UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~June~~September 30, 2017

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to _______.

Commission File Number: 0-22219

FIRST SOUTH BANCORP, INC.

(Exact name of registrant as specified in its charter)

Virginia	56-1999749
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)

1311 Carolina Avenue, Washington, North Carolina 27889

(Address of principal executive offices)

(Zip Code)

(252) 946-4178

(Registrant's telephone number, including area code)

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

Yes x No ¨

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

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

Large Accelerated Filer ¨	Accelerated Filer x
Non-Accelerated Filer ¨	Smaller Reporting Company ¨
(Do not check if a Smaller Reporting Company)	Emerging Growth Company ¨

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

Indicate by check mark whether registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Number of shares of common stock outstanding as of ~~August~~October 831, 2017: 9,~~503~~523,~~691~~716

Explanatory Note

On November 1, 2017, First South Bancorp, Inc. (the “Company”), completed the previously announced merger with Carolina Financial Corporation (“CARO”), whereby the Company merged with and into CARO (the “Merger”), with CARO as the surviving corporation in the Merger. Immediately following the consummation of the Merger, First South Bank, a wholly owned subsidiary of the Company, merged with and into CresCom Bank, a wholly owned subsidiary of CARO (the “Bank Merger”), with CresCom Bank as the surviving bank in the Bank Merger.

The Merger and the Bank Merger were effected by the transactions contemplated in that certain Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) dated as of June 9, 2017, by and between the Company and CARO.

This Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2017, is being filed by CARO as successor to the Company. The financial information in this Quarterly Report and the accompanying Management’s Discussion and Analysis reflect the corporate status of the Company as it was on September 30, 2017.

CONTENTS

		PAGE
PART I.	FINANCIAL INFORMATION
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Statements of Financial Condition as of June 30, 2017 (unaudited) and December 31, 2016	1
	Consolidated Statements of Financial Condition as of September 30, 2017 (unaudited) and December 31, 2016	1
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)	2
	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)	2
	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2017 and 2016 (unaudited)	3
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016 (unaudited)	3
	Consolidated Statements of Changes in Stockholders' Equity for the Six Months Ended June 30, 2017 and 2016 (unaudited)	4
	Consolidated Statements of Changes in Stockholders' Equity for the Nine Months Ended September 30, 2017 and 2016 (unaudited)	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016 (unaudited)	5
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016 (unaudited)	5
	Notes to Consolidated Financial Statements (unaudited)	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	3330
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	4441
Item 4.	Controls and Procedures	4542
PART II.	OTHER INFORMATION
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	4542
Item 1A.	Risk Factors	4542
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	4843
Item 3.	Defaults Upon Senior Securities	4843
Item 4.	Mine Safety Disclosures	4843
Item 5.	Other Information	4843
Item 6.	Exhibits	4843
Signatures		4944
Exhibits

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

	June 30,			December 31,
	September 30,			December 31,
	2017			2016
	(Unaudited)
Assets
Cash and due from banks	$	2319,~~049~~923,~~153~~410		$	22,854,712
Interest-bearing deposits with banks		1736,~~022~~903,~~773~~842			23,320,968
Investment securities available for sale, at fair value		~~195~~190,~~401~~573,~~445~~089			192,606,119
Investment securities held to maturity		506,~~553~~223			509,617
Mortgage loans held for sale		63,~~380~~814,~~856~~715			5,098,518
Loans and leases held for investment		~~776~~780,~~656~~713,~~251~~736			700,642,291
Allowance for loan and lease losses		(9,~~366~~561,~~564~~535	)		(8,673,172	)
Net loans and leases held for investment		~~767~~771,~~289~~152,~~687~~201			691,969,119
Premises and equipment, net		1110,~~152~~799,~~205~~043			11,291,596
Assets held for sale		185,906			192,720
Other real estate owned		2,~~437~~183,~~946~~970			3,229,423
Federal Home Loan Bank stock, at cost		1,~~847~~592,700			1,573,700
Accrued interest receivable		3,~~448~~595,~~043~~669			3,525,684
Goodwill		4,218,576			4,218,576
Mortgage servicing rights		2,~~134~~170,~~256~~658			2,148,905
Identifiable intangible assets		1,~~490~~429,~~348~~929			1,611,187
Bank-owned life insurance		18,~~351~~483,~~387~~438			18,080,183
Prepaid expenses and other assets		65,~~462~~947,~~221~~067			8,470,887
Total assets	$	1,~~061~~073,~~379~~480,~~055~~436		$	990,701,914
Liabilities and Stockholders' Equity
Deposits:
Non-interest bearing demand	$	~~208~~212,~~671~~521,~~921~~157		$	196,917,165
Interest bearing demand		~~308~~323,~~799~~893,~~734~~958			272,098,903
Savings		~~149~~146,~~720~~933,~~673~~193			145,031,981
Large denomination certificates of deposit		136,~~978~~211,~~726~~749			122,819,510
Other time		~~127~~125,~~363~~727,~~292~~563			133,732,804
Total deposits		~~931~~945,~~534~~287,~~346~~620			870,600,363
Borrowed money		2216,500,000			17,000,000
Junior subordinated debentures		10,310,000			10,310,000
Other liabilities		56,~~138~~775,~~320~~248			5,607,832
Total liabilities		~~969~~978,~~482~~872,~~666~~868			903,518,195
Common stock, $.01 par value, 25,000,000 shares authorized; 9,502,520 and 9,494,935 shares outstanding, respectively		95,025			94,949
Common stock, $.01 par value, 25,000,000 shares authorized; 9,504,991 and 9,494,935 shares outstanding, respectively		95,050			94,949
Additional paid-in capital		36,~~072~~191,~~883~~713			36,018,743
Retained earnings		5255,~~822~~405,~~834~~706			49,560,595
Accumulated other comprehensive income		2,~~905~~915,~~647~~099			1,509,432
Total stockholders' equity		9194,~~896~~607,~~389~~568			87,183,719
Total liabilities and stockholders' equity	$	1,~~061~~073,~~379~~480,~~055~~436		$	990,701,914

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

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Operations

Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016

(Unaudited)

Three Months Ended

~~Six~~Nine Months Ended

June 30,

September 30,

2017

2016

2017

2016

Interest income:

Interest and fees on loans

89,~~700~~316,~~534~~002

7,~~642~~915,~~097~~133

1626,~~913~~229,~~822~~824

1422,~~833~~748,~~692~~826

Interest on investments and deposits

1,~~392~~360,~~349~~943

1,~~356~~295,~~030~~051

24,~~783~~143,~~029~~972

24,~~836~~131,~~282~~333

Total interest income

10,~~092~~676,~~883~~945

89,~~998~~210,~~127~~184

1930,~~696~~373,~~851~~796

1726,~~669~~880,~~974~~159

Interest expense:

Interest on deposits

~~830~~841,~~192~~961

~~697~~728,~~426~~106

12,~~584~~426,~~181~~143

12,~~366~~094,~~702~~809

Interest on borrowings

6070,~~469~~093

5855,~~711~~886

~~122~~192,~~429~~521

~~131~~187,~~797~~683

Interest on junior subordinated notes

127,011

~~141~~127,~~578~~011

~~251~~378,~~261~~272

~~281~~408,~~617~~628

Total interest expense

1,~~017~~039,~~672~~065

~~897~~911,~~715~~003

12,~~957~~996,~~871~~936

12,~~780~~691,~~116~~120

Net interest income

9,~~075~~637,~~211~~880

8,~~100~~299,~~412~~181

1727,~~738~~376,~~980~~860

1524,~~889~~189,~~858~~039

Provision for credit losses

~~485~~100,000

~~325~~220,000

~~750~~850,000

~~550~~770,000

Net interest income after provision for credit losses

89,~~590~~537,~~211~~880

78,~~775~~079,~~412~~181

1626,~~988~~526,~~980~~860

1523,~~339~~419,~~858~~039

Non-interest income:

Deposit fees and service charges

1,~~964~~902,~~665~~246

1,~~931~~907,~~050~~878

35,~~820~~723,~~885~~130

35,~~838~~746,~~457~~336

Loan fees and charges

9288,~~723~~799

~~138~~72,~~649~~578

~~178~~267,~~767~~566

~~195~~268,~~634~~212

Mortgage loan servicing fees

~~316~~356,~~988~~823

~~273~~343,~~689~~081

~~638~~995,~~827~~650

~~507~~850,~~689~~770

Gain on sale and other fees on mortgage loans

~~654~~709,~~016~~554

~~568~~812,~~403~~754

1,~~127~~837,~~578~~133

~~982~~1,~~264~~795,017

Gain (loss) on sale of other real estate, net

(26,151

)

(14,315

)

55,500

(26,484

)

Gain on sale of other real estate, net

14,343

77,416

69,843

50,932

Gain on sale of investment securities

~~183,955~~-

467,470

Other income

~~555~~435,~~678~~418

~~466~~477,~~798~~343

1,~~034~~469,~~464~~882

1,~~159~~636,~~085~~428

Total non-interest income

3,~~557~~507,~~919~~183

3,~~548~~691,~~229~~050

610,~~856~~363,~~021~~204

710,~~124~~815,~~115~~165

Non-interest expense:

Compensation and fringe benefits

5,~~000~~130,~~901~~718

4,~~944~~970,~~984~~846

1015,~~114~~245,~~454~~172

914,~~984~~955,~~939~~785

Federal deposit insurance premiums

~~157~~156,~~118~~054

~~160~~157,~~525~~142

~~304~~460,~~492~~546

~~322~~479,~~134~~276

Premises and equipment

1,~~334~~293,~~666~~477

1,~~380~~349,~~675~~243

24,~~733~~026,~~216~~693

24,~~754~~103,~~484~~726

Marketing

~~119~~96,~~050~~646

~~229~~151,~~434~~304

~~182~~279,~~790~~435

~~417~~568,~~253~~556

Data processing

~~807~~799,~~722~~650

~~749~~757,~~731~~200

12,~~601~~400,~~090~~740

12,~~546~~303,~~217~~418

Amortization of intangible assets

~~151~~152,~~269~~816

~~133~~136,~~571~~882

~~300~~453,~~466~~282

~~265~~401,~~099~~981

Other real estate owned expense

~~105~~2,~~093~~483

~~212~~119,~~883~~065

~~269~~272,~~859~~342

~~306~~425,~~557~~622

Other

1,~~538~~105,~~363~~912

1,~~235~~286,~~090~~741

23,~~754~~860,~~365~~278

23,~~556~~842,~~137~~879

Total non-interest expense

98,~~214~~737,~~182~~756

98,~~046~~928,~~893~~423

1826,~~260~~998,~~732~~488

1827,~~152~~081,~~820~~243

Income before income tax expense

24,~~933~~307,~~948~~307

2,~~276~~841,~~748~~808

59,~~584~~891,~~269~~576

47,~~311~~152,~~153~~961

Income tax expense

~~879~~1,~~031~~391,805

~~664~~947,~~734~~496

13,~~657~~048,~~155~~960

12,~~238~~185,~~345~~841

NET INCOME

2,~~054~~915,~~917~~502

1,~~612~~894,~~014~~312

36,~~927~~842,~~114~~616

34,~~072~~967,~~808~~120

Per share data:

Basic earnings per share

0.2231

0.1720

0.4172

0.3252

Diluted earnings per share

0.2231

0.1720

0.4172

0.3252

Dividends per share

0.035

0.030

0.~~070~~105

0.~~055~~085

Average basic shares outstanding

9,~~500~~503,~~958~~800

9,~~493~~494,~~776~~861

9,~~499~~500,~~289~~809

9,~~492~~493,~~489~~285

Average diluted shares outstanding

9,~~554~~567,~~420~~989

9,~~519~~525,~~565~~302

9,~~548~~556,~~382~~254

9,~~517~~520,~~248~~216

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

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income

Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016

(Unaudited)

	Three Months Ended						~~Six~~Nine Months Ended
	June 30,						June 30,
	September 30,						September 30,
	2017			2016			2017			2016
Net income	$	2,~~054~~915,~~917~~502		$	1,~~612~~894,~~014~~312		$	36,~~927~~842,~~114~~616		$	34,~~072~~967,~~808~~120
Other comprehensive income:
Unrealized holding gains on securities available-for-sale		1,427,498			3,108,028			2,238,322			4,790,347
Unrealized holding gains (losses) on securities available-for-sale		12,759			(1,110,351	)		2,251,081			3,679,996
Tax effect		(~~513~~4,~~899~~593	)		(1425,~~164,857~~001	)		(~~805~~810,~~796~~389	)		(1,~~776~~351,969	)
Unrealized holding gains on securities available-for-sale, net of tax		913,599			1,943,171			1,432,526			3,013,378
Unrealized holding gains (losses) on securities available-for-sale, net of tax		8,166			(685,350	)		1,440,692			2,328,027
Reclassification adjustment for realized gains included in net income		-			~~(183,955~~-	)		-			(467,470	)
Tax effect		-			~~53,709~~-			-			134,276
Reclassification adjustment for realized gains, net of tax		-			~~(130,246~~-	)		-			(333,194	)
Unrealized gains (losses) on interest rate hedge position		~~(81~~2,~~648~~009	)		~~(22~~48,~~560~~953	)		(5654,~~737~~728	)		(~~187~~138,~~051~~097	)
Tax effect		~~29,393~~(723	)		8(25,~~415~~176	)		2019,~~426~~703			6944,~~770~~594
Unrealized losses on interest rate hedge position, net of tax		(52,255	)		(14,145	)		(36,311	)		(117,281	)
Unrealized gains (losses) on interest rate hedge position, net of tax		1,286			23,777			(35,025	)		(93,503	)
Other comprehensive income, net of tax		861,344			1,798,780			1,396,215			2,562,903
Other comprehensive income (loss), net of tax		9,452			(661,573	)		1,405,667			1,901,330
Comprehensive income	$	2,~~916~~924,~~261~~954		$	31,~~410~~232,~~794~~739		$	58,~~323~~248,~~329~~283		$	56,~~635~~868,~~711~~450

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

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders' Equity

~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016

(Unaudited)

									Accumulated
			Additional						Other
	Common		Paid-in			Retained			Comprehensive
Six Months Ended June 30, 2017	Stock		Capital			Earnings			Income, Net		Total
Nine Months Ended September 30, 2017	Stock		Capital			Earnings			Income, Net		Total
Balance at December 31, 2016	$	94,949	$	36,018,743		$	49,560,595		$	1,509,432	$	87,183,719
Net income		-		-			36,~~927~~842,~~114~~616			-		36,~~927~~842,~~114~~616
Other comprehensive income, net		-		-			-			1,~~396~~405,~~215~~667		1,~~396~~405,~~215~~667
Vesting of restricted stock awards, net		7645		16(1,~~095~~305	)		-			-		16(1,~~171~~260	)
Stock based compensation expense		-		38,045			-			-		38,045
Exercise of stock options		56		27,507			-			-		27,563
Dividends		-		-			(664,875	)		-		(664,875	)
Stock based compensation expense		-		146,768			-			-		146,768
Balance at June 30, 2017	$	95,025	$	36,072,883		$	52,822,834		$	2,905,647	$	91,896,389
Dividends		-		-			(997,505	)		-		(997,505	)
Balance at September 30, 2017	$	95,050	$	36,191,713		$	55,405,706		$	2,915,099	$	94,607,568

									Accumulated
			Additional						Other
	Common		Paid-in			Retained			Comprehensive
Six Months Ended June 30, 2016	Stock		Capital			Earnings			Income, Net		Total
Nine Months Ended September 30, 2016	Stock		Capital			Earnings			Income, Net		Total
Balance at December 31, 2015	$	94,892	$	35,936,911		$	43,691,073		$	2,447,898	$	82,170,774
Net income		-		-			34,~~072~~967,~~808~~120			-		34,~~072~~967,~~808~~120
Other comprehensive income, net		-		-			-			21,~~562~~901,~~903~~330		21,~~562~~901,~~903~~330
Vesting of restricted stock awards, net		35		(35	)		-			-		-
Exercise of stock options		1122		(1122	)		-			-		-
Stock based compensation expense		-		4261,~~129~~618			-			-		4261,~~129~~618
Dividends		-		-			(~~522~~806,~~045~~894	)		-		(~~522~~806,~~045~~894	)
Balance at June 30, 2016	$	94,938	$	35,978,994		$	46,241,836		$	5,010,801	$	87,326,569
Balance at September 30, 2016	$	94,949	$	35,998,472		$	47,851,299		$	4,349,228	$	88,293,948

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

First South Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016

(Unaudited)

	Six Months Ended
	Nine Months Ended
	June 30,
	September 30,
	2017			2016
Operating activities:
Net income	$	36,~~927~~842,~~114~~616		$	34,~~072~~967,~~808~~120
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses		~~750~~850,000			~~550~~770,000
Depreciation		~~947~~1,~~338~~362,821			~~847~~1,~~168~~351,295
Amortization of intangibles		~~120~~181,~~839~~258			~~122~~213,~~935~~245
Amortization of mortgage servicing rights		~~179~~272,~~627~~024			~~142~~188,~~164~~736
Accretion of discounts and premiums on securities, net		~~635~~937,~~607~~753			~~768~~1,~~201~~123,998
(Gain) loss on disposal of premises and equipment		(2,000	)		1,651
Loss on sale of assets held for sale		-			87,121
(Gain) loss on sale of other real estate owned		(55,500	)		26,484
Gain on sale of other real estate owned		(69,843	)		(50,932	)
Gain on sale of loans held for sale		(~~562~~979,~~938~~799	)		(~~540~~1,~~097~~020,678	)
Gain on sale of investment securities available for sale		-			(467,470	)
Valuation allowance on other real estate owned		~~176~~192,~~919~~139			~~110~~111,170
Stock based compensation expense		38146,~~045~~768			4261,~~129~~618
Originations of loans held for sale, net		(1930,~~160~~775,~~581~~714	)		(1630,~~586~~707,~~508~~244	)
Proceeds from sale of loans held for sale		1833,~~441~~039,~~181~~316			1528,~~818~~359,~~689~~152
Other operating activities		~~724~~2,~~895~~821,013			~~611~~2,492,897
Net cash provided by operating activities		614,~~160~~818,~~546~~352			37,~~996~~481,~~056~~679
Investing activities:
Proceeds from sale of investment securities available for sale		-			40,631,309
Purchases of investment securities available for sale		(10,360,239	)		-
Purchases of investment securities held to maturity		(506,750	)		-
Proceeds from principal repayments of mortgage-backed securities available for sale		913,~~167~~706,~~442~~741			1116,~~829~~962,~~622~~962
Proceeds from maturity of investment securities held to maturity		510,000			-
Proceeds from sale of assets held for sale		-			803,479
Mortgage servicing rights from loans sold with servicing retained		(~~164~~293,~~978~~777	)		(~~130~~235,~~298~~435	)
Originations of loans held for investment, net of principal repayments		(76,279,261	)		(62,371,462	)
Purchase of mortgage servicing rights portfolio		-			(778,392	)
Proceeds from disposal of other real estate owned		935,358			912,253
Originations of loans held for investment, net of principal repayments		(80,511,795	)		(76,054,408	)
Proceeds from disposal of premises and equipment		946,039			297,727
Proceeds from disposal of other real estate owned		1,363,508			1,718,907
Purchase of bank-owned life insurance		(271,204	)		(2,160,066	)
Proceeds from disposal of premises and equipment		1,036,641			336,709
Proceeds from sale (purchase) of FHLB stock		(274,000	)		51,800
Purchase of bank-owned life insurance		(403,255	)		(2,302,152	)
Purchase of premises and equipment		(1,751,986	)		(236,095	)
Proceeds from sale (purchase) of FHLB stock		(19,000	)		668,100
Net cash used in investing activities		(78,049,579	)		(10,371,731	)
Purchase of premises and equipment		(1,904,909	)		(717,004	)
Net cash used in investing activities		(77,382,835	)		(18,965,925	)
Financing activities:
Net increase in deposit accounts		6074,~~933~~687,~~983~~257			1448,~~140~~508,~~167~~852
Net increase (decrease) in FHLB borrowings		5,500,000			(4,500,000	)
Net decrease in FHLB borrowings		(500,000	)		(17,000,000	)
Cash paid for dividends		(~~664~~997,~~875~~505	)		(~~522~~806,~~045~~894	)
Vesting of restricted stock awards, net		16,171			-
Exercise of stock options		27,563			-
Net cash provided by financing activities		65,785,279			9,118,122
Vesting of restricted stock awards, net		(1,260	)		-
Increase (decrease) in cash and cash equivalents		(6,103,754	)		2,742,447
Net cash provided by financing activities		73,216,055			30,701,958
Increase (decrease) in cash and cash equivalents		10,651,572			19,217,712
Cash and cash equivalents, beginning of year		46,175,680			37,991,268
Cash and cash equivalents, end of year	$	4056,~~071~~827,~~926~~252		$	4057,~~733~~208,~~715~~980
Supplemental disclosures:
Other real estate acquired in settlement of loans	$	~~265~~440,~~300~~350		$	464,525
Transfer of premises to assets held for sale	$	-		$	1,083,320
Cash paid for interest	$	12,~~575~~982,~~118~~678		$	12,~~752~~667,~~134~~742

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation. First South Bancorp, Inc. (the "Company") was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. The Bank has one significant operating segment, providing commercial and retail banking services to its markets located in the state of North Carolina. The Bank also provides a full menu of leasing services through its wholly owned subsidiary, First South Leasing, LLC. In addition, under its First South Wealth Management division, the Bank makes securities brokerage services available through an affiliation with an independent broker/dealer. The Bank operates through its main office in Washington, North Carolina, and has 28 full-service branch offices located throughout eastern and central North Carolina.

The accompanying unaudited consolidated ~~financial~~ financial statements are prepared in pursuant to the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements. In the opinion of management, all adjustments necessary for fair presentation of the financial position ~~and~~ and results of operations for the periods presented are included, none of which are other than normal recurring accruals. The ~~financial~~ financial statements of the Company and the Bank are presented on a consolidated basis. The results of operations for the three and ~~six~~ nine months ended ~~June~~September 30, 2017, are not necessarily indicative of the results of operations that may be expected ~~for~~through November 1, 2017, the ~~year ended~~date ~~December~~of ~~31,~~the ~~2017~~Company’s merger with Carolina Financial Corporation described below. The accompanying unaudited consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes appearing in the 2016 Annual Report previously filed on Form 10-K.

On ~~June~~November 91, 2017, the Company ~~entered into~~completed ~~an Agreement and Plan of Merger and Reorganization (~~the ~~“Merger~~previously ~~Agreement”)~~announced merger with Carolina Financial Corporation (“CARO”)~~. The Merger Agreement provides that~~, ~~upon~~whereby the ~~terms and conditions set forth therein, the~~ Company ~~will~~merged ~~merge~~ with and into ~~CARO~~ CARO (the “Merger”), with CARO ~~continuing~~ as the surviving corporation. Asin ~~soon~~the asMerger. ~~practicable~~Immediately following the consummation of the Merger, ~~the~~First South Bank, ~~will~~a ~~merge~~wholly owned subsidiary of the Registrant, merged with and into ~~CARO’s~~CresCom Bank, a wholly owned subsidiary, of ~~CresCom~~CARO (the “Bank ~~("CresCom"~~Merger”), with CresCom ~~continuing~~ Bank as the surviving ~~entity~~bank (in the “Bank Merger. The Merger and the Bank Merger were effected by the transactions contemplated in that certain Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) dated as of June 9, 2017, by and between the Company and CARO. Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, the Company’s stockholders ~~will~~had ~~have~~ the right to receive 0.525064 shares of CARO ~~common~~ common stock for each share of the Company’s common stock. Cash will be paid in lieu of fractional shares. ~~The transaction is expected to close in the fourth quarter of 2017, subject to shareholder and regulatory approval and other customary closing conditions.~~

2. Earnings Per Share. Basic and ~~diluted~~ diluted earnings per share for the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016 are based on weighted average shares of common stock outstanding. Diluted earnings per share include the potentially dilutive effect of stock-based compensation plans. For both the three and ~~six~~nine months ended ~~June~~September 30, 2017 there were 29,250 stock options, respectively, compared to 8730,~~000~~441 and 26,931 stock options, respectively, for ~~both~~ the three and ~~six~~nine months ended ~~June~~September 30, 2016, that were anti-dilutive, because the exercise and grant prices exceeded the average market price of the Company’s common stock. The anti-dilutive shares are excluded from the diluted earnings per share calculation for the three and ~~six~~nine months ended ~~June~~September 30, 2017 and 2016.

3. Comprehensive Income and Accumulated Other Comprehensive Income. Comprehensive income includes net income and changes in other comprehensive income. The components of other comprehensive income primarily include net changes in unrealized gains and losses on available-for-sale securities, and the reclassification of net gains and losses on available-for-sale securities recognized in income during the respective reporting periods. The following table presents changes in accumulated other comprehensive income (“AOCI”), net of taxes for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016:

	Unrealized Holding Gains on Investment Securities Available-For-Sale			Unrealized Holding Gain (Loss) on Cash Flow Hedging Activities			Total Accumulated Other Comprehensive Income
	(In thousands)
Six Months Ended June 30, 2017
Nine Months Ended September 30, 2017
Balance at December 31, 2016	$	1,433		$	77		$	1,510
Other comprehensive income before reclassifications		1,~~432~~440			(3635	)		1,~~396~~405
Amounts reclassified from AOCI		-			-			-
Net current period other comprehensive income		1,~~432~~440			(3635	)		1,~~396~~405
Balance at June 30, 2017	$	2,865		$	41		$	2,906
Balance at September 30, 2017	$	2,873		$	42		$	2,915
Six Months Ended June 30, 2016
Nine Months Ended September 30, 2016
Balance at December 31, 2015	$	2,695		$	(247	)	$	2,448
Other comprehensive income (loss) before reclassifications		32,~~013~~328			(~~117~~94	)		2,~~896~~234
Amounts reclassified from AOCI		(333	)		-			(333	)
Net current period other comprehensive income (loss)		21,~~680~~995			(~~117~~94	)		21,~~563~~901
Balance at June 30, 2016	$	5,375		$	(364	)	$	5,011
Balance at September 30, 2016	$	4,690		$	(341	)	$	4,349

4. Investment Securities. The following is a summary of the investment securities portfolio by major category, with the amortized cost and fair value and gross unrealized gains and losses of each category at ~~June~~September 30, 2017 and December 31, 2016:

	Amortized		Gross		Gross		Fair
	Cost		Unrealized Gains		Unrealized Losses		Value
	(In thousands)
Securities available-for-sale:
June 30, 2017
September 30, 2017
Government agencies	$	23,~~470~~467	$	~~411~~395	$	2425	$	23,~~857~~837
Mortgage-backed securities		8580,~~037~~348		2,~~467~~411		2129		8782,~~483~~730
Municipal securities		55,~~502~~386		1,~~681~~755		2621		57,~~157~~120
Corporate bonds		26,~~917~~883		~~131~~135		~~144~~132		26,~~904~~886
Total	$	~~190~~186,~~926~~084	$	4,~~690~~696	$	~~215~~207	$	~~195~~190,~~401~~573
December 31, 2016
Government agencies	$	16,797	$	245	$	47	$	16,995
Mortgage-backed securities		93,124		2,155		163		95,116
Municipal securities		53,465		536		319		53,682
Corporate bonds		26,983		60		230		26,813
Total	$	190,369	$	2,996	$	759	$	192,606
	Amortized		Gross		Gross		Fair
	Cost		Unrealized Gains		Unrealized Losses		Value
	(In thousands)
Securities held-to-maturity:
June 30, 2017
Government agencies	$	506	$	1	$	-	$	507
Total	$	506	$	1	$	-	$	507
December 31, 2016
Government agencies	$	510	$	1	$	-	$	511
Total	$	510	$	1	$	-	$	511

	Amortized		Gross		Gross		Fair
	Cost		Unrealized Gains		Unrealized Losses		Value
	(In thousands)
Securities held-to-maturity:
September 30, 2017
Government agencies	$	506	$	2	$	-	$	508
Total	$	506	$	2	$	-	$	508

December 31, 2016
Government agencies	$	510	$	1	$	-	$	511
Total	$	510	$	1	$	-	$	511

The following table presents a summary of realized gains and losses from the sale of available-for-sale investment securities:

	Three Months Ended June 30,					Six Months Ended June 30,
	Three Months Ended September 30,					Nine Months Ended September 30,
	2017		2016			2017		2016
	(In thousands)
Proceeds from Sale	$	-	$	~~9,940~~-		$	-	$	40,631
Gross realized gains on sales		-		~~185~~-			-		594
Gross realized losses on sales		-		(1-	)		-		(127	)
Total realized gains, net	$	-	$	~~184~~-		$	-	$	467

4. Investment Securities (Continued)

The following table summarizes gross unrealized losses on investment securities, fair value and length of time the securities were in a continuous unrealized loss position at ~~June~~September 30, 2017 and December 31, 2016. The Company deems these unrealized losses to be temporary and recoverable prior to or at at maturity. The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a market price recovery or until maturity.

	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(In thousands)
June 30, 2017
September 30, 2017
Government agencies	$	6,~~727~~726	$	2425	$	-	$	-	$	6,~~727~~726	$	2425
Mortgage-backed securities		1312,~~240~~482		2129		-		-		1312,~~240~~482		2129
Municipal securities		1,~~126~~128		2621		-		-		1,~~126~~128		2621
Corporate bonds		3,~~994~~998		41		7,~~859~~868		~~140~~131		11,~~853~~866		~~144~~132
Total	$	2524,~~087~~334	$	7576	$	7,~~859~~868	$	~~140~~131	$	32,~~946~~202	$	~~215~~207
December 31, 2016
Government agencies	$	6,766	$	47	$	-	$	-	$	6,766	$	47
Mortgage-backed securities		27,586		163		-		-		27,586		163
Municipal securities		24,156		319		-		-		24,156		319
Corporate bonds		13,751		26		7,795		204		21,546		230
Total	$	72,259	$	555	$	7,795	$	204	$	80,054	$	759

The following table summarizes the amortized cost and fair values of the investment securities portfolio at ~~June~~September 30, 2017, by contractual maturity. Expected maturities ~~will~~ will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or or prepayment penalties.

	Less Than		One to		Five to		Over
	One Year		Five Years		Ten Years		Ten Years
	(In thousands)
Securities available-for-sale:
Government agencies
Amortized cost	$	-	$	23,~~470~~467	$	-	$	-
Fair value		-		23,~~857~~837		-		-
Mortgage-backed securities
Amortized cost		2,~~106~~275		6457,~~736~~853		32,~~165~~987		1517,~~030~~233
Fair value		2,~~131~~319		6658,~~076~~932		3,~~282~~109		1518,~~994~~370
Municipal securities
Amortized cost		4,~~844~~861		13,~~686~~615		35,~~542~~469		1,~~430~~441
Fair value		4,~~886~~881		1413,~~025~~951		36,~~788~~805		1,~~458~~483
Corporate bonds
Amortized cost		7,~~014~~003		11,~~903~~880		8,000		-
Fair value		7,~~015~~006		11,~~973~~957		7,~~916~~923		-
Total Amortized cost	$	1314,~~964~~139	$	~~113~~106,~~795~~815	$	46,~~707~~456	$	1618,~~460~~674
Total Fair value	$	14,~~032~~206	$	~~115~~108,~~931~~677	$	47,~~986~~837	$	1719,~~452~~853
Securities held-to-maturity:
Government agencies
Amortized cost	$	-	$	506	$	-	$	-
Fair value		-		~~507~~508		-		-
Total Amortized cost	$	-	$	506	$	-	$	-
Total Fair value	$	-	$	~~507~~508	$	-	$	-

United States government agency and mortgage-backed securities with an amortized cost of $6078.52 million were pledged as collateral for public deposits at ~~June~~September 30, 2017, compared to to $32.6 million at December 31, 2016. In addition, a government agency bond with an amortized cost of $506,000 and $510,000 was pledged as collateral on an interest rate swap transaction at ~~June~~September 30, 2017 and December 31, 2016, respectively.

4. Investment Securities (Continued)

Prior to purchasing any security, the Bank ensures the security is investment grade. For a security to be investment grade it must: (1) have a low risk of default by the obligor, and (2) the Bank must expect the full and timely repayment of principal and interest over the expected life. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), certain investments are deemed investment grade. These include: U.S. Treasury securities, Federal Agency securities, Revenue Bonds, and Unlimited-Tax General Obligation Municipals. Other securities undergo a pre-purchase analysis to ensure they are investment grade.

To determine if a security is investment grade, if available, management utilizes the ratings of the Nationally Recognized Statistical Rating Organizations (“NRSRO”). However, they are not the sole basis of determining if a security is investment grade. In addition, on a pre-purchase basis, at least one of the following criteria pertaining to the obligor is acquired and reviewed as part of the Bank’s credit analysis: Data from debt offerings (prospectus/offering circular); data from regulatory filings- Securities and Exchange Commission (“SEC”) Forms 10-K, 10-Q, 8-K, etc.; data available from the obligor’s website (annual reports, press releases); data obtained from a third party (bond broker, analyst); NRSRO report on the initial offering and/or subsequent reviews of the issuer; or other pertinent available financial information. There have been no instances where the NRSRO’s credit rating has significantly differed from that of the Bank’s credit analysis.

At ~~June~~September 30, 2017, the investment securities portfolio included 50 taxable and tax-exempt debt instruments issued by various states, counties, cities, municipalities and school districts. The following table is a summary, listed by state, of the Company’s investment in the obligations of state and political subdivisions:

	June 30, 2017
	September 30, 2017
	Amortized Cost		Fair Value
	(In thousands)
Obligations of state and political subdivisions:
General obligation bonds:
California	$	5,~~144~~172	$	5,~~341~~421
Washington		3,~~361~~349		3,~~424~~412
Pennsylvania		2,771		2,~~785~~780
Indiana		2,~~384~~369		2,~~418~~404
Texas		2,~~266~~262		2,260
Florida		2,~~223~~217		2,~~292~~277
Alabama		1,~~813~~808		1,844
Utah		1,~~781~~777		1,~~807~~800
Nevada		1,~~322~~313		1,~~354~~344
Missouri		1,~~301~~299		1,~~429~~423
Other (11 states)		8,~~676~~646		8,~~947~~919
Total general obligation bonds		3332,~~042~~983		33,~~901~~884
Revenue bonds:
New York		7,~~147~~121		7,~~445~~457
North Carolina		4,~~198~~178		4,~~309~~287
Mississippi		2,~~304~~297		2,~~394~~390
Oklahoma		2,~~239~~232		2,~~340~~334
Pennsylvania		1,~~939~~958		1,~~970~~974
Other (4 states)		4,~~633~~617		4,~~798~~794
Total revenue bonds		22,~~460~~403		23,~~256~~236
Total obligations of state and political subdivisions	$	55,~~502~~386	$	57,~~157~~120

The ~~largest~~ largest exposure in general obligation bonds was one bond issued by the Ambridge Area School District, Pennsylvania, with a total ~~amortized~~ amortized cost basis and total fair value of $2.4 million at ~~June~~September 30, 2017.

4. Investment Securities (Continued)

The following table is a summary of the revenue sources related to the Company’s investment in revenue bonds:

	June 30, 2017
	September 30, 2017
	Amortized Cost		Fair Value
	(In thousands)
Revenue bonds by revenue source:
University and college	$	8,~~534~~507	$	8,~~916~~923
Public improvements		6,~~079~~055		6,~~294~~292
Pension funding		1,~~939~~958		1,~~970~~974
Refunding bonds		1,~~621~~617		1,~~649~~651
Other		4,~~287~~266		4,~~427~~396
Total revenue bonds	$	22,~~460~~403	$	23,~~256~~236

The largest single exposure in revenue ~~bonds~~ bonds is an issue from the Dormitory Authority of the State of New York (“DASNY”). DASNY was created in 1944 to finance ~~and~~ and build dormitories for state teachers’ colleges. Its mission has expanded over time and in 1995 DASNY became the largest ~~public~~ public authority issuer of tax-exempt bonds in the country. The debt is secured by a dedication of 25% of the New York State personal income tax. As of ~~June~~September 30, 2017, this issue had an amortized cost of $2.8 million and fair value of $3.0 million.

5. Loans Held for Sale. The Bank ~~originates~~ originates residential mortgage loans for sale in the secondary market. Pursuant to Accounting Standards Codification (“ASC”) 825, Financial Instruments, at ~~June~~September 30, 2017 and December 31, 2016, the Bank marked these mortgage loans to market. ~~Mortgage~~ Mortgage loans held for sale at ~~June~~September 30, 2017 and December 31, 2016, had estimated fair market values of $63.48 million and $5.1 million, respectively. The Bank originates mortgage loans for sale that are approved by secondary investors. Their terms are set by secondary investors, and they are transferred within 120 days after the Bank funds the loans. The Bank issues rate lock commitments to borrowers, and depending on market conditions, may enter into forward contracts with secondary market investors to minimize interest rate risk related to mortgage loan forward sales commitments. The Bank uses forward contracts to minimize interest rate risk related to mortgage loan forward sales commitments to economically hedge a percentage of the locked-in pipeline. The Bank receives origination fees from borrowers and servicing release premiums from investors that are recognized in income when loans are sold. The following table summarizes forward contract positions of the Bank at ~~June~~September 30, 2017 and December 31, 2016:

Forward Contracts	June 30, 2017				December 31, 2016
	September 30, 2017				December 31, 2016
	Fair		Notional		Fair		Notional
	Value		Value		Value		Value
	(In thousands)
Mortgage Loan Forward Sales Commitments	$	81	$	8,949	$	65	$	6,036
Forward Contracts
Mortgage Loan Forward Sales Commitments	$	83	$	5,622	$	65	$	6,036

6. Loans Held for Investment. Loans held for investment at ~~June~~September 30, 2017 and December 31, 2016 are listed below:

	June 30, 2017					December 31, 2016
	September 30, 2017					December 31, 2016
	Amount		Percent of Total			Amount		Percent of Total
	(Dollars in thousands)
Loans Held for Investment
Mortgage loans:
Residential real estate	$	6970,~~649~~693		9.0	%	$	67,264		9.6	%
Residential construction		6,~~830~~740		0.9			7,875		1.1
Residential lots and raw land		~~137~~130		0.0			154		0.0
Total mortgage loans		7677,~~616~~563		9.9			75,293		10.7
Commercial loans and leases:
Commercial real estate		~~421~~420,~~302~~131		5453.27			378,173		53.9
Commercial construction		5155,~~506~~915		67.62			56,118		8.0
Commercial lots and raw land		3130,~~195~~700		43.09			33,434		4.8
Commercial and Industrial		9088,~~375~~893		11.64			67,980		9.7
Lease receivables		2223,~~945~~311		3.0			21,236		3.0
Total commercial loans and leases		~~617~~618,~~323~~950		79.42			556,941		79.4
Consumer loans:
Consumer real estate		2021,~~419~~332		2.67			16,967		2.4
Consumer construction		~~419~~444		0.1			105		0.0
Consumer lots and raw land		89,~~867~~235		1.12			8,975		1.3
Home equity lines of credit		3940,~~738~~537		5.12			36,815		5.3
Consumer other		13,~~992~~403		1.87			6,347		0.9
Total consumer loans		8384,~~435~~951		10.79			69,209		9.9
Gross loans held for investment		~~777~~781,~~374~~464		100.0	%		701,443		100.0	%
Less deferred loan origination fees, net		~~717~~750					801
Less allowance for loan and lease losses		9,~~367~~562					8,673
Net loans held for investment	$	~~767~~771,~~290~~152				$	691,969

The Bank has pledged eligible loans as ~~collateral~~ collateral for actual or potential borrowings from the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank of Richmond (“FRB”). At ~~June~~September 30, 2017, the Bank pledged $~~283~~300.83 million and $~~149~~164.54 million of loans to the FHLB and FRB, respectively. See Note 13. Borrowed Money below, for additional information.

6. Loans Held for Investment (Continued)

The following tables detail nonaccrual ~~loans~~ loans held for investment, including troubled debt restructured (“TDR”) loans accounted for on a nonaccrual status, ~~segregated~~ segregated by class of loans, at ~~June~~September 30, 2017 and December 31, 2016:

	June 30, 2017			December 31, 2016
	September 30, 2017			December 31, 2016
	(Dollars in thousands)
Non-accrual loans held for investment:
Non-TDR loans accounted for on a non-accrual status:
Residential real estate	$	~~821~~627		$	773
Residential lots and raw land		-			-
Commercial real estate		~~915~~929			482
Commercial construction		-			-
Commercial lots and raw land		-			-
Commercial and industrial		-			72
Lease receivables		-			-
Consumer real estate		95230			94
Consumer lots and raw land		2523			80
Home equity lines of credit		~~128~~107			166
Consumer other		-			-
Total non-TDR loans accounted for on a nonaccrual status		1,~~984~~916			1,667
TDR loans accounted for on a nonaccrual status:
Past Due TDRs:
Residential real estate		-			161
Commercial real estate		-			652
Commercial construction		-			-
Commercial lots and raw land		-			-
Commercial and industrial		-			-
Consumer real estate		-			149
Total Past Due TDRs		-			962
Current TDRs:
Residential real estate		~~155~~-			163
Commercial real estate		-			-
Commercial construction		-			-
Commercial lots and raw land		-			-
Commercial and industrial		170			170
Consumer real estate		~~139~~136			-
Consumer lots and raw land		8583			89
Total Current TDRs		~~549~~389			422
Total TDR loans accounted for on a nonaccrual status		~~549~~389			1,384
Total non-performing loans	$	2,~~533~~305			3,051
Percentage of total loans held for investment, net		0.3	%		0.4	%
Loans over 90 days past due, still accruing	$	-		$	-
Other real estate owned		2,~~438~~184			3,229
Total non-performing assets	$	4,~~971~~489		$	6,280

Cumulative interest income not recorded on on loans accounted for on a nonaccrual status was $~~114~~96,~~100~~071 and $115,318 at ~~June~~September 30, 2017 and December 31, 2016, respectively.

See “Note 8. Troubled Debt Restructurings” below for additional information.

6. Loans Held for Investment (Continued)

The following table presents an age analysis of past due loans held for investment, segregated by class of loans as of ~~June~~September 30, 2017 and December 31, 2016:

	30-59		60-89		90 Days		Total				Total		90 Days or
	Days		Days		or More		Past				Financing		More and
Past due loans held for investment:	Past Due		Past Due		Past Due		Due		Current		Receivables		Accruing
	Past Due		Past Due		Past Due		Due		Current		Receivables		Accruing
	(In thousands)
June 30, 2017
Past due loans held for investment:
Residential real estate	$	-	$	120	$	509	$	629	$	69,020	$	69,649	$	-
September 30, 2017
Residential construction		-		-		-		-		6,830		6,830		-
Residential real estate	$	-	$	280	$	324	$	604	$	70,089	$	70,693	$	-
Residential lots and raw land		-		-		-		-		137		137		-
Residential construction		-		-		-		-		6,740		6,740		-
Commercial real estate		98		-		768		866		420,436		421,302		-
Residential lots and raw land		-		-		-		-		130		130		-
Commercial construction		-		-		-		-		51,506		51,506		-
Commercial real estate		63		28		467		558		419,573		420,131		-
Commercial lots and raw land		227		-		-		227		30,968		31,195		-
Commercial construction		-		-		-		-		55,915		55,915		-
Commercial and industrial		30		-		-		30		90,345		90,375		-
Commercial lots and raw land		496		-		-		496		30,204		30,700		-
Lease receivables		-		-		-		-		22,945		22,945		-
Commercial and industrial		-		-		-		-		88,893		88,893		-
Consumer real estate		343		-		61		404		20,015		20,419		-
Lease receivables		-		-		-		-		23,311		23,311		-
Consumer construction		-		-		-		-		419		419		-
Consumer real estate		235		2		125		362		20,970		21,332		-
Consumer lots and raw land		-		33		-		33		8,834		8,867		-
Consumer construction		-		-		-		-		444		444		-
Home equity lines of credit		226		46		44		316		39,422		39,738		-
Consumer lots and raw land		35		25		-		60		9,175		9,235		-
Consumer other		14		27		-		41		13,951		13,992		-
Home equity lines of credit		218		-		11		229		40,308		40,537		-
Total	$	938	$	226	$	1,382	$	2,546	$	774,828	$	777,374	$	-
Consumer other		23		-		-		23		13,380		13,403		-
	30-59		60-89		90 Days		Total				Total		90 Days or
Total	$	1,070	$	335	$	927	$	2,332	$	779,132	$	781,464	$	-
	Days		Days		or More		Past				Financing		More and
Past due loans held for investment:	Past Due		Past Due		Past Due		Due		Current		Receivables		Accruing
	(In thousands)
December 31, 2016
Residential real estate	$	1,048	$	176	$	565	$	1,789	$	65,475	$	67,264	$	-
Residential construction		-		-		-		-		7,875		7,875		-
Residential lots and raw land		-		-		-		-		154		154		-
Commercial real estate		726		4		1,022		1,752		376,421		378,173		-
Commercial construction		-		-		-		-		56,118		56,118		-
Commercial lots and raw land		-		-		-		-		33,434		33,434		-
Commercial and industrial		-		-		72		72		67,908		67,980		-
Lease receivables		-		-		-		-		21,236		21,236		-
Consumer real estate		-		42		206		248		16,719		16,967		-
Consumer construction		-		-		-		-		105		105		-
Consumer lots and raw land		-		8		81		89		8,886		8,975		-
Home equity lines of credit		121		33		98		252		36,563		36,815		-
Consumer other		7		2		-		9		6,338		6,347		-
Total	$	1,902	$	265	$	2,044	$	4,211	$	697,232	$	701,443	$	-

	30-59		60-89		90 Days		Total				Total		90 Days or
	Days		Days		or More		Past				Financing		More and
	Past Due		Past Due		Past Due		Due		Current		Receivables		Accruing
	(In thousands)
Past due loans held for investment:
December 31, 2016
Residential real estate	$	1,048	$	176	$	565	$	1,789	$	65,475	$	67,264	$	-
Residential construction		-		-		-		-		7,875		7,875		-
Residential lots and raw land		-		-		-		-		154		154		-
Commercial real estate		726		4		1,022		1,752		376,421		378,173		-
Commercial construction		-		-		-		-		56,118		56,118		-
Commercial lots and raw land		-		-		-		-		33,434		33,434		-
Commercial and industrial		-		-		72		72		67,908		67,980		-
Lease receivables		-		-		-		-		21,236		21,236		-
Consumer real estate		-		42		206		248		16,719		16,967		-
Consumer construction		-		-		-		-		105		105		-
Consumer lots and raw land		-		8		81		89		8,886		8,975		-
Home equity lines of credit		121		33		98		252		36,563		36,815		-
Consumer other		7		2		-		9		6,338		6,347		-
Total	$	1,902	$	265	$	2,044	$	4,211	$	697,232	$	701,443	$	-

6. Loans Held for Investment (Continued)

The following table presents information on loans that were considered impaired as of ~~June~~September 30, 2017 and December 31, 2016. Impaired loans include loans modified as a TDR, whether on accrual or non-accrual status. At ~~June~~September 30, 2017, impaired loans included $~~1.2~~826,000 ~~million~~ of TDRs, compared to $1.9 ~~million~~ million at December 31, 2016.

			Contractual				YTD Average		Interest Income
	Recorded		Unpaid Principal		Related		Recorded		Recognized on
Impaired Loans June 30, 2017	Investment		Balance		Allowance		Investment		Impaired Loans
	Investment		Balance		Allowance		Investment		Impaired Loans
					(in thousands)
	(In thousands)
Impaired Loans September 30, 2017
With no related allowance recorded:
Residential real estate	$	~~425~~270	$	~~511~~270	$	-	$	~~538~~471	$	1310
Commercial real estate		53,~~904~~729		53,~~947~~801		-		65,~~078~~490		~~159~~151
Commercial lots and raw land		~~1,042~~882		~~1,042~~882		-		1,~~611~~429		2735
Commercial and industrial		9288		9289		-		9795		23
Consumer real estate		~~208~~240		~~224~~259		-		~~202~~212		812
Consumer lots and raw land		8683		9290		-		~~113~~105		24
Home equity lines of credit		2723		3025		-		4237		12
Consumer other		3635		3635		-		37		1
Subtotal:		75,~~820~~350		75,~~974~~451		-		87,~~718~~876		~~213~~218
With an allowance recorded:
Commercial real estate		~~278~~97		~~278~~97		-1		~~282~~236		74
Commercial and industrial		~~170~~440		~~174~~444		~~170~~420		~~218~~274		694
Consumer lots and raw land		589		589		103		609		12
Consumer real estate		105		105		33		26		2
Home equity lines of credit		55		58		36		45		2
Consumer lots and raw land		586		586		102		603		20
Subtotal		1,092		1,099		309		1,154		27
Home equity lines of credit		53		58		36		47		4
Subtotal		1,281		1,290		592		1,186		124
Totals:
Residential		~~425~~270		~~511~~270		-		~~538~~471		1310
Commercial		75,~~486~~236		75,~~533~~313		~~170~~421		87,~~286~~524		~~201~~287
Consumer		1,~~001~~125		1,~~029~~158		~~139~~171		1,~~048~~067		2645
Grand Total	$	86,~~912~~631	$	96,~~073~~741	$	~~309~~592	$	9,~~872~~062	$	~~240~~342

			Contractual				YTD Average		Interest Income
	Recorded		Unpaid Principal		Related		Recorded		Recognized on
Impaired Loans December 31, 2016	Investment		Balance		Allowance		Investment		Impaired Loans
	Investment		Balance		Allowance		Investment		Impaired Loans
					(in thousands)
	(In thousands)
Impaired Loans December 31, 2016
With no related allowance recorded:
Residential real estate	$	597	$	730	$	-	$	804	$	32
Commercial real estate		6,581		6,645		-		7,742		408
Commercial lots and raw land		2,185		2,185		-		2,376		121
Commercial and industrial		102		102		-		59		5
Consumer real estate		221		232		-		257		8
Consumer lots and raw land		129		135		-		86		10
Home equity lines of credit		71		73		-		50		3
Consumer other		38		38		-		40		2
Subtotal:		9,924		10,140		-		11,414		589
With an allowance recorded:
Commercial real estate		287		287		-		579		15
Commercial and industrial		242		678		226		48		35
Consumer real estate		647		647		144		687		34
Consumer lots and raw land		23		25		23		18		3
Subtotal		1,199		1,637		393		1,332		87
Totals:
Residential		597		730		-		804		32
Commercial		9,397		9,897		226		10,804		584
Consumer		1,129		1,150		167		1,138		60
Grand Total	$	11,123	$	11,777	$	393	$	12,746	$	676

6. Loans Held for Investment (Continued)

Credit Quality Indicators. The Bank assigns a risk grade to each loan in the portfolio as part of the on-going monitoring of the credit quality of the loan portfolio.

Commercial loans are graded on a scale of 1 to 9 as follows:

·• Risk Grade 1 (Excellent) - Loans in this category are considered to be of the highest quality. • Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability. • Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability. • Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability. • Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status. • Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. • Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. • Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. • Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.

· Risk Grade 2 (Above Average) - Loans are supported by above average financial strength and stability.

· Risk Grade 3 (Average) - Credits in this group are supported by upper tier industry-average financial strength and stability.

· Risk Grade 4 (Acceptable) - Credits in this group are supported by lower end industry-average financial strength and stability.

· Risk Grade 5 (Watch) - An asset in this category is one that has been identified by the lender, or credit administration as a loan that has shown some degree of deterioration from its original status.

· Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention.

· Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any.

· Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable.

· Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.

Consumer loans are graded on a scale of 1 to 9 as follows:

·• Risk Grades 1 - 5 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. • Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention. • Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any. • Risk Grade 8 (Doubtful) - A loan graded in this category has all the weaknesses inherent in one graded Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. • Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.

· Risk Grade 6 (Special Mention) - An asset in this category is currently protected by collateral but has potential weaknesses that deserve management’s close attention.

· Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the debtor(s) or of the collateral pledged, if any.

· Risk Grade 9 (Loss) - A loan graded as Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.

Mortgage loans are graded on a scale of 1 to 9 as follows:

·• Risk Grades 1 - 4 (Pass) - Loans in this category generally show little to no signs of weakness or have adequate mitigating factors that minimize the risk of loss. • Risk Grade 5 (Pass -Watch) – Watch loans have shown credit quality changes from the original status. • Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention. • Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s). • Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. • Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

· Risk Grade 5 (Pass -Watch) – Watch loans have shown credit quality changes from the original status.

· Risk Grade 6 (Special Mention) – Special Mention loans are currently protected by collateral but have potential weaknesses that deserve management’s close attention.

· Risk Grade 7 (Substandard) - Substandard loans are inadequately protected by the sound net worth and paying capacity of the borrower(s).

· Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable.

· Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

6. Loans Held for Investment (Continued)

The following table presents information on risk ratings of the commercial, consumer, mortgage and lease receivable portfolios, segregated by loan class as of ~~June~~September 30, ~~2017~~ 2017 and December 31, 2016:

June 30, 2017

September 30, 2017

Commercial Credit Exposure by Assigned Risk Grade

Commercial Real Estate

Commercial Construction

Commercial Lots and Raw Land

Commercial and Industrial

(In thousands)

1-Excellent

2-Above Average

2,~~678~~641

~~787~~784

~~286~~381

3-Average

~~120~~124,~~775~~840

1011,~~730~~570

2,~~745~~431

2022,~~298~~628

4-Acceptable

~~269~~267,~~366~~753

4044,~~173~~170

1920,~~645~~492

6156,~~661~~293

5-Watch

17,~~613~~130

~~603~~69

75,~~268~~412

57,~~000~~529

6-Special Mention

75,~~238~~965

~~719~~1,581

1,~~012~~883

7-Substandard

31,~~632~~802

-106

31-

~~2,109~~170

8-Doubtful

9-Loss

Total

~~421~~420,~~302~~131

5155,~~506~~915

3130,~~195~~700

9088,~~375~~893

June 30, 2017
September 30, 2017
Consumer Credit Exposure by Assigned Risk Grade	Consumer Real Estate		Consumer Construction		Consumer Lots and Raw Land		Home Equity Line of Credit		Consumer Other
	(In thousands)
Pass	$	20,~~067~~884	$	~~419~~444	$	8,~~559~~909	$	3940,~~499~~308	$	13,~~954~~367
6-Special Mention		~~118~~116		-		~~197~~194		4139		1
7-Substandard		~~234~~332		-		~~111~~132		~~198~~190		3735
8-Doubtful		-		-		-		-		-
9-Loss		-		-		-		-		-
Total	$	2021,~~419~~332	$	~~419~~444	$	89,~~867~~235	$	3940,~~738~~537	$	13,~~992~~403

June 30, 2017
September 30, 2017
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade	Residential Real Estate		Residential Construction		Residential Lots and Raw Land		Lease Receivable
	(In thousands)
Pass	$	6769,~~927~~327	$	6,~~830~~740	$	~~137~~130	$	22,~~848~~865
6-Special Mention		~~747~~739		-		-		97355
7-Substandard		~~975~~627		-		-		-91
8-Doubtful		-		-		-		-
9-Loss		-		-		-		-
Total	$	6970,~~649~~693	$	6,~~830~~740	$	~~137~~130	$	2223,~~945~~311

6. Loans Held for Investment (Continued)

December 31, 2016
Commercial Credit Exposure by Assigned Risk Grade	Commercial Real Estate		Commercial Construction		Commercial Lots and Raw Land		Commercial and Industrial
	(In thousands)
1-Excellent	$	-	$	-	$	-	$	72
2-Above Average		2,567		-		203		520
3-Average		112,489		13,986		2,237		14,331
4-Acceptable		237,473		40,819		22,042		48,305
5-Watch		17,869		1,184		7,027		1,890
6-Special Mention		3,424		129		1,384		672
7-Substandard		4,351		-		541		2,190
8-Doubtful		-		-		-		-
9-Loss		-		-		-		-
Total	$	378,173	$	56,118	$	33,434	$	67,980

December 31, 2016
Consumer Credit Exposure by Assigned Risk Grade	Consumer Real Estate		Consumer Construction		Consumer Lots and Raw Land		Home Equity Line of Credit		Consumer Other
	(In thousands)
Pass	$	16,472	$	105	$	8,595	$	36,474	$	6,345
6-Special Mention		252		-		211		84		2
7-Substandard		243		-		169		257		-
8-Doubtful		-		-		-		-		-
9-Loss		-		-		-		-		-
Total	$	16,967	$	105	$	8,975	$	36,815	$	6,347

December 31, 2016
Mortgage and Lease Receivable Credit Exposure by Assigned Risk Grade	Residential Real Estate		Residential Construction		Residential Lots and Raw Land		Lease Receivable
	(In thousands)
Pass	$	65,406	$	7,875	$	154	$	21,236
6-Special Mention		761		-		-		-
7-Substandard		1,097		-		-		-
8-Doubtful		-		-		-		-
9-Loss		-		-		-		-
Total	$	67,264	$	7,875	$	154	$	21,236

7. Allowance for Loan and Lease Losses. The following table presents a roll forward summary of activity in the allowance for loan and lease losses (“ALLL”), by loan category, for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016:

	June 30, 2017
	September 30, 2017
	Beginning		Charge-								Ending		Total
	Balance		Offs			Recoveries		Provisions			Balance		Loans
	(In thousands)
Collectively evaluated for impairment:
Residential real estate	$	695	$	(33	)	$	-	$	5516		$	~~717~~678	$	6970,~~224~~423
Residential construction		89		-			-		(1517	)		7472		6,~~830~~740
Residential lots and raw land		2		-			-		(1	)		1		~~137~~130
Commercial real estate		4,562		(4	)		1723		~~396~~361			4,~~971~~942		~~415~~416,~~120~~305
Commercial construction		689		-			-		(8441	)		~~605~~648		5155,~~506~~915
Commercial lots and raw land		365		-			-		(2838	)		~~337~~327		3029,~~153~~818
Commercial and industrial		840		(20	)		23		~~259~~182			1,~~081~~005		9088,~~113~~365
Lease receivables		226		-(5	)		-		1116			237		2223,~~945~~311
Consumer real estate		186		-			17		6136			~~248~~229		20,~~211~~987
Consumer construction		1		-			-		34			45		~~419~~444
Consumer lots and raw land		134		-			2		(3929	)		97107		8,~~192~~566
Home equity lines of credit		414		(5	)		22		(54	)		~~426~~427		3940,~~656~~461
Consumer other		77		(48	)		2526		~~162~~197			~~260~~292		13,~~956~~368
Total		8,280		(6675	)		6983		~~775~~682			98,~~058~~970		~~768~~774,~~462~~833
Individually evaluated for impairment:
Residential real estate		-		-			216		(216	)		-		~~425~~270
Commercial real estate		-		-			-		-1			-1		63,~~182~~826
Commercial lots and raw land		-		-			1489		(1489	)		-		~~1,042~~882
Commercial and industrial		226		(67	)		-		11261			~~170~~420		~~262~~528
Consumer real estate		-		-			-		-33			-33		~~208~~345
Consumer lots and raw land		144		(26	)		15		(3031	)		~~103~~102		~~675~~669
Home equity lines of credit		23		-			34		109			36		8276
Consumer other		-		-			-		-			-		3635
Total		393		(93	)		34124		~~(25~~168	)		~~309~~592		86,~~912~~631
Grand Total	$	8,673	$	(~~159~~168	)	$	~~103~~207	$	~~750~~850		$	9,~~367~~562	$	~~777~~781,~~374~~464

7. Allowance for Loan and Lease Losses (Continued)

	June 30, 2016
	September 30, 2016
	Beginning		Charge-								Ending		Total
	Balance		Offs			Recoveries		Provisions			Balance		Loans
	(In thousands)
Collectively evaluated for impairment:
Residential real estate	$	730	$	-		$	-	$	~~(45~~2	)	$	~~685~~732	$	6667,~~480~~799
Residential construction		47		-			-		2227			6974		6,~~103~~372
Residential lots and raw land		2		-			-		-			2		~~165~~160
Commercial real estate		4,065		-(33	)		1622		~~217~~465			4,~~298~~519		~~355~~364,~~006~~320
Commercial construction		518		-			70		9691			~~684~~679		5654,~~513~~854
Commercial lots and raw land		303		-			-		7352			~~376~~355		3230,~~721~~151
Commercial and industrial		641		(2	)		34		88126			~~730~~769		5759,~~021~~683
Lease receivables		196		-			-		828			~~204~~224		1820,~~927~~452
Consumer real estate		198		-(6	)		711		(175	)		~~188~~198		1617,~~567~~323
Consumer construction		2		-			-		21			43		~~417~~252
Consumer lots and raw land		125		(4	)		-		-4			~~121~~125		8,~~568~~557
Home equity lines of credit		351		-(13	)		1		2165			~~373~~404		3234,~~791~~921
Consumer other		71		(3440	)		1321		23			7375		6,~~331~~484
Total		7,249		(4098	)		~~110~~129		~~488~~879			78,~~807~~159		~~657~~671,~~610~~328
Individually evaluated for impairment:
Residential real estate		-		(2	)		1		1			-		~~779~~774
Commercial real estate		-		(68	)		13		~~414~~224			~~347~~159		7,~~221~~509
Commercial construction		-		-			-		-			-		~~405~~-
Commercial lots and raw land		365		-			-		(365	)		-		2,~~357~~325
Commercial and industrial		14		-			-		(914	)		5-		4068
Consumer real estate		30		(36	)		-		630			-24		~~371~~399
Consumer lots and raw land		209		(5073	)		2		(5	)		~~156~~133		~~765~~785
Home equity lines of credit		-		-			34		2019			23		7653
Consumer other		-		-			-		-			-		4039
Total		618		(~~156~~179	)		710		62(110	)		~~531~~339		1211,~~054~~952
Grand Total	$	7,867	$	(~~196~~277	)	$	~~117~~139	$	~~550~~769		$	8,~~338~~498	$	~~669~~683,~~664~~280

8. Troubled Debt Restructurings. The following table details performing TDR loans at ~~June~~September 30, 2017 and December 31, 2016, segregated by class of financing receivables:

	June 30, 2017			December 31, 2016
	September 30, 2017			December 31, 2016
	(Dollars in thousands)
Performing TDRs accounted for on accrual status:
Residential real estate	$	-		$	-
Commercial real estate		~~609~~351			461
Consumer real estate		3533			-
Consumer lots and raw land		5453			95
Total	$	~~698~~437		$	556
Percentage of total loans, net		0.0	%		0.1	%

8. Troubled Debt Restructurings (Continued)

The following table presents a roll forward of performing TDR loans for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016:

Performing TDRs	Beginning Balance		Additions (1)		Charge-offs (2)		Other (3)			Ending Balance
	Beginning Balance		Additions (1)		Charge-offs (2)		Other (3)			Ending Balance
	(In thousands)
June 30, 2017
Performing TDRs
September 30, 2017
Residential mortgage	$	-	$	-	$	-	$	-		$	-
Commercial		461		252		-		(~~104~~362	)		~~609~~351
Consumer		95		-		-		(69	)		8986
Total	$	556	$	252	$	-	$	(~~110~~371	)	$	~~698~~437
June 30, 2016
September 30, 2016
Residential mortgage	$	-	$	-	$	-	$	-		$	-
Commercial		770		-92		-		(~~385~~394	)		~~385~~468
Consumer		107		-		-		(69	)		~~101~~98
Total	$	877	$	-92	$	-	$	(~~391~~403	)	$	~~486~~566

The following table presents a roll forward of non-performing TDR loans for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016:

Non-Performing TDRs	Beginning Balance		Additions (1)		Charge-offs (2)			Other (4)			Ending Balance
	Beginning Balance		Additions (1)		Charge-offs (2)			Other (4)			Ending Balance
	(In thousands)
June 30, 2017
Non-Performing TDRs
Residential mortgage	$	324	$	-	$	-		$	(169	)	$	155
September 30, 2017
Residential mortgage	$	324	$	-	$	-		$	(324	)	$	-
Commercial		822		-		-			(652	)		170
Consumer		238		-		-			(1419	)		~~224~~219
Total	$	1,384	$	-	$	-		$	(~~835~~995	)	$	~~549~~389
June 30, 2016
September 30, 2016
Residential mortgage	$	809	$	-	$	(2	)	$	(~~303~~308	)	$	~~504~~499
Commercial		534		-		-			(~~234~~235	)		~~300~~299
Consumer		159		-92		-			(79	)		~~152~~242
Total	$	1,502	$	-92	$	(2	)	$	(~~544~~552	)	$	~~956~~1,040

Includes new TDRs and increases to existing TDRs.

Post modification charge-offs.

Includes principal payments, paydowns and performing loans previously restructured at market rates that are no longer reported as TDRs.

Includes principal payments, paydowns and loans previously designated as non-performing that are currently performing in compliance with their modified terms.

The Bank performs restructurings on certain troubled loan workouts, whereby existing loans are restructured into a multiple note structure (i.e., Note A and Note B structure). The Bank separates a portion of the current outstanding debt into a new legally enforceable note (“Note A”) that is reasonably assured of repayment and performance according to prudently modified terms. The portion of the debt that is not reasonably assured of repayment (“Note B”) is adversely classified and charged-off as appropriate. The following table provides information on multiple note restructures for certain commercial real estate loan workouts as of ~~June~~September 30, 2017 and 2016:

	June 30, 2017		June 30, 2016
	September 30, 2017		September 30, 2016
	(In thousands)
Note A Structure
Commercial real estate (1)	$	~~338~~334	$	~~263~~352
Note B Structure
Commercial real estate (2)	$	~~206~~207	$	~~174~~207
Reduction of interest income (3)	$	57	$	58

(1)

If Note A was on nonaccrual status, it may be placed back on accrual status based on sustained historical payment performance of generally nine months.

(2)

Note B is immediately charged-off upon restructuring; however, payment in full is due at maturity of the note.

(3) Reflects amount of interest income reduction during the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016, as a result of multiple note restructures.

8. Troubled Debt Restructurings (Continued)

The benefit of this workout strategy is for Note A note to remain or become a performing asset for which the borrower has the willingness and ability to meet the restructured payment terms and conditions. In addition, this workout strategy reduces the prospects of further write downs and charge offs, and also reduces the prospects of a potential foreclosure. Following this restructuring, the Note A credit classification generally improves to an unclassified risk grade after a period of sustained payments.

The general terms of the new loans restructured under the Note A and Note B structure differ as follows:

Note A: First lien position; fixed or adjustable current market interest rate; fixed month term to maturity; payments – interest only to maturity, or full principal and interest to maturity. Note A is underwritten in accordance with the Bank’s customary underwriting standards and is generally on an accrual basis.

Note B: Second lien position; fixed or adjustable below current market interest rate; fixed month term to maturity; payments – due in full at maturity. Note B is underwritten in accordance with the Bank’s customary underwriting standards, except for the below market interest rate and payment terms, is on a nonaccrual basis and is charged off.

9. Other Real Estate Owned. The following table reflects the changes in other real estate owned (“OREO”) during the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016:

	Beginning							Fair Value			Ending
Six Months Ended:	Balance		Additions		Sales, net			Adjustments			Balance
	Balance		Additions		Sales, net			Adjustments			Balance
	(In thousands)
June 30, 2017	$	3,229	$	266	$	(880	)	$	(177	)	$	2,438
Nine Months Ended:
June 30, 2016	$	6,125	$	464	$	(938	)	$	(110	)	$	5,541
September 30, 2017	$	3,229	$	440	$	(1,293	)	$	(192	)	$	2,184
September 30, 2016	$	6,125	$	464	$	(1,668	)	$	(111	)	$	4,810

Fair value adjustments are recorded in order to adjust the carrying values of OREO properties to estimated fair market values. In most cases, estimated fair market values ~~are~~ are derived from an initial appraisal, an updated appraisal or other forms of internal evaluations. In certain instances when a listing agreement is renewed for a lesser amount, carrying values will be adjusted to the lesser fair value amount. Additionally, in certain instances when an offer to purchase is received near the end of a quarterly accounting period for less than the carrying value, and the sale does not close until the next accounting period, the carrying value will be adjusted to the lesser fair value amount. At ~~June~~September 30, 2017, OREO consisted of residential and commercial properties, developed lots and raw land.

10. Premises and Equipment. The following table presents premises and equipment at ~~June~~September 30, 2017 and December 31, 2016:

	June 30, 2017		December 31, 2016
	September 30, 2017		December 31, 2016
Land	$	2,807,558	$	2,817,308
Office buildings and improvements		10,~~195~~232,~~264~~652		9,667,612
Furniture, fixtures and equipment		9,~~901~~704,~~636~~526		9,877,872
Vehicles		623,~~038~~039		621,238
Projects/work in process		~~510~~543,~~760~~844		571,784
		24,038,256		23,555,814
		23,911,619		23,555,814
Less accumulated depreciation		1213,~~886~~112,~~051~~576		12,264,218
Total	$	1110,~~152~~799,~~205~~043	$	11,291,596

The Bank leases certain branch facilities ~~and~~ and equipment under separate agreements that expire at various dates through October 30, 2027. Rental expense of $~~333~~331,~~082~~985 and $~~665~~997,~~416~~ 401 during the three and ~~six~~nine months ended ~~June~~September 30, 2017, and $~~339~~344,~~099~~166 and $~~687~~1,~~959~~032,125 during the three and ~~six~~nine months ended ~~June~~ September 30, 2016, respectively, is included in premises and equipment expense on the accompanying consolidated statements of operations.

Future rental expenses under these leases as as of ~~June~~September 30, 2017 are as follows:

2017	$	~~661~~331,~~076~~421
2018		1,~~114~~120,~~684~~227
2019		~~854~~860,~~960~~528
2020		~~637~~640,~~077~~102
2021		541,209
Thereafter		1,553,207
Total	$	5,~~362~~046,~~213~~694

11. Goodwill and Other Intangibles. The following table ~~presents~~ presents activity for goodwill and other intangible assets for the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016:

Six Months Ended June 30, 2017:	Goodwill		Identifiable Intangibles			Total
	Goodwill		Identifiable Intangibles			Total
Nine Months Ended September 30, 2017:
Balance at December 31, 2016	$	4,218,576	$	1,611,187		$	5,829,763
Amortization		-		(~~120~~181,~~839~~258	)		(~~120~~181,~~839~~258	)
Balance at June 30, 2017	$	4,218,576	$	1,490,348		$	5,708,924
Balance at September 30, 2017	$	4,218,576	$	1,429,929		$	5,648,505
Six Months Ended June 30, 2016
Nine Months Ended September 30, 2016
Balance at December 31, 2015	$	4,218,576	$	1,895,514		$	6,114,090
Amortization		-		(~~142~~213,~~164~~245	)		(~~142~~213,~~164~~245	)
Balance at June 30, 2016	$	4,218,576	$	1,753,350		$	5,971,926
Balance at September 30, 2016	$	4,218,576	$	1,682,269		$	5,900,845

The following table presents a rollforward of the gross carrying amount, new acquisitions, accumulated amortization and net book value for the Company’s core deposit intangible (“CDI”), related to the acquisition of branch offices from Bank of America, N.A. on December 12, 2014. ~~The~~ The CDI is the only identifiable intangible asset subject to amortization at ~~June~~September 30, 2017 and December 31, 2016, respectively:

	Identifiable Intangibles
Net book value at December 31, 2015	$	1,895,514
Accumulated amortization		(284,327	)
Net book value at December 31, 2016		1,611,187
Accumulated amortization		(~~120~~181,~~839~~258	)
Net book value at June 30, 2017	$	1,490,348
Net book value at September 30, 2017	$	1,429,929

The following table presents estimated future amortization expense of the CDI. At ~~June~~September 30, 2017, the remaining life of the CDI was 7.5025 years.

2017	$	~~120~~60,~~839~~419
2018		223,002
2019		223,002
2020		223,002
2021		223,002
Thereafter		477,~~501~~502
Total	$	1,~~490~~429,~~348~~929

12. Deposits. The following table presents the distribution of the Company’s deposit accounts as of ~~June~~September 30, 2017 and December 31, 2016:

	June 30, 2017		December 31, 2016
	September 30, 2017		December 31, 2016
	(In thousands)
Demand accounts:
Non-interest bearing checking	$	~~208~~212,~~672~~521	$	196,917
Interest bearing checking		~~222~~231,~~266~~529		189,401
Money market		8692,~~533~~366		82,698
Savings accounts		~~149~~146,~~721~~933		145,032
Certificate accounts		~~264~~261,~~342~~939		256,552
Total deposits	$	~~931~~945,~~534~~288	$	870,600

At ~~June~~September 30, 2017, the scheduled maturities of certificate accounts were as follows:

$250,000 or Less

More than $250,000

Total

(In thousands)

Three months or less

3354,~~113~~899

310,~~706~~302

3665,~~819~~201

Over three months through one year

~~107~~77,~~926~~480

1420,~~323~~437

~~122~~97,~~249~~917

Over one year through three years

5352,~~263~~179

25,~~636~~259

7877,~~899~~438

Over three years

1815,~~788~~463

75,~~587~~920

2621,~~375~~383

Total time deposits

~~213~~200,~~090~~021

5161,~~252~~918

~~264~~261,~~342~~939

The aggregate amount of time deposits with balances of $250,000 or more was $5161.39 million and $39.2 million at ~~June~~September 30, 2017 and December 31, 2016, respectively.

13. Borrowed Money. The Bank had $2216.5 million of FHLB borrowings outstanding at ~~June~~September 30, 2017, compared to $17.0 million at December 31, 2016. The Bank pledges ~~its~~ its stock in the FHLB and certain loans as collateral for actual or potential FHLB advances. At ~~June~~September 30, 2017 and December 31, 2016, the Bank had $~~259~~265.60 million and $246.2 million, respectively, of credit available with the FHLB. At ~~June~~September 30, 2017, the Bank had lendable collateral value with the FHLB totaling $~~220~~222.49 million. Additional collateral would be required in order to access total borrowings up to the credit availability limit.

The following table details the Bank’s FHLB advances outstanding and the related maturity dates and interest rates at ~~June~~September 30, 2017:

Maturity Date	Interest Rate			Amount
				(Dollars in thousands)
May 25, 2018		1.320	%	$	6,000
June 22, 2018		1.330	%	$	1,000
June 22, 2018		1.330	%		1,000
June 25, 2018		0.870	%		1,000
June 25, 2018		1.360	%		2,000
June 29, 2018		1.340	%		1,000
December 21, 2018		1.470	%		2,500
June 24, 2019		1.048	%		1,000
July 8, 2019		1.620	%		2,000
June 22, 2020		1.720	%		3,000
June 29, 2020		1.980	%		2,000
July 6, 2020		1.890	%		1,000
				$	2216,500

14. Junior Subordinated Debentures. The Company has sponsored a trust, First South Preferred Trust I (the “Trust”), of which 100% of its common equity is owned by the Company. The Trust was formed for the purpose of issuing Company-obligated trust preferred securities (the “Trust Preferred Securities”) to third-party investors and investing the proceeds from the sale of the Trust Preferred Securities solely in junior subordinated debt securities of the Company (the “Debentures”). The Debentures held by the Trust are the sole assets of the Trust. Distributions on the Trust Preferred Securities issued by the Trust are payable quarterly at a rate equal to the interest rate being earned by the Trust on the Debentures held by the Trust. The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Debentures. The Company has entered into an agreement which fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Debentures held by the Trust are redeemable, in whole or in part, by the Company after September 30, 2008. Subject to certain limitations, the Junior Subordinated Debentures qualify as Tier 1 capital for the Company under current Federal Reserve Board guidelines.

In July of 2013, the banking regulators issued the final Basel III capital rules. Under these rules, bank holding companies with less than $15 billion in consolidated total assets as of December 31, 2009, that issued trust preferred securities prior to May 19, 2010, are permanently grandfathered as Tier 1 or Tier 2 capital.

Consolidated debt obligations as of ~~June~~ September 30, 2017 related to the Trust holding solely Debentures of the Company follows:

LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033	$	10,000,000
LIBOR + 2.95% junior subordinated debentures owed to First South Preferred Trust I due September 26, 2033		310,000
Total junior subordinated debentures owed to unconsolidated subsidiary trust	$	10,310,000

The Trust Preferred Securities bear interest at three-month LIBOR plus 2.95%, payable quarterly. The Company has swapped the interest rate on the Debentures to a fixed rate of 4.97%, with a maturity date of December 30, 2024. This strategy was executed to provide the Company with protection to a rising rate environment. See Note 19 below for additional information.

15. Regulatory Capital. The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and ratios are not significantly different from those of the Bank. At ~~June~~September 30, 2017 and December 31, 2016, ~~the~~ the Company’s and the Bank’s Tier 1 and total capital ratios and their Tier 1 leverage ratios exceeded minimum requirements.

15. Regulatory Capital (Continued)

As of ~~June~~September 30, 2017, the Bank’s ~~regulatory~~ regulatory capital position is categorized as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since ~~June~~September 30, 2017, that management believes have changed the Bank's well capitalized category. Beginning in 2015, the Bank became subject to the Basel III Capital Rules. As a result, certain items in the risk-based capital calculation have changed and the Common Equity Tier 1 Risk-Based Capital Ratio (“CET1”) is now being measured and monitored. For the Bank’s capital structure, the CET1 Capital Ratio and the Tier 1 Risk-Based Capital Ratio are identical.

Basel III limits capital distributions ~~and~~ and certain discretionary bonus payments if a banking organization does not hold a capital conservation buffer consisting of 2.50% of CET1 capital, Tier 1 capital and total capital to risk-weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements. The capital conservation buffer began to be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, and increases each year until fully implemented at 2.50% on January 1, 2019. The CET1 capital conservation buffer for 2017 is 1.25% and the Bank’s buffer as of ~~June~~September 30, 2017 was 4.57%. When fully phased in on January 1, 2019, Basel III will ~~require~~ require (i) a minimum ratio of CET1 capital to risk-weighted assets of at least 4.50%, plus the capital conservation buffer, (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.00%, plus the capital conservation buffer, (iii) a minimum ~~ratio~~ ratio of total capital to risk-weighted assets of at least 8.00%, plus the capital conservation buffer and (iv) a minimum leverage ~~ratio~~ ratio of 4.00%. The Bank’s actual regulatory capital amounts and ratios as of ~~June~~September 30, 2017 and December 31, 2016 are as follows:

Regulatory Capital Amounts and Ratios	6/30/2017					12/31/2016
	9/30/2017					12/31/2016
	Amount		Ratio (1)			Amount		Ratio (2)
Regulatory Capital Amounts and Ratios	Amount		Ratio (1)			Amount		Ratio (2)
	(Dollars in thousands)
Total risk-based capital (1)	$	~~101~~104,~~095~~381		12.~~571~~947	%	$	96,502		13.009	%
Tier 1 risk-based capital (1)		9194,~~444~~535		11.~~371~~725	%		87,517		11.798	%
Common equity Tier 1 risk-based capital (1)		9194,~~444~~535		11.~~371~~725	%		87,517		11.798	%
Tier 1 leverage capital		9194,~~444~~535		8.~~838~~956	%		87,517		8.894	%

(1) Includes 1.25% phase in for capital conservation buffer.

(2) Includes 0.625% phase in for capital conservation buffer.

16. Stock-Based Compensation. The ~~Company~~ Company had two stock-based compensation plans at ~~June~~September 30, 2017. The shares outstanding are for grants under the Company’s ~~1997~~ 1997 Stock Option Plan (the “1997 Plan”) and the 2008 Equity Incentive Plan (the “2008 Plan”). ~~The~~In ~~1997~~connection ~~Plan~~with ~~matured on April 8, 2008 and no additional options may be granted under~~ the ~~1997~~Merger ~~Plan.~~discussed Atin ~~June~~Note ~~30,~~1 ~~2017~~above, the ~~1997~~vesting ~~Plan~~date ~~had 18,250~~on ~~granted~~all ~~unexercised~~remaining nonvested stock option shares. Atand ~~June~~restricted ~~30, 2017, the 2008 Plan included 124,700 granted unexercised~~ stock ~~option~~ ~~shares,~~awards ~~7,165~~was ~~granted~~accelerated ~~nonvested~~to ~~restricted~~September ~~stock award shares and 804~~30,~~150~~ ~~shares available to be granted~~2017.

~~Stock~~The ~~Option~~1997 ~~Grants. Options granted under the 2008~~ Plan ~~are~~matured ~~granted at the closing price of the Company’s common stock~~ on ~~the~~April ~~NASDAQ~~8, ~~Stock~~2008 ~~Market on~~and ~~the~~no ~~date~~additional ~~of grant. Stock~~ options ~~expire~~may ~~ten~~be ~~years~~granted ~~from~~under the ~~date~~1997 ~~of grant and vest over service periods ranging from one year to five years~~Plan. ~~The~~At ~~Company~~September ~~settles~~30, ~~stock~~2017, ~~option~~the ~~exercises~~1997 ~~with~~Plan ~~authorized~~had ~~unissued~~18,250 ~~shares.~~vested ~~The~~unexercised ~~fair value of each~~ stock ~~option grant~~ ~~is estimated on the date of grant using the Black-Scholes~~ option ~~pricing model~~shares. ~~The~~At ~~risk-free~~September ~~interest~~30, ~~rate~~2017, ~~is based on~~ the ~~U.S. Treasury~~2008 ~~rate~~Plan ~~for~~included ~~the~~119,100 ~~expected~~vested ~~life~~unexercised atstock ~~the~~option ~~time~~shares, ~~of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life~~ and ~~forfeiture~~804,650 ~~assumptions are based on historical data. Dividend yield is based on~~shares ~~the~~available ~~yield~~to atbe ~~the time of the option grant~~granted. ~~A summary of option activity under the Plans during the six month periods ended June 30, 2017 and 2016 is presented below:~~

	Options Outstanding			Price		Aggregate Intrinsic Value
Period Ended June 30, 2017:
Outstanding at December 31, 2016		147,750		$	9.91
Granted		-			-
Forfeited		(800	)		8.13
Expired		-			-
Exercised		(4,000	)		7.57
Outstanding at June 30, 2017		142,950			9.98	$	1,057,875
Vested and Exercisable at June 30, 2017		124,750		$	10.33	$	894,894
Period Ended June 30, 2016:
Outstanding at December 31, 2015		165,750		$	10.76
Granted		-			-
Forfeited		(3,000	)		27.87
Expired		(5,750	)		27.71
Exercised		(3,000	)		5.40
Outstanding at June 30, 2016		154,000			9.90	$	306,560
Vested and Exercisable at June 30, 2016		116,850		$	10.84	$	217,940

Stock Option Grants. Options granted under the 2008 Plan are granted at the closing price of the Company’s common stock on the NASDAQ Stock Market on the date of grant. Stock options expire ten years from the date of grant and vest over service periods ranging from one year to five years. The Company settles stock option exercises with authorized unissued shares. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant.

A summary of option activity under the Plans during the nine month periods ended September 30, 2017 and 2016 is presented below:

	Options Outstanding			Price		Aggregate Intrinsic Value
Period Ended September 30, 2017:
Outstanding at December 31, 2016		147,750		$	9.91
Granted		-			-
Forfeited		(1,300	)		8.08
Expired		-			-
Exercised		(9,100	)		9.42
Outstanding at September 30, 2017		137,350			9.96	$	1,246,056
Vested and Exercisable at September 30, 2017		137,350		$	9.96	$	1,246,056
Period Ended September 30, 2016:
Outstanding at December 31, 2015		165,750		$	10.76
Granted		-			-
Forfeited		(4,550	)		20.90
Expired		(5,750	)		27.71
Exercised		(6,450	)		5.84
Outstanding at September 30, 2016		149,000			10.01	$	348,910
Vested and Exercisable at September 30, 2016		112,850		$	11.00	$	240,059

16. Stock-Based Compensation (Continued)

The following table summarizes ~~additional information~~other information about the Company’s outstanding options and exercisable options as of ~~June~~September 30, 2017, including weighted-average ~~remaining~~ remaining contractual term expressed in years (Life) and weighted average exercise price (Price):

	Outstanding						Exercisable
Range of Exercise Price	Shares		Life		Price		Shares		Price
$4.00 – 10.00		8684,~~700~~100		5.4111	$	6.0600		6884,~~500~~100	$	56.6600
$10.01 – 17.00		2724,000		21.2095		1110.0177		2724,000		1110.0177
$17.01 – 30.00		29,250		0.7651		20.65		29,250		20.65
		142,950		3.85	$	9.98		124,750	$	10.33
		137,350		3.58	$	9.96		137,350	$	9.96

A summary of nonvested option shares and ~~vesting~~ vesting changes during the ~~six~~nine months ended ~~June~~September 30, 2017 and 2016 is presented below:

Period Ended:	June 30, 2017					June 30, 2016
	September 30, 2017					September 30, 2016
	Shares			Price		Shares			Price
Period Ended:
Nonvested at beginning of period		32,150		$	7.09		53,300		$	6.67
Granted		-			-		-			-
Forfeited		(~~800~~1,300	)		8.1308		-(950	)		-7.39
Vested		(1330,~~150~~850	)		67.3405		(16,150	)		6.03
Nonvested at end of period		~~18,200~~0		$	70.5900		3736,~~150~~200		$	6.9594

Total compensation expense charged to income for stock options was $765,~~952~~473 and $1884,~~997~~470, respectively, for the three and ~~six~~nine months ended ~~June~~September 30, 2017, ~~compared~~ compared to compensation expense of $1110,~~783~~019 and $2333,~~563~~582, respectively, for the three and ~~six~~nine months ended ~~June~~September 30, 2016. Compensation Asexpense ofcharged ~~June~~to ~~30, 2017,~~income ~~total~~for ~~unrecognized~~stock ~~compensation~~options ~~cost~~for onthe ~~granted~~three ~~unexercised~~and ~~shares~~nine ~~was~~months ended September 30, 2017 included $6756,~~249~~973, respectively, ~~and~~of isexpense ~~expected~~attributable to bethe ~~recognized~~accelerated ~~during~~vesting ~~the next~~of ~~2.75~~all ~~years~~remaining granted unexercised shares.

Restricted Stock Awards. The Company measures the fair value of restricted shares based on the price of its common stock on the grant date and compensation expense is recorded over the vesting period. There were no restricted stock awards granted during the ~~six~~nine months ended ~~June~~ September 30, 2017. During the ~~six~~nine months ended ~~June~~ September 30, 2016, 3,000 restricted stock awards were granted with a four year vesting period, and 2,200 restricted stock awards were granted with a five year vesting period. Total compensation expense recognized for restricted stock awards for the three and ~~six~~nine months ended ~~June~~September 30, 2017 was $943,~~524~~250 and $1962,~~048~~298, respectively, compared to $9,~~687~~470 and $1828,~~566~~036, respectively, for the three and ~~six~~nine months ended ~~June~~September 30, 2016. AsCompensation ofexpense ~~June~~charged ~~30, 2017, there was $43,251 of total unrecognized compensation cost related~~ to ~~nonvested~~income for restricted stock ~~granted~~awards ~~under~~for the ~~2008~~three ~~Plan,~~and ~~which~~nine ~~will~~months beended ~~recognized~~September ~~over~~30, a2017 ~~remaining~~included ~~period~~$33,727, ofrespectively, ~~3.75 years. A summary~~ of ~~nonvested~~expense ~~restricted~~attributable ~~stock~~to ~~awards~~the ~~and~~accelerated vesting ~~changes~~of ~~during~~all ~~the~~remaining ~~six~~awarded ~~months~~nonvested ~~ended June 30, 2017 and 2016 is presented below:~~shares.

Period Ended:	June 30, 2017					June 30, 2016
	Shares			Price		Shares			Price
Nonvested at beginning of period		11,750		$	8.27		10,425		$	8.36
Granted		-			-		5,200			8.15
Forfeited		-			-		-			-
Vested		(4,585	)		8.31		(3,475	)		8.36
Nonvested at end of period		7,165		$	8.25		12,150		$	8.27

A summary of nonvested restricted stock awards and vesting changes during the nine months ended September 30, 2017 and 2016 is presented below:

The following table reflects the combined impact of fair value compensation cost recognition for stock options and restricted stock awards on income before income taxes, net income, basic earnings per share and diluted earnings per share for the three and six month periods ended June 30, 2017 and 2016:

	September 30, 2017					September 30, 2016
	Shares			Price		Shares			Price
Period Ended:
Nonvested at beginning of period		11,750		$	8.27		10,425		$	8.36
Granted		-			-		5,200			8.15
Forfeited		-			-		(200	)		8.15
Vested		(11,750	)		8.27		(3,475	)		8.36
Nonvested at end of period		0		$	0.00		11,950		$	8.27

	Three Months Ended 6/30/17		Three Months Ended 6/30/16		Six Months Ended 6/30/17		Six Months Ended 6/30/16
Decrease in net income before income taxes	$	17,476	$	21,470	$	38,045	$	42,129
Decrease in net income	$	17,476	$	21,470	$	38,045	$	42,129
Decrease in basic earnings per share	$	0.00	$	0.00	$	0.01	$	0.01
Decrease in diluted earnings per share	$	0.00	$	0.00	$	0.01	$	0.01

16. Stock-Based Compensation (Continued)

	Three Months Ended 9/30/17		Three Months Ended 9/30/16		Nine months Ended 9/30/17		Nine months Ended 9/30/16
Decrease in net income before income taxes	$	108,723	$	19,489	$	146,768	$	61,618
Decrease in net income	$	108,723	$	19,489	$	146,768	$	61,618
Decrease in basic earnings per share	$	0.01	$	0.00	$	0.01	$	0.01
Decrease in diluted earnings per share	$	0.01	$	0.00	$	0.02	$	0.01

17. Fair Value Measurement. Fair value is defined as the price that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy prioritizes the inputs of valuation techniques used to measure fair value of nonfinancial assets and liabilities. The inputs are evaluated and an overall level for the fair value measurement is determined. This overall level is an indication of the market observability of the fair value measurement. In order to determine the fair value, the Bank must determine the unit of account, highest and best use, principal market, and market participants. These determinations allow the Bank to define the inputs for fair value and level of hierarchy. Outlined below is the application of the fair value hierarchy to the Bank’s financial assets that are carried at fair value.

Level 1: ~~inputs~~Inputs to the valuation methodology are quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access at the measurement date. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. The type of assets carried at Level 1 fair value generally includes investments such as U.S. Treasury and U.S. government agency securities.

Level 2: ~~inputs~~Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets. ~~and~~Price ~~price~~ quotations can vary substantially either over time or among market makers. The type of assets carried at Level 2 fair value generally includes securities and mortgage-backed securities issued by Government Sponsored Enterprises (“GSEs”), municipal bonds, corporate debt securities, mortgage loans held for sale and bank-owned life insurance.

Level 3: ~~inputs~~Inputs to the valuation methodology are unobservable to the extent that observable inputs are not available. Unobservable inputs are developed based on the best information available in the circumstances and might include the Bank’s own assumptions. The Bank considers information about market participant assumptions that is reasonably available without undue cost and effort. The type of assets carried at Level 3 fair value generally include investments backed by non-traditional mortgage loans or certain state or local housing agency obligations, of which the Bank has no such assets or liabilities. Level 3 also includes impaired loans and other real estate owned.

Quoted market price for similar assets in active markets is the valuation technique for determining fair value of securities available-for-sale and held-to-maturity. Unrealized gains on available-for-sale securities are included in the “accumulated other comprehensive income” component of the Stockholders’ Equity section of the Consolidated Statements of Financial Condition. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. The Bank does not record loans held for investment at fair value on a recurring basis. However, when a loan is considered impaired, an impairment write down is taken based on the loan’s estimated fair value. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those loans not requiring a write down represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans, and are not included below.

17. Fair Value Measurement (Continued)

Assets measured at fair value on a recurring basis as of ~~June~~September 30, 2017 and December 31, 2016:

	Fair Value		Quoted Prices In Active Markets for Identical Assets		Significant Observable Inputs- Outputs		Significant Unobservable Inputs
	(In thousands)
Description	~~June~~September 30, 2017		Level 1		Level 2		Level 3
Securities available-for-sale:
Government agencies	$	23,~~857~~837	$	23,~~857~~837	$	-	$	-
Mortgage-backed securities		8782,~~483~~730		-		8782,~~483~~730		-
Municipal securities		57,~~157~~120		-		57,~~157~~120		-
Corporate bonds		26,~~904~~886		-		26,~~904~~886		-
Mortgage loans held for sale		63,~~381~~815		-		63,~~381~~815		-
Bank-owned life insurance		18,~~351~~483		-		18,~~351~~483		-
Interest rate swap		6466		-		6466		-
Total June 30, 2016	$	220,197	$	23,857	$	196,340	$	-
Total September 30, 2016	$	212,937	$	23,837	$	189,100	$	-
Description	December 31, 2016		Level 1		Level 2		Level 3
Securities available-for-sale:
Government agencies	$	16,995	$	16,995	$	-	$	-
Mortgage-backed securities		95,116		-		95,116		-
Municipal securities		53,682		-		53,682		-
Corporate bonds		26,813		-		26,813		-
Mortgage loans held for sale		5,099		-		5,099		-
Bank-owned life insurance		18,080		-		18,080		-
Interest rate swap		121		-		121		-
Total December 31, 2015	$	215,906	$	16,995	$	198,911	$	-

Assets measured at fair value on a non-recurring basis as of June 30, 2017 and December 31, 2016:

Description	December 31, 2016		Level 1		Level 2		Level 3
Securities available-for-sale:
Government agencies	$	16,995	$	16,995	$	-	$	-
Mortgage-backed securities		95,116		-		95,116		-
Municipal securities		53,682		-		53,682		-
Corporate bonds		26,813		-		26,813		-
Mortgage loans held for sale		5,099		-		5,099		-
Bank-owned life insurance		18,080		-		18,080		-
Interest rate swap		121		-		121		-
Total December 31, 2016	$	215,906	$	16,995	$	198,911	$	-

	Fair Value		Quoted Prices In Active Markets for Identical Assets		Significant Observable Inputs- Outputs		Significant Unobservable Inputs
	(In thousands)
Description	June 30, 2017		Level 1		Level 2		Level 3
Impaired loans, net	$	8,603	$	-	$	-	$	8,603
Other real estate owned		2,438		-		-		2,438
Total June 30, 2016	$	11,041	$	-	$	-	$	11,041
Description	December 31, 2016		Level 1		Level 2		Level 3
Impaired loans, net	$	10,730	$	-	$	-	$	10,730
Other real estate owned		3,229		-		-		3,229
Total December 31, 2015	$	13,959	$	-	$	-	$	13,959

Assets measured at fair value on a non-recurring basis as of September 30, 2017 and December 31, 2016:

Impaired loans at June 30, 2017 and December 31, 2016 include $7.8 million and $9.9 million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC 310-10-35 resulted in no allowance.

	Fair Value		Quoted Prices In Active Markets for Identical Assets		Significant Observable Inputs- Outputs		Significant Unobservable Inputs
	(In thousands)
Description	September 30, 2017		Level 1		Level 2		Level 3
Impaired loans, net	$	6,039	$	-	$	-	$	6,039
Other real estate owned		2,184		-		-		2,184
Total September 30, 2016	$	8,223	$	-	$	-	$	8,223

Description	December 31, 2016		Level 1		Level 2		Level 3
Impaired loans, net	$	10,730	$	-	$	-	$	10,730
Other real estate owned		3,229		-		-		3,229
Total December 31, 2016	$	13,959	$	-	$	-	$	13,959

Impaired loans at September 30, 2017 and December 31, 2016 include $5.4 million and $9.9 million, respectively, of loans identified as impaired, even though an impairment analysis calculated pursuant to ASC 310-10-35 resulted in no allowance.

Impaired loans where a write down is taken based on fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as non-recurring Level 3. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Bank classifies the impaired loan as non-recurring Level 3.

17. Fair Value Measurement (Continued)

OREO is recorded at fair value upon transfer of a loan to foreclosed assets, based on the appraised market value of the property. OREO is reviewed quarterly and values are adjusted as determined appropriate. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is impaired below the appraised value and there is no observable market price, the Bank classifies the foreclosed asset as non-recurring Level 3. Fair value adjustments of $5715,~~624~~220 and $~~176~~192,~~919~~139, respectively, were made to OREO during the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $~~102~~1,~~880~~000 and $~~110~~111,170, respectively, made during the three and ~~six~~nine months ~~ended~~ ~~June~~ended September 30, 2016.

No liabilities were measured at fair value on a recurring or non-recurring basis as of ~~June~~September 30, 2017 or December 31, 2016.

18. Fair Value of Financial Instruments. The following ~~table~~ table represents the recorded carrying values, estimated fair values and fair value hierarchy within which the fair value measurements of the Company’s financial instruments are categorized at ~~June~~September 30, 2017 and December 31, 2016:

Level in

~~June~~September 30, 2017

December 31, 2016

Fair Value

Estimated

Carrying

Estimated

Carrying

Hierarchy

Fair Value

Amount

Fair Value

Amount

(In thousands)

Financial assets:

Cash and due from banks

Level 1

2319,~~049~~923

22,855

Interest-bearing deposits in other banks

Level 1

1736,~~023~~904

23,321

Securities available for sale

Level 1

23,~~857~~837

16,995

Securities available for sale

Level 2

~~171~~166,~~544~~736

175,611

Securities held to maturity

Level 2

~~507~~508

506

511

510

Loans held for sale

Level 2

63,~~381~~815

5,099

Loans and leases HFI, net, less impaired loans

Level 2

~~758~~764,~~880~~002

~~758~~765,~~687~~113

678,911

681,239

Stock in FHLB of Atlanta

Level 2

1,~~848~~593

1,574

Accrued interest receivable

Level 2

3,~~448~~596

3,526

Interest rate swap

Level 2

6466

121

Bank-owned life insurance

Level 2

18,~~351~~483

18,080

Impaired loans HFI, net of related allowance

Level 3

86,~~603~~039

10,730

Mortgage servicing rights

Level 3

2,~~918~~925

2,~~134~~171

3,128

2,149

Financial liabilities:

Deposits

Level 2

~~930~~943,~~387~~880

~~931~~945,~~534~~288

869,591

870,600

Junior subordinated debentures

Level 2

10,310

Fair values of financial assets and liabilities have been estimated using data which management considers as the best available, and estimation methodologies deemed suitable for the pertinent category of financial instrument. With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments. The estimation methodologies used by the Bank are as follows:

Financial assets:

Cash and Due from Banks and Interest –Bearing Deposits in Other Banks: The carrying amounts for cash and due from banks and interest bearing deposits in other banks are equal to their fair value. Fair value hierarchy Input level 1.

Investment Securities Available for Sale and Held to Maturity: The estimated fair value of investment securities is provided in Note 4 of the Notes to Consolidated Financial Statements. These are based on quoted market prices, when available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Fair value hierarchy Input levels 1 and 2.

Loans Held for Sale. The estimated fair value of loans held for sale is based on commitments from investors within the secondary market for loans with similar characteristics. Fair value hierarchy Input level 2.

Loans and Leases Held for Investment, net, less Impaired Loans: Fair values are estimated for portfolios of loans and leases held for investment with similar financial characteristics. Loans and leases are segregated by collateral type and by fixed and variable interest rate terms. The fair value of each category is determined by discounting scheduled future cash flows using current interest rates offered on loans or leases with similar characteristics. Fair value hierarchy Input level 2.

Stock in Federal Home Loan Bank of Atlanta: The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the FHLB. Fair value hierarchy Input level 2.

Accrued Interest Receivable: The carrying amount of accrued interest receivable approximates fair value because of the short maturities of these instruments. Fair value hierarchy Input level 2.

18. Fair Value of Financial Instruments (Continued)

Interest Rate Swap: The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. See Note 19 below for additional information. Fair value hierarchy Input level 2.

Bank-Owned Life Insurance: The carrying value of bank-owned life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the issuer. Fair value hierarchy Input level 2.

Impaired Loans Held for Investment, Net: Fair values for impaired loans and leases are estimated based on discounted cash flows or underlying collateral values, where applicable. Fair value hierarchy Input Level 3.

Mortgage Servicing Rights (“MSRs”): The fair value of MSRs is estimated for those loans sold with servicing retained. The loans are stratified into pools by product type and within product type by interest rate and maturity. The fair value of the MSR is based upon the present value of estimated future cash flows using current market assumptions for prepayments, servicing costs and other factors. Fair value hierarchy Input level 3.

Financial liabilities:

Deposits: The fair value of demand deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated using rates currently offered for similar instruments with similar remaining maturities. Fair value hierarchy Input level 2.

Junior Subordinated Debentures: The carrying amount of junior subordinated debentures approximates fair value of similar instruments with similar characteristics and remaining maturities. Fair value hierarchy Input level 2.

19. Interest Rate Hedging. The Company has executed certain strategies targeted at hedging the impact of rising interest rates on its future earnings. The Company has entered into a pay-fixed receive-floating swap to hedge our $10.0 million of floating rate Trust Preferred debt. The primary objective of the swap is to minimize future interest rate risk. During 2016, the Company restructured the terms of the swap to lower the fixed rate cost and extend its maturity. As a result, the restructured rate is 4.97% and the maturity date of the swap is December 30, 2024.

20. Compensated Absences. The Company has not accrued compensated absences because the amount cannot be reasonably estimated.

21. Subsequent Events. WeOn ~~have~~November ~~evaluated~~1, ~~subsequent~~2017, ~~events~~the ~~after~~Company ~~June~~completed ~~30,~~the ~~2017~~previously announced merger with CARO, whereby the Company merged with and ~~concluded~~into ~~that~~CARO no(the ~~material~~Merger), with ~~transactions~~CARO ~~occurred~~as ~~that~~the ~~provided~~surviving ~~additional~~corporation ~~evidence~~in ~~about~~the Merger. Immediately following the consummation of the Merger, First South Bank, a ~~conditions~~wholly ~~that~~owned ~~existed~~subsidiary atof orthe ~~after~~Company, ~~June~~merged 30with and into CresCom Bank, ~~2017~~a wholly owned subsidiary of CARO (the Bank Merger), with ~~that~~CresCom ~~required~~Bank ~~adjustments~~as tothe orsurviving ~~disclosure~~bank in the ~~Consolidated~~Bank ~~Financial~~Merger. ~~Statements~~See “Explanatory Note” and Note 1. “Basis of Presentation” above for additional information.

~~22.~~We ~~Recent~~have ~~Accounting~~evaluated ~~Pronouncements. The~~subsequent ~~following~~events ~~are~~occurring after ~~Accounting~~September ~~Standards~~30, ~~Updates~~2017, ~~(“ASU”)~~and ~~recently~~concluded ~~issued~~that byno ~~the~~material ~~Financial~~transactions, ~~Accounting~~other ~~Standards~~than ~~Board (~~the ~~“FASB”)~~Merger ~~and~~transaction ~~their~~noted ~~expected~~above, ~~impact~~occurred that onprovided ~~the~~additional ~~Company.~~evidence ~~Other~~about ~~accounting~~conditions ~~standards~~that ~~issued~~existed at or ~~proposed~~after bySeptember ~~the~~30, ~~FASB~~2017, ~~or other~~that ~~standards-setting~~required ~~bodies~~adjustments ~~are not expected~~ to ~~have~~or disclosure ain ~~material impact on~~ the ~~Company’s~~Consolidated ~~consolidated~~Financial ~~financial statements~~Statements.

~~In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers~~22. ~~This~~Recent ~~ASU was developed as a joint project with the International~~ Accounting ~~Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues~~Pronouncements. ~~The~~Pursuant ~~ASU’s core principle is that an entity should recognize revenue when it transfers promised goods or services~~ to ~~customers in~~the anMerger ~~amount~~transaction ~~that~~noted ~~reflects~~above, the ~~consideration~~Company toceased ~~which an entity expects~~ to beexist ~~entitled~~effective inas ~~exchange~~of ~~for~~November ~~those~~1, ~~goods or services~~2017. ~~ASU~~ ~~2015-14~~Consequently, ~~issued in August 2015, amended the effective date of this ASU to annual reporting periods beginning~~ after ~~December~~November 151, 2017, ~~including~~the ~~interim~~Company ~~reporting~~is ~~periods~~no ~~within~~longer ~~that~~subject ~~reporting~~to ~~period. The Company will evaluate~~ the ~~impact~~Accounting ~~this~~Standards ~~ASU~~Updates ~~may~~issued ~~have on~~by ~~its~~the ~~consolidated~~Financial ~~financial~~Accounting ~~statements~~Standards Board.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities. The amendments in this ASU require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this ASU also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this ASU eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

22. Recent Accounting Pronouncements (Continued)

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The amendments in this ASU create Topic 842, Leases, and supersede the leases requirements in Topic 840, Leases. Topic 842 specifies the accounting for leases. The objective of Topic 842 is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. The recognition, measurement and presentation of expenses and cash flows arising from a lease by a lessee will depend on its classification as finance or operating lease. This ASU will require both types of leases to be recognized on the balance sheet. For public entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments in this ASU affect entities with transactions included within the scope of Topic 606 (Revenue from Contracts with Customers). The scope of Topic 606 includes entities that enter into contracts with customers to transfer goods or services (that are an output of the entity’s ordinary activities) in exchange for consideration. The amendments in this ASU clarify the implementation guidance on principal versus agent considerations. The effective date and transition requirements for this ASU are the same as the effective date of ASU 2014-09 above. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In April 2016, the FASB issued ASU 2016-10, Identifying Performance Obligations and Licensing. The amendments in this ASU affect entities with transactions included within the scope of Topic 606. This ASU clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in the new revenue recognition standard. The ASU seeks to address areas in which diversity in practice potentially could arise, as well as to reduce the cost and complexity of applying certain aspects of the guidance both at implementation and on an ongoing basis. The effective date for this ASU is the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by ASU 2014-09 above). The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In May 2016, the FASB issued ASU 2016-12, Narrow-Scope Improvements and Practical Expedients. The amendments in this ASU address narrow-scope improvements to the guidance on collectibility, noncash consideration, and completed contracts at transition. Additionally, the amendments in this ASU provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The effective date and transition requirements for the amendments in this ASU are the same as requirements of ASU 2014-09. ASU 2015-14, issued in August 2015, amended the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The main objective of this ASU is to provide financial statement users with more decision-useful information about expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For public entities that are SEC filers, the amendments in this ASU are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. Current GAAP is either unclear or does not include guidance on certain cash flow issues included in the amendments in this ASU. The amendments are an improvement in GAAP because they provide guidance for each of the noted issues, thereby reducing the current and potential future diversity in accounting practice. This ASU addresses the following specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (COLIs) (including bank-owned life insurance policies (BOLIs)); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

22. Recent Accounting Pronouncements (Continued)

In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory. Topic 740, Income Taxes, prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. In addition, interpretations of this guidance have developed in practice for transfers of certain intangible and tangible assets. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in GAAP. To more faithfully represent the economics of intra-entity asset transfers, the amendments in this ASU require that entities recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this ASU do not change GAAP for the pre-tax effects of an intra-entity asset transfer under Topic 810, Consolidation, or for an intra-entity transfer of inventory. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Restricted Cash. Stakeholders indicated that diversity exists in the classification and presentation of changes in restricted cash on the statement of cash flows under Topic 230, Statement of Cash Flows. This ASU addresses that diversity and its amendments require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this ASU apply to all entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business. The amendments in this ASU clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of businesses. The amendments in this ASU provide a screen to determine when a set is not a business. If the screen is not met, it (1) requires that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) removes the evaluation of whether a market participant could replace the missing elements. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments-Equity Method and Joint Ventures (Topic 323). This ASU adds and amends SEC paragraphs pursuant to SEC Staff Announcements at the September 2016 and November 2016 Emerging Issues Task Force (EITF) meetings. The September announcement is about Disclosure of the Impact That Recently Issued Accounting Standards Will Have on the Financial Statements of a Registrant When Such Standards are Adopted in a Future Period. The November announcement made amendments to conform the SEC Observer Comment on Accounting for Tax Benefits Resulting from Investments in Qualified Affordable Housing Projects to the guidance issued in ASU 2014-01. For public business entities, amendments to the Topics covered by this ASU are effective for various fiscal years beginning after December 15, 2017, 2018 and 2019, respectively, and interim periods within those fiscal years. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. Topic 350, Intangibles-Goodwill and Other, currently requires an entity to perform a two-step test to determine the amount, if any, of goodwill impairment. In Step 1, an entity compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the entity performs Step 2 and compares the implied fair value of goodwill with the carrying amount of that goodwill for that reporting unit. An impairment charge equal to the amount by which the carrying amount of goodwill for the reporting unit exceeds the implied fair value of that goodwill is recorded, limited to the amount of goodwill allocated to that reporting unit. To address concerns over the cost and complexity of the two-step goodwill impairment test, the amendments in this ASU remove the second step of the test. An entity will apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit's carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. For public entities, the amendments in this ASU are effective for annual goodwill impairment tests in fiscal years beginning after December 15, 2019. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

22. Recent Accounting Pronouncements (Continued)

In February 2017, the FASB issued ASU 2017-05, Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. The amendments in this ASU clarify the scope of the nonfinancial asset guidance in Subtopic 610-20. This ASU also clarifies that derecognition of all businesses and nonprofit activities (except those related to conveyances of oil and gas mineral rights or contracts with customers) should be accounted for in accordance with derecognition and deconsolidation guidance in Subtopic 810-10. In addition, this ASU eliminates the exception in the financial asset guidance for transfers of investments (including equity method investments) in real estate entities and supersedes the guidance in the Exchanges of a Nonfinancial Asset for a Noncontrolling Ownership Interest Subsection within Topic 845. This ASU also provides guidance on the accounting for what often are referred to as partial sales of nonfinancial assets within the scope of Subtopic 610-20 and contributions of nonfinancial assets to a joint venture or other noncontrolled investee. The amendments in this ASU are effective at the same time as for ASU 2014-09 above. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In February 2017, the FASB issued ASU 2017-06, Employee Benefit Plan Master Trust Reporting. The FASB is issuing this ASU to improve the usefulness of the information reported to users of employee benefit plan financial statements. This ASU relates primarily to the reporting by an employee benefit plan (a plan) for its interest in a master trust. A master trust is a trust for which a regulated financial institution (bank, trust company, or similar financial institution that is regulated, supervised, and subject to periodic examination by a state or federal agency) serves as a trustee or custodian and in which assets of more than one plan sponsored by a single employer or by a group of employers under common control are held. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In March 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Topic 715, Compensation-Retirement Benefits, requires an entity to present net periodic pension cost and net periodic postretirement benefit cost as a net amount that may be capitalized as part of an asset where appropriate. Users have communicated that the service cost component generally is analyzed differently from the other components of net periodic pension cost and net periodic postretirement benefit cost. To improve the consistency, transparency, and usefulness of financial information for users, the amendments in this ASU require an employer to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. It also requires the other components of net periodic pension cost and net periodic postretirement benefit cost to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. Additionally, only the service cost component is eligible for capitalization, when applicable. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities. This ASU amends guidance on the amortization period of premiums on certain purchased callable debt securities. Specifically, the amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date (that is, at a premium). The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718), Scope of Modification Accounting. This ASU is being issued to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying Topic 718 to a change to the terms and conditions of a share-based payment award. The amendments in this ASU affect any entity that changes the terms and conditions of a share-based payment award. The amendments in this ASU are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

First South Bancorp, Inc. (the "Company") or “FSBK”) was formed for the purpose of issuing common stock and owning 100% of the stock of First South Bank (the "Bank") and operating through the Bank a commercial banking business. The discussion below focuses primarily on the Bank's results of operations. The Bank has one significant operating segment, providing commercial and retail banking services to its markets located in the state of North Carolina. ~~The~~As of September 30, 2017, the Company’s common stock iswas traded on the NASDAQ Global Select Market under the symbol "FSBK". Pursuant to the merger with CARO as described below, all shares of the Company were converted into shares of CARO and trading of FSBK shares was suspended by NASDAQ effective upon opening of business on November 1, 2017.

Mergers and Acquisitions.

~~Proposed~~ Merger with Carolina Financial Corporation. On June 9, 2017, the Company entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Carolina Financial Corporation (“CARO”). ~~The~~As the Merger Agreement provides, ~~that~~ the Company ~~will merge~~was merged with and into CARO (the “Merger”), with CARO continuing as the surviving corporation. AsIn ~~soon~~addition, ~~as practicable~~ following consummation of the Merger, the Bank ~~will~~was ~~merge~~merged with and into CARO’s wholly-owned subsidiary, CresCom Bank ("CresCom"), with CresCom continuing as the surviving entity (the “Bank Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, the Company’s stockholders ~~will~~had ~~have~~ the right to receive 0.525064 shares of CARO common stock for each share of the Company’s common stock. Cash will be paid in lieu of fractional shares. The transaction is ~~expected~~closed toon ~~close in the fourth quarter of 2017~~November 1, ~~subject to shareholder and regulatory approval and other customary closing conditions~~2017.

Comparison of Financial Condition at ~~June~~ September 30, 2017, and December 31, 2016. Total assets increased by $7082.78 million, or 78.14% to $1.1 billion at ~~June~~September 30, 2017, from $990.7 million at December 31, 2016. Earning assets increased by $7390.83 million, or 89.08% to $~~996~~1.0 ~~million~~billion at ~~June~~September 30, 2017, ~~from~~ from $922.2 million at December 31, 2016. The increases are primarily attributable to growth in the loan and lease portfolio (“loans”) and ~~the investment securities portfolio, while being partially offset by a reduction in~~ interest-bearing deposits ~~with~~as ~~banks~~the ~~to help~~Bank’s ~~fund~~robust ~~the~~deposit ~~increased~~growth ~~level~~continues ofto ~~loans~~support ~~outstanding~~our strong liquidity position. The ratio of earning assets to total assets was 9394.83% at ~~June~~September 30, 2017, compared to 93.1% at December 31, 2016.

Interest-bearing deposits with banks ~~were~~increased to $1736.09 million at ~~June~~September 30, 2017, ~~compared~~from to $23.3 million at December 31, 2016. These funds are available to support ~~securities purchases,~~ loan originations, securities purchases, deposit withdrawals, liquidity management activities ~~and~~as well as daily operations of the Bank.

The investment ~~securities~~ securities portfolio ~~increased~~totaled to $~~195~~191.91 million at ~~June~~September 30, 2017, ~~from~~versus $193.1 million at December 31, 2016. The Bank may make changes in the investment securities portfolio mix to manage sensitivity to future interest rate changes. See “Note 4. Investment Securities” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Mortgage loans held for sale totaled $63.~~4 million~~8 million at ~~June~~September 30, 2017, compared to $5.1 million at December 31, 2016~~, reflecting the net effect of current period mortgage lending activity~~. During the ~~six~~nine months ended ~~June~~September 30, 2017, there were $1933.20 million of loan sales, $1830.48 million of loan originations, net of principal payments, and $~~563~~980,000 of net realized gains. ~~Proceeds from mortgage loan sales are used to fund the Bank’s~~ ~~liquidity needs, including loan originations, deposit withdrawals and general bank operations.~~ See “Note 5. Loans Held for Sale” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Total loans held for investment grew by $7680.0 1 million during the current ~~six~~nine month period, or 1011.84% to $~~776~~780.7 million at ~~June~~September 30, 2017, from $700.6 million at December 31, 2016. During the ~~six~~nine months ended ~~June~~September 30, 2017, there were $7680.35 million of originations, net of principal payments, and $~~265~~440,000 of transfers to other real estate owned (“OREO”). The loans-to-deposit ratio increased to 8483.10% at ~~June~~ September 30, 2017, from 81.1% at December 31, 2016, as loan growth outpaced deposit growth during the ~~six~~nine months ended ~~June~~September 30, 2017. See “Note 6. Loans Held for Investment” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Improving asset quality metrics is a key ~~component~~ component of the Bank’s ~~short and long-term~~ performance objectives. Loans held for investment on nonaccrual status, including troubled debt restructurings (“TDRs”) on nonaccrual status declined to $2.53 million at ~~June~~September 30, 2017, from $3.1 million at December 31, 2016. Management and the Board of Directors (“Board”) are committed to improving asset quality, as we believe it is a key driver of stock price performance and overall stockholder value. The ratio of loans held for investment on nonaccrual status to total loans held for investment ~~was~~declined to 0.3330% at ~~June~~September 30, 2017, ~~compared~~from to 0.44% at December 31, 2016.

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Loans are generally placed on nonaccrual ~~status~~ status and accrued unpaid interest is reversed when management determines that collectability of all interest, but not necessarily principal, payments are in doubt. This generally occurs when payments are delinquent in excess of 90 days. Consumer loans more than 180 days past due are generally charged off, or a specific allowance is provided for any expected loss. All other loans are charged off when management concludes that they are uncollectible.

Management has evaluated all nonperforming loans and believes they are either well collateralized or adequately reserved. However, there can be no assurance in the future that regulators, increased volume and risks in the loan portfolio, adverse changes in economic conditions or other factors will not require additional adjustments to the allowance for loan and lease losses (“ALLL”). Aside from the loans identified on nonaccrual status, there were no loans at June 30, 2017 where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with their current loan repayment terms.

The Bank maintains the ALLL at levels management believes are adequate to absorb probable losses inherent in the loan portfolio. The Bank has developed policies and procedures for assessing the adequacy of the ALLL that reflect the assessment of credit risk and impairment analysis. This assessment includes a quarterly analysis of qualitative and quantitative factors regarding the loan portfolio as well as economic conditions within the Bank’s footprint. In developing this analysis, the Bank relies on historical loss experience, estimates and exercises judgment in assessing credit risk. Future assessments of credit risk may yield different results, depending on changes in the qualitative and quantitative trends, which may require adjustments in the ALLL.

The quarterly assessment of ALLL adequacy ~~includes~~ includes an analysis of historical loss percentages of both classified and pass loans, as well as qualitative risk factors allocated ~~among~~ among specific categories of loans. In developing this analysis, the Bank relies on actual loss history for the most recent twelve ~~quarters~~ quarters and uses management’s best judgment in assessing credit risk. The assessment of qualitative factors includes various ~~subjective~~ subjective components assessed in terms of basis points used in determining the ALLL adequacy. The evaluation of qualitative risk ~~factors~~ factors may result in a positive or negative adjustment to the ALLL methodology. There were no significant changes in accounting policy ~~and~~ and methodology used to estimate the ALLL during the ~~six~~nine months ended ~~June~~September 30, 2017.

The ALLL was $9.46 million at ~~June~~September 30, 2017, compared to $8.7 million at December 31, 2016. The ratio of the ALLL to loans held for investment was 1.2122% at ~~June~~ September 30, 2017, compared to 1.24% at December 31, 2016. During the ~~six~~nine months ended ~~June~~September 30, 2017, there were $~~750~~850,000 of provision for credit losses and $5738,000 of net ~~charge-offs~~recoveries. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)”and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” for additional information.

Based on an impairment analysis of loans ~~held~~ held for investment, there were $86.96 million of loans classified as impaired, net of $~~161~~110,000 in write-downs at ~~June~~September 30, 2017, compared to $11.1 million classified as impaired, net of $654,000 in write-downs at December 31, 2016. At ~~June~~September 30, 2017 and ~~December~~ December 31, 2016, the ALLL included $~~309~~592,000 and $393,000 specifically provided for impaired loans, respectively.

A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect scheduled payments of all principal and interest when due according to the contractual terms of the loan arrangement. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payments status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, and various other matters. See “Note 6. Loans Held for Investment”, “Note 7. Allowance for Loan and Lease Losses” and “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

The Bank offers a variety of TDR programs on on a loan-by-loan basis in which, for economic or legal reasons related to an individual borrower’s financial condition, it it grants a concession to the borrower that would not otherwise be considered. The restructuring of a troubled loan may include, ~~but~~ but is not limited to any one or a combination of the following: a modification of the loan terms such as a reduction of the contractual interest rate, principal, payment amount or accrued interest; an extension of the maturity date at a stated interest rate lower than the current market rate for a new debt with similar risks; a change in payment type, e.g. from principal and interest, to interest only with all principal and interest due at maturity; a substitution or acceptance of additional collateral; and a substitution or addition of new debtors for the original borrower.

On a loan-by-loan basis, the Bank restructures loans that were either on non-accrual basis or on accrual basis prior to restructuring. If a loan was on nonaccrual basis prior to restructuring, it remains on nonaccrual until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least nine months. If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis. See “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

OREO acquired from foreclosures declined to $2.2 million at September 30, 2017, from $3.2 million at December 31, 2016. During the nine months ended September 30, 2017, there were $1.3 million of disposals, $192,000 of valuation adjustments and $440,000 of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that ultimate sales will be equal to or greater than the carrying values. See “Note 9. Other Real Estate Owned” and “Note 17. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Mortgage servicing rights (“MSRs”) were $2.2 million at September 30, 2017, compared to $2.1 million at December 31, 2016. The principal amount of loans serviced for others was $366.8 million at September 30, 2017, versus $372.0 million at December 31, 2016, as principal received exceeded the volume of new loans sold servicing retained.

The Bank’s investment in bank-owned life insurance (“BOLI”) was $18.5 million at September 30, 2017, compared to $18.1 million at December 31, 2016. The investment returns from the BOLI are utilized to offset a portion of the cost of providing benefit plans to certain employees.

Goodwill was $4.2 million at both September 30, 2017 and December 31, 2016 and is tested for impairment annually. The Company’s most recent annual test determined there was no goodwill impairment. Identifiable intangible assets were $1.4 million at September 30, 2017, compared to $1.6 million at December 31, 2016, reflecting the core deposit intangible associated with a prior period branch acquisition transaction, which is being amortized over a ten year period. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Total deposits increased by $74.7 million, or 8.6% to $945.3 million at September 30, 2017, from $870.6 million at December 31, 2016. For the current nine month period, non-maturity deposits (personal and business checking, savings and money market accounts) grew by $69.3 million, or 11.3% to $683.3 million at September 30, 2017, from $614.0 million at December 31, 2016.

Certificates of deposit (“CDs”) grew by $5.4 million, to $261.9 million at September 30, 2017, from $256.6 million at December 31, 2016. CDs represented 27.7% and 29.5% of total deposits at September 30, 2017 and December 31, 2016, respectively. The Bank attempts to manage its cost of deposits through a combination of monitoring the volume and pricing of new and maturing CDs and growth in non-maturity deposits, in relationship to current funding needs and market interest rates. See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” and “Interest Expense” below for additional information regarding deposits and the cost of funds.

Federal Home Loan Bank (“FHLB”) borrowings declined to $16.5 million at September 30, 2017, from $17.0 million at December 31, 2016. The Bank may use FHLB borrowings as a funding source to provide an effective means of managing its overall cost of funds and to manage its exposure to interest rate risk. There were $10.3 million of junior subordinated debentures outstanding at both September 30, 2017 and December 31, 2016, respectively. See “Note 13. Borrowed Money” and “Note 14. Junior Subordinated Debentures” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Stockholders' equity increased by $7.4 million to $94.6 million at September 30, 2017, from $87.2 million at December 31, 2016. This increase primarily reflects the $6.8 million of net income earned for the nine months ended September 30, 2017, a $1.4 million increase in accumulated other comprehensive income resulting from the mark-to-market adjustment of the available-for-sale securities portfolio, and is net of $998,000 of dividends declared. There were 9,504,991 common shares outstanding at September 30, 2017, compared to 9,494,935 shares outstanding at December 31, 2016, reflecting the net effect of 4,478 shares issued pursuant to the vesting of restricted stock awards and 5,578 shares issued pursuant to a stock option exercise during the current nine month period.

Accumulated other comprehensive income increased to $2.9 million at September 30, 2017, from $1.5 million at December 31, 2016, reflecting an increase in the mark-to-market adjustment in net unrealized gains in the available-for-sale investment securities portfolio, based on current market prices. See “Consolidated Statements of Comprehensive Income” and “Note 3. Comprehensive Income and Accumulated Other Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

The tangible equity to assets ratio was 8.29% at September 30, 2017, versus 8.21% at December 31, 2016; and the tangible book value per common share increased to $9.36 at September 30, 2017, from $8.57 at December 31, 2016.

The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of September 30, 2017, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position is categorized as “well capitalized”. There are no conditions or events since September 30, 2017 that management believes have changed the Bank's well capitalized category. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” and “Liquidity and Capital Resources” below for additional information.

Comparison of Operating Results – Three and Nine Months Ended September 30, 2017 and 2016.

General. Net income for the three months ended September 30, 2017 increased 53.9% to $2.9 million, or $0.31 per diluted common share, from net income of $1.9 million, or $0.20 per diluted common share earned for the comparative three month period ended September 30, 2016. The improvement in net income on a comparative quarter basis is primarily due to a $1.3 million, or 16.1% increase in net interest income, and the reduction non-interest expenses, despite $109,000 of merger-related expenses incurred during the third quarter of 2017. The improvement in comparative quarterly net interest income reflects the impact of strong loan growth over the past twelve months.

Net income for the nine months ended September 30, 2017 increased 37.8% to $6.8 million, or $0.72 per diluted common share, compared to net income of $5.0 million, or $0.52 per diluted common share earned in the nine months ended September 30, 2016. Earnings for the current nine month period were positively impacted by increases in net interest income while containing non-interest expenses, despite $387,000 of merger-related expenses incurred during the nine months ended September 30, 2017. Strong loan growth over the past twelve month period has driven the Company’s ability to improve its revenue.

Impact of Merger-Related Transaction Expenses. In connection with the merger, the Company incurred $109,000 and $387,000 of merger-related expenses that impacted our results of operations for the three and nine months ended September 30, 2017, respectively. Excluding the net effects of these expenses, net income for the three and nine months ended September 30, 2017 would have been $3.0 million and $7.1 million, respectively, and earnings per share would have been $0.31 and $0.74 per diluted common share, respectively. The following table presents net income and diluted EPS for the respective September 30, 2017 third quarter and nine month periods adjusted for the impact of the merger-related transaction expenses:

	Quarter Ended 9/30/17			Nine Months Ended 9/30/17
	(In thousands, except per share data)
Reported Net Income (GAAP)	$	2,916		$	6,843
Adjustments for Merger Expenses:
Professional Fees and Services		15			293
Miscellaneous Other Expenses		94			94
Total		109			387
Income Tax Benefit (Qtr-32.3% / YTD-30.8%)		(35	)		(119	)
Net Income Adjusted for Merger Expenses	$	2,990		$	7,111

Reported Diluted EPS (GAAP)	$	0.31		$	0.72
Impact of Merger Expenses on Diluted EPS	$	0.00		$	0.02
Diluted EPS Adjusted for Merger Expenses	$	0.31		$	0.74

Interest Income. Interest income increased to $10.7 million and $30.4 million for the three and nine months ended September 30, 2017, respectively, from $9.2 million and $26.9 million for the comparable 2016 periods. The year-over-year growth in interest income is due to changes in the composition and volume of our earning asset base, coupled with an increase in yields on earning assets. The tax equivalent yield on average earning assets increased to 4.30% and 4.22% for the three and nine months ended September 30, 2017, from 4.13% and 4.12% for the three and nine months ended September 30, 2016. Average earning assets increased to $996.9 million and $973.1 million for the three and nine months ended September 30, 2017, from $895.3 million and $878.8 million for the comparative 2016 three and nine month periods.

Interest Expense. Interest expense increased to $1.0 million and $3.0 million for the three and nine months ended September 30, 2017, from $911,000 and $2.7 million for the comparable 2016 periods. Interest expense was primarily impacted by increased interest paid on deposits between the comparative reporting periods, reflecting the growth in total deposits discussed above. The cost of average interest-bearing liabilities increased to 0.55% and 0.54% for the respective three and nine months ended September 30, 2017, from 0.52% for both of the comparable 2016 periods. The Bank’s cost of interest-bearing liabilities has been impacted by the growth of non-maturity deposits and CDs as discussed above, as well as pricing of new and renewed CDs in the current interest rate environment.

Average interest-bearing liabilities increased to $752.6 million and $740.2 million for the three and nine months ended September 30, 2017, from $692.8 million and $687.9 for the comparable 2016 periods. Average non-interest-bearing demand deposits increased to $209.2 million and $202.0 million for the three and nine months ended September 30, 2017, from $181.0 million and $171.5 million for the 2016 three and nine months periods.

Net Interest Income. Net interest income for the three and nine months ended September 30, 2017 increased to $9.6 million and $27.4 million, from $8.3 million and $24.2 million for the comparable 2016 periods. The tax equivalent net interest margin increased to 3.89% and 3.81% for the three and nine months ended September 30, 2017, from 3.73% and 3.72% for the comparable 2016 periods. Yields on earning assets have been positively impacted by the strong growth in the Bank’s loan portfolio. This loan growth has resulted in a significant change in the mix of our earning assets over comparative periods. On the liability side of the balance sheet, continued expansion of our non-maturity deposit base, including non-interest bearing demand deposit accounts, has allowed the Company to efficiently fund its loan growth.

Yield/Cost Analysis. Table 1 below contains comparative information relating to the Company’s average balance sheet and reflects the yield on average earning assets and the average cost of interest-bearing liabilities for the three and nine months ended September 30, 2017 and 2016, respectively, presented on a tax equivalent yield basis. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal statutory tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the cost of average interest-bearing liabilities. The tax equivalent net interest margin represents tax adjusted net interest income divided by average earning assets.

OnTable a1 ~~loan-by-loan~~– ~~basis,~~Yield/Cost the Bank restructures loans that were either on non-accrual basis or on accrual basis prior to restructuring. If a loan was on nonaccrual basis prior to restructuring, it remains on nonaccrual until the borrower has demonstrated a willingness and ability to meet the terms and conditions of the restructuring and to make the restructured loan payments, generally for a period of at least six months. If a restructured loan was on accrual basis prior to restructuring and the Bank expects the borrower to perform to the terms and conditions of the loan after restructuring (i.e. the loan was current, on accrual basis, and the borrower has the ability to make the restructured loan payments), the loan remains on an accrual basis. See “Note 8. Troubled Debt Restructurings” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.Analysis

OREO acquired from foreclosures declined to $2.4 million at June 30, 2017, from $3.2 million at December 31, 2016. During the six months ended June 30, 2017, there were $880,000 of disposals, $177,000 of valuation adjustments and $266,000 of additions. OREO consists of residential and commercial properties, developed lots and raw land. The Bank believes the adjusted carrying values of these properties are representative of their fair market values, although there can be no assurances that ultimate sales will be equal to or greater than the carrying values. See “Note 9. Other Real Estate Owned” and “Note 17. Fair Value Measurement” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

	Three Months Ended September 30,
	2017							2016
	Average Balance		Interest		Average Yield Cost			Average Balance		Interest		Average Yield Cost
	(Dollars in thousands)
Interest earning assets:
Loans receivable	$	782,465	$	9,316		4.68	%	$	685,441	$	7,915		4.54	%
Investments and deposits		214,458		1,361		2.91	(1)		209,849		1,295		2.81	(1)
Total earning assets		996,923		10,677		4.30	(1)		895,290		9,210		4.13	(1)
Nonearning assets		65,327							73,439
Total assets	$	1,062,250						$	968,729

Interest bearing liabilities:
Deposits	$	723,960		842		0.46		$	663,983		728		0.44
Borrowings		18,288		70		1.53			18,506		56		1.18
Junior subordinated debentures		10,310		127		4.82			10,310		127		4.82
Total interest bearing liabilities		752,558		1,039		0.55			692,799		911		0.52
Noninterest bearing demand deposits		209,192		-		-			181,000		-		-
Total sources of funds		961,750		1,039		0.43			873,799		911		0.41
Other liabilities		6,516							6,449
Stockholders’ equity		93,984							88,481
Total liabilities and equity	$	1,062,250						$	968,729

Net interest income			$	9,638						$	8,299

Interest rate spread (1)(2)						3.75	%						3.61	%
Net interest margin (1)(3)						3.89	%						3.73	%
Ratio of earning assets to interest bearing liabilities						132.47	%						129.23	%

Mortgage servicing rights (“MSRs”) were $2.1 million at both June 30, 2017 and December 31, 2016, respectively. Loans serviced for others declined to $363.5 million at June 30, 2017, from $372.0 million at December 31, 2016, as principal repayments exceeded the volume of new loans sold service retained.

	Nine Months Ended September 30,
	2017							2016
	Average Balance		Interest		Average Yield Cost			Average Balance		Interest		Average Yield Cost
	(Dollars in thousands)
Interest earning assets:
Loans receivable	$	747,448	$	26,230		4.64	%	$	654,696	$	22,749		4.59	%
Investments and deposits		225,641		4,144		2.80	(1)		224,065		4,131		2.78	(1)
Total earning assets		973,089		30,374		4.22	(1)		878,761		26,880		4.12	(1)
Nonearning assets		66,548							72,970
Total assets	$	1,039,637						$	951,731

Interest bearing liabilities:
Deposits	$	710,414		2,426		0.46		$	653,116		2,095		0.43
Borrowings		19,483		193		1.32			24,450		187		1.01
Junior subordinated debentures		10,310		378		4.84			10,310		409		5.21
Total interest bearing liabilities		740,207		2,997		0.54			687,876		2,691		0.52
Noninterest bearing demand deposits		202,014		-		-			171,504		-		-
Total sources of funds		942,221		2,997		0.42			859,380		2,691		0.42
Other liabilities		5,872							6,126
Stockholders’ equity		91,544							86,225
Total liabilities and equity	$	1,039,637						$	951,731

Net interest income			$	27,377						$	24,189

Interest rate spread (1)(2)						3.68	%						3.60	%
Net interest margin (1)(3)						3.80	%						3.72	%
Ratio of earning assets to interest bearing liabilities						131.46	%						127.75	%

The Bank’s investment in bank-owned life insurance (“BOLI”) was $18.4 million at June 30, 2017, compared to $18.1 million at December 31, 2016. The investment returns from the BOLI are utilized to offset a portion of the cost of providing benefit plans to certain employees.

Goodwill was $4.2 million at both June 30, 2017 and December 31, 2016, respectively, and is tested for impairment annually. The Company’s most recent annual test determined there was no goodwill impairment. Identifiable intangible assets were $1.5 million at June 30, 2017, compared to $1.6 million at December 31, 2016, reflecting the core deposit intangible associated with a prior period branch acquisition transaction, which is being amortized over a ten year period. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Total deposits increased by $60.9 million, or 7.0% to $931.5 million at June 30, 2017, from $870.6 million at December 31, 2016. For the current six month period non-maturity deposits (personal and business checking, savings and money market accounts) grew by $53.1 million, or 8.7% to $667.2 million at June 30, 2017, from $614.0 million at December 31, 2016.

Certificates of deposit (“CDs”) grew by $7.8 million, to $264.3 million at June 30, 2017, from $256.6 million at December 31, 2016. CDs represented 28.4% and 29.5% of total deposits at June 30, 2017 and December 31, 2016, respectively. The Bank attempts to manage its cost of deposits through a combination of monitoring the volume and pricing of new and maturing CDs and growth in non-maturity deposits, in relationship to current funding needs and market interest rates. See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” and “Interest Expense” below for additional information regarding deposits and the cost of funds.

Federal Home Loan Bank (“FHLB”) borrowings increased to $22.5 million at June 30, 2017, from $17.0 million at December 31, 2016. The Bank may use FHLB borrowings as a funding source to provide an effective means of managing its overall cost of funds and to manage its exposure to interest rate risk. There were $10.3 million of junior subordinated debentures outstanding at both June 30, 2017 and December 31, 2016, respectively. See “Note 13. Borrowed Money” and “Note 14. Junior Subordinated Debentures” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Stockholders' equity increased by $4.7 million to $91.9 million at June 30, 2017, from $87.2 million at December 31, 2016. This increase primarily reflects the $3.9 million of net income earned for the six months ended June 30, 2017, a $1.4 million increase in accumulated other comprehensive income resulting from the mark-to-market adjustment of the available-for-sale securities portfolio, and is net of $665,000 of dividends declared. There were 9,502,520 common shares outstanding at June 30, 2017, compared to 9,494,935 shares outstanding at December 31, 2016, reflecting the net effect of 4,478 shares issued pursuant to the vesting of restricted stock awards and 3,107 shares issued pursuant to a stock option exercise during the current six month period.

Accumulated other comprehensive income increased to $2.9 million at June 30, 2017, from $1.5 million at December 31, 2016, reflecting an increase in the mark-to-market adjustment in net unrealized gains in the available-for-sale investment securities portfolio, based on current market prices. See “Consolidated Statements of Comprehensive Income” and “Note 3. Comprehensive Income and Accumulated Other Comprehensive Income” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

The tangible equity to assets ratio was 8.12% at June 30, 2017, versus 8.21% at December 31, 2016; and the tangible book value per common share increased to $9.07 at June 30, 2017, from $8.57 at December 31, 2016.

The Bank is subject to various regulatory capital requirements administered by its federal and state banking regulators. As of June 30, 2017, the Bank's regulatory capital ratios were in excess of all regulatory requirements and the Bank’s regulatory capital position is categorized as “well capitalized”. There are no conditions or events since June 30, 2017 that management believes have changed the Bank's well capitalized category. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” and “Liquidity and Capital Resources” below for additional information.

Comparison of Operating Results – Three and Six Months Ended June 30, 2017 and 2016.

General. Net income for the three months ended June 30, 2017 increased 27.5% to $2.1 million, or $0.22 per diluted common share, from net income of $1.6 million, or $0.17 per diluted common share earned for the comparative three month period ended June 30, 2016. The improvement in net income on a comparative quarter basis is primarily due to a $975,000, or 12.0% increase in net interest income, while maintaining consistent volumes of non-interest income and non-interest expense (excluding merger-related expenses). The improvement in comparative quarterly net income reflects the impact of strong loan growth over the past twelve months.

Net income for the six months ended June 30, 2017 increased 27.8% to $3.9 million, or $0.41 per diluted common share, compared to net income of $3.1 million, or $0.32 per diluted common share earned in the six months ended June 30, 2016. Earnings for the current six month period were positively impacted by increases in net interest income and non-interest income, as well as maintaining a consistent volume of non-interest expense (excluding merger-related expenses), while being partially offset by an increase in the provision for credit losses associated with the strong loan portfolio growth.

Impact of Merger-Related Transaction Expenses. In connection with the proposed merger transaction, the Company incurred $278,000 of professional fees and services expense that impacted our results of operations for the quarter and six months ended June 30, 2017. Excluding the net effects of these expenses, net income for the 2017 second quarter would have totaled $2.3 million, or $0.24 per diluted common share. Net income for the first six months of 2017 would have been $4.1 million, or $0.43 per diluted common share. The Company anticipates that it will incur additional expenses associated with the merger transaction prior to its expected consummation in the fourth quarter. The following table presents net income and diluted EPS for the respective June 30, 2017 second quarter and six month periods adjusted for the impact of the merger-related transaction expenses:

	Quarter Ended 6/30/17			Six Months Ended 6/30/17
	(In thousands, except per share data)
Reported Net Income (GAAP)	$	2,055		$	3,927
Adjustments for Merger Expenses:
Professional Fees and Services		278			278
Income Tax Benefit (Qtr-29.96% / YTD-29.68%)		(83	)		(82	)
Net Income Adjusted for Merger Expenses	$	2,250		$	4,123
Reported Diluted EPS (GAAP)	$	0.22		$	0.41
Impact of Merger Expenses on Diluted EPS	$	0.02		$	0.02
Diluted EPS Adjusted for Merger Expenses	$	0.24		$	0.43

Interest Income. Interest income increased to $10.1 million and $19.7 million for the three and six months ended June 30, 2017, from $9.0 million and $17.7 million for the comparable 2016 periods. The year-over-year growth in interest income is due to changes in the composition and volume of our earning asset base, coupled with an increase in yields on earning assets. The tax equivalent yield on average earning assets increased to 4.19% and 4.17% for the three and six months ended June 30, 2017, from 4.17% and 4.12% for the three and six months ended June 30, 2016. Average earning assets increased to $975.2 million and $960.9 million for the three and six months ended June 30, 2017, from $875.5 million and $870.5 million for the comparative 2016 three and six month periods.

Interest Expense. Interest expense increased to $1.0 million and $2.0 million for the three and six months ended June 30, 2017, from $898,000 and $1.8 million for the comparable 2016 periods. Interest expense was primarily impacted by increased interest paid on deposits between the comparative reporting periods, reflecting the growth in total deposits discussed above. The cost of average interest-bearing liabilities increased to 0.55% and 0.54% for the respective three and six months ended June 30, 2017, from 0.52% for both of the comparable 2016 periods. The Bank’s cost of interest-bearing liabilities has been impacted by the growth of non-maturity deposits and CDs as discussed above, as well as pricing of new and renewed CDs in the current interest rate environment.

Average interest-bearing liabilities increased to $743.3 million and $733.9 million for the three and six months ended June 30, 2017, from $685.7 million and $685.4 for the comparable 2016 periods. Average non-interest-bearing demand deposits increased to $201.5 million and $198.3 million for the three and six months ended June 30, 2017, from $170.2 million and $166.8 million for the 2016 three and six months periods.

Net Interest Income. Net interest income for the three and six months ended June 30, 2017 increased to $9.1 million and $17.7 million, from $8.1 million and $15.9 million for the comparable 2016 periods. The tax equivalent net interest margin increased to 3.78% and 3.76% for the three and six months ended June 30, 2017, from 3.76% and 3.71% for the comparable 2016 periods. Yields on earning assets have been positively impacted by the strong growth in the Bank’s loan portfolio. This loan growth has resulted in a significant change in the mix of our earning assets over comparative periods. On the liability side of the balance sheet, continued expansion of our non-maturity deposit base, including non-interest bearing demand deposit accounts, has allowed the Company to efficiently fund its loan growth.

Yield/Cost Analysis. Table 1 below contains comparative information relating to the Company’s average balance sheet and reflects the yield on average earning assets and the average cost of interest-bearing liabilities for the three and six months ended June 30, 2017 and 2016, respectively, presented on a tax equivalent yield basis. Tax equivalent yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis, using a 34% federal statutory tax rate and reduced by a disallowed portion of the tax exempt interest income. Average balances are derived from average daily balances. The interest rate spread represents the difference between the tax equivalent yield on average earning assets and the cost of average interest-bearing liabilities. The tax equivalent net interest margin represents tax adjusted net interest income divided by average earning assets.

Table 1 – Yield/Cost Analysis	Three Months Ended June 30,
	2017							2016
	Average Balance		Interest		Average Yield Cost			Average Balance		Interest		Average Yield Cost
	(Dollars in thousands)
Interest earning assets:
Loans receivable	$	750,246	$	8,701		4.60	%	$	657,301	$	7,642		4.62	%
Investments and deposits		224,965		1,392		2.83	(1)		218,228		1,356		2.82	(1)
Total earning assets		975,211		10,093		4.19	(1)		875,529		8,998		4.17	(1)
Nonearning assets		66,612							72,232
Total assets	$	1,041,823						$	947,761
Interest bearing liabilities:
Deposits	$	714,938		830		0.47		$	653,904		697		0.43
Borrowings		18,044		61		4.34			21,531		59		1.10
Junior subordinated debentures		10,310		127		4.87			10,310		142		5.43
Total interest bearing liabilities		743,292		1,018		0.55			685,745		898		0.52
Noninterest bearing demand deposits		201,511		-		-			170,244		-		-
Total sources of funds		944,803		1,018		0.43			855,989		898		0.42
Other liabilities		5,568							5,845
Stockholders’ equity		91,452							85,927
Total liabilities and equity	$	1,041,823						$	947,761
Net interest income			$	9,075						$	8,100
Interest rate spread (1)(2)						3.65	%						3.64	%
Net interest margin (1)(3)						3.78	%						3.30	%
Ratio of earning assets to interest bearing liabilities						131.20	%						127.68	%
	Six Months Ended June 30,
	2017							2016
	Average Balance		Interest		Average Yield Cost			Average Balance		Interest		Average Yield Cost
	(Dollars in thousands)
Interest earning assets:
Loans receivable	$	729,510	$	16,914		4.62	%	$	639,323	$	14,834		4.60	%
Investments and deposits		231,340		2,783		2.75	(1)		231,173		2,836		2.77	(1)
Total earning assets		960,850		19,697		4.17	(1)		870,496		17,670		4.12	(1)
Nonearning assets		67,177							72,736
Total assets	$	1,028,027						$	943,232
Interest bearing liabilities:
Deposits	$	703,463		1,584		0.45		$	647,682		1,367		0.42
Borrowings		20,105		123		1.22			27,422		132		0.97
Junior subordinated debentures		10,310		251		4.85			10,310		281		5.40
Total interest bearing liabilities		733,878		1,958		0.54			685,414		1,780		0.52
Noninterest bearing demand deposits		198,308		-		-			166,756		-		-
Total sources of funds		932,186		1,958		0.42			852,170		1,780		0.42
Other liabilities		5,547							5,966
Stockholders’ equity		90,294							85,096
Total liabilities and equity	$	1,028,027						$	943,232
Net interest income			$	17,739						$	15,890
Interest rate spread (1)(2)						3.63	%						3.60	%
Net interest margin (1)(3)						3.76	%						3.71	%
Ratio of earning assets to interest bearing liabilities						130.93	%						127.00	%

1. Shown as a tax-adjusted yield.

2. Represents the difference between the average yield on earning assets and the average cost of funds.

3. Represents net interest income divided by average earning assets.

3835

Provision for Credit Losses. The Bank's methodology for determining its provision for credit losses includes amounts specifically allocated to credits that are ~~individually~~ individually determined to be impaired and general provisions allocated to groups of loans that have not been individually assessed for impairment. The Bank recorded $~~485~~100,000 and $~~750~~850,000 of provisions for credit losses in the three and ~~six~~nine months ended ~~June~~ September 30, 2017, compared to $~~325~~220,000 and $~~550~~770,000 recorded in the three and ~~six~~nine months ended ~~June~~September 30, 2016. The increase in provision ~~for~~ for credit losses was primarily to support the $764.01 million and $80.1 million net growth in loans held for investment during the ~~current reporting~~three ~~periods~~and nine months ended September 30, 2017, respectively. Provision for credit losses is necessary to maintain the ALLL at a level that management believes is adequate to absorb probable future losses in the loan portfolio. See “Note 7. Allowance for Loan and Lease Losses” of “Notes to Consolidated Financial Statements (Unaudited)” and “Allowance for Loan and Lease Losses” and “Critical Accounting Policies - Loan Impairment and Allowance for Loan and Lease Losses” included herein for additional information.

Non-~~interest~~Interest Income. Total non-interest income totaled $3.65 million and $610.94 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $3.57 million and $710.1 8 million for the 2016 three and ~~six~~nine month periods. Non-interest income consists of deposit fees and service charges; loan fees and charges; mortgage loan servicing fees; gain on sale and other fees on mortgage loans, net gain on investment securities and OREO sales; and other miscellaneous income. Fees and service charges on deposits, and fees on loans and loan servicing fees earned during each period are influenced by the volume of deposits and loans outstanding, the volume of the various types of deposit and loan account transactions processed, the volume of loans serviced for others and the collection of related fees and service charges.

Deposit fees and service charges remained ~~relatively~~ relatively consistent at $21.09 million and $35.87 million for both the three and ~~six~~nine months ended ~~June~~September 30, 2017, ~~compared to $1.9 million~~ and ~~$3.8 million for the~~ 2016 ~~three and six month periods~~. Deposit fees and service charges represented 5554.2% and 55.72% of total non-interest income for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to 5451.47% and 53.91% for the 2016 three and ~~six~~nine month periods. The amount of service charges and fees is generally dependent upon the volume of account transaction activity and the collection of related service charges and fees.

Total non-interest income generated from ~~the~~ the sale and servicing of mortgage loans and loan fees ~~increased~~was to $~~971,000~~1.1 million and $12.8 million for the three and ~~six~~nine months ended ~~June~~ September 30, 2017, ~~from~~compared to $~~842,000~~1.2 million and $12.56 million for the respective 2016 three and ~~six~~nine month periods. The Bank may sell or securitize fixed-rate residential mortgage loans to reduce interest rate and credit risk exposure, and to provide a more balanced sensitivity to future interest rate changes, while retaining certain other mortgage loans for future securitization into available-for-sale mortgage-backed securities. Proceeds from mortgage loan sales provide liquidity to support the Bank’s operating, financing and lending activities. ~~We continue to explore various strategies to enhance our non-interest income, including the purchase of mortgage servicing rights.~~

NoThere ~~gains~~were no gains on sales of investment securities available-for-sale ~~were~~ recorded for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to ~~$184,000~~ none and $467,000 for the respective 2016 three and ~~six~~nine month periods. During the three and ~~six~~nine months ended ~~June~~September 30, 2017, the Bank did not sell any investment securities available-for-sale, compared to ~~$9.9~~none ~~million~~ and $40.6 million sold in the 2016 three and ~~six~~nine month periods. Proceeds from investment securities sales in 2016 were primarily used to fund ~~net~~ growth inof our loan portfolio.

During the three and ~~six~~nine months ended ~~June~~September 30, 2017, the Bank recorded net ~~losses~~gains of $2614,000 and ~~net gains of~~ $5670,000, ~~respectively,~~ from the sale of OREO compared to net ~~losses~~ gains of $1477,000 and $2651,000 for the respective 2016 three and ~~six~~nine month periods, as the Bank ~~continues~~continued in its efforts of disposing of these nonperforming assets. See “Note 9. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Other non-interest income was $~~556~~435,000 ~~and~~ and $1.05 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $~~467~~477,000 and $1.26 million for the 2016 three and ~~six~~nine month periods. Other non-interest income includes revenue from BOLI investments. BOLI earnings were $132,000 and $~~271~~403,000 ~~for~~ for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $142,000 and $~~277~~419,000 for the 2016 periods.

39Other non-interest income also includes revenues of $93,000 and $321,000 for the three and nine months ended September 30, 2017, from gains and retained servicing fees on Small Business Administration (“SBA”) loans sold , compared to $148,000 and $434,000 for the 2016 three and nine month periods. During the first nine months of 2016, other non-interest income also included the receipt of a $230,000 non-recurring fee.

Other non-interest income also includes revenues of $111,000 and $227,000 for the three and six months ended June 30, 2017, from gains and retained servicing fees on Small Business Administration (“SBA”) loans sold , compared to $142,000 and $286,000 for the 2016 three and six month periods. During the first six months of 2016, other non-interest income also included the receipt of a $230,000 non-recurring fee.36

Non-~~interest~~Interest Expense. Total non-interest expense was $98.27 million and $1827.30 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $98.09 million and $1827.2 1 million for the 2016 three and ~~six~~nine month periods. ~~The year~~Non-~~over-year variation in non-~~interest expenses isfor ~~partially~~the ~~attributable to~~three ~~the~~and ~~$278,000~~nine month periods of 2017 were impacted by merger-related expenses as discussed above.

Compensation and benefit expenses, the largest component of non-interest expense, ~~was~~were $5.01 million and $1015.12 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $45.90 million and $1015.0 million for the respective 2016 three and ~~six~~nine month periods. The ~~six~~nine months ended ~~June~~ September 30, 2016 included $65,000 of severance costs associated with branch consolidations during the period. ~~The Bank will continue to manage staffing levels to ensure we meet the ongoing needs of our customers and to support our future growth.~~

Federal Deposit Insurance Corporation (the “FDIC”) insurance premiums were $~~157~~156,000 and $~~304~~461,000 for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to to $~~161~~157,000 and $~~322~~479,000 for the respective 2016 three and ~~six~~nine month periods. The amount of our quarterly FDIC insurance premiums is determined by an FDIC calculation method based on various risk based components, combined with growth in our balance sheet.

Premises and equipment expense remained relatively consistent at $1.3 million and $24.70 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $1.43 million and $24.8 1 million for the 2016 three and ~~six~~nine month periods. During the first quarter of 2017, we consolidated two branch locations with other nearby facilities, ~~compared~~and to three branch locations were consolidated into other facilities in the first quarter of 2016. ~~We continue to explore opportunities to gain efficiencies and performance improvements from our branch network.~~

Marketing ~~expense~~expenses ~~declined~~were reduced to $~~119~~97,000 and $~~183~~279,000 for the three and ~~six~~nine months ended ~~June~~September 30, 2017, from $~~229~~151,000 and $~~417~~569,000 for the respective 2016 three and nine ~~six~~ month periods. During the prior fiscal year, we focused marketing efforts on enhancing our brand awareness throughout our ~~footprint and more specifically~~ ~~in new markets~~footprint.

Data processing costs ~~increased~~were to $~~808~~800,000 and $12.6 4 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $~~750~~757,000 and $12.53 million for the 2016 three and ~~six~~ nine month periods. Data processing costs fluctuate in conjunction with growth in the volume of loan and deposit accounts, combined with transaction activity volumes.

Total amortization of intangible assets, ~~including~~ including MSRs and identifiable intangible assets, ~~increased~~was to $~~151~~153,000 and $~~300~~453,000 for the three and ~~six~~nine months ended ~~June~~September 30, 2017, ~~from~~compared to $~~134~~137,000 and $~~265~~402,000 for the 2016 three and ~~six~~nine month periods. Amortization of MSRs was $9192,000 and $~~180~~272,000 for the ~~three~~ three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $6266,000 and $~~123~~189,000 for the 2016 three and ~~six~~nine month periods. The increase in the amortization of MSRs during the respective 2017 periods is primarily attributable to amortization expense associated with a $778,000 MSR portfolio purchased in the third quarter of 2016. Amortization of the core deposit intangible, which is the only identifiable intangible asset subject to amortization, was $60,000 and $~~121~~181,000 for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to $71,000 and $~~142~~213,000 for the 2016 three and ~~six~~nine month periods. See “Note 11. Goodwill and Other Intangibles” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Total expenses attributable to the ongoing maintenance, property taxes, insurance and valuation adjustments for OREO properties were $~~105~~2,000 and $~~270~~272,000 for the three and nine ~~six~~ months ended ~~June~~September 30, 2017, compared to $~~213~~119,000 and $~~307~~426,000 for the 2016 three and ~~six~~ nine month periods. OREO valuation adjustments included therein were $5815,000 and $~~177~~192,000 for the three and ~~six~~nine months ended ~~June~~ September 30, 2017, compared to ~~$103,000~~ none and $110,000 for the 2016 three and ~~six~~nine month periods. Management continuously analyzes the carrying value of OREO and makes valuation adjustments as necessary. See “Note 9. Other Real Estate Owned” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

40Other non-interest expense was $1.1 million and $3.9 million for the three and nine months ended September 30, 2017, compared to $1.3 million and $3.8 million for the 2016 three and nine month periods. Included in other non-interest expense for the three and six months ended September 30, 2017, is $109,000 and $387,000, respectively, of merger-related expenses discussed above. In addition, during the first quarter of 2017 and the first quarter of 2016, the Bank consolidated two and three existing branches, respectively, into nearby locations. Of the locations that were consolidated, four of the facilities are leased and one was owned. The Bank sold the owned location in first quarter of 2016 and realized an $85,000 pre-tax loss, which is included in other non-interest expense during that reporting period.

Other non-interest expense increased to $1.5 million and $2.8 million for the three and six months ended June 30, 2017, compared to $1.2 million and $2.6 million for the 2016 three and six month periods. The increase in other non-interest expenses is primarily attributable to the $278,000 in merger-related expenses previously discussed. In addition, during the first quarter of 2017 and the first quarter of 2016, the Bank consolidated two and three existing branches, respectively, into nearby locations. Of the locations that were consolidated, four of the facilities are leased and one was owned. The Bank sold the owned location in first quarter of 2016 and realized an $85,000 pre-tax loss, which is included in other non-interest expense during that reporting period.37

Income tax expense ~~increased~~totaled to $~~879,000 and~~1.4 million and $13.70 million for the three and ~~six~~nine months ended ~~June~~September 30, 2017, ~~from~~versus $~~665~~947,000 and $12.2 million for the 2016 three and ~~six month~~nine month periods. The effective income tax rates were 2932.963% and 2930.688% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, compared to 2933.203% and 2830.72 6% for the for the 2016 three and ~~six~~nine month periods. The Bank’s investment in BOLI and tax-exempt municipal ~~bonds~~ bonds contribute to more favorable effective income tax rates, which has been partially offset by the strong growth in the loan portfolio. See “Critical Accounting Policies” below for additional information.

Key Performance Ratios. Three of our key performance ratios are return on average assets (“ROA”), return on average equity (“ROE”) and the efficiency ratio. ROA improved to 01.7909% and 0.7788% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, from 0.6878% and 0.6670% for the comparable 2016 three and ~~six~~nine month periods. ROE improved to 912.0131% and 810.7700% for the three and ~~six~~ nine months ended ~~June~~September 30, 2017, from 7 8.5552% and 7.2669% for the comparable 2016 three and ~~six~~nine month periods. The efficiency ratio improved to ~~71.~~65.53% and 7370.2355% for the three and ~~six~~nine months ended ~~June~~September 30, 2017, from 7773.5984% and 7977.1431% for the comparable 2016 three and ~~six~~nine month periods. The efficiency ratio measures the proportion of net operating revenues that are absorbed by overhead expenses. ~~We anticipate the efficiency ratio to improve as we continue exploring opportunities to increase operating leverage and gain efficiencies from our branch network.~~

Liquidity and Capital Resources. Liquidity generally refers to the Bank's ability to generate adequate amounts of funds to meet its cash needs. Adequate liquidity guarantees that sufficient funds are available to meet deposit withdrawals, fund future loan commitments, maintain adequate reserve requirements, pay operating expenses, provide funds for debt service, and meet other general commitments. FDIC policy requires banks to maintain an average daily balance of liquid assets in an amount which it deems adequate to protect the safety and soundness of the Bank.

At ~~June~~September 30, 2017, the Bank had cash, deposits in other banks, investment securities and loans held for sale totaling $~~242~~251.47 million, compared to $244.4 million at December 31, 2016. The Bank calculates its liquidity position under policy guidelines based on liquid assets in relationship to deposits and short-term borrowings. Based on its calculation guidelines, the Bank’s liquidity ratio was 2019.68% at ~~June~~September 30, 2017, compared to 25.0% at December 31, 2016, which management believes is adequate.

The Bank believes it can meet ~~future~~ liquidity ~~needs~~ needs with existing funding sources. The Bank's primary sources of funds are deposits, principal payments on loans and mortgage-backed securities, funds provided from operations, the ability to borrow from the FHLB of Atlanta and other lines of credit, and the availability of loans and investment securities available-for-sale. At ~~June~~September 30, 2017, the Bank had $~~259~~265.60 million of credit availability ~~with~~ with the FHLB, of which there was lendable collateral value totaling $~~220~~222.49 million. Additional collateral would be required in ~~order~~ order to access total borrowings up to the credit availability limit. In addition, at ~~June~~September 30, 2017, the Bank had additional ~~capacity~~ capacity to borrow $~~107~~116.19 million from the Federal Reserve Bank (“FRB”) Discount Window. At ~~June~~September 30, 2017, the Bank had $70.0 million of pre-approved, but unused lines of credit. See “Note 13. Borrowed Money” of “Notes to ~~Consolidated~~ Consolidated Financial Statements (Unaudited)” for additional information.

The Company and the Bank are subject to ~~various~~ various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and ratios are not significantly different from the Bank. The Bank was in compliance with all regulatory capital requirements at ~~June~~September 30, 2017, and December 31, 2016. See “Note 15. Regulatory Capital” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

41Contractual Obligations. In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. Table 2 below reflects contractual obligations of the Company outstanding as of September 30, 2017.

Contractual Obligations. In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. Table 2 below reflects contractual obligations of the Company outstanding as of June 30, 2017.38

Table 2 – Contractual Obligations	Payments Due by Period
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
	(In thousands)
Borrowed money (1)	$	22,500	$	11,000	$	10,500	$	1,000	$	-
Junior subordinated debentures (2)		10,310		-		-		-		10,310
Lease obligations (3)		5,362		1,241		1,744		1,078		1,299
Deposits (4)		931,534		826,260		78,899		26,375		-
Total contractual obligations	$	969,706	$	838,501	$	91,143	$	28,453	$	11,609

Table 2 – Contractual Obligations

	Payments Due by Period
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
	(In thousands)
Borrowed money (1)	$	16,500	$	5,000	$	11,500	$	-	$	-
Junior subordinated debentures (2)		10,310		-		-		-		10,310
Lease obligations (3)		5,047		1,196		915		702		2,234
Deposits (4)		945,288		846,467		77,438		21,383		-
Total contractual obligations	$	977,145	$	852,663	$	89,853	$	22,085	$	12,544

(1)

See “Note 13. Borrowed Money” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

(2)

See “Note 14. Junior Subordinated Debentures” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

(3)

See “Note 10. Premises and Equipment” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

(4)

See “Note 12. Deposits” of “Notes to Consolidated Financial Statements (Unaudited)” for additional information.

Critical Accounting Policies. The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect reported and expected financial results.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Estimates affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Loan Impairment and Allowance for Loan and Lease Losses. A loan or lease is considered impaired, based on current information and events, if it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant lending relationships and include the accumulation of related data. This data includes loan and lease payment status, borrowers' financial data and borrowers' operating factors such as cash flows, operating income or loss, etc.

The ALLL is increased by charges to income and decreased by charge-offs, net of recoveries. Management's periodic evaluation of the adequacy of the ALLL is based on past loan and lease loss experience, known and inherent risks in loans and unfunded loan commitments, adverse situations that may affect a borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. While management believes that it has established the ALLL in accordance with accounting principles generally accepted in the United States of America and has taken into account the views of its regulators and the current economic environment, there can be no assurance in the future that regulators or risks in its loans portfolio will not require additional adjustments to the ALLL.

Income Taxes. Deferred tax asset and liability balances are determined by application to temporary differences in the tax rate expected to be in effect when taxes will become payable or receivable. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

4239

Off-Balance Sheet Arrangements. The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and involve elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by a party to a financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Table 3 below is a summary of the contractual amount of the Company’s exposure to off-balance sheet commitments.

Table 3 – Off Balance Sheet Arrangements	June 30, 2017		December 31, 2016
	(In Thousands)
Commitments to originate loans	$	120,165	$	112,070
Undrawn balances on lines of credit and credit reserves		56,865		54,186
Standby letters of credit		615		487
Total contractual obligations	$	177,645	$	166,743

Table 3 – Off Balance Sheet Arrangements

The reserve for unfunded commitments was $283,742 and $311,623 as of June 30, 2017 and December 31, 2016, respectively, which was recorded in other liabilities on the consolidated balance sheets.

	September 30, 2017		December 31, 2016
	(In Thousands)
Commitments to originate loans	$	104,825	$	112,070
Undrawn balances on lines of credit and credit reserves		56,811		54,186
Standby letters of credit		655		487
Total contractual obligations	$	162,291	$	166,743

~~Forward Looking Statements.~~ The ~~Private~~ ~~Securities~~reserve ~~Litigation Reform Act of 1995 states that disclosure of forward looking information is desirable~~ for ~~investors and~~unfunded ~~encourages~~commitments ~~such~~was ~~disclosure by providing a safe harbor for forward looking statements by corporate management. This Form 10-Q~~$284,000 ~~including Management’s Discussion~~ and ~~Analysis of Financial Condition and Results of Operations~~$312,000 ~~contains~~as ~~forward looking statements that involve risk and uncertainty. In order to comply with the terms~~ of ~~the~~September ~~safe harbor~~30, ~~the~~2017 ~~Company notes that a variety of risks~~ and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward looking statements. There are risks and uncertainties that may affect the operationsDecember 31, ~~performance,~~ ~~development~~2016, growth projections and results of the Company's business. They include, but are not limited to, failure to obtain all regulatory approvals and meet other closing conditions pursuant to the Merger Agreement by and between CARO and the Company, including approval by the stockholders of CARO and the Company, respectively, onwhich ~~the~~was ~~expected~~recorded ~~terms and time schedule; delay~~ in ~~closing the Merger; difficulties and delays in integrating CARO’s and the Company’s businesses or fully realizing cost savings and~~ other ~~benefits;~~liabilities ~~business~~on ~~disruption as a result of~~ the ~~Merger; customer acceptance of CARO products and services;~~ ~~potential~~consolidated ~~difficulties~~balance encountered in expanding into a new market following the Merger; economic growth; interest rate movements; timely development of technology enhancements for products; services and operating systems; the impact of competitive products; services and pricing; customer requirements; regulatory changes and similar matters; and including without limitation other factors that could cause actual results to differ materially as discussed in documents filed by the Company with the Securities and Exchange Commission from time to timesheets. Readers of this report are cautioned not to place undue reliance on forward looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations. The Company assumes no obligation and does not intend to update these forward-looking statements, except as required by law.

43Forward-Looking Statements. The Private Securities Litigation Reform Act of 1995 states that disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Form 10-Q, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, the Company notes that a variety of risks and uncertainties could cause its actual results and experience to differ materially from anticipated results or other expectations expressed in the Company's forward-looking statements. There are risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business. They include, but are not limited to, difficulties and delays in integrating CARO’s and the Company’s businesses or fully realizing cost savings and other benefits; business disruption as a result of the Merger; customer acceptance of CARO products and services; potential difficulties encountered in expanding into a new market following the Merger; economic growth; interest rate movements; timely development of technology enhancements for products; services and operating systems; the impact of competitive products; services and pricing; customer requirements; regulatory changes and similar matters; and including without limitation other factors that could cause actual results to differ materially as discussed in documents filed by the Company with the Securities and Exchange Commission from time to time. Readers of this report are cautioned not to place undue reliance on forward-looking statements that are subject to influence by these risk factors and unanticipated events, as actual results may differ materially from management's expectations. The Company assumes no obligation and does not intend to update these forward-looking statements, except as required by law.

Item 3. Quantitative and Qualitative Disclosures about Market Risk. The Company intends to reach its strategic financial objectives through the effective management of market risk. Like many financial institutions, the Company’s most significant market risk exposure is interest rate risk. The Company's primary goal in managing interest rate risk is to minimize the effect that changes in market interest rates have on earnings and capital. This goal is accomplished through the active management of the balance sheet. The goal of these activities is to structure the maturity and repricing of assets and liabilities to produce stable net interest income despite changing interest rates. The Company's overall interest rate risk position is governed by policies approved by the Board of Directors and guidelines established and monitored by the Bank’s Asset/Liability Management Committee (“ALCO”). To measure, monitor, and report on interest rate risk, the Company begins with two models: (1) net interest income (“NII) at risk, which measures the impact on NII over the next twelve and twenty-four months of immediate changes in interest rates and (2) net economic value of equity (“EVE”), which measures the impact on the present value of net assets of immediate changes in interest rates. NII at risk is designed to measure the potential short-term impact of changes in interest rates on NII. EVE is a long-term measure of interest rate risk to the Company's balance sheet, or equity. These models are subject to ALCO guidelines and are monitored regularly.40

InItem ~~calculating~~3. ~~NII~~Quantitative atand Qualitative Disclosures About Market Risk. The Company’s most significant market risk, ~~the~~exposure is interest rate risk. The Company ~~begins~~'s ~~with~~primary agoal ~~base~~in ~~amount~~managing ofinterest ~~NII~~rate ~~that~~risk is ~~projected~~to ~~over~~minimize the ~~next~~negative ~~twelve~~effect that changes in market interest rates have on earnings and ~~twenty~~capital. ~~four~~This ~~months,~~goal ~~assuming~~is accomplished through the active management of the balance sheet. The goal of these activities is ~~static and~~to structure the ~~yield~~maturity ~~curve~~and ~~remains~~repricing ~~unchanged~~of ~~over~~assets ~~the~~and ~~period~~liabilities to produce stable net interest income despite changing interest rates. The ~~current~~Company's ~~yield~~overall ~~curve~~interest rate risk position is ~~then~~governed by policies approved by the Board of Directors and guidelines established and monitored by the Bank’s Asset/Liability Management Committee (“~~shocked,~~ALCO”). orTo ~~moved immediately~~measure, ~~±1.0~~ ~~percent~~monitor, ~~±2.0~~and ~~percent~~report on interest rate risk, ~~±3.0~~the ~~percent~~Company ~~and~~begins ~~±4.0~~with ~~percent~~two inmodels: a(1) ~~parallel~~net ~~fashion,~~interest orincome (“NII) at ~~all~~risk, ~~points~~which ~~along~~ measures the ~~yield~~impact ~~curve.~~on ~~New~~NII over the next twelve and twenty -four ~~month~~months ~~NII~~of ~~projections~~immediate ~~are~~changes ~~developed~~in ~~using~~interest ~~the~~rates ~~same~~and ~~balance~~(2) ~~sheet~~net ~~but~~economic ~~with~~value ~~the~~of ~~new~~equity ~~yield curves~~(“EVE”), ~~and~~which ~~these~~measures ~~results~~the ~~are~~impact ~~compared~~on to the ~~base~~present ~~scenario.~~value ~~The~~of ~~Company~~net ~~also~~assets ~~models~~of ~~other~~immediate ~~scenarios~~changes toin ~~evaluate~~interest ~~potential~~rates. NII at risk ~~such~~is asdesigned ato ~~gradual~~measure ~~ramp~~the potential short-term impact of changes in interest rates, aon ~~flattening~~NII. ~~yield~~EVE ~~curve,~~is a ~~steepening~~long-term ~~yield~~measure ~~curve~~of interest rate risk to the Company's balance sheet, ~~and~~or ~~others~~equity. ~~that~~These ~~management~~models ~~deems appropriate~~are subject to ALCO guidelines and are monitored regularly.

~~EVE~~In calculating NII at risk, isthe ~~based~~Company onbegins with ~~the~~a ~~change~~base inamount ~~the present~~of ~~value~~NII ofthat ~~all~~is ~~assets~~projected ~~and~~over ~~liabilities~~the ~~under~~next ~~different~~twelve ~~interest~~and ~~rate~~twenty ~~scenarios.~~four ~~The~~months, ~~present~~assuming ~~value~~the ofbalance ~~existing~~sheet ~~cash~~is ~~flows~~static ~~with~~and the ~~current~~ yield curve ~~serves~~remains asunchanged over the ~~base case~~period. The ~~Company~~current ~~then~~yield ~~applies~~curve anis ~~immediate~~then ~~parallel~~“shocked,” ~~shock~~or tomoved ~~that yield curve of~~ immediately, ±1.0 percent, ±2.0 percent, ±3.0 percent and ±4.0 percent ~~and recalculates the cash flows and related present values. Key assumptions used~~ in ~~the~~a ~~models~~parallel ~~described above include the timing of cash flows~~fashion, ~~the~~or ~~maturity~~at ~~and~~all ~~repricing~~points ~~of assets and liabilities,~~along ~~changes in market conditions, and interest rate sensitivities of~~ the ~~Company's~~yield ~~non-maturity~~curve. ~~deposits~~New ~~with~~twelve ~~respect to interest rates paid~~ and ~~the~~twenty ~~level~~four ofmonth ~~balances.~~NII ~~These~~projections ~~assumptions~~ are ~~inherently~~developed ~~uncertain~~using ~~and, as a result,~~ the ~~models~~same ~~cannot~~balance ~~precisely~~sheet ~~calculate future~~but ~~NII~~with ~~or predict~~ the ~~impact~~new ofyield curves ~~changes in interest rates on NII~~ and ~~EVE.~~these ~~Actual~~ results ~~could~~are ~~differ~~compared ~~from simulated results due~~ to the ~~timing,~~base ~~magnitude and frequency of changes in interest rates and market conditions, changes in spreads and management strategies, among other factors~~scenario. ~~Projections of NII are assessed as part of the Company's forecasting process.~~

~~NII~~EVE at risk is based on the change in the present value of all assets and ~~EVE~~liabilities ~~Analysis~~under different interest rate scenarios. ~~Table~~The present value of existing cash flows with the 4current ~~below~~yield ~~presents~~curve serves as the ~~estimated~~base ~~exposure~~case. The Company then applies an immediate parallel shock to ~~NII~~that ~~for~~yield curve of ±1.0 percent, ±2.0 percent, ±3.0 percent and ±4.0 percent and recalculates the ~~next~~cash ~~twelve~~flows ~~months~~and ~~due~~related topresent ~~immediate~~values. Key assumptions used in the models described above include the timing of cash flows, the maturity and repricing of assets and liabilities, changes in market conditions, and interest rate sensitivities of the Company's non-maturity deposits with respect to interest rates paid and the ~~estimated~~level of balances. These assumptions are inherently uncertain and, as a result, the models cannot precisely calculate ~~exposure~~future toNII or predict the impact of changes in interest rates on NII and EVE. Actual results could differ from simulated results due to ~~immediate~~the timing, magnitude and frequency of changes in interest rates and market conditions, changes in spreads and management strategies, among other factors. ~~All~~Projections ~~information~~of isNII ~~presented~~are assessed as part of ~~June~~the ~~30,~~Company's ~~2017~~forecasting process.

Table 4 – NII and EVE Analysis	June 30, 2017
Immediate change in interest rates:	Estimated Exposure to NII			Estimated Exposure to EVE
+4.0%		6.57	%	1.68	%
+3.0%		5.90		4.25
+2.0%		3.82		5.75
+1.0%		2.09		4.27
No change		—		—
-1.0%		(4.79	)	(9.18	)

NII and EVE Analysis. Table 4 below presents the estimated exposure to NII for the next twelve months due to immediate changes in interest rates and the estimated exposure to EVE due to immediate changes in interest rates. All information is presented as of September 30, 2017.

~~While the measures presented in the~~ Table 4 ~~are~~– ~~not a prediction of future~~ NII orand EVE valuations, they do suggest that if all other variables remained constant, immediate increases in interest rates at all points on the yield curve may produce higher NII in the short term. Other important factors that impact the levels of NII are balance sheet size and mix, interest rate spreads, the slope of the yield curve, the speed of interest rates changes, and management actions taken in response to the preceding conditions.Analysis

	September 30, 2017
	Estimated Exposure to NII			Estimated Exposure to EVE
Immediate change in interest rates:
+ 4.0%		14.13	%		8.28	%
+ 3.0%		11.48			9.36
+ 2.0%		7.46			9.37
+ 1.0%		3.85			6.13
No change		—			—
- 1.0%		(6.96	)		(12.14	)

While the measures presented in the Table 4 are not a prediction of future NII or EVE valuations, they do suggest that if all other variables remained constant, immediate increases in interest rates at all points on the yield curve may produce higher NII in the short term. Other important factors that impact the levels of NII are balance sheet size and mix, interest rate spreads, the slope of the yield curve, the speed of interest rates changes, and management actions taken in response to the preceding conditions.

Item 4. Controls and Procedures. As of the end of the period covered by this report, management of the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules and forms. It should be noted that the design of the Company’s disclosure controls and procedures is based in part upon certain reasonable assumptions about the likelihood of future events, and there can be no reasonable assurance that any design of disclosure controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote, but the Company’s principal executive and financial officers have concluded that the Company’s disclosure controls and procedures are, in fact, effective at a reasonable assurance level. There have been no changes in the Company’s internal control over financial reporting, to the extent that elements of internal control over financial reporting are subsumed within disclosure controls and procedures, identified in connection with the evaluation described above that occurred during the Company’s last fiscal quarter, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item l. Legal Proceedings: The Company is currently not engaged in any material legal proceedings. From time to time, the Bank is a party to legal proceedings within the ordinary course of business wherein it enforces its security interest in loans, and other matters of similar nature.

Item 1A. Risk Factors: As previously discussed in this report, on ~~June~~November 91, 2017, the Company ~~and~~merged ~~Carolina~~with ~~Financial~~and ~~Corporation (“Carolina Financial”) entered~~ into anCARO, ~~Agreement~~with ~~and~~CARO ~~Plan~~as ofthe ~~Merger~~surviving ~~and Reorganization~~entity, ~~pursuant~~subject to ~~which~~ the ~~Company~~terms ~~will~~and ~~merge~~conditions ~~with~~set ~~and~~forth ~~into~~in ~~Carolina~~an ~~Financial,~~Agreement ~~with~~and ~~Carolina~~Plan ~~Financial~~of asMerger ~~the~~and ~~surviving~~Reorganization. ~~entity,~~In ~~subject~~addition to the ~~terms~~risk ~~and~~factors ~~conditions~~previously ~~set~~disclosed ~~forth~~ in the ~~merger~~Company’s ~~agreement.~~Quarterly ~~The~~Report ~~following~~on ~~risk~~Form ~~factors~~10-Q ~~relating~~for to the ~~merger~~Quarterly ~~are~~Period ~~being~~Ended ~~provided~~March in31, ~~addition~~2017, risk factors relating to the ~~risk~~merger ~~factors~~were ~~previously~~also disclosed in the Company’s Quarterly Report on Form 10-Q for the Quarterly Period Ended ~~March~~June 3130, 2017.

~~In addition, Carolina Financial~~CARO’s and the Company’s respective businesses are subject to numerous risks and uncertainties, including the risks and uncertainties ~~described~~ inpreviously ~~this~~disclosed ~~section,~~ in ~~Carolina~~the ~~Financial~~Company’s Quarterly ~~Annual~~ Report on Form 10-KQ for the ~~Fiscal~~Quarterly ~~Year~~Periods Ended ~~December~~March 31, ~~2016~~2017 and June 30, 2017, respectively, and in ~~the Company~~CARO’s Annual ~~Quarterly~~ Report on Form 10-QK for the ~~Quarterly~~Fiscal ~~Period~~Year Ended ~~March~~December 31, 2016.

First South stockholders will experience a reduction in percentage ownership and voting power of their shares as a result of the merger. First South stockholders will experience a substantial reduction in their percentage ownership interest and effective voting power relative to their percentage ownership interest in First South compared to their ownership interest and voting power prior to the merger. Former First South stockholders will own less than a majority of the outstanding voting stock of the combined company and could, as a result, be outvoted by current Carolina Financial stockholders if such current Carolina Financial stockholders voted together as a group.42

Because the market price of Carolina Financial common stock will fluctuate, First South stockholders cannot be sure of the exact value of shares of Carolina Financial common stock they will receive. Upon completion of the merger, each outstanding share of First South common stock will be converted into the merger consideration consisting of shares of Carolina Financial common stock, as provided in the merger agreement. The closing price of Carolina Financial common stock on the date that the shareholder actually receives the shares of such stock after the merger is completed and the closing price of Carolina Financial common stock the date on which the effective time of the merger is to occur may vary from each other, as well as from the closing price of Carolina Financial common stock on the date that the Carolina Financial and First South announced the merger, on the date that this proxy statement/prospectus is being mailed to Carolina Financial and First South stockholders, and on the date of the special stockholders’ meetings. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in Carolina Financial’s business, operations and prospects, and regulatory considerations, among other things. Many of these factors are beyond the control of Carolina Financial. Accordingly, at the time of the First South special stockholders’ meeting, because of the above timing differences, First South stockholders will not be able to calculate the exact value of Carolina Financial common stock they may receive upon completion of the merger.

Combining the two companies may be more difficult, costly, or time consuming than Carolina Financial or First South expects. The success of the merger will depend, in part, on Carolina Financial’s ability to realize the anticipated benefits and cost savings from combining the businesses of Carolina Financial and First South. However, to realize these anticipated benefits and cost savings, we must successfully combine the businesses of Carolina Financial and First South. If we are not able to achieve these objectives, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected.

Carolina Financial and First South have operated, and, until completion of the merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees or disruption of each company’s ongoing business or inconsistencies in standards, controls, procedures, and policies that would adversely affect Carolina Financial’s ability to maintain relationships with clients, depositors, and employees or to achieve the anticipated benefits of the merger. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on First South during that transition period.

Carolina Financial and First South will incur significant transaction and merger-related integration costs in connection with the merger. Carolina Financial and First South expect to incur significant costs associated with completing the merger and integrating the operations of the two companies. Carolina Financial and First South are continuing to assess the impact of these costs. Although Carolina Financial and First South believe that the elimination of duplicate costs, as well as the realization of other efficiencies related to the integration of the businesses, will offset incremental transaction and merger-related costs over time, this net benefit may not be achieved in the near term, or at all.

Carolina Financial has not previously operated in First South’s markets in eastern North Carolina. First South’s service area is eastern and central North Carolina. The banking business in these areas is extremely competitive, and the level of competition may increase further. Carolina Financial has not previously participated in these markets, and there may be unexpected challenges and difficulties that could adversely affect Carolina Financial following the merger.

Carolina Financial and First South may not receive regulatory approvals or such approvals may take longer than expected or impose conditions Carolina Financial and First South do not presently anticipate. The merger of the two banks must be approved by the FDIC, the South Carolina Board of Financial Institutions, and the North Carolina Commissioner of Banks. These regulatory agencies will consider, among other things, the competitive impact of the bank merger, each of Carolina Financial and First South’s financial and managerial resources, and the convenience and needs of the communities to be served. As part of that consideration, Carolina Financial and First South expect that the FDIC will review the capital position, safety and soundness, and legal and regulatory compliance matters and Community Reinvestment Act matters. There can be no assurance as to whether the necessary regulatory approvals will be received, the timing of such approvals, or whether any conditions will be imposed that might limit the combined company’s ability to do business after the bank merger as presently anticipated. Carolina Financial has filed notice of the merger with the Federal Reserve, rather than seeking the approval of the Federal Reserve to consummate the merger, because the merger qualifies as a “waiver transaction” under the applicable rules and regulations of the Federal Reserve. However, if the Federal Reserve were to subsequently determine that the merger did not qualify as a waiver transaction, then Carolina Financial would be required to submit a formal merger application for approval of the merger by the Federal Reserve.

The merger agreement limits First South’s ability to pursue alternatives to the merger. The merger agreement contains provisions that limit First South’s ability to discuss competing third-party proposals to acquire all or a significant part of First South. In addition, First South has agreed to pay Carolina Financial a termination fee of $5,750,000 if the transaction is terminated because First South decides to pursue another acquisition transaction, among other things. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of First South from considering or proposing that acquisition, even if it were prepared to pay consideration with a higher per share price than that proposed in the merger with Carolina Financial, or might result in a potential competing acquirer proposing to pay a lower per share price to acquire First South than it might otherwise have proposed to pay.

First South directors and executive officers have financial interests in the merger that are different from, or in addition to, the interests of First South stockholders. Executive officers of First South negotiated certain terms of the merger agreement with their counterparts at Carolina Financial, and First South’s board of directors adopted the merger agreement and by a unanimous vote of the directors present and voting recommended that First South stockholders vote to approve the merger agreement and the merger on the terms set forth in the merger agreement. In considering these facts, First South stockholders should be aware that First South’s directors and executive officers have financial interests in the merger that are different from, or in addition to, the interests of First South stockholders. For example, two of First South’s directors will be invited to join the Carolina Financial board of directors, the remaining First South directors will be entitled to participate on an advisory board of CresCom Bank following the merger and will receive certain fees for their service, and Bruce W. Elder, president and chief executive officer of First South, will be invited to join the CresCom Bank board of directors. In addition, certain executive officers of First South have entered into agreements with First South and Carolina Financial that provide, among other things, retention, employment, consulting, severance and/or other benefits following the merger. These and some other additional interests of First South directors and executive officers may create potential conflicts of interest and cause some of these persons to view the proposed transaction differently than First South stockholders may view it.

If the merger is not completed, First South common stock could be materially adversely affected. The merger is subject to customary conditions to closing, including the approval of the First South stockholders and the Carolina Financial stockholders. In addition, Carolina Financial and First South may terminate the merger agreement under certain circumstances. If Carolina Financial and First South do not complete the merger, the market price of First South common stock may fluctuate to the extent that the current market prices of those shares reflect a market assumption that the merger will be completed. Further, whether or not the merger is completed, First South will also be obligated to pay certain investment banking, legal and accounting fees, and related expenses in connection with the merger, which could negatively impact results of operations when incurred. In addition, neither company would realize any of the expected benefits of having completed the merger. If the merger is not completed, First South cannot assure its stockholders that additional risks will not materialize or not materially adversely affect the business, results of operations and stock price of First South.

Carolina Financial may fail to realize the cost savings estimated for the merger. Carolina Financial expects to achieve cost savings from the merger when the two companies have been fully integrated. The cost savings estimates assume the ability to combine the businesses of Carolina Financial and First South in a manner that permits those cost savings to be realized. If the estimates turn out to be incorrect or if Carolina Financial is not able to combine successfully the two companies, the anticipated cost savings may not be fully realized or realized at all, or may take longer to realize than expected.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds: Not applicable

Item 3. Defaults Upon Senior Securities: Not applicable

Item 4. Mine Safety Disclosures: Not applicable.

Item 5. Other Information: Not applicable

Item 6. Exhibits: The following exhibits are filed herewith:

Number		Title
2.1		Agreement and Plan of Merger and Reorganization, dated June 9, 2017, by and between Carolina Financial Corporation and First South Bancorp, Inc. (Incorporated herein by reference from Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on June 15, 2017).
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Chief Financial Officer
32		Section 1350 Certification
101		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Financial Condition as of ~~June~~September 30, 2017 (unaudited) and December 31, 2016; (ii) Consolidated Statements of Operations for the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016 (unaudited); (iii) Consolidated Statements of Comprehensive Income ~~(Loss)~~ for the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016 (unaudited); (iv) Consolidated Statements of Changes in Stockholders’ Equity for the ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016 (unaudited); (v) Consolidated Statements of Cash Flows for the ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016 (unaudited); and (vi) Notes to Consolidated Financial Statements (unaudited) as of ~~June~~September 30, 2017 and December 31, 2016, and for the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2017 and 2016.

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SIGNATURES

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

	FIRST SOUTH BANCORP, INC.
CAROLINA FINANCIAL CORPORATION
	By:	/s/ Scott C. McLean
(Successor to First South Bancorp, Inc.)
		Scott C. McLean
/s/ Jerold L. Rexroad		/s/ William A. Gehman, III
		Executive Vice President
Jerold L. Rexroad		William A. Gehman, III
		Chief Financial Officer
President and Chief Executive Officer		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)
Chief Executive Officer		Chief Financial Officer
		Date: August 8, 2017
(Principal Executive Officer)		(Principal Financial and Accounting Officer)
Date: November 9, 2017		Date: November 9, 2017

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