Entegra Financial Corp. files 10-K

Entegra Financial Corp. revealed 10-K form on Mar 14.

As of June 30, 2018, the most recent date for which market data is available, total deposits in the Bank’s North Carolina primary market area, Cherokee, Haywood, Henderson, Jackson, Macon, Polk and Transylvania counties, were over $5.7 billion. At June 30, 2018, our deposits represented 14.4% of the market, ranking us second in deposit market share within our North Carolina primary market area.

As of June 30, 2018, total deposits in the Bank’s South Carolina primary market area, Anderson, Greenville, and Spartanburg counties, were over $19.6 billion. As of June 30, 2018, our $87.2 million of deposits held at South Carolina branches represented less than 0.50% of total deposits in this market.

As of June 30, 2018, total deposits in the Bank’s northern Georgia primary market area of Hall and Pickens counties, were over $4.5 billion. At June 30, 2018, our deposits represented 6.79% of the market, ranking us seventh in deposit market share within our northern Georgia primary market area.

Our primary lending activities are the origination of commercial real estate loans, one-to-four family residential mortgage loans, other construction and land loans, commercial business loans and home equity loans and lines of credit. Our largest category of loans is commercial real estate followed by one-to-four family, and other construction and land loans. At December 31, 2018, our top 25 relationships represented a lending exposure of $208.7 million, or 19.4% of our loan portfolio, with the largest single relationship totaling $18.0 million. These loans are primarily commercial, construction and land development loans and are collateralized by real estate.

Commercial Real Estate Loans. At December 31, 2018, $498.1 million, or 46.2%, of our loan portfolio consisted of commercial real estate loans. Properties securing our commercial real estate loans primarily comprise business owner-occupied properties, small office buildings and office suites, and income-producing real estate.

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

One-to–Four Family Residential Mortgage Loans. At December 31, 2018, $325.6 million, or 30.2%, of our loan portfolio consisted of one-to-four family residential mortgage loans. We offer fixed-rate and adjustable-rate residential mortgage loans with maturities generally up to 30 years. We generally sell 30-year fixed rate loans in the secondary market.

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

Home Equity Loans and Lines of Credit. At December 31, 2018, $48.7 million, or 4.5%, of our loan portfolio, consisted of home equity loans and lines of credit. In addition to traditional one-to-four family residential mortgage loans, we offer home equity loans and lines of credit that are secured by the borrower’s primary or secondary residence. Our home equity loans and lines of credit are currently originated with fixed or adjustable rates of interest. Home equity loans and lines of credit are generally underwritten with the same criteria that we use to underwrite one-to-four family residential mortgage loans. For a borrower’s primary residence, home equity loans and lines of credit may be underwritten with a loan-to-value ratio of 80% when combined with the principal balance of the existing mortgage loan, while the maximum loan-to-value ratio on secondary residences is 70% when combined with the principal balance of the existing mortgage loan. We require appraisals or internally prepared real estate evaluations on home equity loans and lines of credit. At the time we close a home equity loan or line of credit, we record a deed of trust to perfect our security interest in the underlying collateral.

Commercial Loans. At December 31, 2018, $54.4 million, or 5.1%, of our loan portfolio, consisted of commercial loans. We make various types of secured and unsecured commercial loans to customers in our market areas in order to provide customers with working capital and for other general business purposes. The terms of these loans generally range from less than one year to a maximum of 10 years. These loans bear either a fixed interest rate or an interest rate linked to a variable market index. We seek to originate loans to small- to medium-sized businesses with principal balances between $150,000 and $750,000; however, we also originate government-guaranteed Small Business Administration, or SBA, loans with higher balances with the intent of selling the guaranteed portion into the secondary market. From time to time, we also purchase the guaranteed portion of SBA loans in the secondary market to supplement our commercial loan originations.

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

One-to-Four Family Residential Construction, Other Construction and Land, and Consumer Loans. At December 31, 2018, $39.5 million, or 3.7%, of our loan portfolio consisted of one-to-four family residential construction loans. Other construction and land loans comprised $104.6 million, or 9.7%, of our loan portfolio. Consumer loans totaled $6.8 million, or 0.6%, of our loan portfolio, and included automobile and other consumer loans. We make construction loans to owner-occupiers of residential properties, and to businesses for commercial properties. In the past, we made loans to developers for speculative residential construction; however, following the recession we have limited our speculative construction lending. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction, but are generally limited to an 80% loan-to-value ratio based on the appraised value upon completion. Repayment of construction loans on non-residential properties is normally attributable to rental income, income from the borrower’s operating entity or the sale of the property. Repayment of loans on income-producing property is normally scheduled following completion of construction, when permanent financing is obtained. We typically provide permanent mortgage financing on our construction loans for income-producing property. Construction loans are interest-only during the construction period, which typically does not exceed 12 months, and convert to permanent, fully-amortizing financing following the completion of construction.

Borrowings. Our borrowings consist of advances from the FHLB and a holding company line of credit with a correspondent bank. At December 31, 2018, FHLB advances totaled $213.5 million, or 14.5% of total liabilities. At December 31, 2018, the Company had unused borrowing capacity with the FHLB of $43.4 million based on collateral pledged at that date. The Company had total additional credit availability with FHLB of $282.0 million as of December 31, 2018 if additional collateral was pledged. Advances from the FHLB are secured by our investment in the common stock of the FHLB, securities in our investment portfolio, and approved loans in our one-to-four family residential and commercial loan portfolios. The Company had drawn $5.0 million on the $15.0 million revolving line of credit as of December 31, 2018. The line of credit is secured by the stock of the Bank.

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

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

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

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

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

The Basel III Capital Rules require the Bank and, upon completion of this offering, the Company, to comply with four minimum capital standards: a Tier 1 leverage ratio of at least 4.0%; a CET1 to risk-weighted assets of 4.5%; a Tier 1 capital to risk-weighted assets of at least 6.0%; and a total capital to risk-weighted assets of at least 8.0%. CET1 capital is generally comprised of common shareholders’ equity and retained earnings. Tier 1 capital is generally comprised of CET1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (CET1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is generally comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income, or AOCI, up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into CET1 capital (including unrealized gains and losses on available-for-sale-securities). The calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

The Basel III Capital Rules also establish a ‘capital conservation buffer’ of 2.5% above the regulatory minimum risk-based capital requirements. The capital conservation buffer requirement was phased in beginning in January 2016 and, as of January 2019, is now fully implemented. An institution is 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 buffered ratio.

·applying a 250% risk weight to the portion of mortgage servicing rights and deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks that are not deducted from CET1 capital (increased from 100% under the previous risk-based capital rules).

On November 21, 2018, federal regulators released a proposed rulemaking that would, if enacted, provide certain banks and their holding companies with the option to elect out of complying with the Basel III Capital Rules. Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework if it has a community bank leverage ratio, or CBLR, greater than 9% at the time of election.

·temporary difference DTAs of 25% or less of CBLR tangible equity.

As of December 31, 2018, the Bank qualified to elect the community bank leverage ratio framework because it had a CBLR of greater than 9%. The Company will continue to monitor this rulemaking. If and when the rulemaking goes into effect, the Company and the Bank will consider whether it would be possible and advantageous at that time to elect to comply with the community bank leverage ratio framework.

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

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

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

Capital Adequacy Requirements Applicable to the Bank. The Bank is required to comply with the capital adequacy standards established under applicable federal laws and regulations. In addition, the FDIC has promulgated risk-based capital and leverage capital guidelines for determining the adequacy of a bank’s capital, and all applicable capital standards must be satisfied for the Bank to be considered in compliance with the FDIC’s requirements. Under the FDIC’s risk-based capital measure, the minimum ratio (total risk-based capital ratio) of a bank’s total capital to its risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 9.25%. At least half of total capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying non-cumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (tier 1 capital). The remainder may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, a limited amount of loan loss reserves, and net unrealized holding gains on equity securities (tier 2 capital). At December 31, 2018, the Bank’s total risk-based capital ratio and tier 1 risk-based capital ratio were 13.95% and 12.92%, respectively, each was well above the FDIC’s minimum risk-based capital guidelines.

Under the FDIC’s leverage capital measure, the minimum ratio (the ‘tier 1 leverage capital ratio’) of tier 1 capital to total assets is 3.0% for banks that meet certain specified criteria, including having the highest regulatory rating. All other banks generally are required to maintain an additional cushion of 100 to 200 basis points above the stated minimum. The FDIC’s guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets, and the FDIC has indicated that it will consider a bank’s ‘tangible leverage ratio’ (deducting all intangible assets) and other indicia of capital strength in evaluating proposals for expansion or new activities. At December 31, 2018, the Bank’s tier 1 leverage capital ratio was 9.42%, which was well above the FDIC’s minimum leverage capital guidelines.

The new rules include new risk-based capital and leverage ratios, which became effective January 1, 2015, and revise the definition of what constitutes ‘capital’ for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank are: (i) a new common equity tier 1 capital ratio of 4.5%; (ii) a tier 1 capital ratio of 6.0% (increased from 4.0%); (iii) a total capital ratio of 8.0% (unchanged from prior rules); and (iv) a tier 1 leverage ratio of 4.0% for all institutions. The new rules eliminate the inclusion of certain instruments, such as trust preferred securities, from tier 1 capital. Instruments issued prior to May 19, 2010 are grandfathered for companies with consolidated assets of $15 billion or less. The new rules also established a ‘capital conservation buffer’ of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity tier 1 capital and will result in the following minimum ratios: (i) a common equity tier 1 capital ratio of 7.0%; (ii) a tier 1 capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions. At December 31, 2018, all of the Company’s and Bank’s capital ratios were well above the capital guidelines.

Loans to One Borrower. The Bank is subject to the loans to one borrower limits imposed by North Carolina law, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any single borrower outstanding at one time and not fully secured by readily marketable collateral may exceed 15% of the Bank’s capital, as used in the calculation of its risk-based capital ratios, plus those portions of the Bank’s allowance for credit losses, deferred tax assets, and intangible assets that are excluded from the Bank’s capital or the amount permitted for national banks. At December 31, 2018, this limit was $24.6 million. For loans and extensions of credit that are fully secured by readily marketable collateral this limit is increased by an additional 10% of the Bank’s capital or the amount permitted for national banks.

FHLB System. The FHLB System provides a central credit facility for member institutions. As a member of the FHLB, the Bank is required to own capital stock in the FHLB in an amount at least equal to 0.20% of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB. At December 31, 2018, the Bank was in compliance with these requirements.

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

Concentrations in Commercial Real Estate. The federal banking agencies have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm nonresidential properties (excluding loans secured by owner-occupied properties) and loans for construction, land development, and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. On December 18, 2015, the federal banking agencies jointly issued a ‘statement on prudent risk management for commercial real estate lending’. As of December 31, 2017, the Company did not exceed the levels to be considered to have a concentration in commercial real estate lending and believes its credit administration to be consistent with the recently published policy statement.

Minimum Tax. The Internal Revenue Code of 1986, as amended (the ‘Code’), imposed an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, referred to as ‘alternative minimum taxable income.’ The alternative minimum tax was payable to the extent alternative minimum taxable income is in excess of an exemption amount. Net operating losses could, in general, offset no more than 90% of alternative minimum taxable income. The Tax Reform and Jobs Act of 2017 (the ‘Tax Reform’) repealed the alternative minimum tax since the corporate federal tax rate was reduced to 21%. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years or may be refundable. At December 31, 2018, the Company had an alternative minimum tax credit carryforward of approximately $0.3 million.

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

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

Our commercial real estate loans generally carry greater credit risk than one-to-four family residential mortgage loans. At December 31, 2018, we had commercial real estate loans of $498.1 million, or 46.2% of total loans. In general, these loans are collateralized by general business assets including, among other things, accounts receivable, promissory notes, inventory and equipment and most are backed by a personal guaranty of the borrower or principal. These types of loans generally have higher risk-adjusted returns and shorter maturities than one-to-four family residential mortgage loans. Further, loans secured by commercial real estate properties are generally for larger amounts and involve a greater degree of risk than one-to-four family residential mortgage loans. Also, many of our borrowers have more than one of these types of loans outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. Payments on loans secured by these properties are often dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans can be negatively impacted by adverse conditions in the real estate market or the local economy. If loans that are collateralized by commercial real estate become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses which would in turn adversely affect our operating results and financial condition. While we seek to minimize these risks in a variety of ways, these measures may not protect against credit-related losses.

Our concentration of construction financing may expose us to a greater risk of loss and impair our earnings and profitability. At December 31, 2018, we had other construction and land loans of $104.6 million, or 9.7% of total loans, and one-to-four family residential construction loans of $39.5 million, or 3.7% of total loans, to finance construction and land development. These loans are dependent on the successful completion of the projects they finance.

Repayment of our commercial business loans is primarily dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. We offer different types of commercial loans to a variety of small- to medium-sized businesses, and intend to increase our commercial business loan portfolio in the future. As of December 31, 2018, our commercial business loans totaled $54.4 million, or 5.1% of our total loan portfolio. The types of commercial loans offered are business lines of credit and term equipment financing. Our commercial business loans are primarily underwritten based on the cash flow of the borrowers and secondarily on the underlying collateral, including real estate. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use.

Our level of home equity loans and lines of credit lending may expose us to increased credit risk. At December 31, 2018, we had home equity loans and lines of credit of $48.7 million, or 4.5% of total loans. Home equity loans and lines of credit typically involve a greater degree of risk than one-to-four family residential mortgage loans. Equity line lending allows a customer to access an amount up to his or her line of credit limit for the term specified in their agreement. At the expiration of the term of an equity line, a customer may have the entire principal balance outstanding as opposed to a one-to-four family residential mortgage loan where the principal is disbursed entirely at closing and amortizes throughout the term of the loan. We cannot predict when and to what extent our customers will access their equity lines. While we seek to minimize this risk in a variety of ways, including attempting to employ conservative underwriting criteria, these measures may not protect against credit-related losses.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could adversely affect business, results of operations, financial condition and the value of our common stock. A significant portion of our loan portfolio is secured by real estate. As of December 31, 2018, 94.3% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our results of operations, financial condition and the value of our common stock could be adversely affected.

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Concentration of collateral in our primary lending market area may increase the risk of increased non-performing assets. Our primary lending market area consists of: western North Carolina counties of Cherokee, Haywood, Henderson, Jackson, Macon, Polk and Transylvania; Upstate South Carolina counties of Anderson, Greenville, Pickens and Spartanburg; and northern Georgia counties of Hall and Pickens. At December 31, 2018, approximately $775.8 million, or 72.1%, of our loans were secured by real estate located within our primary area. A decline in real estate values in our primary lending market area would lower the value of the collateral securing loans on properties in this area, and may increase our level of non-performing assets.

We rely on the secondary mortgage market for some of our liquidity. In 2018, we sold 36.0% of the mortgage loans we originated in the secondary markets to Fannie Mae and others. We rely on Fannie Mae and others to purchase loans that meet their conforming loan requirements in order to reduce our credit risk and provide funding for additional loans we desire to originate. We cannot provide assurance that these purchasers will not materially limit their purchases of conforming loans due to capital constraints, a change in the criteria for conforming loans or other factors. Additionally, various proposals have been made to reform the U.S. residential mortgage finance market, including the role of Fannie Mae and other agencies. The exact effects of any such reforms are not yet known, but they may limit our ability to sell conforming loans to Fannie Mae and others. If we are unable to continue to sell conforming loans to these agencies, our ability to fund, and thus originate, additional mortgage loans may be adversely affected, which would adversely affect our results of operations.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and defined ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to adjusted total assets, also known as the leverage ratio. As of December 31, 2018, we exceeded the amounts required to be well-capitalized with respect to all three required capital ratios. As of December 31, 2018, the Bank’s common equity Tier 1, Tier 1 leverage, Tier 1 risk-based capital and total risk-based capital ratios were 12.92%, 9.42%, 12.92% and 13.95%, respectively.

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

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

Total assets increased $55.0 million, or 3.5%, to $1.64 billion at December 31, 2018 from $1.58 billion at December 31, 2017. The Company de-leveraged its balance sheet during the fourth quarter of 2018 by approximately $50 million in order to pay off certain higher rate wholesale borrowings.

Loans receivable increased $70.9 million, or 7.1%, to $1.08 billion at December 31, 2018 from $1.00 billion at December 31, 2017. Loan growth continues to be primarily concentrated in commercial real estate and commercial and industrial loans.

Core deposits increased $31.8 million, or 4.2% to $795.3 million at December 31, 2018 from $763.4 million at December 31, 2017. Retail certificates of deposit decreased $7.6 million to $350.0 million at December 31, 2018 from $357.6 million at December 31, 2017. Wholesale deposits increased $34.9 million to $76.0 million at December 31, 2018 from $41.1 million at December 31, 2017. We continue to focus on gathering core deposits, which amounted to 65% of the Company’s deposit portfolio at December 31, 2018.

In mid-2007, as economic conditions began to deteriorate, management recognized the need to reduce our concentration in higher risk loans, especially other construction and land development loans. Since then we first reduced, and have subsequently monitored the concentration in other construction and land loans. As of December 31, 2018, other construction and land loans had fallen to 9.7% of total loans, compared to 12.4% as of December 31, 2012. Reductions have been achieved through payoffs of maturing loans, controlled loan originations, and foreclosure of non-performing loans. The increase in the levels of other construction and land loans from 2016 is primarily the result of the Chattahoochee acquisition. The amount of commercial real estate loans as a percentage of total loans continues to increase as we continue to shift our lending focus to these loan types as we develop stronger commercial relationships in all of our markets.

Total delinquencies as a percentage of loans have decreased from 3.44% at December 31, 2014 to 1.07% at December 31, 2018, representing a decrease of 68.9% over the period. Loans past due 90 days and over and on non-accrual have experienced a greater decline, decreasing from 0.92% at December 31, 2014, to 0.20% at December 31, 2018, a decrease of 78.3% over the period. The decrease in delinquencies is consistent with the improving economic health of our primary market area.

Non-performing loans as a percentage of total loans decreased from 3.1% at December 31, 2014, to 0.45% at December 31, 2018, representing a decrease of 85.5% over the period. Similarly, non-performing assets as a percentage of total assets decreased from 2.35% at December 31, 2014, to 0.45% at December 31, 2018, representing a decrease of 80.9% over the period. This decrease in non-performing loans and non-performing assets is due to a combination of the improving economy and the Bank’s successful resolution and disposal of non-performing loans and non-performing assets by means of restructure, foreclosure, deed in lieu of foreclosure and short sales for less than the amount of the indebtedness, in which cases the deficiency is charged-off.

Non-performing loans increased slightly from 2017 to 2018. However, non-performing loans at December 31, 2018 have decreased $11.9 million, or 71.1%, compared to December 31, 2014. This decrease in non-performing loans is attributable to loan payoffs, transfers to REO, charge-offs, and the return of loans to accrual status upon the determination that ultimate collectability of all amounts contractually due is not in doubt.

Total classified loans decreased $1.3 million, or 14.0%, to $8.2 million at December 31, 2018 from $9.5 million at December 31, 2017. Total criticized loans decreased $4.1 million, or 18.3%, to $18.2 million at December 31, 2018 from $22.2 million at December 31, 2017. The reductions since 2014 reflect an improving economy and an increasing number of criticized loans being paid off or upgraded as a consequence of improvements in our borrowers’ cash flows and payment performance. Management continues to dedicate significant resources toward monitoring and resolving classified and criticized loans. Management continuously monitors non-performing, classified and past due loans to identify any deterioration in the condition of these loans. As of December 31, 2018, we had not identified any potential problem loans that we did not already classify as non-performing.

The allowance for homogenous loans consists of a base loss reserve and a qualitative reserve. The base loss reserve utilizes an average loss rate for the last 16 quarters. Prior to the first quarter of 2015, we more heavily weighted the most recent four quarters than the least recent four quarters. Beginning in the first quarter of 2015, we no longer weight any quarters to calculate our average loss rates. This change in weighting did not have a material impact on our allowance for loan losses methodology. The loss rates for the base loss reserve are segmented into 13 loan categories and contain loss rates ranging from approximately 0.50% to 0.65%.

As indicated in the above table, our net charge-offs to average loans have declined from 0.60% for the year ended December 31, 2014, to 0.01% for the year ended December 31, 2018, representing a decrease of 98.3% over the period. The reduction in net charge-offs is attributable to the continued improvement in quality of our loan portfolio and the continued collection of payments on loans previously charged-off.

Our nonperforming loan coverage ratio has continued to increase since 2014. The increase in our coverage ratio is mainly attributable to the reduction in nonperforming loans of $11.9 million, or 71.1%, to $4.9 million at December 31, 2018 from $16.8 million at December 31, 2014.

Our allowance as a percentage of total loans increased to 1.11% at December 31, 2018 from 1.08% at December 31, 2017 primarily as the result of loan growth and provision related to acquired loans. The historical loss rates used in our allowance for loan losses calculation continue to decline as previous quarters with larger loss rates are eliminated from the calculation as time passes. The remaining fair value discount on acquired loans was $1.0 million as of December 31, 2018.

As indicated in the above table, during the periods presented, we have consistently maintained approximately 19.5% of impaired loans in a reserve, either through a direct charge-off or in a specific reserve included as part of the allowance for loan losses. The total dollar amount of impaired loans decreased $0.3 million, or 2.2%, to $10.9 million at December 31, 2018 compared to $11.6 million at December 31, 2017. The decrease in impaired loans is attributable to loan payoffs, transfers to REO, charge-offs, and the return of loans to non-impaired status upon changes to borrowers’ status that ultimate collectability of all amounts contractually due is not in doubt.

As indicated in the above table, the balance in REO has decreased by $75,000, or 2.9%, to $2.5 million at December 31, 2018 from a balance of $2.6 million at December 31, 2017. We continue to have success in liquidating the properties. We continue to write-down REO as needed and maintain focus on aggressively disposing of our remaining properties.

Available-for-sale investment securities increased $16.9 million, or 4.9%, to $359.7 million at December 31, 2018 from $342.9 million at December 31, 2017. We continue to look for opportunities to re-deploy funds from investments securities to higher yielding loans.

We closely monitor the financial condition of the issuers of our municipal securities. As of December 31, 2018, the fair value of our municipal securities portfolio balance consists of approximately 44.1% of general obligation bonds and 55.9% of revenue bonds. As of December 31, 2018 and 2017, all municipal securities were performing. The table below presents the ratings for our municipal securities by either Standard and Poor’s or Moody’s as of the dates indicated.

As indicated in the above table, average deposit balances increased approximately $196.0 million, or 16.2%, for the year ended December 31, 2018 compared to 2017. The increase in total average deposits was mainly attributable to $166.1 million in deposits assumed from Chattahoochee on October 1, 2017 being included in our average balances for the entire year of 2018.

FHLB advances decreased $10.0 million, or 4.5%, to $213.5 million at December 31, 2018 from $223.5 million at December 31, 2017. The advances had a weighted average rate of 2.58% as of December 31, 2018 compared to 1.48% at December 31, 2017. The use of FHLB advances as a funding source continues to be a low cost complement to core deposits.

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

We had $14.4 million in junior subordinated notes outstanding at December 31, 2018 and 2017, payable to an unconsolidated subsidiary. These notes accrue interest at 2.80% above the 90-day LIBOR, adjusted quarterly. To add stability to net interest revenue and manage our exposure to interest rate movement, we entered into an interest rate swap in June 2016. The swap contract involves the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the four year life of the contract. The effective interest rate was 3.76% at December 31, 2018 and 2017. The Company entered into a new pay-fixed/receive-variable interest rate swap in June 2018 associated with the Company’s junior subordinated debt. The forward starting interest rate swap begins exchanging cash flows in 2020 when the current interest rate swap agreement expires. The notes mature on March 30, 2034.

Total shareholders’ equity increased $11.6 million, or 7.1%, to $162.9 million at December 31, 2018, compared to $151.3 million at December 31, 2017. This increase was primarily attributable to $13.9 million of net income, offset by a $3.4 million after-tax decline in the market value of investment securities available for sale.

(1) Tax exempt loans and investments are calculated giving effect to a 21% federal tax rate in 2018 and a 35% federal tax rate in 2017 and 2016.

(2) Interest income on tax exempt loans and investments are adjusted for based on a 21% federal tax rate in 2018 and a 35% federal tax rate in 2017 and 2016.

Net income for the year ended December 31, 2018 was $13.9 million compared to $2.6 million for the same period in 2017. The increase in net income for the period was primarily the result of the increase in net interest income of $6.5 million for the year ended December 31, 2018 compared to the same period in 2017 combined with the one-time non-cash income tax expense of $4.9 million in 2017 related to the revaluation of deferred tax assets and liabilities at the newly enacted Federal tax rate of 21%. The provision for loan losses was $1.2 million for the year ended December 31, 2018 compared to $1.9 million for the same period in 2017. The increase in noninterest income was primarily the result of the other than temporary impairment charge of $0.7 million in 2017. The increase in noninterest expense was primarily the result of increased compensation and employee benefits and data processing expenses related to 2017 acquisition activity partially offset by reduced merger-related expenses in 2018.

Our tax-equivalent net interest income increased by $5.4 million, or 10.8%, to $50.1 million for the year ended December 31, 2018 compared to $44.7 million for the year ended December 31, 2017. This improvement was primarily the result of increases in average loan balances and a 26 basis point increase in rates on interest-earning assets partially offset by increased balances of time deposits and money markets and a 37 basis point increase in rates paid on interest-bearing liabilities. Our tax-equivalent net interest margin decreased 4 basis points to 3.35% for 2018 compared to 3.39% for 2017.

Our average interest-earning assets increased $176.6 million, or 11.8%, to $1.5 billion in 2018 compared to $1.3 billion in 2017. This increase was mainly attributable to $181.6 million in interest earning assets acquired from Chattahoochee on October 1, 2017, with those assets included in our average balances from the date of acquisition through December 31, 2017 compared to being included in our average balances the entire year of 2018.

Our average interest-bearing liabilities increased $151.0 million, or 12.0%, to $1.3 billion in 2018 compared to $1.1 billion in 2017. This increase was mainly attributable to $166.1 million in deposits assumed from Chattahoochee on October 1, 2017 with the deposits included in our average balances from the date of acquisition through December 31, 2017 compared to being included in our average balances the entire year of 2018. This increase was partially offset by declines in average FHLB advances of $18.5 million, or 8.5%, in 2018. Our related interest-bearing liability costs increased 37 basis points, or 34.9%, in 2018 compared 2017 driven primarily by competition created in gathering deposits as an alternative to higher cost borrowings.

Compensation and employee benefits increased by $2.5 million, or 12.3%, for 2018 compared to 2017. The additional expense is related to increases in the number of employees primarily as the result of the Stearns branch and Chattahoochee acquisitions in April 2017 and October 2017, respectively, annual raises, employee benefits, incentives and commissions.

Net occupancy increased $0.4 million, or 10.2%, in 2018 compared to 2017 primarily as the result of the Stearns branch and Chattahoochee acquisitions.

Professional and advisory expense increased $0.2 million, or 13.8%, in 2018 compared to 2017 primarily due to increased tax compliance and expenses related to mortgage banking advisory services.

Data processing expense increased $0.4 million, or 18.9%, in 2018 compared to 2017 primarily as the result of increased number of accounts related to the conversion of the Stearns and Chattahoochee branch customers.

Merger-related expenses decreased $2.5 million, or 81.7%, primarily as the result no acquisitions completed in 2018 compared to two in 2017.

Income tax expense was $3.1 million for 2018 compared to $7.5 million for the same period in 2017. Income tax expense for the 2018 period benefitted from the newly enacted federal tax rate of 21% compared to a federal tax rate of 35% in 2017. In addition, income tax expense for all periods benefitted from tax-exempt income related to municipal bond investments and BOLI income. The effective tax rate for 2018 was 18.3% compared to 74.5% in 2017 which included $4.9 million related to the revaluation of deferred tax assets and liabilities at the newly enacted Federal tax rate of 21%.

Net income for the year ended December 31, 2017 was $2.6 million compared to $6.4 million for the same period in 2016. The decrease in net income for the period was primarily the result of a one-time non-cash income tax expense of $4.9 million related to the revaluation of deferred tax assets and liabilities at the newly enacted Federal tax rate of 21%, a decrease in other noninterest income of $1.9 million, and an increase in noninterest expense of $4.6 million for the year ended December 31, 2017 compared to the same period in 2016. The increase in noninterest expense was primarily the result of increased compensation and employee benefits related to acquisition activity. The decline in noninterest income includes a loss of $1.1 million on the sale of approximately $45.0 million of tax exempt municipal securities in response to enacted tax rate changes. These items were partially offset by an increase in net interest income of $8.4 million for the year ended December 31, 2017 as compared to the year ended December 31, 2016. Furthermore, there was a provision for loan losses of $1.9 million for the year ended December 31, 2017 compared to $0.3 million for the same period in 2016.

Our tax-equivalent net interest income increased by $9.2 million, or 26.1%, to $44.7 million for the year ended December 31, 2017, compared to $35.5 million for the year ended December 31, 2016. This improvement was the result of increases in average loan and investment balances along with increased rates on interest-bearing assets of 14 basis points for the year ended December 31, 2017 compared to 2016. Our tax-equivalent net interest margin increased 11 basis points to 3.39% for 2017 compared to 3.28% for 2016.

Our average interest-earning assets increased $238.8 million, or 22.1%, to $1.3 billion in 2017 compared to $1.1 billion in 2016. This increase was mainly attributable to $181.6 million in interest earning assets acquired from Chattahoochee on October 1, 2017, with those assets included in our average balances from the date of acquisition through December 31, 2017 combined with increases in the investment portfolio.

Our average interest-bearing liabilities increased $220.6 million, or 24.9%, to $1.1 billion in 2017 compared to $886.2 million in 2016. This increase was mainly attributable to $154.2 million and $166.1 million in deposits assumed from Stearns on April 1, 2017, and Chattahoochee on October 1, 2017, respectively, with the deposits included in our average balances from the date of acquisition through December 31, 2017. In addition, average FHLB advances increased $41.6 million, or 21.4%, in 2017 primarily to fund investments. Although our average interest-bearing liabilities increased during 2017, we were able to maintain the overall related cost in 2017 compared to 2016.

Compensation and employee benefits increased by $3.0 million, or 17.5%, for 2017 compared to 2016. The additional expense is related to increases in the number of employees primarily as the result of the Stearns branch and Chattahoochee acquisitions in April and October, respectively, annual raises, employee benefits, incentives and commissions.

Net occupancy increased $0.6 million, or 15.7%, in 2017 compared to 2016 primarily as the result of the Stearns branch and Chattahoochee acquisitions in 2017.

Professional and advisory expense increased $0.3 million, or 29.0%, in 2017 compared to 2016 primarily due to increased tax compliance and expenses related to public reporting requirements.

Data processing expense increased $0.1 million, or 8.4%, in 2017 compared to 2016 primarily as the result of increased number of accounts related to the conversion of the Stearns branch customers.

Marketing and advertising expenses decreased $0.1 million, or 10.9%, in 2017 compared to 2016 primarily as the result of increased merger-related communications in 2017.

Merger-related expenses of increased $0.9 million, or 40.5%, primarily as the result of two acquisitions completed in 2017 as compared to one in 2016.

Net cost of operation of REO declined $0.5 million, or 70.8%, from 2016 compared to 2017 primarily as the result of lower REO balances.

Other noninterest expense increased $0.3 million, or 9.7%, for 2017 compared to 2016 primarily as a result of an increase in amortization related to core deposit intangibles of $0.3 million primarily as a result of the Old Town Bank acquisition in April 2016 and the Stearns branch and Chattahoochee acquisitions in 2017.

Income tax expense for 2017 of $7.5 million was impacted by the recognition of a provisional expense of $4.9 million related to the revaluation of deferred tax assets and liabilities at the newly enacted Federal tax rate of 21%. As such, the Company recorded a provisional amount totaling $4.9 million related to the revaluation of its deferred tax assets and liabilities in 2017. The accounting was completed during 2018 and the final amounts did not materially differ from the provisional amount recorded. The one-time non-cash expense related to the revaluation was partially offset by increased tax-exempt income related to municipal bond investments and BOLI income.

(1) – As of December 31, 2018, includes capital conservation buffer of 1.875%. On a fully phased in basis, effective January 1, 2019, under Basel III, minimum capital ratios to be considered ‘adequately capitalized’ including the capital conservation buffer of 2.5% will be as follows: Tier 1 Leverage Capital – 4.0%; Common Equity Tier 1 Capital – 7.0%; Tier 1 Risk-based Capital – 8.5%; and Total Risk-based Capital – 10.5%.

(1) – As of December 31, 2018, includes capital conservation buffer of 1.875%. On a fully phased in basis, effective January 1, 2019, under Basel III, minimum capital ratios to be considered ‘adequately capitalized’ including the capital conservation buffer of 2.5% will be as follows: Tier 1 Leverage Capital – 4.0%; Common Equity Tier 1 Capital – 7.0%; Tier 1 Risk-based Capital – 8.5%; and Total Risk-based Capital – 10.5%.

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

The results from the rate shock analysis on NII are consistent with having a slightly liability sensitive balance sheet. Having a liability sensitive balance sheet means liabilities will reprice at a faster pace than assets during the short-term horizon. The implications of a liability sensitive balance sheet will differ depending upon the change in market rates. For example, with a liability sensitive balance sheet in a declining interest rate environment, the interest rate on liabilities will decrease at a faster pace than assets. This situation generally results in an increase in NII and operating income. Conversely, with a liability sensitive balance sheet in a rising interest rate environment, the interest rate on liabilities will increase at a faster pace than liabilities. This situation generally results in a decrease in NII and operating income. As indicated in the table above, a 200 basis point increase in rates would result in a 0.7% decrease in NII as of December 31, 2018 as compared to a 1.2% decrease in NII as of December 31, 2017, suggesting that there is no benefit for the Company to net interest income in rising interest rates. The Company generally seeks to remain neutral to the impact of changes in interest rates by maximizing current earnings while balancing the risk of changes in interest rates.

The results from the rate shock analysis on EVE are consistent with a balance sheet whose assets have a longer maturity than its liabilities. Like most financial institutions, we generally invest in longer maturity assets as compared to our liabilities in order to earn a higher return on our assets than we pay on our liabilities. This is because interest rates generally increase as the time to maturity increases, assuming a normal, upward sloping yield curve. In a rising interest rate environment, this results in a negative EVE because higher interest rates will reduce the present value of longer term assets more than it will reduce the present value of shorter term liabilities, resulting in a negative impact on equity. As noted in the table above, our exposure to higher interest rates from an EVE or present value perspective has decreased slightly from December 31, 2017 to December 31, 2018. For example, as indicated in the table above, a 200 basis point increase in rates would result in a 1.3% decrease in EVE as of December 31, 2018 as compared to a 1.5% decrease in EVE as of December 31, 2017.

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

The allowance for non-impaired loans consists of a base historical loss reserve and a qualitative reserve. The loss rates for the base loss reserve are segmented into 18 loan categories and contain loss rates ranging from approximately 0.5% to 0.65%.

Accrued taxes represent the net estimated amount due to or from taxing jurisdictions and are reported in other assets or other liabilities, as appropriate, in the Consolidated Balance Sheets. We evaluate and assess the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other information and maintain tax accruals consistent with the evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities and changes to statutory, judicial and regulatory guidance. These changes, when they occur, can affect deferred taxes and accrued taxes, as well as the current period’s income tax expense and can be significant to our operating results. As a result of the Tax Cuts and Jobs Act of 2017, the Company realized deferred tax expense of $4.9 million upon the revaluation in December 2017 of its deferred assets and deferred liabilities at the newly enacted Federal tax rate of 21%.

On February 24, 2017, the Bank completed its acquisition of two branches from Stearns Bank, N.A. (‘Stearns’). In connection with the acquisition, the Bank acquired the bank facilities and certain other assets and assumed $154.2 million of deposits. In consideration of the purchased assets and assumed liabilities, the Bank paid (1) the book value, or approximately $1.0 million, for the branch facilities and certain assets, and (2) a deposit premium of $5.7 million, equal to 3.65% of the average daily deposits for the 30- day period ending the tenth (10th) business day prior to the acquisition. The excess of net liabilities assumed over the cash received to settle the acquisition resulted in the establishment of $5.0 million of goodwill which is deductible over 15 years for tax purposes.

The Company has total credit availability with the FHLB of up to 30% of assets, subject to the availability of qualified collateral. As collateral for these borrowings, the Company pledges certain investment securities, its FHLB stock, and its entire loan portfolio of qualifying mortgages (as defined) under a blanket collateral agreement with the FHLB. At December 31, 2018, the Company had unused borrowing capacity with the FHLB of $46.4 million based on collateral pledged at that date. The Company has total additional credit availability with FHLB of $282.0 million as of December 31, 2018, if additional collateral was available and pledged.

The Company also maintained approximately $48.3 million in borrowing capacity with the FRB discount window as of both December 31, 2018 and 2017. The Company had no FRB discount window borrowings outstanding at December 31, 2018 or 2017. The rate charged on discount window borrowings is currently the Fed Funds target rate plus 0.50% (i.e., 3.00% as of December 31, 2018).

The Company issued $14.4 million of junior subordinated notes to its wholly owned subsidiary, Macon Capital Trust I, to fully and unconditionally guarantee the trust preferred securities issued by the Trust. These notes qualify as Tier I capital for the Company. The notes accrue interest quarterly at 2.80% above the 90-day LIBOR, adjusted quarterly. To add stability to net interest revenue and manage our exposure to interest rate movement, we entered into an interest rate swap in June 2016. The 2016 swap contract involves the payment of fixed-rate amounts to a counterparty in exchange for our receipt of variable-rate payments over the four year life of the contract. The effective interest rate was 3.76% at December 31, 2018 and 2017. The notes mature on March 30, 2034.

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

·Supplemental Executive Retirement Plan (‘SERP’) – provides a post-retirement income stream to several current and former executives. The estimated present value of the future benefits to be paid during a post-retirement period of 216 months is accrued over the period from the effective date of the agreement to the expected date of retirement. The SERP is an unfunded plan and is considered a general contractual obligation of the Company. The Company recorded expense related to the SERP utilizing a discount rate of 4.0% for the years ended December 31, 2018, 2017, and 2016.

·CAP Equity Plan (‘Plan’) – provides a post-retirement benefit payable in cash to several current and former officers and directors. During 2015, the Company funded a Rabbi Trust to seek to generate returns that will fund the cost of certain deferred compensation agreements associated with the Plan. Some Plan participants elected to have their benefits tied to the value of specific assets, including, for example, the Company’s common stock. The remaining participants elected to continue receiving interest of 8% which is accrued on such participant’s unpaid balance after termination from the Company, subject to the terms of the Plan. The Plan was frozen in 2009, and no additional deferrals are allowed.

·Life Insurance Plan – provides an endorsement split dollar benefit to several current and former executives, under which the Company has agreed to maintain an insurance policy during the executive’s retirement and to provide the executive with a death benefit. The estimated cost of insurance for the portion of the policy expected to be paid as a split dollar death benefit in each post-retirement year is measured for the period between expected retirement age and the earlier of (a) expected mortality and (b) age 95. The resulting amount is then allocated on a present value basis to the period ending on the participant’s full eligibility date. A discount rate of 4% and life expectancy based on the 2001 Valuation Basic Table has been assumed.

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Accordingly, the Company’s deferred tax assets and liabilities were remeasured to reflect the reduction in the U.S. corporate income tax rate from 35 percent to 21 percent, resulting in a $4.9 million decrease in net deferred tax assets as of December 31, 2017. In addition, the Company recognized a reduction in its net deferred tax assets of approximately $0.1 for the year ended December 31, 2017, as a result of a reduction in the expected North Carolina income tax rate from 3.0% to 2.5%.

When Basel III is fully phased in on January 1, 2019, the Company and the Bank will be required to maintain a 2.5% capital conservation buffer which is designed to absorb losses during periods of economic distress. This capital conservation buffer is comprised entirely of Common Equity Tier 1 Capital and is in addition to minimum risk-weighted asset ratios.

(1) – As of December 31, 2018, includes capital conservation buffer of 1.875%. On a fully phased in basis, effective January 1, 2019, under Basel III, minimum capital ratios to be considered ‘adequately capitalized’ including the capital conservation buffer of 2.5% will be as follows: Tier 1 Leverage Capital – 4.0%; Common Equity Tier 1 Capital – 7.0%; Tier 1 Risk-based Capital – 8.5%; and Total Risk-based Capital – 10.5%.

(1) – As of December 31, 2018, includes capital conservation buffer of 1.875%. On a fully phased in basis, effective January 1, 2019, under Basel III, minimum capital ratios to be considered ‘adequately capitalized’ including the capital conservation buffer of 2.5% will be as follows: Tier 1 Leverage Capital – 4.0%; Common Equity Tier 1 Capital – 7.0%; Tier 1 Risk-based Capital – 8.5%; and Total Risk-based Capital – 10.5%.