degree of inherent risk on each individual loan. The grade is initially assigned by the lending officer and reviewed by the credit administration function throughout the life of the loan. There have been no significant changes in credit grade definitions as outlined in the Company's Annual Report on Form 10-K for the year ended December 31, 2014.

The following tables are an analysis of the creditworthiness by loan class and credit card portfolio exposure as of September 30, 2015 and December 31, 2014 (amounts in thousands).



	September 30, 2015
			Real Estate
	Commercial and Industrial		Commercial Construction and Land Development		Commercial Real Estate		Residential Construction		Residential Mortgage		Consumer		Other		Totals
1 - Lowest Risk	$	2,085	$	—	$	—	$	—	$	—	$	1,611	$	3	$	3,699
2 - Satisfactory Quality	671		739		1,921		—		15,957		260		8		19,556
3 - Satisfactory Quality - Merits Attention	10,623		10,944		95,494		3,111		53,564		1,175		538		175,449
4 - Low Satisfactory	10,156		34,350		101,040		26,991		54,178		3,112		244		230,071
5 - Special Mention	267		2,658		5,863		1,038		5,230		57		27		15,140
6-8 - Substandard ⁽¹⁾	2		1,778		2,230		437		1,659		41		12		6,159
	$	23,804	$	50,469	$	206,548	$	31,577	$	130,588	$	6,256	$	832	$	450,074



	Consumer - Credit Card		Business- Credit Card
Performing	$	2,136	$	1,299
Non Performing	4		—
Total	$	2,140	$	1,299

Total Loans			$	453,513

⁽¹⁾The above table includes loans held for investment only. As of September 30, 2015, there were $2.0 million in Risk Grade 6 loans classified as loans held for sale.

-20-



	December 31, 2014
			Real Estate
	Commercial and Industrial		Commercial Construction and Land Development		Commercial Real Estate		Residential Construction		Residential Mortgage		Consumer		Other		Totals
1 - Lowest Risk	$	2,099	$	—	$	—	$	—	$	—	$	1,638	$	—	$	3,737
2 - Satisfactory Quality	606		630		2,206		—		14,794		314		11		18,561
3 - Satisfactory Quality - Merits Attention	9,506		10,625		81,761		1,893		53,007		3,556		225		160,573
4 - Low Satisfactory	11,932		34,709		110,683		26,074		56,359		1,186		146		241,089
5 - Special Mention	143		1,892		3,989		—		8,720		62		117		14,923
6-8 - Substandard ⁽¹⁾	—		5,786		1,871		163		2,142		492		—		10,454
	$	24,286	$	53,642	$	200,510	$	28,130	$	135,022	$	7,248	$	499	$	449,337



	Consumer- Credit Card		Business- Credit Card
Performing	$	2,263	$	1,248
Non Performing	13		3
Total	$	2,276	$	1,251

Total Loans			$	452,864

⁽¹⁾ The above table includes loans held for investment only. As of December 31, 2014, there were $2.5 million in Risk Grade 6 loans classified as held for sale.

Asset Quality

The following tables are an age analysis of past due loans, including those on nonaccrual by loan class, as of September 30, 2015 and December 31, 2014 (amounts in thousands).



	September 30, 2015
	30-89 Days Past Due⁽¹⁾		Nonaccrual⁽¹⁾		Greater than 90 Days Past Due		Total Past Due		Current		Total Loans
Commercial & industrial	$	—	$	2	$	—	$	2	$	23,802	$	23,804
Commercial construction & land development	1,663		1,132		—		2,795		47,674		50,469
Commercial real estate	1,223		1,072		—		2,295		204,253		206,548
Residential construction	—		437		—		437		31,140		31,577
Residential mortgage	288		721		—		1,009		129,579		130,588
Consumer	104		14		—		118		6,138		6,256
Consumer credit cards	21		—		4		25		2,115		2,140
Business credit cards	32		—		—		32		1,267		1,299
Other loans	27		12		—		39		793		832
Total	$	3,358	$	3,390	$	4	$	6,752	$	446,761	$	453,513

⁽¹⁾ The above table includes loans held for investment only. As of September 30, 2015, there were $0 in loans 30-89 past due and $1.5 million in loans on nonaccrual classified as loans held for sale.

-21-



	December 31, 2014
	30-89 Days Past Due ⁽¹⁾		Nonaccrual ⁽¹⁾		Greater than 90 Days Past Due		Total Past Due		Current		Total Loans
Commercial & industrial	$	14	$	—	$	—	$	14	$	24,272	$	24,286
Commercial construction & land development	27		5,533		—		5,560		48,082		53,642
Commercial real estate	—		983		—		983		199,527		200,510
Residential construction	—		—		—		—		28,130		28,130
Residential mortgage	1,058		1,271		—		2,329		132,693		135,022
Consumer	82		472		—		554		6,694		7,248
Consumer credit cards	46		—		14		60		2,216		2,276
Business credit cards	41		—		3		44		1,207		1,251
Other loans	84		—		—		84		415		499
Total	$	1,352	$	8,259	$	17	$	9,628	$	443,236	$	452,864

⁽¹⁾ The above table includes loans held for investment only. As of December 31, 2014, there were $67,000 in loans 30-89 days past due and $1.9 million in loans on nonaccrual classified as held for sale.

Nonperforming assets

Nonperforming assets at September 30, 2015 and December 31, 2014 consist of the following (amounts in thousands):



	September 30, 2015		December 31, 2014
Loans past due ninety days or more and still accruing	$	4	$	17
Nonaccrual loans	3,390		8,259
Foreclosed assets	2,088		3,782
Loans held for sale - nonperforming	1,462		1,865
Total nonperforming assets	$	6,944	$	13,923

As of September 30, 2015, there were $1.5 million of loans held for sale that were in nonaccrual status and therefore considered nonperforming.

Impaired Loans

Impaired loans are those loans for which the Bank does not expect full repayment of all principal and accrued interest when due either under the terms of the original loan agreement or within reasonably modified contractual terms. If the loan has been restructured, such as in the case of a troubled debt restructuring ("TDR"), the loan continues to be considered impaired for the duration of the restructured loan term. Whereas loans which are classified as Substandard (Risk Grade 6) are not necessarily impaired, all loans which are classified as Doubtful (Risk Grade 7) are considered impaired.

Once a loan has been determined to meet the definition of impairment, the amount of that impairment is measured through one of a number of available methods; a calculation of the net present value of the expected future cash flows of the loan discounted by the effective interest rate of the loan, through the observable market value of the loan or should the loan be collateral dependent, upon the fair market value of the underlying assets securing the loan. If a deficit is calculated, the amount of the measured impairment results in the establishment of a specific valuation allowance or charge-off, and is incorporated into the Bank's allowance for loan and lease losses.

When a loan has been designated as impaired and full collection of principal and interest under the contractual terms is not assured, the impaired loan will be placed into nonaccrual status and interest income will not be recognized. Payments received against such loans are initially applied fully to the principal balance of the note until the principal balance is satisfied. Subsequent payments are thereupon applied to the accrued interest balance which only then results in the recognition of interest income. Payments received against accruing impaired loans are applied in the same manner as that of accruing loans which have not been deemed impaired. The recorded investment in impaired notes does not include deferred fees or accrued interest and management deems this amount to be immaterial.

-22-

The following tables illustrate the impaired loans by loan class as of September 30, 2015 and December 31, 2014 (amounts in thousands).



	September 30, 2015
	As of Date						Year to Date
	Recorded Investment ⁽¹⁾		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial construction & land development	$	968	$	2,250	$	—	$	1,354	$	13
Commercial real estate	3,063		3,853		—		3,037		95
Residential construction	437		437		—		409		5
Residential mortgage	1,934		2,200		—		2,000		63
Other	12		84		—		61		2
Subtotal:	6,414		8,824		—		6,861		178

With an allowance recorded:
Commercial and industrial	2		2		—		3		—
Commercial construction & land development	1,325		2,383		502		1,443		68
Commercial real estate	403		651		114		415		12
Residential mortgage	269		332		22		323		8
Consumer	17		19		4		19		1
Subtotal:	2,016		3,387		642		2,203		89

Totals:
Commercial	5,761		9,139		616		6,252		188
Consumer & Other	29		103		4		80		3
Residential	2,640		2,969		22		2,732		76
Grand Total	$	8,430	$	12,211	$	642	$	9,064	$	267

⁽¹⁾ The above table includes loans held for investment only. As of September 30, 2015, there were $1.8 million in impaired loans classified as held for sale and there were no reserves recorded for these loans.

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	December 31, 2014
	As of Date						Year to Date
	Recorded Investment⁽¹⁾		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial construction & land development	$	5,445	$	6,454	$	—	$	6,715	$	15
Commercial real estate	3,468		4,295		—		4,103		139
Residential mortgage	2,030		1,614		—		2,279		59
Consumer	467		729		—		524		—
Subtotal:	11,410		13,092		—		13,621		213

With an allowance recorded:
Commercial construction & land development	1,433		2,656		580		1,866		92
Commercial real estate	372		379		17		378		19
Residential mortgage	192		169		61		224		5
Consumer	8		6		5		8		—
Subtotal:	2,005		3,210		663		2,476		116

Totals:
Commercial	10,718		13,784		597		13,062		265
Consumer	475		735		5		532		—
Residential	2,222		1,783		61		2,503		64
Grand Total:	$	13,415	$	16,302	$	663	$	16,097	$	329

⁽¹⁾ The above table includes loans held for investment only. As of December 31, 2014, there were $2.4 million in impaired loans classified as held for sale and there were no reserves recorded for these loans.

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Troubled Debt Restructurings

Loans are classified as TDRs when, for economic or legal reasons which result in a debtor experiencing financial difficulties, the Bank grants a concession through a modification of the original loan agreement that would not otherwise be considered. The Bank's policy with respect to accrual of interest on loans restructured in a TDR process follows relevant supervisory guidance. If a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is considered and the loan is considered performing. If the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status. If the borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual and nonperforming until such time as continued performance has been demonstrated, which is typically a period of at least six consecutive payments.

The following table provides a summary of loans modified as TDRs at September 30, 2015 and December 31, 2014 (amounts in thousands).



	September 30, 2015
	Accrual		Nonaccrual		Total TDRs		Allowance for Loan Losses Allocated
Commercial construction and land development	1,155		717		1,872		492
Commercial real estate	2,395		596		2,991		20
Residential mortgage	790		28		818		—
Consumer	3		—		3		3
Total modifications	$	4,343	$	1,341	$	5,684	$	515



	December 31, 2014
	Accrual		Nonaccrual		Total TDRs		Allowance for Loan Losses Allocated
Commercial construction and land development	$	1,336	$	2,776	$	4,112	$	516
Commercial real estate	2,469		552		3,021		4
Residential mortgage	950		54		1,004		—
Consumer	4		467		471		4
Total modifications	$	4,759	$	3,849	$	8,608	$	524

⁽¹⁾ The above table includes loans held for investment only. At September 30, 2015, there were $157,000 in accruing TDRs and $562,000 in TDRs in nonaccrual and classified as held for sale compared to $203,000 and $932,000, respectively, at December 31, 2014.

There were no new TDRs made to borrowers for the three and nine months ended September 30, 2015 and there were no TDR loans modified during the previous twelve months that had a payment default for the three and nine months ended September 30, 2015.

The table below details TDRs that the Bank has entered into during the twelve months ended September 30, 2015.



	Twelve Months Ended September 30, 2015
	Paid in full			Paying as restructured			Converted to nonaccrual			Foreclosure/Default
	Number of loans	Recorded Investment		Number of loans	Recorded Investment		Number of loans	Recorded Investment		Number of loans	Recorded Investment
	(amounts in thousands, except number of loans)
Extended payment terms	—	$	—	1	$	3	—	$	—	—	$	—
Total	—	$	—	1	$	3	—	$	—	—	$	—

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NOTE E – SUBORDINATED DEBT

Prior to July 30, 2015, the Company was prohibited by the 2011 Written Agreement, described in Note H - Regulatory Restrictions of these Notes to Consolidated Financial Statements, from paying interest on its subordinated promissory notes and on its subordinated debentures in connection with its trust preferred securities ("TPS") without prior approval of the supervisory authorities. The Company and the Bank were also prohibited from declaring or paying dividends without prior approval of the supervisory authorities. On July 30, 2015, the 2011 Written Agreement was terminated and these restrictions were eliminated allowing the Company to pay the deferred interest on its TPS and pay interest on its subordinated promissory notes for the third quarter of 2015 without obtaining approval. The Company is now current with interest payments on the TPS and subordinated promissory notes.

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NOTE F - COMMITMENTS AND CONTINGENCIES

Commitments

The following table presents loan commitments at September 30, 2015 (amounts in thousands).



	September 30, 2015
Commitments to extend credit	$	29,436
Undisbursed lines of credit	89,212
Financial stand-by letters of credit	368
Performance stand-by letters of credit	668
Legally binding commitments	119,684

Unused credit card lines	13,641

Total	$	133,325

Pledged Assets

Certain assets are pledged to secure municipal deposits, borrowings, and borrowing capacity, subject to certain limits, at the Federal Home Loan Bank (the "FHLB") and the Federal Reserve Bank of Richmond (the "FRB"), as well as for other purposes as required or permitted by law. FHLB borrowings are secured by securities and a floating lien covering the Company's loan portfolio of qualifying residential (1-4 units) first mortgage and commercial real estate loans. The following table provides the total market value of pledged assets by asset type at September 30, 2015 (amounts in thousands).



	September 30, 2015
Securities	86,666
Loans	35,967

Litigation Proceedings

There have been no material developments in the description of material litigation proceedings as reported in Note L to the consolidated financial statements filed as part of the Company's Annual Report on Form 10-K for the year ended December 31, 2014, as updated in Note F to the consolidated financial statements filed as part of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2015.

Additionally, the Company is party to certain legal actions in the ordinary course of its business. The Company believes these actions are routine in nature and incidental to the operation of its business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on its business, financial condition, results of operations, cash flows or prospects. If, however, the Company's assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, its business, financial condition, results of operations, cash flows and prospects could be adversely affected.

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NOTE G – FAIR VALUE MEASUREMENT

Fair Value Measured on a Recurring Basis.

The Company measures certain assets at fair value on a recurring basis, as described below.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities have historically included equity securities traded on an active exchange, such as the New York Stock Exchange. As of September 30, 2015, there were no Level 1 securities. Level 2 securities include taxable municipalities, mortgage-backed securities issued by government sponsored entities, and certain equity securities. The Company’s mortgage-backed securities were primarily issued by GNMA, FNMA, and FHLMC. As of September 30, 2015, all of the Company’s mortgage-backed securities were agency issued and designated as Level 2 securities. Securities historically classified as Level 3 include trust preferred securities in less liquid markets; however, as of September 30, 2015, there were no Level 3 securities.

The following table presents information about assets measured at fair value on a recurring basis at September 30, 2015 and December 31, 2014 (amounts in thousands).



					Fair Value Measurements at
					September 30, 2015, Using
	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Available-for-Sale Securities:	9/30/2015		9/30/2015		(Level 1)		(Level 2)		(Level 3)
Taxable municipal securities	$	24,965	$	24,965	$	—	$	24,965	$	—
Mortgage-backed securities:
GNMA	13,740		13,740		—		13,740		—
FNMA & FHLMC	33,266		33,266		—		33,266		—
Equity securities	11		11		—		11		—
Total available-for-sale securities	$	71,982	$	71,982	$	—	$	71,982	$	—



					Fair Value Measurements at
					December 31, 2014, Using
	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Available-for-Sale Securities:	12/31/2014		12/31/2014		(Level 1)		(Level 2)		(Level 3)
Taxable municipal securities	$	17,078	$	17,078	$	—	$	17,078	$	—
Mortgage-backed securities:
GNMA	16,264		16,264		—		16,264		—
FNMA & FHLMC	30,858		30,858		—		30,858		—
Equity securities	11		11		—		11		—
Total available-for-sale securities	$	64,211	$	64,211	$	—	$	64,211	$	—

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The following table presents the reconciliation for the three and nine months ended September 30, 2015 and 2014 for all Level 3 assets that are measured at fair value on a recurring basis (amounts in thousands).



	Three Months Ended					Nine Months Ended
	September 30,					September 30,
Securities Available-for-Sale:	2015		2014			2015		2014
Beginning Balance	$	—	$	—		$	—	$	1,025
Total realized and unrealized gains or (losses):
Included in earnings	—		175			—		250
Included in other comprehensive income	—		—			—		150
Purchases, issuances and settlements	—		(175		)	—		(1,425		)
Ending Balance	$	—	$	—		$	—	$	—

Fair Value Measured on a Nonrecurring Basis.

The Company measures certain assets at fair value on a nonrecurring basis, as described below.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans held for sale as a Level 2 valuation.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, when a loan is considered impaired, it is evaluated for impairment and written down to its estimated fair value or an allowance for loan losses is established. When the fair value of an impaired loan is based on an observable market price or a current appraised value with no adjustments, the Company records the impaired loan as nonrecurring Level 2. When there is no observable market prices, an appraised value is not available, or the Company determines the fair value of the collateral is further impaired below the appraised value, the impaired loan is classified as nonrecurring Level 3.

Foreclosed Assets

Foreclosed assets are adjusted to fair value less estimated selling costs upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Given the lack of observable market prices for identical properties, the Company records foreclosed assets as non-recurring Level 3.

Assets measured at fair value on a non-recurring basis are included in the tables below at September 30, 2015 and December 31, 2014 (amounts in thousands).



					Fair Value Measurements at
					September 30, 2015, Using
	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	9/30/2015		9/30/2015		(Level 1)		(Level 2)		(Level 3)
Loans held for sale	$	2,100	$	2,100	$	—	$	2,100	$	—
Impaired loans	2,216		2,216		—		—		2,216
Foreclosed assets	2,088		2,088		—		—		2,088

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					Fair Value Measurements at
					December 31, 2014, Using
	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	12/31/2014		12/31/2014		(Level 1)		(Level 2)		(Level 3)
Loans held for sale	$	2,882	$	2,882	$	—	$	2,882	$	—
Impaired loans	9,855		9,855		—		—		9,855
Foreclosed assets	3,782		3,782		—		—		3,782

Quantitative Information about Level 3 Fair Value Measurements

The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a nonrecurring basis at September 30, 2015 (amounts in thousands, except percentages).



	Total Carrying Amount at September 30, 2015		Valuation Methodology	Range of Inputs
Nonrecurring measurements:
Impaired loans	$	2,216	Collateral discounts	9 - 50%
Foreclosed assets	$	2,088	Discounted appraisals	10 - 30%

Collateral discounts to determine fair value on impaired loans vary widely and result from the consideration of the following factors: the age of the most recent appraisal (i.e. an appraisal dating from an earlier period of real estate speculation could require as much as a 50% discount), the type of asset serving as collateral, the expected marketability of the asset, its material or environmental condition, and comparisons to actual sales data of similar assets from both internal and external sources.

The following table reflects the general range of collateral discounts for impaired loans by segment.



Loan Segment:	Range of Percentages
Commercial construction and land development	10% - 40%
Commercial real estate	9% - 50%
Residential construction	9% - 30%
Residential mortgage	9% - 20%
All other segments	9% - 20%

As foreclosed assets are brought into other real estate owned through a process which requires a fair market valuation, further discounts typically reflect market conditions specific to the asset. These conditions are usually captured in subsequent appraisals which are required on an annual basis, and depending upon asset type and marketability demonstrate a more restrained variance than that noted above.

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Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of each class of financial instrument.

Cash and Cash Equivalents

The carrying amounts of cash and cash equivalents are equal to the fair value due to the liquid nature of the financial instruments.

Certificate of Deposits

These investments are valued at carrying amounts for fair value purposes.

Securities Available-for-Sale and Securities Held-to-Maturity

Fair values of investment securities are based on quoted market prices. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans Held For Sale

The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar

characteristics.

Loans

The fair value of loans has been estimated utilizing the net present value of future cash flows based upon contractual balances, prepayment assumptions, and applicable weighted average interest rates, adjusted for a 5% current liquidity and market discount assumption. The Company has assigned no fair value to off-balance sheet financial instruments since they are either short term in nature or subject to immediate repricing.

FHLB Stock

The carrying amount of FHLB stock approximates fair value.

Deposits

The fair value of non-maturing deposits such as noninterest-bearing demand, money market, NOW, and savings accounts, are by definition, equal to the amount payable on demand. Fair value for maturing deposits such as CDs and IRAs are estimated using a discounted cash flow approach that applies current interest rates to expected maturities.

Borrowings, Subordinated Debentures, and Subordinated Promissory Notes

The fair value of borrowings, subordinated debentures, and subordinated promissory notes, is based on discounting expected cash flows at the interest rate from debt with the same or similar remaining maturities and collection requirements.

Accrued Interest Receivable and Payable

The carrying amounts of accrued interest approximates fair value.

-31-

The following table presents information for financial assets and liabilities as of September 30, 2015 and December 31, 2014 (amounts in thousands).



	September 30, 2015
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	48,013	$	48,013	$	48,013	$	—	$	—
Certificates of deposit	24,010		24,010		—		24,010		—
Securities available-for-sale	71,982		71,982		—		71,982		—
Securities held-to-maturity	68,992		69,872		—		69,872		—
Loans held for sale	2,100		2,100		—		2,100		—
Loans, net	442,491		422,336		—		—		422,336
FHLB stock	4,564		4,564		—		4,564		—
Accrued interest receivable	1,712		1,712		—		1,712		—

Financial liabilities:
Deposits	$	535,764	$	536,210	$	—	$	536,210	$	—
Subordinated debentures and subordinated promissory notes	24,372		26,070		—		—		26,070
Borrowings	90,000		94,855		—		94,855		—
Accrued interest payable	775		775		—		775		—



	December 31, 2014
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	158,527	$	158,527	$	158,527	$	—	$	—
Certificates of deposit	27,784		27,784		—		27,784		—
Securities available-for-sale	64,211		64,211		—		64,211		—
Securities held-to-maturity	81,583		82,242		—		82,242		—
Loans held for sale	2,882		2,882		—		2,882		—
Loans, net	442,879		422,906		—		—		422,906
FHLB stock	4,788		4,788		—		4,788		—
Accrued interest receivable	1,627		1,627		—		1,627		—

Financial liabilities:
Deposits	$	661,185	$	663,000	$	—	$	663,000	$	—
Subordinated debentures and subordinated promissory notes	24,372		25,671		—		—		25,671
Borrowings	90,000		95,573		—		95,573		—
Accrued interest payable	1,704		1,704		—		1,704		—

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NOTE H - REGULATORY RESTRICTIONS

North Carolina banking law requires that the Bank may not pay a dividend that would reduce its capital below the applicable required capital. In addition, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure the financial soundness of the Bank. No dividends were paid to the Company by the Bank during the nine months ended September 30, 2015.

Current federal regulations require that the Bank maintain a minimum ratio of total capital to risk weighted assets of 8.0%, with at least 6.0% being in the form of Tier 1 capital, as defined in the regulations. In addition, the Bank must maintain a common equity Tier 1 capital ratio of 4.5% and a leverage ratio of 4.0%. To be categorized as well capitalized, the Bank must maintain minimum amounts and ratios as set forth in the table below. At September 30, 2015, the Bank was classified as well capitalized for regulatory capital purposes.

The Bank’s actual capital amounts and ratios are also presented in the table below (amounts in thousands, except ratios).



	Actual				Minimum For Capital Adequacy Purposes				Minimum to be Well Capitalized under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
As of September 30, 2015:
Total Capital (to Risk Weighted Assets)	$	76,556	15.5	%	$	39,538	8.0	%	$	49,422	10.0	%
Tier I Capital (to Risk Weighted Assets)	70,328		14.2	%	29,653		6.0	%	39,538		8.0	%
Common Equity Tier 1 Capital (to Risk Weighted Assets)	70,328		14.2	%	22,240		4.5	%	32,125		6.5	%
Tier I Capital (to Average Assets)	70,328		10.0	%	28,065		4.0	%	35,081		5.0	%

As of December 31, 2014:
Total Capital (to Risk Weighted Assets)	$	66,498	14.7	%	$	36,109	8.0	%	$	45,136	10.0	%
Tier I Capital (to Risk Weighted Assets)	60,810		13.5	%	18,054		4.0	%	27,082		6.0	%
Tier I Capital (to Average Assets)	60,810		7.2	%	33,844		4.0	%	42,305		5.0	%

The Company is also subject to capital requirements that differ from the Bank. In order for the Company to be adequately capitalized, total capital to risk weighted assets, Tier 1 capital to risk weighted assets, common equity Tier 1 capital to risk weighted assets, and Tier 1 capital to average assets must be 8.0%, 6.0%, 4.5%, and 4.0%, respectively. At September 30, 2015, the Company’s total capital to risk weighted assets, Tier 1 capital to risk weighted assets, common equity Tier 1 capital to risk weighted assets, and Tier 1 capital to average assets were 15.1%, 12.4%, 11.2%, and 8.7%, respectively, as compared to total capital to risk weighted assets, Tier 1 capital to risk weighted assets, and Tier 1 capital to average assets of 15.0%, 11.6%, and 6.2%, respectively, at December 31, 2014.

In late May 2011, the Company and the Bank entered into a Written Agreement (the "2011 Written Agreement") with the FRB and the North Carolina Commissioner of Banks (the "NCCOB"). Working closely with its regulatory partners, the Company demonstrated substantial business and risk management progress and was deemed in compliance with the 2011 Written Agreement. The Company's 2014 capital raise, continued asset quality improvements, and implementation of the Asset Resolution Plan were critical to the Bank's ability to demonstrate the required compliance. As a result, on July 30, 2015, the 2011 Written Agreement was terminated by the FRB and the NCCOB. In connection with the termination of the 2011 Written Agreement, the Bank entered into a new Written Agreement on July 30, 2015 (the “2015 Written Agreement”) with only the FRB, which is unrelated to the Bank’s financial condition. Under the terms of the 2015 Written Agreement, the Bank has submitted the following plans for approval:

•a written plan to assure ongoing board oversight of the Bank's management and operations;

•a written program for the review of new products, services, or business lines acceptable to the FRB; and


•	an enhanced written program for conducting appropriate levels of customer due diligence by the Bank acceptable to the FRB.

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In addition, the Bank has agreed that it will:


•	within ten days of approval by the FRB, adopt the approved programs specified in the second and third bullets, above; and


•	within 30 days after the end of each calendar quarter following the date of the 2015 Written Agreement, submit to FRB written progress reports detailing the form and manner of all actions taken to secure compliance with the 2015 Written Agreement and the results thereof.

-34-

NOTE I - RESTRICTED STOCK

In January 2015, the Board of the Company approved and adopted the Four Oaks Fincorp, Inc. 2015 Restricted Stock Plan (the “Plan”). During 2015, the Company awarded 1,461,000 shares of the Company’s common stock at $1.00 par value per share to certain employees, directors and third party service providers in the form of restricted stock. Awards of performance based restricted stock vest in two separate tranches, 15% at the end of the one-year period ending on December 31, 2015, and 85% at the end of the three-year period ending on December 31, 2018 (each such period, a “Performance Period”), in each case based on the attainment of the performance measures and goals for that Performance Period. The performance measures for the one-year period ending December 31, 2015 are (1) budgeted net income as set forth in the Company’s 2015 budget and (2) the Company having net income in each quarter of 2015. Budgeted net income must be achieved at the 70% threshold performance level in order for 10.5% of the awards to vest and at the 100% target performance level in order for 15% of the awards to vest. Where achievement against budgeted net income falls between these performance levels, the number of shares vested will be determined based on straight-line interpolation. If the performance goals are not met, 15% of the awards will be forfeited. The performance measures and related goals for the three-year period ending December 31, 2018 will be determined by the compensation committee of the Board (the "Committee"), in its sole discretion as administrator of the Plan, in the fourth quarter of 2015.

Awards of time based restricted stock also vest in two separate tranches, 15% at the end of the one-year period ending on December 31, 2015, and 85% at the end of the three-year period ending on December 31, 2018. In order for these shares to vest, the recipient of the award generally must be employed by the Company on the vesting date. Any restricted stock that has not vested at the time of the termination of the recipient's service relationship will be forfeited; although, the Committee has the power, in its sole and absolute discretion, to accelerate vesting where such termination is a result of the recipient's death or disability or in other termination situations.

The following table summarizes non-vested restricted stock awards as of the period ended September 30, 2015:



	Restricted Stock	Weighted Average Grant-Date Fair Value
Balance as of December 31, 2014:	—	$	—
Granted	1,461,000	1.52
Vested	—	—
Forfeited	60,000	1.52
Balance as of September 30, 2015:	1,401,000	$	1.52

The Company recognized $405,000 in compensation expense related to restricted stock awards for the nine months ended September 30, 2015 and the Company estimates there was $1.9 million in unrecognized compensation expense for restricted stock granted.

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NOTE J - INCOME TAXES

For the nine months ended September 30, 2015, the Company recorded a discrete income tax benefit of $16.5 million. This compares to no income tax benefit or expense for the same period in 2014. The year-over-year variance is due to the Company’s release of $16.6 million of the valuation allowance against its deferred tax assets in the second quarter of 2015 offset by an income tax expense of $92,000 for the three months ended September 30, 2015 as a result of changes to the North Carolina tax rate and its impact on future deferred tax benefits.

Under US GAAP, companies are required to assess whether a valuation allowance should be established against their deferred tax assets based on consideration of all available positive and negative evidence using a “more likely than not” standard. During the analysis for the twelve months ended December 31, 2010 and continuing through March 31, 2015, the Company had concluded that it was not more-likely-than-not that the Company would be able to utilize its deferred tax assets and, accordingly, had established a full valuation allowance against the value of the deferred tax assets. This conclusion was based on negative credit quality trends, increasing provision for loan losses, cumulative loss position, and uncertainty regarding the amount of future taxable income that the Company could forecast.

As part of the ongoing evaluation of positive and negative factors, the Company determined in the second quarter of 2015, it is more likely than not that it will generate sufficient taxable income to utilize a significant portion of its deferred tax assets. As a result of this change in judgment about the ability to utilize its deferred tax assets in future years, the Company released $16.6 million of the valuation allowance against its deferred tax assets resulting in an income tax benefit. This conclusion, and partial release of the valuation allowance, was based upon a number of factors including continued improvement in quarterly earnings, forecasted future profitability, improved asset quality and the execution of the Asset Resolution Plan.

The Company will continue to evaluate its ability to utilize the remaining $4.1 million in net deferred tax assets as more objective information on growth and profitability becomes available. Future evidence may show that it is more likely than not that the remaining deferred tax assets will be utilized at which point the remaining valuation allowance can be reversed. Alternatively, future evidence may prove that it is more likely than not that a portion of the deferred tax assets will not be utilized in which case a valuation allowance may be reestablished.

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ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the major components of the financial condition and results of operations of Four Oaks Fincorp, Inc. (the “Company”) and its subsidiaries and should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto in Part I, Item 1 of this Quarterly Report. Unless the context otherwise indicates, references in this report to "we," "us" and "our" refer to the Company and its subsidiaries.

Regulatory Update

In late May 2011, the Company and Four Oaks Bank & Trust Company, the Company's wholly-owned subsidiary (the "Bank"), entered into a Written Agreement (the "2011 Written Agreement") with the Federal Reserve Bank of Richmond (the "FRB") and the North Carolina Office of the Commissioner of Banks (the "NCCOB"). Working closely with its regulatory partners, the Company demonstrated substantial business and risk management progress and was deemed in compliance with the 2011 Written Agreement. The Company's 2014 capital raise, continued asset quality improvements, and implementation of the asset resolution plan (the "Asset Resolution Plan") were critical to the Bank's ability to demonstrate the required compliance. As a result, on July 30, 2015, the 2011 Written Agreement was terminated by the FRB and the NCCOB. In connection with the termination of the 2011 Written Agreement, the Bank entered into a new, more narrow Written Agreement on July 30, 2015 (the “2015 Written Agreement”) with only the FRB, which is unrelated to the Bank’s financial condition. Under the terms of the 2015 Written Agreement, the Bank has submitted the following plans for approval:

•a written plan to assure ongoing board oversight of the Bank's management and operations;

•a written program for the review of new products, services, or business lines acceptable to the FRB; and


•	an enhanced written program for conducting appropriate levels of customer due diligence by the Bank acceptable to the FRB.

In addition, the Bank has agreed that it will:


•	within ten days of approval by the FRB, adopt the approved programs specified in the second and third bullets, above; and


•	within 30 days after the end of each calendar quarter following the date of the 2015 Written Agreement, submit to FRB written progress reports detailing the form and manner of all actions taken to secure compliance with the 2015 Written Agreement and the results thereof.

The Bank has made progress in improving these areas and believes that it will be able to demonstrate full compliance with this agreement in the future.

Comparison of Financial Condition at September 30, 2015 and December 31, 2014

The Company’s total assets declined $106.3 million or 13.0% during the nine month period ending September 30, 2015, from $820.8 million at December 31, 2014 to $714.5 million at September 30, 2015. This decrease related nearly entirely to the exit of the Automated Clearing House ("ACH") third party payment processor ("TPPP") business line, offset by the reversal of a portion of the valuation allowance against deferred tax assets during the second quarter of 2015 and declines in the Company's investment portfolio. Cash, cash equivalents, and investments were $217.6 million at September 30, 2015 compared to $336.9 million at December 31, 2014, a decrease of $119.3 million or 35.4% related to the above mentioned business line exit. Outstanding gross loans increased slightly to $452.8 million at September 30, 2015 compared to $452.3 million at December 31, 2014 as solid loan production was offset by loan pay downs, maturities, and disposals under the Asset Resolution Plan.

Total liabilities were $654.3 million at September 30, 2015, a decrease of $125.8 million or 16.1%, from $780.1 million at December 31, 2014. Total deposits decreased $125.4 million or 19.0% during the nine month period ended September 30, 2015, from $661.2 million at December 31, 2014, to $535.8 million at September 30, 2015. This decline was also almost entirely due to the ACH TPPP business line exit. Total shareholders’ equity increased $19.5 million or 47.8%, from $40.7 million at December 31, 2014, to $60.2 million at September 30, 2015. This increase resulted from increased net income due to improved operating performance, as well as the partial reversal of a $16.6 million valuation allowance against the Company's deferred tax assets.

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Results of Operations for the Three Months Ended September 30, 2015 and 2014

Net Income (Loss). Net income for the three months ended September 30, 2015 was $734,000, or $0.02 net income per basic and diluted share, as compared to net loss of $8.6 million, or $0.42 net loss per basic and diluted share, for the three months ended September 30, 2014, an increase of $9.3 million or $0.44 per basic and diluted share. The year-over-year increase in net income primarily resulted from an $8.0 million decrease in provision for loan loss expense and a $1.5 million decrease in non-interest expense. The reduction in provision for loan loss expense is related to the Asset Resolution Plan executed in the third quarter of 2014. The Plan involved a process to identify and value for disposal certain impaired loans and foreclosed real estate, which resulted in an $8.1 million provision for loan loss and $1.4 million in write downs on foreclosed assets.

Net Interest Income. Net interest income is the difference between interest income, principally from loan and investment securities, and interest expense, largely on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread, and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and capital.

Net interest income increased to $5.6 million for the three months ended September 30, 2015 compared to $5.1 million as of this same period in 2014, an increase of $550,000. The increase in net interest income was largely attributable to increased investment income of $326,000 generated from additional investments purchased in the fourth quarter of 2014 and a $238,000 decrease in interest expense on borrowings that resulted from the prepayment of Federal Home Loan Bank ("FHLB") long term borrowings in 2014. Interest expense on deposits additionally declined $108,000 as we continue to implement strategies for shifting the deposit mix from time deposits to demand, savings, and money market deposits. Net interest margin improved 92 basis points to 3.43% for the quarter ended September 30, 2015, as compared to 2.51% for the same period ended September 30, 2014.

Provision for Loan Losses. The provision for loan losses is charged to bring the allowance for loan losses to the level deemed appropriate by management after adjusting for recoveries of amounts previously charged off. Loans are charged against the allowance for loan losses when management believes that the uncollectibility of a loan balance is confirmed. The allowance for loan losses is maintained at a level deemed adequate to absorb probable losses inherent in the loan portfolio and results from management’s consideration of such factors as the financial condition of borrowers, past and expected loss experience, current economic conditions, and other factors management feels deserve recognition in establishing an appropriate reserve. During the three months ended September 30, 2015, no provision for the allowance for loan losses was recognized in earnings due to continued improvement in asset quality, as compared to $8.0 million for the three months ended September 30, 2014 due to the Asset Resolution Plan from 2014.

Non-Interest Income. Non-interest income decreased $586,000 to $1.7 million for the quarter ended September 30, 2015, as compared to $2.3 million for the quarter ended September 30, 2014. This decrease resulted primarily from lower income received from ACH TPPP indemnifications as the Company exited this line of business during the first half of 2015. Such indemnification amounts represent indemnification for legal costs already incurred and estimated to occur.

Non-Interest Expenses. Non-interest expense decreased $1.5 million to $6.5 million for the quarter ended September 30, 2015, as compared to $8.0 million for the quarter ended September 30, 2014. This decrease was driven by reduced foreclosed asset related expenses of $1.3 million, lower professional and consulting fees of $414,000, a $314,000 decrease in non-interest expense on borrowings that resulted from the prepayment of FHLB long term borrowings in 2014, and reduced FDIC insurance premiums of $228,000. These declines were partially offset by increases in salary and benefit related expenses of $690,000 due to personnel additions, changes in performance based compensation plans, and implementation of a restricted stock plan.

Income Taxes. The Company reported an income tax expense of $92,000 for the three months ended September 30, 2015 compared to no income tax expense during this same quarter in 2014.

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Results of Operations for the Nine Months Ended September 30, 2015 and 2014

Net Income (Loss). Net income for the nine months ended September 30, 2015 was $19.2 million, or $0.60 net income per basic and diluted share, as compared to net loss of $4.8 million, or $0.38 net loss per basic and diluted share, for the nine months ended September 30, 2014. The year-over-year $24 million increase in net income resulted primarily from the partial reversal of the valuation allowance against deferred tax assets that resulted in a $16.6 million income tax benefit in the second quarter of 2015. The net income increase was further attributable to an $8.0 million decrease in provision for loan loss, a $1.5 million increase in net interest income, and a $961,000 decrease in non-interest expense, which were partially offset by a $2.9 million decrease in non-interest income.

Net Interest Income. Net interest income for the nine months ended September 30, 2015 was $17.0 million, as compared to $15.5 million for the nine months ended September 30, 2014, an increase of $1.5 million. The increase in net interest income stems primarily from a $707,000 decrease in interest expense on borrowings, a $668,000 increase in investment income, and a $322,000 decrease in interest expense on deposits. The decline in interest expense on borrowings is a result of the prepayment of $22.0 million in FHLB long term borrowings in 2014. The increased investment income compared to the prior year stems primarily from the additional investment purchases made in the fourth quarter of 2014 and lower costs on deposits continue as we work to shift deposit mix from time deposits to demand, savings, and money market deposits. Net interest margin improved 62 basis points to 3.25% for the nine month period ended September 30, 2015, as compared to 2.63% for the same period ended September 30, 2014.

Provision for Loan Losses. The provision for loan losses is charged to bring the allowance for loan losses to the level deemed appropriate by management after adjusting for recoveries of amounts previously charged off. Loans are charged against the allowance for loan losses when management believes that the uncollectibility of a loan balance is confirmed. The allowance for loan losses is maintained at a level deemed adequate to absorb probable losses inherent in the loan portfolio and results from management's consideration of such factors as the financial condition of borrowers, past and expected loss experience, current economic conditions, and other factors management feels deserve recognition in establishing an appropriate reserve. During the nine months ended September 30, 2015, no provision for the allowance for loan losses was recognized in earnings due to continued improvement in asset quality and the Company's net recovery position year to date, as compared to $8.0 million for the nine months ended September 30, 2014 as a result of the Asset Resolution Plan executed during the third quarter of 2014.

Non-Interest Income. Non-interest income for the nine months ended September 30, 2015 was $4.9 million, as compared to $7.8 million for the nine months ended September 30, 2014, a decrease of $2.9 million. During the nine months ended September 30, 2015, other non-interest income included indemnification income of $348,000, as compared to $3.1 million for the same period in 2014, a decrease of $2.7 million due to exiting the ACH TPPP business line during the first half of 2015.

Non-Interest Expenses. Non-interest expense for the nine months ended September 30, 2015 was $19.2 million, as compared to $20.1 million for the nine months ended September 30, 2014, a decrease of $961,000. The primary contributors to the decline in non-interest expense from the prior year were reductions in collections and foreclosure related expenses of $1.7 million, a decrease in FDIC insurance premiums of $757,000, and a decline of $462,000 in professional and consulting fees, which were collectively driven by improved asset quality and an improvement in the overall financial condition of the Bank. Offsetting these decreases were increases in salaries and benefit related expenses and technology related expenses as the Company continues to make investments in our associates and upgrades its technology platform.

Income Taxes. Beginning in 2010 and through the period ended March 31, 2015, the Company had established a full valuation allowance against net deferred tax assets primarily due to historical negative credit quality trends, cumulative losses in prior years, and uncertainty regarding the amount of future taxable income that the Company could forecast. As part of the ongoing evaluation of positive and negative factors, the Company determined in the second quarter of 2015, it is more likely than not that it will generate sufficient taxable income to utilize a significant portion of its deferred tax assets. As a result of this change in judgment about the ability to utilize its deferred tax assets in future years, the Company released $16.6 million of the valuation allowance against its deferred tax assets resulting in an income tax benefit which positively impacted earnings and increased capital for the Company and Bank. This conclusion, and partial release of the valuation allowance, was based upon a number of factors including continued improvement in quarterly earnings, forecasted future profitability, improved asset quality, and the execution of the Asset Resolution Plan. Management will continue to evaluate the ability to utilize the remaining portion of the deferred tax assets as more objective information on growth and profitability becomes available. Future evidence may show that it is more likely than not that the remaining deferred tax assets will be utilized at which point the remaining valuation allowance can be reversed. Alternatively, future evidence may prove that it is more likely than not that a portion of the deferred tax assets will not be utilized in which case a valuation allowance may be reestablished. Additionally, the Company reported an income tax expense of $92,000 for the three months ended September 30, 2015 due to a reduction in the North Carolina state tax rate.

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Asset Quality

Asset quality continues to improve as we work to resolve problem assets identified during the Asset Resolution Plan and additions to this category continue to slow. Classified assets as of September 30, 2015, which include loans risk graded substandard or lower and foreclosed assets, totaled $10.2 million compared to $16.8 million at December 31, 2014, a decline of $6.6 million. Classified to capital totaled 12.7% as of September 30, 2015 compared to 23.9% at year end 2014, a 46.8% decline.

Nonperforming Assets

Nonperforming assets are comprised of nonperforming loans, accruing loans which are past due 90 days or more, repossessed assets, other real estate owned ("foreclosed assets"), and certain loans held for sale which are classified as nonperforming. As of September 30, 2015, nonperforming assets declined $7.0 million or 50.1% when compared to December 31, 2014. This decline continues to be the result of our aggressive asset resolution efforts as we focus efforts on resolving nonperforming assets while minimizing associated losses and completing the Asset Resolution Plan.

The following table describes our nonperforming asset portfolio by loan class as of September 30, 2015 and December 31, 2014 (amounts in thousands, except ratios).



	September 30, 2015			December 31, 2014
Nonaccrual loans:
Commercial and industrial	$	2		$	—
Commercial construction and land development	1,132			5,533
Commercial real estate	1,072			983
Residential construction	437			—
Residential mortgage	721			1,271
Consumer	14			472
Other	12			—
Total nonaccrual loans	3,390			8,259

Past due 90 days or more and still accruing:
Consumer credit cards	4			14
Business credit cards	—			3
Total past due 90 days and still accruing	4			17

Nonperforming loans held for sale	1,462			1,865

Foreclosed assets:
Commercial and industrial	23			44
Commercial construction and land development	1,649			2,613
Commercial real estate	211			485
Residential mortgage	205			640
Total foreclosed assets	2,088			3,782

Total nonperforming assets	$	6,944		$	13,923

Nonperforming loans to gross loans	0.7		%	1.8		%
Nonperforming assets to total assets	1.0		%	1.7		%
Allowance coverage of nonperforming loans	302.7		%	113.3		%

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Nonaccrual Loans

Loans are moved to nonaccrual status and recognition of interest income ceases when it is probable that full collectibility of principal and interest in accordance with the terms of the loan agreement may not occur. Nonaccrual loans held for investment as a percentage of gross loans held for investment has decreased to 0.7% as of September 30, 2015 compared to 1.8% as of December 31, 2014. At September 30, 2015, there were 42 nonaccrual loans held for investment totaling $3.4 million compared to 45 loans totaling $8.3 million at December 31, 2014. The amount of interest income for the nine months ended September 30, 2015 that would have been reported on loans in nonaccrual status as of September 30, 2015 totaled $200,000. The allowance for loan losses as a percentage of nonperforming loans held for investment increased to 302.7% as of September 30, 2015 compared to 113.3% as of December 31, 2014.

Foreclosed Assets

At September 30, 2015, there were 40 foreclosed properties valued at a total of $2.1 million compared to 128 foreclosed properties valued at $3.8 million as of December 31, 2014. The continued decline in foreclosed assets resulted from sales of foreclosed properties and reductions in the number of properties being added to foreclosed assets each quarter.

Nonperforming Loans Held for Sale

As part of the Asset Resolution Plan, the Company transferred a portion of loans held for investment to loans held for sale in anticipation of near term loan sales. As of September 30, 2015, there were $1.5 million of loans held for sale that were in nonaccrual status and therefore considered nonperforming. These loans are not included in the $3.4 million in nonaccrual loans but have been included as nonperforming assets for the period.

Troubled Debt Restructurings

Loans are classified as a troubled debt restructuring ("TDR") when, for economic or legal reasons which result in a debtor experiencing financial difficulties, the Company grants a concession through a modification of the original loan agreement that would not otherwise be considered. Loans in the process of renewal or modification are reviewed by the Company to determine if the risk grade assigned is accurate based on updated information. The Company's policy with respect to accrual of interest on loans restructured in a TDR process follows relevant supervisory guidance. If a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is considered and the loan is considered performing. If the borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual and nonperforming until such time as continued performance has been demonstrated, which is typically a period of at least six consecutive payments. If the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.

As of September 30, 2015, there were 19 restructured loans in accrual status compared to 20 as of December 31, 2014. Regardless of whether any individual TDR is performing, all TDRs are considered to be impaired and are evaluated as such in the allowance for loan losses calculation. As of September 30, 2015, the recorded investment in performing TDRs and their related allowance for loan losses totaled $4.3 million and $363,000, respectively. Outstanding nonperforming TDRs totaled $1.3 million with $152,000 in specific reserves as of September 30, 2015. The amount of interest recognized for performing and nonperforming TDRs during the first nine months of 2015 were approximately $205,000 and $8,000, respectively.

As noted above, the Company transferred a portion of loans to held for sale in anticipation of near term loan sales. As of September 30, 2015, there were 14 TDRs included in the loans held for sale classification. Of these, 2 or $157,000 were performing and 12 or $562,000 were in nonaccrual status and are included as nonperforming assets for the period.

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The following table presents performing and nonperforming TDRs at September 30, 2015 and December 31, 2014 (amounts in thousands).



Performing TDRs:	September 30, 2015		December 31, 2014
Commercial construction and land development	$	1,155	$	1,336
Commercial real estate	2,395		2,469
Residential mortgage	790		950
Consumer	3		4
Total performing TDRs	$	4,343	$	4,759



Nonperforming TDRs:	September 30, 2015		December 31, 2014
Commercial construction and land development	$	717	$	2,776
Commercial real estate	596		552
Residential mortgage	28		54
Consumer	—		467
Total nonperforming TDRs	$	1,341	$	3,849

Allowance for Loan Losses and Summary of Loss Experience

The allowance for loan losses is established through periodic charges to earnings in the form of a provision for loan losses. Increases to the allowance for loan losses occur as a result of provisions charged to operations and recoveries of amounts previously charged-off. Decreases to the allowance occur when loans are charged-off because management believes that the uncollectibility of a loan balance is confirmed. Management evaluates the adequacy of our allowance for loan losses on at least a quarterly basis. The evaluation of the adequacy of the allowance for loan losses involves the consideration of loan growth, loan portfolio composition and industry diversification, historical loan loss experience, current delinquency levels, adverse conditions that might affect a borrower’s ability to repay the loan, estimated value of underlying collateral, prevailing economic conditions and all other relevant factors derived from our history of operations.

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The following table summarizes the Company's loan loss experience by class for the three and nine months ended September 30, 2015 and 2014 (amounts in thousands, except ratios).



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2015			2014			2015			2014
Balance at beginning of period	$	9,812		$	10,946		$	9,377		$	11,590

Charge-offs:
Commercial and industrial	—			436			47			460
Commercial construction and land development	160			2,779			179			3,096
Commercial real estate	(7		)	2,529			199			3,019
Residential construction	—			—			—			171
Residential mortgage	261			4,177			426			4,417
Consumer	38			25			136			114
Other	28			—			70			—
Total charge-offs	480			9,946			1,057			11,277

Recoveries:
Commercial and industrial	73			49			213			163
Commercial construction and land development	590			113			1,094			297
Commercial real estate	198			43			388			205
Residential mortgage	44			123			167			312
Consumer	35			64			88			81
Other	—			1			2			22
Total recoveries	940			393			1,952			1,080

Net recoveries (charge-offs)	460			(9,553		)	895			(10,197		)

Provision for loan losses	—			7,954			—			7,954

Balance at end of period	$	10,272		$	9,347		$	10,272		$	9,347

Ratio of net charge-offs to average gross loans	—		%	2.02		%	—		%	2.12		%

The allowance for loan losses at September 30, 2015 was $10.3 million, which represents 2.3% of total loans held for investment compared to $9.3 million or 2.1% as of September 30, 2014. For the nine months ended September 30, 2015, recoveries outpaced charge-offs resulting in a net loan recovery of $895,000 compared with net charge-offs of $10.2 million for the prior year period.

The allowance for loan losses on individually reviewed impaired loans totaled $608,000 as of September 30, 2015, compared to $524,000 as of December 31, 2014, an 16% increase. The allowance for loan losses on the loans reviewed collectively increased from $8.9 million as of December 31, 2014 to $9.7 million as of September 30, 2015 as recoveries outpaced new charge-offs during the quarter as a result of continued improvements in credit quality and the actions taken in connection with the Asset Resolution Plan during 2014.

Because of the nature of the Company’s primary markets and business, a significant portion of the loan portfolio is secured by commercial real estate, including residential and commercial acquisition, development, and construction properties. As of September 30, 2015, approximately 93% of the loan portfolio had real estate as a primary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower. Real estate values in many markets have improved. The Company continues to thoroughly review and monitor its commercial real estate concentration and the associated allowance and sets limits by sector and region based on this internal review.

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The following table summarizes the Company’s allowance for loan losses and percent of total loans at September 30, 2015, and December 31, 2014 (amounts in thousands, except ratios).



	September 30, 2015				December 31, 2014
	Amount		% of loans in each category		Amount		% of loans in each category
Commercial and industrial	$	124	5	%	$	119	6	%
Commercial construction and land development	5,527		11	%	5,105		12	%
Commercial real estate	2,664		46	%	2,382		44	%
Residential construction	397		7	%	436		6	%
Residential mortgage	1,416		29	%	1,206		30	%
Consumer	91		2	%	89		2	%
Other	53		—	%	40		—	%
Total	$	10,272	100	%	$	9,377	100	%

Liquidity and Capital Resources

Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources. The term "liquidity" refers to our ability to generate adequate amounts of cash to meet our needs for funding loan originations, deposit withdrawals, maturities of borrowings and operating expenses. Management measures our liquidity position by giving consideration to both on and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.

Sources of liquidity include cash and cash equivalents (net of federal requirements to maintain reserves against deposit liabilities), investment securities eligible for pledging to secure borrowings, investments available-for-sale, loan repayments, loan sales, deposits and borrowings from the FHLB secured with pledged loans and securities, and from correspondent banks under overnight federal funds credit lines. During the first nine months of 2015, the Company's primary demands for liquidity were due to the strategic exit of the ACH TPPP line of business. These deposits declined $124.1 million during the nine month period from $134.8 million at December 31, 2014 compared to $10.7 million at September 30, 2015. Management actively managed the changes in these deposits to maintain adequate liquidity during the transition.

The Company sold $12.0 million aggregate principal amount of subordinated promissory notes to certain accredited investors between May and August 2009. These notes are due ten years after the date of issuance, beginning May 15, 2019, and the Company is obligated to pay interest at an annualized rate of 8.5% payable in quarterly installments beginning on the third month anniversary of the date of issuance. The Company may prepay the notes at any time after the fifth anniversary of the date of issuance, subject to compliance with applicable law.

On August 15, 2014, the Company closed its shareholder rights offering and concurrent private placement standby offering pursuant to the Securities Purchase Agreement dated March 24, 2014 between the Company and Kenneth R. Lehman, a private investor. In connection with the rights offering and standby offering, the Company issued an aggregate of 24,000,000 shares of its common stock at $1.00 per share for aggregate gross proceeds of $24.0 million.

Management believes that the Company’s liquidity sources are adequate to meet its operating needs for the next eighteen months. Total shareholders’ equity was $60.2 million or 8.4% of total assets at September 30, 2015 and $40.7 million or 5.0% of total assets at December 31, 2014. Supplementing customer deposits as a source of funding, we have available lines of credit from various correspondent banks to purchase federal funds on a short-term basis of approximately $42.0 million that remain unused at September 30, 2015. As of September 30, 2015, the Company has the credit capacity to borrow up to $142.9 million from the FHLB with $90.0 million outstanding.

The Bank had total risk based capital of 15.5%, Tier 1 risk based capital of 14.2%, and leverage ratio of 10.0% at September 30, 2015, as compared to 14.7%, 13.5%, and 7.2%, respectively, at December 31, 2014. The Company had total risk based capital of 15.1%, Tier 1 risk based capital of 12.4%, and leverage ratio of 8.7% at September 30, 2015, as compared to 15.0%, 11.6% and 6.2%, respectively, at December 31, 2014. Additionally, the Bank and the Company had common equity Tier 1 capital of 14.2% and 11.2%, respectively, at September 30, 2015.

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Prior to July 30, 2015, the Company was prohibited by the 2011 Written Agreement from paying interest on its subordinated promissory notes and on its subordinated debentures in connection with its trust preferred securities ("TPS") without prior approval of the supervisory authorities. The Company and the Bank were also prohibited from declaring or paying dividends without prior approval of the supervisory authorities. On July 30, 2015, the 2011 Written Agreement was terminated and therefore these provisions are no longer in force allowing the Company to pay the interest on its subordinated promissory notes and TPS for the third quarter of 2015 without obtaining prior approval. The Company has not paid any cash dividends on its common stock since it suspended dividends in the fourth quarter of 2010. As a bank holding company, the Company’s ability to declare and pay dividends also depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.

Forward-Looking Information

Information set forth in this Quarterly Report on Form 10-Q, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which statements represent our judgment concerning the future and are subject to business, economic and other risks and uncertainties, both known and unknown, that could cause our actual operating results and financial position to differ materially. Such forward looking statements can be identified by the use of forward looking terminology, such as “may,” “will,” “expect,” “anticipate,” “estimate,” or “continue” or the negative thereof or other variations thereof or comparable terminology.

We caution that any such forward-looking statements are further qualified by important factors that could cause our actual operating results to differ materially from those in the forward-looking statements, including, without limitation, our ability to comply with the 2015 Written Agreement, the effects of future economic conditions, governmental fiscal and monetary policies, legislative and regulatory changes, the risks of changes in interest rates on the level and composition of deposits, the effects of competition from other financial institutions, our ability to raise capital, the failure of assumptions underlying the establishment of the allowance for possible loan losses, our ability to maintain an effective internal control environment, the low trading volume of our common stock and the risks discussed in Part II, Item 1A. Risk Factors, and other considerations described in connection with specific forward-looking statements and other cautionary elements specified in the Company's periodic filings with the Commission, including without limitation, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.

Any forward-looking statements contained in this Quarterly Report on Form 10-Q are as of the date hereof and we undertake no duty to update them if our view changes later, except as required by law. These forward-looking statements should not be relied upon as representing our view as of any date subsequent to the date hereof.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4 – CONTROLS AND PROCEDURES

As required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation was carried out under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report. As defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act, the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this Quarterly Report, the Company's disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits to the Commission under the Exchange Act is recorded, processed, summarized and reported, within the time periods required by the Commission's rules and forms.

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Changes in Internal Control Over Financial Reporting

There have been no changes in the Company's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by this Quarterly Report that the Company believes have materially affected or are likely to materially affect, its internal control over financial reporting.

Part II. OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

There have been no material developments in the description of material legal proceedings as reported in Part I, Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2014, as updated in Part II, Item 1 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2015.

Additionally, we are party to certain other legal actions in the ordinary course of our business. We believe these actions are routine in nature and incidental to the operation of our business. While the outcome of these actions cannot be predicted with certainty, management’s present judgment is that the ultimate resolution of these matters will not have a material adverse impact on our business, financial condition, results of operations, cash flows or prospects. If, however, our assessment of these actions is inaccurate, or there are any significant adverse developments in these actions, our business, financial condition, results of operations, cash flows and prospects could be adversely affected.

ITEM 1A - RISK FACTORS

There have been no material changes in the Company’s risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014, except that the risks related to the 2011 Written Agreement are no longer applicable and except as set forth below.

We are subject to examination and scrutiny by a number of regulatory authorities, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations, or financial position pursuant to the terms of formal or informal regulatory orders, including the 2015 Written Agreement with the FRB.

We are subject to examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions, and requirements on us if they identify violations of laws with which we must comply or weaknesses or failures with respect to general standards of safety and soundness. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, cease and desist orders, civil money penalties and termination of deposit insurance and bank closures. Enforcement actions may be taken regardless of the capital levels of the institutions, and regardless of prior examination findings.

In late July 2015, the Bank entered into the 2015 Written Agreement with the FRB. The 2015 Written Agreement requires the Bank to take certain actions, including developing and submitting for approval a written plan to assure ongoing board oversight of the Bank's management and operations; a written program for the review of new products, services, or business lines acceptable to the FRB; and an enhanced written program for conducting appropriate levels of customer due diligence by the Bank acceptable to the FRB, among other things.

There can be no assurance that the terms and conditions of the 2015 Written Agreement will be fully and completely met or that the impact or effect of such terms and conditions will not have a material adverse effect on our financial condition, results of operations and future prospects. A material failure to comply with the terms of the 2015 Written Agreement could subject the the Bank, and subsequently the Company, to additional regulatory actions and further restrictions on our business. The Bank cannot determine whether or when the 2015 Written Agreement will be terminated. Even if the 2015 Written Agreement is terminated, in whole or in part, the Bank or Company could be subject to supervisory enforcement actions that restrict our activities.

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We may not be able to realize the benefit of our deferred tax assets.

As of December 31, 2014 and December 31, 2013, we had a deferred tax asset of $23.4 million and $23.6 million, a valuation allowance of $22.0 million and $22.5 million, and a deferred tax liability of $1.4 million and $1.1 million, respectively, for a net deferred tax liability of $0 in both years. As of December 31, 2014, and December 31, 2013, the amount of the gross deferred tax asset attributable to our net operating loss carryforwards was $16.2 million and $16.3 million, respectively, and was fully reduced by a valuation allowance at both dates. A deferred tax asset is reduced by a valuation allowance if, based on the weight of the evidence available, it is more likely than not that some portion or all of the total deferred tax asset will not be realized. During the second quarter of 2015, the Company determined that it is more likely than not that sufficient taxable income will be generated to realize a significant portion of its deferred tax assets, warranting a partial release of the valuation allowance. As a result, the Company recognized a $16.6 million income tax benefit, which positively impacted earnings and increased capital for the Bank and the Company. Future evidence may show that it is more likely than not that the remaining deferred tax assets will be realized, at which point the remaining valuation allowance can be reversed. Alternatively, future evidence may prove that it is more likely than not that a portion of the deferred tax assets will not be realized, in which case a valuation allowance may be reestablished.

We believe that, subject to certain limitations including federal tax laws relating to “ownership changes,” should we continue to maintain profitability and project future profits while remaining well capitalized, then we would be able to reverse some or all of the remaining deferred tax asset valuation allowance. Even if we are able to reverse additional amounts of the deferred tax asset valuation allowance, however, the portion of a deferred tax asset that may be included in Tier 1 Capital for regulatory capital purposes is limited within the regulatory capital rules.

We structured our 2014 shareholder rights offering to avoid an “ownership change” under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). Following the closing of the rights offering, the Board of Directors approved a rights plan designed to preserve the ability to fully utilize our net operating loss carryforwards by deterring any person from acquiring our common stock without approval of the Board of Directors if such acquisition would result in a shareholder owning 4.9% or more of our then outstanding common stock, which rights plan was subsequent ratified by our shareholders. Additionally, our shareholders approved an amendment to our articles of incorporation to include ownership limitations that help preserve the ability to fully utilize our net operating loss carryforwards. Together, these two changes help prevent an ownership change that could substantially reduce or eliminate the significant long-term benefits our net operating loss carryforwards might provide. However, it is important to note that even with the amendment to our articles of incorporation and the adoption of the rights plan, neither measure offers a complete solution and an ownership change could still occur, which would significantly limit the amount of the net operating loss carryforwards that we might otherwise be able to utilize.

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ITEM 6 - EXHIBITS

The following exhibits are filed as part of this Quarterly Report on Form 10-Q.



Exhibit No.	Description

10.1	Amendment No. 3 to the Employment Agreement with David H. Rupp

10.2	Written Agreement, effective July 30, 2015, by and among Four Oaks Bank & Trust Company and the Federal Reserve Bank of Richmond (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on August 4, 2015)

10.3	Severance and General Release Agreement with Nancy S. Wise

31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101	The following materials from Four Oaks Fincorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Comprehensive Income (Loss); (iv) Consolidated Statement of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.

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SIGNATURES

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



		FOUR OAKS FINCORP, INC.


Date:	November 16, 2015	By:	/s/ David H. Rupp
		David H. Rupp
		President and
		Chief Executive Officer

Date:	November 16, 2015	By:	/s/ Deanna W. Hart
		Deanna W. Hart
		Executive Vice President and
		Chief Financial Officer

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Exhibit Index



Exhibit No.	Description

10.1	Amendment No. 3 to the Employment Agreement with David H. Rupp

10.2	Written Agreement, effective July 30, 2015, by and among Four Oaks Bank & Trust Company and the Federal Reserve Bank of Richmond (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on August 4, 2015)

10.3	Severance and General Release Agreement with Nancy S. Wise

31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101	The following materials from Four Oaks Fincorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015 formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Comprehensive Income (Loss); (iv) Consolidated Statement of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.

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