FOUR OAKS FINCORP INC - FORM 10-K

Attached files

file	filename
EX-32.2 - EXHIBIT 32.2 - FOUR OAKS FINCORP INC	fofn12312016ex322.htm
EX-32.1 - EXHIBIT 32.1 - FOUR OAKS FINCORP INC	fofn12312016ex321.htm
EX-31.2 - EXHIBIT 31.2 - FOUR OAKS FINCORP INC	fofn12312016ex312.htm
EX-31.1 - EXHIBIT 31.1 - FOUR OAKS FINCORP INC	fofn12312016ex311.htm
EX-23 - EXHIBIT 23 - FOUR OAKS FINCORP INC	exhibit23-cbconsent123116.htm
EX-10.12 - EXHIBIT 10.12 - FOUR OAKS FINCORP INC	exhibit1012-summaryofnonxe.htm
EX-4.1 - EXHIBIT 4.1 - FOUR OAKS FINCORP INC	exhibit41stockcertificate.htm
EX-3.1 - EXHIBIT 3.1 - FOUR OAKS FINCORP INC	exhibit31-articlesofincorp.htm

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

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 Identification
incorporation or organization)	Number)

6114 U.S. 301 South
Four Oaks, North Carolina	27524
(Address of principal executive offices)	(Zip Code)



Registrant's telephone number, including area code:	(919) 963-2177

Securities registered under Section 12(b) of the Act: NONE

Securities registered under Section 12(g) of the Act:

Common Stock, par value $1.00 per share

(Title of Class)

Preferred Share Rights

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

YES o NO x

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

YES o NO x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:

YES x NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate 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).

YES x NO o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 Act): oYES xNO

$32,464,210

(Aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant

based on the price at which the registrant’s Common Stock, par value $1.00 per share

was sold on June 30, 2016)

6,759,964

(Number of shares of Common Stock, par value $1.00 per share, outstanding as of March 29, 2017)



Documents Incorporated by Reference		Where Incorporated
(1)	Proxy Statement for the 2017 Annual Meeting of Shareholders	Part III

Forward-Looking Information

Information set forth in this Annual Report on Form 10-K under the caption “Business” and “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, 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 comply with the 2015 Written Agreement (the "2015 Written Agreement") we entered with the Federal Reserve Bank of Richmond (the “FRB”) on July 30, 2015, 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 Item 1A. Risk Factors below.

Any forward-looking statements contained in this Annual Report on Form 10-K 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.

PART I

Item 1 - Business

Overview

Four Oaks Bank & Trust Company (referred to herein as the “Bank”) was incorporated under the laws of the State of North Carolina in 1912. On February 5, 1997, the Bank formed Four Oaks Fincorp, Inc. (referred to herein as the “Company”; references herein to “we,” “us” and “our” refer to the Company and its consolidated subsidiaries, unless the context otherwise requires) for the purpose of serving as a holding company for the Bank. Our corporate offices and banking offices are located in eastern and central North Carolina. We have no significant assets other than cash, the capital stock of the Bank and its membership interest in Four Oaks Mortgage Services, L.L.C. (inactive).

In addition, we have an interest in Four Oaks Statutory Trust I, a wholly owned Delaware statutory business trust (the “Trust”), for the sole purpose of issuing trust preferred securities. The Trust is not included in the consolidated financial statements of the Company.

The Bank is a community-focused bank engaging in general consumer and commercial banking business to the communities we serve. The Bank provides a full range of banking services, including offering:



Deposit Accounts		Loan Products		Wealth Management		Delivery Channels		Commercial Services		Other Services
ü	Checking	ü	Mortgage	ü	Financial Planning Services	ü	Internet Banking	ü	Remote Deposit Capture	ü	Cashier's Checks
ü	Savings	ü	Equity Line of Credit	ü	Wealth Management Services	ü	Telephone Banking	ü	Remote Check Capture	ü	Gift Cards
ü	Money Market	ü	Agriculture	ü	Investment Services	ü	Mobile Banking	ü	Debit Cards	ü	Safe Deposit Box
ü	Certificates of Deposit (CD)	ü	Commercial/ Business	ü	Individual Retirement Account (IRA)	ü	Night Depository	ü	Automated Clearing House (ACH) Origination	ü	Wire Services
ü	Christmas Club	ü	Real Estate	ü	Life Insurance				Automated Clearing House (ACH) Origination	ü	Notary Services
ü	Overdraft Lines	ü	Home Improvement	ü	Long Term Care			ü	Prepaid and Payroll Cards
ü	E-Statements	ü	Construction	ü	Annuities			ü	Merchant Processing
ü	Mobile Check Capture	ü	Consumer
		ü	Credit Cards

The wealth management services listed above are made available through an arrangement with Lincoln Financial Services Corporation acting as a registered broker-dealer performing the brokerage services. The securities involved in these services are not deposits or other obligations of the Bank and are not insured by the Federal Deposit Insurance Corporation (“FDIC”).

Residential mortgages are originated by Four Oaks Mortgage Company, a division of Four Oaks Bank & Trust Company. Upon closing, these loans, together with their servicing rights, are sold to mortgage loan investors under prearranged terms.

Our market area is concentrated in eastern and central North Carolina. From its headquarters located in Four Oaks and its fifteen other locations, the Bank serves a major portion of Johnston County, and parts of Wake, Harnett, Duplin, and Sampson counties. In Four Oaks, the main office is located at 6144 US 301 South. The Bank also operates a branch office in Clayton at 102 East Main Street, two in Smithfield at 128 North Second Street, and 403 South Brightleaf Boulevard, one in Garner at 200 Glen Road, one in Raleigh at 1408 Garner Station Boulevard, one in Benson at 200 East Church Street, one in Fuquay-Varina at 325 North Judd Parkway Northeast, one in Wallace at 406 East Main Street, one in Holly Springs at 201 West Center Street, one in Harrells at 590 Tomahawk Highway, one in Zebulon at 805 North Arendell Avenue, and one in Dunn at 115 Four Oaks Place. The Bank additionally operates a loan production office in Raleigh at 5909 Falls of Neuse Road and one in Apex at 1091 Investment Boulevard.

Johnston County has a diverse economy and is not dependent on any one particular industry. The leading industries in the area include retail trade, manufacturing, pharmaceuticals, government, services, construction, wholesale trade and agriculture. The majority of the Bank’s customers are individuals and small to medium-size businesses. The deposits and loans are well diversified with no material concentration in a single industry or group of related industries. There are no seasonal factors that would have any material adverse effect on the Bank’s business, and the Bank does not rely on foreign sources of funds or income.

On March 22, 2013, the Bank sold selected deposits and assets associated with two branches located in Rockingham and Southern Pines, North Carolina. The transaction was consummated pursuant to a definitive purchase and assumption agreement with First Bank of Troy, North Carolina, which was entered into on September 26, 2012. Under the terms of the purchase and assumption agreement, First Bank assumed the selected customer deposits of both branches offset by the purchase of (i) the aggregate net book value of the real property and related tangible personal property of the Rockingham, North Carolina branch as well as the cash on hand at the Rockingham and Southern Pines, North Carolina branches, (ii) the aggregate of certain loans for both branches, and (iii) a 1% premium of the deposits assumed.

On March 24, 2014, the Company entered into a securities purchase agreement (the “Securities Purchase Agreement”) with Kenneth R. Lehman (the “Standby Investor”) and, on June 18, 2014, the Company commenced its shareholder rights offering (the “Rights Offering”). On August 15, 2014, the Company concluded the Rights Offering and concurrent standby offering to the Standby Investor (the “Standby Offering”), in which the Company issued an aggregate of 4,800,000 shares of common stock at $5.00 per share for aggregate gross proceeds of $24.0 million (the maximum permissible pursuant to the terms of the Rights Offering and Standby Offering). During the third quarter of 2014, the Company identified problem assets and began the disposition process under the asset resolution plan (the "Asset Resolution Plan"), as required by the Securities Purchase Agreement. The Asset Resolution Plan was completed in the fourth quarter of 2015.

On March 8, 2017, the Company completed a one for five reverse stock split of the Company’s authorized, issued, and outstanding common stock, par value $1.00 per share (the “Reverse Stock Split”). The number of authorized shares of common stock was reduced from 80,000,000 to 16,000,000. At that time, every five shares of the Company’s issued and outstanding common stock were automatically combined into one issued and outstanding share of the Company’s common stock. No fractional shares were issued in connection with the Reverse Stock Split, and any fractional shares resulting from the Reverse Stock Split were rounded up to the nearest whole share. All share and share-related information presented in this Annual Report on Form 10-K have been retroactively adjusted to reflect the decreased number of shares resulting from the Reverse Stock Split.

The following table sets forth certain of our financial data and ratios for the years ended December 31, 2016 and 2015 derived from our audited financial statements and notes. This information should be read in conjunction with and is qualified in its entirety by reference to the more detailed audited financial statements and notes thereto included in this report:



	2016			2015
	(in thousands, except ratios)
Net income	$	6,858		$	20,008
Average equity capital accounts	$	63,879		$	51,830
Ratio of net income to average equity capital accounts	10.7		%	38.6		%
Average daily total deposits	$	552,015		$	570,759
Ratio of net income to average daily total deposits	1.2		%	3.5		%
Average daily loans	$	483,741		$	458,679
Ratio of average daily loans to average daily total deposits	87.6		%	80.4		%

Employees

At December 31, 2016, we employed 175 full time employees and 6 part time employees. Our employees are extremely important to our continued success and the Bank considers its relationship with its employees to be good. Management continually seeks ways to improve upon their benefits and well being.

Competition

Commercial banking in North Carolina is extremely competitive due in large part to North Carolina’s early adoption of statewide branching. As a result, many commercial banks have branches located in several communities. The Bank competes in its market area with some of the largest banking organizations in the state and the country and other financial institutions, such as federally and state-chartered savings and loan institutions. At June 2016, we operated branches in Johnston, Wake, Sampson, Duplin, and Harnett counties, North Carolina. At that time in Johnston County, North Carolina, the Bank’s primary market, there were a total of 40 branches represented by 12 FDIC insured financial institutions. The Bank ranked second among the 12 banks with approximately $330 million or 21% of the Johnston County deposit market share. Many of the Bank’s competitors have broader geographic markets and higher lending limits than those of the Bank and are also able to provide more services and make greater use of media advertising. In our market area, the Bank has significant competition for deposits and loans from other depository institutions and credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit with varying degrees of regulatory restrictions. Additionally, credit unions have been permitted to expand their membership criteria and expand their loan services to include traditional bank services such as commercial lending creating a greater competitive disadvantage for tax-paying financial institutions.

The enactment of legislation authorizing interstate banking has caused great increases in the size and financial resources of some of the Bank’s competitors. See “Holding Company Regulation” below for a description of this legislation. In addition, as a result of interstate banking, out-of-state commercial banks may acquire North Carolina banks and heighten the competition among banks in North Carolina.

Although the competition in its market areas is expected to continue to be significant, the Bank believes that it has certain competitive advantages that distinguish it from its competition such as: a strong local brand, its affiliation with the community, and its emphasis on providing specialized services to small and medium-sized businesses as well as professional and high net worth individuals. The Bank offers its customers modern, high-tech banking without forsaking community values such as prompt, friendly, and personalized service. Being responsive and sensitive to individualized needs helps the Bank to attract and retain customers. To continue attracting new customers, the Bank also relies on goodwill and referrals from our shareholders and satisfied customers, as well as traditional media. To enhance a positive image in the community and support one of the Bank's values, we participate in many local events, and our officers and directors serve on boards of local civic and charitable organizations.

Supervision and Regulation

Holding companies, banks and many of their non-bank affiliates are extensively regulated under both federal and state law. The following is a brief summary of certain statutes, rules, and regulations affecting us and the Bank. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and are not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company or Bank. Supervision, regulation and examination of the Company and the Bank by bank regulatory agencies is intended primarily for the protection of the Bank’s depositors rather than the Company’s shareholders.

Holding Company Regulation

Overview

Four Oaks Fincorp, Inc. is a holding company registered with the Board of Governors of the Federal Reserve System (the "Federal Reserve") under the Bank Holding Company Act of 1956 (the “BHCA”). As such, we are subject to the supervision, examination and reporting requirements contained in the BHCA and the regulation of the Federal Reserve. The Bank is also subject to the BHCA. The BHCA requires that a bank holding company obtain the prior approval of the Federal Reserve before (i) acquiring direct or indirect ownership or control of more than five percent of the voting shares of any bank, (ii) taking any action that causes a bank to become a subsidiary of the bank holding company, (iii) acquiring all or substantially all of the assets of any bank or (iv) merging or consolidating with any other bank holding company.

The BHCA generally prohibits a bank holding company, with certain exceptions, from engaging in activities other than banking, or managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be closely related to banking, or managing or controlling banks, as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. For example, banking, operating a thrift institution, extending credit or servicing loans, leasing real or personal property, providing securities brokerage services, providing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance underwriting activities have all been determined by regulations of the Federal Reserve to be permissible activities.

Pursuant to delegated authority, the FRB has authority to approve certain activities of holding companies within its district, including us, provided the nature of the activity has been approved by the Federal Reserve. Despite prior approval, the Federal Reserve has the power to order a holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it believes that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company.

Effective December 2, 2009, we elected to become a bank holding company, and therefore we are not subject to the financial holding company regulatory framework under the Gramm-Leach-Bliley Act (“GLBA”). However, the additional customer privacy protections introduced by the GLBA do apply to us and the Bank. The GLBA’s privacy provisions require financial institutions to, among other things: (i) establish and annually disclose a privacy policy, (ii) give consumers the right to opt out of disclosures to nonaffiliated third parties, with certain exceptions, (iii) refuse to disclose consumer account information to third-party marketers and (iv) follow regulatory standards to protect the security and confidentiality of consumer information.

Pursuant to the GLBA’s rulemaking provisions, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the FDIC, and the Office of Thrift Supervision adopted regulations, establishing standards for safeguarding customer information. Such regulations provide financial institutions guidance in establishing and implementing administrative, technical, and physical safeguards to protect the security, confidentiality, and integrity of customer information.

Mergers and Acquisitions

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “IBBEA”) permits interstate acquisitions of banks and bank holding companies without geographic limitation, subject to any state requirement that the bank has been organized for a minimum period of time, not to exceed five years, and the requirement that the bank holding company, prior to or following the proposed acquisition, controls no more than 10% of the total amount of deposits of insured depository institutions in the U.S. and no more than 30% of such deposits in any state (or such lesser or greater amount set by state law).

In addition, the IBBEA permits a bank to merge with a bank in another state as long as neither of the states has opted out of the IBBEA prior to May 31, 1997. In 1995, the State of North Carolina “opted in” to such legislation. In addition, a bank may establish and operate a de novo branch in a state in which the bank does not maintain a branch if that state expressly permits de novo interstate branching. As a result of North Carolina having opted-in, unrestricted interstate de novo branching is permitted in North Carolina.

Additional Restrictions and Oversight

Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve on any extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or securities thereof and the acceptance of such stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. An example of a prohibited tie-in would be any arrangement that would condition the provision or cost of services on a customer obtaining additional services from the bank holding company or any of its other subsidiaries.

The Federal Reserve may issue cease and desist orders against bank holding companies and non-bank subsidiaries to stop actions believed to present a serious threat to a subsidiary bank. The Federal Reserve also regulates certain debt obligations, changes in control of bank holding companies and capital requirements.

Under the provisions of North Carolina law, we are registered with and subject to supervision by the North Carolina Office of the Commissioner of Banks (the "NCCOB").

Dodd-Frank Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which was enacted on July 21, 2010, was intended primarily to overhaul the financial regulatory framework following the global financial crisis and impacts all financial institutions including our holding company and the Bank. The Dodd-Frank Act contains significant regulatory and compliance changes, including, among other things.


•	enhanced authority over troubled and failing banks and their holding companies;


•	increased capital and liquidity requirements;


•	increased regulatory examination fees; and


•	specific provisions designed to improve supervision and safety and soundness by imposing restrictions and limitations on the scope and type of banking and financial activities.

In addition, the Dodd-Frank Act changes the framework for systemic risk oversight within the financial system that will be enforced by several federal regulatory agencies, including the Financial Stability Oversight Council, the Federal Reserve, the Office of Comptroller of the Currency, the FDIC, and the Consumer Financial Protection Bureau (the "CFPB"). The Dodd-Frank Act requires the various federal agencies to adopt a broad range of implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act are not yet known and may not be known for many months or years. However, a few changes pursuant to the Dodd-Frank Act that may have an impact on us include, but are not limited to,


•	elimination of the federal law prohibition on the payment of interest on commercial demand deposit accounts;


•	expansion of the assessment base for determining deposit insurance premiums to include liabilities other than just deposits;


•	regulations regarding debit card fees;


•	heightened capital standards;


•	increased requirements and limitations with respect to transactions with affiliates and insiders; and


•	enhanced corporate governance and executive compensation requirements.

Consumer Financial Protection Bureau

The Dodd-Frank Act creates the CFPB, an independent federal agency that is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products.

Source of Strength Requirements

Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources, and, if the Bank becomes undercapitalized, the Company may be required to guarantee the Bank’s compliance with capital restoration plans filed with their bank regulators, subject to certain limits.

Ability-to-Repay and Qualified Mortgage Rule

Pursuant to the Dodd-Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implemented by the Truth in Lending Act, requiring creditors to make a reasonable and good faith determination, based on verified and documented information, that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Creditors are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the creditor to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the creditor can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher-priced” (e.g., subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g., prime loans) are given a safe harbor of compliance.

Bank Regulation

Overview

The Bank is subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and is supervised and examined by the NCCOB and the Federal Reserve. The Federal Reserve and the NCCOB regularly examine the operations of banks over which they exercise jurisdiction. They have the authority to approve or disapprove the establishment of branches, mergers, consolidations, and other similar corporate actions, and to prevent the continuance or development of unsafe or unsound banking practices and other violations of law. The Federal Reserve and the NCCOB regulate and monitor all areas of the operations of banks and their subsidiaries, including loans, mortgages, issuances of securities, capital adequacy, loss reserves, and compliance with the Community Reinvestment Act of 1977 (the “CRA”), as well as other laws and regulations. Interest and certain other charges collected and contracted for by banks are also subject to state usury laws and certain federal laws concerning interest rates.

Insurance Assessments

The deposit accounts of the Bank are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to a maximum of $250,000 per insured depositor. Any insured bank that is not operated in accordance with or does not conform to FDIC regulations, policies, and directives may be sanctioned for noncompliance. Civil and criminal proceedings may be instituted against any insured bank or any director, officer or employee of such bank for the violation of applicable laws and regulations, breaches of fiduciary duties or engaging in any unsafe or unsound practice. The FDIC has the authority to terminate insurance of accounts pursuant to procedures established for that purpose.

The Bank is subject to insurance assessments imposed by the FDIC. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 and further amended by the Dodd-Frank Act.

Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. The FDIC's assessment rate calculator is based on a number of elements to measure the risk each institution poses to the DIF, and the assessment rate is applied to average consolidated total assets minus average tangible equity, as defined under the Dodd-Frank Act. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. The Dodd-Frank Act also changed the minimum designated reserve ratio of the DIF, requiring the fund reserve ratio to reach 1.35% by September 30, 2020 (rather than 1.15% by the end of 2016).

Anti-Money Laundering and OFAC Regulation

Governmental policies on financial institutions in recent years have been aimed at combating money laundering and terrorist financing. The Bank Secrecy Act of 1970 ("BSA") and subsequent laws and regulations require financial institutions to take steps to prevent the use of its systems from facilitating the flow of illegal or illicit money or terrorist funds. The USA Patriot Act of 2001 is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat money laundering and terrorist financing. Title III of the USA Patriot Act of 2001 contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFA”). The anti-money laundering provisions of IMLAFA impose affirmative obligations on a broad range of financial institutions, including banks, brokers, and dealers. Among other requirements, IMLAFA requires all financial institutions to establish anti-money laundering programs that include, at minimum, internal policies, procedures, and controls; specific designation of an anti-money laundering compliance officer; ongoing employee training programs; and an independent audit function to test the anti-money laundering program. IMLAFA requires financial institutions that establish, maintain, administer, or manage private banking accounts for non-United States persons or their representatives to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering. Additionally, IMLAFA provides for the Department of Treasury to issue minimum standards with respect to customer identification at the time new accounts are opened.

Additional rules were finalized in 2016 and must be implemented by May 2018 that create expanded obligations regarding customer due diligence and the identification of beneficial owners of business entities. An institution subject to the BSA, such as the Bank, must provide anti-money laundering training to employees, designate an anti-money laundering compliance officer and annually audit the anti-money laundering program to assess its effectiveness. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. Based on their administration by the United States Department of the Treasury's Office of Foreign Assets Control ("OFAC"), these are typically known as the OFAC rules. Generally, the OFAC rules contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, and (ii) blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to United States jurisdiction. Blocked assets cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure of a financial institution to maintain and implement adequate BSA, IMLAFA and OFAC programs, or to comply with all the relevant laws and regulations, could have serious legal and reputational consequences for the institution and result in material fines and sanctions.

As of the date of this filing, we believe that BSA, IMLAFA and OFAC rules have not had a material impact on the Bank’s operations. The Bank has established policies and procedures to ensure compliance with BSA, IMLAFA and OFAC, which are overseen, in part, by an Anti-Money Laundering Officer who was appointed by our Board of Directors.

Community Reinvestment Act

Banks are also subject to the CRA, which requires the appropriate federal bank regulatory agency, in connection with its examination of a bank, to assess such bank's record in meeting the credit needs of the community served by that bank, including low and moderate-income neighborhoods. Each institution is assigned one of the following four ratings of its record in meeting community credit needs: “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The regulatory agency's assessment of a bank's record is made available to the public and our most recent examination returned a rating of satisfactory. Further, such assessment is required of any bank which has applied to (i) charter a national bank, (ii) obtain deposit insurance coverage for a newly chartered institution, (iii) establish a new branch office that will accept deposits, (iv) relocate an office or (v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application.

In addition, the GLBA’s “CRA Sunshine Requirements” call for financial institutions to disclose publicly certain written agreements made in fulfillment of the CRA. Banks that are parties to such agreements also must report to federal regulators the amount and use of any funds expended under such agreements on an annual basis, along with such other information as regulators may require. This annual reporting requirement is effective for any agreements made after May 12, 2000.

Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) provides for, among other things, (i) publicly available annual financial condition and management reports for certain financial institutions, including audits by independent accountants, (ii) the establishment of uniform accounting standards by federal banking agencies, (iii) the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with greater scrutiny and restrictions placed on depository institutions with lower levels of capital, (iv) additional grounds for the appointment of a conservator or receiver and (v) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements. FDICIA also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums.

A central feature of FDICIA is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to FDICIA, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.” An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity. Institutions that fail to comply with capital or other standards are restricted in the scope of permissible activities and are subject to enforcement action by the federal banking agencies.

Written Agreement

In July 2015, the Bank entered into a Written Agreement (the "2015 Written Agreement") with the Federal Reserve Bank of Richmond (the "FRB") replacing the Written Agreement the Company and the Bank entered into with the FRB and the NCCOB in May 2011. Under the terms of the 2015 Written Agreement, the Bank submitted and implemented the following plans:

•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; and


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

In addition, the Bank agreed that within 30 days after the end of each calendar quarter following the date of the 2015 Written Agreement, it will 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 each of these areas and believes it is currently in full compliance with the provisions of the agreement.

Consumer Laws and Regulations

The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, Real Estate Settlement Procedures Act, Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Fair Housing Act and the Servicemembers Civil Relief Act. The laws and related regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.

Transactions with Affiliates

Pursuant to Sections 23A and 23B of the Federal Reserve Act, Regulation W and Regulation O, the authority of the Bank to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. An affiliate of a bank is any company or entity which controls, is controlled by or is under common control with such bank. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Bank and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Bank generally may not purchase securities issued or underwritten by affiliates.

Loans to Directors, Executive Officers and Principal Shareholders

State member banks also are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act and Regulation O on loans to executive officers, directors and principal shareholders. Under Section 22(h), loans to a director, executive officer and to a greater than 10% shareholder of a bank and certain affiliated interests of such persons, may not exceed, together with all other outstanding loans to such person and affiliated interests, the institution’s loans-to-one-borrower limit and all loans to such persons may not exceed the institution’s unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and greater than 10% shareholders of a depository institution, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the institution with any “interested” director not participating in the voting. Regulation O prescribes the loan amount (which includes all other outstanding loans to such person) as to which such prior board approval is required as being the greater of $25,000 or 5% of capital and surplus (or any loans aggregating $500,000 or more). Further, Section 22(h) requires that loans to directors, executive officers and principal shareholders generally be made on terms substantially the same as offered in comparable transactions to other persons. Section 22(h) also generally prohibits a depository institution from paying the overdrafts of any of its executive officers or directors.

Banks are also subject to the requirements and restrictions of Regulation O on loans to executive officers. Section 22(g) of the Federal Reserve Act requires approval by the board of directors of a depository institution for such extensions of credit and imposes reporting requirements for and additional restrictions on the type, amount and terms of credits to such officers. In addition, Section 106 of the BHCA prohibits extensions of credit to executive officers, directors, and greater than 10% shareholders of a depository institution by any other institution which has a correspondent banking relationship with the institution, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features.

Capital Requirements

The Federal Reserve has established risk-based capital guidelines for bank holding companies and state member banks. The minimum standard for the ratio of capital to risk-weighted assets (including certain off balance sheet obligations, such as standby letters of credit) is 8%. At least half of this capital must consist of common equity, retained earnings and a limited amount of perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill items and certain other items (“Tier 1 capital”). The remainder (“Tier 2 capital”) may consist of mandatory convertible debt securities and a limited amount of other preferred stock, subordinated debt and loan loss reserves.

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets less certain amounts (“Leverage Ratio”) equal to 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a Leverage Ratio of between 4% and 5%.

The guidelines also provide that bank holding companies experiencing significant growth, whether through internal expansion or acquisitions, will be expected to maintain strong capital ratios well above the minimum supervisory levels without significant reliance on intangible assets. The same heightened requirements apply to bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as to other banking institutions if warranted by particular circumstances or the institution's risk profile. Furthermore, the guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 Leverage Ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve has not advised us of any specific minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable to us.

In early July 2013, the Federal Reserve approved revisions to their capital adequacy guidelines and prompt corrective action rules that implement the revised standards of the Basel Committee on Banking Supervision (“Basel III”) and address relevant provisions of the Dodd-Frank Act. Basel III and the regulations of the federal banking agencies require bank holding companies and banks to undertake significant activities to demonstrate compliance with the higher capital standards. These new minimum capital requirements, which became effective for the Company and the Bank on January 1, 2015, require a common equity Tier 1 risk-adjusted, Tier 1 risk-adjusted, total regulatory capital and leverage ratio of 4.5%, 6.0%, 8.0%, and 4.0%, respectively. The new capital standards also revise the definitions and components of regulatory capital and include other requirements that phase in over time. One of these requirements includes the implementation of a capital conservation buffer which will require banks to hold an additional 2.5% above the minimum capital thresholds or limitations will be placed on dividends, distributions, and executive compensation. The buffer was phased in beginning at 0.625% as of January 1, 2016, increasing each year and reaching the target 2.5% on January 1, 2019. We expect these changes to have little impact on the Company and Bank.

As of December 31, 2016, the Company had common equity Tier 1 risk-adjusted, Tier 1 risk-adjusted, total regulatory capital and Tier 1 leverage capital of approximately 10.9%, 12.2%, 15.6% and 9.5%, respectively. At December 31, 2016, the Bank had common equity Tier 1 risk-adjusted, Tier 1 risk-adjusted, total regulatory capital and leverage capital of approximately 14.1%, 14.1%, 15.4% and 11.0%, respectively, of which all are materially greater than the minimum requirements to be considered well capitalized.

Dividends

Under the North Carolina Business Corporation Act (the "NCBCA"), the Bank may not pay a dividend or distribution, if after giving it, the effect would be that the Bank would not be able to pay its debts as they become due in the usual course of business or its total assets would be less than its liabilities. North Carolina banking law requires that the Bank may not pay a dividend that would reduce its capital below the applicable required capital. The Federal Reserve also imposes limits on the Bank's payment of dividends. All dividends paid by the Bank are paid to the Company, the sole shareholder of the Bank.

Additionally, under Basel III capital requirements, banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. The amount of future dividends paid by the Bank will be determined based on a number of factors including capital position and capital adequacy, ongoing operations and profitability, the risk profile of the institution and general market conditions.

During 2016, we paid no cash dividends on our common stock. In general, our ability to pay cash dividends is dependent in part upon the amount of dividends paid to us by the Bank. No dividends were paid to us by the Bank during 2016. In the past, we have received cash dividends from the Bank and may continue to do so from time to time in the future as necessary for cash flow purposes. Also, applicable federal banking law contains additional limitations and restrictions on the payment of dividends by a bank holding company. Accordingly, shareholders receive dividends from us only to the extent that funds are available from our operations or the Bank. In addition, the Federal Reserve generally prohibits bank holding companies from paying dividends unless the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition.

Monetary Policy and Economic Controls

Both the Company and the Bank are directly affected by governmental policies and regulatory measures affecting the banking industry in general. Of primary importance is the Federal Reserve Board, whose actions directly affect the money supply which, in turn, affects banks’ lending abilities by increasing or decreasing the cost and availability of funds to banks. The Federal Reserve Board regulates the availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in United States government securities, changes in the discount rate on member bank borrowings, changes in reserve requirements against bank deposits, and limitations on interest rates that banks may pay on time and savings deposits.

Executive Officers of the Registrant

The following table sets forth certain information with respect to our executive officers:



Name	Age	Year first employed	Positions and Offices with our Company & Business Experience During Past Five (5) Years
David H. Rupp	53	2014	Director, Chief Executive Officer and President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Mr. Rupp became the President of the Company and the Bank in March 2015 and Chief Executive Officer in July 2015 after serving as Executive Vice President from September 2014 to March 2015 and Chief Operating Officer from September 2014 to July 2015. Mr. Rupp joined the Company and the Bank as Senior Vice President, Strategic Project Manager in June 2014. Prior to joining the Company and the Bank, he most recently served as Retail Banking and Mortgage President of VantageSouth Bank from 2012 to 2014. From 2009 to 2011, Mr. Rupp served as Chief Executive Officer of Greystone Bank and, from 2008 to 2009, he served as Senior Executive Vice President of Regions Financial Corporation. Prior to his employment with Regions Financial Corporation, Mr. Rupp held various positions at Bank of America and First Union Corporation.
Deanna W. Hart	39	2003	Executive Vice President, Chief Financial Officer of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company. Ms. Hart was appointed to her current position in September 2015. Prior to her appointment as Chief Financial Officer, Ms. Hart served as the Bank’s Senior Vice President and Controller since January 2014 and as acting CFO for the Company and the Bank beginning in September 2015. Prior to that, Ms. Hart served as the Bank’s Senior Vice President and Director of Internal Audit starting in January 2010. From 2005 to 2010, Ms. Hart served as Vice President and Senior Auditor and previously served as Assistant Vice President and Staff Auditor from 2003 to 2005.
Jeff D. Pope	60	1991	Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Chief Banking Officer of Four Oaks Bank & Trust Company. Mr. Pope has been an Executive Vice President of the Company and Chief Banking Officer of the Bank since January 2009. From 2005 until January 2009, he served as Executive Vice President and Branch Administrator, and from 2000 until 2005, he served as Senior Vice President and Regional Executive.



Lisa S. Herring	41	2002	Executive Vice President, Chief Operating Officer of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company and Chief Risk Officer of the Bank. Ms. Herring was named Chief Operating Officer of the Company and the Bank in December 2015. Ms. Herring has been an Executive Vice President of the Company and Chief Risk Officer of the Bank since July 2009. From 2005 until July 2009, Ms. Herring served as the Bank’s Senior Vice President and General Auditor. From 2002 until 2005, Ms. Herring served as the Bank’s Vice President and General Auditor.
Warren D. Herring, Jr.	47	2015	Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Chief Credit Officer of Four Oaks Bank & Trust Company. Mr. Herring joined the Company and the Bank in March 2015, initially serving as Chief Credit Officer on an acting basis until May 2015. Prior to joining the Company and the Bank, he most recently served as Chief Credit Officer and Executive Vice President of Premier Commercial Bank from August 2010 until March 2015. From 2008 until 2010, Mr. Herring served as Senior Credit Administration Manager of CommunityOne Bank and, from 2007 to 2008, he served as Senior Regional Risk Manager of RBC Bank. Prior to his employment with RBC Bank, Mr. Herring held positions at First National Bank and Trust Company and Central Carolina Bank.
Lawrence F. DesPrés	53	2016	Executive Vice President of Four Oaks Fincorp, Inc. and Four Oaks Bank & Trust Company, Chief Information Officer of Four Oaks Bank & Trust Company. Mr. DesPrés joined the company and the bank in April 2016. Prior to joining the company and the bank, he most recently served as IT Director of Community & Southern Bank in Atlanta, Georgia from August 2014 to March 2016. From February 2011 to July 2013, Mr. DesPrés served as Chief Information Officer of LoneStar National Bank in McAllen, Texas and from January 2010 to February 2011, he served as Chief Technology Officer of City National Bank in Miami, Florida. Prior to his employment with City National Bank, Mr. DesPrés served as IT Director of United Community Bank in Blairsville, Georgia from February 2002 to August 2009.

Available Information

We maintain a website at www.fouroaksbank.com where our periodic reports on Form 10-Q and 10-K and our current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available under “Investor Relations.” We are registered as a bank holding company with the Federal Reserve System. Additionally, we are a state-chartered member of the Federal Reserve System and the FDIC insures the Bank’s deposits up to applicable limits. Our corporate offices are located at 6114 US 301 South, Four Oaks, North Carolina, 27524. Our common stock is traded on the OTC Market's OTCQX tier (the "OTCQX") under the symbol “FOFN”.

Item 1A. Risk Factors

Risk Related to Our Business

We are exposed to risks in connection with the loans we make, and may not be able to prevent unexpected losses which could adversely impact our results of operations.

A significant source of risk for us arises from the possibility that loan losses will be sustained because borrowers, guarantors, and related parties fail to perform in accordance with the terms of their loans. Our policy dictates that we maintain an allowance for loan losses. The amount of the allowance is based on management’s evaluation of our loan portfolio, the financial condition of the borrowers, current economic conditions, past and expected loan loss experience, and other factors management deems appropriate. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations.

With most of our loans concentrated in the central region of North Carolina, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. In addition to the financial strength and cash flow characteristics of the borrower in each case, the Bank often secures loans with real estate collateral. If the value of real estate in our core market areas were to decline materially, a significant portion of our loan portfolio could become under collateralized, which could have a material adverse effect on us. At December 31, 2016, approximately 94% of the Bank's loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

Our loan portfolio consists primarily of loans secured by residential and commercial real estate.

We are subject to risk with respect to our residential and commercial real estate loan portfolios, both of which represent a large percentage of our total loan portfolio. As of December 31, 2016, we had $133.0 million or 26% of the portfolio in residential mortgage loans and $341.9 million or 67% in commercial real estate loans, including non-owner occupied, owner occupied, acquisition, development, and construction loans.

We originate fixed and adjustable rate loans secured by one- to four-family residential real estate. The residential loans in our loan portfolio are sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. Residential loans with high combined loan-to-value ratios generally are more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, the borrowers may be unable to repay their loans in full from the sale proceeds. As a result, these loans may experience higher rates of delinquencies, defaults and losses, which could in turn adversely affect our financial condition and results of operations.

We extend real estate land loans, construction loans, and acquisition and development loans to builders and developers, primarily for the construction/development of properties. We originate these loans on both a presold and speculative basis and they include loans for both residential and commercial purposes. At December 31, 2016, our loan portfolio was comprised of $88.8 million of acquisition, development, and construction loans which totaled 17% of total loans and $1.7 million or 28% of our nonperforming assets at December 31, 2016.

In general, construction and land lending involves additional risks because of the inherent difficulty in estimating a property’s value both before and at completion of the project. Construction costs may exceed original estimates as a result of increased materials, labor, or other costs. In addition, because of current uncertainties in the residential and commercial real estate markets, property values have become more difficult to determine than they have been historically. Construction and land acquisition and development loans often involve the repayment dependent, in part, on the ability of the borrower to sell or lease the property. These loans also require ongoing monitoring. In addition, speculative construction loans to residential builders are often associated with homes that are not presold, and thus pose a greater potential risk than construction loans to individuals on their personal residences. At December 31, 2016, $30.0 million or 70% of our residential construction loans were for speculative construction loans.

We also originate owner and non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve repayment dependent upon income generated, or expected to be generated, from the business which occupies the property which may be adversely affected by changes in the economy or local market conditions. Commercial real estate loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. Additionally, non-owner occupied commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on non-owner occupied commercial real estate loans may be larger on a per loan basis than those incurred with other segments in the loan portfolio. As of December 31, 2016, our owner occupied commercial real estate loans totaled $94.3 million or 19% of our total loan portfolio and non-owner occupied commercial real estate loans, excluding acquisition, development, and construction loans, totaled $158.7 million, or 31%.

Our allowance for probable loan losses may be insufficient.

We maintain an allowance for probable loan losses, which is a reserve established through a provision for probable loan losses charged to expense. This allowance represents management’s best estimate of probable losses based on those that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality and trends; present economic, political, and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for probable loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates and assumptions regarding current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside our control, may require an increase in the allowance for probable loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for probable loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for probable loan losses; we will need additional provisions to increase the allowance for probable loan losses. Any increases in the allowance for probable loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Notes A and D to our consolidated financial statements presented under Item 8 of Part II of this Form 10-K, for further discussion related to our process for determining the appropriate level of the allowance for probable loan losses.

We are subject to interest rate risk.

Like most financial institutions, our most significant market risk exposure is the risk of economic loss resulting from adverse changes in market prices and interest rates. Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Open Market Committee. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Rates have been historically low for a long period of time and at this point, should rates rise steadily, the environment would be different than that which the Bank has been operating in for the last decade. This change could pressure our margins if we are unable to adjust our business practices. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our business, financial condition and results of operations.

Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations.

Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. We are subject to regulations of the FRB, the FDIC, the CFPB and the State of North Carolina. Our business is highly regulated and the laws and applicable regulations are subject to frequent change. Changes to statutes, regulations, or regulatory policies, including interpretation and implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer or increasing the ability of non-banks to offer competing financial services and products. While we cannot predict the extent to which legislation will be enacted or the extent we will become subject to increased regulatory scrutiny by any of these regulatory agencies, any regulatory changes or scrutiny could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations, and other institutions.

We are also subject to the accounting rules and regulations of the Securities and Exchange Commission (the "SEC") and the Financial Accounting Standards Board (the "FASB"). Changes in accounting rules could adversely affect our reported financial statements or our results of operations and may also require extraordinary efforts or additional costs to implement. Any of these laws or regulations may be modified or changed from time to time, and we cannot be assured that such modifications or changes will not adversely affect us.

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, written agreements, 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 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.

The Bank has made progress in improving each of the areas noted in the 2015 Written Agreement and believes it is in full compliance with the provisions of the agreement. However, there can be no assurance that the Bank will maintain full compliance with the terms of the agreement in the future and that the agreement 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 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.

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any failure, interruption, or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that we can prevent any such failures, interruptions or security breaches. The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

Inadequate resources to make technological improvements may impact our business.

The banking industry undergoes frequent technological changes with introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in continuous technological improvements than we do. We may not be able to quickly deploy these new products and services or be successful in marketing these products and services to our customers. Additionally, the implementation of changes and maintenance to current systems may cause service interruptions, transaction processing errors and system conversion delays. Failure to successfully keep pace with technological change affecting the banking industry while avoiding interruptions, errors and delays could have a material adverse effect on our business, financial condition or results of operations.

We continuously monitor our operational and technological capabilities and make modifications and improvements when we believe it will be cost effective to do so. We generally outsource a portion of these modifications and improvements to third parties and they may experience errors or disruptions that could adversely impact us and over which we may have limited control. We also face risk from the integration of new infrastructure platforms and/or new third party providers of such platforms into our existing businesses.

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

As of December 31, 2016 and December 31, 2015, we had a deferred tax asset of $18.5 million and $20.7 million, a valuation allowance of $87,000 and $3.8 million, and a deferred tax liability of $220,000 and $263,000, respectively. 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. During the fourth quarter of 2016, based on improving performance and the Company's determination that sufficient future taxable income would be generated, the Company realized substantially all of the remaining valuation allowance. 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. While the reversal of the valuation allowance in the fourth quarter added to GAAP capital, 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 the 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.

The value of our deferred tax asset may be adversely affected by changes in U.S. tax and other laws and regulations.

The United States Congress and the President’s Administration have indicated an interest in reforming the internal revenue code. Possible approaches include lowering the corporate income tax rate and limiting or eliminating various other deductions, tax credits, and other tax preferences. Our deferred tax asset is carried at its value based on the current rates within the tax code and therefore its value may be adversely affected by such changes to the internal revenue code. It is not possible at this time to determine what changes may be made and to quantify either the one-time impacts from the re-measurement of our deferred tax assets and liabilities that might result from tax reform or the ongoing impact reform proposals might have on income tax expense, though any impact on Tier I Capital is currently forecast to be modest.

Pending or future litigation could adversely affect our financial condition, results of operations and cash flows.

We are from time to time party to various legal actions in the course of our business and an adverse outcome in such litigation could adversely affect our business, financial condition and results of operations. Refer to Part I, Item 3, Legal Proceedings, of this Annual Report on Form 10-K for further information regarding our litigation.

Our profitability may be impacted by the economic conditions of our principal operating regions.

The majority of our customers are individuals and small to medium-size businesses located in North Carolina’s Johnston, Wake, Duplin, Sampson, and Harnett counties and surrounding areas. As a result of this geographic concentration, our results may correlate to the economic conditions in these areas. Declines in these markets’ economic conditions may adversely affect the quality of our loan portfolio and the demand for our products and services, and accordingly, our results of operations.

We may not be able to effectively compete with larger financial institutions for business.

Commercial banking in North Carolina is extremely competitive due in large part to North Carolina’s early adoption of statewide branching. The Bank competes in the North Carolina market area with some of the largest banking organizations in the state and the country and other financial institutions, such as federally and state-chartered savings and loan institutions and credit unions, as well as consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of these competitors have broader geographic markets, higher lending limits, more services, and more media advertising. We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition.

Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that historically would have been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. Additionally, our customer base of consumers and small businesses has increasing non-bank options for credit. With the advent of credit delivery through the Internet, competition for small balance loans is expected to increase. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

We may not be able to attract and retain skilled people and the lack of sufficient talent could adversely impact our operations.

Our success depends in part on our ability to retain key executives and to attract and retain additional qualified management personnel who have experience both in sophisticated banking matters and in operating a small to mid-size bank. Competition for such personnel is strong in the banking industry and we may not be successful in attracting or retaining the personnel we require. Consequently the loss of one or more members of our executive management team may have a material adverse effect on our operations. We expect to compete effectively in this area by offering competitive financial packages that include incentive-based compensation.

The Consent Order with the Department of Justice could adversely affect us.

On May 20, 2013, the U. S. Department of Justice (the "DOJ") issued a subpoena to the Bank requiring the production of documents in connection with an investigation of consumer fraud related to third party payment processing. In connection with this investigation, the Bank negotiated a civil settlement with the DOJ (the "Consent Order"), which was filed with the United States District Court for the Eastern District of North Carolina (the “District Court”) on January 8, 2014. The Consent Order was filed contemporaneously with the filing of a complaint by the DOJ alleging violation of a variety of laws, including money laundering laws. The Consent Order was approved by the District Court on April 26, 2014. As part of the terms of the Consent Order, the Bank agreed to pay a civil monetary penalty in the amount of $1 million, plus a civil forfeiture in the amount of $200,000 and terminated its relationship with a certain third party payment processor (“TPPP”) and ceased providing bank accounts and banking services to such TPPP’s client originators. The Company has maintained compliance with the terms of the Consent Order since entering into it in March 2014. We expect that we will remain in compliance going forward; however, should we fail to remain in compliance, a material failure to comply with the terms of the Consent Order could subject us to additional enforcement action and further restrictions on our business.

We are subject to minimum capital thresholds established by our regulators as part of their implementation of Basel III.

In early July 2013, the Federal Reserve approved a final rule that implemented Basel III’s integrated regulatory capital framework. The Basel III capital rule substantially revised the risk-based capital requirements applicable to bank holding companies as well as depository institutions, including the Company and the Bank, compared to the previous U.S. risk-based capital rules. The Basel III capital rule defines the components of capital and addresses other issues affecting the numerator in banking institutions’ regulatory capital ratios. The Basel III capital rule also addresses risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replaced the previous risk-weighting approach, which was derived from the Basel I capital accords of the Basel Committee on Banking Supervision, with a more risk-sensitive approach based, in part, on the standardized approach in the Basel Committee on Banking Supervision’s 2004 Basel II capital accords. The Basel III rule modified the regulatory minimum risk-based capital ratios and also established a capital conservation buffer to be maintained above the new regulatory minimums. In January 2016, the capital conservation buffer began its phase in and will be fully implemented in January 2019. Institutions that do not maintain the required capital conservation buffer are subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount. The Basel III capital rule also implemented the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules. The Basel III capital rule became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period). Although the implementation of Basel III has not had and is not expected to have, once fully phased in, a material impact on the capital ratios of the Company and the Bank, there can be no assurance of this and any future changes to capital requirements may have such an effect.

We may be subject to environmental liability associated with our lending activities.

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

Risk Related to Our Common Stock

An investment in our common stock is not an insured deposit, and as with any stock, inherent market risk may cause you to lose some or all of your investment.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

Our common stock is thinly traded.

Our common stock is traded on the OTCQX. There can be no assurance, however, that an active trading market for our common stock will develop or be sustained in the future. Our common stock is thinly traded and has substantially less liquidity than the average trading market for many other publicly traded companies. Thinly traded stocks can be more volatile than stock trading in an active public market. Our stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to changes in analysts’ recommendations or projections, our announcement of developments related to our business, operations, and stock performance of other companies deemed to be peers, news reports of trends, concerns, irrational exuberance on the part of investors and other issues related to the financial services industry. Over the past several years, the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies, including those in the financial services sector, have experienced wide price fluctuations that have not necessarily been related to operating performance. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector of the economy, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Therefore, our shareholders may not be able to sell their shares at the volume, prices, or times that they desire.

A single shareholder owns over 47% of the outstanding shares of the Company.

A single shareholder, Kenneth R. Lehman, owns over 47% of the outstanding shares of the Company. In addition, Mr. Lehman currently serves on the Company's Board of Directors. Because of the percentage of our common stock held by Mr. Lehman, he may be able to influence the outcome of any matter submitted to a vote of our shareholders and his interests may not align precisely with the interests of the other holders of our common stock.

Our ability to pay dividends and interest on our outstanding securities may be limited.

Our ability to pay cash dividends on our common stock may be limited by regulatory restrictions, by the Bank's ability to pay cash dividends to the Company, and by our need to maintain sufficient capital to support our operations. We have not paid any cash dividends on our common stock since we suspended dividends in the fourth quarter of 2010. As a bank holding company, our ability to declare and pay dividends depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends. A decision to pay any dividend in the future would be determined based on a number of factors including, but not limited to, capital position and capital adequacy, ongoing operations and profitability, the risk profile of the institution and general market conditions, among other things. Holders of our common stock are entitled to receive dividends only when and if declared by the Board of Directors. No assurance can be given, therefore, that cash dividends on our common stock will be paid in the future.

In addition, our subordinated debentures and subordinated promissory notes are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures (and the related trust preferred securities) and subordinated promissory notes before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution, or liquidation, the holders of the debentures and promissory notes must be satisfied before any distributions can be made to the holders of common stock. Pursuant to the terms of the indenture governing the subordinated debentures, we may not pay any cash dividends on our common stock until we are current on interest payments on such subordinated debentures.

Our announced share repurchase program could affect the price of our common stock and increase volatility and may be suspended or terminated at any time, which may result in a decrease in the trading price of our common stock.

In March 2017, we announced that the Board authorized a share repurchase program. The Company may effect repurchases under the program from time to time in the open market or in private transactions. The timing and actual number of shares repurchased under the share repurchase program will be based on the Company’s evaluation of market conditions and other factors. Repurchases pursuant to such program could affect our stock price and increase its volatility. The existence of a share repurchase program could also cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. There can be no assurance that any share repurchases will occur or that if they do, that they will enhance shareholder value as the market price of our common stock may decline below the levels at which we repurchased shares of common stock. In addition, short-term stock price fluctuations could reduce the program’s effectiveness.

Item 1B – Unresolved Staff Comments.

Not applicable.

Item 2 - Properties.

The Bank owns its main office, which is located at 6144 US 301 South, Four Oaks, North Carolina. The main office, which was constructed by the Bank in 1985, is a 12,000 square foot facility on 1.64 acres of land. The Bank owns a 5,000 square foot facility renovated in 1992 on 1.15 acres of land located at 5987 US 301 South, Four Oaks, North Carolina, which houses its training center. The Bank also owns a 15,000 square foot facility built in 2000 located at 6114 US 301 South, Four Oaks, North Carolina, which houses its administrative offices, data operations, loan operations, and wide area network central link. In addition, the Bank owns the following:



Properties Owned

Location	Year Built/Acquired	Present Function	Square Feet
102 East Main Street Clayton, North Carolina	1986	Branch Office	4,900

200 East Church Street Benson, North Carolina	1987	Branch Office	2,300

128 North Second Street Smithfield, North Carolina	1991	Branch Office	5,500

403 South Brightleaf Boulevard Smithfield, North Carolina	1995	Limited-Service Facility	860

200 Glen Road Garner, North Carolina	1996	Branch Office	3,500

325 North Judd Parkway Northeast Fuquay-Varina, North Carolina	2002	Branch Office	8,900

406 East Main Street Wallace, North Carolina	2006	Branch Office	9,300

805 N. Arendell Avenue Zebulon, North Carolina	2007	Branch Office	6,100

105 Commerce Avenue Southern Pines, North Carolina	2005	Vacant	4,100

115 Four Oaks Place Dunn, North Carolina	2016	Branch Office	3,994

On March 21, 2013, the Bank renewed the lease on the Holly Springs branch office located at 201 West Center Street, Holly Springs, North Carolina for a five year term. Under the terms of the lease, the Bank pays $3,165 per month for the period beginning April 1, 2016 through March 31, 2017 with an annual rate increase of 3.0%. The Bank’s Harrells office located at 590 Tomahawk Highway, Harrells, North Carolina is under a lease with terms specifying the Bank will pay $600 each month for periods of one year duration until the lease is terminated by one of the parties. During the first quarter of 2017, the Bank provided notification of termination for the Harrells office lease which will terminate on December 31, 2017. In addition, the Bank has a lease on the building at 1408 Garner Station Boulevard, Raleigh, North Carolina which expires on June 30, 2022. The Bank pays $13,947 each month from June 2016 until May 2017, with a 2.5% increase each consecutive year thereafter, until expiration on June 30, 2022. On September 30, 2014, the Bank entered into a three year lease on its Raleigh loan production office located at 5909 Falls of the Neuse Road, Raleigh, North Carolina. Under the terms of the lease, the Bank will pay $2,000 each month for the period beginning November 1, 2014 and ending October 31, 2017. The Bank also has a two year lease which went into effect on May 1, 2015, on its Apex loan production office located at 1091 Investment Boulevard, Apex, North Carolina. Under the terms of the lease, the Bank pays $2,151 each month for the period beginning May 1, 2016 through April 30, 2017 with an annual rate increase of 3.0%. Following is a summary of leased properties.



Properties Leased

Location		Present Function
201 West Center Street Holly Springs, North Carolina		Branch Office

590 Tomahawk Highway Harrells, North Carolina		Branch Office

1408 Garner Station Boulevard Raleigh, North Carolina		Branch Office

5909 Falls of Neuse Raleigh, North Carolina		Loan Production Office

1091 Investment Boulevard Apex, North Carolina		Loan Production Office

Management believes each of the properties referenced above are adequately covered by insurance. At December 31, 2016, the net book value for our properties, including land, buildings, and furniture and equipment was $12.2 million of which $2.4 million were classified as held for sale. Additional information is disclosed in Note E - Bank Premises and Equipment to our consolidated financial statements presented under Item 8 of Part II of this Form 10-K.

Item 3 - Legal Proceedings

In October 2013, multiple putative class action lawsuits were filed in United States district courts across the country against a number of different banks based on the banks’ alleged role in “payday lending.” As previously disclosed, two of these lawsuits, filed in the Middle District of North Carolina and the Southern District of Florida, named the Bank as one of the defendants. In December 2016, pursuant to a confidential settlement agreement, the parties filed stipulations of dismissal with prejudice as to both lawsuits.

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 4 - Mine Safety Disclosures

Not applicable.

PART II

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

Our common stock trades on the OTCQX under the symbol “FOFN.” Prior to February 2, 2015, our common stock traded on the OTC Bulletin Board under the same symbol. As previously disclosed, the Company completed the Reverse Stock Split on March 8, 2017, at which time every five shares of the Company’s common stock issued and outstanding were consolidated into one issued and outstanding share of common stock. As a result, on March 9, 2017, our common stock began trading under the symbol "FOFND" for 20 business days in order to reflect the Company's completion of the Reserve Stock Split. After this time period has elapsed, the Company's symbol will return to "FOFN".

The range of high and low bid prices of our common stock for each quarter during the two most recent fiscal years, as published by the OTC Bulletin Board and OTCQX, adjusted to reflect the Reverse Stock Split, is as follows (prices reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions):



	Fiscal Year Ended December 31,
	2016				2015
	High		Low		High		Low
First quarter	$	9.60	$	8.75	$	8.60	$	7.00
Second quarter	$	10.75	$	9.25	$	8.35	$	7.10
Third quarter	$	11.85	$	10.25	$	9.40	$	7.60
Fourth quarter	$	14.40	$	11.05	$	9.15	$	8.00

As of March 29, 2017, the approximate number of holders of record of our common stock was 2,400. Holders of record are defined as those shareholders whose shares are registered in their names in our stock records and do not include beneficial owners of common stock whose shares are held in the names of brokers, dealers, or clearing agencies. We have no other issued class of equity securities. The Bank’s ability to declare a dividend to us and the Company’s ability to pay dividends are subject to the restrictions of the NCBCA. North Carolina banking law requires that the Bank may not pay a dividend that would reduce its capital below the applicable required capital. No dividends were paid to us by the Bank during 2015 or 2016. A decision to pay any dividend in the future would be determined based on a number of factors including (but not limited to) capital position and capital adequacy, ongoing operations and profitability, the risk profile of the institution, and general market conditions, among other things.

On March, 8, 2017, the Company also announced that the Board authorized a share repurchase program under which the Company is authorized to repurchase shares of its common stock in an amount not to exceed an aggregate value of $1,000,000. The program authorizes the Company to repurchase shares of the Company’s common stock until March 1, 2018 in open market or private transactions. The Company expects to use available cash to finance these purchases and will determine the timing and amount of share repurchases based on its evaluation of market conditions and other factors.

Item 6 - Selected Financial Data

Not applicable.

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

The following discussion and analysis provides information about the major components of our results of operations and financial condition, liquidity and capital resources and should be read in conjunction with our audited consolidated financial statements and notes thereto which are contained in this report.

Description of Business

As a community-focused commercial bank, our primary business consists of providing a full range of banking services to our customers with an emphasis on quality personal service. Our core products consist of loans secured by real estate, commercial and consumer loans, as well as various deposit products to meet our customers’ needs. Our primary source of income is generated from net interest margin, the difference between interest income received on our loans and securities and interest expense paid on deposits and borrowings. Our income is also affected by our ability to price our products competitively and maximize the interest rate spread between the interest yield on loans and securities and the interest rate paid on deposits and borrowings. Our products also generate other income through product related fees and commissions. We incur operating expenses consisting primarily of salaries and benefits, occupancy and equipment, technology and other professional and miscellaneous expenses. Refer to Item 1. Business, of this Annual Report on Form 10-K for a more detailed description of the business.

Recent Events

On March 8, 2017, the Company completed the Reverse Stock Split and the number of authorized shares of common stock was reduced from 80,000,000 to 16,000,000. No fractional shares were issued in connection with the Reverse Stock Split, and any fractional shares resulting from the Reverse Stock Split were rounded up to the nearest whole share. All share and share-related information presented in this Annual Report on Form 10-K have been retroactively adjusted to reflect the decreased number of shares resulting from the Reverse Stock Split.

Comparison of Financial Condition at December 31, 2016 and 2015

Overview

Total assets were $719.9 million at December 31, 2016 compared to $691.4 million at December 31, 2015, an increase of $28.5 million or 4.1%. Cash and cash equivalents were $32.6 million at December 31, 2016 compared to $26.8 million at December 31, 2015. The investment portfolio decreased $26.3 million or 19.4% during the twelve month period ended December 31, 2016, from $135.6 million at December 31, 2015, to $109.3 million at December 31, 2016. Strong loan demand offset the reductions in the investment portfolio resulting in growth of $48.7 million or 10.6% as outstanding gross loans grew to $507.0 million at December 31, 2016 compared to $458.3 million at December 31, 2015. Investments in life insurance totaled $20.0 million at December 31, 2016 compared to $14.8 million at December 31, 2015, an increase of $5.2 million, which was primarily due to a $5.0 million additional investment in life insurance executed in the fourth quarter of 2016.

Total liabilities were $651.9 million at December 31, 2016, an increase of $20.9 million or 3.3%, from $631.0 million at December 31, 2015. Total deposits increased $11.2 million or 2.1% during the twelve month period ended December 31, 2016, from $542.3 million at December 31, 2015, to $553.5 million at December 31, 2016. Demand, savings, and money market deposit accounts increased $40.0 million or 12.8% for the year ended December 31, 2016 totaling $352.3 million compared to $312.3 million as of December 31, 2015. This growth was offset by reductions in time deposits of $28.8 million or 12.5%, which totaled $201.3 million as of December 31, 2016 compared to $230.1 million at December 31, 2015. Long-term borrowings were $70.0 million at December 31, 2016 compared to $60.0 million at December 31, 2015. Total shareholders' equity increased $7.6 million or 12.6% ending the year at $68.0 million.

As of December 31, 2016, nonperforming assets had declined $2.4 million or 28.2% when compared to December 31, 2015. The Company’s ratio of nonperforming assets to regulatory Tier 1 capital plus the allowance has also improved during the year falling from 12% at December 31, 2015, to 7.9% at December 31, 2016.

Prior to 2010, for 73 consecutive years, we paid dividends (prior to 1997 when we reorganized into a holding company, it was our wholly-owned subsidiary, Four Oaks Bank & Trust Company, which paid dividends). We suspended dividends in the fourth quarter of 2010 due to losses for the year and continue to monitor our ability to pay dividends based on our risk profile, capital levels, and expected earnings.

The following table indicates the ratios for return on average assets and average equity, dividend payout, and average equity to average assets in addition to earnings (loss) per common share and book value per common share for the years ended December 31, 2016, 2015, and 2014:



	As of and for the Year Ended December 31,
Performance Ratios:	2016			2015			2014
Return on average assets	0.96		%	2.70		%	(0.50		)%
Return on average equity	10.74		%	38.60		%	(13.09		)%
Dividend payout ratio	0.00		%	0.00		%	0.00		%
Average equity to average assets	8.96		%	7.00		%	3.85		%
Earnings (Loss) per Common Share⁽¹⁾:
Basic earnings per common share	$	1.06		$	3.12		$	(1.20	)
Diluted earnings per common share	$	1.04		$	3.10		$	(1.20	)
Book Value per Common Share⁽¹⁾:
Book value per common share	$	10.06		$	8.99		$	6.36

⁽¹⁾ Per common share amounts used in the computation of basic and diluted earnings per common share, as well as book value per common share, were adjusted to reflect the Reverse Stock Split.

Investment Portfolio

Our investment portfolio as of December 31, 2016 consists of primarily residential mortgage-backed securities ("MBSs") and taxable municipal securities. The MBSs consist of fixed-rate mortgage securities underwritten and guaranteed by Ginnie Mae ("GNMA"), Fannie Mae ("FNMA") and Freddie Mac ("FHLMC") with the U.S. Department of the Treasury. In addition to economic and market conditions, our overall management strategy for our investment portfolio is determined by, among other factors, loan demand, deposit mix, liquidity and collateral needs, our interest rate risk position and the overall structure of our balance sheet.

Available for sale securities are reported at fair value and consist of taxable municipal securities, MBSs, and other debt securities. As of December 31, 2016, our available-for-sale investment portfolio consisted of $25.4 million in FNMAs and FHLMC MBSs, $20.0 million of taxable municipal securities, $11.7 million in GNMA MBSs, and $1.0 million of other debt securities.

Held-to-maturity securities are carried at book value and consist of taxable municipal securities and MBSs. As of December 31, 2016, we owned $46.0 million in GNMA MBSs, $3.4 million in taxable municipal securities, and $1.9 million in FNMA MBSs that are accounted for as held-to-maturity.

During 2016, total investments decreased $26.3 million or 19.4%. Cash received from sales and paydowns totaled $26.6 million of which $500,000 was deployed to purchase new securities and the remainder was used to fund loan growth.

Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary would result in permanent write-downs of the individual securities to their fair value. If we do not intend to sell the security prior to recovery and it is more likely than not we will not be required to sell the impaired security prior to recovery, the credit loss portion of the impairment is recognized in earnings and the remaining impairment is recognized in other comprehensive income. Otherwise, the full impairment loss is recognized in earnings. At December 31, 2016, management had the intent and ability to hold impaired securities and no impairment was evaluated as other than temporary. As a result, no other than temporary impairment losses were recognized during the twelve months ended December 31, 2016.

The valuations of investment securities, available-for-sale, at December 31, 2016, 2015 and 2014 were as follows (amounts in thousands):



	Available for Sale
	2016				2015				2014
	Amortized cost		Estimated fair value		Amortized cost		Estimated fair value		Amortized cost		Estimated fair value
Taxable Municipals	$	19,846	$	20,049	$	24,789	$	24,567	$	16,412	$	17,078
Mortgage-backed securities
GNMA	11,704		11,680		13,512		13,530		16,204		16,264
FNMA & FHLMC	25,684		25,412		32,024		31,673		30,992		30,858
Other debt securities	1,000		1,000		500		500		—		—
Equity securities	—		—		11		11		11		11
Total securities	$	58,234	$	58,141	$	70,836	$	70,281	$	63,619	$	64,211

Pledged securities			$	—			$	14,290			$	20,618

The valuations of investment securities, held-to-maturity, at December 31, 2016, 2015 and 2014 were as follows (amounts in thousands):



	Held to Maturity
	2016				2015				2014
	Amortized cost		Estimated fair value		Amortized cost		Estimated fair value		Amortized cost		Estimated fair value
Taxable Municipals	$	3,380	$	3,386	$	3,531	$	3,512	$	3,584	$	3,556
Mortgage-backed securities
GNMA	45,968		46,188		59,185		59,464		74,482		75,125
FNMA	1,857		1,878		2,638		2,657		3,517		3,561
Total securities	$	51,205	$	51,452	$	65,354	$	65,633	$	81,583	$	82,242

Pledged securities			$	28,429			$	47,031			$	81,225

The following table sets forth the carrying value of our available-for-sale investment portfolio at December 31, 2016 by expected maturities (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.



	Available for Sale
	Carrying Value
	Within 1 year		After 1 year through 5 years		After 5 years through 10 years		After 10 years		Total
Taxable Municipals	$	—	$	—	$	—	$	20,049	$	20,049
Mortgage-backed securities
GNMA	—		—		—		11,680		11,680
FNMA & FHLMC	—		—		—		25,412		25,412
Other debt securities	—		—		1,000		—		1,000
Total securities	$	—	$	—	$	1,000	$	57,141	$	58,141

The following table sets forth the weighted average yield (computed on a tax equivalent basis) by maturity of our available-for-sale investment portfolio at December 31, 2016 amortized cost:



	Available-for-Sale
	Weighted Average Yields
	Within 1 year		After 1 year through 5 years		After 5 years through 10 years		After 10 years		Total
Taxable Municipals	—	%	—	%	—	%	4.07	%	4.07	%
Mortgage-backed securities
GNMA	—	%	—	%	—	%	2.40	%	2.40	%
FNMA & FHLMC	—	%	—	%	—	%	1.60	%	1.60	%
Other debt securities	—	%	—	%	6.00	%	—	%	6.00	%
Total weighted average yields	—	%	—	%	6.00	%	2.62	%	2.68	%

The following table sets forth the carrying value of our held-to-maturity investment portfolio at December 31, 2016 by expected maturities (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.



	Held to Maturity
	Carrying Value
	Within 1 year		After 1 year through 5 years		After 5 years through 10 years		After 10 years		Total
Taxable Municipals	$	155	$	2,700	$	525	$	—	$	3,380
Mortgage-backed securities
GNMA	—		—		5,231		40,737		45,968
FNMA	—		—		1,857		—		1,857
Total securities	$	155	$	2,700	$	7,613	$	40,737	$	51,205

The following table sets forth the weighted average yield (computed on a tax equivalent basis) by maturity of our held-to-maturity investment portfolio at December 31, 2016 amortized cost:



	Held to Maturity
	Weighted Average Yields
	Within 1 year		After 1 year through 5 years		After 5 years through 10 years		After 10 years		Total
Taxable Municipals	2.46	%	3.36	%	3.90	%	—	%	3.40	%
Mortgage-backed securities
GNMA	—	%	—	%	2.61	%	2.06	%	2.12	%
FNMA	—	%	—	%	1.75	%	—	%	1.75	%
Total weighted average yields	2.46	%	3.36	%	2.49	%	2.06	%	2.19	%

Loan Portfolio

We have a loan policy in place that relates to loan administration, documentation, underwriting, approval, and reporting requirements for various types of loans. The policy is designed to comply with all applicable federal and state regulatory requirements and establishes minimum standards for the extension of credit. The lending policy also provides for pre-determined lending authorities for loan officers commensurate with their abilities and experience. In addition, the policy outlines guidelines for authorities for approval of credit requests at various lending amounts. This includes the Executive Loan Committee, comprised of the Chief Executive Officer, the Chief Credit Officer, and three non-management directors, and the Board of Directors, which reviews the larger requests beyond certain dollar limits and requests that fall under Regulation O. Approval authorities are under regular review and are subject to adjustment. Loan requests outside of standard policy or guidelines may be made on a case by case basis when justified, documented, and approved by the appropriate authority.

Underwriting criteria for all types of loans are prescribed within the lending policy. The following is a description of each loan type and related criteria.

Commercial Real Estate

Commercial real estate, including acquisition and development, and real estate construction makes up the largest segment of our loan portfolio. This segment is closely monitored at the management and Board level. Our Board of Directors receives reports on a quarterly basis detailing trends. Underwriting criteria and procedures for commercial real estate loans generally include:


•	Procurement of federal income tax returns and financial statements, preferably for the past three years if available, and related supplemental information deemed relevant.


•	Rent rolls, tenant listings, and other similar documents are requested as needed.


•	Detailed financial and credit analysis related to cash flow, collateral, the borrower’s capital and character, and the operational environment is performed and presented to the appropriate officer or committee for approval.


•	Cash flows from the project financed and aggregate cash flows of the principals and their entities generally should produce a minimum debt service coverage ratio of 1.25:1.


•	Cash or collateral equity injection by the applicant, ranging from 15% to 35% based on regulatory loan to value ratio limits, in order to meet minimum federal guidelines for each loan category.


•	Past experience of the investor in commercial real estate.


•	Past experience of the customer with the Bank.


•	Tangible net worth analysis of the borrower and any guarantors.


•	General and local commercial real estate conditions are monitored and considered in the decision-making process.


•	Alternative uses of the security are considered in the event of default.


•	Credit enhancements are utilized when necessary and desirable, such as the use of guarantors and take out commitments.


•	Non-construction real estate loans typically have a 15 to 20 year amortization with a five or seven year balloon payment. If appropriate, a loan may be set up as an interest only single payment if the identified repayment source coincides with the maturity.


•	Commercial construction projects generally require that an engineer or architect review the applicant’s cost figures for accuracy. In addition, all draw requests must be approved by either the engineer or architect for accuracy before payment is made.


•	On-site progress inspections are completed to protect the Bank.


•	Requests for residential construction loans are closely monitored at the contractor level and subdivision level for concentrations. A request is generally denied if either the predetermined builder’s concentration or Bank’s concentration limit has been attained.


•	Real estate construction loans are made for terms not to exceed 12 to 18 months for residential construction and 18 to 24 months for commercial construction.


•	Collateral is investigated using current valuations and is supplemented by the loan officer’s knowledge of the local market. Outside appraisals are completed by appraisers on the Bank’s approved list. The appraisals on loans greater than $250,000 are reviewed to ensure they are compliant with Uniform Standards of Professional Appraisal Practice.

Residential Real Estate

Residential real estate makes up the second largest segment of our loan portfolio and outstanding balances have generally been very stable, as a percentage of loans outstanding. Terms generally range up to 15 years with amortizations of up to 30 years. Underwriting criteria and procedures for residential real estate mortgage loans generally include:


•	Monthly debt payments of the borrower to gross monthly income should not exceed 45% with stable employment of two years.


•	Loan to value ratio limits of up to 90% of the appraised value.


•	A credit investigation, which includes an Equifax credit report with a Beacon score of at least 620.


•	Verification of income by various methods.


•	Appropriate insurance to protect the Bank, typically in the amount of the loan.


•	Flood certifications are procured.


•	Collateral is investigated using current valuations and is supplemented by the loan officer’s knowledge of the local market. Outside appraisals are completed by appraisers on the Bank’s approved list. The appraisals on loans greater than $250,000 are reviewed to ensure they are compliant with Uniform Standards of Professional Appraisal Practice.

Financial

Financial loans are secured by stocks, bonds, and mutual funds. Underwriting procedures and criteria for financial loans generally include:


•	Stock loans should be structured to coincide with the identified source of repayment.


•	The maximum loan to value ratio for stock listed for sale on the NYSE, AMEX, or NASDAQ is 85% of its market value.


•	Generally, stock loans should not exceed 60 months.

Agricultural

Crop production lending presents many risks to the lender because of weather uncertainty and fluctuations in commodity prices. Underwriting procedures and criteria for agricultural loans generally include:


•	The farmer should have the financial capacity to withstand at least one bad crop year.


•	The farmer must possess sufficient equity in equipment or farmland for the Bank to term, within acceptable collateral margins (ranging from 50% to 80%) and cash flow debt service coverage requirements (generally 1.25:1), any line outstanding after the sale of crops.


•	Farmers should meet certain qualitative criteria with respect to the farmer’s knowledge and experience.


•	For new customers, documentation on where the farmer previously banked and the circumstances underlying the new loan request.

Commercial Inventory and Accounts Receivable

Underwriting procedures and loan to value ratios for commercial inventory loans and accounts receivable loans generally include:


•	Up to 80% of eligible accounts receivable.


•	Up to 80% of the individually assigned accounts receivable. The customer assigns individual invoices, sometimes with shipping documents attached. These may be stamped or marked to show that they have been assigned to the Bank. The customer brings payments to the Bank for processing against individual invoices.


•	50% or less of the cost or market on materials and qualified finished goods, depending on their quality and stability.


•	0% on work-in-progress.

Installment Loans

These loans are predominantly direct loans to established customers of the Bank and primarily include the financing of automobiles, boats, and other consumer goods. The character, capacity, collateral, and conditions are evaluated using policy limitations. Installment loans are typically made for terms that do not exceed 60 months with any exceptions being documented. Installment loan underwriting criteria and procedures for such financing generally include:


•	Financial statements are generally required on all consumer loans secured by a primary residence, all unsecured loans of $10,000 or more, and all secured transactions of $50,000 or more.


•	Income verification is generally required on all consumer loans.


•	Past experience of the customer with the Bank.


•	A debt to income ratio that does not exceed 45%.


•	Stable employment record of two years.


•	Stable residency record of two years.


•	A Beacon score of at least 620.


•	Terms to match the usefulness or life of the security.


•	If unsecured, the total unsecured loans of the applicant should not exceed 15% of adjusted net worth or 20% of the applicant’s gross annual income.

Interest Only Loans

Interest only loans are generally limited to construction lending, properties recently completed and undergoing occupancy stabilization period, and revolving lines of credit. Any other loans made as interest only should have a reason and proper approval.

Bank policy generally prohibits underwriting negative amortization loans or hybrid loans.

The following loan table describes our loan portfolio composition by segment based on the loan classifications discussed in Note D - Loans and Allowance for Loan Losses to the financial statements for December 31, 2016, 2015, 2014, 2013, and 2012 (amounts in thousands):



	Loan Portfolio Classification
	2016			2015			2014			2013			2012
Loans receivable:
Commercial and industrial	$	21,742		$	23,163		$	24,286		$	25,858		$	28,377
Commercial construction and land development	46,114			50,510			53,642			66,253			90,899
Commercial real estate	253,086			208,737			200,510			214,159			181,194
Residential construction	42,660			36,618			28,130			28,697			20,445
Residential mortgage	132,971			128,442			135,022			147,300			165,009
Consumer	6,896			6,638			7,248			6,750			7,399
Consumer credit cards	2,114			2,240			2,276			2,339			2,265
Business credit cards	1,235			1,168			1,251			1,124			1,186
Other	502			1,257			499			738			1,278
	507,320			458,773			452,864			493,218			498,052

Net deferred loan fees	(316		)	(460		)	(608		)	(506		)	(123		)
Net loans before allowance	507,004			458,313			452,256			492,712			497,929

Allowance for loan losses	(9,647		)	(9,616		)	(9,377		)	(11,590		)	(16,549		)
Total net loans	$	497,357		$	448,697		$	442,879		$	481,122		$	481,380

Loans held for sale	$	206		$	1,145		$	2,882		$	—		$	19,297

Commitments and contingencies:
Commitments to make loans	$	135,100		$	139,577		$	100,843		$	66,341		$	71,924
Standby letters of credit	$	861		$	671		$	1,441		$	991		$	2,838

The maturities and carrying amounts of loans, excluding credit cards, as of December 31, 2016 are summarized as follows (amounts in thousands):



	Loan Maturities
	Commercial & Industrial		Commercial Construction & Land Development		Commercial Real Estate		Residential Construction		Residential Mortgage		Consumer		Other		Total
Due within one year:
Fixed rate	$	2,161	$	6,857	$	9,564	$	3,249	$	6,695	$	2,916	$	139	$	31,581
Variable rate	7,485		9,821		19,461		38,043		8,578		65		144		83,597

Due after one year through five years:
Fixed rate	7,769		19,654		134,810		395		44,969		3,791		51		211,439
Variable rate	445		6,690		19,043		973		16,885		1		168		44,205

Due after five years:
Fixed rate	3,298		2,738		64,141		—		15,903		123		—		86,203
Variable rate	584		354		6,067		—		39,941		—		—		46,946
Total	$	21,742	$	46,114	$	253,086	$	42,660	$	132,971	$	6,896	$	502	$	503,971

As of December 31, 2016, the Company had approximately $147.0 million of variable rate loans with interest rate floors in effect (i.e., the floor rate exceeded the variable rate). Interest rates on these loans will not adjust until the underlying index plus any rate adjuster increases above the floor rate.

Asset Quality

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. Nonperforming loans are loans that have been placed into nonaccrual status when doubts arise regarding the full collectability of principal or interest and we are therefore uncertain that the borrower can satisfy the contractual terms of the loan agreement. Our policy is to place a loan on nonaccrual status at the point when the loan becomes past due 90 days unless there is sufficient documentation to establish that the loan is well secured and in the process of collection. These nonaccrual loans may be returned to accrual status when the factors which initially indicated the doubtful collectability of the loans have ceased to exist. Foreclosed assets consists typically of real estate assets acquired either through foreclosure proceedings or deed in lieu of foreclosure. Foreclosed assets are recorded at an estimated fair value less costs to sell the property, or the recorded investment in the loan at the time of foreclosure, whichever is less. These assets are periodically evaluated and any decreases in the property's fair value result in corresponding write downs of the asset's carrying value.

As of December 31, 2016, nonperforming assets declined $2.4 million or 28.2% when compared to December 31, 2015. The Company’s ratio of nonperforming assets to regulatory Tier 1 capital plus the allowance has improved during the year. At December 31, 2016, this ratio was 8% compared to 12% at December 31, 2015.

The following table describes our nonperforming asset portfolio composition by category based on the loan classifications discussed in Note D - Loans and Allowance for Loan Losses to the financial statements for December 31, 2016, 2015, 2014, 2013, and 2012 (amounts in thousands):



	Nonperforming Assets
	2016			2015			2014			2013			2012
Nonaccrual loans:
Commercial and industrial	$	36		$	119		$	—		$	651		$	664
Commercial construction and land development	691			1,626			5,533			9,536			15,941
Commercial real estate	2,153			2,929			983			6,391			9,091
Residential construction	—			721			—			695			833
Residential mortgage	1,444			1,203			1,271			9,943			9,408
Consumer	—			—			472			11			33
Total nonaccrual loans	$	4,324		$	6,598		$	8,259		$	27,227		$	35,970

Past due 90 days or more and still accruing:
Consumer credit cards	$	19		$	29		$	14		$	23		$	32
Business credit cards	21			36			3			—			—
Total past due 90 days and still accruing	$	40		$	65		$	17		$	23		$	32

Foreclosed assets:
Commercial and industrial	$	3		$	3		$	44		$	44		$	71
Commercial construction and land development	988			1,493			2,613			6,364			8,363
Commercial real estate	637			82			485			1,077			2,420
Residential construction	—			69			—			42			602
Residential mortgage	54			113			640			975			3,680
Total foreclosed assets	$	1,682		$	1,760		$	3,782		$	8,502		$	15,136

Nonperforming loans held for sale	$	—		$	—		$	1,865		$	—		$	—

Total nonperforming assets	$	6,046		$	8,423		$	13,923		$	35,752		$	51,138

Nonperforming loans to gross loans	0.85		%	1.44		%	1.83		%	5.53		%	7.22		%
Nonperforming assets to total assets	0.84		%	1.22		%	1.70		%	4.35		%	5.91		%
Allowance coverage of nonperforming loans	221.06		%	144.32		%	113.30		%	42.53		%	45.97		%

Foreclosed Assets

As of December 31, 2016, there were 26 foreclosed properties valued at $1.7 million compared to 35 foreclosed properties valued at $1.8 million as of December 31, 2015. For the twelve months ended December 31, 2016, a significant portion of the $1.7 million value of foreclosed properties was due to the addition of one property in the amount of $863,000 in the first quarter of 2016. The amount of loans transferred into foreclosed assets decreased from $1.2 million for the year ending December 31, 2015 to $1.0 million for the year ending December 31, 2016. Sales of foreclosed assets decreased to $700,000 in 2016 compared to $3.0 million in 2015 as the number and value of properties in the portfolio continues to decline. The continued decline in foreclosed assets resulted primarily from sales of foreclosed properties and reductions in the number of properties added to foreclosed assets.

Nonaccrual and TDR Loans

Interest income is calculated by the relevant interest method based upon the daily outstanding balance of the loan. The recognition of interest income ceases however when it becomes probable that full collectability of all interest due under the contractual terms of the loan agreement may not occur. As a result, loans may either be placed in nonaccrual status and/or restructured to allow for a payment stream which may appropriately accommodate a borrower's diminished repayment capacity. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. Such restructured loans are typically initially placed into nonaccrual status and may later be returned to accrual status depending upon a demonstrated ability by the borrower to meet the repayment terms of the restructured loan. Payments received on nonaccrual loans are applied first to principal and thereafter interest only after all principal has been collected. We accrue interest on restructured loans at the restructured rates when we anticipate that no loss of original principal will occur.

Nonaccrual loans as a percentage of gross loans decreased to 0.85% as of December 31, 2016 compared to 1.44% as of December 31, 2015. At December 31, 2016, there were 29 nonaccrual loans totaling $4.3 million compared to 42 loans totaling $6.6 million at December 31, 2015. The gross interest income that would have been recorded for loans accounted for on a nonaccrual basis at December 31, 2016 and 2015 was approximately $196,000 and $153,000, respectively. These amounts represent interest income that would have been recorded if the loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination, if held for part of the period.

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 December 31, 2016, there were six restructured loans in accrual status compared to eight as of December 31, 2015. 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 December 31, 2016, the recorded investment in performing TDRs and their related allowance for loan losses totaled $1.2 million and $0, respectively, compared to $2.3 million and $328,000 as of December 31, 2015. Outstanding nonperforming TDRs totaled $802,000 with $156,000 in specific reserves as of December 31, 2016 compared to $1.1 million in outstanding nonperforming TDRs with $139,000 in related allowance for loan losses as of December 31, 2015. The amount of interest recognized for performing and nonperforming TDRs during the twelve months of 2016 was approximately $73,000 and $10,000, respectively.

The following table describes performing and nonperforming TDRs for December 31, 2016, 2015, 2014, 2013, and 2012 (amounts in thousands):



Performing TDRs:	2016		2015		2014		2013		2012
Commercial and industrial	$	—	$	—	$	—	$	37	$	349
Commercial construction and land development	—		1,059		1,336		227		3,484
Commercial real estate	714		1,028		2,469		4,447		5,522
Residential mortgage	474		226		950		2,319		3,945
Consumer	—		—		4		—		—
Total performing TDRs	$	1,188	$	2,313	$	4,759	$	7,030	$	13,300



Nonperforming TDRs:	2016		2015		2014		2013		2012
Commercial and industrial	$	24	$	—	$	—	$	301	$	87
Commercial construction and land development	—		557		2,776		6,699		10,659
Commercial real estate	657		574		552		4,204		4,437
Residential mortgage	121		—		54		3,055		3,113
Consumer	—		—		467		1		—
Total nonperforming TDRs	$	802	$	1,131	$	3,849	$	14,260	$	18,296

Allowance for Loan Losses and Summary of Loan 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, and 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. Additionally, regulatory agencies review our allowance for loan losses and may require additional provisions for estimated losses based on judgments that differ from those of management.

Management has developed a model for evaluating the adequacy of the allowance for loan losses. The model uses the Company’s internal grading system to quantify the risk of each loan. The grade is initially assigned by the lending officer and/or the credit administration function. The internal grading system is reviewed and tested periodically by an independent internal loan review function as well as an independent external credit review firm. The testing process involves the evaluation of a sample of new loans, loans having been identified as possessing potential weakness in credit quality, and past due and nonaccrual loans to determine the ongoing effectiveness of the internal grading system. Additionally, regulatory agencies review the adequacy of the risk grades assigned as well as the risk grade process and may require changes based on judgments that differ from those of management that could impact the allowance for loan losses.

The grading system is comprised of seven risk categories for active loans. Grades 1 through 4 demonstrate various degrees of risk, but each is considered to have the capacity to perform in accordance with the terms of the loan. Loans possessing a grade of 5 exhibit characteristics which indicate higher risk that the loan may not be able to perform in accordance with the terms of the loan. Grade 6 loans are considered sub-standard and are generally impaired, however, certain of these loans continue to accrue interest, and are not TDRs and are not considered impaired. Grade 7 loans are considered doubtful and would be included in nonaccrual loans. Grade 8 loans are considered uncollectable and identified as a confirmed loss. Loans can also be classified as non-accrual, TDR, or otherwise impaired, all of which are considered impaired and evaluated for specific reserve under FASB Accounting Standard Codification ("ASC") 310-10 regardless of the risk grade assigned.

Once a loan has been determined to meet the definition of impairment, the amount of that impairment is measured through one of two 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 or upon the fair market value of the underlying assets securing the loan. If the fair market value of collateral method is selected for use, an updated collateral value is generally obtained based on where the loan is in the collection process and the age of the existing appraisal. Each loan is then analyzed to determine the net value of collateral or cash flows and an estimate of potential loss. The net value of collateral per our analysis is determined using various subjective discounts, selling expenses and a review of the assumptions used to generate the current appraisal. If collection is deemed to be collateral dependent then the deficiency is generally charged off. Appraised values on real estate collateral are subject to constant change and management makes certain assumptions about how the age of an appraisal impacts current value. Impaired loans are re-evaluated periodically to determine the adequacy of specific reserves and charge-offs. Groups of small dollar impaired loans with similar risk characteristics may be evaluated for impairment collectively.

Loans that are not assessed for specific reserves under FASB ASC 310-10 are reserved for under FASB ASC 450. The loans analyzed under FASB ASC 450 are assigned a reserve based on a quantitative factor and a qualitative factor. The quantitative factor is based on historical charge-off levels and is adjusted for the loan's risk grade. The qualitative factors address loan growth, loan portfolio composition and industry diversification, historical loan loss experience, current delinquency levels, prevailing economic conditions and all other relevant factors derived from our history of operations. Together these two components comprise the ASC 450, or general reserve.

The Company utilizes a five year look back period to determine historical loss rates under the quantitative ASC 450 reserve. The Company calculates historical loss rates from the most recent five years on a rolling quarter basis to provide an estimate of potential losses and to provide for the highest base charge-off rate regardless of whether the historical charge-offs are improving or declining. In addition, the Bank assigns a different percentage ("multiplier") of the base charge-off rate to the balances for each risk grade within a loan category to reflect the varied risk of charge-off for each. The standard multipliers range from 0% for a risk grade 1 to 300% for a risk grade 6 that is unimpaired. In addition, categories that have a concentrated level of charge-offs associated with a particular risk grade could have an additional reserve factor of 50% to 100% added to that particular risk grade. Lastly, categories that have had historically high charge-offs also have an additional reserve factor between 25% to 100% added to the risk grade 5s and 6s to account for the additional risk in those categories. The reserve amount by risk grade is calculated and then combined for a blended quantitative reserve factor for each loan category.

The allowance for loan losses at December 31, 2016 was $9.6 million, which represents 1.9% of total loans outstanding compared to $9.6 million or 2.1% as of December 31, 2015. For the year ended December 31, 2016, net loan recoveries were $31,000 compared to $239,000 for the prior year period because the volume of total charge-offs and recoveries continued to decline as asset quality normalizes. Non-accrual loans were $4.3 million and $6.6 million at December 31, 2016 and 2015, respectively. The 30-89 day past due numbers are down to $493,000 as of December 31, 2016 compared to $1.2 million as of December 31, 2015, a 57.9% decrease.

The ASC 450 reserve as of December 31, 2015 was 2.2% compared to 1.7% as of December 31, 2016. As of December 31, 2016, the Company had $5.1 million in loans in the coastal North Carolina region which are collateralized by properties that have seen significant declines in value since the loans' origination, compared to $6.6 million as of December 31, 2015. Those loans in this category that are evaluated as part of the ASC 450 general reserve are being reserved at an average of 43.8% as of December 31, 2016.

Impaired loans evaluated for specific reserve as of December 31, 2016 were $5.4 million compared to $8.6 million for the year ended December 31, 2015, a decline of $3.2 million or 37.6%. The ASC 310 reserve was $1.0 million as of December 31, 2016 compared to $1.3 million as of December 31, 2015.

The allowance for loan losses represents management’s estimate of an appropriate amount to provide for known and inherent losses in the loan portfolio in the normal course of business. While management believes the methodology used to establish the allowance for loan losses incorporates the best information available at the time, future adjustments to the level of the allowance may be necessary and the results of operations could be adversely affected should circumstances differ substantially from the assumptions initially used. We believe that the allowance for loan losses was established in conformity with generally accepted accounting principles; however, there can be no assurances that the regulatory agencies, after reviewing the loan portfolio, will not require management to increase the level of the allowance. Likewise, there can be no assurance that the existing allowance for loan losses is adequate should there be deterioration in the quality of any loans or changes in any of the factors discussed above. Any increases in the provision for loan losses resulting from such deterioration or change in condition could adversely affect our financial condition and results of operations.

The following table summarizes the Bank’s loan loss experience for the years ending December 31, 2016, 2015, 2014, 2013, and 2012 (amounts in thousands, except ratios):



	Allowance for Loan Losses
	2016			2015			2014			2013			2012
Balance at beginning of period	$	9,616		$	9,377		$	11,590		$	16,549		$	21,141

Charge-offs:
Commercial and industrial	73			74			492			411			703
Commercial construction and land development	229			196			3,106			3,759			7,929
Commercial real estate	565			578			3,315			2,220			3,691
Residential construction	—			41			171			138			103
Residential mortgage	45			713			4,847			1,559			1,801
Consumer	161			210			183			271			516
Other	9			69			—			—			—
Total charge-offs	1,082			1,881			12,114			8,358			14,743

Recoveries:
Commercial and industrial	97			234			208			514			622
Commercial construction and land development	788			1,176			397			587			1,176
Commercial real estate	21			393			334			1,506			366
Residential construction	21			—			—			—			—
Residential mortgage	70			201			866			599			458
Consumer	113			113			120			154			148
Other	3			3			23			4			—
Total recoveries	1,113			2,120			1,948			3,364			2,770

Net recoveries (charge-offs)	31			239			(10,166		)	(4,994		)	(11,973		)
Provision for loan losses	—			—			7,953			35			7,381
Balance at end of year	$	9,647		$	9,616		$	9,377		$	11,590		$	16,549

Ratio of net charge-offs during the year to average gross loans outstanding during the year	—		%	—		%	2.14		%	1.01		%	2.21		%

The following table summarizes the Bank’s allocation of allowance for loan losses at December 31, 2016, 2015, 2014, 2013, and 2012 (amounts in thousands, except ratios).



	Allowance for Loan Losses by Loan Classification
	2016				2015				2014				2013				2012
	Amount		% Total Loans ₍₁₎		Amount		% Total Loans ₍₁₎		Amount		% Total Loans ₍₁₎		Amount		% Total Loans ₍₁₎		Amount		% Total Loans ₍₁₎
Commercial and industrial	$	58	5	%	$	221	5	%	$	119	6	%	$	487	6	%	$	1,185	6	%
Commercial construction and land development	4,915		9	%	5,470		11	%	5,105		12	%	5,037		13	%	7,251		18	%
Commercial real estate	3,198		50	%	2,268		46	%	2,382		44	%	2,981		43	%	2,961		37	%
Residential construction	258		8	%	305		8	%	436		6	%	713		6	%	423		4	%
Residential mortgage	1,078		26	%	1,191		28	%	1,206		30	%	2,146		30	%	4,471		33	%
Consumer	98		2	%	113		2	%	89		2	%	188		2	%	188		2	%
Other	42		—	%	48		—	%	40		—	%	38		—	%	70		—	%
Total	$	9,647	100	%	$	9,616	100	%	$	9,377	100	%	$	11,590	100	%	$	16,549	100	%

⁽¹⁾Represents total of all outstanding loans in each category as a percentage of total loans outstanding.

Deposits

Deposits are the primary source of funds for our portfolio loans, loan pipeline and investments. Our deposit strategy is to obtain deposit funds from within our market areas through relationship banking. The majority of our deposits are from individuals and entities located in our primary markets of Johnston and Wake counties. We are positioned to obtain wholesale deposits, including brokered deposits, from various sources in order to supplement our liquidity if needed. As of December 31, 2016, total deposits were approximately $553.5 million, up from $542.3 million at December 31, 2015.

Noninterest-bearing demand deposits and interest-bearing transaction accounts, which include savings, money market and interest checking, increased $40.0 million or 12.8%. Time deposits declined $28.8 million as we did not replace wholesale time deposits that matured during 2016 and continue to execute a strategy of exiting high cost time deposits for non-relationship customers.

Wholesale deposits, including time deposits placed in the Certificate of Deposit Account Registry Service, ("CDARS"), and various brokered deposit programs decreased $17.2 million, or 41.4%, from $41.5 million as of December 31, 2015, to $24.3 million at December 31, 2016 as some brokered deposit maturities were not replaced. The CDARS program provides full FDIC insurance on deposit balances greater than posted FDIC limits by exchanging larger depository relationships with other CDARS members. CDARS is offered as a service to our customers who either require or desire full FDIC insurance coverage of their deposits.

Time certificates in amounts of $250,000 or more outstanding at December 31, 2016, 2015, 2014, 2013, and 2012, by maturity were as follows (amounts in thousands):



	Time Certificates of $250,000 or More by Maturity
	2016		2015		2014		2013		2012
Three months or less	$	3,980	$	2,820	$	4,350	$	3,555	$	14,394
Over three months through six months	7,835		10,680		6,454		8,380		6,223
Over six months through twelve months	3,731		5,196		8,203		5,857		5,401
Over twelve months through three years	8,236		10,970		13,428		16,316		17,791
Over three years	5,985		5,595		5,183		4,068		10,613
Total	$	29,767	$	35,261	$	37,618	$	38,176	$	54,422

Borrowings

The Bank borrows funds principally from the Federal Home Loan Bank of Atlanta (the "FHLB"). During 2016, the Bank increased total advances by $10.0 million as compared to December 31, 2015.

Information regarding borrowings at December 31, 2016, 2015, and 2014, are as follows (amounts in thousands, except rates):



	FHLB Advances
	2016			2015			2014
Balance outstanding at December 31	$	70,000		$	60,000		$	90,000
Weighted average rate at December 31	2.06		%	2.38		%	3.42		%
Maximum borrowings during the year	$	80,000		$	90,000		$	112,000
Average amounts outstanding during year	$	69,672		$	88,773		$	110,416
Weighted average rate during year	2.09		%	3.39		%	3.57		%

In late 2015, the Company sold $11.5 million aggregate principal amount of subordinated promissory notes. These notes are due on November 30, 2025 and the Company is obligated to pay interest at an annualized rate of 6.25% payable in quarterly installments commencing on March 1, 2016. The Company may prepay the notes at any time after November 30, 2020, subject to compliance with applicable law. The proceeds of the offering were used to refinance the Company's then outstanding subordinated promissory notes issued in 2009.

On March 30, 2006, $12.4 million of trust preferred securities (the “Trust Preferred Securities”) were placed through the Trust. The Trust has invested the net proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Debentures”) issued by the Company and recorded in borrowings on the accompanying consolidated balance sheets. The Trust Preferred Securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to three month LIBOR plus 1.35%. The dividends paid to holders of the Trust Preferred Securities, which will be recorded as interest expense, are deductible for income tax purposes. The Trust Preferred Securities are redeemable in whole or in part, on any June 15, September 15, December 15, or March 15. Redemption is mandatory by June 15, 2036.

The Bank may purchase federal funds through secured federal funds lines of credit with various banks. These lines are intended for short-term borrowings and are payable on demand and bear interest based upon the daily federal funds rate. For 2016, 2015, and 2014, the Bank purchased no federal funds except in conjunction with semi-annual testing of the borrowing lines available. At December 31, 2016 and December 31, 2015, the Bank had no federal funds borrowings outstanding under these lines.

Results of Operations for the Years Ended December 31, 2016 and 2015

Overview

Pre-tax net income for the twelve months ended December 31, 2016 was $5.3 million compared to $3.5 million for the same period in 2015, an increase of $1.8 million or 50%. Net income for the twelve months ended December 31, 2016 was $6.9 million, or $1.06 net income per basic and $1.04 per diluted share, as compared to net income of $20.0 million, or $3.12 net income per basic and $3.10 per diluted share, for the twelve months ended December 31, 2016. For the twelve months ended December 31, 2016, the Company reported an income tax benefit of $1.6 million compared to an income tax benefit of $16.5 million for the same period in 2015. The prior year income tax benefit resulted from the partial reversal of the valuation allowance against the Company's deferred tax assets executed in the second quarter of 2015. The current year income tax benefit was due to the reversal of substantially all of the remaining valuation allowance on the deferred tax assets executed in the fourth quarter of 2016.

Net interest income totaled $24.4 million for the twelve months ended December 31, 2016 as compared to $22.6 million for the same period in 2015, an increase of $1.8 million or 7.8%. Net interest margin for the twelve months ended December 31, 2016 was 3.7% compared to 3.3% for the same period in 2015. The primary driver of the improved margins and overall net interest income was the reduction in funding costs due to the balance sheet strategies executed in late 2015. The 2015 balance sheet strategies included the extinguishment of high-cost long term borrowings and refinancing the Company's subordinated debt at lower rates. Additionally contributing to the increase was additional interest income on loans from the portfolio growth during 2016.

Non-interest income was $5.8 million for the twelve months ended December 31, 2016 compared to $9.6 million for the same period in 2015. This decrease was primarily due to reductions in gains from the sale of problem loans as we completed the previously disclosed Asset Resolution Plan during 2015 and had few loan sales during 2016. Additionally, we completed our exit from the ACH third party payment processor business line in 2015 and indemnification income from this exit was absent from 2016 totals. Other factors contributing to the overall decline were less significant but included reduced premium income from the sale of government guaranteed loans and reductions in service charges on deposit accounts.

Non-interest expense totaled $24.8 million for the twelve months ended December 31, 2016 compared to $28.6 million for the same period in 2015. As previously mentioned, the Company restructured the balance sheet during the fourth quarter 2015, resulting in the extinguishment of high-cost long term borrowings. The absence of these long term debt extinguishment costs in 2016 was a primary driver in the overall decline of non-interest expense. Another significant contributor included a reduction in salary expense in 2016 as the Company exited certain personnel contracts and incurred related expenses during 2015 as it transitioned the leadership team.

Net Interest Income

The primary component of earnings for the Bank is net interest income, which is the difference between interest income, principally from loan and investment securities, and interest expense, principally 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 by $1.8 million or 7.8%, to $24.4 million in 2016 from $22.6 million in 2015. The net interest margin increased 40 basis points to 3.74% in 2016 from a net interest margin of 3.29% in the previous year. The increase in net interest income was primarily due to declines in interest expense of $2.0 million driven primarily by reductions in high cost long term borrowings that were paid down or refinanced during 2015. Interest expense on FHLB borrowings declined $1.6 million or 51.7% as compared to 2015. Also contributing to the decline in interest expense was the refinancing of the Company's subordinated promissory notes during late 2015 from an interest rate of 8.50% to 6.25%. The reduction in rate and $500,000 reduction in balances resulted in savings of approximately $300,000 for the twelve months ended December 31, 2016. This improvement in overall net interest income was offset by a reduction in total interest income of $178,000 as overall investment balances and resulting interest income declined and was only partially offset by increases in interest income on loans.

On average, our interest-earning assets declined $36.6 million during 2016 from 2015; however, the rate earned on these assets increased 21 basis points. The primary drivers for the decline in interest-earning assets were reductions in interest earning deposits with banks and total investments offset by increases in average loans. Interest earning deposits in banks, which carried a relatively low yield, declined $42.6 million during the year while average investments declined $18.7 million. Part of this decline was from the ACH TPPP business line exit during 2015 which caused us to carry elevated levels of interest bearing deposits during the exit process. This was offset by increases in average loans which grew $25.1 million during 2016. Interest bearing liabilities declined $9.1 million as we remained focus on improving balance sheet efficiency to ensure any unnecessary funding was eliminated. In addition to the total reduction in interest bearing liabilities, the rate paid on these liabilities declined 36 basis points driven primarily by reductions in high cost long term borrowings paid down during 2015.

We set interest rates on deposits and loans at competitive rates. Interest rate spreads have increased from 3.0% in 2015 to 3.5% for 2016. The interest rate spread is the difference between the interest rates earned on average loans and investments, and the interest rates paid on average interest-bearing deposits and borrowings.

The following schedule presents average balance sheet information for the years 2016, 2015, and 2014, along with related interest earned and average yields for interest-earning assets and the interest paid and average rates for interest-bearing liabilities (amounts in thousands, except for average rates). Nonaccrual notes are included in loan amounts.



	Average Daily Balances, Interest Income/Expense, Average Yield/Rate For the Years Ended December 31,
	2016						2015						2014
	Average Balance		Interest		Average Rate		Average Balance		Interest		Average Rate		Average Balance		Interest		Average Rate
Interest-earning assets:
Loans	$	483,741	$	25,464	5.26	%	$	458,679	$	25,208	5.50	%	$	474,327	$	25,331	5.34	%
Investment securities - taxable	123,618		2,937		2.38	%	142,305		3,299		2.32	%	112,989		2,401		2.12	%
Other investments and FHLB stock	4,264		351		8.23	%	4,628		331		7.15	%	6,106		326		5.34	%
Interest earning deposits in banks	39,178		436		1.11	%	81,787		528		0.65	%	199,140		747		0.38	%
Total interest-earning assets	650,801		29,188		4.48	%	687,399		29,366		4.27	%	792,562		28,805		3.63	%
Other assets	62,525						53,056						39,346
Total assets	$	713,326					$	740,455					$	831,908
Interest-bearing liabilities:
Deposits:
NOW and money market deposits	$	150,917	$	354	0.23	%	$	139,985	$	316	0.23	%	$	128,345	$	286	0.22	%
Savings deposits	41,801		66		0.16	%	38,194		57		0.15	%	34,856		51		0.15	%
Time deposits, $250,000 and over	32,570		280		0.86	%	36,644		328		0.90	%	37,340		396		1.06	%
Other time deposits	186,703		1,628		0.87	%	186,647		1,745		0.93	%	210,098		2,139		1.02	%
Borrowed funds	69,676		1,479		2.12	%	88,776		3,059		3.45	%	110,419		3,997		3.62	%
Subordinated debentures and promissory notes	23,872		1,021		4.28	%	24,371		1,273		5.22	%	24,372		1,219		5.00	%
Total interest-bearing liabilities	505,539		4,828		0.96	%	514,617		6,778		1.32	%	545,430		8,088		1.48	%
Noninterest-bearing deposits	140,024						169,289						249,266
Other liabilities	3,884						4,719						5,222
Stockholders' equity	63,879						51,830						31,990
Total liabilities and stockholders' equity	$	713,326					$	740,455					$	831,908
Net interest income and interest rate spread			$	24,360	3.53	%			$	22,588	2.95	%			$	20,717	2.15	%
Net yield on average interest-earning assets					3.74	%					3.29	%					2.61	%
Ratio of average interest-earning assets to average interest-bearing liabilities					128.73	%					133.57	%					145.31	%

The following table shows changes in interest income and expense by category and rate/volume variances for the years ended December 31, 2016, 2015 and 2014. The changes due to rate and volume were allocated on their absolute values (amounts in thousands, except for average rates):



	Year Ended December 31, 2016 vs. 2015									Year Ended December 31, 2015 vs. 2014
	Increase (Decrease) Due to									Increase (Decrease) Due to
	Volume			Rate			Total			Volume			Rate			Total
Interest income:
Loans	$	1,348		$	(1,092	)	$	256		$	(848	)	$	725		$	(123	)
Investment securities - taxable	(439		)	77			(362		)	651			247			898
Other investments	(28		)	48			20			(92		)	97			5
Interest earning deposits in banks	(375		)	283			(92		)	(599		)	380			(219		)
Total interest income	506			(684		)	(178		)	(888		)	1,449			561

Interest expense:
Deposits
NOW and money market deposits	25			13			38			26			4			30
Savings deposits	6			3			9			5			1			6
Time deposits, $250,000 and over	(36		)	(12		)	(48		)	(7		)	(61		)	(68		)
Other time deposits	1			(118		)	(117		)	(229		)	(165		)	(394		)
Borrowed funds	(532		)	(1,048		)	(1,580		)	(764		)	(174		)	(938		)
Subordinated Debentures	(24		)	(228		)	(252		)	—			54			54
Total interest expense	(560		)	(1,390		)	(1,950		)	(969		)	(341		)	(1,310		)

Net interest income increase	$	1,066		$	706		$	1,772		$	81		$	1,790		$	1,871

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 twelve months ended December 31, 2016 and December 31, 2015, no provision for the allowance for loan looses was recognized in earnings.

Non-interest Income

Non-interest income for the twelve months ended December 31, 2016 was $5.8 million, as compared to $9.6 million for the same period in 2015, a decrease of $3.8 million. The principal drivers for the decline are related to non-recurring items that either declined significantly year over year or were absent during the twelve months ended December 31, 2016. Total gains from problem loan sales were $351,000 for the twelve months ended December 31, 2016 as compared to $3.2 million for the same period in 2015, a $2.9 million decline due to the Company completing disposal of loans identified in the Asset Resolution Plan during 2015. Additionally, the Company exited the ACH third party payment processor business line in 2015 which resulted in a loss of $445,000 on indemnification income from the prior year and also contributed to the decline in other non-interest income. Other less significant factors furthering the decline in non-interest income were reductions in other service charges, commissions and fees largely due to reduced premium income from the sale of government guaranteed loans and reduced insufficient funds charges on deposit accounts.

Non-interest Expense

Non-interest expense for the year ended December 31, 2016 was $24.8 million, as compared to $28.6 million for the year ended December 31, 2015, a decrease of $3.8 million. The balance sheet strategies executed in 2015 that entailed paying down high cost long term borrowings by $40.0 million led to $2.1 million in related extinguishment costs for the twelve months ended December 31, 2015. The absence of this expense in 2016 was a primary driver in the decline in non-interest expense for the twelve month period. During late 2015, the Company also incurred one-time costs associated with changes in three members of the executive management team that contributed to non-recurring salary expenses of $1.2 million for the twelve months ended December 31, 2015. Reductions were seen in almost all other expense categories as we continued reviewing ways to improve efficiency and reduce expenses. These declines were offset by an increase of $282,000 in employee benefits which was primarily due to the absence of a premium holiday by our medical insurance provider and the increase in our 401K plan match during 2016.

Income Taxes

For the twelve months ended December 31, 2016, the Company reported a $1.6 million income tax benefit as compared to a $16.5 million benefit for this same period in 2015. For both periods, the income tax benefit recorded was the result of a reversal of a portion of the valuation allowance against deferred tax assets net of income tax expense. Since the partial valuation allowance reversal executed in the second quarter of 2015, the Company continued to assess both positive and negative evidence to determine the ability to fully utilize the deferred tax assets prior to its expiration. During the fourth quarter of 2016, based upon the assessment of all positive and negative evidence, we determined that it is more likely than not that the Company will generate sufficient taxable income of the appropriate character that would fully allow it to utilize the deferred tax assets and reversed substantially all of the remaining valuation allowance.

Off-Balance Sheet Arrangements

As part of its normal course of business to meet the financing needs of its customers, the Bank is at times a party to financial instruments with off-balance sheet credit risk. Such instruments include commitments to extend credit and standby letters of credit. At December 31, 2016, the Bank’s outstanding commitments to extend credit consisted of undisbursed lines of credit, other commitments to extend, undisbursed portion of construction loans and stand-by letters of credit of $136.0 million. See Note L - Commitments and Contingencies in the accompanying notes to the consolidated financial statements for additional detail regarding the Bank's off-balance sheet risk exposure.

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 twelve months ended 2016, the Company's primary use of its excess liquidity was to fund growth in the loan portfolio.

At December 31, 2016, our outstanding commitments to extend credit consisted of loan commitments of $21.1 million, undisbursed lines of credit of $97.4 million, unused credit card lines of $16.6 million, financial stand-by letters of credit of $439,000 and performance stand-by letters of credit of $422,000. We believe that our combined aggregate liquidity position from all sources is sufficient to meet the funding requirements of loan demand, and deposit maturities and withdrawals in the near term.

At December 31, 2015, our outstanding commitments to extend credit consisted of loan commitments of $29.4 million, undisbursed lines of credit of $94.2 million, unused credit card lines of $16.0 million, financial stand-by letters of credit of $438,000 and performance stand-by letters of credit of $233,000.

Certificates of deposits represented 36.4% of our total deposits at December 31, 2016, a decrease from 42.4% at December 31, 2015. Brokered and out-of-market certificates of deposit totaled $24.3 million at year-end 2016 and $41.5 million at year-end 2015, which comprised 4.4% and 7.7% of total deposits, respectively. Certificates of deposit of $250,000 or more, inclusive of brokered and out-of-market certificates, represented 5.4% of our total deposits at December 31, 2016 and 6.5% at December 31, 2015. Large certificates of deposits are generally considered rate sensitive. While we will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention.

On August 15, 2014, the Company closed the Rights Offering and Standby Offering with Kenneth R. Lehman, a private investor, who later became a member of our Board of Directors. In connection with the Rights Offering and Standby Offering, the Company issued an aggregate of 4,800,000 shares of its common stock at $5.00 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 twelve months. Total shareholders’ equity was $68.0 million or 9.45% of total assets at December 31, 2016 and $60.4 million or 8.74% of total assets at December 31, 2015. 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 $37.0 million that remain unused at December 31, 2016. As of December 31, 2016, the Company has the credit capacity to borrow up to $180.3 million from the FHLB with $70.0 million outstanding as of December 31, 2016.

The Company had total risk based capital of 15.6%, Tier 1 risk based capital of 12.2%, a leverage ratio of 9.5%, and common equity Tier 1 capital of 10.9% at December 31, 2016, as compared to 16.0%, 12.4%, 8.8%, and 11.3%, respectively, at December 31, 2015. The Bank had total risk based capital of 15.4%, Tier 1 risk based capital of 14.1%, a leverage ratio of 11.0%, and common equity Tier 1 capital of 14.1% at December 31, 2016, as compared to 15.6%, 14.4%, 10.2%, and 14.4%, respectively, at December 31, 2015. At December 31, 2016, both the Company and the Bank were well capitalized.

The Company sold $11.5 million aggregate principal amount of subordinated promissory notes to certain accredited investors in December 2015. These notes are due on November 30, 2025 and the Company is obligated to pay interest at an annualized rate of 6.25% payable in quarterly installments commencing on March 1, 2016. The Company may prepay the notes at any time after November 30, 2020, subject to compliance with applicable law. The proceeds were used to refinance the Company's then outstanding subordinated promissory notes issued in 2009.

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. A decision to pay any dividend in the future would be determined based on a number of factors including capital position and capital adequacy, ongoing operations and profitability, the risk profile of the institution and general market conditions, among other things.

Impact of Inflation and Changing Prices

The primary effect of inflation on our operations is reflected in increases in the price of goods and services resulting in higher operating expenses. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans, and deposits.

Recent Accounting Pronouncements

See Note A - Organization and Summary of Significant Accounting Policies, in the accompanying notes to the consolidated financial statements presented under Item 8 of Part II of this Form 10-K, for a discussion of recent accounting pronouncements and management's assessment of the potential impact on our consolidated financial statements.

Critical Accounting Estimates and Policies

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Critical accounting estimates and policies are those we believe are both most important to the portrayal of our financial condition and results, and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We believe that the allowance for loan losses, other than temporary impairment of investments available-for-sale, valuation of foreclosed assets, and income taxes, represent particularly sensitive accounting estimates.

See Note A - Organization and Summary of Significant Accounting Policies, in the accompanying notes to the consolidated financial statements presented under Item 8 of Part II of this Form 10-K, and other statements set forth elsewhere in this report, for a comprehensive view of significant accounting estimates and policies.

Item 7A - Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 8 - Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Shareholders of Four Oaks Fincorp, Inc.

Four Oaks, North Carolina

We have audited the accompanying consolidated balance sheets of Four Oaks Fincorp, Inc. and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the years in the two year period ended December 31, 2016. The Company's management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Four Oaks Fincorp, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the two year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

/s/ Cherry Bekaert LLP

Raleigh, North Carolina

March 30, 2017

Four Oaks Fincorp, Inc.

Consolidated Balance Sheets

As of December 31, 2016 and December 31, 2015

(Amounts in thousands, except per share data)



	2016			2015
ASSETS
Cash and due from banks	$	23,940		$	17,375
Interest-earning deposits	8,623			9,380
Cash and cash equivalents	32,563			26,755
Certificates of deposits held for investment	18,125			23,520
Investment securities available-for-sale, at fair value	58,141			70,281
Investment securities held-to-maturity, at amortized cost	51,205			65,354
Total investment securities	109,346			135,635
Loans held for sale	206			1,145
Loans	507,004			458,313
Allowance for loan losses	(9,647		)	(9,616		)
Net loans	497,357			448,697
Accrued interest receivable	1,598			1,594
Bank premises and equipment held for sale	2,373			—
Bank premises and equipment, net	9,844			12,293
FHLB stock	3,596			3,288
Investment in life insurance	19,987			14,777
Foreclosed assets	1,682			1,760
Deferred tax assets, net	18,201			16,679
Other assets	5,005			5,244
TOTAL ASSETS	$	719,883		$	691,387
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand	$	151,860		$	132,044
Money market, NOW accounts and savings accounts	200,386			180,214
Time deposits, $250,000 and over	29,767			35,261
Other time deposits	171,518			194,815
Total deposits	553,531			542,334
Borrowings	70,000			60,000
Subordinated debentures	12,372			12,372
Subordinated promissory notes	11,500			11,500
Accrued interest payable	384			437
Other liabilities	4,091			4,338
TOTAL LIABILITIES	651,878			630,981
Commitments and Contingencies (Note L)
Shareholders’ equity:
Common stock, $1.00 par value, 16,000,000 shares authorized; 6,757,047 and 6,719,162 shares issued and outstanding at December 31, 2016 and December 31, 2015, respectively⁽¹⁾	6,757			6,719
Additional paid-in capital	58,976			58,543
Retained earnings (accumulated deficit)	2,287			(4,571		)
Accumulated other comprehensive loss	(15		)	(285		)
Total shareholders' equity	68,005			60,406
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	719,883		$	691,387

⁽¹⁾ Common stock shares authorized, issued and outstanding have been adjusted to reflect the one for five reverse stock split that occurred on March 8, 2017.

See notes to consolidated financial statements.

Four Oaks Fincorp, Inc.

Consolidated Statements of Operations

For the Years Ended December 31, 2016 and 2015

(Amounts in thousands, except per share data)



	2016				2015
Interest and dividend income:
Loans, including fees	$	25,464			$	25,208
Taxable investments	2,937				3,299
Dividends and other investments	351				331
Interest-earning deposits	436				528
Total interest and dividend income	29,188				29,366
Interest expense:
Deposits	2,328				2,446
Borrowings	1,479				3,059
Subordinated debentures	255				250
Subordinated promissory notes	766				1,023
Total interest expense	4,828				6,778
Net interest income	24,360				22,588
Provision for loan losses	—				—
Net interest income after provision for loan losses	24,360				22,588
Non-interest income:
Service charges on deposit accounts	1,445				1,566
Other service charges, commissions and fees	3,444				3,664
Gains on sale of investment securities available-for-sale, net	266				265
Gains on sale of loans held for sale	351				3,205
Income from investment in life insurance	210				187
Indemnification from third party payment processor clients	—			—	445
Other non-interest income	61				225
Total non-interest income	5,777				9,557
Non-interest expense:
Salaries	10,970				12,190
Employee benefits	2,354				2,072
Occupancy expenses	1,338				1,342
Equipment expenses	567				707
Professional and consulting fees	2,246				2,500
FDIC assessments	422				736
Foreclosed asset-related costs, net	623				393
Collection expenses	129				337
Prepayment of FHLB borrowings	—				2,089
Other operating expenses	6,198				6,251
Total non-interest expense	24,847				28,617

Income before income taxes	5,290				3,528
Income tax benefit	(1,568		)		(16,480		)
Net income	$	6,858			$	20,008

Basic net income per common share⁽¹⁾	$	1.06			$	3.12
Diluted net income per common share⁽¹⁾	$	1.04			$	3.10

⁽¹⁾ Weighted average common shares outstanding used in the computation of basic and diluted net income per common share were adjusted to reflect the one for five reverse stock split that occurred on March 8, 2017.

See notes to consolidated financial statements.

Four Oaks Fincorp, Inc.

Consolidated Statements of Comprehensive Income

For the Years Ended December 31, 2016 and 2015

(Amounts in thousands)



	2016			2015
Net income	$	6,858		$	20,008

Other comprehensive income (loss):
Securities available-for-sale:
Unrealized holding gains (losses) on available-for-sale securities	728			(882		)
Tax effect	(170		)	203
Reclassification of gains recognized in net income	(266		)	(265		)
Tax effect	—			—
Amortization of unrealized losses on investment securities transferred from available-for-sale to held-to-maturity	(36		)	(59		)
Tax effect	14			(38		)
Total other comprehensive income (loss)	270			(1,041		)

Comprehensive income	$	7,128		$	18,967

See notes to consolidated financial statements.

Four Oaks Fincorp, Inc.

Consolidated Statements of Shareholders’ Equity

For the Years Ended December 31, 2016 and 2015

(Amounts in thousands, except share data)



	Common stock					Additional paid-in capital			(Accumulated deficit) retained earnings			Accumulated other comprehensive income (loss)			Total shareholders' equity
	Shares⁽¹⁾		Amount			Additional paid-in capital			(Accumulated deficit) retained earnings			Accumulated other comprehensive income (loss)			Total shareholders' equity
BALANCE, DECEMBER 31, 2014	6,406,465		$	6,406		$	58,146		$	(24,579	)	$	756		$	40,729
Net income	—		—			—			20,008			—			20,008
Other comprehensive loss	—		—			—			—			(1,041		)	(1,041		)
Stock based compensation	—		—			565			—			—			565
Issuance of common stock	23,405		24			146			—			—			170
Issuance of restricted stock	304,200		304			(304		)	—			—			—
Forfeiture of restricted stock	(12,000	)	(12		)	12			—			—			—
Stock withheld for payment of taxes	(2,908	)	(3		)	(22		)	—			—			(25		)
BALANCE, DECEMBER 31, 2015	6,719,162		$	6,719		$	58,543		$	(4,571	)	$	(285	)	$	60,406
Net income	—		—			—			6,858			—			6,858
Other comprehensive income	—		—			—			—			270			270
Stock based compensation	—		—			352			—			—			352
Issuance of common stock	22,083		22			166			—			—			188
Excess income tax benefit	—		—			2			—			—			2
Issuance of restricted stock	42,000		42			(42		)	—			—			—
Forfeiture of restricted stock	(18,700	)	(19		)	19			—			—			—
Stock withheld for payment of taxes	(7,498	)	(7		)	(64		)	—			—			(71		)
BALANCE, DECEMBER 31, 2016	6,757,047		$	6,757		$	58,976		$	2,287		$	(15	)	$	68,005

⁽¹⁾ Common stock shares outstanding have been adjusted to reflect the one for five reverse stock split that occurred on March 8, 2017.

See notes to consolidated financial statements.

Four Oaks Fincorp, Inc.

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2016 and 2015

(Amounts in thousands)



	2016			2015
Cash flows from operating activities:
Net income	$	6,858		$	20,008
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income tax benefit	(1,678		)	(16,514		)
Provision for depreciation and amortization	675			684
Net amortization of bond premiums and discounts	924			1,153
Stock based compensation	352			565
Excess tax benefits from stock options	2			—
Gain on sale of investment securities	(266		)	(265		)
Loss on disposition of bank premises and equipment	21			48
Gain on sale of foreclosed assets, net	(10		)	(73		)
Valuation adjustment on foreclosed assets	405			344
Earnings on investment in bank-owned life insurance	(210		)	(187		)
Gain on sale of mortgage loans held for sale	(580		)	(644		)
Gain on sale of problem loans held for sale	(351		)	(3,205		)
Originations of mortgage loans held for sale	(23,334		)	(29,060		)
Proceeds from sale of loans held for sale	25,204			37,003
Changes in assets and liabilities:
Other assets	239			1,004
Accrued interest receivable	(4		)	33
Other liabilities	(247		)	1,532
Accrued interest payable	(53		)	(1,267		)
Net cash provided by operating activities	7,947			11,159

Cash flows from investing activities:
Proceeds from sales and calls of investment securities available-for-sale	5,198			8,324
Proceeds from maturities and calls of investment securities held-to-maturity	100			—
Proceeds from paydowns of investment securities available-for-sale	7,756			6,008
Proceeds from paydowns of investment securities held-to-maturity	13,503			15,430
Purchases of investment securities available-for-sale	(500		)	(21,697		)
Redemption of certificates of deposits held for investment	5,395			4,264
Purchase of bank-owned life insurance	(5,000		)	—
(Purchase) redemption of FHLB stock	(308		)	1,500
Net increase in loans outstanding	(49,677		)	(9,414		)
Purchases of bank premises and equipment	(620		)	(1,130		)
Proceeds from sales of foreclosed assets	700			2,990
Net cash (used in) provided by investing activities	(23,453		)	6,275

Cash flows from financing activities:
Net proceeds (repayments) from borrowings	10,000			(30,000		)
Net increase (decrease) in deposit accounts	11,197			(118,851		)
Proceeds from issuance of common stock	188			170
Net repayments of subordinated promissory notes	—			(500		)
Shares withheld for payment of taxes	(71		)	(25		)
Net cash provided by (used in) financing activities	21,314			(149,206		)



Change in cash and cash equivalents	5,808				(131,772		)
Cash and cash equivalents at beginning of year	26,755				158,527
Cash and cash equivalents at end of year	$	32,563			$	26,755

Supplemental disclosures of cash flow information:
Interest paid on deposits and borrowings	$	4,881			$	8,045

Supplemental disclosures of noncash investing and financing activities:
Unrealized gains (losses) on investment securities available-for-sale	$	462			$	(1,147	)
Loans transferred from held for investment to held for sale	—				2,618
Transfer of loans to foreclosed assets	1,017				1,239
Transfer from premises and equipment to premises and equipment held for sale	2,373				—
Loans transferred from held for sale to held for investment	—			—	261
Amortization of net losses on investment securities transferred to held-to-maturity	(36		)		(59		)

See notes to consolidated financial statements.

Four Oaks Fincorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2016 and 2015

NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Four Oaks Fincorp, Inc. (the "Company") was incorporated under the laws of the State of North Carolina on February 5, 1997. The Company’s primary function is to serve as the holding company for its owned subsidiaries, Four Oaks Bank & Trust Company, Inc. (the "Bank") and Four Oaks Mortgage Services, L.L.C (inactive). The Bank operates fifteen offices in eastern and central North Carolina, and its primary source of revenue is derived from loans to customers and from its securities portfolio. The loan portfolio is comprised mainly of real estate, commercial, and consumer loans. These loans are primarily collateralized by residential and commercial properties, commercial equipment, and personal property.

Reverse Stock Split

On March 8, 2017, the Company completed a one for five reverse stock split of the Company’s authorized, issued, and outstanding common stock, par value $1.00 per share (the “Reverse Stock Split”). The number of authorized shares of common stock was reduced from 80,000,000 to 16,000,000. At the effective time of the Reverse Stock Split, every five shares of the Company’s issued and outstanding common stock were automatically combined into one issued and outstanding share of the Company’s common stock. No fractional shares were issued in connection with the Reverse Stock Split, and any fractional shares resulting from the Reverse Stock Split were rounded up to the nearest whole share. All share and share-related information presented in this Annual Report on Form 10-K have been retroactively adjusted to reflect the decreased number of shares resulting from the Reverse Stock Split. Refer to Note S - Subsequent Events for additional information.

Basis of Presentation

The consolidated financial statements include the accounts and transactions of the Company, a bank holding company incorporated under the laws of the State of North Carolina, and its wholly-owned subsidiaries, the Bank, and Four Oaks Mortgage Services, L.L.C., which has been inactive since September 30, 2012. All significant intercompany transactions have been eliminated. In March 2006, the Company formed Four Oaks Statutory Trust I, a wholly owned Delaware statutory business trust (the “Trust”), for the sole purpose of issuing Trust Preferred Securities (as defined in Note H - Trust Preferred Securities). The Trust is not included in the consolidated financial statements of the Company.

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 period's Statements of Operations, Comprehensive Income, or Shareholders' Equity as previously reported.

Use of Estimates

Preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, fair value of impaired loans, fair value of foreclosed assets, other than temporary impairment of investment securities available-for-sale and held-to-maturity, and the valuation allowance against deferred tax assets.

Cash and Cash Equivalents

For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions cash and due from banks, and interest-earning deposits.

Federal regulations require institutions to set aside specified amounts of cash as reserves against transactions and time deposits. As of December 31, 2016, there was no daily average gross reserve requirement due to the amount of cash on the balance sheet.

Investment Securities

Investment securities are classified into three categories:

(1) Held-to-Maturity - Debt securities that the Company has the positive intent and the ability to hold to maturity are classified as held-to-maturity and reported at amortized cost.

(2) Trading - Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings.

(3) Available-for-Sale - Debt and equity securities not classified as either securities held-to-maturity or trading securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of income taxes, as other comprehensive income, a separate component of shareholders' equity. Gains and losses on sales of securities, computed based on specific identification of adjusted cost of each security, are included in income at the time of the sale. Premiums and discounts are amortized into interest income using a method that approximates the interest method over the period to maturity.

Transfers of securities into held-to-maturity from available-for-sale are made at fair value as of the transfer date. The unrealized gain or loss as of the transfer date is retained in accumulated other comprehensive income and in the carrying value of the held-to-maturity securities. The unrealized gain or loss is then amortized over the remaining life of the securities.

Each investment security in a loss position is evaluated for other-than-temporary impairment on at least a quarterly basis. The review includes an analysis of the facts and circumstances of each individual investment such as: (1) the length of time and the extent to which the fair value has been below cost, (2) changes in the earnings performance, credit rating, asset quality, or business prospects of the issuer, (3) the ability of the issuer to make principal and interest payments, (4) changes in the regulatory, economic, or technological environment of the issuer, and (5) changes in the general market condition of either the geographic area or industry in which the issuer operates.

Regardless of these factors, if we have developed a plan to sell the security or it is likely that we will be forced to sell the security in the near future, then the impairment is considered other-than-temporary and the carrying value of the security is permanently written down to the current fair value with the difference between the new carrying value and the amortized cost charged to earnings. If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the other-than-temporary impairment is separated into the following: (1) the amount representing the credit loss and (2) the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings and the amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes.

Loans Held for Sale

As part of the asset resolution plan (the "Asset Resolution Plan") executed during 2014 and 2015 and for other asset resolution efforts, the Company transferred loans held for investment to loans held for sale in anticipation of near term loan sales. The Asset Resolution Plan was completed in the fourth quarter of 2015 and all loans not sold were transferred from loans held for sale to loans held for investment. Other loans held for sale generally represent single-family, residential first mortgage loans on a pre-sold basis originated by our mortgage division. Commitments to sell the residential first mortgage loans are made after the intent to proceed with mortgage applications are initiated with borrowers, and all necessary components of the loan are approved according to secondary market underwriting standards of the investor that purchases the loan. Upon closing, these loans, together with their servicing rights, are sold to mortgage loan investors under prearranged terms. Loans held for sale are measured at the lower of cost or fair value on an aggregated basis within the consolidated balance sheet under the caption “loans held for sale”.

Rate Lock Commitments

The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). As required by Accounting Standard Codification ("ASC") ASC 815, Derivatives and Hedging, rate lock commitments related to the origination of mortgage loans held for sale and the corresponding forward loan sale commitments are considered to be derivatives. The commitments are generally for periods of 60 days and are at market rates.

In order to mitigate the risk from interest rate fluctuations, the Company enters into forward loan sale commitments on a “best efforts” basis while the loan is in the pipeline. Interest rate lock commitments and forward sales commitments are not material to the financial statements for any period presented.

Loans

Loans are stated at the amount of unpaid principal, reduced by an allowance for loan losses. Interest on all loan classifications is calculated by using the simple interest method on daily balances of the principal amount outstanding.

Loan origination fees are deferred, as well as certain direct loan origination costs. Such costs and fees are recognized as an adjustment to yield over the contractual lives of the related loans utilizing the interest method.

For all classes of loans, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect 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. Once a loan has been determined to meet the definition of impairment, the amount of that impairment is measured through one of the following 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 or by determining the fair market value of the underlying collateral 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 ("ALLL"). Groups of small dollar impaired loans with similar risk characteristics are evaluated for impairment collectively.

Income Recognition on Impaired and Nonaccrual Loans

Loans, including impaired loans, are generally classified as nonaccrual when doubts arise regarding the full collectibility of principal or interest and we are therefore uncertain that the borrower can satisfy the contractual terms of the loan agreement. In addition our policy is to place a loan on nonaccrual status at the point when the loan becomes past due 90 days unless there is sufficient documentation to establish that the loan is well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or is partially charged-off, the loan is generally classified as nonaccrual.

While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

Allowance for Loan Losses

Management has developed a model for evaluating the adequacy of the allowance for loan losses. The model uses the Company’s internal grading system to quantify the risk of each loan. The grade is initially assigned by the lending officer and/or the credit administration function. The internal grading system is reviewed and tested periodically by an independent internal loan review function as well as an independent external credit review firm. The testing process involves the evaluation of a sample of new loans, loans having been identified as possessing potential weakness in credit quality, and past due and nonaccrual loans to determine the ongoing effectiveness of the internal grading system. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on their judgments of information available to them at the time of their examination.

The grading system is comprised of seven risk categories for active loans. Grades 1 through 4 demonstrate various degrees of risk, but each is considered to have the capacity to perform in accordance with the terms of the loan. Loans possessing a grade of 5 exhibit characteristics which indicate higher risk that the loan may not be able to perform in accordance with the terms of the loan. Grade 6 loans are considered substandard and are generally impaired. Grade 7 loans are considered doubtful and would be included in nonaccrual loans. Grade 8 loans are considered uncollectable and identified as a confirmed loss. Loans can also be classified as non-accrual, troubled debt restructuring ("TDR"), or otherwise impaired, all of which 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 the following 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 or by determining the fair market value of the underlying collateral securing the loan. If the fair market value of collateral method is selected for use, an updated collateral value is generally obtained based on where the loan is in the collection process and the age of the existing appraisal. Groups of small dollar impaired loans with similar risk characteristics are evaluated for impairment collectively. Other impaired loans are then analyzed individually to determine the net value of collateral or cash flows and an estimate of potential loss. The net value of collateral per our analysis is determined using various subjective discounts, selling expenses and a review of the assumptions used to generate the current appraisal. If collection is deemed to be collateral dependent then the deficiency is generally charged off. Appraised values on real estate collateral are subject to constant change and management makes certain assumptions about how the age of an appraisal impacts current value. Impaired loans are re-evaluated periodically to determine the adequacy of specific reserves and charge-offs. Groups of small dollar impaired loans with similar risk characteristics may be evaluated for impairment collectively.

The Company utilizes a look back period of five years to determine historical loss rates under the quantitative ASC 450 reserve. The Company calculates historical loss rates from the most recent five years on a rolling quarter basis to provide an estimate of potential losses and to provide for the highest base charge-off rate regardless of whether the historical charge-offs are improving or declining. In addition, the Bank assigns a different percentage ("multiplier") of the base charge-off rate to the balances for each risk grade within a loan category to reflect the varied risk of charge-off for each. The standard multipliers range from 0% for a risk grade 1 and 300% for a risk grade 6 that is unimpaired. In addition, categories that have a concentrated level of charge-offs associated with a particular risk grade could have an additional reserve factor of 50% to 100% added to that particular risk grade. Categories that have had historically high charge-offs also have an additional reserve factor between 25% to 100% added to the risk grade 5s and 6s to account for the additional risk in those categories. The reserve amount by risk grade is calculated and then combined for a blended quantitative reserve factor for each loan category.

The allowance for loan losses represents management’s estimate of an appropriate amount to provide for known and inherent losses in the loan portfolio in the normal course of business. While management believes the methodology used to establish the allowance for loan losses incorporates the best information available at the time, future adjustments to the level of the allowance may be necessary and the results of operations could be adversely affected should circumstances differ substantially from the assumptions initially used. We believe that the allowance for loan losses was established in conformity with generally accepted accounting principles. However, upon examination by various regulatory agencies, adjustments to the allowance may be required. Likewise, there can be no assurance that the existing allowance for loan losses is adequate should there be deterioration in the quality of any loans or changes in any of the factors discussed above. Any increases in the provision for loan losses resulting from such deterioration or change in condition could adversely affect our financial condition and results of operations.

Bank Premises and Equipment

Land is carried at cost. Buildings, furniture, and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method based on the estimated useful lives of assets. Useful lives range from 5 to 10 years for furniture and equipment and 40 years for buildings. Expenditures for repairs and maintenance are charged to expense as incurred.

Stock in Federal Home Loan Bank of Atlanta

The Company owned Federal Home Loan Bank of Atlanta (“FHLB”) stock that it accounts for under the cost method. Based on the continued payment of dividends and that redemption of this stock has historically been at par, management believes that its investment in FHLB stock was not other-than-temporarily impaired as of December 31, 2016 or December 31, 2015. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not cause a decrease in the value of the FHLB stock held by the Company.

Foreclosed Assets

Assets acquired as a result of foreclosure are valued at fair value, less estimated selling costs, at the date of foreclosure establishing a new cost basis. After foreclosure, valuations of the property are periodically performed by management and the assets are carried at the lower of cost or fair value minus estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of debt are treated as credit losses. Routine holding costs, subsequent declines in value, and gains or losses on disposition are included in other income and expense.

Income Taxes

Accrued taxes represent the estimated amount payable to or receivable from taxing jurisdictions, either currently or in the future, and are reported, on a net basis, as a component of “other assets” in the consolidated balance sheets. The calculation of the Company’s income tax expense is complex and requires the use of many estimates and judgments in its determination.

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. These temporary differences consist primarily of the allowance for loan losses, differences in the financial statement and income tax basis in premises and equipment and differences in financial statement and income tax basis in accrued liabilities. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be fully realized.

Management’s determination of the realization of the net deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income and the implementation of various tax plans to maximize realization of the deferred tax asset.

From time to time, management bases the estimates of related tax liabilities on its belief that future events will validate management’s current assumptions regarding the ultimate outcome of tax-related exposures. While the Company has obtained the opinion of advisors that the anticipated tax treatment of these transactions should prevail and has assessed the relative merits and risks of the appropriate tax treatment, examination of the Company’s income tax returns, changes in tax law and regulatory guidance may impact the treatment of these transactions and resulting provisions for income taxes.

Stock Compensation Plans

The Company accounts for stock based awards granted to employees using the fair value method. The cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). The cost of employee services received in exchange for an award is based on the grant-date fair value of the award. Excess tax benefits are reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

Recent Accounting Pronouncements

In August 2016, the FASB issued Accounting Standards Update ("ASU") No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific classification issues in an effort to reduce the diversity in practice in how these certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The adoption of this guidance is not believed to be material to the Company's consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This update replaces the incurred loss impairment methodology with one that reflects current expected credit losses (CECL) and requires consideration of a broader range of reasonable and supportable forecasted information to inform credit loss estimates. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This update amends several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for annual and interim reporting periods beginning after December 15, 2016. The adoption of this guidance is not believed to be material to the Company's consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which will require lessees to be recorded as an asset on the balance sheet for the right to use the leased asset and a liability for the corresponding lease obligation for leases with terms of more than 12 months. The accounting treatment for lessors will remain relatively unchanged. The ASU also requires additional qualitative and quantitative disclosures related to the nature, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company has five lease agreements which are currently considered operating leases, and therefore, not recognized on the Company's consolidated statements of condition. The Company expects the new guidance will require these lease agreements to be recognized on the consolidated statements of condition as a right-of-use asset and a corresponding lease liability. Therefore, the Company's preliminary evaluation indicates the provisions of ASU No. 2016-02 will impact the Company's consolidated statements of condition and continues to evaluate the extent of potential impact on it's consolidated financial statements.

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which revises the accounting treatment related to classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. Upon adoption, investments in equity securities, except those accounted for under the equity method or that result in the consolidation of the investee, will be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have a readily determinable fair value may be measured at cost minus impairment, plus or minus changes from observable price changes in an orderly transaction. ASU 2016-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption of certain provisions is permitted. The Company does not believe the adoption of this ASU will have a material impact on the Company's consolidated financial statements.

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. We adopted ASU No. 2015-03 and there was no impact to 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). Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the Company does not expect the new guidance to have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company is performing an overall assessment of revenue streams possibly affected by the ASU to determine the potential impact the new guidance will have on the Company's consolidated financial statements. In addition, the Company continues to follow certain implementation issues relevant to the banking industry which are still pending resolution. The Company plans to adopt ASU No. 2014-09 on January 1, 2018.

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.

NOTE B - NET INCOME PER SHARE

Basic net income per share represents earnings credited to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted net income 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 solely to outstanding stock options and vesting of restricted stock awards.

Basic and diluted net income per common share are computed based upon net income as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding. All share and per common share amounts have been adjusted to reflect the Reverse Stock Split. Refer to Note S - Subsequent Events for additional information.

The following table presents the calculation of basic and diluted net income per common share (amounts in thousands, except share data).



	Twelve Months Ended
	December 31,
	2016		2015
Net income available to common shareholders	$	6,858	$	20,008

Weighted average number of common shares - basic	6,480,154		6,420,734
Effect of dilutive stock options	7,664		3,155
Effect of dilutive restricted stock awards	76,475		25,656
Weighted average number of common shares - dilutive	6,564,293		6,449,545

Basic earnings per common share	$	1.06	$	3.12
Diluted earnings per common share	$	1.04	$	3.10
Anti-dilutive awards	2,461		29,531

NOTE C - INVESTMENT SECURITIES

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities available-for-sale as of December 31, 2016 and 2015 are as follows (amounts in thousands):



	Securities Available-for-Sale
	At December 31
	2016								2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Taxable municipal securities	$	19,846	$	350	$	147	$	20,049	$	24,789	$	225	$	447	$	24,567
Mortgage-backed securities
GNMA	11,704		44		68		11,680		13,512		68		50		13,530
FNMA & FHLMC	25,684		—		272		25,412		32,024		—		351		31,673
Other debt securities	1,000		—		—		1,000		500		—		—		500
Equity securities	—		—		—		—		11		—		—		11
Total	$	58,234	$	394	$	487	$	58,141	$	70,836	$	293	$	848	$	70,281

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of securities held-to-maturity as of December 31, 2016 and 2015 are as follows (amounts in thousands):



	Securities Held-to-Maturity
	At December 31
	2016								2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Taxable municipal securities	$	3,380	$	9	$	3	$	3,386	$	3,531	$	1	$	20	$	3,512
Mortgage-backed securities
GNMA	45,968		407		187		46,188		59,185		509		230		59,464
FNMA	1,857		21		—		1,878		2,638		19		—		2,657
Total	$	51,205	$	437	$	190	$	51,452	$	65,354	$	529	$	250	$	65,633

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 it is 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 December 31, 2016 resulted from changing market interest rates compared to the yields available at the time the underlying securities were purchased. The investment portfolio included 19 of 54 Government National Mortgage Association ("GNMA") mortgage-backed securities ("MBS"), 11 of 14 Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corporation ("FHLMC") MBS, and 10 of 33 taxable municipal securities that contained net unrealized losses at December 31, 2016. Management identified no impairment related to credit quality. At December 31, 2016, management had the intent and ability to hold impaired securities and no impairment was evaluated as other than temporary. As a result, no other than temporary impairment losses were recognized during the twelve months ended December 31, 2016.

The following tables reflect the gross unrealized losses and fair values of securities available-for-sale, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates presented. (amounts in thousands):



	Securities Available-for-Sale
	December 31, 2016
	Less Than 12 Months				12 Months or More				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
Taxable municipal securities	$	9,988	$	147	$	—	$	—	$	9,988	$	147
Mortgage-backed securities
GNMA	8,842		68		—		—		8,842		68
FNMA & FHLMC	25,412		272		—		—		25,412		272
Total temporarily impaired securities	$	44,242	$	487	$	—	$	—	$	44,242	$	487



	Securities Available-for-Sale
	December 31, 2015
	Less Than 12 Months				12 Months or More				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
Taxable municipal securities	$	16,888	$	447	$	—	$	—	$	16,888	$	447
Mortgage-backed securities
GNMA	10,010		50		—		—		10,010		50
FNMA & FHLMC	31,673		351		—		—		31,673		351
Total temporarily impaired securities	$	58,571	$	848	$	—	$	—	$	58,571	$	848

The following tables reflect the gross unrealized losses and fair values of securities held-to-maturity, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates presented. (amounts in thousands):



	Securities Held-to-Maturity
	December 31, 2016
	Less Than 12 Months				12 Months or More				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
Taxable municipal securities	$	525	$	3	$	—	$	—	$	525	$	3
Mortgage-backed securities
GNMA	21,074		187		—		—		21,074		187
Total temporarily impaired securities	$	21,599	$	190	$	—	$	—	$	21,599	$	190



	Securities Held-to-Maturity
	December 31, 2015
	Less Than 12 Months				12 Months or More				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
Taxable municipal securities	$	3,325	$	20	$	—	$	—	$	3,325	$	20
Mortgage-backed securities
GNMA	20,784		116		5,130		114		25,914		230
Total temporarily impaired securities	$	24,109	$	136	$	5,130	$	114	$	29,239	$	250

The amortized cost and fair value of available-for-sale and held-to-maturity securities at December 31, 2016 by expected maturities are shown below (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.



	Available-for-Sale
	Taxable municipal securities				Mortgage-backed securities - GNMA				Mortgage-backed securities - FNMA & FHLMC				Other Debt Securities
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due after five years through ten years	$	—	$	—	$	—	$	—	$	—	$	—	$	1,000	$	1,000
Due after ten years	19,846		20,049		11,704		11,680		25,684		25,412		—		—
Total Munis, GNMA, FNMA & FHLMC, and Other Debt securities	$	19,846	$	20,049	$	11,704	$	11,680	$	25,684	$	25,412	$	1,000	$	1,000

	Held-to-Maturity
	Taxable municipal securities				Mortgage-backed securities - GNMA				Mortgage-backed securities - FNMA
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due within one year	$	155	$	155	$	—	$	—	$	—	$	—
Due after one year through five years	2,700		2,701		—		—		—		—
Due after five years through ten years	525		530		5,231		5,366		1,857		1,878
Due after ten years	—		—		40,737		40,822		—		—
Total Munis, GNMA, and FNMA securities	$	3,380	$	3,386	$	45,968	$	46,188	$	1,857	$	1,878

Securities with a carrying value of approximately $28.4 million and $61.1 million at December 31, 2016 and 2015, respectively, were pledged to secure public deposits, FHLB advances and for other purposes required or permitted by law.

Sales and calls of securities available-for-sale during 2016 and 2015 of $5.2 million and $8.3 million generated gross realized gains of $266,400 and $264,771, respectively, and no gross realized losses for 2016 and 2015.

NOTE D - LOANS AND ALLOWANCE FOR LOAN LOSSES

The classification of loan segments as of December 31, 2016 and 2015 are summarized as follows (amounts in thousands):



	2016			2015
Commercial and industrial	$	21,742		$	23,163
Commercial construction and land development	46,114			50,510
Commercial real estate	253,086			208,737
Residential construction	42,660			36,618
Residential mortgage	132,971			128,442
Consumer	6,896			6,638
Other	502			1,257
Consumer credit cards	2,114			2,240
Business credit cards	1,235			1,168
	507,320			458,773
Net deferred loan fees	(316		)	(460		)
Allowance for loan losses	(9,647		)	(9,616		)
Total net loans	$	497,357		$	448,697

Loans held for sale	$	206		$	1,145

Nonperforming assets

Nonperforming assets at December 31, 2016 and 2015 consist of the following (amounts in thousands):



	2016		2015
Loans past due ninety days or more and still accruing	$	40	$	65
Nonaccrual loans	4,324		6,598
Foreclosed assets	1,682		1,760
Total	$	6,046	$	8,423

Related Party Loans

The Company had loan and deposit relationships with directors, executive officers, and associates of these parties as of December 31, 2016 and 2015. The following is a reconciliation of these loans (amounts in thousands):



	2016			2015
Beginning balance	$	7,729		$	7,683
New loans	32			1,689
Principal repayments	(384		)	(1,643		)
Ending balance	$	7,377		$	7,729

As a matter of policy, these loans and credit lines are approved by the Company’s Board of Directors and are made with interest rates, terms, and collateral requirements comparable to those required of other borrowers. In the opinion of management, these loans do not involve more than the normal risk of collectibility.

Credit Risk

We use an internal grading system to assign the degree of inherent risk on each individual loan and monitor trends in portfolio quality. The grade is initially assigned by the lending officer or credit administration and reviewed by the loan administration function throughout the life of the loan. The credit grades have been defined as follows:


•	Grade 1 - Superior / Lowest Risk

Loans that are virtually risk-free and are well-collateralized by cash or cash-equivalent instruments held by the Bank. They are loans secured by properly margined liquid collateral such as certificates of deposit, government securities, cash value of life insurance, stock actively traded on one of the major stock exchanges, etc. The repayment program is well-defined and achievable, and repayment sources are numerous. Repayment is definite and being handled as agreed. No material documentation deficiencies or exceptions exist.


•	Grade 2 - Strong

Loans secured by readily marketable collateral, properly margined and with a definite repayment program in effect. These loans are within guidelines to borrowers with sound financial condition and financial statements with liquid assets and/or other assets that can be easily liquidated to satisfy debts. These loans have excellent, multiple sources of repayment, with no significant identifiable risk of collection. The repayment source is well-defined by proven income, cash flow, trade asset turn, etc. Documented sources of repayment meet or exceed required minimum Bank guidelines, and can be supplemented with verifiable cash flow from other sources. Such loans conform in all respects to Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).


•	Grade 3 - Solid / Standard

These loans have adequate sources of repayment, with little identifiable risk of collection. Generally, loans assigned this risk grade will demonstrate the following characteristics:


◦	Conformity in most respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (limited exceptions of any kind). All exceptions noted have documented mitigating factors that offset any additional risk associated with the exceptions noted.


◦	Documented sources of repayment that meet required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.


◦	Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.


◦	Secured loans repaying as agreed where collateral value and marketability are sufficient and do not materially affect risk.


◦	Fully collectible, unsecured loans repaying as agreed and backed by sound personal or business financial statements with reachable assets that can be readily liquidated.


•	Grade 4 - Acceptable

These are acceptable loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss. Loans assigned this grade may demonstrate some or all of the following characteristics:


◦	Exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank. Although the combination and/or severity of identified exceptions are greater for this risk grade, the exceptions may be properly mitigated by other documented factors that offset any additional risks.


◦	Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.


◦	Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.


◦	Secured loans repaying as agreed where collateral value or marketability are questionable but do not materially affect risk of repayment/collection.


◦	Includes loans to borrowers with an established borrowing history with the Bank, with no Bank delinquencies and no delinquencies with other creditors, but with little or no identifiable cash flow to support the borrower's unblemished repayment history.


•	Grade 5 - Special Mention or Watch List

A Special Mention loan (OAEM) has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank's credit position at some future date. Special Mention loans are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Special Mention or Watch List loans may include the following characteristics:


◦	Loans with guideline tolerances or exceptions of any kind that have not been mitigated by other economic or credit factors.


◦	Loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date.


◦	Borrowers that are experiencing adverse operating trends or an ill-proportioned balance sheet.


◦	Loans being repaid as agreed that require close following because of complexity, information or underwriting deficiencies, emerging signs of weakness or non-standard terms.


◦	Potential weaknesses exist, generally the result of deviations from prudent lending practices, such as over advances on collateral or unproven and inadequate primary repayment sources.


◦	Loans where adverse economic conditions have developed subsequent to the loan origination that may not jeopardize liquidation of the debt, but do substantially increase the level of risk, may also warrant this rating.


•	Grades 6-8 - Substandard (Grade 6), Doubtful (Grade 7) and Loss (Grade 8)

A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be affected in the future. Loans are not typically made if graded Substandard or worse at inception without management's approval.

The following tables illustrate the credit risk profile by creditworthiness class as of December 31, 2016 and 2015 (amounts in thousands):



	December 31, 2016
	Commercial and Industrial		Commercial Construction and Land Development		Commercial Real Estate		Residential - Construction		Residential - Mortgage		Consumer		Other		Total
1 - Lowest Risk	$	897	$	—	$	—	$	—	$	—	$	1,321	$	—	$	2,218
2 - Strong	915		1,524		5,439		292		15,105		597		97		23,969
3 - Standard	9,588		13,671		116,065		12,300		56,374		1,131		311		209,440
4 - Acceptable	9,932		26,926		118,077		30,068		53,832		3,770		94		242,699
5 - Special Mention	373		3,261		10,088		—		5,804		77		—		19,603
6 - Substandard or worse ⁽¹⁾	37		732		3,417		—		1,856		—		—		6,042
	$	21,742	$	46,114	$	253,086	$	42,660	$	132,971	$	6,896	$	502	$	503,971

⁽¹⁾ The above table does not include business and consumer credit cards.



	December 31, 2015
	Commercial and Industrial		Commercial Construction and Land Development		Commercial Real Estate		Residential - Construction		Residential - Mortgage		Consumer		Other		Total
1 - Lowest Risk	$	1,942	$	—	$	—	$	—	$	—	$	1,773	$	—	$	3,715
2 - Strong	971		749		2,280		—		15,187		386		7		19,580
3 - Standard	10,530		11,262		94,357		4,296		56,493		1,250		469		178,657
4 - Acceptable	9,297		33,832		103,740		31,431		50,226		3,170		757		232,453
5 - Special Mention	304		2,486		4,444		170		5,231		59		—		12,694
6 - Substandard or worse ⁽¹⁾	119		2,181		3,916		721		1,305		—		24		8,266
	$	23,163	$	50,510	$	208,737	$	36,618	$	128,442	$	6,638	$	1,257	$	455,365

⁽¹⁾ The above table does not include business and consumer credit cards.

The following table illustrates the credit card portfolio exposure as of December 31, 2016 and 2015 (amounts in thousands):



	December 31, 2016				December 31, 2015
	Consumer - Credit Card		Business - Credit Card		Consumer - Credit Card		Business - Credit Card
Performing	$	2,095	$	1,214	$	2,211	$	1,133
Nonperforming	19		21		29		35
	$	2,114	$	1,235	$	2,240	$	1,168

Nonaccruals and Past Due Loans

The following tables illustrate the age analysis of past due loans by loan class as of December 31, 2016 and 2015 (amounts in thousands):



	December 31, 2016
	30-89 Days Past Due		Nonaccrual		90 Days or More Past Due		Total Past Due		Current		Total Loans
Commercial & industrial	$	—	$	36	$	—	$	36	$	21,706	$	21,742
Commercial construction & land development	89		691		—		780		45,334		46,114
Commercial real estate	10		2,153		—		2,163		250,923		253,086
Residential construction	—		—		—		—		42,660		42,660
Residential mortgage	295		1,444		—		1,739		131,232		132,971
Consumer	42		—		—		42		6,854		6,896
Consumer credit cards	48		—		19		67		2,047		2,114
Business credit cards	9		—		21		30		1,205		1,235
Other loans	—		—		—		—		502		502
Total	$	493	$	4,324	$	40	$	4,857	$	502,463	$	507,320



	December 31, 2015
	30-89 Days Past Due		Nonaccrual		90 Days or More Past Due		Total Past Due		Current		Total Loans
Commercial & industrial	$	56	$	119	$	—	$	175	$	22,988	$	23,163
Commercial construction & land development	211		1,626		—		1,837		48,673		50,510
Commercial real estate	—		2,929		—		2,929		205,808		208,737
Residential construction	133		721		—		854		35,764		36,618
Residential mortgage	499		1,203		—		1,702		126,740		128,442
Consumer	71		—		—		71		6,567		6,638
Consumer credit cards	95		—		29		124		2,116		2,240
Business credit cards	107		—		36		143		1,025		1,168
Other loans	—		—		—		—		1,257		1,257
Total	$	1,172	$	6,598	$	65	$	7,835	$	450,938	$	458,773

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 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 reserve or charge-off, and is incorporated into the Bank's ALLL.

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 loans does not include deferred fees or accrued interest and management deems this amount to be immaterial.

The following tables illustrate the impaired loans by loan class as of December 31, 2016 and 2015 (amounts in thousands):



	December 31, 2016
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	18	$	19	$	—	$	21	$	—
Commercial construction & land development	53		60		—		58		—
Commercial real estate	1,131		1,660		—		1,189		50
Residential mortgage	1,804		1,882		—		1,881		37
Subtotal:	$	3,006	$	3,621	$	—	$	3,149	$	87

With an allowance recorded:
Commercial and industrial	$	18	$	18	$	2	$	17	$	—
Commercial construction & land development	638		763		420		660		11
Commercial real estate	1,736		1,739		529		1,741		36
Residential mortgage	164		208		56		191		13
Subtotal:	$	2,556	$	2,728	$	1,007	$	2,609	$	60

Totals:
Commercial	$	3,594	$	4,259	$	951	$	3,686	$	97
Residential	1,968		2,090		56		2,072		50
Grand Total	$	5,562	$	6,349	$	1,007	$	5,758	$	147

At December 31, 2016, the recorded investment in loans considered impaired totaled $5.6 million. Of the total investment in loans considered impaired, $2.6 million were found to show specific impairment for which a $1.0 million valuation allowance was recorded; the remaining $3.0 million in impaired loans required no specific valuation allowance because either previously established valuation allowances had been absorbed by partial charge-offs or loan evaluations had no indication of impairment which would require a valuation allowance.



	December 31, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	67	$	67	$	—	$	63	$	3
Commercial construction & land development	737		1,706		—		1,031		19
Commercial real estate	2,258		2,614		—		2,020		50
Residential construction	721		722		—		408		8
Residential mortgage	1,305		1,312		—		1,191		51
Subtotal:	$	5,088	$	6,421	$	—	$	4,713	$	131

With an allowance recorded:
Commercial and industrial	$	52	$	63	$	7	$	58	$	4
Commercial construction & land development	1,948		3,020		1,006		2,086		122
Commercial real estate	1,699		1,699		228		1,713		79
Residential mortgage	139		217		20		183		8
Subtotal:	$	3,838	$	4,999	$	1,261	$	4,040	$	213

Totals:
Commercial	$	6,761	$	9,169	$	1,241	$	6,971	$	277
Residential	2,165		2,251		20		1,782		67
Grand Total:	$	8,926	$	11,420	$	1,261	$	8,753	$	344

At December 31, 2015, the recorded investment in loans considered impaired totaled $8.9 million. Of the total investment in loans considered impaired, $3.8 million were found to show specific impairment for which a $1.3 million valuation allowance was recorded; the remaining $5.1 million in impaired loans required no specific valuation allowance because either previously established valuation allowances had been absorbed by partial charge-offs or loan evaluations had no indication of impairment which would require a valuation allowance.

Troubled Debt Restructurings

Loans are classified as a TDR 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. Generally, concessions are granted as a result of a borrower's inability to meet the contractual repayment obligations of the initial loan terms and in the interest of improving the likelihood of recovery of the loan. We may grant these concessions by a number of means such as (1) forgiving principal or interest, (2) reducing the stated interest rate to a below market rate, (3) deferring principal payments, (4) changing repayment terms from amortizing to interest only, (5) extending the repayment period, or (6) accepting a change in terms based upon a bankruptcy plan. However, the Bank only restructures loans for borrowers that demonstrate the willingness and capacity to repay the loan under reasonable terms and where the Bank has sufficient protection provided by the cash flow of the underlying collateral or business.

Loans in the process of renewal or modification are reviewed by the Bank to determine if the risk grade assigned is accurate based on updated information. All loans identified by the Bank's internal loan grading system to pose a heightened level of risk at or prior to renewal or modification are additionally reviewed to determine if the loan should be classified as a TDR. The Bank's knowledge of the borrower's situation and any updated financial information obtained is first used to determine whether the borrower is experiencing financial difficulty. Once this is determined, the Bank reviews the modification terms to determine whether a concession has been granted. If the Bank determines that both conditions have been met, the loan will be classified as a TDR. If the Bank determines that both conditions have not been met, the loan is not classified as a TDR, but would typically then be monitored for any additional deterioration. Documentation to support this determination of TDR classification is maintained within the credit file.

For the year ended December 31, 2016, there were seven loans modified as TDRs totaling $1,004,000. There were no loans modified as TDRs for the year ended December 31, 2015. The following table presents a breakdown of TDRs by loan class and the type of concession made to the borrower as of December 31, 2016 (amounts in thousands, except number of loans):




	For the Year Ended
	December 31, 2016
	Number of loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Extended payment terms:
Commercial & industrial	3	$	27	$	24
Commercial real estate	2	591		587
Residential mortgage	1	260		260
Subtotal	6	$	878	$	871

Other:
Residential mortgage	1	$	126	$	121
Subtotal	1	$	126	$	121

Total	7	$	1,004	$	992

There were no loans modified as TDRs and for which there was a payment default during the year ended December 31, 2016.

The table below details the progression of TDRs which have been entered into during the previous 12 months (amounts in thousands, except number of loans):




	December 31, 2016
	Paid in full			Paying as restructured			Converted to non-accrual			Foreclosure/Default
	Number of loans	Recorded Investment		Number of loans	Recorded Investment		Number of loans	Recorded Investment		Number of loans	Recorded Investment
Extended payment terms	—	$	—	6	$	871	—	$	—	—	$	—
Other	—	—		1	121		—	—		—	—
Total	—	$	—	7	$	992	—	$	—	—	$	—

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.

Following is an analysis of the allowance for loan losses by loan segment as of and for the years ended December 31, 2016 and 2015 (amounts in thousands):



	December 31, 2016
				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	$	221		$	5,470		$	2,268		$	305		$	1,191		$	113		$	48		$	9,616

Provision for loan losses	(187		)	(1,114		)	1,474			(68		)	(138		)	33			—			—
Loans charged-off	(73		)	(229		)	(565		)	—			(45		)	(161		)	(9		)	(1,082		)
Recoveries	97			788			21			21			70			113			3			1,113
Net recoveries (charge-offs)	24			559			(544		)	21			25			(48		)	(6		)	31

Balance, end of period	$	58		$	4,915		$	3,198		$	258		$	1,078		$	98		$	42		$	9,647

Ending balance: individually evaluated for impairment	$	—		$	415		$	530		$	—		$	39		$	—		$	—		$	984
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	58		$	4,500		$	2,668		$	258		$	1,039		$	98		$	42		$	8,663

Loans:
Balance, end of period	$	22,977		$	46,114		$	253,086		$	42,660		$	132,971		$	9,010		$	502		$	507,320

Ending balance: individually evaluated for impairment	$	24		$	652		$	2,866		$	—		$	1,844		$	—		$	—		$	5,386
Ending balance: collectively evaluated for impairment⁽¹⁾	$	22,953		$	45,462		$	250,220		$	42,660		$	131,127		$	9,010		$	502		$	501,934

⁽¹⁾At December 31, 2016, there were $176,000 in impaired loans collectively evaluated for impairment with $23,000 in reserves established.



	December 31, 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	(58		)	(615		)	71			(90		)	497			121			74			—
Loans charged-off	(74		)	(196		)	(578		)	(41		)	(713		)	(210		)	(69		)	(1,881		)
Recoveries	234			1,176			393			—			201			113			3			2,120
Net recoveries (charge-offs)	160			980			(185		)	(41		)	(512		)	(97		)	(66		)	239

Balance, end of period	$	221		$	5,470		$	2,268		$	305		$	1,191		$	113		$	48		$	9,616

Ending balance: individually evaluated for impairment	$	2		$	989		$	228		$	—		$	—		$	—		$	—		$	1,219
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	219		$	4,481		$	2,040		$	305		$	1,191		$	113		$	48		$	8,397

Loans:
Balance, end of period	$	24,331		$	50,510		$	208,737		$	36,618		$	128,442		$	8,878		$	1,257		$	458,773

Ending balance: individually evaluated for impairment	$	84		$	2,564		$	3,957		$	721		$	1,305		$	—		$	—		$	8,631
Ending balance: collectively evaluated for impairment ⁽¹⁾	$	24,247		$	47,946		$	204,780		$	35,897		$	127,137		$	8,878		$	1,257		$	450,142

⁽¹⁾ At December 31, 2015, there were $295,000 in impaired loans collectively evaluated for impairment with $42,000 in reserves established.

NOTE E - BANK PREMISES AND EQUIPMENT

Company premises and equipment at December 31, 2016 and 2015 are as follows (amounts in thousands):



	2016			2015
Land	$	2,564		$	4,394
Buildings and leasehold improvements	11,837			11,312
Furniture and equipment	4,691			5,182
Construction in process	—			1,467
	19,092			22,355
Less accumulated depreciation	(9,248		)	(10,062		)
	$	9,844		$	12,293

Depreciation expense was $675,000 and $684,000 for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, the Company had a total of $2.4 million in premises and equipment which were classified as held for sale.

NOTE F - DEPOSITS

At December 31, 2016, the scheduled maturities of time deposits are as follows (amounts in thousands):



	Less than $250,000		$250,000 or more		Total
2017	$	101,946	$	15,546	$	117,492
2018	43,423		4,909		48,332
2019	9,278		3,327		12,605
2020	6,787		3,438		10,225
2021	9,843		2,297		12,140
2022 and beyond	241		250		491
Total time deposits	$	171,518	$	29,767	$	201,285

NOTE G - BORROWINGS

At December 31, 2016 and 2015, borrowed funds included the following FHLB advances (amounts in thousands):



Origination Date	Maturity Date	Interest Rate		December 31, 2016
February 4, 2008	February 5, 2018	2.06%	Fixed	$	10,000
June 5, 2008	June 5, 2018	2.25%	Fixed	5,000
June 5, 2008	June 5, 2018	2.55%	Fixed	5,000
September 18, 2008	September 18, 2018	2.71%	Fixed	10,000
February 10, 2016	August 9, 2017	0.73%	Fixed	10,000
April 29, 2016 ⁽¹⁾	April 29, 2019	2.54%	Fixed	5,000
April 29, 2016 ⁽¹⁾	April 29, 2019	2.62%	Fixed	5,000
April 29, 2016 ⁽¹⁾	April 29, 2019	2.83%	Fixed	10,000
May 25, 2016	May 25, 2018	1.13%	Fixed	10,000
				$	70,000

⁽¹⁾ These advances were redeemed and restructured on April 29, 2016 and were originally executed between 2007 and 2008.



Origination Date	Maturity Date	Interest Rate		December 31, 2015
August 13, 2007	August 14, 2017	3.94%	Fixed	$	5,000
February 4, 2008	February 5, 2018	2.06%	Fixed	10,000
June 5, 2008	June 5, 2018	2.25%	Fixed	5,000
June 5, 2008	June 5, 2018	2.55%	Fixed	5,000
June 5, 2008	June 5, 2018	3.03%	Fixed	5,000
September 9, 2008	September 10, 2018	3.14%	Fixed	10,000
September 18, 2008	September 18, 2018	2.71%	Fixed	10,000
December 21, 2015	February 22, 2016	0.48%	Fixed	10,000
				$	60,000

FHLB advances are secured by a floating lien covering the Company’s loan portfolio of qualifying mortgage loans, as well as specific bonds in the investment portfolio. At December 31, 2016, the Company had available lines of credit totaling $110.3 million with the FHLB for borrowing dependent on adequate collateralization. The weighted average rates for the above borrowings at December 31, 2016 and 2015 were 2.06% and 2.38%, respectively.

In addition to the above advances, the Company has lines of credit of $37.0 million from various financial institutions to purchase federal funds on a short-term basis. The Company has no federal funds purchases outstanding as of December 31, 2016.

NOTE H - TRUST PREFERRED SECURITIES

On March 30, 2006, $12.4 million of trust preferred securities (the “Trust Preferred Securities”) were placed through the Trust. The Trust has invested the net proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Debentures”) issued by the Company and recorded in borrowings on the accompanying consolidated balance sheets. The Trust Preferred Securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to three month LIBOR plus 1.35%. The dividends paid to holders of the Trust Preferred Securities, which will be recorded as interest expense, are deductible for income tax purposes. The Trust Preferred Securities are redeemable on June 15, 2011 or afterwards in whole or in part, on any June 15, September 15, December 15, or March 15. Redemption is mandatory by June 15, 2036.

The Company has fully and unconditionally guaranteed the Trust Preferred Securities through the combined operation of the Debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company. The Trust Preferred Securities qualify as Tier I capital for regulatory capital purposes subject to certain limitations.

The Company has the right to defer payment of interest on the Debentures at any time and from time to time for a period not exceeding five years, provided that no deferral period extends beyond the stated maturities of the Debentures. Such deferral of interest payments by the Company will result in a deferral of distribution payments on the related Trust Preferred Securities. Whenever the Company defers the payment of interest on the Debentures, it will be precluded from the payment of cash dividends to shareholders. As of December 31, 2016, the Company is current with interest payments on the Debentures.

NOTE I – SUBORDINATED PROMISSORY NOTES

NOTE J - INCOME TAXES

Allocation of income tax expense between current and deferred portions is as follows (amounts in thousands):



	Years Ended December 31,
	2016			2015
Current tax expense (benefit):
Federal	$	110		$	34
State	—			—
	110			34
Deferred tax expense (benefit):
Federal	(954		)	(15,184		)
State	(724		)	(1,330		)
	(1,678		)	(16,514		)

Income tax benefit	$	(1,568	)	$	(16,480	)

The reconciliation of expected income tax at the statutory federal rate of 34% with income tax expense is as follows (amounts in thousands):



	Years Ended December 31,
	2016			2015
Expense computed at statutory rate of 34%	$	1,800		$	1,200
Effect of state income taxes, net of federal benefit	(1,006		)	(790		)
Tax exempt income	(28		)	(19		)
Bank owned life insurance income	(72		)	(64		)
Valuation allowance	(2,287		)	(16,819		)
Other, net	25			12
	$	(1,568	)	$	(16,480	)

Deferred income taxes consist of the following (amounts in thousands):



	Years Ended December 31,
	2016			2015
Deferred tax assets:
Allowance for loan losses	$	3,471		$	3,523
Restricted stock and stock options	255			240
OTTI	184			188
Net deferred loan fees	114			169
Net operating loss	13,217			14,901
SERP accrual	147			186
Other	1,111			1,335
Unrealized gain on securities	9			165
Total deferred tax assets	18,508			20,707
Less valuation allowance	(87		)	(3,765		)
Net deferred tax assets	18,421			16,942
Deferred tax liabilities:
Property and equipment	$	95		$	133
Prepaid expense	76			80
Other	49			50
Total deferred tax liabilities	220			263
Net deferred tax asset	$	18,201		$	16,679

When tax returns are filed, it is highly likely that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely to be realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. For the years ended December 31, 2016 and 2015, there were no uncertain tax positions taken by the Company. The Company classifies interest and penalties related to income tax assessments, if any, in income tax expense in the consolidated statements of operations. Fiscal years ending December 31, 2009 and thereafter are subject to IRS examination.

For the twelve months ended December 31, 2016, the Company recorded a discrete income tax benefit of $1.6 million as compared to $16.5 million for the same period in 2015. The year-over-year variance is due to the Company’s release of the valuation allowance against its deferred tax assets in the second quarter of 2015 offset by an income tax expense in the third quarter of 2015 as a result of changes to the North Carolina tax rate and its impact on future deferred tax benefits.

As of December 31, 2016, the Company had net operating losses available for carryforward of $37.1 million that will expire, if unused, from 2028 through 2034.

Under the accounting principles generally accepted in the United States ("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. In the second quarter of 2015, the Company determined it was more likely than not that it will generate sufficient taxable income to utilize a significant portion of its deferred tax assets and completed a partial reversal of the valuation allowance on its deferred tax assets totaling $16.6 million.

As part of the ongoing evaluation of positive and negative factors, the Company determined in the fourth quarter of 2016 that it is more likely than not that it will generate sufficient taxable income to utilize substantially all of the remaining portion of its deferred tax assets. As a result of this judgment about the ability to utilize its deferred tax assets in future years, the Company released $3.7 million of the remaining valuation allowance against its deferred tax assets resulting in an income tax benefit. This conclusion, and release of substantially all remaining valuation allowance, was based upon a number of factors including continued improvement in quarterly earnings, forecasted future profitability, and improved asset quality.

NOTE K - CAPITAL AND REGULATORY INFORMATION

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. Although not currently limited by regulatory authorities, there were no dividends paid to the Company by the Bank during 2016.

Current federal regulations require that the Company and 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 Company and the Bank must maintain a common equity Tier 1 capital ratio of 4.5% and a leverage ratio of 4.0%. For the Bank to be categorized as well capitalized, the Bank must maintain minimum amounts and ratios as set forth in the table below. There is no such category for well capitalized at the Company level. At December 31, 2016, the Bank was classified as well capitalized for regulatory capital purposes.

Capital ratios for the Bank and the Company are presented in the table below.



	Actual Ratio				Minimum For Capital Adequacy Purposes		Minimum To be Well Capitalized under Prompt Corrective Action Provisions
	12/31/2016		12/31/2015		Ratio		Ratio
Bank
Total Capital (to Risk Weighted Assets)	15.4	%	15.6	%	8.0	%	10.0	%
Tier I Capital (to Risk Weighted Assets)	14.1	%	14.4	%	6.0	%	8.0	%
Common Equity Tier 1 Capital (to Risk Weighted Assets)	14.1	%	14.4	%	4.5	%	6.5	%
Tier I Capital (to Average Assets)	11.0	%	10.2	%	4.0	%	5.0	%

Company
Total Capital (to Risk Weighted Assets)	15.6	%	16.0	%	8.0	%	N/A
Tier I Capital (to Risk Weighted Assets)	12.2	%	12.4	%	6.0	%	N/A
Common Equity Tier 1 Capital (to Risk Weighted Assets)	10.9	%	11.3	%	4.5	%	N/A
Tier I Capital (to Average Assets)	9.5	%	8.8	%	4.0	%	N/A

In July 2015, the Bank entered into a Written Agreement (the "2015 Written Agreement") with the FRB replacing the Written Agreement the Company and the Bank entered into with the FRB and the North Carolina Office of the Commissioner of Banks in May 2011. Under the terms of the 2015 Written Agreement, the Bank submitted and implemented the following plans:

•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; and

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

NOTE L - COMMITMENTS AND CONTINGENCIES

The Company is a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the commitment letter or contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Undisbursed lines of credit are commitments for possible future extensions of credit to customers on existing loans. These lines of credit generally contain a specified maturity date, but could also exclude an expiration date such as is the case for our overdraft protection lines. Similar to commitments, undisbursed lines of credit may not be drawn upon to the total extent to which the Bank is committed and do not necessarily represent future cash requirements.

Stand-by letters of credit are conditional lending commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within four years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

At December 31, 2016 and 2015, financial instruments whose contract amounts represent credit risk were (amounts in thousands):



	2016		2015
Commitments to extend credit	$	21,118	$	29,354
Undisbursed lines of credit	97,358		94,241
Financial stand-by letters of credit	439		438
Performance stand-by letters of credit	422		233
Legally binding commitments	119,337		124,266
Unused credit card lines	16,624		15,982
Total	$	135,961	$	140,248

Litigation Proceedings

NOTE M – FAIR VALUE MEASUREMENTS

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 December 31, 2016, there were no Level 1 securities. Level 2 securities include taxable municipalities and mortgage-backed securities issued by government sponsored entities. The Company’s mortgage-backed securities were primarily issued by GNMA, FNMA, and FHLMC. As of December 31, 2016, all of the Company’s mortgage-backed securities were agency issued and designated as Level 2 securities. Securities classified as Level 3 include other debt securities in less liquid markets and with no quoted market price.

The following table presents information about assets measured at fair value on a recurring basis at December 31, 2016 and 2015 (amounts in thousands):



Available-for-Sale Securities:	Fair Value Measurements at December 31, 2016, 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
	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		(Level 1)		(Level 2)		(Level 3)
Taxable municipal securities	$	20,049	$	20,049	$	—	$	20,049	$	—
Mortgage-backed securities:
GNMA	11,680		11,680		—		11,680		—
FNMA & FHLMC	25,412		25,412		—		25,412		—
Other debt securities	1,000		1,000		—		—		1,000
Total available-for-sale securities	$	58,141	$	58,141	$	—	$	57,141	$	1,000



Available-for-Sale Securities:	Fair Value Measurements at December 31, 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
	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		(Level 1)		(Level 2)		(Level 3)
Taxable municipal securities	$	24,567	$	24,567	$	—	$	24,567	$	—
Mortgage-backed securities:
GNMA	13,530		13,530		—		13,530		—
FNMA & FHLMC	31,673		31,673		—		31,673		—
Other debt securities	500		500		—		—		500
Equity securities	11		11		—		11		—
Total available-for-sale securities	$	70,281	$	70,281	$	—	$	69,781	$	500

The table below presents reconciliation for the years ended December 31, 2016 and 2015 for all Level 3 assets that are measured at fair value on a recurring basis (amounts in thousands). During the year ended December 31, 2016, no securities were transferred from Level 3 to Level 2.



	Available-for-Sale Securities
	2016		2015
Beginning Balance	$	500	$	—
Purchases, issuances and settlements	500		500
Ending Balance	$	1,000	$	500

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.

At December 31, 2016, the Company had $206,000 in loans held for sale which were made up entirely of residential mortgage loans held for sale in the secondary market as compared to $1.1 million at December 31, 2015.

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.

As of December 31, 2016, the Bank identified $2.2 million in impaired loans that were carried at fair value compared to $3.3 million at December 31, 2015. For 2016, this total included $2.4 million in loans that had a specific valuation allowance of $1.0 million and $784,000 in loans without a specific valuation allowance that were previously written down to fair value. For 2015, this total included $3.5 million in loans that had a specific valuation allowance of $1.2 million and $1.0 million in loans without a specific valuation allowance that were previously written down to fair value.

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. At December 31, 2016, there were $405,000 of fair value adjustments required after transfer related to foreclosed real estate of $1.7 million compared to $344,000 and $1.8 million, respectively, at December 31, 2015.

Premises and Equipment Held for Sale

Premises and equipment held for sale are carried at the lower of cost or fair value less estimate selling costs. Fair value is based upon independent market prices, appraised values of the property or management’s estimation of the value of the property. Given the lack of observable market prices, the Company records premises and equipment held for sale assets as non-recurring Level 3.

At December 31, 2016, the Company had $2.4 million in premises and equipment held for sale which included building and land held for sale. There were no premises and equipment classified as held for sale at December 31, 2015.

Assets measured at fair value on a non-recurring basis are included in the table below at December 31, 2016 and 2015 (amounts in thousands):



	Fair Value Measurements at December 31, 2016, Using
Description	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Loans held for sale	$	206	$	206	$	—	$	206	$	—
Impaired loans	2,179		2,179		—		—		2,179
Foreclosed assets	1,682		1,682		—		—		1,682
Premises and equipment held for sale	2,373		2,373		—		—		2,373



	Fair Value Measurements at December 31, 2015, Using
Description	Total Carrying Amount in the Consolidated Balance Sheet		Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Loans held for sale	$	1,145	$	1,145	$	—	$	1,145	$	—
Impaired loans	3,288		3,288		—		—		3,288
Foreclosed assets	1,760		1,760		—		—		1,760

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 recurring and nonrecurring basis at December 31, 2016 (amounts in thousands, except percentages):



	Total Carrying Amount at December 31, 2016		Valuation Methodology	Range of Inputs
Recurring measurements:
Other debt securities	$	1,000	Probability of default	0%
			Loss given default	100%
Nonrecurring measurements:
Impaired loans	$	2,179	Collateral discounts	9 - 50%
Foreclosed assets	$	1,682	Discounted appraisals	10 - 30%
Premises and equipment held for sale	$	2,373	Discounted appraisals	10 - 50%

Collateral discounts to determine fair value on impaired loans varies widely and result from the consideration of the following factors: the age of the most recent appraisal, 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.

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.

Certificates of Deposit

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 mortgage loans held for sale is based on commitments on hand from investors within the secondary market for loans 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 3% 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.

The following table presents information for financial assets and liabilities as of December 31, 2016 and 2015 (amounts in thousands):



	December 31, 2016
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	32,563	$	32,563	$	32,563	$	—	$	—
Certificates of deposit	18,125		18,125		—		18,125		—
Securities available-for-sale	58,141		58,141		—		57,141		1,000
Securities held-to-maturity	51,205		51,452		—		51,452		—
Loans held for sale	206		206		—		206		—
Loans, net	497,357		479,184		—		—		479,184
FHLB stock	3,596		3,596		—		3,596		—
Accrued interest receivable	1,598		1,598		—		1,598		—

Financial liabilities:
Deposits	$	553,531	$	552,207	$	—	$	552,207	$	—
Subordinated debentures and subordinated promissory notes	23,872		23,872		—		—		23,872
Borrowings	70,000		70,896		—		70,896		—
Accrued interest payable	384		384		—		384		—



	December 31, 2015
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	26,755	$	26,755	$	26,755	$	—	$	—
Certificates of deposit	23,520		23,520		—		23,520		—
Securities available-for-sale	70,281		70,281		—		69,781		500
Securities held-to-maturity	65,354		65,633		—		65,633		—
Loans held for sale	1,145		1,145		—		1,145		—
Loans, net	448,697		423,285		—		—		423,285
FHLB stock	3,288		3,288		—		3,288		—
Accrued interest receivable	1,594		1,594		—		1,594		—

Financial liabilities:
Deposits	$	542,334	$	541,818	$	—	$	541,818	$	—
Subordinated debentures and subordinated promissory notes	23,872		23,872		—		—		23,872
Borrowings	60,000		61,709		—		61,709		—
Accrued interest payable	437		437		—		437		—

NOTE N - STOCK OPTION PLAN

The Company has a non-qualified stock option plan for certain key employees under which it is authorized to issue options for up to 308,555 shares of common stock. Options are granted at the discretion of the Company’s Board of Directors at an exercise price approximating market value, as determined by a committee of Board members. All options granted subsequent to a 1997 amendment will be 100% vested after either one or two years from the grant date and will expire after such a period as is determined by the Board at the time of grant. Options granted in 2014 have a two year vesting provision. There were no options granted during 2015 or 2016. All share and share-related information have been adjusted to reflect the Reverse Stock Split. Refer to Note S - Subsequent Events for additional information.

A summary of option activity under the Plan for the year ended December 31, 2016, is presented below:



	Shares	Option Price Per Share		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at January 1, 2016	38,621	$	21.68
Issued	—	—
Exercised	2,825	6.70
Forfeited	3,840	7.58
Expired	8,215	15.00
Balance at December 31, 2016	23,741	$	28.06	1.22	$	117,814

Exercisable at December 31, 2016	23,741	$	28.06	1.22	$	117,814

The weighted average exercise price of all exercisable options at December 31, 2016 is $28.06. There were 42,969 shares reserved for future issuance under the Company’s stock option plan at December 31, 2016.

A summary of the status of the Company's non-vested options as of December 31, 2016 and changes during the year then ended is presented below:



	Shares	Weighted average grant date fair value
Non-vested - December 31, 2015	9,906	$	5.13
Granted	—	—
Vested	9,781	5.13
Forfeited/Expired	125	5.13
Non-vested - December 31, 2016	—	$	—

As of December 31, 2016, there was no unrecognized compensation cost related to non-vested options compared to $6,241 at December 31, 2015.

Additional information concerning the Company’s stock options at December 31, 2016 is as follows:



Exercise Price	Number Outstanding	Contractual Life (Years)	Number Exercisable
5.75 - 8.49	6,085	1.19	6,085
8.50 - 203.94	15,195	1.26	15,195
203.95	2,461	1.07	2,461
	23,741	1.22	23,741

NOTE O - RESTRICTED STOCK

In January 2015, the Board of the Company approved and adopted the Four Oaks Fincorp, Inc. 2015 Restricted Stock Plan (the “Plan”), which provides for awards of both performance and time based restricted stock and restricted stock unit awards. Awards of performance based restricted stock granted in 2015 vest in two separate tranches, 15% at the end of the one-year period ended 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. Awards of performance based restricted stock granted in 2016 vest 100% at the end of the three-year period ending on December 31, 2018 based on the attainment of the performance measures and goals for that Performance Period. The performance measures for the one-year period which ended December 31, 2015 were (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 is determined based on straight-line interpolation. We achieved our targeted performance level for the one-year Performance Period ending December 31, 2015, and therefore 15% of the shares of restricted stock have now vested. If the performance goals had not been met, 15% of the awards would have been forfeited.

The performance measures and related goals for the three-year period ending December 31, 2018 are based on cumulative earnings per share and were set by the compensation committee of the Board (the "Committee"), in its sole discretion as administrator of the Plan, in the fourth quarter of 2015. Earnings per share must be achieved at the 60% threshold performance level in order for 50% of the remaining awards to vest and at the 100% target performance level in order for 100% of the awards to vest. Where achievement against earnings per share falls between these performance levels, the number of shares vest also falls within these levels. Achievement of 70%, 80%, and 90% of target earnings per share results in vesting of 60%, 75%, and 87.5% respectively. Additionally, if 110% or more of the target performance level is obtained, 100% of the awards will vest and an additional 10% of the applicable restricted stock grant amount will be awarded to each recipient in fully-vested shares.

Awards of time based restricted stock granted in 2015 also vest in two separate tranches, 15% at the end of the one-year period ended on December 31, 2015, and 85% at the end of the three-year period ending on December 31, 2018. No awards of time based restricted stock were made in 2016. 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.

All share and share-related information have been adjusted to reflect the Reverse Stock Split. Refer to Note S - Subsequent Events for additional information.

A summary of the activity of the Company's restricted stock awards as of the period ended December 31, 2016 is presented below:



	Restricted Stock		Weighted Average Grant-Date Fair Value
Unvested at December 31, 2015:	272,635		$	8.20
Granted	42,000		9.51
Vested	(37,865	)	7.70
Forfeited	(18,700	)	8.29
Unvested at December 31, 2016:	258,070		$	8.49

The Company measures the fair value of restricted shares based on the price of the Company's common stock on the grant date, and compensation expense is recorded over the vesting period. The related compensation expense recognized for restricted stock awards for the twelve months ended December 31, 2016 and 2015 was $350,000 and $540,000, respectively. At December 31, 2016, the Company estimates there was $2.0 million of total unrecognized compensation cost related to unvested restricted stock granted under the plan. That cost is expected to be recognized over the next three years. The grant-date fair value of restricted stock grants vested during the twelve months ended December 31, 2016 was $7.70.

NOTE P - OTHER EMPLOYEE BENEFITS

Supplemental Retirement

In 1998, the Bank adopted a Supplemental Executive Retirement Plan (“SERP”) for its then president. The Company purchased life insurance policies in order to provide future funding of benefit payments. SERP benefits accrued and vested during the period of employment. Annual benefit payments began in 2016 after the officer's retirement on December 31, 2015. The liability accrued under the SERP plan amounts to $410,000 and $507,000 at December 31, 2016 and 2015, respectively. There were no expenses related to the SERP plan for 2016 compared to $30,000 for 2015. The annual benefit payout in 2016 was $50,000.

Employment Agreements

The Company has entered into employment agreements with certain of its executive officers to ensure a stable and competent management base. The agreements provide for benefits as spelled out in the contracts and cannot be terminated by the Company’s Board of Directors, except for cause, without triggering the officers’ rights to receive certain vested rights, including severance compensation. In addition, the Company has entered into additional severance compensation arrangements with certain of its executive officers and key employees to provide them with increased severance pay benefits in the event of a termination of employment following a change in control of the Company, as outlined in the agreements; the acquirer will be bound to the terms of the contracts.

Defined Contribution Plan

The Company sponsors a contributory profit-sharing plan in effect for substantially all employees. Participants may make voluntary contributions resulting in salary deferrals in accordance with Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Code”). For the year ended December 31, 2016, the plan provided for employee contributions of up to $18,000 of the participant's annual salary and an employer contribution of 75% matching of the first 6% of pre-tax salary contributed by each participant. For the year ended December 31, 2015, the plan provided for employee contributions of up to $18,000 of the participant's annual salary and an employer contribution of 50% matching of the first 6% of pre-tax salary contributed. Expenses related to these plans for the years ended December 31, 2016 and 2015 were $336,000 and $189,000, respectively. Contributions under the plan are made at the discretion of the Company’s Board of Directors.

Employee Stock Purchase and Bonus Plan

The Employee Stock Purchase and Bonus Plan (the “Purchase Plan”) is a voluntary plan that enables full-time employees of the Company and its subsidiaries to purchase shares of the Company’s common stock. The Purchase Plan is administered by a committee of the Board of Directors, which has broad discretionary authority to administer the Purchase Plan. The Company’s Board of Directors may amend or terminate the Purchase Plan at any time. The Purchase Plan is not intended to be qualified as an employee stock purchase plan under Section 423 of the Code.

Once a year, participants in the Purchase Plan purchase the Company’s common stock at fair market value. Participants are permitted to purchase shares under the Purchase Plan up to five percent (5%) of their compensation, with a maximum purchase amount of $1,000 per year. The Company matches, in cash, fifty percent (50%) of the amount of each participant’s purchase, up to $500. After withholding for income and employment taxes, participants use the balance of the Company’s matching grant to purchase shares of the Company’s common stock.

As of December 31, 2016, 23,388 shares of the Company’s common stock had been reserved for future issuance under the Purchase Plan, and 110,322 total shares had been purchased to date. During the year ended December 31, 2016, 14,374 shares were purchased under the Purchase Plan. All shares have been adjusted to reflect the Reverse Stock Split. Refer to Note S - Subsequent Events for additional information.

Sick Leave Plan

The Company allows employees to accrue up to 60 days of sick leave that can be carried forward from one year to the next. Employees with 10 consecutive years of service who retire after age 55 are paid for unused sick leave up to a maximum of 60 days. As of December 31, 2016 and 2015, the Company maintained an accrued liability for future obligations in the amount of $544,000 and $587,000, respectively. Future obligations under the plan are assessed on an annual basis. Deferred compensation expenses under the plan totaled $59,000 and $68,000 for 2016 and 2015, respectively. Cash benefits paid to retiring employees totaled $106,000 and $43,000 for 2016 and 2015, respectively.

NOTE Q - LEASES

The Company has entered into non-cancelable operating leases for five facilities. Future minimum lease payments under the leases for future years are as follows (amounts in thousands):



Leases
2017	$	249
2018	185
2019	178
2020	183
2021	187
2022 and beyond	79
	$	1,061

Total rental expense under operating leases for the years ended December 31, 2016 and 2015 amounted to $329,000 and $373,000, respectively.

NOTE R - PARENT COMPANY FINANCIAL INFORMATION

Condensed financial information of Four Oaks Fincorp, Inc. at December 31, 2016 and 2015, and for the years ended December 31, 2016 and 2015 is presented below (amounts in thousands):



Condensed Balance Sheets	2016		2015
Assets:
Cash and cash equivalents	$	289	$	1,362
Equity investment in subsidiaries	88,997		81,803
Investment securities available-for-sale	—		11
Other assets	2,603		1,128
Total Assets	$	91,889	$	84,304

Liabilities and Shareholders’ Equity:
Other liabilities	$	12	$	26
Subordinated debentures	12,372		12,372
Subordinated promissory notes	11,500		11,500
Shareholders' equity	68,005		60,406
Total Liabilities and Shareholders’ Equity	$	91,889	$	84,304



	For the Years Ended December 31,
Condensed Statements of Operations	2016			2015
Equity in undistributed income of subsidiaries	$	6,642		$	20,367
Interest income	7			27
Other income	10			11
Other expenses	(1,203		)	(1,408		)
Income before income taxes	5,456			18,997
Applicable income tax benefit	(1,402		)	(1,011		)
Net income	$	6,858		$	20,008



Condensed Statements of Cash Flows	2016			2015
Operating activities:
Net income	$	6,858		$	20,008
Equity in undistributed income of subsidiaries	(6,642		)	(20,367		)
Excess tax benefits from stock options	2			—
Increase in other assets	(1,405		)	(972		)
Decrease in other liabilities	(14		)	(910		)
Net cash used in operating activities	(1,201		)	(2,241		)

Investing activities:
Sales and maturities of securities	11			—
Net cash provided by investing activities	11			—

Financing activities:
Proceeds from issuance of common stock	188			170
Repayment of subordinated promissory notes	—			(500		)
Shares withheld for payment of taxes	(71		)	(25		)
Net cash provided by (used in) financing activities	117			(355		)

Net decrease in cash and cash equivalents	(1,073		)	(2,596		)
Cash and cash equivalents, beginning of year	1,362			3,958
Cash and cash equivalents, end of year	$	289		$	1,362

NOTE S - SUBSEQUENT EVENTS

On March 7, 2017, the Company filed with the North Carolina Department of the Secretary of State Articles of Amendment (the “Articles of Amendment”) to the Company’s Articles of Incorporation, as amended, to effect a one for five reverse stock split of the Company’s authorized, issued, and outstanding common stock, par value $1.00 per share. The Articles of Amendment did not change the par value of the Company’s common stock. The Articles of Amendment provided that the Reverse Stock Split became effective at 5 P.M., Eastern Time, on March 8, 2017, at which time every five shares of the Company’s issued and outstanding common stock were automatically combined into one issued and outstanding share of the Company’s common stock. No fractional shares were issued in connection with the Reverse Stock Split, and any fractional shares resulting from the Reverse Stock Split were rounded up to the nearest whole share. In addition, the number of authorized shares of common stock was reduced from 80,000,000 to 16,000,000.

The Articles of Amendment were approved by, and proposed and recommended to the Company’s shareholders by, the Company’s Board of Directors on September 26, 2016 and approved by the shareholders of the Company at a special meeting of shareholders held on November 8, 2016.

Item 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.

None

Item 9A - Controls and Procedures.

Disclosure 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 Annual 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 Annual 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 SEC under the Exchange Act is recorded, processed, summarized and reported, within the time periods required by the SEC's rules and forms.

Management's Report on Internal Control Over Financial Reporting

Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of internal control over financial reporting, based on the framework in Internal Control - Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the framework in Internal Control - Integrated Framework, management of the Company has concluded the Company maintained effective internal control over financial reporting as of December 31, 2016.

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 fourth quarter of 2016 that the Company believes have materially affected or are likely to materially affect, its internal control over financial reporting.

Item 9B - Other Information.

Not applicable.

PART III

The information called for in Items 10 through 14 is incorporated by reference from the definitive proxy statement for the Company's 2017 Annual Meeting of Shareholders, to be filed with the SEC within 120 days after the end of the Company's fiscal year.

Item 10 - Directors, Executive Officers and Corporate Governance.

Item 11 - Executive Compensation.

Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.

Item 13 - Certain Relationships and Related Transactions, and Director Independence.

Item 14 - Principal Accounting Fees and Services.

Item 15 – Exhibits, Financial Statement Schedules.

(a)(1) Financial Statements. The following financial statements and supplementary data are included in Item 8 of Part II of this Annual Report on Form 10-K.



TABLE OF CONTENTS
Financial Statements	Form 10-K Page
Report of Independent Registered Public Accounting Firm	46

Consolidated Balance Sheets as of December 31, 2016 and 2015	47

Consolidated Statements of Operations for the years ended December 31, 2016 and 2015	48

Consolidated Statements of Comprehensive Income for the years ended December 31, 2016 and 2015	49

Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2016 and 2015	50

Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2015	51

Notes to Consolidated Financial Statements	53

(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been included in the Notes to Consolidated Financial Statements.

(a)(3) Exhibits. The following exhibits are filed as part of this Annual Report on Form 10-K.



Exhibit No.		Description of Exhibit

3.1		Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of Amendment to Articles of Incorporation
3.2		Bylaws of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997)
4.1		Specimen of Certificate for Four Oaks Fincorp, Inc. Common Stock
4.2		Tax Asset Protection Plan, dated as of August 18, 2014, between Four Oaks Fincorp, Inc. and Computershare Trust Company, N.A. (as successor to Registrar and Transfer Company), as Rights Agent, including the form of Rights Certificate, Summary of Rights and Articles of Amendment to Articles of Incorporation as Exhibits A, B and C, respectively (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on August 19, 2014)



4.3		Agreement to furnish instruments and agreements defining rights of holders of long-term debt (incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015)
10.1		Amended and Restated Nonqualified Stock Option Plan (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement)
10.2		Amendment No. 1, effective September 1, 2009 to Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement)
10.3		Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement)
10.4		Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement)
10.5		Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement)
10.6		Amendment No. 1, effective September 1, 2009 to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.2 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement)
10.7		Amendment No. 2, effective March 25, 2013, to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 28, 2013) (management contract or compensatory plan, contract or arrangement)
10.8		Amendment No. 3, effective March 23, 2016, to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.9		Four Oaks Fincorp, Inc. 2015 Restricted Stock Plan (incorporated by reference to Exhibit 99.1 to the Company's Registration Statement on Form S-8 (File No. 333-201579) filed with the SEC on January 16, 2015) (management contract or compensatory plan, contract or arrangement)
10.10		Form of Restricted Stock Award Agreement (Management Team) (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 22, 2015) (management contract or compensatory plan, contract or arrangement)
10.11		Form of Restricted Stock Award Agreement (Executive Team) (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on January 22, 2015) (management contract or compensatory plan, contract or arrangement)
10.12		Summary of Non-Employee Director Compensation (management contract or compensatory plan, contract or arrangement)
10.13		Death Benefit Only Plan (including the form of Participation Agreement as Exhibit A thereto) (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 2, 2017) (management contract or compensatory plan, contract or arrangement)
10.14		Fourth Amended and Restated Dividend Reinvestment and Stock Purchase Plan (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-175771) filed with the SEC on July 25, 2011)
10.15		Amended and Restated Executive Employment Agreement with David H. Rupp (incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.16		Amended and Restated Executive Employment Agreement with Jeff D. Pope (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.17		Amended and Restated Executive Employment Agreement with Lisa S. Herring, as amended by Amendment No. 1 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.18		Executive Employment Agreement with Deanna W. Hart (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.19		Amended and Restated Executive Employment Agreement with Warren D. Herring, Jr. (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)



10.20		Employment Agreement with Lawrence F. DesPrés (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2016) (management contract or compensatory plan, contract or arrangement)
10.21		Amended and Restated Executive Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement)
10.22		Amendment No. 1 to the Amended and Restated Executive Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 2, 2015) (management contract or compensatory plan, contract or arrangement)
10.23		Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement)
10.24		Severance and General Release Agreement with Nancy S. Wise (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2015) (management contract or compensatory plan, contract or arrangement)
10.25		Severance and General Release Agreement with W. Leon Hiatt, III (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2016) (management contract or compensatory plan, contract or arrangement)
10.26		Amended and Restated Declaration of Trust of Four Oaks Statutory Trust I, dated as of March 30, 2006 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006)
10.27		Guarantee Agreement of Four Oaks Fincorp, Inc. dated as of March 30, 2006 (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006)
10.28		Indenture, dated as of March 30, 2006 by and between Four Oaks Fincorp, Inc. and Wilmington Trust Company, as Trustee, relating to Junior Subordinated Debt Securities due June 15, 2036 (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006)
10.29		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 SEC on August 4, 2015)
10.30		Purchase and Assumption Agreement, dated as of September 26, 2012, between Four Oaks Bank & Trust Company and First Bank (incorporated by reference to Exhibit 10.b to First Bancorp's (File No. 000-15572) Quarterly Report on Form 10-Q for the period ended September 30, 2012)
10.31		Securities Purchase Agreement, dated as of March 24, 2014, between Four Oaks Fincorp, Inc. and Kenneth R. Lehman (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 26, 2014)
10.32		Form of Registration Rights Agreement with Kenneth R. Lehman (included as part of Exhibit 10.31)
21		Subsidiaries of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2010)
23		Consent of Cherry Bekaert LLP
31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		The following materials from Four Oaks Fincorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2016, 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; (iv) Consolidated Statements of Shareholders' Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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:	March 30, 2017	By:	/s/ David H. Rupp
			David H. Rupp President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated



Date:	March 30, 2017	/s/ David H. Rupp
		David H. Rupp President and Chief Executive Officer



Date:	March 30, 2017	/s/ Deanna W. Hart
		Deanna W. Hart Executive Vice President and Chief Financial Officer and Principal Accounting Officer



Date:	March 30, 2017	/s/ Ayden R. Lee, Jr.
		Ayden R. Lee, Jr. Chairman and Director



Date:	March 30, 2017	/s/ Warren L. Grimes
		Warren L. Grimes Director



Date:	March 30, 2017	/s/ Kenneth R. Lehman
		Kenneth R. Lehman Director



Date:	March 30, 2017	/s/ Robert G. Rabon
		Robert G. Rabon Director



Date:	March 30, 2017	/s/ Dr. R. Max Raynor, Jr.
		Dr. R. Max Raynor, Jr. Director



Date:	March 30, 2017	/s/ Michael A. Weeks
		Michael A. Weeks Director

EXHIBIT INDEX



Exhibit No.		Description of Exhibit

3.1		Articles of Incorporation of Four Oaks Fincorp, Inc. including Articles of Amendment to Articles of Incorporation
3.2		Bylaws of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K12G3 filed with the SEC on July 2, 1997)
4.1		Specimen of Certificate for Four Oaks Fincorp, Inc. Common Stock
4.2		Tax Asset Protection Plan, dated as of August 18, 2014, between Four Oaks Fincorp, Inc. and Computershare Trust Company, N.A. (as successor to Registrar and Transfer Company), as Rights Agent, including the form of Rights Certificate, Summary of Rights and Articles of Amendment to Articles of Incorporation as Exhibits A, B and C, respectively (incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed on August 19, 2014)
4.3		Agreement to furnish instruments and agreements defining rights of holders of long-term debt (incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015)
10.1		Amended and Restated Nonqualified Stock Option Plan (incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement)
10.2		Amendment No. 1, effective September 1, 2009 to Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement)
10.3		Form of Stock Option Agreement (Non-Employee Director) (incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement)
10.4		Form of Stock Option Agreement (Employee) (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year ended December 31, 2009) (management contract or compensatory plan, contract or arrangement)
10.5		Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004) (management contract or compensatory plan, contract or arrangement)
10.6		Amendment No. 1, effective September 1, 2009 to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.2 to the Company's Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on September 29, 2009) (management contract or compensatory plan, contract or arrangement)
10.7		Amendment No. 2, effective March 25, 2013, to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 28, 2013) (management contract or compensatory plan, contract or arrangement)
10.8		Amendment No. 3, effective March 23, 2016, to Amended and Restated Employee Stock Purchase and Bonus Plan (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.9		Four Oaks Fincorp, Inc. 2015 Restricted Stock Plan (incorporated by reference to Exhibit 99.1 to the Company's Registration Statement on Form S-8 (File No. 333-201579) filed with the SEC on January 16, 2015) (management contract or compensatory plan, contract or arrangement)
10.10		Form of Restricted Stock Award Agreement (Management Team) (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on January 22, 2015) (management contract or compensatory plan, contract or arrangement)
10.11		Form of Restricted Stock Award Agreement (Executive Team) (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on January 22, 2015) (management contract or compensatory plan, contract or arrangement)
10.12		Summary of Non-Employee Director Compensation (management contract or compensatory plan, contract or arrangement)
10.13		Death Benefit Only Plan (including the form of Participation Agreement as Exhibit A thereto) (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 2, 2017) (management contract or compensatory plan, contract or arrangement)
10.14		Fourth Amended and Restated Dividend Reinvestment and Stock Purchase Plan (incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (File No. 333-175771) filed with the SEC on July 25, 2011)



10.15		Amended and Restated Executive Employment Agreement with David H. Rupp (incorporated by reference to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.16		Amended and Restated Executive Employment Agreement with Jeff D. Pope (incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.17		Amended and Restated Executive Employment Agreement with Lisa S. Herring, as amended by Amendment No. 1 (incorporated by reference to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.18		Executive Employment Agreement with Deanna W. Hart (incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.19		Amended and Restated Executive Employment Agreement with Warren D. Herring, Jr. (incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 2015) (management contract or compensatory plan, contract or arrangement)
10.20		Employment Agreement with Lawrence F. DesPrés (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2016) (management contract or compensatory plan, contract or arrangement)
10.21		Amended and Restated Executive Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement)
10.22		Amendment No. 1 to the Amended and Restated Executive Employment Agreement with Ayden R. Lee, Jr. (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 2, 2015) (management contract or compensatory plan, contract or arrangement)
10.23		Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed with the SEC on December 16, 2008) (management contract or compensatory plan, contract or arrangement)
10.24		Severance and General Release Agreement with Nancy S. Wise (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2015) (management contract or compensatory plan, contract or arrangement)
10.25		Severance and General Release Agreement with W. Leon Hiatt, III (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2016) (management contract or compensatory plan, contract or arrangement)
10.26		Amended and Restated Declaration of Trust of Four Oaks Statutory Trust I, dated as of March 30, 2006 (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006)
10.27		Guarantee Agreement of Four Oaks Fincorp, Inc. dated as of March 30, 2006 (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006)
10.28		Indenture, dated as of March 30, 2006 by and between Four Oaks Fincorp, Inc. and Wilmington Trust Company, as Trustee, relating to Junior Subordinated Debt Securities due June 15, 2036 (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed with the SEC on April 4, 2006)
10.29		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 SEC on August 4, 2015)
10.30		Purchase and Assumption Agreement, dated as of September 26, 2012, between Four Oaks Bank & Trust Company and First Bank (incorporated by reference to Exhibit 10.b to First Bancorp's (File No. 000-15572) Quarterly Report on Form 10-Q for the period ended September 30, 2012)
10.31		Securities Purchase Agreement, dated as of March 24, 2014, between Four Oaks Fincorp, Inc. and Kenneth R. Lehman (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed with the SEC on March 26, 2014)
10.32		Form of Registration Rights Agreement with Kenneth R. Lehman (included as part of Exhibit 10.31)
21		Subsidiaries of Four Oaks Fincorp, Inc. (incorporated by reference to Exhibit 21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2010)
23		Consent of Cherry Bekaert LLP
31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002



32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101		The following materials from Four Oaks Fincorp, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2016, 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; (iv) Consolidated Statements of Shareholders' Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.

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